Bring a trader's mindset to your investing

Private investors are having a tough time of it lately, faced with poor returns from their savings accounts and investments in an often depressing economic climate.

During difficult times, it's easy to start wondering whether you're using the right investment strategy or the best judgment when it comes to buying and selling holdings.

Professional traders seem to have extra tools at their disposal and an innate sense of when to buy and sell. Is there anything a private investor could learn from how traders work and could a portfolio be perked up by employing a trader's mentality?

The trading profession has taken a battering over the past few decades. The 1987 film Wall Street portrayed a "Gordon Gekko" mentality, where "greed is good". More recently, rogue traders falling from grace - Jerome Kerviel and Kweku Adoboli were given prison sentences for unauthorised trading while at Société Générale and UBS respectively - have further tarnished the image of the City whizzkids.

Justin Urquhart-Stewart of Seven Investment Management says: "Trading has always had the air of excitement, but in reality creates the same buzz as a punter at the races. Investment and trading are very different in the role and action, and as a result need a very different mindset."

He adds: "The investor would usually be regarded as having a longer-term view rather than the trader buying and selling on a regular basis. Any conversation with a spread-betting firm will show that most of their clients lose money, but in effect become hooked on the short-term buzz of being able to make a quick buck."

Neil Shillito, financial planner and wealth manager at SG Wealth Management, emphasises the importance of a long-term strategy for private investors who are trading the markets.

He comments: "Investors need to concentrate on capital preservation as well as gain. Trading with leverage, for example, offered by spread betting companies, carries acutely high levels of risk."

Tricks of the trade

However, there are certain skills and tricks of the trade that Shillito says private investors can learn from traders.

Technical analysis is one such area. Traditionally used by large investment houses but now made accessible because of the internet, chart analysis can be a useful way of managing risk.

"One way of making informed investment choices is by using charts because the chart price line is a perfect record of the mood, news and expectations for the future based on all the news available. Learning about disciplined use and analysis of charts is not for all but it can help put investors on the correct side of probability for making successful investments," notes Shillito.

Zak Mir, author of 101 Charts for Trading Success and senior analyst at the Institute of Trading and Portfolio Management, is another big fan of charting. He thinks the best way of understanding the psychology of the market is "to look at the price action, which is the emotional audit trail of your fellow trader/investor".

Mir says: "It follows that if you can tell what state of mind a trader is in, you are more likely to be able to second guess their next move in the market and hence whether you should be buying or selling. For instance, so-called price gaps - areas on a chart where there have been no trades - can indicate panic/surprise."

He uses the example of Tesco's January 2012 profits warning, which showed the value of charts in revealing the mentality of the market: "The shares moved own from an overnight 385p to an open of 349p on 12 January. A couple of sessions later the stock was at 311p. The gap down indicated panic selling and traders caught on the hop - and was therefore a great weapon in gleaning the psychology of the market at the time."

John Piper, one of the UK's most experienced indepenent traders, and author of The Way To Trade, agrees with Mir. He says: "The actual determinant of market action is buying and selling; this ultimately governs price, so if you want to understand the markets you need to focus on this factor, along with the following that affect buying and selling: availability of cash, positions already in place, the economy, feel good/feel bad factors and news flow."

Mike McCudden, head of derivatives at Interactive Investor, says when he started out "it didn’t matter how much education I was offered. I chose to learn the hard way and let my emotions do the trading.

"But as they say, you learn from your mistakes and nothing from your successes. Many aspects of trading discipline you can only learn from experience, but if I could turn back the clock I would have spent more time mastering the basics of technical analysis and fundamental research."

Investment clubs

Private investors can also set up investment clubs and focus on smaller trades. "If it goes wrong then it may be disappointing but it’s not a disaster," according to Urquhart-Stewart. "For those starting off the best way to learn is by setting up your own investment club with some friends and putting in say £50 per month. That way you share the risk but learn what to do and how to do it."

He adds: "The secret though of good investment clubs is to focus on, say, six stocks and just follow those. Often big companies with liquid trading and lots of news are the best to follow and very quickly the group will build up a healthy level of expertise."

Despite the growth in seminars and trading academies in recent years, Louise Cooper, financial analyst at CooperCity, believes the professional trading mindset can't be taught as ultimately trading is about removing emotion from investing: "I believe the ability to think like a successful professional trader is an ingrained personality trait. Essentially what trading profitably requires is to be able to make decisions unaffected by emotions. And that is a lot more difficult than it sounds because when it comes to money, very few of us are unemotional."

So what lessons can the individual take from the traders? It is arguably difficult and also unwise to think and behave exactly like a City trader whose job it is to trade huge amounts of other people's money on a daily basis. Looking to preserve wealth and aiming for modest profits is more important than chasing big financial gains - which, as former star traders can attest, can often lead to big losses.

But there are opportunities to become educated about the technical aspects of the market, via seminars and academies or by studying charts, and coupled with a long-term strategy, it could give your portfolio a boost.

An investor's view: The benefits of not getting greedy

Ian Pollard, a retired solicitor, has been investing and trading in shares since 1968. In 1996, he moved to Greece where he set up his own online real estate business called HiddenGreece.net.

Pollard is a fairly frequent online trader and uses Traders Own (tradersown.co.uk), a website that combines a social media and networking platform with a share dealing and Isa service.

Pollard admits that he is "neither a wealthy nor a big investor" and his "trades are comparatively small". He says: "I am not interested in dividends for income. I regard any capital gains that I make as additional income, or even, on a good day, as savings and achieving that, I regard as a challenge.

"I keep a close watch on the shares that I follow, looking for trends and signals. I believe the charts do reveal a lot of information that can help in making investment decisions. Basic investment advice such as Warren Buffett's 'buy when there is blood on the streets' is one of my guidelines."

One of his better short-term successes was Petra Diamonds, bought in September 2010 at 71.4p and sold four months later at 149p. A smaller one was Asian Citrus bought at HK$7.81 (64p) and sold two months later at HK$9.42 (78p). Pollard has since bought back into Petra at 108p and hopes for a steady if not spectacular rise. Another hope is Sirius Minerals, bought at 18p and now at 25p. He expects good news flow and resource updates to keep the price firm.

Pollard says he is constantly reminding himself not to be too greedy. If you can make 20% in a few weeks or even a few months and then reinvest and do the same with another share, you are doing very well, even taking into account the inevitable losers. He adds: "Nothing goes up for ever and market makers always win in the end, so take it while you have got it."

Pollard is dubious about reading "tipsters" to get some understanding of the financial markets. He says: "Cynicism mixed with suspicion is the appropriate attitude there."

On rules of trading, he does admit that he has one rule he always breaks and that is "to bail out of any share that reaches a 10% loss. That is something to do with the psychology of not wanting to admit to having made a mistake. If I had stuck to that rule, I really would have been a wealthy investor making big purchases."