HOW TO SUCCESSFULLY INVEST IN RESOURCE STOCKS How to Successfully Invest in Resource Stocks Jason Stevenson, Resources Analyst [Published: Monday, ...
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How to Successfully Invest in Resource Stocks Jason Stevenson, Resources Analyst

[Published: Monday, 3 April 2017] Jason Stevenson, Resources Analyst • A lesson worth knowing • A secret that could change your life • Answering a reader question on risk management • The difference between using a 30% and 40% stop loss • How to use stop losses My favourite book is Reminiscences of a Stock Operator, by Jesse Livermore. It’s a story on Livermore’s experiences, documenting multiple lessons learnt along the way. I try to read the book once a year. If you haven’t read it, I strongly recommend doing so. You can download it for free on Google here. Or, if you’re happy to break the bank, pay $1 on your Amazon Kindle. Livermore always played with big swings in the markets (something you shouldn’t do if you’re just starting off), making numerous fortunes. He amassed over US$100 million shorting the 1929 stock market crash. That’s equivalent to about US$1.38 billion today. As you might know, Livermore wasn’t always right. He went ‘flat broke’ (as he called it) numerous times during his life. Of course, his loss was never a total loss. Otherwise, he wouldn’t have been able to come back as frequently as he did. Livermore committed suicide in November 1940. The gentleman went broke and gave up. He didn’t see a point in making the losses back, as he had done so many times over his trading career. In his eyes, he was a total failure.


How to Successfully Invest in Resource Stocks

A lesson worth knowing Here’s a noteworthy quote from Reminiscences of a Stock Operator: ‘My losses have taught me that I must not begin to advance until I am sure I shall not have to retreat. But if I cannot advance I do not move at all.’

Livermore only invested a lot of his money once a trade was confirmed. He initially invested some of his money to test whether he was on the right side of the market, and then ‘averaged higher’ into the trade. This technique is different to most other investors’. Most people ‘average down’ their investments. In other words, say you buy $5,000 worth of shares at $1 per share, but the share price falls to 70 cents. Do you sell or buy more? Most people will buy more to reduce their buy-in average. Livermore didn’t do this and neither do I. I’ll never ‘average down’ on an investment. If I’m on the wrong side of the trade, I’ll either wait for it to work out before buying more or cut my losses. I’ve learnt this by making losses…a lot of them…in the past. That’s the education cost of investing, mind you. Learning from your losses is the most important part of the investment business. Livermore made money when he followed his rules. But he lost a fortune when he let them slip. In reality, few investors actually learn from their losses. Livermore often ignored them himself! The biggest losses are emotionally challenging — you can trust me on that one. It can be hard to come back from them, and gain the confidence to recommence trading. The best way to avoid big losses is by sticking to these investment rules: 1. Follow the buy-up-to prices — pay as little as possible for each trade. 2. Use stop losses — get out of a trade that’s losing you money before it loses all your money. 3. Sell a company when the original investment thesis doesn’t work out. 4. Remember rules one, two and three. If you follow those rules, you should be able to stay solvent following any losses, and go on to increase your wealth…hopefully quickly, after backing a few winners!


How to Successfully Invest in Resource Stocks

Note that I always recommend spreading your risk across multiple stocks. Also, never invest more than you can afford to lose. Finally, have some ‘dry powder’ available for the best opportunities. The stock market will always throw you unexpected opportunities when you least expect it. You want to have some cash on hand to capture those opportunities. The stock market will also throw unexpected challenges your way. If you can’t take a small loss, you’re finished from the start. Losses are part of the business. Stock trading doesn’t need to be difficult. Keep it simple. Admit when you’re wrong by taking those smaller losses, and then move on to the next stock opportunity.

A trade secret that could change your life Based on my own experiences, and having studied Livermore’s work intensely, I want to share a trade secret with you today. If you want to consistently profit from the resources sector, this is — in my view — the number one secret. Before I tell you about it, I want to make a plea: I hope you take it seriously. It took me years to work this secret out, and I hope it saves you years of frustration, tears and losses. OK, here goes… The key to successful investing — especially in the resources sector — is more than just buying a ‘good stock’. It’s about implementing a strong money and risk management strategy. It’s a simple secret. Yet the majority of investors can’t master it. Most punters are trend followers. They buy at the top and, when the trend reverses, tend to sell at the bottom. Instead of managing their money and taking a small loss, they hold on for the ride until the frustration becomes too much. With this in mind, my goal is simple… I want to help you become a more profitable investor in the resources sector. In this case, I’ll talk about implementing strong risk and money management today.


How to Successfully Invest in Resource Stocks

Answering a reader question on risk management Let’s start with a question on risk management. Esme wrote, ‘I have worked out the quantity for each buy for each share, and had to reduce my % exposure/capital with most companies trading below $1.00. I invested $1,375. I tend to invest $1,000 per trade for higher priced companies. ‘You mentioned to buy 40% of your exposure sometimes? I haven’t come across any material where you have suggested the total capital to put into these very cheap – very risky – types of trades, some with great potential. ‘Can you please explain how to look at the capital/exposure of each trade?’

