We have heard a lot of real-life stories over the last few years of people who have lost a fortune on the stock market, bankrupted perfectly sound businesses and amassed amazing debts.
Is there any way of engaging with the stock market without running such risks?Of course there is! It is rather simple: limit the amount that you expose to the market. If you make a loss, accept that fact and don’t throw good money after bad trying to recoup the loss.
Huge losses are made when punters try to recoup their losses by putting more money into the loss-making situation.
ExampleA great example is Sean Quinn whose gamble in Anglo Irish Bank shares has become notorious. He bought a sizable block of shares in the Bank when the shares hit a low on the Stock Market, thinking, as we all did at the time, that the shares would rebound. He followed the apparently sound maxim, “Invest on the Dip,” but used Contract for Differences to maximise his profits (i.e., a bet on the difference in price between the investment date and the future “contract” date). The shares continued to fall, and by the contract date he had lost a lot of money. Solution: borrow money to renew the contract, and win back the losses in the next period. However, the next period went the same way, and the next. In fact, Anglo kept falling until it was worth nothing at all. Quinn should have abandoned the investment, accepting his losses, after the first period. (There are plenty of investment opportunities other than the one which is losing you money). By the end, he had lost €3B and bankrupted the Quinn group of companies in the process as well as contributing to the collapse ofAnglo Irish Bank.
And the moral of the story is:
- don't try to catch a falling knife;
- don't throw good money after bad;
- don't borrow to invest;
- treat CFDs with caution.
Learning from our own or others' experience:
- Modify the motto “Invest on the Dip” by adding "but wait until the share is rising again, if ever;"
- Adopt the motto: "Buy Shares that are Rising," but add: "but not if they have already risen too high," remembering that "the wise alight when the fools jump on the bandwagon."
- Add the motto: “Sell shares that are falling.”
With these maxims, losses are minimised.
An example of a safe strategy:
- Open an account with an online broker with a limited amount of money: one or two thousand;
- Add a monthly instalment that is well within your means;
- Since the stock market does not move in a continual upwards movement, but in a wave motion, rising and falling all the time, keep some money in cash (or an available uncalled margin) so as to be able to take advantage of the Dips;
- Take Shipman's advice to keep used margin (i.e., money borrowed from the broker) within 10% of your portfolio.