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Smart Investor: what is the correct attitude for an investor?

Is a pessimistic outlook more helpful to the smart investor than an optimistic one? Is defence the best form of attack?

 
Smart Investor: what is the correct attitude for an investor?

Is a pessimistic outlook more helpful to the smart investor than an optimistic one? Is defence the best form of attack?

Eternal optimism

The optimism of private investors, investment professionals and the financial media is incredibly difficult to dampen, even in the toughest of economic times. Some may argue it is endearing, others that it is foolhardy, but either way the investment community is certainly an optimistic bunch.

This eternal optimism normally takes the form of bullish research notes, upbeat television appearances and very positive predictions for the future direction of the stock market.

However, is a pessimistic outlook more helpful to the smart investor than an optimistic one? Is defence the best form of attack?

Focus on the facts

Of course this optimism should not be disregarded simply because those at the centre of it may or may not have vested interests. However, in the first instance it may be wise to put dreams of economic recovery to one side and instead focus on the facts. 

In other words investors would benefit from a large dose of honesty, in terms of assessing the facts contained in the company accounts and deciding how impressive these figures really are. They should leave themselves a wide margin of safety in terms of budgeting for a lack of profitability growth in future; this would include allowing the company considerable breathing space for when bad years inevitably occur.

Furthermore, many investors focus on areas such as forecasts, recent news and economic predictions when assessing whether to buy shares in a company. Whilst this approach may serve some investors well, it is perhaps not a sound basis with which to invest capital in the long run because the focus is often on optimism and upbeat predictions. Even if recent news is poor and economic data is disappointing, there is often a flip side where attempts are made to paint a brighter picture of the future than may be the reality.

Indeed emphasis should not be placed on optimism or pessimism because in the world of investing there is a wide range of known unknowns and even more unknown unknowns. Nobody can be expected to predict with any degree of accuracy how individual companies will be performing in 5-10 years time.

The defensive investor

Thus the smart investor should be a defensive investor by applying large amounts of caution and logic to investment decisions in an attempt to protect his capital. Of course whilst the past is only a guide to future performance, it is the only available factual information upon which to base investment decisions. It is also the only means through which an investor can assess which companies he believes are trading at a fair price.

So, how does the smart investor go about maintaining a strong defence of his capital?

The smart investor should ascertain what he believes is the intrinsic value of any company he buys. This will not make him immune to losses, but it will ensure that he pays a fair price for a good business in his own mind. Crucially, this keeps him in control if the optimists prove to be wrong. In other words, an investor who believes he has paid a fair price for a company and has given himself a margin of safety will be far less concerned about falling share prices than an investor who buys for other reasons. Many investors will tell you than staying sane in the dark days is a crucial part of investing.

Listen to your fear

Furthermore, whilst the eternal optimist will entertain the emotion of greed when buying, the smart investor must instead listen to his fearful side. He is likely to benefit from basing his decisions on facts such as net profit figures from the last 5-10 years in order to glean how the company may perform in good and bad years in future. In addition, he must allow a margin of safety when making any assumptions about future profitability.

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26 comments so far. Why not have your say?

an elder one

Sep 30, 2010 at 14:03

Well Robert I think you have covered all the angles but what's your'e conclusion. I would suggest that some people are innate optimists and some are not; let's face it the entrepreneur has got to be a natural optimist; where would we be without them.

I daresay not a lot of investors are able to understand company balance sheets - especially the way accountants write them - and if one is able, are they to be believed. You could say, I know, that if one is unable then one should not be in shares; but the money has to go somewhere; at the present time banks are a dead loss - literally - and bonds are blowing up a bubble.

I think the strategy for many is to listen to the judgements of those with whom one has become familiar and found to be reasonably sound - takes a few years - then go for good solid companies paying a good dividend or those producing good growth, when one can always sell out when the tide seems to be turning.

The market is governed by sentiment as much as profit and loss valuations so it behoves one to listen to opinions whether they be bears or bulls. One has to make a judgement. Personally I take the long term view that the sky won't fall in of a sudden thus giving time to adjust. In summary I would suggest that the average anyone investing in equities has got to be an optimist; bears and bulls are something else, probably mainy short termists trading the market for quick profits.

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Charlie Marshall

Sep 30, 2010 at 16:06

Well said Elder one.

I believe in cautious optimism.

