Becoming your own investment manager?

Many people think that successful investment is about hot tips. If someone rings you with a hot tip, ask yourself, ‘Why is he calling me?’ and put down the phone. If you act on a hot tip from a friend, you may lose a friend and some money. If you act on a hot tip from a stranger, you will just lose some money.

Books tell you how to become rich from stocks. Software programs and training courses claim to help you trade successfully. Their authors assert that, with their assistance, you can make a comfortable living playing the market. Before you succumb, ask the following question: if I had a system that held the secret of lazy riches, would I publicise it in a book from which I will earn – at most – a few thousand pounds?

You may already have asked a similar question: why would anyone who could write like this one choose to do so? If you are hesitant about taking on that responsibility, you should, by the end of reading this, be able to ask penetrating questions of anyone who offers you financial advice. This post is not for people who want to become professional traders but for those who want to sleep securely, knowing that their portfolio is in the most trustworthy of hands – their own.

Is it possible to be your own investment manager? The financial services industry attracts many of the smartest people in the country, and certainly includes many of the best-paid people in the country. The City of London is made up of office blocks accommodating thousands of professionals. Traders in the City spend long days dealing in securities, with access to unlimited computing power and extensive data resources. How can you compete with them? You can’t, and you shouldn’t. But you can hold your own in their world.

There are reasons why DIY investing is possible, even necessary, unlike DIY law or DIY medicine. An obvious and depressing reason for relying on your own judgement is that most people who offer financial advice to small and medium-size investors aren’t much good. A doctor or lawyer may not always get it right, but you can be confident that their opinions are based on extensive knowledge derived from a rigorous training programme with demanding entry requirements. You can also expect that the doctor or lawyer will have real concern for your interests, not just his or her own.

Traditionally, financial advisers were neither expert nor disinterested. People who called themselves financial advisers were salesmen (overwhelmingly they were men) remunerated by commissions and selected for bonhomie and persuasiveness rather than financial acumen. They were financial advisers in the same sense that car dealers are transport consultants. Most of these financial advisers knew little that their customers did not know – except one piece of information which they did not share: how much the adviser would be paid to make a sale.

Things are getting better. Comprehensive regulation of the sale of retail financial services began in Britain only in 1987. As regulators investigated, they found instances of major abuse; the mis-selling of personal pensions and endowment mortgages was followed by the marketing of over-priced and often useless payment insurance (PPI) to millions of customers by salespeople motivated by commissions and targets. Some victims were scammed again by claims management companies which offered to assist in recovering the compensation banks were obliged to pay. The Retail Distribution Review, implemented from 2013, attempted to clarify the distinction between the independent financial adviser and the sales force, and banned many commission payments, requiring advisers to seek remuneration through clearly disclosed fees. This sits on top of a requirement to ‘know your client’; advisers must obtain basic information about their client’s situation and needs, and understand key features of the products they sell.

Training obligations are more demanding, although there are still many financial advisers whose expertise has been acquired in the school of life, over a drink, or several. There is still a long way to go. A ‘bias to activity’ is intrinsic to the processes of financial advice; few people will pay much to be told to do nothing, even though that is often wise counsel. Training is largely concerned with the process of selling and the mechanics of regulation rather than financial economics. You will understand the principles of investment better than most people who offer financial advice to retail investors. You do not have to worry about ‘knowing your customer’ if you are your own customer. You need not fear that the advice you give yourself will be biased by the prospect of a fat commission. You can also benefit from the wider set of opportunities that the internet gives the individual investor.

Financial services cannot only be bought and sold electronically, but can also be delivered electronically. From home or office you can now obtain a wide range of information, buy and sell securities very cheaply and access many investment products that did not exist two decades ago. Comparison sites enable you to scan a range of providers. The internet will never replace the truly skilled intermediary, just as it will never replace the doctor or lawyer, though it may change the roles of these intermediaries. But the search engine and the comparison site can now do much of what intermediaries would once have done. Unfortunately, the search engine and the comparison site are also corruptible. Like the salespeople, they are paid by product providers. What these sites display may not be comprehensive; what they highlight is not necessarily what is best for you.

The divergence between your interests and the interests of those who would sell you financial products is pervasive. One of the oldest anecdotes in the financial world tells of a visitor to Newport, Rhode Island, weekend home of American plutocrats, who is shown the symbols of the wealth of financial titans. There is Mr Morgan’s yacht, and there is Mr Mellon’s yacht. But, he asks, where are the customers’ yachts? That question is as pertinent today. For a time I served on the board of the statutory body that paid compensation to retail investors who had lost money through fraudulent or incompetent financial advisers. One such business was run by a flamboyant and persuasive individual who drove a Rolls-Royce and entertained his customers at lavish parties. In the small town in the north of England where he had lived all his life, his extravagant lifestyle was interpreted as evidence of his financial acumen. In a sense, it was: the money received from customers went directly into his pocket and paid for the chauffeur and champagne. Crude theft is, fortunately, rare in the financial services industry, although some practices came close to what an ordinary person would describe as robbery. But the lawful earnings of many people in the industry seem ludicrous to an ordinary person, and they are.

