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that markets trend more than they chop. Do markets trend more than they chop? This is one of those cosmic questions that can’t be definitely answered, and certainly not without an understanding of the fundamentals that determine market behavior.

      There is no escaping the need to have a deep understanding of the fundamentals so that one can sensibly assess what is cheap and what is expensive. In playing poker, I would rather place my bet based on my ability to count the cards and calculate odds than on the likelihood of a hot streak continuing (e.g. betting that I will do well because I won the last few hands).

      2. Focus.

      Adding value is a zero-sum game - for me to add value I must be a better player than my opponents. The markets are extremely competitive. That means that my understanding must be very deep, which requires focus. I have rarely seen investors that win over time who trade a lot of different markets. The winners I know discuss their markets with the same depth that specialists in other professions (e.g. physicians, scientists, etc.) discuss the subjects of their focus.

      In addition, successful market players have the capacity to think conceptually and independently. Equipped with knowledge and perspective, they can justifiably have the confidence to stand apart from the crowd, which is essential for being able to buy low and sell high.

      3. Perspective without data-mining.

      Many years ago I did a lot of discretionary trading based on the flow of information I was seeing at the time. I wrote down the criteria I used to make each trade so that I could reflect on the trade later. I learned that if I specified the criteria clearly I could see how these criteria would have worked in the past, and in different countries, which gave me perspective. That perspective was invaluable.

      In many cases I learned that the criteria wouldn’t have worked in the past and I could see why. In other cases I learned how well my decision rule worked so that I would not abandon it when it lost (all rules lose sometime) or put too much on it because it has recently been hot and I thought it was better than it really was. As a result, I developed a good sense of what I could expect from my criteria.

      I learned that I could program the computer to scan the world for opportunities, according to these criteria. And I learned a lot more. I learned to be especially wary about data mining - to not go looking for what would have worked in the past, which will lead me to have an incorrect perspective. Having a sound fundamental basis for making a trade, and an excellent perspective concerning what to expect from that trade, are the building blocks that have to be combined into a strategy.

      4. Strategy.

      Knowing how to identify good bets is only the first step. Knowing how to balance these bets - how much to place to on each based on their different expected returns, risks and correlations - is at least as important. This requires an understanding of probabilities, statistics, and money management principles. It requires the ability to simulate how this strategy would have worked in the past and to stress test its performance under varying conditions.

      5. Substantial resources.

      The days that an astute individual trader equipped with little more that his wits, being able to be a substantial winner at this game are over. Now, world class teams consisting of conceptual thinkers suppported by specialists and advanced technology set the standard of play. While technology has radically advanced the average level of play, in markets as in warfare, it has served to widen the gap between the resource-rich and the resource-constrained players.

      ‘Buy and hold strategies generally are less rewarding than trading strategies. The cliché that markets can’t be timed may be right for some investors all of the time, and for all investors some of the time, but there are times when market prices are far above or far below their long run equilibrium prices.’

      Robert Aliber

      Alexander Davidson

      Alexander Davidson used to work as a share dealer, specialising in small, high-growth companies. Disillusioned with the biased advice that some City firms gave clients, he quit his job to write The City Share Pushers, a best-selling exposé which was made into a TV documentary and formed the basis of a motion on City practices in the House of Commons. Davidson now writes for International Financing Review, which specialises in new issues, and Vanguard Investor, which specialises in high tech stocks.

       The City Share Pushers

      How to Win in a Volatile Stock Market, Kogan Page, 2000

      Stock Market Rollercoaster, John Wiley, 2001

      How to avoid being a victim of stock manipulation

      1. Do not over-trade.

      It will cost you a fortune in commission costs. This is why most day traders lose money.

      2. Never buy only on share tips.

      Journalists often write these as a favour to PR agencies. They make the tips sound enticing, but the skill is often in the writing, not in the analysis or insight. Also, be wary of analysts’ recommendations, which are typically biased or outdated.

      3. Be prepared to stag new issues.

      If you invest in a new issue in shares, be prepared to sell out immediately after flotation if the institutional investors do.

      4. Avoid penny shares in most cases.

      Avoid penny shares unless you really understand the company and have a strong reason for investing. Small companies are more subject to market manipulation than their larger counterparts. They are relatively illiquid, with large spreads.

      5. Do not take your broker’s recommendations at face value.

      Many brokers have very limited qualifications and no real ability to understand a company, but simply bluff their way.

      6. Never buy from share dealing firms abroad.

      Dubious share promoters from abroad are still trying to get your money, sometimes initially via the internet. Put the phone down on them and don’t visit their web sites. If you deal, do not feel obliged to stick to the oral agreement.

      7. Don’t rely on technical analysis.

      It makes money for the gurus but does not work except to a limited extent in short term trading situations.

      8. Avoid a poor investment proposition in a fashionable industry.

      Do not be seduced into buying shares simply because they are in a fashionable industry. A broker can usually present a stock’s poor fundamentals in an attractive light. If the PE ratio is very high, he may say that this is normal for growth stocks. If it is low, he may say that this is an undervalued stock.

      9. Be wary of stock recommendations on internet message boards.

      Use internet chat room and message boards only as pointers for conducting your own research. They are full of manipulators trying to persuade you to buy and sell stocks because it suits their purposes.

      10. Always think for half an hour before buying or selling.

      Give any stock recommendation half an hour’s thought before you commit yourself, and make sure you have enough facts about the company at your finger tips.

      Nigel Davies

      Nigel Davies read law at Oxford

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