Author: Editor

  • Most Traders Fail When Trading Stocks, Why?

    Most Traders Fail When Trading Stocks, Why?

    Most Traders Fail When Trading Stocks, Why?
    Lack of knowledge is the biggest reason behind unsuccessful trades. Searching the internet can give you some clues but also a poor education. The consequence is that you’ll be among 90% of losers. 

    By Guy Avtalyon

    Most traders fail when trading stocks, why is that? The stats are cruel. Only 10% of all traders make money permanently. That means the rest of the 90% of traders fail to make significant success. To break it down and be more precise, 80% suffer losses, 10% give up over time and only 10% are profiting permanently. 

    How is that possible, why do most traders fail when trading stocks? We have to find out the reasons behind because everyone wants to be in that 10% of successful traders. It doesn’t depend on gender, age, nationality, it simply depends on how much you are resolute to dedicate your time and effort to achieve success and make money on the stock market.

    Since the stats show that most traders fail when trading stocks, why do the majority simply copy losing traders? Why don’t they do just the opposite? The information is all around us thanks to the internet, but how can some inexperienced trader know what to use, what to do? 

    So, let’s start and explain why most traders fail to make money on the stock market. Also, we’ll give you some hints on how to avoid unsuccessful trades.

    Why most traders fail when trading stocks?

    Because they neglect the rules.

    If you want to become a successful trader you’ll need knowledge, experience, and hard work. Only when you gain all these three ingredients you may count on success eventually. You have to forget the luck factor. Trading the stock market isn’t a lottery game. You can’t just pick a ticket and pray. Trading stocks is a serious job so you’ll need to study a lot and acquire knowledge. When you acquire knowledge, you can start developing experience. You’ll walk a thorny path but if you put some effort you’ll reach your goals and finally enter in that 10% of successful traders. 

    But you’ll need time. Some surveys show that you’ll need form three to five years of learning to obtain experience. You have to go out the whole way, there are no shortcuts. The good news is that trading stocks aren’t rocket science so don’t be afraid of it, it isn’t complicated. Keep in mind that most successful traders like to look as they have the key to a great secret. They are acting like they revealed the Philosopher’s Stone. 

    Nothing is that complex and mysterious on the stock market but some traders are frightened by the attitude of successful traders. Remember, knowledge and experience are something that they obtained over time. They aren’t born with that.

    Of course, you’ll find numerous agencies offering instant solutions with no knowledge and experience required. Just don’t trust and avoid them. the only thing they want is your money.

    Most traders fail when trading stocks because of lack of knowledge

    This is the biggest reason behind the unsuccessful trades. Where do you try to learn more about trading stocks? You’ll need to learn from the respectable investors, they wrote so many books. Searching the internet can give you some clues but if you rely on that only it is more likely you’ll end up getting a poor education. The consequence is that you’ll still be among 90% of losers. 

    Are you impressed with graphs? How much do you really understand what you are looking at? Do you have a trading plan? What do you know about risk or money management? 

    Successful traders know how to develop an effective trading plan. The fact that you are buying a stock and selling it, doesn’t mean you are a trader. 

    Okay, to put more pain into your life we have to ask you. Let’s assume you have a trading strategy which means you are not that much inexperienced. Do you know why your trading strategy stopped working? How do you know it stops working? 

    What is an outstanding strategy for trading stocks?

    Most traders fail when trading stocks because of different reasons but the most common reason is that they are constantly seeking an outstanding strategy. So, what will happen when they find it? Will they use that one single strategy during the whole trading career? What a dangerous mistake! When trading strategy stops working you have to adjust it or replace it. There is no other way. But first, you have to understand why your strategy doesn’t work anymore. 

    As being a trader you know that the stock market is changing. One single strategy cannot be suitable for all market conditions. The trading strategy must be in sync with these market changes. It has to be adjusted for the new condition in the market. If your strategy stops working that means it is unable to meet the current market.

    The good news is that you could adjust your strategy and reduce failure.

    How to recognize that your strategy doesn’t work anymore?

    We are pretty sure you have a great strategy that passed all backtesting. Also, we believe you made money with it. But what if your strategy suddenly doesn’t work and you have a sizable drawdown? Will you get panicked? Well, don’t! That is part of trading. Sometimes you’ll even not be able to notice that but sometimes it will cause great losses. And you’ll start to examine your trading strategy. How will you know that your strategy doesn’t work anymore?

    The problem is that you can’t know if it is temporary or permanent. Some experts suggest setting stop-loss on the whole strategy level. So, when your strategy nails that level, you’ll stop trading it. If your strategy starts working again be patient and wait until you see that the continued strength isn’t temporary. Also, there are some tests to help you to assure that your strategy is still working. For example, in-sample and out-of-sample testing can be very useful to check the validity of your strategy. Check it by the training tools firstly, and then confirm on the validation set.

    The idea behind this is that real market performance will continue on both sets. Random market noise will not be registered. Use walk forward analysis to perform differently in and out of sample tests. Forward testing is also a good method to examine how your strategy will perform going forward.

    Most traders fail when trading stocks because they think their strategy isn’t working anymore and stop to use it.

    Poor risk management cause failure trades 

    You might have a winning trading strategy but if your risk management is poor your trade will fail. 

    Risk management assists to cut down losses. It will protect your account from losing the money. If you know how to manage the risks, you’ll make money. Most traders fail when trading stocks because of overlooked requirements for successful trading. One bad trade without risk management strategy can end up in great loss. 

    How to develop the best system to control the risks of stock trading?

    First of all, you have to plan your trading. Stop-loss and take-profit points are keys to planning. That means you’ll need to know what price you are prepared to pay and at what price you are ready to sell. If the return is fairly high, you can execute the trade. 

    Even with the best trading strategy in the world, without proper risk management, you’ll end up with poor trades

    Trading with poor risk management could reveal why most traders fail when trading the stock market. If you want to stay in this game, the best advice you can get is to learn everything possible on risk management.

    Most traders fail due to unrealistic expectations 

    Trading stocks naturally include some level of risk. But it is completely understandable why so many traders are taking high risks. A few books that you had read or one or two webinars are not guarantees for winning trades. There are no instant solutions in trading stocks. Also, if you think that using some complex strategy will bring you more profits we have to say you couldn’t be more wrong. 

    Unfortunately, traders are still losing their hard-earned money thanks to unrealistic expectations. 

    We already said that knowledge is extremely important in trading but proper implementation of it is more important. When you hear that someone had great trade during the bull market, for example, you have to know that it isn’t always thanks to great knowledge. It is easy to trade bull markets since they can cover the mistakes caused by a lack of knowledge. But what will you do when the bear market occurs?

    To define yourself as a trader you must have at least two or three years of continuous success. Don’t ask for easy and easy solutions. That is a blind way. You’ll be among 90% of unsuccessful traders.

    Trading is a professional career and as being that it takes years of dedication and work to be good at it. While learning you can do that from your mistakes but also, from other traders’ experience. That is the beauty of learning to trade. With the decreasing number of trading errors, you are closer and closer to become a successful trader. Most traders fail when trading because they avoid learning. And to be honest, that is the easiest part. The troublesome part is understanding your own psychology. That will determine how you will enter the stock market.

  • Traps of Buy and Hold Strategy In Investing

    Traps of Buy and Hold Strategy In Investing

    Traps of Buy and Hold Strategy In Investing
    In the long run, buy and hold strategy is less costly than other more active strategies but has some traps also.