No complex analysis is required to see that every penny that people take home from the City is derived from fees, commissions and trading profits obtained from outside the City. This is a simple matter of accounting. You and I, and people like us around the world, pay the large salaries and bonuses of people who work in the financial sector. We do so in our various roles as investors, as prospective pensioners, as customers of financial institutions and as consumers of the products of businesses that use financial services. There may be consolation for British readers in the knowledge that the City of London is a very large exporter, so that much of what the City takes is paid by foreigners.

In Britain, even people who do not work in the City benefit from the foreign exchange earned and the tax paid by City individuals and City institutions, although they also have to compete with City folk to buy houses and hail taxis. This consolation may, however, turn to anger when it emerges that some of the best-rewarded City people pay little or no UK tax – the result of unwisely generous concessions on capital gains tax and liberal interpretation of rules governing residence and domicile. The massive rewards available in financial services are sometimes defended as the result of competition to attract talented people. The observation is true.

The City of London recruits many of the best minds in the country. In my experience, only a few top academics and lawyers rival the best minds in the City for raw intelligence. The mechanism that achieves this result is indirect. Massive rewards attract greedy people. If the number of greedy people is large, then financial services businesses can select the most talented among them. Within the City you find many who are greedy and talented, many who are greedy and untalented, but few who are talented but not greedy. Interest in ideas is generally secondary to interest in money. That is why these people are in the City.

So it is, unfortunately, necessary to be suspicious of the motives of everyone who offers you financial advice. There are people in the financial world whose concerns are primarily intellectual. You will find some in the finance departments of universities and business schools. Others are behind the scenes in banks and financial institutions, where they are described as ‘quants’ or ‘rocket scientists’. Modern financial markets are sufficiently complex, and the relevant analytic tools sufficiently sophisticated, for some people to find observation of these markets interesting for its own sake.

The good news is that the retail investor can take a free ride on all these skills and activities. You can be a beneficiary of the efficiency of financial markets. Efficiency has both a wide and a narrow interpretation. Financial markets, though costly and imperfect, have proved to be a more effective mechanism for promoting economic growth than central direction of production and investment. But in investment circles market efficiency has a specific technical meaning. That meaning relates to the ‘efficient market hypothesis’ (EMH), the bedrock of financial economics.

The professional expertise of everyone in financial markets is focused on the value of stocks and shares, bonds, currencies and properties, and on advising on when to buy and sell. These market prices reflect a consensus of informed opinions. The information that Vodafone is a successful company or that the economy of Venezuela is in a mess is known to everyone who trades Vodafone stock or Venezuelan bolivars. The efficient market hypothesis posits that all such information is absorbed in the market-place – it is ‘in the price’. The market is a voting machine in which the opinions of all participants about the prospects of companies, the value of currencies and the future of interest rates are registered, and the result is publicly announced. The corollary of the efficient market hypothesis is that the results of the painstaking research of everyone in the City are available to you for free.

If that conclusion seems startling, and it should, then imagine going to an auction – a fine-wine auction, for example – dominated by professionals. At first, you might be intimidated by the assembled expertise. But if you behave prudently, the dominance of professionals ensures you can’t go too far wrong, because their bids will be the main influence on the price you pay. You may not be convinced by this analogy. You may fear that there will be collusion amongst the dealers at the auction, that the market is rigged against the little guy. You may well be right.

Fifty years ago you would have been justified in having similar suspicions about securities markets. But, over recent decades, extensive public resources have been devoted to securing the integrity and transparency of financial transactions. This is partly because of popular revulsion at corrupt and fraudulent practice, and also because a reputation for honest dealing, or at least more honest dealing than is found elsewhere, is a real competitive advantage in international markets, in which the City trades so successfully. These regulatory provisions don’t work perfectly, and never will. When you trade, your broker must normally secure ‘best execution’, which means you get the best price available in the market. The reality is that a bank dealing on its own account will often do better. But not so much better. The edge that the skilled and experienced buyer may have can be more than offset by the advantages you have in trading for yourself. You have greater knowledge of your own needs, you know that you can trust yourself. Best of all, you don’t have to pay yourself. Your bonus is already in your pocket.

