Important Investing lessons

Very Important lessons

Without flogging the dead horse too much, I want to briefly explain the importance of being “contrarian” as an investor or a trader. Being “Contrarian” is when you go against the flow, when the flow is at it’s strongest. It is important, because I feel everyone screws this one up. Here is an example we can all relate to.

Last week, I mentioned that the SA rand had weakened ridiculously, and I expected it to strengthen. As it turns out, so far I am right. Rather than embark on a mission of intellectual m_sturbation, I want to explain why I said this. Here is what happened.

The SA rand started weakening heavily about 2 months ago, the reasons were unclear at the time. It went from the good R/$ 6.60 level to about R7.80 very quickly. Some people blamed it on Mr. Zuma blah blah etc. In the last 2 weeks, the news came out about our poor current account deficits and our high imports. Now, you don’t have to know what this means, but basically, it’s very bad news for our currency.

Lesson 1:over this period is this: markets (in this case the rand) anticipated the bad news way before it actually came out.

Now when the news came out, all the economists were climbing on top of each other saying how the rand will continue weakening forever more, calling for R/$9.00 and more. Newspapers churned out the bad news, the public were squeamish and the pro’s were telling everyone to get their money out the country etc etc.

Lesson 2: prices affect sentiment. The rand devaluation resulted in fear.

Then something happened. On the bad news, the rand plummeted for about 2 hours and hit R/$7.95. Then it somehow started to get stronger and ended the day at R/$ 7.89. How so? All the news was terrible, and I mean it. It was really really bad. So here is a lesson I have learnt from trading:

Lesson 3: Once the news comes out & the market anticipated it, all the bad news is in the price.

My technical analysis suggested that the rand was heavily oversold, producing a good risk reward trade to buy the rands. I suggested to my fokes that they convert a stack of their forex back into rands. I had a very hard time trying to convince them too. This in the face of professionals, economists, public etc selling out rands big time. It’s not an easy decision. However, I guessed that the rand had absorbed all the bad news already. My fokes caught the top. The rand today is at R7.48, having come from R7.95

Lesson 4: Being contrarian when the flow is at it’s strongest, is usually a good risk reward opportunity.

Having dabbled a little in all types of markets around the world, I have learnt these lessons. As a trader, you should have sold the rand when no one knew why it was weakening. Once the news comes out, and the market hardly moves, you should close your trade and go the other way.

Final lesson: News itself is worthless to trade on. What is important is how the market anticipated the news and how it absorbed the news once it comes out.

Was it easy going against the flow? Definitely not! Especially when a lot of highly experienced, quality people I know, nail the colours to the mast and say that the rand will weaken. Such is the difficulty of such decisions.

Just out of interest, I have a similar setup for buying gold and selling all world stock markets right now. Will I be right? I don’t know, and it’s not really important. As long as I trade with a tight stop loss, I risk losing little and maximize possible gains.

That’s what good risk reward opportunities are all about.. in both investing and trading.

As Warren Buffet says: the first rule to making money is not to lose any. In the game of investing and trading, the optimal times to participate, usually arise when it makes the least sense to do so. That, my dear friends, is the ultimate challenge.