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It is best not to trade or invest beyond your ability to control your heart and emotions or nerves – call it what you like. My view is that whatever you invest in you must be able to sleep at night. Yes it must pass a simple ‘sleep test’ – will it keep me awake? And if it will, then you need to ease back to something that will not distract you to the point of overpowering emotion.
If you are unsure about market direction or any other element then it is better to pass and not be in the market at all. Remember that the pain of losing is a stronger emotion than the joy of winning.
If you are trading a wide range of straight equities there are basically three main options. Firstly you can buy straight fully funded shares as you might do in a superannuation fund. Generally stocks in such a fund are bought for the longer term and because they are not leveraged volatility is less an issue. This passes the sleep easy test and is a strategy used by investors who are near or at retirement age. They cannot afford the risk of savings being wiped out although we did see that happen in the latest sharemarket rort and many have still not recovered much of their hard earned savings. Take a look at the All Ords chart:
click to enlarge
You can see the market has not yet recovered 50% of the fall. Many will have bought in recent months with some good gains but how secure are these gains? Time will tell. But if you want to lock in such gains you may well need to consider hedging by using an option spread. Yes there is a cost but all insurance costs money.
The other way of buying equities is through margin lending or leveraged equities as they are commonly described. To do this, one has to be somewhat surer of market direction as volatility can cause some pain depending on your pain threshold. For me I always aim to buy in a pullback as that way I am down the risk curve. You also needs to be much more vigilant about positions and cannot afford to sit back and wait for them to grow as losses can mount quite fast if the market goes against you. This method for me, and given the way I use leverage, is not high risk but for others any form of leverage may not suit.
And thirdly we have CFDs. Much misunderstood. And they do not pass the sleep test for a big portion of investors. Fine if you are skilled and you have a strategy that is largely proven. Although no system is totally fail safe as we all well know. Even if you have a relatively good system you still need to be able to manage your psyche. CFD accounts can move in a volatile manner and it is an experience that is hard to describe if you have not been there!
Next week I will talk about how to manage the pain – which is the greatest of challenges!
Enjoy the ride
Tom Scollon
Chief Analyst
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