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Peter Thoresen

Sep 30, 2010 at 16:56

I like to invest optimistically in those companies I have carefully researched, particularly on AIM. However, somewhere at the back of my mind is the the thought that AIM dropped maybe 80% very quickly back in 2003. If we have a general economic catastrophe most of us will not get our money out of the market as we rush for the door. And many companies will not survive such a crash and their shares will become worthless. So the pessimist in me has some vaulted gold and silver just in case.

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roger bartliff

Sep 30, 2010 at 17:26

My investments are made with cash I can afford! to lose only. I don't buy shares with the certainty that I will be able to come back in say 2 years and get my money back plus a profit. My real savings are in fixed investments with a guaranteed return and that way I know what I'm going to get even though it is less than a potential return from equities. Equity investments are a game which I enjoy playing but which I curse when I lose.

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an elder one

Sep 30, 2010 at 18:36

There are no certainties at all in investment Roger - except perhaps Government bonds held to redemption - it don't matter where you put your cash, it is at risk to loss and depreciation; you are right to do what suits you; investment in equities needs rather more attention than some would have us believe. In the recent few years I have tended towards strategic companies; mining including gold, oil and its engineering support, gold ETFS, a couple of supermarkets, tobacco, booze, a telecom, some others including Unilever just now, who look to have good prospects in the eastern countries. I probably hold too many and at my age should be predominantly in Government bonds, but couldn't stand the boredom thereby. I've tried aim shares and made a useful profit in the techie bubble but lost most of it through not selling soon enough - got hung up on capital gains; very silly. I tend to keep clear of them now; they are too volatile and v difficult to evaluate and in any case I reckon for every good one there are probably ten duds so the net result is average. We all curse, its a way of keeping level headed.

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Victor Meldrew

Sep 30, 2010 at 18:45

I only gamble money I can afford to lose, and my gambles are doing better than my inestments.

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an elder one

Sep 30, 2010 at 18:54

Victor I daresay a national lottery winner could say the same, and some, but the odds are not attractive enough for me to venture even a few quid a week. Sounds like you have some sort of system going, of which there a few around I guess from the odd bits of mail I get from time to time; mainly to do with geegees.

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Victor Meldrew

Sep 30, 2010 at 19:14

Sorry, I should have made it clear my gambles are small-caps generally regarded as risky, many of them in tech or mining sector. I'll admit to a few dogs as well. Todays old dog confession is Eruma who make security products, when they have enough cash.

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an elder one

Sep 30, 2010 at 19:42

Sorry I misunderstood Victor. AIM seems to go through fashions and we seem to be in the realms of junior oil and mining companies, if you pick the right ones the rewards can be phenomenal in time, but there won't be many such. Even they won't really know what they are going to get until they dig a few holes, so how can we investors. These people will all dress it up none the less to attract the money and there are the bulletin boards to help them, or not. The trouble with the techies is there is so much competition - everyone can do it now - and it is the end product that sells that makes the profit, no matter how clever it looks in concept. Look at computer games, they are lost on me it is a youth market and I ain't a youth anymore.

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Victor Meldrew

Sep 30, 2010 at 20:11

Thanks for the friendly advice, elder one. I like to at least think I'm reasonably selective and ready to learn from mistakes, even with my gambles. Only time will tell if present good fortune is sheer luck or anything more.

This might sound crazy but sometimes I worry more about other investors, for instance if I visit a bulletin board and see someone claiming to be 60% invested in a tech or mining small-cap that they have total confidence in. I know such posts could be attempts at ramping but I have a feeling some are genuine.

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an elder one

Sep 30, 2010 at 20:43

Victor, whether such posts are genuine or not there will always be those who will risk their shirt; best ignore them, though on the other hand even if they are ramping it can still be profitable to join them; for a while, don't hang on too long. As I said, it's a young man's sport.

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cherrybowl

Sep 30, 2010 at 20:54

Its a calculated gamble-therefore the odds are slightly in your favour.always bed-and breakfast when you've' got the percentage profit your happy with -in my case 25percent

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an elder one

Sep 30, 2010 at 21:18

A good strategy cherrybowl leave some for someone else; not easy though, you can only kick yourself when you miss a ten bagger; still a few self inflicted bruises are better than an empty purse.

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novice henry

Oct 01, 2010 at 10:12

The best posts on a current artical I've read in a long time, appears you guys know what its all about,

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Roger May

Oct 01, 2010 at 11:20

Cautious optimism is about right.