    Some may ask how are possible traps of buy and hold strategy? So many investors have this approach in investing and see this strategy as the best and safest one. But recently, due to the coronavirus pandemic that caused, and still has influence, on the stock markets over the globe, as well as on the overall economy, we can hear different sounds. Lately, some investors propose some other strategies and marked some traps of buy and hold strategy in investing. 

    News of the end of the “buy and hold” strategy in investing was blooming. But, those sounds are also greatly magnified. Saying that this strategy isn’t able to survive the last market downturn is nonsense, at least. The truth is that this strategy is able to survive any market condition. This pandemic environment cannot decrease the importance of this strategy. 

    But is the buy and hold strategy perfect, is it possible that it has some traps, downfalls, pitfalls? That is exactly what we would like to point out. Also, it is important to notice that the majority of traps of buy and hold strategy are developed from investors’ behavior. They became more worried about their investments, which is normal in the situation when we have had a great market decline. But this strategy is still relevant and it will be despite some traps it has.

    Traps of Buy and Hold Strategy

    Trap 1: Buy and Forget 

    This is the first of many traps of buy and hold strategy in investing.

    Managing your portfolio is a must. Long-term investing doesn’t mean that you can neglect the importance of developments and adjustments, if necessary, in your portfolio. We all know that famous Buffet likes to keep the investment for a long time, but do you think he never looks at his portfolio? It’s 100% opposite. He, and many other investors who do care about capital invested, are fully informed of each of their holdings. So, as you can see, one of the traps of buy and hold strategy is the approach to this investing expressed in the mantra “buy and forget”. 

    You simply have to keep your eyes on your portfolio. It is very important to check if the company you bought is really the right one. Times are changing, management is changing, the trend is changing, and since literally everything and anything may affect your holdings, it is smart to stay fully tuned on your investment. 

    For example, let’s say you bought the shares of stock in some company that looked pretty good but suddenly you reveal that it wasn’t such a good pick. What are you going to do? Will you keep holding that stock? Why not, your strategy was the buy and hold? See how you can jump into the trap very easily? If you bought the wrong company even at a low price, the buy and hold strategy is a stupid move. 

    What if you were smart and purchased the right company but the price was wrong? Do you still think you did a good job? Of course not. So, you should never even try the buy and forget strategy because it is a losing strategy. And also, one of the traps of the buy and hold strategy.

    Trap 2: The simplicity of buy what you know

    It is a nice mantra, seducing like a poem, but that level of simplicity can be very dangerous. Why is simplicity one of the traps of buy and hold strategy in investing? To make this clear, do you hold stocks of the company whose products you use in everyday life? Yes? Look, there is nothing wrong, you can like the company’s product because of its quality, design, smell, whatever. However, it is unreasonable as a criterion when it comes to picking the stock for long-term investing. The meaning of buy what you know is something else. You don’t need to buy Disney’s coats or sleepwear if you want to buy the shares of the company. 

    Investing is a very serious job, so when you choose stocks some other things you’ll need to know before buying them. For example, what is the company’s prospect, how the company is positioned among competitors, is the stock fair valued, etc. 

    Some studies unveiled that inexperienced investors have a disabled blind spot when they estimate what they know and what not in the sense of picking the stocks. Remember, stocks are not your lover. You don’t need to love them. Keep that love in your private life. But when you estimate and evaluate the stocks you’ll need your rational mind. Free of feelings and emotions. It’s simple. When you are choosing the stocks where you’re gonna put your hard-earned money, the emotions are a burden and could lead you to the wrong and harmful decisions.

    Trap 3: Stay to your investment plan

    Of course, it is a good decision and you have to do that but not always. We said that numerous times: Stick to your plan! Yes, but only if you hold well-evaluated stocks in your portfolio. If you have a portfolio filled with stocks you “love” and you picked them randomly, you’ll have to change your plan and your portfolio. What else can you do? Nothing. You can do nothing with wrongly chosen stocks. Why would you like to hold stocks with poor performances? And there is a great chance that you picked losers if you didn’t build your portfolio based on investment outlook. So, how to stay with your plan if you have losers? The only reasonable action is to improve your investment portfolio. You have to change your holdings, and you’ll need to be more realistic when picking the stock. 

    Don’t be afraid! You don’t need a detailed and exact outlook for growth in the next year. But you surely need to have a basic understanding of the economy and the market.

    For example, the whole world has an economic downturn today. The fears of many companies regarding solvency are rising. But this situation is likely not to continue. Actually, we are 100 percent sure it will not. The economy will bounce back soon or later, there is no doubt. And you as an investor also have to know that. 

    To put it simply, if you have a long investment horizon, why should you be worried if prompt recovery or a slow recovery will come. Your only concern should be your ability to be clever enough and to be prepared to adjust your position if your investment outlook has to change.

    If you stick to your investment plan and you do not manage your investments with due diligence, you’ll be faced with traps of buy and hold strategy in investing. 

    Trap 4: The money is locked

    Despite the fact that it looks like a great strategy, the “buy and hold” strategy has some traps and drawbacks. First of all, this strategy means investing for the long run, so your money invested will be locked in stocks. During the holdings period, it might happen that you’ll have to stay away from other investment opportunities. It will be hard for all of the investors to have such discipline, particularly if they made bad purchasing and choose lagging stocks. Especially today when many investors realize that their choice wasn’t that good.

    Trap 5: Time is my friend

    Well, it can be true especially if we count on compounding. But just because you owned the stock for 15 years, does not mean that you are qualified for a generous reward for your capital invested. Just look at the differences in return between your stocks. If your portfolio includes a few great investments, over time it can be dragged down by the losers. Of course, what or who can stop you from holding all losers in your portfolio. That’s your choice. But think about diversification or buying some index funds. We hope you understand that time isn’t always your friend and that your investments may drop over time. There are no guarantees unless you keep your eye on your investing, manage your portfolio, adjust it is necessary, or engage some to handle it. But yet, nothing is 100 percent sure when it comes to long-term investing. You should count on it. And try to avoid traps of buy and hold strategy because it has them many.

    Trap 6: My best players will always beat the market

    Really? What if the market crashes? Despite the fact that the markets will survive even an Armageddon, the market crashes can lessen the value of your investment significantly. For example, if a prolonged bear market occurs, investors stick to the buy and hold strategy and can lose all gains. Yes, your winners are solid stocks and they may bounce back, but if you own the stocks that are notably going down, your portfolio will be hurt a lot. That kind of stock could wipe out your portfolio. Think about the oil sector today. What do you think, will it be better? Of course, but the damage is done.

    If you prefer the buy and hold strategy it doesn’t mean that you’ll never need a risk management strategy in place. Every single investor or trader must know when to pull the plug and avoid bigger losses. 

    Bottom line

    Buy and hold strategy in investing is one of the most popular ways to invest in the stock market. In most cases, investors who practice this strategy have no worries. But, if we say it has no drawbacks we’ll lie. Moreover, this strategy has some serious traps and failures. If you pay enough attention to your portfolio it is possible to avoid them. That will require your time and money to secure your investment against market crashes. Also, you have to know how and when to cut your losses and take profits.

  • Concentrated Stock Positions Are Risky

    Concentrated Stock Positions Are Risky

    Concentrated Stock Positions Are Risky
    The worst-case scenario of holding a concentrated stock position is that the chosen company can bankrupt and the stock value drops to zero.

    Concentrated stock positions occur when you as an investor own shares of one stock in a big percentage of your portfolio. So your capital is concentrated in a single position. How big is that percentage? It depends on the size of your portfolio and the volatility of the stock. But concentrated stock positions commonly occur when that stock represents 10% or more of your overall portfolio. 

