Think to yourself – have you ever made an investment loss which you could have sold for a profit?
If you answered yes to this question, you’re not alone. 99.9% of investors have done the same thing.
Even the best investors make mistakes. But they’re successful because they learn from their mistakes.
One of my investment mentors said to me, ‘it’s the absence of big losses, not the big gains, that makes an investor truly successful‘.
This quote transformed my life as an investment analyst.
It made me truly understand the importance of capital preservation. I then became obsessed with understanding the true risks behind each company.
I can assure you that 99% of investors don’t understand the real concept of risk (even after they lose money). This is why many people continue to repeat their mistakes as they spend all their time thinking about the reward, and rarely think about the risks.
Well, I take protecting your capital seriously. My goal as resource analyst for Diggers & Drillers is two-fold: 1) Helping my readers make money and; 2) Helping them protect their capital.
In fact this is what Diggers & Drillers investment director Kris Sayce wrote in a previous weekly update:
‘Let me address one point made by subscriber John where he wrote, ‘OK [the previous] recommendations mainly fell over but it was due to being a victim of the times.’
‘John may be fine with stocks that turn into losers, but I’m not. While it’s impossible to pick a winner every time, we’re not happy with the idea that investors should be ‘victims of the times’.‘
Too many analysts and investment advisors take that view. They lap up the praise when a stock idea goes well, and then claim they are a ‘victim of the times’ when a stock idea goes bad.
There are plenty of great investors who have blown themselves up by not properly considering the risks.
Look at Jesse Livermore; he could have been one of the greatest investors of all time (some even argue that he is). Livermore started with nothing and by 1929 had an estimated net worth of US$100 million (or over one billion dollars in today’s value)…before going on to losing it all due to ignoring his risk principles.
Stock markets are volatile. Prices can quickly rise and fall. As a result, we publish what we call a ‘buy-up to price’ with each recommendation in Diggers & Drillers. I take the buy-up-to price seriously, and so should you.
A buy-up-to price is similar to what Warren Buffett calls his ‘margin of safety’.
A ‘margin of safety’ is a share price that an investor should pay which is significantly below its intrinsic value. This will minimise the risk of investment losses and maximise the opportunity for gains.
The ‘buy-up-to price’ isn’t a randomly selected share price. From the hours of research I spend analysing stock recommendations, I attempt to comprehensively understand the investment risks.
As such, the buy-up-to price reflects the maximum price you should pay for taking on the level of investment risk.
Let me briefly explain my thought process when recommending the buy-up-to price.
In the February issue of Diggers and Drillers, I recommended a small-cap energy company. In the report I flagged the key risks investors should keep in mind before buying the stock.
At the time of recommending the stock, with the share price closing at a few cents, I set a buy-up-to price slightly higher.
Considering the risk for reward, this was the margin of safety I recommended readers buy in at. But the share price shot higher overnight and, based on that price, the risk far outweighed the reward.
Sure, possible future events could double the stock’s share price, but equally readers could lose up to 50% of their investment if nothing happens. And if readers bought at the higher price (which none should have done, following my buy-up-to price), which is more than 20% above my suggested maximum buy price, they’ve just increasing their risk.
For readers to invest in this new recommendation on the off chance that it dips to or below the maximum buy price, one option is to set a limit order at or below the buy-up-to price. Online share trading platform will give easy instructions for placing limit orders.
Considering the high volume and share price rally, I wouldn’t be surprised if the share price did fall below the maximum buy-up-to price. That little bit of patience could make a huge difference in protecting investor’s capital.
I hope that makes things clear and that you understand the importance of buy-up-to prices. It’s a strategy that Kris implemented nearly four years ago in Australian Small-Cap Investigator, and they have worked to good effect to make sure you don’t overpay for a stock.
Next week I will discuss some of the investment strategies for the Diggers and Drillers buy list, such as knowing when to sell, an important part of any investor’s strategy that is often overlooked.
Jason Stevenson+
Contributing Editor, Money Morning
Ed note: The above article is an edited extract from Diggers and Drillers.
