DIY Investor Magazine
/
2015 Issue
34
Putting in a stop-loss order is like buying a house for
1 million dollars and then instructing the real estate
broker to accept the first bid for the property that
comes in below 800 000 dollars.
Warren Buffet
stock market works and where attractive shares are to
be found. Each of them has developed his own method,
which he uses to try and profit from opportunities in
the market. And, ultimately, they pursue that method in
a rigorous, disciplined manner.
Some investment methods and philosophies are usually
incompatible with one another.
Investors use a share’s intrinsic value as a guiding
principle for their investment decisions and thus exploit
price fluctuations. If a share falls in price without good
reason, then the share becomes more attractive to
them because it can be bought at a lower price.
Momentum traders, on the other hand, are not
interested in the intrinsic value of shares, they look
only to price fluctuations and try to follow price trends.
Momentum traders generally buy shares that perform
well, whereas they short or sell shares that do badly.
In other words, to a trader, a share whose price falls is
an opportunity to short, whereas an investor might see
this as an opportunity to buy.
That said, investors have to realise that it’s wrong to use
instruments from the traders’ arsenal to base their buy
and sell decisions on. One classic mistake, for example,
is the use of stop losses by investors. A stop loss is an
instruction to sell a share automatically and without
further ado if it drops below a certain price. This is a
very useful instrument for momentum traders who are
led by price movements, so that it’s logical if they want
to exit positions that move in the wrong direction.
However, for investors, stop losses make no sense. If a
share falls whilst the intrinsic value stays the same, the
share becomes more attractive to the investor. Declines
of this kind present more of an opportunity to buy
(more of) the share than to sell it. Therefore, the stop
loss is anathema to the basic philosophy of investing
and those who use it have to realise that they’re not
investing. If they think they are, then they haven’t
grasped exactly what investing is all about.
So, there we have it, our brief discussion of a number
of common investment mistakes. In my book Excess
Returns: A Comparative Study of the Methods
of the World’s Greatest Investors, I look at many
more investment mistakes. In all of this, the general
conclusion is that most investment mistakes are caused
by psychological biases, a lack of clear strategy (that
does not produce any advantage in the market), a
lack of discipline, senseless conventional wisdoms
that people believe in, a lack of insight into the drivers
behind the market, and so on.
Frederik Vanhaverbeke is a bond portfolio manager
at KBC Asset Management, Belgium and author of
Excess Returns: A comparative study of the methods of
the world’s greatest investors (published by Harriman
House, ISBN: 9780857194329
)
To purchase this book for the special DIY Investor
price of £18 + P&P (RRP £25) for the paperback or £12
(RRP £20) for the ebook use the following promotional
code when checking out at the Harriman House online
bookshop: DiYEE15.