    The modern theory says that it can be any position size that may hurt your investment plan. So, we won’t be wrong if we say that concentrated stock positions are any portion in one single stock in your portfolio that have a major influence on your overall portfolio no matter if it is 5% or 55%. Generally, it is a position size that can destroy your financial goals.

    But nothing is so bad as it looks at first glance. Many people created their wealth by holding a single stock. So many families built a fortune in this way. The value of that stock grew heavily over time and the members of such a family inherit these concentrated stock positions, a large one that consists of just one stock.

    Don’t matter how the concentrated stock positions are earned, they always represent an unbalanced allocation of investments. Since the holder of such a portfolio needs to reduce risk, it is essential to understand it and maintain it properly. There are several strategies very suitable for handling concentrated stock positions.

    Strategies for handling concentrated stock positions 

    Have you ever heard a saying: “Concentrated wealth makes people wealthy, but diversified wealth keeps them wealthy.” It’s kind of credo among investors. Concentrated stock positions are challenging for managing. They have great risk potential included. So for that to be done, the investor needs a proper strategy.

    One of the most common strategies is selling the part of these concentrated stock positions or the whole holding on it. To be honest, that is the simplest way to reduce the concentration on the stock. 

    But there are some that may occur, for example, the capital gains tax is connected with selling. In order to decrease the tax, you don’t need to sell the whole position. Sell it in the parts. For instance, you can define an amount and sell one by one quarterly. Of course, you can choose a different time frame but the goal will stay the same, to reduce the concentrated stock position since you would like to reduce the exposure also. Depending on the position’s value it may take a few years unless the whole process is done. Some experts claim that 3 to 5 years is the optimal time frame for that.

    So you have two choices with this strategy: to sell the stock immediately or in portions over time.

    Hedge the position – a strategy for handling concentrated stock positions

    Those are actually two strategies but we’ll put them in one because they are connected. This is a bit of a complicated strategy but an effective one. Everyone wants to protect the owned stock against drops. You can do it by using options. So, think about the buying of put options as a kind of insurance against the potential losses in your stock. When you buy a protective put option, you’ll have the right to sell your stock, the whole or part of it, at a predetermined price. Don’t be worried if the stock price increases above the predetermined price. Your option will expire worthlessly and you’ll still hold your stock.

    This strategy is quite good if you need short-term protection, so think twice are you willing to use it because over the long run this strategy may cost you a lot.

    Also, you may sell covered call options. The strike price should be above the current market price. That will give you an extra income but the smallest protection against total loss if the stock price decreases significantly. Moreover, you’ll not benefit from price appreciation if you use covered call options as a strategy to handle concentrated stock positions. 

    Maybe you can use covered call options as a part of a well-organized selling process based on the market movements. Meanwhile, you get paid the premium.

    Diversifying

    It doesn’t mean you’ll make some small adjustments to your portfolios. Your main goal is to reduce the volatility that a concentrated position generates. And you cannot do that randomly, this diversification has to be exact.

    As we said, you can sell this large position at once but there are some problems that may arise. The most important is that you can reduce the value of your overall portfolio by doing so. For example, if you sell the whole position at once that could cause the stock price to drop in value. 

    Sometimes such a decision can be emotionally difficult. So, a staged sale can be a way to avoid emotional reactions when selling a large position. You can do this if you determine the number of shares of the stock you want to sell by a particular date.

    For example, you want to sell 21,000 shares of the stock over the next 21 months. And you decide to sell shares every quarter. There will be seven sales during this period, right? At the end of each quarter, you are selling 3,000 shares. This will not disturb you a lot, you have a schedule, your emotions will be under control, you don’t even have to think about the market fluctuation.

    Use the exchange fund 

    This method is useful when you find other investors in the same situation with concentrated stock positions and who want to diversify as you do. What investors have to do? What are their options? They can join their shares into a partnership where each investor gets a proportional share of that exchange fund. Since the stocks are not the same, each shareholder will have a portfolio of different stocks. That will provide diversification. The additional advantage of this method is that it provides the deferral of taxes. 

    The straightforward approach to diversify the concentrated stock positions

    It is rebalancing with a completion fund. We describe it above. It is simply selling smaller parts of your position over time. You can use the money you got to buy some other asset and have a more diversified portfolio. That’s how a completion fund operates. But as a difference from exchange funds, you are in control of your stock.

    For example, you own $10 million worth stock, and you want to reduce the exposure to this stock. But you would rather sell part of your position because if you sell $10 million in one transaction the taxes you have to pay would be expensive. So, you prefer to sell  20% of the position every 6 months, and use that money to diversify into other assets. Over time you’ll have a fully diversified portfolio adjusted to your risk tolerance. 

    Bottom line

    Some wealth transfer strategies could benefit you. For example, family gifting strategies, and charity gifting strategies such as direct gifts, foundation, or trusts.

    The most important is to have peace of mind. Holding such a great but only one stock that generated money for many generations is a great responsibility. But that kind of portfolio is very volatile and risky. So you have to be smart and find the concentrated stock positions exit strategy suitable for your circumstances and goals. Your chosen strategy has to increase your overall wealth. 

    These strategies can reduce risks, reduce the tax of reducing the position. They are worth seeking. If you still are not sure which strategy to choose, find a professional financial advisor.

  • Concentrated Stock Portfolios – Are They Risky?

    Concentrated Stock Portfolios – Are They Risky?

    Concentrated Stock Portfolios - Are They Risky?
    A portfolio of fewer than 10 stocks can be more volatile than a portfolio of 200 stocks and riskier. But it is able to produce greater wealth.

    Concentrated stock portfolios are portfolios that hold a small number of different stocks. The aim is to reach a specific level of diversification. But it is different from diversified portfolios because concentrated stock portfolios can consist of less than 10 stocks. This kind of portfolio can increase the risks but at the same time, it increases potential gains. While we are broadly talking about the importance of portfolio diversification concentrated portfolios actually generate the highest returns. And if you examine the results of both, you’ll see that concentrated portfolios that include only a few stocks are better solutions for creating huge wealth. 

    How is that possible?

    Concentrated portfolios also allow investors to be focused on a small number of investments but high-quality. Many famous and extremely successful investors made fortunes with concentrated stock portfolios. 

    We don’t want to neglect the importance of diversification. It’s the opposite. Diversification is by far the most important lesson that we can learn. Also, the importance of spreading money across different stocks and sectors isn’t doubtful and will significantly reduce risk. But a lot of investors don’t follow that advice and are growing their wealth as a result. Warren Buffett once said “diversification is a protection against ignorance” and what is interesting, data shows that concentrated stock portfolios generate more profits. Simply, they are better performers. 

    Disadvantages of diversification

    Diversification has benefits but you’ll need a balance between risk-controls and returns. This highlights investors that diversify across concentrated stock portfolios rather than diversified. Diversified portfolios have a lot of market risk, anyone can confirm. 

    But, how much is proper?

    All investors are faced with this question and it isn’t a simple one. If you have a concentrated stock portfolio you may experience the stressful event if you don’t understand the company you are investing in completely. However, if you are ready to explore and spend time to get to grasp the companies you want to buy, the concentrated stock portfolio might be a great choice and it can generate high returns.

    But be careful, invest only in the companies that you believe you have an advantage. Concentrated stock portfolios aren’t necessarily risky but only if you are ready to work more. This means you have to be responsible for your investments and never neglect the dangers that may appear. You have to pay a lot of attention and spend time to be able to reduce the risk if you want to build a concentrated stock portfolio.

