Transcript STEP FOUR:

What is Portfolio Management?
Portfolio management is important as it means getting the maximum
from one's share investments. Remember, you main goal is to
maximize wealth by maximizing returns (i.e. portfolio strategies) and
to minimize risk (portfolio management).
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Portfolio Strategy - You need to decide if you are an investor or a trader? If you
are more the conservative type investor or have a longer-term outlook, then you
may consider the buy and hold strategy to investing on the share market.
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Buy and hold strategy - The objective is to develop your investment portfolio and
only make adjustments when absolutely necessary. This strategy is often the most
sensible and least risky strategy to choose. The medium to long term buy and hold
strategy will almost always outpace inflation.
If you are more the aggressive-type investor or have a much
Shorter term outlook, then you may consider the swing
trading strategy or even shorter jobbing strategy.
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Swing Trading Strategy - This is a more leisurely version of jobbing, where the
objective is to climb in at the bottom and jump off at the top. Timing is the critical
success factor.
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Jobbing Strategy - Jobbing is enjoyed by bold speculators who seek excitement. It
is a process of jumping in and out of shares and taking advantage of very small
price movements. Jobbing requires an active ear to the ground, an in-depth
knowledge of the share market and takes up more time. Here you have to be
careful from a tax point of view as you may classified as a share dealer and be
taxed accordingly.
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People invest in the share market because of the potential for high returns, but
this comes at a price. This price is the higher risk associated with share market
investments compared with, for example a fixed deposit with a bank. To reduce
risk, one basic principle of portfolio management is diversification.
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Diversification means to spread your capital among different shares and
industries. By doing this, one reduces the risk of losing money if things should go
wrong with a particular share or shares. "Concentrate" one's portfolio by carefully
choosing between 6 and 12 shares across 3 to 5 sectors.
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Portfolio structuring is similar to diversification, but instead of spreading holdings
across market sectors, you diversify your portfolio in terms of quality and time
frame. The classic traditional portfolio consists of a well-balanced selection of "bluechip" shares that are held indefinitely. This tends to minimize risk, but does not allow
for exceptional returns. Portfolio structuring attempts to improve the return on a
portfolio without increasing the risk.
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The typical structured portfolio should have the following:
• 50-70% would remain in blue-chip shares (i.e. Top 40 shares) with a long-term
view.
• 20-40% would be placed in growth shares (i.e. Mid Cap shares) with a mediumterm view.
• 10-30% would be used for active trading in speculative shares (i.e. Small Cap
shares or warrants) with a very short-term view (i.e. maximum 3-months).
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The biggest enemy in the share market is human emotion (i.e. greed & fear).
The biggest challenge to you, as an investor, is to remain objective.
One way to eliminate human emotion is to apply a stop loss strategy.
Just as a seatbelt is there to protect you in your car in the event of an accident, so
does the stop loss strategy attempt to protect you, the investor, from the
unexpected.
When it comes to successful share market investment, it is not so much a story of
capital gains that is important, but rather one of avoiding capital losses.
The major function of a stop loss strategy is to limit your losses to a predetermined amount. This is an essential tool for traders, speculators or short-term
investors.
Most successful long-term investors snub the use of stop loss strategies, as they
rather limit their downside risk by proper diversification, hedging and detailed
fundamental research.
However, traders normally lack any wide diversification, as well as detailed
fundamental research and therefore need some other method of safeguarding
their capital.
A successful trader has to have an extremely strict selling discipline.
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A long-term investor can be right at the wrong time if he has patience.
A trader who is right at the wrong time, however, is not a trader for very long.
Traders that see a share fall and then decide to hang on to the share, pretty soon
lose their capital.
A good trader is an opportunist who risks his capital with the object of making a
large profit within a small period of time.
If the position turns against him he should cut his losses or take his profits
immediately and move onto to another position.
He can not afford to base his future on the vague hope that he will be proven
right and the share will recover at some later stage. A trader can not afford to have
his capital locked into a position that is not working for him, this capital should
reallocated to a more profitable position.
