U.S. Central Bank's (Fed) decision concerns very closely the emerging countries. The saving rates of these countries are very low; they need to borrow from abroad in order to reach the investment/GDP ratio to an international level which is currently mediocre. Each step towards the tightening and then the reducing by the Fed of the quantitative easing monetary cause the long term bonds' intertest rates to rise. Under these conditions, the U.S. bonds will become more attractive compared to the bonds of the countries with higher risks. Financial reports point specifically to the five risky emerging countries. U.S. bonds which become more attractive compared to the government bonds of these countries means a decrease in net capital entering into these countries (note: does not have to be necessarily net exit). The first effect of this is a much higher exchange rate and interest rates. Then there will be a dropping in the credit growth rate and a lesser investment and growth opportunities due to a less direct borrowing possibilities.
Developments in the inflation and unemployment are playing an important role in the decisions of the Fed. First of all, the Fed wants the unemployment rate to drop permanently below 6.5 percent and wants it to drift towards the normal level of 5.5 percent as it is customary. Already the unemployment rate was 7.5 percent in the middle of 2013 and it was not expected to come to the threshold of 6.5 percent in a short period of time. However, the unemployment rate fell faster the expected in recent months. According to the data released Friday, it showed a drop to 6.7 percent in December and thus the threshold was approached. In this context, one would ask the following question: will the Fed accelarate the gradual termination of the operations regarding the monetary expansion which it started in December and will it start the process of raising the interest rates shortly after the conclusion of this operation?
In order to be able to answer this question, the unemployment data alone is not enough. The inflation is also very important for the Fed. It wants the inflation to stay at 2 percent in terms of price stability target. However, currently the inflation in the U.S. is clearly under this level. This phenomenon makes the Fed nervous. If the inflation was 2 percent instead of being that low in a period where the unemployment rate is 6.7 percent and is showing a tendency to drift lower, one would expect the Fed to bring forward the monetary tightening steps and to increase the intesity of the tightening.
Meanwhile, there is another indicator that we have been hearing in the past few months but which has not been highlighted in a very strong manner by the Fed: the labor force participation rate. This rate has been declining in the past few years. The decline rate in the labor force may also occur because of the decline in the rate of the labor force participation. For example, unemployed persons may lose hope in finding a job. In order for a person to be counted as unemployed, he must both be unemployed and supposed to be looking for a job. If he does not look for a job, he is regarded as gone out of the labor force. The Fed does not see the rate of unemployment to be reduced in this way as a healthy development. But lately, the declarations from the Fed officials point out to the aging population regarding the decrease in the labor force participation; it is regarded to be natural. In this case, one can expect the Fed to terminate towards the Fall the operation it started in December. Stated differently, one should not expect from the Fed to apply earlier the end date of the operation in a way that will disturb the emerging countries or to reduce further the amount of bonds that it buys every month. But if the inflation were to rise to 2 and because the unemployment rate is near 6.5 percent, the possibility of disturbing decisions for the emerging countriees is substantial. In the coming months, the market experts' main topic of discussion is going to be the inflation and the unemployment rate. Under these circumstances, we can only hope for the best...
Thursday 16 January 2014
Tuesday 7 January 2014
ON MANEUVER AND MOBILITY
Most of the investors tend to buy and hold stocks on the expectation that the price will appreciate substantially in the long run, thus delivering them a nice return on yearly basis. In order to achieve this, they tend to dig in the financial statements of the companies and look for cases of either undervaluation or some promising future as far as the growth stocks are concerned. In both cases, they calculate the probable intrinsic value of these stocks (which is flawed in the sense that they reflect their optimism or their hope into the earnings growth component as well as into the discount rate) and buy them if their respective price is below the determined figure. To complicate the matters, as they don't know for sure which stock is going to outperform the market, they create a portfolio which incorporates a myriad of stocks selected in the same fashion and hope that the general performance of these stocks will create a positive return which in turn will be substantially higher than the market's own return in a given period of time.
This approach will be successful during the periods when the stock market as a whole is very low (for example at the bottom of a bear market) and where the stock selection will be easy. But this will be less so when the market reaches the mid level during which the undervalued stocks would have declined substantially. It is also true that the stock selection process is influenced by the personal conditions of the investor such as available capital, age, time horizon and risk preference.
When one has a limited capital which will be allocated to the investment in the stock market, the frustration becomes great when one sees the myriad of stocks. Generally, the average investor would prefer to invest in the investment funds as his knowledge regarding the capital markets is limited. But if he wants to invest in stocks, he is generally helpless in front of the enormous task of analyzing and selecting the issues because he lacks the necessary knowledge and experience.
