Tag: Risk management

All risk management related articles are found here. Educative, informative and written clearly.

  • Investment Portfolio Rebalancing – Why Should We Do That?

    Investment Portfolio Rebalancing – Why Should We Do That?

    Investment Portfolio Rebalancing - Why Should We Do That?
    Even if you’re a less aggressive investor, you should rebalance your portfolio at least once a year.

    By Guy Avtalyon

    You invested your hard-earned money for the long term, you added your lovely stocks, bonds, whatever, and thought everything is done and suddenly somebody told you’ll need investment portfolio rebalancing. What? Should you find an accountant? What you have to do? How to perform that investment portfolio rebalancing? What does it mean, at all?

    That is the main key, the fundamentals of investing. You have to do two main things: building it and investment portfolio rebalancing. 

    The investment portfolio is a collection of your investments. You hold stocks, bonds, mutual funds, commodities. The allocation of the assets you own has to be done based on your risk tolerance and your financial goals. But nothing is finished with the moment you bought your lovely assets. It is just a beginning. After a few years or sooner you’ll notice that different assets generate different returns and losses as well. Some stocks may have nice and high returns, so they become a large part of your portfolio. Much bigger than you wanted. 

    Assume you built up a 60/40 portfolio where 60% were in stocks. But after some time, you found that the value of those stocks represents over 80% of your portfolio’s overall value. What you have to do? Honestly, it is the right time for investment portfolio rebalancing.

    Investment portfolio rebalancing means that you have to adjust your investments, you have to change the asset allocation of the portfolio to obtain your desired portfolio outlook.

    Why is investment portfolio rebalancing important?

    It will help you to keep your desired target asset allocation. In other words, to keep the percentage of assets you want to hold adjusted to your risk tolerance and to earn the returns you need to reach your investment goals. If you hold more in stocks, you’re taking on more risks since your portfolio will be more volatile. That might have a bad influence on your portfolio because the value will change with changes in the market. 

    But stocks look like a better investment than bonds due to their ability to outperform bonds as a long-term investment. That is the reason to hold more stocks than bonds in your portfolio but as a reasonable portion to avoid additional risk.

    In periods when the stock market performs well, the portfolio’s money value that’s come from stocks will grow along with stock price rise. We already mentioned this possible scenario when your 60% of holdings in stocks rise to over 80%. This means your portfolio can become riskier. So, you’ll need investment portfolio rebalancing. How to do that? Simply sell stocks until you manage them to represent 60% of your portfolio. For the money received from that selling, you can buy some less volatile assets such as bonds, for example. 

    The drawbacks of investment portfolio rebalancing

    However, there are some problems if you rebalance your portfolio during the time when the markets are doing well. Even more, it can be hard to sell stocks that are doing well, they are your winners and their prices might go even higher. What if you miss huge returns?

    But consider this. What if they drop and you lose an important amount of money? Are you okay with that? 

    Remember, every time you sell any asset that is an excellent player, you are actually locking in gains. That’s real money and you can use it to obtain some stocks that are not such a good player but you’ll buy them at a bargain. Do you understand what you actually did? You sold high and bought low. You’re every single investor’s dream. You made it happen! 

    The real-life example 

    Our example of rising to 80% is rather drastically than a realistic one. Investment portfolio rebalancing ordinarily means selling 5% to 10% of your portfolio. We are pretty sure you are able to choose 5% of your winners and to buy some current losers but in the long run also winners. Investors usually buy bonds instead of stocks when rebalancing their portfolios. 

    Investment portfolio rebalancing is important because it provides you balanced asset allocation and, what is also important, in this way you’ll avoid additional volatility of your portfolio. If you’re the risk-averse type of investor this added risk might produce bad investment decisions. For example, you might sell stocks at a loss.

    Investment portfolio rebalancing is the best way to follow your financial plan and obtain the best returns adjusted to your risk tolerance. Anyway, you don’t need to be overweight in stocks because the markets are cyclical, and it could be a matter of time when the next reverse will come.