    Diversified portfolios hold stocks of numerous companies. 

    It is between 40-75 stocks. Concentrated stock portfolios hold less than 25, and it is common to hold less than 10. For example, the structure of such portfolios means that you have 5 to 10 stocks which constitute over 50% of your overall investments. It is important to follow this structure because if you don’t follow these percentages and your portfolio holds under 40%, your portfolio will be diffused.

    Diversification has some advantages. It can reduce the level of portfolio volatility and potential risk. When investments in one sector perform inadequately, other investments will offset losses. But you have to hold assets that are negatively correlated. 

    But diversification can have negative effects on your portfolio. That is a great disadvantage. A diversified portfolio can limit your potential gains and produce average returns. For example, you hold a few winning stocks but beside them, you hold 20 stocks with poor performances and they will reduce your overall gains.

    Also, diversification requires to rebalance your portfolio. If you created a widely diversified portfolio you’ll have a problem monitoring and adjusting your investments. And if you don’t pay sufficient attention the risk may increase.

    The benefits of a concentrated stock portfolios

    Conventional thinking states that diversification reduces the overall risk of investing in stocks. And what is interesting, investors support that approach but, for some reason, avoid concentrated stock portfolios as too risky. It is understandable, but having too much can be bad.

    But not all investors are opponents to concentrated stock portfolios. For example, Warren Buffet who advocates for a concentrated portfolio suggests: ‘‘An investor should act as though he had a lifetime decision card with 20 punches on it. With every investment decision, his card is punched, and he has one fewer available for the rest of his life.’’

    How to build concentrated stock portfolios

    It isn’t as hard as you may think. For example, buy stocks of companies you know well, stay focused on your main investment purpose, invest for long-term to gain the benefit of compounding. And, what is most important, research a lot to find the best stock to invest in.

    When you invest in a limited number of companies you actually have a great opportunity to invest in high-quality companies. There is no need to compromise on quality. What you have to pay attention to? Be informed and buy the stock when it is priced below its worth when the market undervalues it. This gap will provide you significant and profitable upward potential. 

    Legendary John Maynard Keynes suggested investors hold concentrated investment portfolios. In 1938 he wrote:

    1. A careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;
    2. A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake;
    3. A balanced investment position, i.e., a variety of risks in spite of individual holdings being large, and if possible, opposed risks.”

    The ideas for concentrated stock portfolios

    Let’s examine two possible portfolios and compare them.

    The first one consists of all stocks in the market. You can hold such a portfolio without a problem if you use mutual funds and index-tracking investment trusts, for example. If we ignore all fees, the return of this portfolio will be an exact match of overall market returns.

    The second is a concentrated stock portfolio with one single stock. Let’s assume that stock is a great player, so its return could beat the market. Of course, if the investor made a bad pick the total loss is guaranteed.

    So where is the point of holding concentrated stock portfolios? 

    If you have a smaller stock portfolio, the possibility to have a higher return than the market average is greater. If you want to hold a smaller portfolio everything depends on your ability to identify all details of some company, you have enough time to find some low-priced stock that can outperform the market greatly. A careful selection of stocks will maximize your long-term returns. 

    But the concentrated portfolio should be balanced 

    Concentrated stock portfolios hold several stocks and as being such, are resistant to the risk of a total loss. Even if the value of a single holding falls to zero. It is possible if every stock from the portfolio performed the same. So, you should hold stocks with incompatible risks or opposed risks. For example, you could reduce the risk if you invest in some hedge funds.

    Bottom line

    No risks, no rewards is the most meaningful sentence in investing.

    When you know all the company’s details, that allows you to decide which investment concept has the highest profit potential. If you want your capital to put to work, your investments should be your top choices. Of course, you have to be selective. No one has hundreds of top choices.

    Try to think of a small portfolio with several stocks like this: a small portfolio can increase risks, but it will also maximize the returns with a few outstanding players. Always keep in mind the investors in Microsoft. Why should any of them want to hold any other stock?

  • Before Taking Out A Loan Ask Questions

    Before Taking Out A Loan Ask Questions

    Before Taking Out A Loan Ask Questions
    Before you begin the whole process of taking out the loan, you have to recognize what kind of loan you need. Personal loans are unsecured and different lenders will offer them under various conditions.

    By Guy Avtalyon

    Before even starting to investigate opportunities, you have to know what to ask before taking out a loan. Your account will thank you later. The truth is that almost everyone will find a good reason to take out a loan, but keep in mind, that has to be a GOOD REASON. For example, vacations are a bad idea.

    Suppose you already asked yourself all the important questions and you got the answers on them. Did you? Well, it isn’t quite the truth, right? 

    You’re in need and in a hurry to find a lender is a more realistic situation. Before you start examining what are your opportunities or start investigating online offers, for example, you have two main subjects that you should consider: why do you need a loan and what to ask a lender.

    What to ask yourself before taking out a loan?

    Why do you need a loan? It is a personal question. Will that borrowed money help you achieve your goals? Do you really need it?
    Personal loans are tools that must help you to solve your financial problems but you must have a plan for that. As we said, taking out a loan for vacations is a bad idea, rather open target savings account for that purpose. It will take time until you save enough but paying back loans also require time. 

    But the reasonable decision is to take out a loan to pay out some debt with high interest. How much do you need exactly to borrow is crucial. Online applying for personal loans is very easy, but did you determine the exact amount of cash you need to borrow. If you add up all your debts you’ll find that exact amount. 

    How much can you afford to repay?

    Personal loans will provide you cash for your needs, but it’s important to borrow what you can afford to repay. So, before you apply you have to examine your payment options. Calculate your monthly payment. For example, you know the amount of money you’ll need to borrow. But to calculate your monthly payment you’ll need to know the interest rate and loan length. Loan length is an important question and it is often your decision. You may choose to pay a larger payment per month, so you’ll need a shorter time period to repay your loan as a whole. If you choose a longer repayment timeline, you’ll have to pay smaller amounts every month. 

    Also, the interest rates will affect your repayments. Try to find a lender that offers lower interest rates, that will save you money because if the interest rate is higher, you’ll pay more money for the interest.
    When you are searching for some online lender, always seek the lowest interest rate as possible.

    Before taking out a loan ask what is your credit score 

    Your credit score may decide if you are qualified for a personal loan at all. Also, if you are qualified for getting a personal loan, a good credit score may provide you better terms. With a bad credit score, you’ll haven’t such good terms. Yet, it’s still possible to get a personal loan with a bad credit score. 

    Some online lenders will give you a chance to see your credit score without paying and without obligation to take out a loan.

    It’s up to you to decide if an unsecured personal loan is suitable for you. Unsecured personal loans have fixed interest rates and fixed payments every month. Payments for other loans may differ from month to month and as the lifetime of your loan is approaching to the end.

    Can you trust the lender?

    When you’re in a real need and you need that money quickly, there is an army of lenders willing to deceive you and put you in a dangerous situation.
    Trustworthy lenders will look at your credit score, credit report, and examine whether you are able to repay the loan based on the ratio of your debt to income. 

    If they can check you, you can check them also before taking out a loan. For the US-based residents, check complaints reported to the Consumer Financial Protection Bureau. Also, you have plenty of websites where you can find other borrowers’ stories. Thanks to the internet everything is much easier. The trickiest part is that you’ll need to give some sensitive personal information if you want to use an online lender. 