I shadow my portfolio in a "virtual portfolio" which allows me to add a note. I use the note to keep a track of what -10% and -20% from the present price would be, and generally sell when the share reaches -20%. But this does mean that when shares are rising strongly you have to update almost every day. But a fixed "+20% sell" policy would have meant I lost out on big gains on ASOS, ARM Holdings and XP Power . . . . . .

My "fliers" are doing better than my ISA and my SIPP too!

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an elder one

Oct 01, 2010 at 12:18

Yes, stop losses are a useful way to avoid big losses -10% is a bit low I reckon 20% or a bit more might be tried but one can lose out by being too dogmatic on the likes of the more volatile shares such as ARM holdings; still better safe than sorry. Extreme volatility is caused I think by uncertain sentiment; people are trading in and out frequently as the price moves about which compounds the movement; one way to judge the behaviour of a share is to follow its charting, although historic this can give you a likely measure of the expected volatility and thus a possibly more appropriate judgement of the level of stop loss to apply.

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judy garland

Oct 01, 2010 at 15:42

elder ones comments well made, Also believe in stop-loss although I have so far just used same % and applied it to the highest price reached & when price falls by that % - sold out.

At times of course the damn price goes thru your stop loss & then leaps back upwards, still theres the cheery thought that nobody ever makes a loss when taking a profit!

Would appreciate elderones thoughts on fine tuning stop losses-- perhaps by increasing the % when a stock has run up rapidly or when the overall increase is above a certain amount??

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an elder one

Oct 01, 2010 at 16:52

Judy I'm no expert in this matter; you are obviously doing the right thing in resetting your stop loss price as the share appreciates, I don't think one should change the % range because a share has increased in value. I think it is important to judge it satisfactorily at outset - different shares need different treatment I reckon - and stick with it until there is some behavioural reason to change it. One can to some extent judge the likely behaviour of a share from its day to day price chart going back a few months, but there are no guarantees. Having said all that, I have only a very basic understanding of charts - keep meaning to read it up - and don't use software to judge; you can get a basic idea from the FT website www.ft.com.

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an elder one

Oct 01, 2010 at 17:10

I meant to add; share charting can be very useful in that it reflects the sentiment surrounding a share and that is an important consideration to have in addition to the company balance sheet.

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paul darbyshire

Oct 01, 2010 at 19:29

One thought on stop losses....use trailing stop losses where appropriate.....start off with say a 15% stop loss.....as a value in pence eg price = 100p so set stop loss at 15p. As this trails the 15p will remain the same but the % will decrease so allowing you to lock in before a correction or a bubble forms. Just a thought.

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fatcat

Oct 02, 2010 at 17:41

nice input Elder one-what do you think of trading CFD contracts on high paying divi companies? I seem to be having some luck or It is a good strategy.?

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judy garland

Oct 02, 2010 at 18:21

Thanks for your input, Paul.

Will back test some trades & check effects.

This may mean keeping more of a profit-- so that cant be bad!!

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judy garland

Oct 02, 2010 at 18:25

Thanks for your further comments, Elderone.

Will check the site & do some further homework.

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an elder one

Oct 02, 2010 at 19:08

I'm not into CFDs fatcat, though I get periodic email invites from CMC Markets UK plc - not cold calls - I understand these people are very good. I've been tempted but am getting a bit too long in the tooth to get involved I think. The beauty of CFDs is that there is the potential to make a nice profit which ever way a share is moving but it is something of a gamble and you can lose your shirt because of the gearing. I don't have an opinion as to which shares to choose but clearly you need to follow the share's charting and/or be aware of news likely to move the share.

Nice to see you are in luck, you could have the knack; as far as a strategy is concerned, one has to be prepared to study closely the behaviour of a share by its charting and pay more attention to the companies activities and work out the maths. I believe CMC will provide relevant software for the task, but from me this is all heresay not actual experience.

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fatcat

Oct 03, 2010 at 12:03

Thank you elder one-I have also heard good things about CMC. I think I have more luck than knack so time to get help. Thanks again for all your input.

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david Bhatti

Oct 04, 2010 at 11:01

Not long ago I read a comment by a fellow day trader on 'you have to protect your investment'. I took it seriously. My lazy attitude to decision making has changed. It is showing results. In my case, my attitude was behind my failures-it needed fine-tuning. So your attitude will affect the outcome of your decision.

The article reflects my experience and has some good insight!

I believe there are certain brokers who provide daily notes on what to invest in, company trends, market depth on certain stocks and various indicators.

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