Three steps to making hay while the sun isn't shining
A LOT of investors think the sharemarket is about finding good companies, and a lot of traditional value-based broker research focuses simply on that on which stocks to buy, on finding good companies.
A LOT of investors think the sharemarket is about finding good companies, and a lot of traditional value-based broker research focuses simply on that on which stocks to buy, on finding good companies.And after a 33-year bull market this process is now quite developed, with a list of good value, low-risk companies with sound balance sheets and a high return on equity just a click away.But with respect to the decades of value-focused research that hasn't changed its format since Benjamin Graham first put pen to paper, it is not enough, not in a bear market.In this market, "good" companies are going down in price, so we have to do better than just identifying good companies.Making money in this market is about risk and sentiment, and that means timing the buying and selling of specific stocks over any time frame, not just the long term and palming off the responsibility for when to buy good companies with the line that "You can't time the market", and evading the responsibility with the declaration that one day the value will be reflected in the share price is a copout.The truth is that share prices are just as likely to lead changes in value as value is to lead changes in the share price. But the value-based approach plays only one side of the equation and implicitly asks you to rely on the assumption that the value is right and the share price wrong. That's some assumption, especially in a market in which value is eroded daily by deteriorating trends in many sectors of the global and domestic economy.More likely than not, the value calculation is wrong rather than the share price because the assumptions in the calculation are changing for the worse every day. No wonder so many stocks look like a "buy". The valuations are too high.In a high-risk bear market (the market is down 9.6 per cent a year compound for the past five years) we have to do a little bit better than just buy good companies and wait for the value to appear.This is not a bull market you can hide in. Making money in this market is about timing your buying and timing your selling, and for investors who are confronted by that, here's how to do it in less than 400 words.Pick up a copy of Nick Radge's book Unholy Grails, published this year. He will tell you that while most beginners think success depends on their "win percentage", the number of winning trades they make versus the number of losing trades, what really matters is your win/loss ratio, which is how much you make on a winning trade versus how much you lose on a losing trade.For instance, you can lose 80 per cent of the time (in other words have eight out of 10 trades lose money) but if you can contain the losses and let your profits run then you will still be profitable overall as long as you make more than four times as much on those two good trades as you lose on your eight losing trades.To quote Radge: "How much you win when you win and how much you lose when you lose is far more important than how often you win." Logical stuff. The aim is profitability and you don't need to be a divine stock picker to achieve it. In fact, you can be a bad one, as long as you can make more on your wins than you lose on your losses, and here's how you do that in three steps, in order of priority: Control losses (by using stop losses). Let your profits run (by using a trailing stop-loss mechanism that lifts the stop loss as the price rises, allowing unlimited gains). Pick trades. Enter trades with as high a probability of winning as possible and on the arguments above this is a subordinate priority to the other two.The bottom line is that the post-purchase mechanisms are key and in this market you need to focus more on managing the trade after you buy than you do on what to buy before you buy. Identifying good companies is still important, but until a bull market returns, it is a secondary, not primary, function.