Before the crash of 2007/ 2008, we all followed bad advice. That advice included:
We received an e-mail telling us that Small-cap Such and Such (not a real name) was about to take off. Already its price has doubled. Next week it will treble and it will quadruple the week after that. We put our money in, only to find it collapsing down to below what it was originally. The Spamster and his cronies had, of course, pushed up the price of the shares by pumping their money into them. When our money followed, they sold out at a profit, while we made a loss.
Lesson No. 1: If following a tip, take your money out when you make a little profit, and don’t wait for the share to collapse again.
THE RISING STAR
We can avoid being taken by a Spamster if we check the charts before investing. Is this a share that has been rising steadily over a year or two, or, at least, having regard to the story being told, for a few months? If so, it is worth putting money in while it is still rising. Take care, however, that, when it starts to fall, you take your money out again. Anglo Irish Bank was a star that was rising spectacularly for a few years before the crash. However, its prosperity was based on a property bubble. When the price started to fall, the Regulator chastised the Hedge Funds for spreading bad rumours about a good company, so we held onto our shares, didn’t we? However, the price fell ever more rapidly until in the end there was nothing left. Moral: get out when a share starts to fall. After all, if the fall is shortlived, we can always buy back in when it starts to rise again.
GOOD, RELIABLE COMPANIES
We were advised that the Banks and other Financial Companies were as sound as a rock, gave a good dividend and always grew over a period of years. Your portfolio should not be without a good representation, we were told. And then the crash. Some of the banks were literally wiped out. Moral: there is no such thing as a good, reliable company. Companies rise and fall. True, banks and financials are sound most of the time, but not always. Moral: no matter what investment policy you follow (short, medium or long term), keep an occasional eye on the price of your shares. If a share dips to a suspicious level, sell before it falls further, no matter what the experts say. What is true of the Rising Stars is also true of the solid reliables. Don’t hold onto falling shares.Exception: Shares rise and fall all the time. Don't sell on a normal Dip. "Buy on the dip," is still good advice. However, when a share plunges out of its normal range, let the alarm bells ring. How to know its normal range: use the charting facility provided by your online broker and draw one line joining the summits of the price-waves (the "Resistance Line") and the bottoms (the "Support Line"). Normally the price will fluctuate between these two lines, and we would always buy at or near the Support Line and reduce our holding at the Resistance Line. When the graph breaks decisively through the Support Line, something is wrong: this is the time to exit and watch.
A BALANCED PORTFOLIO
They told us we should have a balanced portfolio. This, however, meant holding shares in a large number of companies. When the market started to collapse, we had a large number of deals to carry out urgently.
Much better would be to follow the practice of John Maynard Keynes, who only held a small number of companies, but traded frequently, buying rising shares and selling falling shares. It is much easier to manage a portfolio consisting of half a dozen securities than a large, balanced portfolio. For balance, we can use ETFs (Exchange Traded Funds), which are shares in a portfolio consisting of an expert selection of securities within a given geographic area or industrial sector (e.g., based on the Dow or the Nasdaq or the Hang Seng or the Oil Industry or whatever). Holding one ETF gives us a balanced portfolio of the securities within its area or sector.