    Why rebalancing your investment portfolio?

    Let us ask you. Are you having a car? Do you change the oil or broken parts from time to time? The same is with your investment portfolio even if it is the best created. As we said, the markets are cyclical and some parts of your portfolio might not play well in every circumstance. Why should you want to hold a stock that isn’t able to meet your investing goals or you bought it by mistake?
    It isn’t hard to rebalance your portfolio, at least once per year. In short, that is investment portfolio rebalancing. If you think your investment portfolio is well-diversified among asset classes, just think again. Maybe it is diversified among asset classes but is it diversified within each asset class?

    For example, why would you like to hold only Swiss biotech stocks? There is no reason. Moreover, it can be dangerous. It can hurt your investment portfolio a lot. It is better and safer if you hold a mix of different stocks, domestic and foreign from different sectors.

    What if some of the investments grow in value while others decline? 

    In the short term, it is good. In the long run, it can be a disaster. That is the reason to rebalance your portfolio promptly and properly. Otherwise, your portfolio will be hurt as well as your overall returns.

    For example, you own 50% in stocks and 50% in bonds. Sometime later, your stocks performed unsuccessfully and their value is lower now, but bonds performed outstandingly. So, what do we have here? Bad performers – stocks at lower value and bonds as excellent players at a higher value. Would you think to change the proportion in your portfolio? Of course, you would. So, what do you need to achieve that? 

    Let’s examine a different mix. For example, you may rebalance your portfolio and now it will be 40% in stocks and 60% in bonds. But what is the consequence if you don’t rebalance your portfolio and stay with your initial mix? You will not have enough capital invested in stocks to profit when stocks come growing back. Your returns will be below expected.

    What if stocks were growing in value while bonds did unsuccessfully? Or, what if your portfolio turned into a collection of 60% stocks and 40% bonds, and quickly the stock market dropped? You’ll have greater losses, much bigger than it is possible with rebalanced the 50/50 mix. In short, you had more money in stocks. Your long-term gains are in danger.

    To make a long story short, when rebalancing, you have to cut the over-performing stocks and buy more underperforming assets. The point is to sell overvalued stocks and buy less expensive but with good prospects. Do you understand this? We came up again to the winning recipe: buy low, sell high.

    How often should you do that?

    The answer is short, once or twice per 12 months mostly. Markets are cyclical and unpredictable. However, if you rebalance at an uncertain period of the year you’ll put your money at risk. Never avoid rebalancing your portfolio after significant market moves. Follow a 5-percent rule. Your investments should be within 5% of where they were when you build your portfolio. For example, if your initial portfolio was with 60% in stocks (you were smart to buy good players) and after several months they changed to 65% or over, it’s time to rebalance. In case you weren’t so smart and you bought poor performers and they changed to 55% or below, it is also time to rebalance. You have to prevent your portfolio from fluctuating more than 5%.
    That’s the whole wisdom.

  • Sell in May and Go Away Strategy – Repeated Every Year

    Sell in May and Go Away Strategy – Repeated Every Year

    Sell in May and Go Away Strategy
    April is the past, and May is here. “Sell in May and go away” is an old saying that investors repeat every year without giving any actual belief to. Should they?

    “Sell in May and go away” is a popular maxim in the market. Investors noticed that some stocks are underperforming over the summer when they compare their performances to the winter period. The stock market summer-period starts in May and finishes at the end of October. The six-months period from November to the end of April is known as the winter period in the market.

    Sell in May and go away is a strategy which investors use to sell their holdings in May and come back again in November to invest. They usually sell their holdings in late spring, sellings are not in May exactly.  But nevermind. We have “Sell in May and go away” as a well-known saying in the market.

    A lot of investors find this strategy is more comfortable than staying in the markets over the whole year. They believe that when warm weather occurs, volumes are lower and the number of market participants is also lower. Investors hold that vacations may cause trading to become riskier and, at least a lifeless period in the market.