What being a day trader involves

Make money from the comfort of your home! Be your own boss! Beat the market with your own smarts! Build real wealth! Tempting, isn’t it?

Day trading can be a great way to make money all on your own. It’s also a great way to lose a ton of money all on your own. Do you have the fortitude to face the market every morning?

Day trading is a crazy business. Traders work in front of their computer screens, reacting to blips, each of which represents real dollars. They make quick decisions because their ability to make money depends on successfully executing a large number of trades that generate small profits. They close out their positions in the stocks, options, and futures contracts they own at the end of the day, which limits some of the risks — nothing can happen overnight to disturb an existing profit position — but those limits on risk can limit profits. After all, a lot can happen in a year, increasing the likelihood that your trade idea will work out, but in a day?

You have to be patient and work fast. Some days offer nothing good to buy. Other days, every trade seems to lose money. The individual human-being day trader is up against a tough opponent: high-frequency algorithms programmed and operated by brokerage firms and hedge funds that have no emotion and can make trades in less time than it takes to blink your eye. If you’re not prepared for that competition, you will be crushed.

You may find that day trading is a great career option that takes advantage of your street smarts and clear thinking — or that the risk outweighs the potential benefits. Either is okay: The more you know before you make the decision to trade, the greater your chance of being successful. If you decide that day trading isn’t right for you, you can apply strategies and techniques that day traders use to improve the performance of your investment portfolio.

The definition of day trading is that day traders hold their securities for only one day. They close out their positions at the end of every day and then start all over again the next day. By contrast, swing traders hold securities for days and sometimes even months; investors sometimes hold for years. The short-term nature of day trading reduces some risks, because nothing can happen overnight to cause big losses. Meanwhile, many other types of investors go to bed thinking their position is in great shape only to wake up the next morning to find that the company has announced terrible earnings or that its CEO is being indicted on fraud charges. But there’s a flip side (there’s always a flip side, isn’t there?). The day trader’s choice of securities and positions has to work out in a day, or it’s gone. Tomorrow doesn’t exist for any specific position. Meanwhile, the swing trader or the investor has the luxury of time, because it sometimes takes a while for a position to work out the way your research shows it should.

In the long run, markets are efficient, and prices reflect all information about a security. Unfortunately, a few days of short runs may need to occur for this efficiency to kick in.
Day traders are speculators working in zero-sum markets one day at a time. That makes the dynamics different from other types of financial activities you may have been involved in. When you take up day trading, the rules that may have helped you pick good stocks or find great mutual funds over the years no longer apply. Day trading is a different game with different rules.

Professional traders fall into two categories: speculators and hedgers. Speculators look to make a profit from price changes. Hedgers look to protect against a price change. They make their buy and sell choices as insurance, not as a way to make a profit, so they choose positions that offset their exposure in another market.

As examples of hedging, consider a food-processing company and the farmer who raises or grows the ingredients the company needs. The company may look to hedge against the risks of price increases of key ingredients — like corn, cooking oil, or meat — by buying futures contracts on those ingredients.

That way, if prices do go up, the company’s profits on the contracts help fund the higher prices it has to pay for those ingredients. If the prices stay the same or go down, the company loses only the price of the contract, which may be a fair tradeoff to the company. The farmer raising corn, soybeans, or cattle, on the other hand, benefits if prices go up and suffers if they go down.

To protect against a price decline, the farmer would sell futures on those commodities. His futures position would make money if the price went down, offsetting the decline on his products. And if the prices went up, he’d lose money on the contracts, but that loss would be offset by his gain on his harvest.

The commodity markets were intended to help agricultural producers manage risk and find buyers for their products. The stock and bond markets were intended to create an incentive for investors to finance companies. Speculation emerged in all of these markets almost immediately, but it was not their primary purpose. Day traders are all speculators. They look to make money from the market as they see it now. They manage their risks by carefully allocating their money, using stop and limit orders (which close out positions as soon as predetermined price levels are reached), and closing out at the end of the night. Day traders don’t manage risk with offsetting positions the way a hedger does. They use other techniques to limit losses, like careful money management and stop and limit orders.

Markets have both hedgers and speculators in them. Knowing that different participants have different profit and loss expectations can help you navigate the turmoil of each day’s trading. And that’s important, because to make money in a zero-sum market, you only make money if someone else loses.

A zero-sum game has exactly as many winners as losers. And options and futures markets, which are popular with day traders, are zero-sum markets. If the person who holds an option makes a profit, then the person who wrote (which is option-speak for sold) that option loses the same amount. There’s no net gain or net loss in the market as a whole.
Now some of those people buying and selling in zero-sum markets are hedgers who are content to take small losses in order to prevent big ones. Speculators may have the profit advantage in certain market conditions, but they can’t count on having that advantage all the time.