For my part, I had to devise an investment strategy where I would not dissipate my limited capital by investing it in a basket of stocks but rather concentrate it on a limited number of company (preferably one). By concentrating the limited capital on individual companies, I could expect to obtain a high return to my portfolio provided that I could make a correct selection based on sound analysis of the stocks. Then the problem to solve was as follows: what type of stocks are best suited for this kind of investment strategy?
In short, I had to find stocks that were financially strong and profitable as well as trading at bargain prices compared to their intrinsic value. Though this is obvious, in practice, it was hard to determine the criteria for such a selection. After some back testing, I managed to determine some of the components of this investment strategy and thus select the stock accordingly. The challenge comes after this...
Any serious investor knows that the most attributable element of an investment process in patience. The time horizon that exists between the buying and the selling of the stock can be equated as the patience during which the price fluctuation will move towards the intrinsic value of the stock in question. This also involves to sit tight in a position until one is rewarded for his patience. I must admit that it is not an easy task especially when one gets frustrated to see the stock's price drift lower due to the caprice of the stock market.
The compounded interest rate is a powerful tool which can determine indirectly the investment strategy to be adopted. Generally, people use it for interest rates in order to determine the future value of the investment in place. They also discount it by actualization of the said investment. But I added another twist to this approach.
If I have a capital of 1.000 USD and I were to have an investment return averaging 20% after tax on yearly basis for the following 10 years, I would have 6.191,73 USD. But let me state this in another way. If I have a capital of 1.000 USD and I want to have 100.000 USD in 10 years, then my yearly return should be 58.49% after tax. For 1.000.000 USD, this yearly return would be 99.53%. Then the question becomes like this: what kind of an investment approach can achieve such a return?
I was adjusting the answer to this by stating it differently: how many investments (in stocks) do I have to undertake given the fact that I will earn a minimum of 50% on each investment with a capital of 1.000 USD in order to attain 1.000.000 USD? The answer is 17. If I lower the figure, the number will rise.
The strategy of investing in individual companies one after another in a time frame involves a psychological problem. The investing into one company has a frustrating part which is linked to the feeling of facing a loss. When one buys an undervalued company at a big discount, that loss which may occur quite naturally due to the fluctuating stock market is of temporary nature and will disappear with the gradual rise of the stock's price. For example, if you buy a stock at 10 USD while the book value is 20 USD and the intrinsic value of the stock is 100 USD, just because the stock drops to 5 USD does not mean that your investment is a mistake; it is a temporary setback.
When applying this investment strategy, the problem of liquidity will arise with time but it may also appear right from the start. If you select an illiquid stock, you may have a hard time to get in or to get out. And when the capital that you are going to invest is substantially big, you will necessarily limit your investment to liquid stocks. My experience on this matter was forcing me to look for a maximum of 10% of the average daily trading volume of any stock before considering any investment. This kind of approach will also force you to look for more prominent companies when your capital grows to a substantial level.
As far as the trading activity is concerned, I have a similar approach. Though open to debate, I deliberately consider again the maximum of 10% of the daily average trading volume but I also add the factor of price volatility as well as the average daily price range. I don't want to see big price differences when I am placing the orders. Also, I need an important level of liquidity in order to have a mobility when moving in and out and also moving from one stock to the other as part of the maneuver in the stock market.
Once I establish a list of stocks that I will trade, I study the chart by placing half a dozen of indicators such as moving averages or mathematical indicators such as MACD or RSI, and then I place the resistance and the support levels in order to determine the possible entry and exit levels. After that, once I establish my entry and exit levels as well as my stop loss level, I place my order. Once the order goes through, I follow the position closely and adjust the exit levels or the stop loss levels according to the price movement.
When trading a stock, the fundamental data as well as the news regarding the stock itself represent barely 10% of my trading decision whereas the technical indicators as well as the chart's picture represent the remaining 90%. What I look for are a set of charts where there is a definite price formation which is confirmed by the technical indicators. Once I am satisfied with it, I place my orders.
This trading approach may look to be in a sharp contrast with the investment approach but the idea is to guarantee a positive return and thus to avoid as much as possible the loss. Of course, this may not work all the time because some positions may result in a loss and one has to take it without questioning it. The mortal blow in a trading or investing activity is to have a second guess in one's position when evaluating the validity of the indicators or criteria. When the chart and the indicators tell you what to do, you do it, that's it! You don't reconsider them. It's like a U-boat commander who is just about to send his torpedo when he suddenly says "let me check the figures again" and misses his target.