    Where the saying “Sell in May and Go Away” came from

    The old custom among English aristocrats was to leave the city of London and spend their vacations in the countryside and come back to London in early autumn when St. Leger’s day is. So the full phrase is: Sell in May and go away, and come back on St. Leger’s Day which is in September. For British aristocrats, it was a very important day because it was a race day for pureblooded horses as a final part of the British Triple Crown competition.

    Later, traders from America adopted the habit of going on long vacations after Labor Day. Moreover, they adopted this phrase as an investing saying. What is really interesting, all data from almost the whole of the past century confirmed the theory behind this strategy.

    For example, in the span of 60 years, DJIA reported average returns of 0,3% during the period from May to October. In contrast, in the same span of 60 years, the average return was 7,5% from November to April.

    But despite the historical background of this seasonal trading pattern in disparity in performance during summers and winters, it looks that it isn’t relevant in modern times. In recent years, some excellent runs occurred during the summers, the stock markets were very dynamic and generated lucrative gains to the investors who stayed in the market. 

    Some markets closed higher in May and rose in June giving an increase of over 50% from the end of June until the end of January. So, the phrase “Sell in May and Go Away” isn’t correct anymore.

    “Sell in May and go away” strategy 

    Some investors use this phrase as a strategy to manage a portfolio over the summers based on the perception that markets underperform during summer. They believe that lower trading volumes from May till October can boost share price volatility and weigh on stocks also. Selling off in May is a method to react to the slowdown. Our suggestion is to look at facts before you adopt this strategy.

    The strategy requires the stock allocation before and throughout the summer months to protect your portfolio against seasonal changes in trading. That means you would sell off stocks you own in May, then stay out of the market for the summer. When the autumn comes you would buy stocks back.

    In an academic study of the saying “Sell in May and go away,” we found that from 1998 to 2012 the returns from November to April surpassed the returns generated from  May to October by nearly 10%.

    Maybe this strategy is good because you’ll be out of volatility that might occur during summer, so you would be able to protect your portfolio from losses caused by volatility. Also, when you reinvest in autumn and do it just before stock’s upward trend you’ll probably generate better returns. The problem might occur when to seek what stock to buy and when to do that. In other words, timing the market is the key question.  

    That can be a critical part because timing the market isn’t a precise science. Actually, it is difficult for even the most skilled investors.

    The other benefit is that you would have a chance to re-evaluate your portfolio and remove losing players. But for this to do, you must have a great understanding of the market subtleties. For example, how a particular stock acts during different periods of the year. 

    For long-term investors, this strategy might be irrelevant but investors with a shorter horizon or for active traders it can be very profitable since they have a more active approach to investing.

    Drawbacks of this strategy

    Sitting out the stock market during the summer and having a long, long vacation might seem attractive, but you have to be cautious. What if there is the potential to miss out on great opportunities? The 

    This strategy is based on past trends. But here is the key problem. Not all investments or stocks will act according to this date-based investing, that to say.

    The “Sell in May and go away” strategy neglects the performance of particular assets or prevailing market or economic circumstances, changes in interest rates, or inflation, for example. Also, as you already know, everything and literally anything may influence the stock market. It might be the political atmosphere, natural disasters, change tariffs, etc. For instance, you sold your stocks in May but they hold strong during the summer. What the consequence can be? It will cost you your gains. No one has the ability to predict what the market will do during a few months.

    The impact on your portfolio is very important also when we talk about the “Sell in May and go away” strategy. It is very important, even if your stocks hold steady, to invest constantly, which means, you shouldn’t avoid summer investing. Otherwise, your portfolio could be hurt. 

    Time is probably the most influential tool you have as an investor. This is all about compounding interest and how long you are invested. That is the power of the time. If you go in and out of the market you will lessen the chance for your portfolio to grow. Also, to compound.

    The “Sell in May and go away” strategy can cause increased trading costs. Yes, online brokerages offer commission-free trading, but not all of them. Also, free trades could be set for stocks or ETFs but what if you sell options in May?  When you buy them back later, the fees could be higher which could lead to lower returns.

