Investment: Traders take care to toe the line

A disciplined approach to risk can bring the best rewards.

By Gavin Alexander, December 13, 2010
Research thoroughly - and keep to your plan

Research thoroughly - and keep to your plan

I am often asked what skills it takes to trade the stock market; indeed I have sat with my fair share of school leavers and young graduates, all looking to get an insight into the high-flying world of City trading. There are a number of important aspects to investment decisions: the risk, the reward, the thought process of the impending trade, research, but most importantly of all, discipline. Without discipline, you may as well throw your money down the drain.

When examining the merits of a trade, the first thing I ask myself is: "what am I prepared to lose on this investment?" That in itself is the first process in the discipline of trading. Too many times, casual investors tell me the returns they are looking for and how much they think they will make. Do they believe that all trades are always going to be winners? It's all about averages, how many trades you will get right and how many will turn sour. This brings into place the risk-reward question. If an investor is happy to put on a trade and make seven per cent return on his capital, does he cut his losses if his position goes against him and he loses seven per cent? Often the case is not. Ask anyone who has ever dabbled in the stock market or attempted to trade for a living. The most common flaw is the emotion of the trade: "Surely at seven per cent down, this investment can go no lower? I must be silly to not buy some more at these levels..." Yet if the trade had hit the investor's target of seven per cent to the upside, would he be happy to add some more? Of course not! He would be closing his trade and patting himself on the back for a job well done. Risk over reward is now out of balance; what was a trade for a seven per cent return to the upside has just been stacked in favour of losing more than you were prepared to.

Emotion is human, the frustration and at times pain you can feel as a professional trader is part and parcel of the job. Keep it under control, don't shout from the rooftops when you get it right and don't destroy yourself when things go wrong. Confidence is key. Did you follow your plan? Did you employ the discipline to cut a bad trade? If the answers are yes - and if you believe in your ability to pick stocks to invest in - then you will be a net winner.

I have witnessed markets over the last few years like no other in my 24-year city career. I have seen the most able and confident traders wither and pull back, sapped of confidence, beaten by the losses they have suffered and even questioning why they do what they do. The life of a trader can be extremely lonely at points - it's you versus the market, a bank of screens, lots of flashing numbers and at times intense concentration.

Many people are fascinated by what I do for a living. They tell me how they like to invest and proceed to reel off all their wining trades. Very few ever tell you about the losses they have suffered.

Research is the number one factor in successful spread betting - know your market, in and out

Trading for a private individual has never been easier; information is freely available through the internet to conduct research; online trading platforms aimed at retail customers are also easy to use.

One of the most common forms of trading is via CFDs or spread betting. It is not often in life that you can make money without paying her majesty's government some tax, but that option is open to all UK investors via spread betting. Not only are your gains tax-free, but you also have no need to pay stamp duty on your trade. This is something that everyone who has an account with a stockbroker should look into. If you believe you are a net winner with your trading, then why give away any more than you should in tax?

The best way to view financial spread betting is as a well-crafted tool that allows investors the opportunity to wager on financial markets without ever actually taking physical ownership of the instruments that are underlying the investment. In essence, the trader is speculating on the direction of a financial instrument or market, whether that is specific shares of a company or based upon currencies, commodities or indices, all the while without ever actually owning any of the instruments on which he or she is betting.

The reason financial spread betting has begun to rise in popularity in the 21st century is due to the absence of capital gains tax on profits, allowing individuals to take home a significantly larger portion of their profits than with conventional share trading where the CGT applies. In the UK, all transactions can be processed without a duty stamp, because the transactions are viewed as bets rather than investments.

While financial spread betting is by its very nature riskier than traditional fixed-odds betting, or even conventional share trading where bettors are protected by the fixed odds, profitability from financial spread betting can be guaranteed to some degree, as long as you take calculated risks and make sure to employ the various measures in place to keep you from losing money. Patience and intelligence are key to making a profit from spread betting. Knowing your market and limiting your bets using stop losses will help you make a profit on a majority of your trades. The costs associated with spread betting are generally included in the spread, so the wider the spread is, the more you may have to pay, which allows you to determine how much money to risk when you consider a spread betting company who specialises in financial spread betting. Due to the increased competition and the explosive growth of spread betting in the 21st century, these spreads are only getting tighter as the years go by. As more investors begin to put their money in the market, the system is becoming more efficient, more profitable and more trustworthy.

One of the most important things to remember about financial spread betting is that it is risky only if you go into it with an emotional attachment. Guaranteed stop loss limits are one of the best ways to ensure that you do not lose money on emotional wagers, but rather put limits in place, so that if, for example, the underlying share price on one of your bets were to move against you overnight, rather than lose your entire investment by purchasing the share, your stop loss limit would automatically keep your loss to a predetermined figure, allowing you to control the outcome to a degree.

Research is the number one factor in successful spread betting. Knowing your market in and out allows you to control the amount of profit through your experience and knowledge in a particular area. Whether you choose to research spread trading on share holdings, currency exchange, commodities or other instruments, everyone has an area of expertise, and as every trader knows, the only way to remain profitable in the long run is to stick to markets that you know, so that you can predict the outcomes to a fairly high level of probability.

Bearing in mind the aforementioned stop loss limits, there is no such thing as a guaranteed profit, but a higher level of knowledge associated with a market allows for a high level of profitability as long as the trades are being made based on well researched information.

Keeping abreast of the most up-to-date news information is also a key factor in establishing which trade to make and which way to place your bet. An example of this might be the recent volcanic eruption in Iceland, which brought the UK aviation industry to a standstill. As a result, shares in many UK and European airlines immediately plummeted in price, so anyone who had short sold these shares early enough would have made a profit. The share prices stabilised again fairly quickly as investors waited on news for when flights would again be resumed and later rallied. In this instance, traders who reacted quickly enough in the beginning and then closed their positions prior to any bounce-back would have made a quick profit.

Whichever way you decide to make your investments, always maintain your discipline. The market very rarely gets it wrong, but investors do!

Gavin Alexander, 40, has worked in financial markets since leaving school at 16. Many years of his career have been spent working for Cantor Fitzgerald Europe, running the investment trust and emerging markets team. Since 2003, he has been trading for himself and managing a fund, Bohemian Capital LLP

Last updated: 12:18pm, December 13 2010