    Check them again and again

    So you have to check them and be sure you are dealing with trustworthy lenders because some risks may occur. Fake lenders can be an extremely dangerous choice. They can promise a lot of beneficial things, but after you pay what is needed for approving the loan, you may not get what you wanted and what you paid nor what they promised. Also, if you choose a fake lender, it is possible to pay more interest or more fees. For example, some trustworthy lenders will never ask for advance fees. With legitimate lenders, the only fees you have to pay upfront are, for example, appraisals or credit checks. But you’ll have to do that only if you are taking out large loans.

    To lenders who allow anybody to take a loan, you’ll pay high interest. They will always calculate the risk they have to take or simply, they want to steal your data or money.  

    Also, be very careful, actually, you have to avoid all lenders that offer you to send the amount requested by wire. 

    Why would they want you to send money by wire? You have a credit card or check to do that. If you find such a lender you can be sure it’s a scam.

    Some of these “artists” added some words to their names that may suggest the U.S. government has approved the lender. Also, some will choose the name of some well-known financial institution but will make small, barely visible changes. That is a sign you are dealing with the false lender.

    What to ask a lender before taking out a loan?

    Ask the lender to explain all about different interest rates and to tell you how each of them could influence your financial situation and loan purpose. The other info you should ask your lender is how much you’ll need for down payments. In most cases, it will be 20% but can be changeable from lender to lender and depending on your credit score. For example, some will demand significantly less.

    Also, you would like to know what all the costs are. This means you have to know even before taking out a loan the cost of lender’s fees, recording fees, taxes, etc. 

    You need to know if you can get a loan rate lock. That is important if interest rates are rising. Of course, they are changing on a daily basis but if that change is notable maybe you’ll choose to lock a loan rate, for that the lender will charge you and you’ll need to know how much the fee will be. 

    Also, are there some prepayment penalties? They are not allowed in every state in the US, but it is important to know if your lender can charge you penalties if you pay the loan earlier. 

    Not everyone is an expert in mortgages and mortgage terms. Ask anything you’re not certain about. There is no stupid questions. You have to know all details, ask the lender for each one before taking out a loan.

    What to pay attention to before taking out a loan?

    When you need money, you may not have enough time to think about your financial future. So, you have to be careful and wise. Take care of how and under which conditions you are taking out a loan. Ask as many questions as you can. Demand the answers because they can save you money. Before taking out a loan from a lender, ask yourself what is the real purpose of borrowing and can you keep your debt under control. For that, you’ll need to know all details about the conditions under which you are taking out a loan. 

    Borrow only the amount you really need and you are capable of repaying. Lenders will try to give you the maximum loan but do you need it? Can you afford it? Always think about the future and possible problems that can arise.

  • The Importance Of A Trading Journal

    The Importance Of A Trading Journal

    The Importance Of A Trading Journal
    If you want to become a successful trader you will do what is obvious, you’ll start keeping a trading journal. That will give you a lot of benefits.

    The importance of a trading journal isn’t arguable. A trading journal is helpful for every trader to track trades. Using a trading journal is one of the essential components for trading success. Even the most successful traders understand the importance of a trading journal and use it all the time.

    But still, some traders don’t understand the importance of the trading journal and use it inefficiently. The reason for doing so is quite hard to understand because using a trading journal is a great tool. Without it, you will not be able to execute your trades with higher efficiency. The importance of a trading journal is obvious if you know what kind of important data it can provide you. It could show you the info about what were the market conditions and you went through them, where you were panicked and wrong or had successful trades and under which conditions. Another importance of using a trading journal is that it can give you a clue for your future trading strategy since you have recorded your prior strategies.

    Keeping a trading journal is an exceptional strategy to improve performance and grow confidence in trading. Success in trading doesn’t matter if it is stock, options, forex trading demands a high level of planning and discipline. If you want to be successful in trading, you’ll need to go through a full learning process. And here we come to the importance of a trading journal, one of the best tools that will guide you and help to optimize your trading system and can drive you towards profitable trades.

    What is a trading journal?

    As we said, a trading journal is one of the most powerful tools for trade management. It is the place where you have recorded all your trades and you can always check for better output and for future trades. By using a journal you can track development as a trader but also examine mistakes you made when you enter or exit your trades. Without it, you cannot act. It is your best base for better future executions.

    The importance of a trading journal is that you have all data records ordered by the date with all trades that you ever take. You’ll have all entries, meaning every single trade ever taken. So, you’ll have a prompt overview of all trades you made, every entry and exit prices, the prices’ direction,  the size of all your positions, all trade results. Of course, you can add to your trading journal all data you want and find they can be useful for your trading success.

    Why keep a trading journal?

    The same as it is important to have a trading strategy, one or several of them, risk management, it is also important to keep a trading journal as a part of your trading plan.

    It is important to keep a quantifiable record of your trading performance and learn from past winnings and losers. However, past performance cannot predict future performance, but you can use a journal to learn from your trading history, to recognize the emotional actions, why did you or the price go against your strategy. So, your trading journal should include all your profitable trades, also unprofitable, market records, the reasons behind all your buying or selling the stock, and many other details. 

    At first glance, it looks very complicated and you may think it’s better to give up before even starting, but when you start it and recognize how beneficial it can be to keep a trading journal, you’ll stick with it throughout all your career. 

    What are the benefits?

    Your trading journal is the most important statistic of your trades. It keeps tracking your progress and it is by far the best way to estimate how successful you are. By keeping a trading journal you’ll have valuable feedback on your performances but also, you’ll have the patterns that will provide you important and accurate information about what you did well and what you have to change.

    As we mentioned above, it may seem like a complex work but in essence, a trading journal is a simple diary where you have to write down all your trades, the reasons behind them, and how it ended up. 

    We say the end is very important, we say it deliberately.

    If you plan to become a successful trader, all ends are important and should find their places in your trading journal. Never add only the winning trades or ignore the losing ones. You’ll need a valuable tool that will provide you accurate feedback into your trading method. That’s the main goal of keeping a trading journal.

    What traders do wrongly?

    There are several major mistakes (more about “option trading” mistakes in this article) in keeping a trading journal. Some traders will just add the stocks they trade but forget to write down how the trade ended, did they have the winning or losing trades. That is a common mistake that leads to keeping a journal incorrectly. You have to know whether you executed your trades in profits or losses and you’ll need that information documented later to recognize the patterns.

    Add to your journal what were your reasons before entry, where you placed the stop-loss, where was your target profit. Also, it is important to add how much risk you planned to take and write it down in money. The next step is to follow your own rules, right? That will show how you manage your trades.

    But let us explain why it is so important to add market conditions to your journal. If you don’t, there will be a great possibility to continue trading out the market context. Moreover, you’ll not be able to seek new approaches and ideas of trading. 

    More detailed explanation 

    If you have data about market conditions added to your journal you’ll be able to recognize the markets with a high possibility for more aggressive trades. In case you aren’t that kind of trader, you’ll just stay away because you’ll know when not to be in the market. On the other hand, if you like that kind of trade you’ll be ready to take a risk.

    Additionally, the trading journal will give you a great chance to monitor movements and risks, to recognize the strength and weaknesses in your portfolio. It will give a clear indication which stocks or other assets you trade well and which you don’t manage well. If you ignore this information you’ll not earn the money. It is more likely you’ll have consistent losses. What really you would like in such a case is to get your money back. 

    There is a difference between a bad trade and a bad stock and you have to realize that. Maybe the stock is quite good but you don’t trade it well. 

    The journal will show you which stocks you have to focus on.

    What things to add to your trading journal?

    The following are basics. 

    Add the stock price action before you enter the trade. It can be a one or two hours time frame. That will be the context in which you’ll open the position. Further, include a text note of your starting time to know if you enter the trade too early or too late. Also, why maybe you did miss some signals.