    Maybe the most important drawback of this strategy is that it could go against you. For example, the volatility is increasing in May and you decide to get out of the market because you’re panicked. Well, in June, for example, stock rebound, the prices increase. What do you have? You’ve missed the opportunity to get the returns.

    Bottom line

    Instead of “Sell in May and go away” strategy, sometimes rotation is a smarter move. This means, to not sell your investment and cash it out. It is better to diversify your portfolio to the assets that could be less influenced by the seasonal slow market growth. For example, the health or high-tech sector.

    For retail investors with a long-term objective, a buy-and-hold strategy continues as the best choice.

  • Greeks In Trading Options As A Risk Measure

    Greeks In Trading Options As A Risk Measure

    Greeks In Trading Options As A Risk Measure
    Using Greeks in trading options can confuse a trader but can be extremely helpful. 

    By Guy Avtalyon

    Greeks in trading options can provide helpful information, but also they can add a bit of complexity that can confuse options traders. Greeks in trading are a measure of how some option’s price is sensitive to its basic parameters, volatility, or price of the underlying asset. This measure is important when you analyze the sensitivity of your options’ portfolio or single option. So many traders and investors think this is a vital measure for decision making in options trading.

    The key Greeks are Delta, Gamma, Vega, Theta but some will include Rho too. Also, you’ll find some other Greeks derived from these four or five.

    Greeks in trading options can indeed hide the most important part, the difference between the stock price and strike price and the value decrease with reducing time to expiration on the option. For these reasons some options traders never examine the Greeks at all when making trades. But they are important and we will show you why.

    The importance of Greeks in trading options

    It isn’t easy to have an accurate prediction of what is going to happen to the price of the option especially when the market is moving. Even more difficult can be to predict the options positions that efficiently couple multiple individual positions. That is the case with options spreads, for example. 

    The problem is that most options trading strategies require the spreads, anything that can help you to predict the option position is important and you have to know them better. These measures can be very useful when you have to predict the future of the option price since they measure the sensitivity of a price related to the price of the underlying assets, interest rates, volatility, and time decay. By having all this information you can be in a much better position because you will know when and which trades to make. 

    How is that possible?

    The Greeks in trading options will provide you a hint of how the price of your options will run related to how the price of the underlying asset changes. Also, the Greeks will help you forecast how much time value an option is losing daily. Moreover, by using Greeks in trading options you will have a valuable tool for risk management. In other words, you can use these measures to understand the risk for each position and where the risk will appear. Greeks will help you to recognize which risk factors you have to remove from your position and your positions’ portfolio. Also, they can show you how much hedging you need for that. 

    Keep in mind, you can use Greeks as an indicator of how the price will go related to different factors but they are theoretical. To make this more clear, Greeks are actually values based on mathematical rules and can be accurate only if they are calculated according to the exact mathematical model.

    How to calculate Greeks?

    It is possible to do yourselves but, we have to warn you, the process is complex and you’ll need a lot of time for that. Usually, traders use some software to do that for them and get accurate calculations. The serious online broker will automatically present values for the Greeks in the options they display. That makes the use of Greeks in trading options a lot easier.

    Anyway, we will show you how to calculate the four most popular Greeks.

    Calculate Greek Delta

    Delta, the sign is Δ, can measure the sensitivity of price changes related to the moves in the price of the underlying assets. So, for example, when the price of the underlying asset grows by some amount in money, the price of the option will change by Δ amount. Here is the formula to calculate that Δ amount

    Δ = ∂V/∂S

    ∂  represents the first derivative
    V  represents the option’s price which is the theoretical value
    S –represents the price of the underlying asset

     Why did we take the first derivative of the option and price of the underlying asset? Because the first derivative is a measure of the rate change of the variable over a determined period.

    The delta is visible as a decimal figure from -1 to 1. For example, call options will have a delta from 0 to 1, but puts will have a delta from -1 to 0. We have to point one important thing here, to give you a better perception of how to understand Delta numbers. When you see the option’s delta is close to 1 or -1, you will know the options are deep-in-the-money.