Whether investing or trading, the whole process must be planned and the plan must be followed thoroughly. If one permits itself to deviate from the plan during the course of the operation, he will face unwanted results. The investment or trading plan is strict in the entry and exit levels in a given position but is very loose in terms of time period. Following the plan requires two core qualities: discipline and indifference.
The discipline to follow the plan without permitting the interference of exterior or internal factors is crucial for the success of the financial operation. It permits the concentration of the person upon his target and the adjustment of oneself according to the progress made in a given direction. The magnitude of the object mobilizes the one's resources and forces the adoption of an appropriate approach in order to tackle the given situation, provided that the object is attainable in comparison to one's resources.
The indifference is a psychological attitude where one shuts down the psychological elements that may affect negatively the investment process. Such psychological elements have a tendency to surge when facing uncertainty or a danger and interferes with the proper adoption of the necessary steps. For example, instead of getting out of a losing position with a stop loss order, one stays in it by hoping to recover the loss. The stop loss order is a remedy to this psychological state where one shuts down the emotions by transferring the necessary order to an emotionless status.
Like in war, being emotional in a given situation is synonymous with death in the investment world. One cannot be brave or courageous all the time or have a psychological breakdown but being indifferent is a state that is manageable almost indefinitely; it avoids the drawbacks associated with the human character which is filled with flaws. The major drawback of this approach is that, in spite of being very effective in dealing with unwanted situations, it is extremely destructive if not lethal in the field of social relations: you become a person without a soul.
Three things kill a man: alcohol, gambling and woman. This Turkish saying has a point: the stated three elements are part of the set of emotions that have a negative effect upon the man. They have a tendency to drain the resources to the point of annihilation. When one stays away from these, he has a more clear picture about what to do with his life. This also applies to the investment or trading which is, in some respect, another type of life.
This approach will be successful during the periods when the stock market as a whole is very low (for example at the bottom of a bear market) and where the stock selection will be easy. But this will be less so when the market reaches the mid level during which the undervalued stocks would have declined substantially. It is also true that the stock selection process is influenced by the personal conditions of the investor such as available capital, age, time horizon and risk preference.
When one has a limited capital which will be allocated to the investment in the stock market, the frustration becomes great when one sees the myriad of stocks. Generally, the average investor would prefer to invest in the investment funds as his knowledge regarding the capital markets is limited. But if he wants to invest in stocks, he is generally helpless in front of the enormous task of analyzing and selecting the issues because he lacks the necessary knowledge and experience.
For my part, I had to devise an investment strategy where I would not dissipate my limited capital by investing it in a basket of stocks but rather concentrate it on a limited number of company (preferably one). By concentrating the limited capital on individual companies, I could expect to obtain a high return to my portfolio provided that I could make a correct selection based on sound analysis of the stocks. Then the problem to solve was as follows: what type of stocks are best suited for this kind of investment strategy?
In short, I had to find stocks that were financially strong and profitable as well as trading at bargain prices compared to their intrinsic value. Though this is obvious, in practice, it was hard to determine the criteria for such a selection. After some back testing, I managed to determine some of the components of this investment strategy and thus select the stock accordingly. The challenge comes after this...
Any serious investor knows that the most attributable element of an investment process in patience. The time horizon that exists between the buying and the selling of the stock can be equated as the patience during which the price fluctuation will move towards the intrinsic value of the stock in question. This also involves to sit tight in a position until one is rewarded for his patience. I must admit that it is not an easy task especially when one gets frustrated to see the stock's price drift lower due to the caprice of the stock market.
The compounded interest rate is a powerful tool which can determine indirectly the investment strategy to be adopted. Generally, people use it for interest rates in order to determine the future value of the investment in place. They also discount it by actualization of the said investment. But I added another twist to this approach.
If I have a capital of 1.000 USD and I were to have an investment return averaging 20% after tax on yearly basis for the following 10 years, I would have 6.191,73 USD. But let me state this in another way. If I have a capital of 1.000 USD and I want to have 100.000 USD in 10 years, then my yearly return should be 58.49% after tax. For 1.000.000 USD, this yearly return would be 99.53%. Then the question becomes like this: what kind of an investment approach can achieve such a return?