    One thing is also important and it is smart to add it. Add, it can be a kind of reminder, what are the market circumstances that could force you to stay away from trading or you missed the trade. When such a circumstance occurs, write it. Write down that you didn’t trade because of the news, for example.

    Write a note about the trends you saw. If you made a mistake, write it also. Do the same if you miss a trade or how many trades you made, make a note of it. Note how many winning or losing trades you had, calculate expressed in money how much you earned and loss, and write down the net result. But this method may have some disadvantages so it could be better if you, instead of money to use points for the futures, or cents for stocks, as well as pips for forex trades.

    Bottom line

    Keeping a trading journal makes a difference between amateur traders and professionals. Professionals understand the importance of a trading journal. You can count on a lot of benefits when you start keeping your trading journal. First of all, your whole comprehension of trading will be changed and you’ll get a better direction, of course. Moreover, you’ll be able to make progress from the very first day. You will have confidence and trust in your strategy and your skills when your journal backs you up with the statistics that verify that your strategy works.

    These are only a few benefits of a trading journal. If you want to become a successful trader just use this number one tool for professional traders. That will improve your trading.

  • The Danger of Diversification In Investing

    The Danger of Diversification In Investing

    The Danger of Diversification In Investing
    Diversification has to be a well thought out step for investors. It can boost growth and lead you to wealth. But if doing improperly, it can cause costly failures.

    Investors infrequently pay attention to the danger of diversification. All taught that the idea of diversification is to reduce the portfolio’s risk. And nothing is wrong with that. Some amount of diversification is important or investors will take too much risk that will never be neutralized for.
    But sometimes too much can be very bad. It is the same with the diversification of the portfolio if it is too diversified. And we will explain to you the danger of diversification. 

    So, in the first place, the danger of diversification may come when the diversification is done improperly but also if the investment portfolio is over-diversified. But let’s go step by step through all examples of the danger of diversification because they can be very costly. They can ruin the whole investment and leave you with your empty hands.

    The danger of diversification in investing

    Portfolio without focus

    No one will tell you that the danger of diversification is the reduced quality of your investments. In investing, one of the very important parts is to have a well-focused portfolio. That provides investors to have the best opportunities. To say this way, publicly listed companies are not all worthy to invest in. Also, what is maybe more important, you can find even fewer companies that are so-called safe investments. In order to have well-diversified portfolios, investors don’t pay enough attention when picking the stocks they could add many of them that don’t give a margin of safety to the portfolio. That will cause a reduction in the quality of investment. That would be the danger of diversification.

    A complicated mixture of assets

    The other danger may appear if investors add too many assets without truly understanding what they have. In other words, their portfolios are too complicated. The point with investing is to have control over your investments and know what they are. If you have too many assets from different classes you would be lost in attempting to follow them and to stay on top of them. 

    Portfolio volatility

    It’s very important to understand that the more stocks you add to your portfolio, it will be more correlated to the market returns. There is some logic behind and you have to understand it because portfolio volatility can lower your portfolio performance. So, it can be too risky. Always keep in mind that the number of investors that ever reach average returns is under the average. The reason is the volatility caused by risk.

    Having an index fund instead of a portfolio

    Instead of buying too many stocks and adding too many assets, it’s better to buy some index funds. If you have too many assets, your portfolio will look like an index fund anyway. So indexing can be the danger of diversification. Indexing is good when the bull market, but if it is bear you could be faced with a lot of problems and danger.

    Indexing, as well as over-diversification, represents the hidden danger of diversification. For example, if your portfolio may not have quality if you hold second-rate investments along with great investments. Sometimes, holding so-called inferior investments is the result of ef emotional buying, so avoid that. Pick stocks after you research them, never based on some emotions.

    What can put us in danger of diversification?

    The largest single danger is a surprise risk. Surprises are often part of our everyday life but when it comes to our investment it is a sign that we as investors are not cautious enough. Investors should be aware of risks and to predict them as much as possible. It is crucial in investing, due to safety, to quickly transfer our assets that show more risks than we expected or we can accept.

    Also, forget you’re able to have an excellent and perfect plan for your future. Very often some unexpected events can arise. For example, this coronavirus pandemic that we have now. These events have a great impact on our investments so if we have over-diversified portfolios how could we manage all the investment? It’s almost impossible.

    The perfect investment plan doesn’t exist. Every single investor made some mistakes. Just listen to what Warren Buffet has to say about his mistakes and wrong decisions. Yes, even him.

    The belief that you are always right isn’t only a stupidity, it is a more dangerous practice. However, it demands to keep on learning in order to modify your behavior. 

    If you never change your behavior you’ll take too many risks and you’ll put yourself in one of the dangerous situations. Moreover, you’ll never grow as an investor and, also, your capital will not grow. Sometimes it is better to give up and admit we are wrong than stay with the wrong plan and make more mistakes. 

    Comfort from following others

    We are all vulnerable and insecure at some level, whether we admit it or not. A great number of people seek help in instant solutions. The easiest way is to follow what other investors do. That’s a kind of psychological effect. If the majority is doing something, how can that be wrong? Remember, only a few investors know how to make money on the stock market. The others, the majority fail. The stats are cruel. 

    The winners represent a small part of all investors. 

    Investing is difficult but it can be very successful and profitable. All you have to do is to guess where the new gain capacity will come from. The tricky part is that you cannot do that without the knowledge and without comprehensive research. The best suggestion is: follow the standards, not the people.

    The fake feeling of security can bring us to the danger of diversification

    The truth is that many apparently diversified portfolios aren’t really diverse. For example, if your portfolio consists of stocks of 5 different companies and 5 different industries it might seem as a well-diversified one. But if all your portfolio consists of 100% stock in one market index and they are all based in the same country and have exposure to the same currency, you have a very dangerous diversification. In other words, your investment is at great risk. 

    You might think you made a great choice, but in reality, you are at risk to lose everything if some unfortunate event hit that country or currency.

    Bottom line

    Proper diversification is a matter of great importance. Smart investors allocate their money based on their own valuations, never on some prophecy or doubted predictions. Avoid over-diversification if you are invested in ETFs or mutual funds since it is a common mistake. When picking the stocks, seek the highest quality companies, to direct the chances of success in your favor.

    The bright side of portfolio management is that you can avoid the danger of diversification if you manage your portfolio on your own. Diversification is an extremely crucial concept in portfolio management, but it has to be done properly. When building your portfolio keep in mind the danger of diversification in investing. That will help you to reach optimal diversification.

  • Value Investing Tools That Every Investor Must Use

    Value Investing Tools That Every Investor Must Use

    Value Investing Tools That Every Investor Must Use
    “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” – Benjamin Graham

    To find accurate value investing tools you’ll need time, a lot of it to do your homework. Finding the right tools requires a lot of research. It is the same as finding a good value stock to invest in. It can be so complicated that many investors are scared of all that job. 

    But if you don’t like to do your own research, here are some tricks to help you. 

    By having the value investing tools to value a company and evaluate its prospects, you can eliminate unsuitable stocks. Also, you can do it more quickly and focus on the best picks. One of the most accurate among value investing tools is the P/E ratio. 

    P/E ratios as value investing tools 

    The price-earnings ratio or P/E ratio is classified as a primary tool to identify undervalued or cheap stock. It is a simple metric that is easy to calculate. All you have to do is to divide a stock’s price per share by its earnings per share. Earnings per share is shortly expressed as EPS. Value investors always have the P/E ratio in their value investing tools boxes and seek a low P/E ratio. A lower ratio means that they will pay less per each dollar of the company’s current earnings.

