Naked Trader 3 – Winning Strategies

Naked Trader

Today’s post is our third visit to the UK’s favourite active trading book, The Naked Trader. Let’s find out about Robbie’s Winning Strategies.

Ten Winning Strategies

  1. Seek companies starting to change
    • we came across this as an overarching principle in our previous articles
    • Robbie is looking for a company that hasn’t been doing too well, but is changing direction or focus
    • he wants them to shut down or sell off loss-making operations (perhaps to pay down debt), or find new revenue streams, or commit more resources to existing ones
    • director buying can be a clue that things are about to change
    • so can a change in management (chairman or CEO)
    • Robbie recommends a tight stop loss in these situations
  2. Find cheap shares
    • Robbie likes PEs below 15, and ideally closer to 10.
    • But if a share is cheap, you need to double-check that there isn’t a good reason for this.
    • Also make sure that it doesn’t have too much debt.
  3. Buy into a hot sector
    • This is just a sector where lots of shares are rising faster than the general market.
    • Sectors can stay hot for longer than you think, so “it’s worth riding a hot sector for as long as possible”.
  4. Recovery plays
    • These are shares that were doing well, then had a bad time, but are now starting to rise again.
    • The key here is to find the reason why the share is recovering.
    • And you need to be sure that there’s no risk the firm will go bust.
    • You also have to be sure that the recovery has begun – you mustn’t try to catch a falling knife.
  5. Play short-term trends (trade shares that range)
    • Here Robbie recommends getting to know a small number of FTSE-250 (or even FTSE-100) shares.
    • When you get a feel for how they move up and down in a range, you can start to trade them.
    • Buy at the bottom of their trading range, and sell at the top.
    • You can also short on the way down (via spread bets) if you like.
    • Only pick shares that are doing well and likely to rise eventually.
    • Avoid anything with a serious risk of a profit warning.
  6. Buy boring companies
    • Robbie is thinking mostly of engineering firms here (like Fenner and Volex).
    • Retail investors tend to ignore boring shares, so you can often get in when they are cheap.
    • Robbie says that usually after three years or so, the market notices increased earnings, and the stock price goes up.1
  7. Buy share splits and consolidations
    • Companies usually like their share price to be between £1 and £10.
    • Shares above £10 feel expensive, and those below £1 attract the “penny share” (ie. could be dodgy) tag.
    • Both types of shares can also have large spreads.
    • So shares above 1000p are often split into two or even five, and shares below 50p are sometimes consolidated together.
    • After the price changes, the shares usually outperform for a while as the market catches up with the fact that they now have a “nice” price.
  8. Buy companies in niche markets
    • Fast-growing companies in specialised markets have a strong position for defending profits in good times.
    • They are also likely to be taken over at a premium by larger rivals in related fields.
  9. Buy bid targets
    • Obviously, bid targets tend to rise by 20% to 40% (or more), but how do you find them before the bid is announced?
    • Robbie looks for sectors ripe for consolidation and companies which look like good bid targets.
    • Then he looks for bid gossip and increased buying activity (volume) in the shares.
  10. Buy shares being promoted from AIM to the main market
    • Note: the version of the book I have was written when AIM shares weren’t eligible for ISAs.
    • AIM shares can be held in ISAs now, and also have protection from inheritance tax after 2 years.
    • So this technique may not won’t work any more.
    • On the other hand, main market stocks will be more attractive to institutional investors, so there are two effects here, working in opposite directions.
See also:  Naked Trader 1 - Getting Started

Beyond these main 10 techniques, Robbie also lists a few other strategies:

  • companies with government contracts
    • less attractive now since the 2008 financial crisis and the resulting budget cuts
    • government contracts might not be renewed
  • tech firms
    • if you can spot the next big thing, or the suppliers to the next big thing
  • oil exploration
    • not so hot since the crash in the oil price
  • momentum trading
    • just buy stocks in long-term up trends
  • avoid small pharma companies
    • I think this advice can be extended to most small, loss-making, “blue sky” companies

That’s it for the winning strategies, now onto the next section, titled “More knowledge”

SIPPs

Robbie begins by discussing SIPPs, but I’m going to assume that most readers are familiar with these.

  • If not, you can read about them here.
  • To be fair to Robbie they were much less common when he was writing the book – I think I opened my first SIPP in 2006, the year before the book was published.
Bulletin boards, Twitter and Reddit

Robbie then moves on to bulletin boards, mentioning four in particular:

  1. ADVFN (of course)
  2. Hemscott (now part of Morningstar)
  3. Money-AM
  4. Interactive Investor

Another big bulletin board was Motley Fool.

  • They recently got rid of their bulletin boards, but they have popped up again at the independent Lemon Fool.

I should also mention the discussion boards on Stockopedia, which can be very useful.

[hr]

The big development since Robbie wrote his book has been the rise of Twitter.

  • I strongly recommend that you get on to Twitter
  • use Tweetdeck to follow several lists of key users at once
  • and more importantly, to filter out the noise

I’m also surprised that Reddit hasn’t caught on for financial discussions.

  • my own theory is that the demographics (young and American) mean that there isn’t the critical mass to discuss UK stocks
  • I run a couple of subReddits (here and here) but they act more as repositories of links to interesting articles than as discussion boards

[hr]

Before we leave the topic of online discussion, a word of warning:

  • not everyone online can be trusted

For the most part, this doesn’t matter, but one area of concern is small stocks, often tech or resource related.