    Also, you can calculate delta for your options’ portfolios. It is the weighted average of all deltas of options added to the portfolio. As one of the Greeks, delta can be a hedge ratio, also. When you know the amount of delta, you can hedge your position if you buy or short the number of underlying assets multiplied by delta. It’s quite simple, don’t you think? 

    Gamma as one of the Greeks in trading options

    Gamma or Γ is a measure of the rate of change of its delta per 1-point move in the price of the underlying stock.

    The formula to calculate is expressed as:

     Γ = ∂Δ/∂S = ∂2V/∂2S

    The gamma can be expressed as a percentage also. And as same as delta, gamma is changing even with very small moves of the underlying asset price. Gamma is at its peak when the asset price is near to strike price of the option. It drops when the options go deeper out of or into the money. When the option has gamma value close to 0 that means it means the option is very deep out of or into the money. 

    Long options will have positive gamma values. When the options strike price is equal to the price of the underlying stock gamma will have the maximum value.

    One of the Greeks in trading options is Vega

    Vega or ν is also an option Greek. It measures the influence of changes in the underlying volatility on the option price. In other words, it measures the sensitivity of the option price in comparison to the volatility of the underlying stock. Vega will show the change in the price of the option for each change in underlying volatility, for every 1% of it.

    Here is the calculation:

    ν = ∂V / ∂σ

    ∂  represents the first derivative
    V  represents the option’s price  which is the theoretical value
    σ  represents the volatility of the underlying asset

    The vega is shown as a money amount.

    Options will be more costly when volatility is higher. So, when volatility rises, the price of the option will rise too. Consequently, when volatility decreases, the price of the option will drop also. Hence, when you want to calculate the new option price caused by volatility changes, you have to add the vega when volatility goes up. This means, to subtract it when the volatility decreases.

    Theta

    Theta symbol is θ. It is a measure of the sensitivity of the option price relative to the option’s time decay. If the date of expiry is closer by one day, the option’s price will change for the theta value. The theta is related to the option’s time to maturity.

    The formula is:

    θ = ∂V / ∂τ

    ∂ represents the first derivative
    V is the option’s price in sense of theoretical value
    τ represents the option’s time to maturity

    Generally speaking, the theta is expressed as a negative figure and it is negative for the options. Well, for some European options it can be positive. This is possible because theta describes the most negative value when the asset is at-the-money and shows the value by which the option’s price will decrease every day.

    Long-term options will have theta of near 0 because they do not lose value daily. Hence, theta is higher for short-term options, particularly at-the-money options. The reason is that short-term options have more premiums and a chance to lose every day. Theta will dramatically increase when the option is near to the date of expiry and time decay is greatest during those periods.

    Rho

    Rho or ρ. It measures the sensitivity of the option price related to interest rates. When a benchmark interest rate rises by 1%, the option price will switch by the rho value. The rho isn’t too important as other  Greeks are. Interest rates don’t have such a big influence on option prices and they are less sensitive to interest rate changes.

    Nevertheless, here is the formula to calculate:

    ρ = ∂V / ∂r

    ∂ is the first derivative
    V is the option’s price meaning the theoretical value
    r is the interest rate

    The call options will have a positive rho, but the rho for put options will be negative.

    Why using Greeks in trading options?

    In real trading, the Greeks will all change and develop their changes over the other variables. Every single change in the underlying asset’s price, interest rates, the expiry date may influence all variables simultaneously. So, it’s a smarter decision to use some software to calculate the final result.

    But it is very important to know why and how the Greeks can help and provide you a measure of position’s risk and reward. When the Greeks in trading options become familiar to you, apply them to your trading strategies. It is necessary to use all types of risk-exposure measures. This may bring your options trading to a higher level.

    Meanwhile, learn more about pattern trading from the “Two Fold Formula” book and check it with the our preferred trading platform.

