When, at about 16, I first decided I wanted to be a stockbroker, I subscribed to a small-cap tip sheet. It was a spivvy world then and it has not improved. More than a quarter of a century later — yes, I’m that old — the internet has replaced tip sheets with bulletin boards, but there’s still no alchemy: base metals can’t be turned into gold.
Naturally, stock pickers like to advertise with promises of riches. But if they’re really such brilliant investors, why would they tell you their tips? If they really can create ‘alpha’ (excess returns) they should set up a fund. But they don’t. Why? Because they are rarely as brilliant as they promote themselves to be.
I am a certified Chartered Financial Analyst, which involves three years of study and exams. In the course syllabus, many chapters are devoted to how performance statistics can be manipulated by the unscrupulous.
The easiest way for tipsters to manipulate performance is to use a price that does not reflect the real price an investor has to pay to buy or sell. This can be done in two ways. First, tipsters can calculate performance based on the ‘mid price’, below the offer price at which investors can buy. For small companies this difference can easily be 5 per cent. Secondly, if a stock is tipped by a ‘famous’ tipster, market makers will tend to move its price up, maybe 5 per cent, with no volume trading. But a tipster will usually use the previous day’s closing price as the base to calculate performance.
So a real investor following a tip may have to pay as much as 10 per cent above the price the tipster uses in his performance calculations. Then of course a winning position needs to be sold — and when the tipster says it’s time to get out, the reverse occurs, so a 20 per cent advertised return from a tipster can sometimes mean no profit at all for a real investor.
I find it entertaining that veteran tipster Tom Winnifrith admits he used mid prices to boost his performance data in the past. In a posting on his website on 16 February 2014 he stated, ‘I admit that when at t1ps [“the UK’s top share tipping website”] the performance of Steve [Moore, his fellow tipster] and I was calculated in this way. It gets compliance sign off, it is legal, everyone does it but it is completely misleading.’ After many years as a tipster, that mea culpa’s a bit late, Tom.
There are a plethora of other ways to manipulate performance data: only selecting the profitable recommendations and ignoring the bad; selecting the most favourable time period; omitting trading costs. There’s also money to be made in teaching people to trade, and the advertising may show the example of the one follower who has made a fortune. But if enough people follow a trader’s strategy then a normal distribution suggests most will neither lose nor gain much — but a small percentage may lose or win big-time. And of course the light will not be shone on the trainee who followed the advice and lost all his or her savings.
And charts? The richest chartist I know has made his money from selling his charting software to others and not from investing in his own ideas. Charts are for sailors.
I was recently chatting to a Manchester cab driver. He told me he had £15,000 — his entire life savings — invested in a small-cap oil exploration firm. He knew little about the company but had followed a tip on a website. I didn’t know where to begin helping him.
Investing for yourself is fun. It’s intellectually demanding. It should teach humility, as there will always be investments that go wrong. But (unlike my cabbie) learn the basics, like how to manage risk, and only play with 10 or 20 per cent of your wealth. And if you do hit the jackpot, be grateful you hit the far right-hand side of a normal distribution and don’t expect to do so again.
I offer opinions on stocks on TipTV or iii.co.uk, but I try not to give recommendations as I don’t think I can create alpha. I find financial markets fascinating. But I don’t suffer the self-delusion of so many in this industry.
There are very, very few people who can beat the market consistently over a long period of time. I realise that I’m unlikely to be one of them.
Louise Cooper CFA is an independent financial commentator at www.coopercity.co.uk