So who wins and who loses in a zero-sum market? Some days, whether you win or lose all depends on luck, but over the long run, the winners are the people who are the most disciplined: They have a trading plan, set limits and stick to them, and can trade based on the data on the screen rather than on emotions like hope, fear, and greed.

Unlike the options and futures markets, the stock market is not a zero-sum game. As long as the economy grows, company profits grow, which in turn lead to growing stock prices. The stock market really has more winners than losers over the long run. That doesn’t mean that any given day will have more winners than losers, however.

In the short run, the stock market should be treated like a zero-sum market. If you understand how profits are divided in the markets that you choose to trade, you have a better awareness of the risks that you face as well as the risks that the other participants are taking. People do make money in zero-sum markets, but you don’t want those winners to be making a profit off you. Some traders make money — lots of money — doing what they like. Trading is all about risk and reward. The traders who are rewarded risked the 80 percent washout rate.

Knowing that, do you want to take the plunge? If so, read on. And if not, read on anyway, because you may get some ideas that can help you manage your other investments.

Being disciplined: Closing out each night
Day traders start each day fresh and finish each day with a clean slate. This daily regimen reduces some of the risk, and it forces discipline. You can’t keep your losers longer than a day, and you have to take your profits at the end of the day before those winning positions turn into losers.

That discipline is important for day traders. When you day trade, you face a market that does not know and does not care who you are, what you’re doing, or what your personal or financial goals are. There’s no kindly boss who may cut you a little slack today, no friendly coworker to help you through a jam, no great client dropping you a little hint about her spending plans for the next fiscal year. Unless you have rules in place to guide your trading decisions, you’ll fall prey to hope, fear, doubt, and greed — the Four Horsemen of trading ruin. So how do you start?

One of the first steps is for you to develop a business plan and a trading plan that reflect your goals and your personality. Then you set your working days and hours, and you accept that you’ll close out every night. As you think about the securities that you’ll trade and how you may trade them, you’ll also want to test your trading system to see how it may work in actual trading.

Being a day trader is rewarding but carries a lot of risks. If you do decide on that route, keep yourself informed and know what you are letting yourself in for!

A beginner’s guide to the stock market

If you are going to invest through the stock market, we had better start with what it is that you are actually buying. You will be buying what are known as ordinary shares. You, together with all the other investors who have bought shares in a particular company, will become the owners of that company. You have a right to a say in the decision making and you share the profits through the payment of dividends.


These shares are often referred to as equities. They represent ownership of the company, just as you have equity in your house: the percentage of your house that you own when the building society’s loan is deducted. The names of the shareholders and the number of shares held will be kept on a share register. Each time a batch of shares changes hands, the new shareholder will be recorded on the register.


There is a difference between running a company and owning it. The day-to-day running of the company will be carried out by a board of directors who may act as if they own the company but they do not. It is you, and the other shareholders, who are the owners. The directors do have the right to own shares. Indeed it is normal for them to buy shares as a show of faith in the company they are running. They have exactly the same rights as shareholders as you do. Shareholders have the right to attend an annual meeting where they can question the executives who run the company, to receive accounts at least twice a year and to vote for who will be the directors and who will be the auditors. They can approve or veto any proposed major acquisition of another company or the proposed sale of a major part of the existing business.


The number of votes you have and the size of your share of the profits depend on how many shares you own. If you have 1,000 shares in Marks & Spencer and someone else has 10,000 shares then they have 10 times as many votes as you do and they will receive 10 times as much in dividends. Every share carries one equal vote.


In the United Kingdom the two terms stocks and shares have become virtually synonymous. The Americans tend to refer to stocks but they are talking about the same thing as our shares. Each share has a nominal value. This was the value of each share when the company was originally formed. If you have a penny black stamp in your possession, it was originally issued back in 1840 for 1p. That is its face value, not its value today. It can be sold for whatever a stamp collector is prepared to pay for it. Similarly you should not expect to pay the nominal face value of a share. You have to pay whatever price the share commands on the stock market.


Where do shares come from? In the first instance, shares are issued by the company when it is set up. Investors put money in to get the company going. Premises have to be bought or rented, machinery may be needed, staff have to be paid, materials bought … all this before any money comes in from customers. In return, the investors are allocated a stake in the company. Money, or capital as it is referred to, is one of the many inputs that a company needs. Capital can come through the founders putting their hands in their pockets, from taking out bank loans or from selling shares.


The issuing of new shares by the company is known as the primary market because it is the first time that the shares have been allocated to investors. When these shares are subsequently bought and sold on the stock market, that is the secondary market.