  • Risk Management Strategy For Buying Stocks

    Risk Management Strategy For Buying Stocks

    Risk Management Strategy For Buying Stocks
    Risk management is the most important thing that you can learn if you want to trade stocks. That will provide you with staying in the game.

    By Guy Avtalyon

    A risk management strategy for buying stocks means you have a plan. It seems a bit fishy to suggest that you can simply search for  “high yield” and “low risk” and find trading opportunities that will beat the odds in the stock market for sure and do it with minimum risk. If it is so simple, why do we have losing trades? How is it possible that no one is doing that?  What forces you to choose low yield stock with high risk? Must we really be a genius to be able to find a risk management strategy for buying stocks?

    To be honest, smart trading or investing isn’t that simple. In other words, buying stocks requires a risk management strategy among other things. 

    Risk management for some unknown reasons is low placed on the list of the priorities for the majority of stock traders. Every single trader would rather seek the best indicator than to create a risk management strategy for buying stocks. There is no reason to put this very important issue so low. It is the opposite. 

    A risk management strategy for buying stocks has to be on the top of a stock trader’s priorities. Without knowledge about risk management, no one can be a profitable trader. As a trader, you must understand how to manage your risk, how to size your position, how to set the orders accurately. 

    Of course, only if you want to be a profitable trader. In case you don’t stop reading this. For those who want, here is a risk management strategy for buying stocks. Actually, several suggestions. 

    What is a risk management strategy for buying stocks?

    A risk management strategy for buying stocks helps to lower losses. If you have a risk management strategy or you improve it, you’ll avoid most of the problems that can arise and cause you to lose money.

    One of the tips is, determine where you will set your stop loss and take profit order but before you enter the position. At the same moment when you find a good entry point, you have to decide where you’d set these important levels: stop loss and take profit points.

    When you have recognized the right price levels for your orders, you have to measure the risk/reward ratio. If it doesn’t match your goals, stay away from the trade. Never try to stretch your take profit order or squeeze your stop loss to reach a higher risk/reward ratio. Keep in mind that the reward is always potential, it isn’t 100%-sure. What you can control for sure is a risk. 

    Yes, we know very well some beginners in stock trading who do this thing totally opposite. They think it is possible to randomly find a risk/reward ratio and then adjust stop loss and take profit orders to reach the desirable ratio. Well, it is possible but what really you’ll get is a losing trade.

    Can a trader who has made solid profits waste it all in one bad trade?

    Yes, it is particularly true if you don’t have a proper risk management strategy for buying stocks. 

    Failed traders enter a trade without having any idea of break-even stops or what does it mean at all. Somewhere and somehow they picked that phrase and wanted to implement. Please, avoid it. First of all, if you move the stop loss to the level of your entry wanting to create a trade without losses you are entering one of the most dangerous trades. Moreover, such a trade will often end up as unprofitable. Yes, you have to protect your position but this tactic is going to put you into various problems. It is particularly true if you base your trades on technical analysis. How is that possible? Your entry point is very often evident for other traders too. So many of them will have the same or similar entry point. And what can happen? Well, the elite traders will eat you. 

    For example, you enter a short trade when support breaks, and the stop loss point is above the support level. But you move your stop loss to a break-even point in order to protect your trade. What happened? The price goes back into support and takes out your stop loss. Support held but you miss profits. Yes, support validated your trading idea but your risk or, in this case, stop loss management fired you out. You moved too soon. That’s a possible danger which amateurs almost never notice. One bad trade and you lost all your money.

    Set stop-loss points more effectively

    You can do this by using technical analysis, but fundamental analysis can help in timing. For example, you are holding a stock ahead of earnings and drama grows. But you may want to sell before expectations become too high. Use the moving average. For experienced traders, it is maybe the most popular method to set stop loss and take profit points. It’s easy to calculate. Main averages are 5-days, 9-days, 20-days, 50-days, 100-days, and 200-days moving averages. Just apply them to your chart and check how the stock price reacted to them previously, both as support or as a resistance level.

