Editor’s note: This article was first published in February 2017. The ArcelorMittal answer is a view on a specific stock from that month (“neutral zone”, wait for the results) and is no longer current.
I recently gave my opinion on a few stock market topics, answering questions about what the stock market really is, what it isn’t, what the best way to invest is and what kinds of games we should avoid so as not to lose our money.
Both in the comments and by email, I have received a lot of questions about some of the points I made, since I couldn’t stop to explain each one. So I will answer the most common ones in this article, so that they can be useful to our readers.
Questions from Escualo7:
You seem to be in favour of long-term investing. However, you say not in the way Warren Buffett does it. Could you explain that?
Warren Buffett’s long-term investment horizon is “forever”, although his managers at Berkshire Hathaway also buy and sell when they think it is better to get out of a sector or a company.
Even so, Buffett says that if one of the companies in his portfolio fell 50%, he would buy more shares at that point. But we don’t have Warren Buffett’s fortune, and our aim is to invest intelligently and make as much money as we can within limited risk.
What I mean is that if tomorrow the winds of economic recession start blowing and we know the market is going to collapse, as it did in 2007, there is no need to stay invested in those companies and watch ourselves lose part of our gains.
The smartest thing to do there is to take profits, and if we need to be out of the stock market, we are out of the stock market. A good investor doesn’t have to be invested all the time. If a recession is clearly coming, we could even make money from the fall of a particular sector (banks, construction companies and so on).
Once the recession has passed, or we get the chance to buy the shares well below their previous price, we will have made much bigger gains, because we invest with money we didn’t lose and buy more shares with the same money.
In short, if we know something is going to sink and we can see it coming, why stay in that company, however much we like it? Remember that in a crisis like the one we went through, some companies will never get back to the prices they traded at before the crisis, because their share price was extremely inflated.
What should we understand by long term?
It is often said that in stock market investing, with a diversified portfolio of shares, nobody loses money over 10 years. For me, though, long term is relative.
In fact, I think I interpret long term as holding a stock in my portfolio for as long as I expect that company to still have room to rise and grow.
Sometimes I have invested in a company intending to hold it for five years, but then it has risen 300% in a short space of time and started correcting, while I have spotted another company that I think has more growth potential.
For example, when I sold Gowex with a profit of almost 700%, it was because I felt I had already made enough from that company, and I still didn’t understand how it was making money while the rest of its sector couldn’t turn a profit. I sold Gowex to buy Lenovo, which, in hindsight, wasn’t a bad idea.
Later, however, Lenovo turned downwards.
Is there an optimal number of companies to diversify into, depending on the capital invested?
When we have very little money, we clearly need to aim like a laser, that is, stay highly concentrated: diversify little.
This is a very personal opinion, and it would be perfectly valid for someone to advise you to always diversify. But sometimes what we do with diversification is look for a way not to lose money, at times sacrificing the chance to make more.
When we have a large amount of capital, our main goal should be to protect our money in exchange for somewhat lower returns, by investing in more solid companies with good dividends, even if their growth is more gradual.
(See: 19 investment secrets everyone should know before investing)
Why is it more profitable to make fewer trades than many?
I have said that one of the rules of the stock market is: “Tell me how many trades you make, and I’ll tell you how much money you lose.”
An investor who makes only three trades or moves in a year has, as a rule, analysed and studied the operation they are going to make. Someone who makes 300 trades a year is, as a rule, a trader, and there is no difference between a trader and a gambler. Gamblers lose in casinos, despite their methods for tilting the odds in their favour. And the same thing happens to traders.
So here is a new rule of thumb: if you play the stock market, you will lose. If you invest in the stock market, as a rule, you will win.
What books do I recommend to people who want to learn to invest?
5 books on investing and the stock market: from the bible of investing (The Intelligent Investor) to a good book on technical analysis that can be very useful for learning to read trends, such as the one by Cárpatos, Leones contra gacelas (“Lions versus gazelles”).
Alejandro asks:
What do you think about setting a stop-loss on a long-term investment?
This is a good question, because at first it might seem contradictory to place a stop-loss on an investment we consider long term. But yes, I usually set them in several cases.
When entering the investment: if I decide to invest in a company that is sitting right on a support level and, according to technical analysis, the share price could go into a tailspin if it loses that support, I usually set one. I’m willing to cut a loss with the idea of buying back in at a better moment, unless I have already planned a DCA strategy (averaging down).
The stop against bad decisions: I don’t know if you have ever watched a stock in which you had a 200% gain start to correct, and correct, and correct some more. By the time you realise, you are already at a loss. That doesn’t happen to me any more.
Now I always set a safety stop-loss that I stick to no matter what, where I tell myself that whatever happens, I will sell that stock at a profit, even if it’s only 10 or 20 per cent.
And the usual stop-loss.
When a stock has already had a good run and there is nothing to make us think it could keep rising attractively, I don’t like to sell. What I do is let the market itself take me out. As long as the market doesn’t take me out, it means the stock is rising, and what I do is set a dynamic or trailing stop-loss, the kind that adjusts upwards by itself as the price climbs.
A warning about very tight stop-losses.
If you set a very tight stop-loss, the algorithms may sweep your stop during a dip and then carry on with their upward path. At that point you are left looking like an idiot. So if your plan is long term and you are aware there may be a correction, it may not be a good idea to set a tight stop-loss.
A question from Yamaha:
Do you still see upside potential in ArcelorMittal?
Arcelor is now in a neutral zone, where we don’t know whether it may extend its correction or continue its upward path. Although it will most likely keep rising, at this level it is already a riskier trade, because the margin of safety at entry has been lost.
Those who are already in and have doubts, or who have already built up an excellent return, can stay in or set a rising (trailing) stop-loss to take profits if a correction begins. Still, I would wait to see how the market reacts to the results it has published.
The steel sector is going through a bad patch, but we shouldn’t forget that Arcelor is no penny stock: it is one of the largest steelmakers in the world.
Featured image: Coradoline, CC BY-SA 3.0, via Wikimedia Commons.
