The complete breakdown of trust and confidence by shareholders and depositors in Northern Rock and the Bank of England, and the government’s attempts to restore calm and order is something so shocking that no one has really had time to evaluate the long term damage or implications. Setting aside the usual blame game – i.e. it’s all the fault of the US and the sub prime debacle and the political point scoring which is inevitable, is the government now really going to guarantee 100% everyone’s bank deposits in the event of another bank collapse? This effectively means the banking system has been nationalised. If not, will the £30k compensation limit be reinstated or reviewed?
Money on deposit at a bank has always been considered the safest and least risky form of investment whilst buying individual shares one of the most risky and only to be undertaken by the more sophisticated investor. Given the events of the past few days I suspect most people are now deeply sceptical of any form of investment, and the government has been at pains to distinguish between the protection of depositors who have simply been caught up in the whole debacle, as opposed to shareholders who are considered fair game.
I agree shareholders should know the risks and likewise traders and investors but I have been truly shocked at the number of Northern Rock shareholders calling into various programmes to bemoan their losses. Clearly they live in a world where prices are always going to go up and have never been taught the simple money management techniques which involve the preservation of capital, which is the number one rule in trading and investing.
One of the most straightforward techniques to preserve your capital is to use a stop loss. Let me give a simple example using Northern Rock. Supposing 2 years ago you purchased 100 Northern Rock shares, which at the time were trading at approximately £8.00 per share. Your stop loss would be set at roughly 10% below i.e. £7.20. Over the next two years the share price gradually increased to just over £12.00. Throughout this period you would have gradually been moving your stop loss up (which we now call a trailing stop loss) initially to reduce any possible loss and ultimately to lock in profits. Once your stop loss had passed the original purchase price of £8.00 then you would be locking in your profits and protecting them against any sudden fall. This then becomes a risk free trade or investment which is something we all want!!
Had the shareholders ringing in to the radio programmes followed this simple procedure then they would have been automatically stopped out when the market price fell, while still retaining a substantial element of profit. I fully accept that in order to have 100% protection you would require a guaranteed stop loss. This effectively guarantees your position being closed even in volatile markets such as those currently being experienced.
Given that Northern Rock is now a takeover target I am sure there are many in the market who are now looking to buy at today’s price of 300p or even less. Indeed many of the other banking shares are also starting to look cheap. As Warren Buffet has said on more than one occasion: ‘Be fearful when others are greedy and greedy when they are fearful’- but you have to be brave!!
