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INVESTING

Can you actually make money through speculation?

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Warren Buffet warns don’t listen to forecasters – they are journalists and stock brokers whose hands have never been burnt in the market doing the actual business, but rather have lived on the reporting aspect of the market

Ken wakes up in the morning and looks at the newspaper. He has been tracking the Crown Berger counter for over a week now, after buying it when the price fell. The price has been stagnant for the last one week and it gives him the jitters. His deal last month was not as good as the one for three months before. The trend is not good.

Like a great majority of Kenyans, Ken is a speculator. He watches the market closely, buys counters when prices are low and sells them when the prices rise. Speculation is the art of buying shares at current prices hoping the prices will rise then you sell off and make a fortune. Indeed it is practiced by many Kenyans who do it for a living.

So how does it work? First, one has to know the market well. Which shares are prone to big movements? Which ones are seen to be growth counters? Which ones are undervalued? Etc. When these facts are internalised, then the trader raises capital depending on capacity. He then opens an account with a stock broker and deposits some money in the account. When the prices fall to a comfortable level, he starts to trade by buying in the preferred counters. He then follows the market fluctuations closely, and immediately the prices rise to the target price, he sells them.

A livid case of speculating is when an Initial Public Offer (IPO) is in the offing. People tend to like these IPOs because of the assumption that when the shares are finally floated at the market the prices will rise – as they did during the Kengen IPO. Indeed, as is the case with speculation not all IPOs have behaved in the same manner. The Safaricom IPO for which some even took loans indeed disappointed many Kenyans. The expectations were high, yet the performance on the first day of trading did not meet these expectations. 

How speculation works

Here, the only principle that applies is buy low, sell high. So what influences the speculator’s decision on how, what and when to buy?

It is believed that a speculator is mainly influenced by what we call the gambler’s fallacy. The fallacy states that because a counter performed well in the past, it follows that it will perform as well in the future. Of course this is a misrepresentation of facts, even as depicted by the story of Goldman Sachs.

To the point that a speculator is influenced by the gambler’s fallacy, I would agree. For one to be able to hope for a rise in the future, he must be informed by precedence.

There is also a group that follows forecasters. It must be understood that the forecasts are usually right only 30 percent of the time. In other words, you are better off throwing a coin than trusting them. Most of these forecasters are journalists and stock brokers whose hands have never been burnt in the market doing the actual business, but rather have lived on the reporting aspect of the market. Warren Buffet says, don’t listen to them.

Thirdly, there is the gut feeling. There are those of us who uses non intelligent means like feelings, premonitions etc. Indeed this could be a good thing in handling men or women, but not the stock market. An investors responsibility of due diligence cannot be wished away and must be employed well in decision making. It just doesn’t work.

Ultimately, what works in the market never works for speculation. In the market, one needs to have information on a certain counter before making a decision to buy it. The information sought include capital base, turnover, past performance, industry indicators and government policy affecting the business. This is what we call fundamentals. The fundamentals will inform the buyer on the company’s growth trajectory.

Given the above, it would probably pay off to say speculation is not a good way to invest as one never has time to take all factors into consideration.

Should you speculate?

Many investment advisors do not regard speculation as an investment. The reason being, it is hardly rational and does not fit into the traditional sense of the word. To them, and I agree, speculation is gambling. It could work, or not.

In essence, any market has cycles of bullish and bearish periods. Market timing is a term coined by speculators to make one believe that these periods can be forecasted. Truly, they are sure to occur, but cannot be accurately foretold, at least for now. Market timing has proved to be primitive, inconsistent and unyielding. Yet it would deny the investor dividends, compounding growth and the windfall benefits that accrue in time with the investment.

Any investment needs time, stocks included, to give forth returns. A long term investor will thus give time to his investment to grow and not attempt to time the market. A stock investment must be given at least 5 years to mature. Of course there are instances where returns come much earlier, however a good counter will not give zero/negative capital growth curve after 5 years. When one follows this approach, temporary market hitches do not shock him.

When all is said and done, speculation remains just that, and not an investment. Of course, as is the case in gambling, some have been successful and have reported great rewards. But these cases are few and isolated while the case of those who felt cheated are higher. It is important for one to build a formidable investment portfolio. Speculation does not allow one to do this as the rationality is usually below par. Rather than speculate, I would advise an investor to have a long term perspective, invest wisely and take on the market dances as they come.

Ultimately, investment is not about analytical smartness, but rather a disciplined character of patience and perseverance.

 

 

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COMMENTS email 2
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Kenneth Mwangi Says:
August 20, 2010
All investment managers practice speculation. I do not agree with some comments in this article and it leaves a lot to be desired. Fundamental analysis (practiced by all fund managers in Kenya) is based on the idea that we can predict the incomes of the company under valuation. Technical analysis believes in predicting the future (mean reversion) we know that does not work, unless its in forex trading where all traders are using technical analysis so there is self fulfillment from their part. Lastly, Berkshire Hathaway on August 5th announced it would mark down $3b worth of put options and their exposure to mortgage backed securities, tells a different story about speculation. So sorry but there is a lot which is a miss in this article....
   
Evans Okello Says:
August 21, 2010
Very educative to us young Kenyans, and i think we should take note before involving our selves to such speculative business. Thanks Odhiambo for sharing with us your ideas.
   

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