This is the first of a series of posts dedicated to individuals interested in investing and trading, but without experience, where I try to explain the basics of money self management.
A lot of people is intimidated by any discourse about money, for various reasons the first being the total lack of formation and experience. Others have followed the suggestions of relatives, friends or even professional advisors and lost money. These are very common situations that may motivate a person to consider to self manage its own money.
There are a few things that I want to make clear immediately:
- about 95% of people that begins to trade stocks or other speculative financial markets go broke in 12-18 months, this is the statistic. Your first attention must be on not losing money.
- every financial instrument has its own price and there is absolutely no meaning in the relative values: i.e. the fact that General Electric share price is today at 31.74 and Caterpillar is 92.02 has no meaning in itself – some meaning may stand in market capitalization (the global value of the business) that is for GE near $281 bil and for CAT around $56 bil
- the value is continuously fluctuating and there is no limit to gains and primarily to losses
- always consider percentage variations and not absolute ones
The market is composed by thousand, millions of individuals that consider correct buy or sell every particular instrument at the current price: none is right and none is wrong, anyone is just acting following his own evaluations and attitudes and expectations.
Always invest or trade into very liquid instruments, being “liquidity” measured by the price spread. Every instrument in every single moment has a buy price and a sell price: the difference is the spread and the higher the spread the less liquid is the instrument. So, do not invest in non liquid instruments.
Cut losses and let your profit run: this is the most widely confirmed Wall street adage and money management rule and its really true, mostly for the first part – always cut your losses before they eat up your capital. You can easily recover 2%, 3% or even 5% losses, but not a 20% or more loss.
Never buy a stock because you read a positive note on a newspaper or because its name is sounding or because the logo is graphically beautiful. Finance is about numbers, just that. Always make your homework before a trading decision.
There are two main classical approaches to market analysis: fundamental analysis and technical analysis.
Fundamental analysis looks at the value of a business in terms of capital, revenues, profits and so on. Technical analysis looks at the value of a business in terms of the chart of the price, considering that price encapsulate every possible (even hidden) information available.
Both the approaches have a good side and a bad one: I’m not here to judge what’s better, but I may say that if you want to invest long term some fundamentals are better to be taken in account, and if you want to speculate short term some charting tools can be indispensable.
About fundamental analysis, you may read Benjamin Graham and Warren Buffett manuals, among others, widely available in bookstores. I did find very useful an old book “The Zulu Principle” by Jim Slater.
About technical analysis, the basic author is Martin Pring; many others authors are available and one principal magazine at traders.com offers a continuous update on the topic.
A third way is rising in latest years and it is Artificial Intelligence applied to the markets (it is the main topic of this website!) that offers the possibility to bypass either fundamental or technical analysis with totally different instruments. Many academic papers on this topic, but it is still a frontier activity, open to research and innovation.
A final word: never ever blame someone else for your losses. Never. Always put yourself into the conditions that you are the real unique responsible for your choices.
upcoming: how to choose your trading platform