Ever watched a football match where the best team hasn't won? Or a horse race where the favourite came last? The same can often happen in investing.
I could spend hours researching a stock, crunching ratios, scouring the accounts, watching the news flow. I then buy and wait in vain for what I think is a cheap stock to rise. It doesn't. Am I wrong about it being cheap? Maybe or maybe not. The key point is that unless I am a name like Warren Buffett, George Soros or Anthony Hilton I can be wrong even when I am right. In other words if the herd doesn't follow me into a stock, it won't go up no matter how right I think I am.
So, for many short term spread betters what matters isn't detailed fundamental analysis of a commodity, currency or share. No, what really matters is which way the price of an asset is moving and how quickly you spot the prevailing trend. For example if you see a share price tick up every ten minutes 20, 22, 25, 27, 31 then you have an up trend. Your choices are to either join the action quickly or sit out the rise. Your fundamental analysis may be screaming "don't buy" perhaps the price to earnings ratio is crazily high, or the dividend yield pitifully low. Perhaps you don't even fully understand what the company does. But a trend follower would say "who cares?" Something is moving the stock up (it might just be short sellers covering their open positions by buying it) so you should go with the trend until you get decisive evidence that it has ended.
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- Spread betting The easy way to geared, tax-free returns
- Forex trading- How to profit from currency movements
But surely following prices up and down is the strategy of a monkey? Where's the cleverness? Answer there is none. Keep it simple. And as for those who say "well if following a trend was so easy, everyone should be doing it" the retort is "they don't". How many of us should switch to a better bank but never do? Or should take up jogging but can't be bothered? Or should only ever drink four units of alcohol but somehow always drink more? Humans are fallible. A strategy doesn't always need to be ferociously clever to succeed.
Here's a closing thought do you honestly think all the people that trade derivatives, or complex bond products actually understand the detail behind say the Black Scholes option pricing model? Of course they don't. But they do know when the market has got excited about an asset and is pushing the price up even when the fundamentals don't support it. A classic example is wheat just now. Supply isn't actually that tight, according to many commentators, but speculators have been piling in on the back of Russian fires and scare stories about this year's hot weather causing a huge grain shortage.
As for how to protect yourself when a trend ends try a trailing stop. This follows an asset up but with a fixed trigger, say a 15% drop. Not from the price you open a position (a standard stop loss) but from the opening price for the latest period you are running the trade. That way you get to ride a trend but limit the damage and lock in profits, once the herd turns against you.
Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.
He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.
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