Choosing Shares
This article is the third in a series of finance articles by Steve Bishop, a retired accountant living in Bodrum.
Other articles in this series:
Part 1: No Interest?
Part 2: To Trade or not to Trade…
Part 3: Choosing Shares
Part 4: Turkish Mutual Funds
Part 5: Interesting Deposits
Part 6: Currency Trading
Part 7: Comparing Investments
Choosing Shares
It would be nice to think that choosing a share was simply a matter of finding a highly profitable company with a consistent trading record. Unfortunately, the value of a share is based on future expectations. That in turn is affected by many factors including:
- Predictions of future profit
- International events and crisis
- General market sentiment (positive or negative)
- Same sector news i.e other competitors
- Release of Government data such as unemployment or inflation data
- Foreign exchange rates
- Broker & credit reference agency recommendations
In the longer term, the share price of profitable companies will rise more than loss making concerns but in the short term, the price of even a successful business can still fall or oscillate wildly. A good example in 2009 was the UK banking sector (see Barclays vs FTSE-100 below) that was highly volatile due to world events and political pressures. The result being that some banks, despite earning billions of profit, still saw their share prices plummet. Here in Turkey, this Jan 6th saw the Turkish ISE-100 share index at its highest level for 2 years because of (probably false) rumours that an IMF deal was back on the table.
Some sectors have particular dependencies: the mining sector, for example, on commodity prices and the US$ exchange rate. The retail sector of course is affected by consumer confidence, seasonal sales and government fiddling with tax rates. It has been interesting to note that during the recent financial crisis, all the traditional mathematical models for predicting share price movements failed ! The world has never experienced the combination of events that triggered the current crisis and experts are still totally divided on what will happen next.
“Make 3 correct guesses consecutively and you will establish a reputation for being an expert” Lawrence Peter
So given all that news, how do you go about choosing shares to invest in ? Well, the first question (raised in the last article) is what type of investor are you ? If you are looking long term i.e more than a year, then your criteria is totally different – and much easier – than for a short term investment. Most long term investors with low-medium risk appetite will stick to the so-called “blue chip” companies. These are the largest companies, generally in the FTSE 100, with long trading records showing consistent growth in profits and dividends. Most will be household names. Their shares are unlikely to grow spectacularly but equally are unlikely to fall dramatically either.
This is also true of “defensive stocks”. These are sectors that are considered lower risk because shares tend to be less volatile. Examples include Pharmaceuticals, Insurance and Supermarkets. Even in a recession, people still have to buy pain killers, insurance and food. At the opposite end of the risk spectrum are “penny shares”, generally priced at under 100p per share. Many are only a few pence per share and are generally for new companies with few assets. These shares could double overnight or become worthless !
For the swing trader, a great deal more research is needed. Some sectors such as mining and (in 2009 anyway) banking are particularly volatile. You need to carefully examine recent trading history, compare with competitors, monitor share prices for some time, watch for company news, understand (as much as is possible) what causes the share price for the particular company to rise or fall. You need to find shares that tend to go up and down on a daily or regular basis by more than a few percent in order to profit from them.
The most important issue though is timing – when to buy AND when to sell. If you get this right, you can make money out of a highly unsuccessful company or lose money on a highly successful one if you get it wrong. There are numerous mathematical tools on trading sites that assist you to predict the ideal time to buy (as low as possible prior to an increase) or sell (as high as possible after an increase). However, shares can be fickle, especially within the trading day. As the list above showed, there are so many factors that can affect the share price and, unfortunately, the professional traders usually have an inside edge.
Some of the most common mistakes for inexperienced traders are:
- Investing in too many different companies at once. Find a few good ones (max 5-10).
- Trading too often so trading fees use up all your gains
- Choosing shares on sentiment. Just because they make your favourite coffee or clothes, doesn’t mean they are a good investment
- Buying too high (coming in too late after a share has risen)
- Selling too early when shares rise and losing out on further profits
- Selling too late when shares fall. You will need to accept losses.
- Trading on impulse rather than to a pre-planned strategy
Never risk money you might suddenly need and always aim to preserve your capital. You will make mistakes as do professional traders. It’s better to limit your losses and keep the majority of your capital than risk losing most of it or having funds tied up for years in shares that are worth a fraction of what you paid for them. Some traders suggest limiting losses to 2% of your capital on any one trade. So, if you have £5000 total capital to invest, cut your losses to a maximum of £100 per trade. Some trading systems allow to set automatic stop losses, others rely on manual sell orders.
After looking in the next article at alternatives to bank deposit accounts for those with TL funds, in each future issue of the Bodrum Bulletin we’ll compare some example portfolios with returns from Turkish mutual funds and deposit interest. Fantasy portfolio A will have 5 FTSE-100 shares with a consistent increase in value over the last 6 months; portolio B will have a wider selection of 10 low-medium risk shares; portfolio C will have 5 more speculative shares. All portfolios and other investments will deemed to be purchased at 1st January 2010 prices, having been selected on data from 2009. The contents of each portfolio and the selection criteria used will be covered in a future article. Remember that you can set up your own fantasy portfolio at no cost or risk.
| Investment | % Change YTD |
| Portfolio A Portfolio B Portfolio C Mutual Funds D Mutual Funds E Bank Deposit |
-0.88% -2.76% +8.34% +0.38% +2.97% +0.13% |
| As at 7 Jan 2010 - % YTD after taxes/fees | |