    Also, you can set stop-loss or take-profit levels on support or resistance trend lines. Just connect the prior highs or lows that befell above-average volume. The point is to find the levels at which the stock price responded to the trend lines and on volume. For more volatile stocks use a long-term moving average. This will minimize the possibility of an unimportant price move to execute your stop-loss order before it’s time. 

    Also, you have to adjust moving averages to your target price. For long targets use longer averages. In this way, you’ll reduce the number of generated signals. This will reduce the noise too. If the stock price is changing too much it is the sign of high volatility, set a stop loss adjusted to the market’s volatility. The great help is to know when some major event may occur. For example, earnings reports can be a good time to be in or out of the trade because the volatility can arise.

    Pay attention to extremely low P/E stocks as a risk management strategy for buying stocks

    Don’t think that playing the stock market is easy. Beating it is more difficult. All you need is to find a stock that is trading at fantastic bargain levels. Well, how to find such opportunities?

    One way is to use the P/E ratio. Calculate it by dividing the share price by the number of earnings per share. If the stock is making a high-profit but its share price is low, the stock is undervalued. Beginners may think it is a good opportunity but if they never calculate the P/E ratio they could increase their risk.

    A trick of finding low-priced stocks

    For example, the stock made $4 per share of profit last year. But this stock is still cheap, its share price is $8 and the P/E ratio is, for example, 4. The average P/E ratio for the industry is, let’s say, 16. And you may think this stock should be trading at least over 4 times higher based on this ratio. But remember, that is just one single ratio. 

    This stock doesn’t have such a low P/E ratio without the reason. For example, the earnings are unsteady and the company may have problems paying a debt. So, the stock can be cheap if you look at the P/E ratio as a sole metric but traders noticed an increased risk and volatile stock. That affected its share price and the stock is trading at a lower price with the possible high risk involved.

    So, you’ll need to analyze other earning ratios or numbers. For example, compare the company’s share price to its cash flow per share. Find the industry average.  Only than you’ll if the stock is fairly valued. One note more, if the company boasts a low P/E ratio, be cautious. There is an added risk.  

    Traders-Paradise wants to show you how to do smart trading. A risk management strategy for buying stocks is one of the most important parts of trading. As far as you learn this, the more successful your trades will be. 

  • How to Create a Trading Plan

    How to Create a Trading Plan

    How to Create a Trading Plan
    A trading plan is a set of rules and guidelines that define your trading performance, financial goals,  rules, risk management and criteria for entry and exit positions.

    Why is it so important to know how to create a trading plan? Because if you know how to create a trading plan, you’ll know on which market to trade, how to cut your losses, when to take profits and find other opportunities for investing. But first, we have to understand what a trading plan is.

    A trading plan is…

    It is a full decision-making tool that helps you determine what, when, and how to trade. Every trader has an individual trading plan suited only for her/his style, goals, risks tolerance, capital available, motivation for trading, the market you want to trade. 

    A trading plan is a methodical tool that helps traders to identify and trade securities. If you want to have a successful trading plan you have to take into consideration a number of variables such as time, risk and goals. A trading plan gives you control of how you will find and execute trades, the conditions you will buy and sell assets. Moreover, it determines how large a position you will take, how to manage it. Also, your trading plan will determine what assets you can trade, as well as when to trade or when not to.

    But there is also one important step more. Never invest before you make your trading plan because your capital might be at risk. A trading plan will guide your decision-making process.

    To know how to create a trading plan you must understand it is different from a trading strategy. Trading strategy means you know how and when to enter and exit the trade.

    The benefits of knowing how to create a trading plan

    Since the trading plan defines the reasons why you are making a trade, when and how you are making a trade, it is an outline of all your trades. If you follow your trading plan, you’ll be able to minimize errors and losses.

    Okay, creating a trading plan isn’t the most exciting thing you can do in your lives, and maybe that’s the reason why so many traders think about it as an irrelevant thing. How to think about the trading plan while some sexy things jump every second? News, charts, trend lines, hot stocks are more exciting, right? Wrong!

