10 tips to make more money

Published in the ASX Newsletter

By adhering to these simple yet effective rules you will learn to protect your capital and increase returns. These rules are especially important with the sharemarket rally likely to continue until July or August before the bears return later in the year, says Dale Gillham from Wealth Within.

The two most pressing questions on investors’ minds these days are, have we seen the bottom yet and where is the sharemarket heading over the next 12 months? I will address the second question first but there is certainly no simple answer, foremost because of the continued uncertainty with the US economy, which tends to wreak havoc on world markets.

That said, there are still opportunities in the market if you know what to look for.
In this article, we consider these opportunities by way of investigating the important do’s and don’ts when trading the sharemarket. From experience, I can honestly say if you follow the rules I suggest, you will not only be able to manage your risk but also be far more profitable.

First, a review of what is happening in the market.

On present indications I believe the All Ordinaries index will continue to rise to a high of around 4200 points before falling again over one or two weeks near the end of May. After that low, the market will again turn bullish and rise to a high of around 4500, with the possibility that it could continue to rise to a year’s high of around 5000 in July or August before turning bearish in September.

How far the market falls in September will determine whether the low of March 9 is in fact the bottom of the longer-term bear market.

So what should and shouldn’t you be doing to take advantage of the current market conditions? There are only two things we can control when it comes to the sharemarket – when we enter a trade and when we exit. That is why it is essential to have a workable trading plan and solid money management rules.

These two strategies alone can save you thousands in lost opportunity but there are other things to consider when trading.

Here are 10 tips to preserve more capital and make more money:

1. Ignore dollar-cost averaging

Many professionals say dollar-cost averaging can reduce the risk of investing in volatile markets and help to avoid the so-called pitfalls associated with timing your entry into and out of the market. The concept involves placing small deposits into a particular investment at regular intervals over a period of time, regardless of whether the market is moving up or down, so as to average the price at which you purchase the asset.

In my opinion, this strategy is flawed because investors subject themselves to higher risks when investing in assets that are falling in value, which has certainly been the case over the past two years.

2. Don’t buy cheap small caps

Many investors tend to buy shares simply because they perceive them as being cheap. But cheap implies that you will get a bargain. This may be the case when you shop at the supermarket but this mindset is not the best strategy to adopt when investing in the sharemarket. You want to buy quality, not quantity, because that is where you will generally receive the greatest gains.

3. Don’t buy and hold

Time in the market is probably the most perpetuated myth in the financial planning and managed fund industry. The reason why most of us hear the words ‘buy and hold’ or ‘it is time in the sharemarket that yields returns’ is because the industry cannot, or does not want to, time the market. Consequently, the public is cautioned through advertising slogans about the perils of market timing.

But to accept that time in the market is more important than timing the market is probably the greatest downfall of anyone wanting to beat the market average.

4. Don’t over use leverage

In the past, many investors have been attracted by the hype and supposed quick returns that leveraging can provide, but reality has bitten many in the past 18 months with record margin calls being experienced. It is important to understand that leveraging can not only magnify gains but will certainly magnify losses, particularly in a falling market.

As a general rule of thumb, if you cannot profitably trade blue-chip shares on a consistent basis, do not attempt to trade other instruments such as CFDs, warrants and options. And if you use margin lending, never leverage beyond 50 per cent of your portfolio.

5. Don’t be affected by the herd mentality

Many investors react to market conditions by purchasing shares en masse when markets are rising and selling en masse when markets are falling. However, in my experience it is far better to take a contrarian view to investing in the sharemarket. This is supported by Warren Buffet, who once said it is better to be fearful when others are greedy and greedy when others are fearful.

In reality, most investors are fearful and greedy at the same time, which often results in an inability to profit from market fluctuations.

6. Use stop-loss points to protect capital

Successfully investing in the sharemarket is not simply about how much you make; rather, it is about how much you do not lose. In other words it is about minimising risk, not maximising profits. A stop-loss is simply a determined price point at which you sell a security to preserve capital if a recently entered trade turns against you, or to protect the profits of a winning trade.

This rule alone would have saved investors from losing thousands of dollars over the years.

7. Buy only top-quality shares

The top 50 shares on the Australian market achieved their status for one reason – they are the best-performing shares in the market. It makes sense to stick with a good thing. Many believe, however, that blue chips are slow in generating returns and therefore they prefer to take higher risks investing in ‘penny dreadfuls’.

In recent times, investors have bought ‘penny dreadfuls’ in the hope of recouping their losses over a few years. Unfortunately, this strategy results in taking higher risks, leading to even greater losses.

8. Always manage your risk

The amount people invest in the sharemarket tends to change their perception of the risk being taken and the research required to manage that risk. Usually this is because it is much easier to swallow a $1000 mistake than a $500,000 mistake. But let me assure you, the process you take to invest $1000 or $500,000 should be exactly the same, because they both represent the same amount of risk.

9. Diversify but not too much

It is true that diversification reduces risk, but a portfolio that is over-diversified (for example, more than 12 shares) is exposed almost exclusively to market risk, which cannot be eliminated by diversification. A portfolio that is over-diversified will generally mirror the market, which in the past two years has meant losses of up to 50 per cent or more for some investors.

A properly diversified portfolio should have somewhere between eight and 12 shares. The trick is not to have lots to shares with small amounts invested in each, but rather to have a smaller number of shares with larger amounts invested in each. This lessens the risk and increases the returns.

10. Educate yourself

Ignorance can be very expensive. Many who told me in the bull market that they did not need or could not afford to learn have now suffered losses many times greater than if they had gained a solid education. When it comes to the sharemarket, the first investment should always be to educate yourself.

Over the next two years, it is very likely the market will continue to be volatile and only educated investors will profit during this period.

By adhering to these simple yet effective rules you will not only protect capital but also increase returns, and in this market nothing is more important.