Spread Trading Lessons from the Frontline

I have noticed that hardly any investors do their own research, preferring to quote brokers and analysts estimates the consequences of which are already priced into the market. One of the ways the independent investor can gain advantage is in conducting original research into a quoted business. Obviously some lend themselves more readily to this than others. It is easy to walk into a branch of a quoted coffee bar or restaurant for example but impossible to walk around and look at a complex business like RTZ. On a number of occasions I have been able to devise ways of assessing how a business is doing - on some occasions even before the business' Directors, and certainly before desk bound analysts get to learn of new trends.

Currently I have been looking at quoted hotel businesses (in particular CEU) because (as a regular user of UK hotels) I have noticed that 1) Room rates have gone up sharply, and 2) Availability is poorer than for many years. Clearly this suggests that profitability will increase sharply, but in most cases the impact will not reach the bottom line for 6-12 months minimum and a further 12 months will need to elapse before a new eps trend is established, and a relating of the share price occurs.

I have decided to hang in for the long run - maybe even all day!

The one research tool you should never overlook is the simple phone call to the company. Until recently, I was heavily invested in a company. Less than 2 weeks ago the fundies were excellent but the chart started to look really weak.

All it takes is a telephone and a directory of relevant hotels and a couple of hours, and you will know as much if not more, than the management about what lies ahead profit wise.

I called the company and asked them to answer some of my doubts. The whole tone of the conversation did not sit right with me. I sold. Two days later the share went on a fall as the only institution holding sold out. From now on, every large holding I have will only be initiated after a phone call to that company. I learnt more in that 5 minute call than I did with months of fundamental research.

I used this method many years ago when McCarthy and Stone convertible Loan stock was trading at around #20 - implying a bust - I telephoned every development in the business and collate the results of a friendly chat with the sales office. I enquired on behalf of 'my elderly mother' who was anxious not to live in a flat in a development unless she could expect the other flats to be occupied in the reasonably near future - percentages of the development sold and sales trends were teased out over the course of a five minute chat.

I bought and bought....sold too soon of course, a four bagger though!

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Don't fall in love with your stocks

Love is in the air this hot summer, so take deep breaths but my advice when it comes to shares is: Don't fall in love!

Investors often get emotionally involved with their share buys instead of taking a dispassionate view.

This can often happen when share buyers actually like or use the products or services produced by a company.

For example one of my biggest trading mistakes was buying Coffee Republic shares back in 1999 because I liked their coffee and I used my local branch a lot.

So I bought shares at 27p without doing any proper research and over the months the share price kept on going lower.

I even went in and started to buy more coffee in the vain hope it would help the share price!

All I ended up with was sleepless nights due to all the caffeine.

Of course, I should simply have sold out once the shares started to tumble and take my losses early. In the end I sold at 8p, losing nearly #7,000.

But it was a lesson well learned. The way to stay unemotional is to use stop losses and be disciplined about using them.

I set them around 10-15% away from my buying price. So under this system I would have sold Coffee Republic at around 23p and lost a lot less money.

As you can imagine I go to Starbucks now!

If you do fall in love with a share, at least make sure its a winner.

One of the main reasons my SIPP (self-invested personal pension) has leapt higher in value is I've been happy to hold on to my best-performing shares for many months.

I've kept them, ignoring any short-term falls that have occurred from time to time.

For example I've doubled my money in Burren, an oil exploration company after holding it for nine months.

Market-makers (who control share prices in smaller companies) are known to try and 'tree-shake' investors into selling shares so they can buy them on the cheap.

They drop the share price dramatically in order to shake out scared holders. They often do this when they have a big buy order to fill. Dropping the price means they get instant sellers. Once they've got the shares they need then the price goes back up.

I've learned over the years to spot these tricks and avoid being panicked out of a good share by a sudden manipulated fall.

Lastly, whatever share you buy, ALWAYS USE A STOPLOSS. You might be like me and sell on very small falls (disadvantage: you get stopped out quite easily; advantage: you very rarely lose much) or you might have a medium stop loss of 15% or you may want a relaxed one of 25% or even more.

But not risking 100% of your capital (which is what you're doing if you don't have any stop loss) is the most important rule of all in stock market investment, far more important even than stock selection IMO. After all, if you keep getting the latter wrong, stop losses constantly being triggered and losses being taken should quickly tell you that you're doing something wrong!

People who don't use stop losses like to kid themselves that "you haven't lost until you've sold" which to my mind is like saying a body is not dead until the doctor provides a death certificate. Self-delusion and groundless optimism are two of the Deadly Sins in stock-market investment.

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Match shares with your personality

Once any share starts getting a "cult following", its nature changes totally. Market-makers start mucking about all the time, and what was once a nice little earner becomes another volatile casino-type.

There is no such thing as "the ideal share" - or rather, there is to me, and to you, and to Tom, Dick and Harry; but we would not often agree on it. It's rather like "the ideal person". Some people like extroverts, others prefer quiet sorts, still others like volatile personalities etc etc.

As I've said before in past articles, an important part of trading is to find shares that suit your personality and which you feel comfortable with. Some people actually like shares that swing around violently, because they are able to buy on the downs and sell on the ups. Others (like me) like shares that glide smoothly in a reasonably predictable direction. Long-termers don't care much even if their share drops 50% in the short-run because they are confident that they will make a huge profit further down the line.

There's room for all these different types of trading - all are perfectly valid, and my only test would be whether they are profitable - and the most important thing for people is to work out which one they can excel in. There is no more point in someone recommending to me a "long-term" share which may drop a huge amount in the short term, than there is recommending a delicious juicy steak to a vegetarian!

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