Clem Chambers, CEO of leading stocks and shares information site ADVFN.com, market commentator and author of novels and financial titles, including A Beginner’s Guide To Value Investing, answers your questions

Question for Clem:

“I am tempted to start trading low-cap shares on AIM and Plus. Any advice on how I can find bargains amongst the minnows?”

 

Clem answers:

When it comes to your money, the term ‘trading’ connotes danger.

Trading is to investing what rock climbing is to mountaineering. Even with the proper ropes and equipment, rock climbing has its risks. Yet mountaineering is a whole different ball game.

Trading should be reserved for very experienced investors – and most of them either don’t do it, or only dabble a little on the margins.

So firstly, let’s drop ‘the T-word’.

For a start, small caps are expensive to buy and sell. They are also hard to get in and out of. As little as £5000 put into a small company can move the price. That move is not going to be in your favour.

This doesn’t kill small cap companies for investment but it means that you have to be looking long term. In the long term they can be excellent investments.

Beginner investors often don’t understand the hidden costs of buying and selling shares. A £20 trade in a £500 investment for example is a 8% cost (when the buying and selling total is £40).

That’s a big hurdle to clear. It drops to 4% if you buy £1000 worth and 2% if you buy £2000. So your investment size is important.

That’s just basic maths but many don’t understand the bid offer spread, the price you buy and the price you sell at is also key.

There is always a bid and offer, the price you buy at is always higher than the price you can sell at.

If the bid and offer is 90-100, you will be buying at a hundred and selling at 90. That’s another 10% charge, which is hidden, it is another hurdle the share must rise for you to be in profit. So if you are planning to buy and sell a stock in two months like this, the cost is 18%.

Many small companies are in reality rubbish. They are just too small to do anything

You cannot make money like that. The costs are too high.

This is one of many reasons trading will only makes you poor.

However, all is not lost.

Small caps are high risk. That means the chances of failure are high. That means the rewards for success are higher. Like much in investing, what seems bad can be good and visa-versa.

The fact small caps are dangerous is why they pay, ON AVERAGE, better than big companies where the risk is lower.

Another reason small caps can be lucrative is that they are too small for there to be much interest in them, especially from the institutions. This makes them cheap. If they ever do get attention then their price zooms.

But many small companies are in reality rubbish. They are just too small to do anything or go anywhere or even be well run.

So the trick is to find small, well run companies, with a solid story and super management. Any other opportunities should be avoided.

Then you should buy a small stake, a £1,000 or more worth but less than you mind losing.

Then you have to repeat the selection process with the plan to buy many to diversify the risk of any one of them coming up dud.

If you carefully select 20 to 30 companies the impact of diversification will iron out the risks.

Alternately you can buy a few as a spice to a large stodgy portfolio. So if you have £100,000 of big caps you might buy 5-10 small caps for a total of £10,000 of added risk.

This sounds really boring and it is.

Excitement costs. It costs because the market charges you for all services rendered and when you get a kick out of trading or investing or owning a certain stock the market will make you pay for it. Most people take their payment in kind, which is why they trade. Trading is fun and expensive. You trade exciting stocks and by and large they will hurt you. This might sound supernatural, but the selection of stocks for excitement, like it does with horses, produces a short term price premium and this premium, when it disappears turns into a financial penalty.

So if you want to buy into small cap companies.

Plan to buy 20 or more over a period of time. 5 years is fine. Or to make them part of a portfolio strategy where they are a small component.

Use the internet and sites liketo research and find small companies that have a solid businesses, look cheap compared to bigger players, have a good balance sheet and impressive management. Select only the soundest. Read their reports and statements and judge whether you like the sound of the MD and Chairman.

Select a stock you can imagine holding for 1 to 3 years.

Then make sure their bid/offer spread isn’t outlandish.

If all the above works, then buy.

When it comes to AIM or PLUS, you should look to see how much information can be found on the company. PLUS is even more high risk than AIM but it also lack the kind of information that AIM stocks enjoy. For me this means I very, very, rarely buy PLUS stocks.

It is key to put your purchases into a portfolio tracking piece of software, like the one on www.advfn.com. Don’t leave your shares unattended, you need to watch them trade and grow, so you can take profits and weed out poor picks as you go.

That way as you build up a portfolio and watch it perform it will hone your skills and improve your stock picking. This is how to make good money in the market; old fashion hard work and diligence.

It’s sad to say but the more you risk the harder you have to work to make sure your investments are good. The stock market is a skill game mastered through practice, patience and diligence. Meanwhile in the end, only a portfolio can save you from your many justifiable and unavoidable errors needed to deliver the solid profit you deserve.