I was adjusting the answer to this by stating it differently: how many investments (in stocks) do I have to undertake given the fact that I will earn a minimum of 50% on each investment with a capital of 1.000 USD in order to attain 1.000.000 USD? The answer is 17. If I lower the figure, the number will rise.
The strategy of investing in individual companies one after another in a time frame involves a psychological problem. The investing into one company has a frustrating part which is linked to the feeling of facing a loss. When one buys an undervalued company at a big discount, that loss which may occur quite naturally due to the fluctuating stock market is of temporary nature and will disappear with the gradual rise of the stock's price. For example, if you buy a stock at 10 USD while the book value is 20 USD and the intrinsic value of the stock is 100 USD, just because the stock drops to 5 USD does not mean that your investment is a mistake; it is a temporary setback.
When applying this investment strategy, the problem of liquidity will arise with time but it may also appear right from the start. If you select an illiquid stock, you may have a hard time to get in or to get out. And when the capital that you are going to invest is substantially big, you will necessarily limit your investment to liquid stocks. My experience on this matter was forcing me to look for a maximum of 10% of the average daily trading volume of any stock before considering any investment. This kind of approach will also force you to look for more prominent companies when your capital grows to a substantial level.
As far as the trading activity is concerned, I have a similar approach. Though open to debate, I deliberately consider again the maximum of 10% of the daily average trading volume but I also add the factor of price volatility as well as the average daily price range. I don't want to see big price differences when I am placing the orders. Also, I need an important level of liquidity in order to have a mobility when moving in and out and also moving from one stock to the other as part of the maneuver in the stock market.
Once I establish a list of stocks that I will trade, I study the chart by placing half a dozen of indicators such as moving averages or mathematical indicators such as MACD or RSI, and then I place the resistance and the support levels in order to determine the possible entry and exit levels. After that, once I establish my entry and exit levels as well as my stop loss level, I place my order. Once the order goes through, I follow the position closely and adjust the exit levels or the stop loss levels according to the price movement.
When trading a stock, the fundamental data as well as the news regarding the stock itself represent barely 10% of my trading decision whereas the technical indicators as well as the chart's picture represent the remaining 90%. What I look for are a set of charts where there is a definite price formation which is confirmed by the technical indicators. Once I am satisfied with it, I place my orders.
This trading approach may look to be in a sharp contrast with the investment approach but the idea is to guarantee a positive return and thus to avoid as much as possible the loss. Of course, this may not work all the time because some positions may result in a loss and one has to take it without questioning it. The mortal blow in a trading or investing activity is to have a second guess in one's position when evaluating the validity of the indicators or criteria. When the chart and the indicators tell you what to do, you do it, that's it! You don't reconsider them. It's like a U-boat commander who is just about to send his torpedo when he suddenly says "let me check the figures again" and misses his target.
Whether investing or trading, the whole process must be planned and the plan must be followed thoroughly. If one permits itself to deviate from the plan during the course of the operation, he will face unwanted results. The investment or trading plan is strict in the entry and exit levels in a given position but is very loose in terms of time period. Following the plan requires two core qualities: discipline and indifference.
The discipline to follow the plan without permitting the interference of exterior or internal factors is crucial for the success of the financial operation. It permits the concentration of the person upon his target and the adjustment of oneself according to the progress made in a given direction. The magnitude of the object mobilizes the one's resources and forces the adoption of an appropriate approach in order to tackle the given situation, provided that the object is attainable in comparison to one's resources.
The indifference is a psychological attitude where one shuts down the psychological elements that may affect negatively the investment process. Such psychological elements have a tendency to surge when facing uncertainty or a danger and interferes with the proper adoption of the necessary steps. For example, instead of getting out of a losing position with a stop loss order, one stays in it by hoping to recover the loss. The stop loss order is a remedy to this psychological state where one shuts down the emotions by transferring the necessary order to an emotionless status.
Like in war, being emotional in a given situation is synonymous with death in the investment world. One cannot be brave or courageous all the time or have a psychological breakdown but being indifferent is a state that is manageable almost indefinitely; it avoids the drawbacks associated with the human character which is filled with flaws. The major drawback of this approach is that, in spite of being very effective in dealing with unwanted situations, it is extremely destructive if not lethal in the field of social relations: you become a person without a soul.
Three things kill a man: alcohol, gambling and woman. This Turkish saying has a point: the stated three elements are part of the set of emotions that have a negative effect upon the man. They have a tendency to drain the resources to the point of annihilation. When one stays away from these, he has a more clear picture about what to do with his life. This also applies to the investment or trading which is, in some respect, another type of life.
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