    But this metric has some downsides. Of course, it is still a good start but if you rely on this one measure solely it is more likely your strategy will not be accurate and successful. 

    Investors are frequently attracted by low P/E ratio stocks. The problem is that they can be inaccurate and inflated numbers. Sometimes, companies report incorrectly high earnings sums or some forecasts show much higher earnings, so the low P/E ratio can be false. Everything becomes more clear after real earnings reports and the P/E ratio goes up and investors’ research result is false too.

    So, if you use the P/E ratio alone you’ll end up trapped with the wrong decision.

    Use PEG ratios as value investing tools

    If the P/E ratio is flawed, what should you do to find true value stocks? Which one of the value investing tools you have to use? PEG ratio will help you to recognize if a company with earnings growth is trading below its intrinsic value. The price-to-earnings ratio or PEG ratio can help you to avoid some traps while searching for value stocks. To calculate the PEG ratio use this formula:

    PEG Ratio = Price To Earnings Ratio / Earnings Growth Rate

    If the PEG ratio is less than 1 it is supposed to be a sign of an undervalued stock and it is possible to buy such stock at discount. So, the PEG ratio of 1 means the company is correctly valued. Contrary, if the PEG ratio is above 1 it may indicate that a stock is too expensive. But the PEG ratio shouldn’t be used as an individual metric. The valuation puzzle requires using other value investing tools to have a comprehensive picture of the stock’s value. 

    For many investors, the PEG ratio is a favorite among value investing tools due to its ability to show the stock that is at discount. However, as with all of the value investing tools the PEG ratio is useful to recognize the stock that could deserve a closer look. You’ll need more research and tools to reveal the possibility that the stock is cheap for a reason, in which case it isn’t the right choice. Simply, you wouldn’t want such stock in your investment portfolios.

    But keep in mind, for example, various industries will have different PEG ratios. So be careful when judging the company’s value.

    The company’s cash flow

    The company is worth only the amount of the future cash flows it can make from its operations. Keep this in mind. The value investors will always check the company’s cash flow before starting to invest. 

    As we noticed above, the P/E ratio is by no means a complete measure. The company’s net income is only an accounting entry and it is often influenced by numerous non-cash costs, for example, by depreciation. Also, companies use tricks to misrepresent their earnings. As a difference, cash flows measure the real money that the companies paid out or acquired over a given period. 

    Cash flows exclude the influence of non-cash accounting charges. They don’t include depreciation or amortization. So they are more objective value investing tools because they only admit the real cash that flows into or out of a company. Cash flows are a clear picture of the company’s real profitability. However, we have to repeat, it makes no sense to estimate cash flows as the only tool you use when seeking the value investment. 

    Enterprise value

    It is important to compare operating cash flow to the company’s Enterprise Value if you want a clearer picture of the amount of cash the business is generating related to its total value.

    To explain the enterprise value. 

    It is as a number that in theory outlines the full cost of a company if someone buys 100% of it. If the company is publicly-traded, this means buying up every single of the company’s shares.

    To calculate it you have to sum up the company’s market capitalization, add debt, preferred stock together, and subtract out the company’s cash balance. The result will show how much money an investor or group of them would need to buy the whole company. So, it is an outstanding picture of the total value of the company.
    When you divide a company’s operating cash flow by its enterprise value, you can easily calculate the company’s operating cash flow yield. 

    These measures are also the value investing tools. Especially cash flow yield because it presents the amount of cash that the company generates per year in comparison to the total value investors invested in the company.

    Return-on-Equity – ROE is excellent for value investing tool

    ROE is another excellent tool that can help you to find value stocks.  

    It is a profitability ratio and measures the ability of a company to generate profits from its shareholders’ investments. To put it simpler, the ROE shows how much profit generates each dollar of stockholders’ investment generates.
    The ROE of 1 indicates that every dollar of stockholders’ investments generates 1 dollar of net income. This measure shows how efficiently a company uses investors’ equity to generate net income.

    ROE is also an indicator of how efficient management is.

    The formula is 

    ROE = Net Income / Shareholders’ equity

    This measure is broadly used, and it is easy to find the ROE lists for publicly traded companies on almost all financial websites. When investors look for value investment opportunities, they are looking to find a stable or growing ROE of the company. 

    However, there are some cautions. For example, some companies can produce enormous ROE in one year, but the next one or more years later resulted in reduced profitability.

    Also, the tricky part is the relationship between ROE and debt. For example, if the company is taking higher debt loads it is possible to use debt capital instead of equity capital. Such a company will have a higher ROE. These companies with exponential and fast growth can be favorable, but also, can ruin shareholder value. Investors prefer ROE at around the average of the S&P 500. 

    Bottom line

    Sadly, there’s no fixed method that will provide investors a distinct way to reveal the best value stock for investing. Investors have to take into consideration the company’s sector and industry, also, if the company has an advantage over its peers. Look for the companies that are able to become brands, or have some unique product, the new technology, in other words, with a sustainable competitive advantage. 

    Remember, some companies operate in a cyclical market. For example, automakers. Such companies will have great growth and huge returns in periods of the rising economy but they will fail if the economy is in a slowdown. So think about the company’s profitability under all conditions. 

    These value investing tools will help you to uncover plenty of potential picks and to find a good stock to invest with trust.

  • Negative Numbers In Asset Allocation

    Negative Numbers In Asset Allocation

    Negative Numbers In Asset Allocation
    Asset allocation is one of the most efficient investment strategies. The percentage allocation shows the level of risk and the expected return. What if the numbers are negative?

    By Guy Avtalyon

    If you wonder how it is possible to have negative numbers in asset allocation we will say the shorting on the asset may cause that.
    For example, you have a long-short strategy with two classes only: equity long, and equity short. You can be sure that an equity short class will have negative numbers in asset allocation because all short investments are allocated under this class.

    Asset allocation is important because it is an individual investment strategy. The numbers of stocks, bonds, commodities, cash show the level of risk and hence, how big returns an investor expects.
    Investors use asset allocations in their factsheets that have to precisely represent their investment strategy. The asset allocation sums up to 100%,  which means that the invested volume and cash all together build total net assets.

    But if you build a portfolio that makes weightings of asset classes, you’ll have the negative numbers in your asset allocation. A good example comes from futures contracts, they can make your cash weighting appear negative.

    This is connected to the leverage of the futures and the difference between the exposure and the actual book value of futures contracts. You know the future contracts are derivatives, right? Never mind. Let’s explain it in short.

    The influence of derivatives on negative numbers in asset allocation

    Derivatives receive their value from the performance of underlying assets. The issuer can modify practically arbitrarily the exposure of derivatives to the price changes of the underlying assets. The changes in the market value of the underlying asset can be strong or weak. That is the so-called leverage effect. But, also it can be inverse. The point is that some small changes in the market value of the underlying assets may cause a really huge change in the value of derivatives.

    Maybe the most popular derivatives are futures. Futures are contracts specified for the buying or sale of a financial instrument at a pre-arranged price in the future. 

    For the buyer of a futures contract we say to go long, hence the seller goes short. Futures are traded on exchanges. The counterparty risk is close to zero. To guarantee that traders of a futures contract can cover possible losses at any time, they have to deposit an amount of the overall exposure of that futures contract. That is a margin account. 

    What happens if the futures’ price goes against the trader?

    In such a case, the trader has to cover the losses on the margin account which is known as a margin call. But if the price goes in a trader’s direction, the trader will withdraw the profit from a margin account.