A stop loss strategy automatically fulfils this function.
After buying a share the trader should determine the loss he is prepared to take
(normally between 10-20%) and immediately place a stop loss order. For example
if he decides the maximum loss he is willing to accept is 10%, and then buys a
share at 1000cps, then he should place a stop loss order to sell if the price is
smaller or equal to 900cps. If the share price now falls to 900cps or below, the
trader should immediately give an order to sell the shares at the specified price.
Depending on the liquidity of the share he should then have sold out at a 10% loss.
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Another and actually better method is to
place an automated trailing stop loss order
at say 10%.
This means that as with the above example if
the share drops by 10% an order will be
placed to sell out at 900c.
In addition, if the share increased to
1500cps, the stop loss will automatically trail
the share price and the new stop loss order
will be at 1350cps (10% or 150c below the
current share price of 1500cps).
When the share now drops 10% from its
high, a sell order will automatically be
generated at the new stop loss of 1350cps.
The same applies when the share price has moved higher to 2000cps.
The stop loss order will trigger when it reaches 1800cps. In this
manner the trader is able not only to limit his losses but also to lock
in profits. This is a strategy that every trader should consider to
ensure his longevity in a sometimes very volatile market.
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Have you established whether you are a conservative investor or an aggressive
trader?
Have you decided to use the Buy and Hold Strategy if you are a conservative
investor?
As a conservative investor, have you established the portfolio structure along the
lines of good quality blue chip shares with a long-term view?
As a conservative investor, have you established the portfolio diversification along
the lines of different industries and different sectors?
As a conservative investor, have you decided upon what factors would cause you
to sell your long-term buy and hold shares?
As an aggressive trader, have you decided whether you would use the Swing
Trading Strategy and/or the Jobbing Strategy?
As an aggressive trader, have you established the portfolio diversification along
the lines of different industries and different sectors?
As an aggressive trader, have you decided on the portfolio stop loss strategy?
Step #4 would have provided you with knowledge on how to
build a diverse portfolio whilst managing your risks.
Essentially all of these steps together form the foundation for any good investment
strategy. The more you are able to apply and put into practice using these investment
methods you will be able to make more informed trading decisions. Ultimately, the
more time you spend on mastering these steps the more likely you are to be successful
and profitable in your wealth creation endeavors.
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There are four steps to choosing your first shares, namely:
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Narrow down the choice;
Gather information;
Get your timing right; and
Build a balanced portfolio
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There are four methods to use when prospecting for interesting-looking shares, namely; Top-Down Method,
Using Financial Journalism, Using Fundamental Analysis and Using Technical Analysis.
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The two most important factors to watch when it comes to the "big economic picture" are: Inflation rates; and
Interest rates.
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There are many financial ratios, but the most important ones are: HEPS Growth %, Turnover Growth %,
Operating Margin %, Interest Cover, Effective Tax Rate %, ROE %, Debt/Equity ratio, Cash/EPS and ROC%.
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Some basic technical analysis includes: Trends and Cycles analysis; the use of Price Charts (Closing Line Chart
and Bar Charts) and technical analysis indicators such as Moving Averages (21 & 40-day Simple Moving Average
crossovers), the OB/OS indicator, the Momentum indicator, the RSI indicator, the Slow Stochastic indicator, the
MACD indicator and the Volume Indicators such as the OBV and VPT indicators as well as the Relative Strength
indicator.
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There are three ways to invest using portfolio strategies, namely: Buy and Hold, Swing Trading and Jobbing.
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There are three ways to manage the risk in a portfolio, namely: Diversification, Portfolio Structuring and Stop
loss Strategy
We would really appreciate any feedback with regards the general format of
this tutorial. Please send your comments to: [email protected]
Thank you for your support and happy share trading!
Shaun van den Berg
Head of Investor Education / Technical Analyst
PSG Online