How to make money at the stock market

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

02 November 2008

“How can one make money on the stock exchange?” This is a question that I have been asked by many readers and my answer has always been; “buy when prices are down and sell when the go up”. But then Peter adds a twist thus: “suppose I buy a share at sh10 today then the price moves up gradually to sh15. How can I tell that this is the time to sell? I mean, what if the price goes to sh20 after I have sold at sh15?”

This is a dilemma that many people face. I know someone who had bought Kenya Airways at sh8. Then when it started going up, he sold at sh27.50 thinking he has made a tidy profit…but the share climbed to over Sh50 a few weeks later!

There is no way of knowing at which point the price will settle. Therefore, this is how an investor can collect profits when the price is on the way up: Suppose Peter buys 1,000 shares at sh10 each. These will cost him sh10,000 plus broker’s commission (about 2 percent). When the price reaches sh15, the value of his investment will gain sh5,000, rising from sh10,000 to sh15,000.

Now Peter can decide to collect the sh5,000 profit made so far by selling some of the shares. At sh15 each, he only has to offload 334 units to raise the sh5,000. But since it is difficult to get buyers for such an “odd lot”, he sells 300 (rounding to the nearest 100) and takes sh4,500 (15 times 300) profit in cash. His is now left with 700 stocks.

If the price goes up further to, say, sh20, Peter will make another sh3,500 (the remaining 700 shares times the additional sh5 in the price). At that point, he may do the same thing as before, that is; sell enough to cash out his profit. In this case he offloads 200 shares at sh20 to raise sh4,000 – leaving 500 shares to his name.

At sh20 each, the value of these 500 shares is sh10,000 (exactly the same as what he invested initially) and there is sh8,500 in his bank account (the profit cashed out so far) bringing his total worth to sh18,500.

Now, suppose his friend, Jane, had also invested in the same company at the same time, but had not taken out any profit. Her net worth would be sh20,000 (sh20 times 1,000) – sh1,500 more than Peter’s. Both investors have gained, but Jane is slightly ahead of Peter.

This sh1,500 is the “price” Peter has to pay for cashing out his profits. But imagine what the outcome would have been if the share price had gone down from sh15 to sh8 (instead of up to sh20). Peter’s net worth would be sh,10,100 while Jane’s would be sh8,000…and, with the sh4,500 profit cashed out earlier, Peter can easily go back to the market and buy 500 more shares bringing his total holding to 1,200 – compared to Jane’s 1,000.

Think about it: Peter now has 1,200 shares for his Sh10,000. His average buying price per share is sh8.33. So, if the price goes back to sh10, he can sell off the extra 200, keep the sh2,000 proceeds and still have the original 1,000 shares worth sh10,000!

Did some one say you can’t eat your cake and have it? Well, Peter just did!