The Hindu Business Line : The secret is steady learning

What is `the first golden rule for winning in trading and investing'? Appreciating the difference (and some of the similarities) between investing and speculating, begins Dimitris N. Chorafas in The Management of Equity Investments, from Elsevier (www.books.elsevier.com).

"Risk should always condition the choice of assets," he cites Gordon Midgley thus. And adds: "Individual investors may drift into speculation if they believe in promises of high return and low risk."

The second golden rule is to own your assets, be they stocks, bonds or other commodities. "Private investors should not borrow money to buy equities, and they should not take a mortgage on their house to play in the stock market." Because, "worry is the extra interest investors pay when they buy stock on margin or with borrowed money."

Don't expect markets to be democratic, cautions the author. For, the system operates on the principle of `one dollar one vote,' with power concentrated among the few who have the money. "These few are the top traders, major investors, and well-known speculators — nearly all motivated by the profit motive."

There can be a small minority of the successful to whom trading or investing comes as naturally as being `a great pianist or violin virtuoso,' concedes Chorafas. "But for the majority of competent market operators, the secret is steady learning. Trading and investing are skills one can learn, provided one is willing to do so and has the right methodology." To help, the book has chapters on capital markets, performance criteria, damage control and investment case studies.

Rocket scientists in the markets

Investing may not be rocket science, yet rocket scientists can be spotted in trading rooms. "These are engineers, physicists and mathematicians who have worked in the past in aerospace, weapons systems and nuclear engineering." They use powerful metaphors describing thought as a process of travelling, and mapping it into models, quips Chorafas.

Remember, though, that the main objects of computing are `foresight, insight, analysis and design,' not `the automation of numerical calculation.' Another fallacy that the author exposes is that `experts' may slip into thinking that the process is more important than the end result. Insight is of more importance; and it is "not just looking at last year's, month's, week's or day's data to discover trends". A chapter on `private investor's self-protection' begins with `the tenth golden rule' — that is, `never chase the return of shares you did not buy.' Else, you would pursue elusive goals, and as a consequence colour your perceptions of the future. Also, "it often leads the investor to buy at the peaks." Moral: Stop worrying about something that didn't happen to you!

Resist, therefore, `last-minute rush' and also regret not for what you haven't done at that time, counsels the book. "One of the flaws in managing equity investments is that people often try to catch up with a lost opportunity, and/or tend to trade far too frequently because they are trying to emulate returns on shares they had bought earlier. This is one of the ways in which investors get burned."

Listen to the contrarian

Always consider the contrarian advice, advises Chorafas, as the eleventh golden rule. "It is likely that a contrarian opinion will contradict the results and findings of a fundamental analysis, of a technical analysis, or of both. When this happens, so much the better for the investor — because it gives him or her food for thought." An apt quote of Eugen Buck instructs: "Listen to contrarians but make your own investment decision."

That goes well with rule 13 — accept responsibility of your won decisions. "Computers and models act as instruments assisting in decisions; they are not a substitute for the decision-maker." Sage wisdom from Chorafas is that wise traders and commensurate investors do not just look at the risk, they control it. "They know that run-away exposures are highly contagious, they appreciate that every minute counts, and they act fast in an informed and sensible way to avert a crisis."

Sobering read if you are suffering from market fever!

Reality about real estate

Real estate is not always risk free, explains an example, from Down Under. "In the early years of the twenty-first century, a booming business of new construction has produced a glut of homes, with the result that net rental yields, after maintenance and other cost, have gone down to 2 per cent, way under the 7 per cent mortgage rate most investors were counting on." Alarmingly, "household debt, including mortgage financing, grew from 85 per cent of disposable income in 1996 to about 140 per cent at the end of 2003."

At the core of investors' homework is data analysis, insists the author. However, "looking at data and comprehending the message they convey is no simple and linear matter," he alerts. "Today we practically have an unlimited computing power, but our data sources are not well organised, and the information elements in our databases are often incomplete or obsolete." Hence, your first task in statistical analysis is to present the data in simple and comprehensible manner.

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