Esme, thanks for your question. I’ve arbitrarily selected numbers in the past. For example, I recommend buying 40% of your exposure in Lucapa Diamond Company [ASX:LOM]. I believe it won’t find the diamond kimberlite overnight, which may put some pressure on the share price over time. So, I expect a better buying opportunity to average down. Of course, I could be wrong and it could hit the mother lode soon. That’s why I recommend owning some shares today. In future monthly issues, I’ll suggest buying 25%, 50%, 75% or 100% of your full position for developers, producers and advanced explorers. This reflects my confidence of the immediate near-term upside. Of course, the decision is yours. You can buy as much as you want, or none at all. I won’t make a specific allocation in speculative stocks in the future. Although they can outperform in both bull and bear markets, speculative stocks are high risk. So, no matter how good the story sounds, never punt more than you can afford to lose. I’d also like to address one of your statements. You said: ‘I tend to invest $1,000 per trade for higher priced companies.’ Remember, a share price means nothing — it’s just a number. Whether a resource stock trades at 5 cents, $5 or $50, it’s just a number. In this case, it’s incorrect to assume that a $10 dollar stock is less risky than a sub-$1 stock. The enterprise valuation (market capitalisation less cash plus debt), on the other hand, tells you how much a company is worth. I’ll always quote a company’s enterprise valuation (EV). Enterprise value is a very simple calculation, which you can apply to all resource stocks at a superficial level (i.e. before diving deeper into the fundamentals). After calculating a company’s EV, you can compare it to others. Based on a company’s stage of development and success, the metric will show


How to Successfully Invest in Resource Stocks

you who is cheap and expensive in the sector. Now, there may be a reason behind why a company is cheap or expensive…so that’s why more analysis is required. Nevertheless, at a superficial level, I often look for speculative stocks cheaper than $10 million (enterprise valuation) most of the time. Why $10 million? That price allows us to get into the company at an early stage…before the market catches onto the story. Each trade also represents a risk/reward trade-off. The more you pay for a stock (i.e. enterprise value, and not the stock price), the lower your potential reward and the higher your potential loss. I want you to pay as little as possible for your shares, which is why I stress the importance of buy-up-to prices. The buy-up-to price reflects the enterprise valuation and is deemed a good entry for your shares. Esme, before moving on, I’d like to share another reader’s email.

The difference between using a 30% and 40% stop loss David wrote, ‘Just a quick note to let you know that I follow your recommendations & use your buy up to price I always use limit orders & found that way I have made fantastic profits. I have learnt to take use stop losses, many thanks for the last year up just over 200%.’

David, it’s great to hear about your success. While every stock recommendation won’t work out in the future, Resource Speculator has recorded some great wins over the past 12–18 months. When a stock price goes the wrong way, stop losses are crucial. If you’re a more active investor or trader, you may want to set your stop losses at 10–15%. If you’re a more passive investor, I have suggested using 30% stop losses for your producers, developers and advanced explorers. Resource Speculator will apply a 40% stop-loss rule on speculative stocks — except for two special circumstances: • The company must be drilling at the time. • The company is waiting for a specific event. With regard to the second change, speculative stocks — as I’ve shown multiple times in the past — could outperform during any market.


How to Successfully Invest in Resource Stocks

For example — and yes, I love this example — 88 Energy [ASX:88E] announced a major crude oil discovery in January last year. It was trading 50% below the buy-up-to price on 27 January. The company had been going nowhere for years. But the discovery sent the share price soaring. Readers who followed my recommendation walked away with a 242% gain. Readers who bought in near the low bagged a 550% profit in five days. The stop-loss rule’s first exception — the company must be drilling at the time — allows for a repeat of 88 Energy. I will let you know clearly whether this rule applies to a speculative stock. There will be no ‘ifs’ or ‘buts’. If a company has a drilling plan in the distant future, it may not qualify for this exception. It must be drilling now, or very soon at the least. The stop-loss rule’s second exception — waiting for a specific event — applies to speculative companies waiting for a specific announcement. For example, Axiom Mining [ASX:AVQ] has been waiting…very patiently…for the Kolosori tenement lease in the Solomon Islands. I recommended the stock for that purpose. A stop loss would discount that investment thesis, and shouldn’t apply. This is a rare circumstance. I do believe a wider stop loss is required for the rest of our speculative stocks. That should keep your money ‘active’, while allowing for the story to play out. If a speculative stock consistently misses the mother lode, it’s worth asking the question: Why bother holding on to it? The 40% stop-loss rule will give us that answer. I recommend holding an ‘active’ portfolio of speculative stocks. Every company should meet, or exceed, your initial investment thesis. If it doesn’t, you’re probably in a bad trade. That means it’s time to look for a better stock. If you’re wondering why, it’s simple…

How to use stop losses The idea is to cut your losers quicker, and ride your winners for longer. The stop loss is applied on an intra-day basis. So if the stock price hits the stop loss during the trading day, you should sell your shares…without hearing from me. Of course, I’ll let you know whether a stop loss is triggered later. If it is, and the stock still offers huge potential, I’ll move it to the watchlist. I’ll recommend buying it again later, when the time is right. If your stop loss is triggered, stick to it and sell out immediately. Call


How to Successfully Invest in Resource Stocks

your broker and tell them to sell. Don’t rely on your broker, or the platform, to remember to do it for you. And don’t let the loss develop into something bigger. When you lose money, it’s easy to get emotional. If you believe your money will come back to you at some point, you may not want to sell. Remember, punters tend to think: ‘I’ve lost 30–40% of my investment… that’s not much. I’ll wait for it to come back.’ But they never think about the remaining 60–70% or whether the loss can grow. Sell your losers, and let your winners run. Allocate your capital towards assets that can make you money. If you aren’t sure, sit it in cash. Above all, start using risk management. Remember, that’s the key to consistently profitable investing! I’ve been working hard on my top-down approach over the past year to find you the best resource stocks on the ASX. While I haven’t picked any 10-baggers yet, things are going well. We’ve backed plenty of good winners. That doesn’t mean every stock will work out in the future. After all, I am only human. If we find a dud, don’t be deterred. This is where a strong money and risk management strategy comes into play. As long as we cut our losers and ride the winners (to pay for the losers), it should be a profitable future. Cheers,

Jason Stevenson, Resources Analyst, Resource Speculator


How to Successfully Invest in Resource Stocks

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