  • When the market cap of a stock is only a few million pounds, concerted action by “rampers” or “de-rampers” can manipulate the price up or down.
  • So always DYOR, and think about why somebody might be saying what they are saying
  • Do they hold the stock, and are they looking to sell?

Or more simply, avoid these small stocks all together.

Level 2 and DMA

Normally when you want to trade a stock, you can only see the current spread.

  • This is made up of the best bid price and the best offer price.

With Level 2, you can see the queue of bids and offers in each direction, and the number of shares that can be traded at those various prices.

  • This give you an idea of how the price might move in the very short term.

Robbie says that he couldn’t trade without Level 2.

  • I can understand that you easily get used to the services available to you, but given that Robbie typically holds stocks for weeks or months, I can’t see that Level 2 is essential.
  • No doubt Robbie is choosing slightly better entry points, but I doubt that these lead to much bigger gains over the medium term.

ADVFN (of course) offer Level 2, but I can’t show you what the screen looks like because it isn’t free.

  • That’s not entirely true – very frequent traders who spend enough in commissions might be given Level 2 for nothing.
  • But for most of us, it’s not free.

[hr]

DMA stands for Direct Market Access.

  • This allows you to act as a market maker, and put your own buy and sell orders directly into the market.
See also:  The Naked Trader - Lessons Learned

Which means that you can trade inside the regular Level 1 spread.
This sounds like a decent benefit for frequent traders, but Robbie doesn’t go into too much detail on how and when he uses it.

Spread betting

We’ve written several times before about spread betting, so we won’t go into too much detail here.

Spread betting is basically making a bet with a specialised bookmaker, rather than buying or selling the actual shares.

The key advantages are:

  1. leverage (you can take out large positions for a small deposit)
  2. you can easily trade a wide range of stocks (including international), plus other asset classes (commodities and FX)
  3. you can trade indices rather than individual stocks
  4. you can easily go short
  5. profits are tax-free (because the government doesn’t want to make gambling losses tax deductible – most people lose money)

The key disadvantages are:

  1. you can lose more money than you originally staked (the flip-side of leverage) – so always use a stop-loss (ordinary, guaranteed or trailing)
  2. spreads are wider (though there are no commissions or stamp duty)
  3. you pay interest on open positions (on the leveraged money you have effectively borrowed)

As noted above, most spread-bettors lose money.

Robbie includes a couple of factors that set winners apart:2

  1. winners trade less
  2. winners trade more obscure shares than FTSE-100 shares
  3. winners are often flat (have no positions at all)
  4. winners tend not to keep positions open for too long
Shorting

Robbie usually has a couple of shorts open.

  • Normally he only shorts large companies, as the spreads are too wide on smaller stocks.
  • He also sometimes shorts a stock or an index as a temporary hedge.

To find shorts, he looks for:

  1. profit warnings – they often come in threes, so shorting after the first one can be profitable
  2. long downtrends – momentum trading, through the 52-week low or a key support level
  3. very high PE – means that any negative news will cause a price crash
  4. words like “challenging”, “difficulties” or “problems” in the company updates
  5. debts that are more than six times profits

You need also check that the sector is out of favour and the company is not likely to be a bid target.

Other instruments

Robbie briefly covers the following:

  • CFDs – like spread bets, but not tax-free
  • warrants – too complicated for beginners, but another leveraged derivative
  • investment trusts – find out more about those here
Conclusions

That’s it for today.

  • We’re now three quarters of the way through the book and with luck we’ll be done with one more article.

We can group Robbie’s trading strategies (15 in all) around a number of themes:

  1. Change
    • new directions, executives and recovery plays
  2. Stock characteristics
    • PE less than 15
    • boring shares
    • growth stocks in niche markets
    • tech stocks but not small pharma (or other “blue-sky” stocks)
  3. Technical plays (charts and momentum)
    • hot sectors
    • shares that range
    • long-term up trends
  4. Special situations
    • share splits and consolidations
    • bid targets
  5. Techniques that won’t work any more
    • promotions from AIM to main market
    • government contracts
    • oil exploration

We also covered some things that are essential / very useful to the typical private investor:

  1. SIPPs
  2. Investment trusts
  3. Spread betting
  4. Twitter

And some that are less useful:

  1. Bulletin boards
  2. Reddit
  3. Level 2
  4. DMA
  5. Shorting
  6. CFDs
  7. Warrants

I’ll be back in a couple of weeks with the final section of the book, which is called “Trading in Real Life”.

Until next time.

  1. For me, you would still need to see some catalyst for why they might be re-rated eventually – otherwise they could stay boring and cheap forever []
  2. He learned these from a spread-bet market maker at a boozy dinner []

Mike Rawson

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 35 years, with some success.

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1 Response

  1. Avatar Stuart says:

    Well done Mike – Some very useful comments to add extra understanding to the original ‘Naked Trader’ ideas. Having read the book (a number of times) and having invested in the market for the last couple of years there are a number of important trading techniques that Robbie Burns does not touch upon; Diversification within a portfolio and also initial position size.

    I don’t use Level 2 – I would be interested to hear from anyone that does use it. Is it worth the money? Maybe paying attention to spreads and dealing costs might be of more importance than buying a share at a couple of pence less? Any thoughts?

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Naked Trader 3 – Winning Strategies

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