How to conquer your fears when learning to trade

Learning how to trade the markets can't just come from books. Sometimes you need to get some real life struggles under your belt to conquer your emotions. Bengt Saelensminde shows you how.

The SAS use live ammo in many training exercises. And so should you.

Training for trading the markets can't come purely from a text book. Sometimes you need to get some real life struggles under your belt to conquer your emotions.

I want to show you how getting used to trading volatile markets can give you the edge over other investors. I want to show you how volatility is often misunderstood. And how to make the most of it as part of your training regime.

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Investors hate volatility

Volatile stocks and markets are often feared and there are two reasons for that.

First, volatility is confused with risk. While they are related, they are not the same thing. Volatility refers to how far the price of an asset tends to deviate from its average price. The more volatile the stock, the more wild the stock chart looks.

Take gold. At the moment, the gold price is quite volatile. In fact, Tuesday's commodities as a whole took a bit of a pounding having had a great couple of weeks before that. But at the same time, I can find you any number of dodgy AIM quoted companies with very low volatility and a smooth stock chart.

Does this make commodities more risky than say a tiny AIM quoted stock? Not to me it doesn't. I'm interested in where the graph ends up over the long run.

The second reason that volatility is feared is because investors tend to focus their emotions on the risk of a loss. We have a natural tendency to fear losses more than we appreciate gains. It's the way we are wired.

But the flip side is that volatility can give you the upside risk. The shares could fly. And your fear about losses could mean you miss out.

Providing a portfolio is diversified, there shouldn't be a problem with including some volatile stocks - it's bad stocks we want to avoid - not volatile ones.

But there's another more important reason why it pays to have some volatility in your portfolio...

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Tutorials don't come cheap

Trading a trending market, or share won't teach you much about your personal trading style. And it certainly won't help you build an emotional advantage.

And that's why you need to train with live ammo'. Like the SAS you need to learn to control your emotions, ready for the inevitable day when all about you lose their heads.

You've probably heard the phrase buy when there's blood on the streets'. It's accredited to Baron Rothschild who made a fortune mopping up stocks during the panic of The Battle of Waterloo. Rothschild was a seasoned trader - well trained in the art of volatility.

But most investors hate volatility because it can be scary. When there's blood on the streets, the uninitiated stand by and watch in a daze - and the bad traders sell into it. Study after study show that investors trade-in to markets when they're expensive and trade-out when they're cheap. They can't help their reactions.

Reflexes had got the better of me'

That was the excuse for shooting the sheriff says Bob Marley. In the same way, reflexes get the better of unprepared traders as they shoot from the hip. Selling at the bottom (fear) and buying at the top (greed).

And every market has its volatile days. Great traders look forward to those days. So long as they're well trained...

To improve your investing skills, you should embrace volatile stocks - they're the very ones that will help you learn to conquer your emotions. Jesse Livermore, the patron saint of The Right Side said of the market, she'll give you tutorials. But her tutorials don't come cheap'. You don't have to punt large stakes on volatile stocks, in fact, you probably shouldn't.

But you do have to use live ammo in training... that means real money and real volatility. Sure, the tutorial can be expensive. You could lose some cash. But if you want to get better at something, then you've got to be prepared to pay.

Now, I'm not condoning going crazy on volatile stocks here. All I'm saying is don't reject a stock just because it's a bit tempestuous. As is always the case with the stock market, only punt what you can afford to lose - that's even more important with volatile investments. Don't let the market bully you as she moves the prices around.

So, where should you start?

Follow an old hand with a hard stomach

Well the classic hunting ground for volatile stocks is the penny stock arcade. Smaller companies are generally more volatile for two reasons. First newsflow can be make or break' for many small companies. A contract win, an exploration find can send them soaring. So yes, there are elements of risk here - and they shouldn't be underestimated.

Secondly, these stocks can be illiquid - so large buys and sells can influence the price, buffeting it around... these stocks certainly give you some volatility training.

I've just been going through the performance table for Tom Bulford's Red Hot Penny Shares. Get this...

In one month alone (to November), he's got 8 stocks in the portfolio that went up more than 25% - and that's in just one month! Two were even up 264%, and 177% respectively (both energy groups). Of course there were some falls too - we're talking about volatile markets here.

But overall, Tom had a great month. His portfolio of open positions was up 17.8%.

Five year performance of closed positions for Red Hot Penny Shares

Swipe to scroll horizontally
PeriodAverage return
Row 1 - Cell 0 Row 1 - Cell 1
Row 2 - Cell 0 Row 2 - Cell 1
Nov 2009 - Oct 201031.87%
Nov 2008 - Oct 2009-26.79%
Nov 2007 - Oct 2008-2.08%
Nov 2006 - Oct 200753.08%
Nov 2005 - Oct 2006-10.62%
Row 8 - Cell 0 Row 8 - Cell 1
Average 5 year return:9.09%

This article was first published in the freeinvestment email The Right side. Sign up to TheRightSide here.

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Past performance is not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you've bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.

Bengt graduated from Reading University in 1994 and followed up with a master's degree in business economics.

 

He started stock market investing at the age of 13, and this eventually led to a job in the City of London in 1995. He started on a bond desk at Cantor Fitzgerald and ended up running a desk at stockbroker's Cazenove.

 

Bengt left the City in 2000 to start up his own import and beauty products business which he still runs today.