Think of it this way. When a builder puts up a house and sells it for the first time, this is the primary market. When the house is sold on to new owners, that is the secondary market. It is exactly the same with shares.


Issued capital

How many shares a company issues is decided by the company itself. There is no fixed number of shares. The number of shares will depend basically on how much capital the company has needed to raise, not only when it was first set up but also at any time subsequently. The shares that have actually been sold by the company to shareholders are the issued share capital (this is also referred to as the called-up capital). Do not expect a conveniently round number.


For example, high street retailer Marks and Spencer in its 2011 annual report had an issued capital of 1,584,863,882 shares. Part paid shares When you buy shares you will almost invariably have to pay up the full amount due immediately but on very rare occasions you may pay for the shares in instalments.


Investors who bought shares in the privatisation issues, when the government was selling off state enterprises, may recall that in some cases payments to the government were made in instalments; the idea being that more ordinary investors would be tempted to join the great share owning democracy if they could pay in manageable bits, just like buying a washing machine in monthly instalments. This is a very messy and expensive arrangement, since some shareholders inevitably forget by the time the third payment is due or they simply do not have the cash. Either way they have to be chased up, which is why part payments rarely happen.


A and B shares

We have assumed so far that you will be buying ordinary shares and that these will rank equally with each other. Each ordinary share has one equal stake in the company and one equal vote. There is one exception to this, and that is where there are two classes of ordinary shares known as A shares and B shares. In the past, some family-owned companies tried to get the best of both worlds, raising cash by selling shares but retaining family ownership by the rather sneaky method of having two classes of shares. One class of shares, usually the A shares, had one vote each and were sold to the general public while the other class, usually the B shares, had 10 votes each and were issued to the family. Thankfully this subterfuge is now regarded as unethical and has all but disappeared. The best known name that still treats the public unfairly with two classes of shares is that bastion of moral rectitude, newspaper publisher Daily Mail & General Trust.


Its A shares, the ones most widely traded on the stock market, have no votes although there are nearly 400 million of them, while the 20 million ordinary shares control the company.


Technically you can also buy the ordinary shares on the stock market but don’t bother looking for them; they are rarely traded and just two shareholders held 88.8% of them according to the 2011 annual report. A and B shares used to be widespread in the brewing industry and two examples survive, though not to the detriment of ordinary shareholders.


Youngs A shares with full voting rights are the ones traded on the stock market and not the ordinary non-voting shares; Fullers A shares, also with full rights, are the ones that are traded and not the B shares with only a tenth of a vote each. Royal Dutch Shell has A and B shares but these have equal rights and the split exists only because Shell is an Anglo-Dutch company. The A shares are for Dutch investors and the B shares for those in the UK.


During privatisations you may have come across the Government’s golden share, which was the ultimate B share. The Government hung on to one share in each privatised company, which could be used to outvote all the other shares put together. This golden share was retained in case the Government felt it needed to intervene in the national interest. Golden shares were used in the UK as a veto only twice and the European Court of Justice has ruled that they are against European law unless national interest is clearly at risk. They can now be disregarded.

Preference shares

There is one other class of shares apart from ordinary shares and they are called preference shares. These are in fact more like loans than shares. Preference shareholders do not have voting rights except on issues that specifically affect them. They receive a set rate of interest, usually twice a year, just as you would receive a rate of interest on a savings account in a bank or building society. It is possible to buy and sell preference shares on the London Stock Exchange in the same way that you buy and sell ordinary shares, although not all companies issue preference shares.


Dividends on preference shares must be paid before dividends on ordinary shares and if the company goes bust any cash left over when the creditors have been paid off goes to the preference shareholders first. That’s why they are called preference shares.


However, we naturally hope that our investments have gone into prosperous enterprises. While the poor preference shareholders are stuck with a fixed rate of interest, we, the ordinary shareholders, see our dividends rising along with the profits of the company. Investors who take the greatest risk expect to receive the greatest reward, and this does tend to happen although there are no guarantees.



Companies raise money by taking out loans, usually by borrowing from the bank through overdrafts or term loans, which are loans for a set number of years. They may also borrow from the general public by issuing loan stock, also referred to as bonds, in much the same way that shares are issued except that holders of loan stock do not own the company. Some loans can be converted into ordinary shares. These loans are known as convertibles. The terms on which they can be converted, and the dates at which conversion is allowed, will have been set out when the loans were issued. If the loans are at any time converted into ordinary shares, these shares will carry exactly the same rights as those of existing ordinary shares. Preference shares may be convertible into ordinary shares and will thus be convertible preference shares.