Rationale behind Choosing the Shares - Essay Example

Financial Management Report Name: Institution: Abstract This report basically expounds three elements of our trading choices for the period 3rd October 2013 to 22nd November 2013.The first section gives details of the rationale behind selecting the shares that were selected and traded in. It briefly explains the key features that guided this in line with the selection of shares from eight dividend-declaring companies in different sectors of the UK economy. Eight companies from different sectors were selected as a way of building an efficient portfolio and diversifying risk. The second section of the report is a brief description of the observations that were made during the trading period. It explores the market forces that prompted selling or buying of the selected shares with the main aim of getting profits or evading losses. This part also explores the price movement and how this related to the news assuming semi-strong-form EMH (all the stock prices already incorporate all publically available information and that prices change instantly to reflect new information). The third section is a summary of the main lessons learnt from the trading activities. These lessons will act as guidelines for future trading in the stock market. Rationale behind choosing the shares For a person with capital and an intention of investing in a portfolio of shares, the most difficult decision to make is selecting the appropriate portfolio of shares that would both reduce risk and maximize the returns. In the UK scenario, under this project, the decision to invest in the ACM Shipping Group (ACMG), AEC Education (AECE),Aberdeen UK Tracker Trust (AUKT), Axa Property, Antlantis Japan Group (AJG),Avanti Communications Group (AVN),Associated British Foods (ABF),Associated British Engineering (ABE) and Armor Designs Inc (ADID) shares was guided by the following eight principles; Insider dealings; the amount of shares chief executive officers (CEOs) and other executives were buying and selling was considered as a way of establishing what was happening on the inside decision making structures of these companies. For instance, when the number of shares bought by insiders increased, this study considered it an appropriate time to make purchase[Rob06]. On 9.10.13, 35500 shares were purchased from AEC Education (AECE) because there was news concerning the increment in purchase of these shares by the CEOs. Stock prices also changed instantly to incorporate this new information[Rob06]. Avoidance of companies frequent in the news; the study avoided at all costs the stocks that featured constantly in the news. This is because most share prices are a reflection of the shareholder’s insight of the stock which is inaccurate in valuation of an underlying firm[Cha03]. The study therefore avoided stocks which were victims of publicity and TV headlines. Such stocks are very volatile since their prices always change to reflect any new information[DeB85].Specifically there was no trade in the shares of Associated British Engineering (ABE) and Armor Designs Inc (ADID) between 7.10.13 and 15.11.13 because this period marketed these stocks being featured in the headlines. Dividends; this study only selected companies that offered dividends. Dividends are hard cash paid per share by firms as a reward to shareholders for holding the firm’s stocks. Payment of dividends by a company shows that the company is doing well[Rob06]. Companies paying highest dividend often show steady growth as well. Companies paying highest dividend often show steady growth as well. To be specific, ACM Shipping Group (ACMG), AEC Education (AECE), Aberdeen UK Tracker Trust (AUKT), Axa Property, Atlantis Japan Group (AJG), Avanti Communications Group (AVN), Associated British Engineering (ABE) and Armor Designs Inc (ADID) all offer dividends which is at least 2.5 % of the companies profits. Low beta; since the trading period for this study was short i.e. there was short time horizon to invest; the shares picked were those with low beta. Beta depends on the investor’s risk tolerance. For all the companies selected, their beta ranged between 0.5 and 3. Company size; basically, the smaller the company the greater the potential for growth and the higher the risk posed by their stocks. Large companies on the other hand are considered more stable and safe. Assuming to have a high risk tolerance, the study chose stocks of small companies commonly dictated by the market cap. Invested was done in both small (AEC Education shares) and large companies (Aberdeen UK Tracker Trust) as a way of diversifying our risk in the portfolio. Positive earnings and cash flow per share; this ratio breaks down the profit or earnings of a firm in terms of individual shares and the amount of cash a firm has at hand plus the effectiveness of its operations. The study selected stocks whose CPS (capital per share) was positive as a surety that there was enough cash to pay off debt and take up upcoming ventures that contribute to stock price increases. For instance, Armor Designs Inc. shares were selected because they had positive earnings. Stocks that are trading closer to the 52- week low than the high and also has upward momentum; the study avoided stocks that were trading near their 52-week high since these stocks stand chances of hitting a resistance level and shooting down. Average volume around 50,000; this refers to the number of stocks traded on a single day. Low volume means low liquidity which implies it is hard to buy and sell because there are few buyers and sellers and the stock exhibits a choppy trend. This calls for unwanted volatility which many investors avoid[Ehr10]. In the study’s portfolio selection, stocks with average volume around 50,000 or more but not less were selected. Observations on trading Trading throughout this time was a learning experience if not an enriching venture. The decisions to buy or sell were dictated by the major market forces. Stock prices are dependent on a number of factors which include business fundamentals, world and company news, and human psychology[Ros85]. The following are some of the observations that these factors had on trading decisions assuming efficient market hypothesis; Human psychology; greed and fear are the two strongest emotions that sometimes prompted us to sell or buy. For instance some stocks were fearfully sold prematurely because it dipped momentarily. Conversely greater gain was lost because greed influenced the decision to hold out for more when the stock suddenly dropped back. World and company news; because the study was very keen on the news from the companies invested in, and world events, these determined the trading decisions accordingly. Technical analysis; this is the method that the study used to forecast the stock’s price in the short term. Basically, it was used in investigating patterns or indicators in stock prices and volumes over time. For example, when a stock price was seen to be falling significantly, this prompted the decision to sell the held positions without investigating the cause of the fall leading to overshoot in the price of stock. Lessons learnt to be applied to future trading The choice of time frame in trade. The study found it prudent enough to choose a proper time frame for trade. In this study, three main time frames in trading were employed. These included day trading (enter and exit same day), swing trading (enter and exit 2 to 5 days) and position trading (enter and exit 5-20 days) depending on the performance of the stock. There was need to develop a trading strategy initially before starting to trade. This strategy should be tailored to suit risk tolerance and trading style. These should be based on widely accepted principles of fundamental analysis and technical analysis[Ehr10]. There was need to start small and grow progressively. Initially, it is good to enter positions that represent small fraction ( Read More