Few investors have profited in 2004. No surprises here. Gains are hard to come by when broad stock market averages drift sideways for a lengthy period.
Experts describe periods of aimless drifting as a stock picker's market. These are perfect conditions for share tipping services that advise investors about which share to buy. Unfortunately, investors who follow the advice of tipsters are often disappointed.
The biggest problem in this segment of the financial industry is product quality. The industry has more than its share of sharp operators who make unrealistic performance claims or offer tips based upon shoddy research. Potential subscribers must learn how to avoid these charlatans who have little stock-picking talent.
A good starting point is to check the historical record. Reputable tipsters should be able to quickly provide a complete history of all recent tips. Be suspicious if you can not quickly peg how a tipster performed relative to a relevant index.
Review all performance claims with a healthy dose of cynicism. There is nothing wrong with a company putting its best foot forward. But one organisation provides a performance review that only lists completed investments. At the same time, it tends to hold on to its losers, rarely advising subscribers to terminate red ink investments.
This approach improves the "official" trading record but causes serious financial damage to subscribers who follow those recommendations.
Some companies manipulate the historical record by publicising prices in effect when the magazine or newsletter is mailed, not when subscribers actually receive the tip. No surprises for guessing which price looks better. One tipster brags that its tips are out-performing the main UK stock market indices in 2004. But the trades listed in its historical record are quite revealing. It claims to have recommended Sopheon on February 19 at 35.25 pence. The tip did not work out so the company told its followers to close out the trade on April 8 at 30.25 pence, a loss of 14 per cent. Nothing bad so far because no one gets it right all the time.
But my research finds the price to buy Sopheon on February 19 was 36.5 pence, a bit higher than the tipster claimed. The selling price available to investors on April 8 when the trade was unwound was 26 pence, much lower than the tipster claimed. Investors who closely follow this tipster's advice lost a whopping 29 per cent, double what the tipster claimed. No wonder the company's performance stats look so rosy.
Another red flag is the use of mid-prices, not "ask prices" when trades are opened and "bid prices" when trades are closed. One tipster claimed to have tipped Sectorguard, a small security company, at 3.75 pence and that the price rose to 4.0 pence one week later, a quick gain of seven per cent.
The reality was much different for subscribers. According to Thompson Financial Datastream, a leading financial record-keeping organisation, the actual ask price available to investors at the time of the tip was 4.5 pence. The true bid price one week later was 3.75 pence. The tipster's claimed seven per cent gain was actually a loss.
Some tipsters offer subscribers a lengthy list of potential buys. However, they fail to highlight a few shares they consider to be their best prospects. Treat such failures to focus as an important warning sign that the tipster lacks confidence or commitment.
Sadly, the list goes on.....and on. Treat frequent price spikes the day before a tip arrives as a serious warning signal. Favoured insiders could be trading on advanced information.
A useful rule of thumb is to avoid tipsters who recommend shares with wide gaps between the bid and ask price. It is very difficult to make money from investments with wide spreads. Also stand aside from tipsters who tip potential acquisition targets. Experience teaches that betting on takeover stories is generally a license to lose money unless you are a full-time trader who is able to jump in very early in the game.
Claims about inside information should cause your warning bells to start ringing. Even after ignoring the ethical and legal aspects of trading on this kind of information, the simple truth is that most "inside" information is not market-moving. Exceptions to the rule typically trigger very rapid price adjustments that only full-time traders can exploit. Private investors rarely profit from so-called confidential information.
If you are considering subscribing to any tipping service, remember that its main function is to answer three questions: What to buy? What price to pay? When to sell? Treat other commentary like the state of the world economy or Labour's strategy for the year ahead as interesting fluff. If this information interests you, read a newspaper. You will get the same information faster and less expensively.
And finally, do not be influenced by layout or appearance. Several good newsletters are produced by tiny companies, often one-man-bands. Their layouts are second-rate but smart subscribers recognise they are paying for ideas, not presentation slickness.
In the topsy-turvy world of the tipping industry, low circulation is an important plus. High circulation means more subscribers chase each tip. This increases the chance of profit-destroying price spikes just before you attempt to buy a tipped share.