Why You’ve Got to be an Active Investor

Below is a chart of the S&P/ASX 200 for the past ten years:

Let’s be honest, if you were a buy and hold investor from mid 2000 onwards you’d be pretty disappointed with your return.

Sure, you could have got some pretty good dividends, plus a capital gain. But considering the risks the return isn’t that great. Not that I’m saying you need to be looking for 50% gains every year.

Only Bernie Madoff could manage that. And turns out he was a crook.

No, what I’m saying is that as an investor you’ve got to realise that the buy and hold approach doesn’t work anymore.

The stock market is a risky place. And when things are risky you can’t afford to sit still and let everyone ride roughshod over you.

That means you’re really left with two choices. And both involve being an active investor.

You can either be an active fundamental investor, or an active technical investor…. or I don’t suppose there’s anything to stop you from being both.

Let me give you the rundown on being an active fundamental investor first. That’s what I am. It’s the method I use for picking stocks in Australian Small-Cap Investigator, and it’s also the method Alex Cowie uses in Diggers & Drillers.

The reason I’m an active fundamental investor is simple – I’m a touchy-feely kind of guy…

[Needle scratches off record]

Don’t worry, I’m not gonna freak you out here. What I mean is that I like to invest in stocks where the company has either got a big plan, they own or are looking for something tangible – such as gold or copper, or they’re actually making money right now.

[Replaces needle on record]

In other words, I’m looking at what the company does, how it does it, and what it’s getting out of it. Plus most importantly, what will the shareholders get out of it.

Based on all that information I then make the choice whether to tip the stock or not.

But tipping a stock as a buy recommendation is only half the story. The other half is what to do with it once you own it. That’s where you’ve got to be an active investor. As I say, in these fast moving, computer driven markets you can’t afford to just watch from the sidelines.

You’ve got to muck in and get your hands dirty, or at least get someone else to get their hands dirty for you.

Because when you own a stock as a fundamental investor it’s essential to make sure that the fundamentals haven’t changed from when you bought the stock.

Think about it, you’ve done all the hard work before buying the stock, it doesn’t make sense to lose interest and become indifferent when you own it. If anything you should be even more interested in it now that you’re an owner.

Yet the buy and hold investment approach teaches you the opposite. Ever heard of the expression, “Set and forget it.”? Why on earth would you do that?

It just doesn’t make sense. You wouldn’t buy a car and then forget you own it. That doesn’t do you any good. It’d be a waste of money. You wouldn’t even choose to buy a ham sandwich and then not eat it. That’d be a waste too.

Yet the buy and hold approach is still the most widely followed investment strategy. Despite it being the worst.

Instead of that, once you hold a stock, if something changes, then you’ve got to act. If it’s a positive change then you can do nothing or buy some more. But if it’s a negative change then you’ve either got to pull the pin and get out, or use the method I choose, and that’s to implement a trailing stop strategy.

Look, most mainstream fundamental investors will tell you that trailing stops are for technical traders only. Personally I don’t think they could be any more wrong if they tried.

Sure, technical traders such as Slipstream Trader Murray Dawes, uses them all the time – I’ll have more on technical trading in a moment – but there’s no rule that says fundamental investors can’t use them either.

Let me give you a perfect example of how the trailing stop strategy has worked for Australian Small-Cap Investigator subscribers over the last eight months.

In August 2009 I tipped Virgin Blue Holdings [ASX: VBA] when the stock was trading for just 35 cents. It was a crazy tip. Who in their right mind would invest in an airline stock?

But anyway, we recommended high risk investors buy in as I believed the stock was primed to soar.

Turns out I was right. Over the next seven months the stock price doubled. As the share price increased I moved the trailing stop higher, until the stock traded above 75 cents and the trailing stop was set at 70 cents.

Well, what do you know, shortly after, the stock traded lower, hit our trailing stop and I told subscribers to Australian Small-Cap Investigator to sell their shares for a 100% gain.

Where’s the share price now? Take a look at the chart below:

On Friday it was trading just above 30 cents. That’s less than half the price subscribers sold it for. Now, at 30 cents it’s worth looking at as a potential buy… But only if the fundamentals stack up.

Look, we don’t get every stock tip right. But that’s why a trailing stop strategy is so important. It takes your emotions out of the trade and forces you to act when previously you may have either hung on in there, or even worse bought more, thinking the stock was going back up again.

In the past couple of weeks, the mainstream broking firms have all cut their price targets on Virgin Blue: Macquarie, Morgan Stanley, UBS, Deutsche Bank, Credit Suisse, and RBS.

For instance, RBS has cut its price target from 81 cents to just 37 cents. Three months after we told subscribers to sell at 70 cents.

But I mentioned there was another kind of investor – the technical trader. This is where guys such as Slipstream Trader Murray Dawes relies almost purely on the share price action.

To some degree it doesn’t matter what the stock is or what it does, the important thing to a technical trader is which way the share price is going to move next and what the potential upside reward and downside risk will be.

But to be fair, working next to Murray, I’ve got to say that he approaches technical analysis like no one I’ve ever met.

Most technical traders I speak to are quick to tell me about which indicator they use, why it’s the best there is, why all the others are rubbish, and why they’re still ‘back-testing’ their strategy after ten years hoping to put their first trade on “when the market is in the right condition.”

Here’s some late breaking news, if you wait for the market to be “in the right condition” you’re gonna have a long wait. A very long wait.

That’s one of the things that has impressed me the most about Murray’s technical approach. But more on that in a moment. First, Murray’s money and risk management approach deserve a mention.

The most important thing for a trader is not to lose your capital. In that way a trader is no different from any other businessman or women. It’s important that McDonald’s doesn’t lose all of its stores otherwise it can’t sell burgers, and it’s important that a trader doesn’t lose all of his or her trading capital.

Because without money in the bank there’s nothing to use to enter a trade.

It’s this money and risk management approach that’s at the heart of Murray’s ‘1-2-3′ technical trading approach. I can’t go through all the details here, because I don’t want to give away his trading secrets, especially as it’s a proprietary trading style.

But for Slipstream Trader members, Murray isn’t so secretive. He goes through his reasoning behind each trade every time he sends out a trading alert and in his weekly video updates.

However, if you’re interested, Murray has lifted the lid a little on what goes into the Slipstream Trader service, just click here to find out more…

You see, the idea is to give traders a risk-free trade. I know that sounds mad and unbelievable, but I’ve seen him do it enough times to know it’s true.

Of course, nothing comes completely without risk. But using Murray’s technical approach there is a way that you can trade the market, so that your risk exposure gradually diminishes. It’s a trading strategy that Murray has used to optimum effect.

And never more so than during the last few weeks. As the mainstream advisers sat on their hands watching their clients portfolios get smaller and smaller, or just selling out in panic, Murray was making cash – real cash – for Slipstream Trader members hand over fist.

The point is, you’ve got to be active. And when markets are this volatile, as a technical trader you’ve got to get involved.

I’ve spoken to several traders over the last few weeks, and do you know what, most have done the opposite. The market has them spooked and they’ve chosen to sit on the sidelines, watching the market as it’s made big moves.

The kind of big moves traders should relish. The kind of big moves that traders should be making big money from.

But many haven’t. They’ve missed one chance and my bet is they’ll miss the next chance as well.

But there’s something else I’m prepared to bet on, and that is that Murray’s Slipstream Trader members won’t miss the next market move, regardless of which way it goes.

Cheers,
Kris.