    Therefore, the trader only places a part of the overall futures contract exposure in cash on the table. So, there is leverage. For example, let’s imagine a trader enters a contract with exposure in the underlying of $100.000. The requested margin for that trade, meaning the booking value of such a futures contract is $20.000. A 1% rise in the underlying asset or +$1.000,  will result in a 5% rise in the booking value of the futures contract. So, the leverage in our example is 5.

    Let’s take a look at a portfolio example

    Let’s assume you have a portfolio of $500,000 net assets. The total volume is in cash, so the portfolio allocation is 100% cash. Now let’s enter into 10 of the futures contracts we mentioned prior, for example. The portfolio will consist now of $300.000 in cash and $200.000 invested in the futures contract. Expressed in percentages it will be 60% cash and 40% futures.

    Is this an accurate picture? If we examine the booking value, this allocation is perfectly mathematically accurate. But should we base the allocation on the booking value solely? Of course not, because it is useless.

    As the $200.000 booking value describes an exposure in the underlying of one million dollars, the allocation should display 60% cash and 200% underlying. This would show the real risk and anticipated potential return of this portfolio. But it is 260% in total?

    How the negative numbers in asset allocation occur

    We have only one test left now to understand negative numbers in asset allocation. 

    It is expected the sum of all allocation positions in the calculation that use the booking value equals 100%. But if we use the interpretable exposure it doesn’t. It is a lot above 100%, actually, it is 260%! How to solve this issue that puts investors in a difficult situation? Speaking from the financial point of view, this increased exposure is based on the leverage. If you want the same exposure in the underlying assets, you will need cash. But if you don’t want to use the remaining cash,  you have to lend the amount you need to invest in underlying assets. 

    This means you have to balance the leverage by an additional position. That is known as – synthetic cash.

    In our example, this will appear as an allocation of 60% cash, 200% underlying assets, and -160% in synthetic cash. But as managers of our portfolios, we like clear stats, so we can express our allocation as follows: underlying assets 200%,  – 100% cash (synthetic cash included).

    And can you see how the negative numbers in asset allocation arise? All without shorting.

    Negative returns as negative numbers

    Negative returns are valuable in risk estimation. Investors have negative returns when the percentage of periodical return is below zero. To calculate this you have to divide the number of negative returns by the number of all returns over a given period. In this way, you can see the negative returns frequencies. 

    For example, (note the numbers are for the purpose of this example only, they are not accurate) the negative return frequencies for 6-month returns from March 1960 to December 2001 were 2% for Treasury bills, 26% for long bonds,  and 24% for the S&P 500 Index.

    The high negative return frequency for long bonds implies that bonds in the long periods present lower volatility than stocks. And this is very important info when it comes to the risk estimation.

    The investors who recognize risk from the aspect of volatility, it might seem reasonable to believe that long bonds would have several more difficult years than stocks during a 41-year period. But this is a misconception. 

    But recent data show investment returns might not be normally distributed. The normal distribution can minimize the influence of market shocks, for example, market corrections. Also, it doesn’t take into account the changes in returns within and between separate asset classes.

    Do negative numbers in asset allocation have any positive aspects?

    There is some positive aspect of negative numbers also. 

    We know it isn’t easy to stick with your long-term strategy when the markets fall sharply. But you can lose the bigger picture when such dramatic times come. Just think about the future, the time when you really will need that money. The majority of portfolios have between 10 and 30 years time horizon. Stay focused on how many shares you have, don’t think what they are worth now.

    Continue with regular investing, buy shares at lower prices, just keep investing even the share prices are dropping. Keep in mind that the markets are cyclical. So, what is bad today easily may become fantastic tomorrow. Markets are moving up and down, the negative numbers in asset allocation can turn into positive. Who can predict the time and how sharp the market can drop. The only thing is sure, the down markets always recover ultimately.

  • Disruptive Technology – Keep an Eye On

    Disruptive Technology – Keep an Eye On

    5 Disruptive Technologies Investors Should Keep an Eye On
Image source: Pexels

    by Micky Oliver

    Every investor, whether a newbie or a veteran, wants good returns on their investment. But in investing, there are no guarantees to reaping high profits. As mentioned in a previous Traders Paradise post, investors should learn how to temper expectations to prevent disappointment. However, if you want to increase your chances of long-term returns, you ought to consider disruptive technology—innovations that alter the way that consumers, industries, or businesses operate.

    Investing in disruptive technology is something that investors have always done, and often with great success. One prominent example is Masayoshi Son’s investment in industry trailblazers like Uber, Slack, and WeWork. Through his Japanese conglomerate Softbank, he was able to take early bets on these companies, and now the way we work, travel, and life has changed for the better.

    Success stories like this have urged investors to keep an eye out on technologies that could potentially revolutionize industries. If you, too, want to place your bets, here are five disruptive technologies that may be worth investing in:

    Advanced artificial intelligence (AI) and analytics

    AI has already been adopted by many industries, but it appears that its full potential hasn’t been realized. While we already reap its benefits every day with our continued use of things like ridesharing apps, voice assistants, and mobile check deposits, there is a whole crop of emerging uses of AI. This includes adaptive machine learning, edge analytics, transfer learning, generative adversarial networks, and more, as mentioned in the Tech Republic. And as technology continues to evolve, there will be more opportunities for investment.

    Blockchain

    It may seem like blockchain technology has lost its novelty since having gone mainstream, but tech writer James Gonzales explains that it’s seeing lots of use outside of the finance industry, with new applications in the legal sector ranging from the creation of smart contracts to corporate filings and notarizations. While these use cases are still primarily theoretical, they could potentially have a transformative impact, making them worth investing in.

    Space exploration as a disruptive technology

    Renowned entrepreneurs like Elon Musk, Richard Branson, Jeff Bezos, and Paul Allen have long been at the forefront of investing in space exploration technology. Business journalist Derin Cag highlighted that there is already quite a bit of progress in this domain, most notably the NASA-spearheaded space colonization projects, including the National Space Society, and International Space Development Conference. Given the prediction that the human population could exceed one trillion people in the 22nd century, it may be a good time to explore investment opportunities in space colonization as it’s likely that disruptive macro technologies will get invested as a result.

    Green IT

    Green technologies are nothing new, but as Tech World noted, renewed discussions about climate change propelled its resurgence. New advancements in green IT include renewable energy sources, electric vehicles, and environmentally-friendly services, all of which allow companies to increase resource productivity and efficiency, cut on costs, as well as decrease their environmental impact. In an effort to cut their emissions and go carbon neutral, organizations continue to invest in environmental technology, which led to an all-time high of $393.8 billion in transactions. As Greenpeace head of IT Andrew Hatton noted, going green is not only the ethical thing to do, but it also makes the most financial sense.

    High-speed travel as a disruptive technology

    Another disruptive technology impact, that is predicted to have a second coming, is high-speed travel, which reemerged thanks in part to Elon Musk’s Hyperloop project. In 2003, when the Concorde went out of commission, the high-speed travel industry took a massive downturn. But its demise was expected due to its exorbitant costs and defiance to noise regulations. With Hyperloop, a sealed tube with reduced air resistance through which a pod, or in this case, a train, would move at impressive speeds, people can travel from London to Scotland in just 45 minutes. It managed to secure $80 million in funding, and we can soon enjoy a mode of travel that solves many complex long-distance issues. Supersonic flights, aircraft that can travel faster than the speed of sound, may soon follow. 

    Investing in disruptive technology can be intimidating due to the sheer complexity of the underlying products, but if you manage to hit the jackpot, the rewards are astounding.