This report is not a personal recommendation and does not take into account your personal circumstances or appetite for risk.
Waiting for a share price to bounce reduces the remaining profit potential from a recovery rally. But as the price rises, so too does certainty about a rebound rally to your target. Correctly calling the bottom offers maximum profit, but it also comes at the point of maximum risk. Waiting for signs of a rebound reduces profits, but it also reduces risk. Patience may have its costs but it also has its benefits.
Think of it in a sporting context. At the start of the football season each team in the premiership has a theoretical chance of winning the league (bouncing and rallying). The odds of doing so will depend on track record: whether they have won, or come close before, dictates the odds and profit potential from correctly picking them as the season victor.
Some odds will be very long. Think newly promoted, e.g. no history of the shares finding support and bouncing, or whoever survived relegation last season. Some odds will be much shorter. Think regular contenders; e.g. bounced off clear support level several times.
As the season progresses, odds and profit potential will rise and fall as teams win, lose and draw each weekend. Anyone stretching out a sizeable points lead will see the odds of them winning the league shorten. This is akin to a share price bouncing, reducing the recovery distance and profits on offer if the shares rally back to prior highs. Anyone struggling each week, languishing at the bottom of the table, will see odds remain low, perhaps even worsen. This is like a share falling, finding support but showing no signs of a bounce, then treading water or, worse still, breaking even lower.
Calling the bottom before a rally will make you the maximum profit, but it also involves you taking maximum risk. Why not give up a small portion of the profits on offer? Why not wait for proof and more certainty that the shares do indeed want to bounce? Surely this is worth some patience and a small amount of profit forgone.
Calling it right at the beginning of the season may well gain you bragging rights in the pub come May. But is it worth a potentially wasted punt? You can have a flutter on the success of new players, a new manager or a newly promoted team in August (hoping for a bounce). You can place a wager on one of the serial top 5 finishers (history of bouncing off support).
But is it not worth waiting a few weeks, to see who’s really on form, showing signs of a genuine bounce? It’s not always easy. “Fear of missing out”, or FOMO, is a well known phenomenon. But the difference between making a rash decision that turns bad, versus waiting for credible proof can be well worth the wait.
Here’s two options for you. Would you prefer a 30% chance of a bounce that delivers a 25% rally? What about waiting for signs of a bounce in return for an improved 60% chance of a 20% profit? The first is an outright gamble, the second is rather more of a calculated decision.
Patience has a trading cost, but only in terms of profit foregone. The trade itself doesn’t cost you anything more.
Patience may have its costs but it also has its benefits.
Mike van Dulken, Head of Research, 5 Feb 2019
This research is produced by Accendo Markets Limited. Research produced and disseminated by Accendo Markets is classified as non-independent research, and is therefore a marketing communication. This investment research has not been prepared in accordance with legal requirements designed to promote its independence and it is not subject to the prohibition on dealing ahead of the dissemination of investment research. This research does not constitute a personal recommendation or offer to enter into a transaction or an investment, and is produced and distributed for information purposes only.
Accendo Markets considers opinions and information contained within the research to be valid when published, and gives no warranty as to the investments referred to in this material. The income from the investments referred to may go down as well as up, and investors may realise losses on investments. The past performance of a particular investment is not necessarily a guide to its future performance.Prepared by Michael van Dulken, Head of Research