    Without a trading plan, you cannot use all these sexy tools, you have to couple them with your plan to produce reliable results.

    What do you think now, do you need to know how to create a trading plan?

    Frankly, the trading plan is not necessary to make a trade. You can trade without a plan. But, if you want to hit the road of successful traders, you will need it. We are pretty sure you don’t want a hold-and-pray strategy because it isn’t a strategy at all. It is a sure way to lose everything you have. Maybe it’s better to go to a casino where there will be more chances to win something. Remember, trading isn’t gambling. 

    And without a trading plan, you’re gambling. The truth is that you may have some winning trades from time to time, but your progress will be questionable. Your losses will be bigger than gains, think about this and do smart trading. Learn how to create a trading plan, so create it.

    How to create a trading plan?

    Follow the old saying: If you fail to plan, you plan to fail. Every trader should follow this expression as it is written in stone. While trading you have only two choices: to follow a trading plan and have a chance to win or trade without a plan and lose with almost 100% possibility.

    So, let’s create a trading plan and see what you have to take into consideration while doing that. Here are some hints.

    First, set your goals. 

    What do you want to get from the trade? Please, be realistic about your expectations toward profits. This will come with a bit more experience. Experienced traders, for example, expect the potential profit triples the risk.

    Can you see how much you have to be focused on risk? So, you must focus on risk. Your trading plan has to mirror your risk tolerance level. You have to determine how much risk you are willing to take. How much of your portfolio are you willing to risk on one trade? And you have to do that for every single trade. The regular risk range is from 1% to 5%, but usually, it is 2%. If your account is small you can take a bit more risk to get a bigger position. But if you lose a predetermined amount at any period in the day, you get out and stay out. Take a break, and then attack another day, when things are going your way.

    Do your research before you enter the trade. 

    Explore the big winners, take a look at the stock charts and find possible spurs to the value of a stock. Be careful while doing this. Your research has to be accurate as it can help you discover if the stock is going to perform in your direction. You can’t be sure 100%, but it will be easier for you to know that you did everything possible to avoid losses.

    Importance of entry and exit in a trading plan

    Every serious trader plans entries and exits. This means you must have a plan on when you enter the trade and where you exit. For that purpose, we are recommending our tool. 

    You must give equal importance to the exit of a trade if you want to make a profit.
    Set a stop-loss, to secure your pull out if things aren’t going in your direction. But you really have to get out at that point. Do you know your profit target? Get out when your profit target is met, don’t be greedy. 

    Take a pen and write down your plan

    Exactly. It is the best way to show how responsible you are toward your capital invested. It is your hard-earned money, you don’t want to fool around with that. Put your trading plan in a visible place, stick it to your computer, for example. Yes, we are recommending your trading plan has to stare at you all the time while you are trading.

    When you exit your trade, review it afterward. You will need to study how the trade went. If something was right or wrong you will be able to repeat or avoid it. So, take notes and keep them in your trading log.

    What do you have to determine else?

    Your stock trading plan should include additional factors to ensure it is completed.

    First is liquidity

    Liquidity can be a problem. When trade stocks this can be a serious element that needs to be considered because you can find a lot of stocks with very low liquidity. This doesn’t mean you should trade only large-cap stocks. You wouldn’t like to limit your opportunities.
    Just filter out the stocks without enough turnover to get in and out of the market quickly. For example, you can trade stocks that have an average daily turnover of 10 or 15 times the size of the position you want to take. Don’t avoid small stocks because they can provide you to trade wider.

    Second is volatility

    Your trading plan should take into account the volatility of the stocks. Some stocks are more volatile some less but, generally speaking, the stocks are volatile. This should befall your trading rules as part of a trading plan. So, adjust your trend filter for the volatility of the stocks. You may have a lot of benefits using that. Your trading plan should be adjusted for what you will do if stocks go bankrupt or are taken over at a premium. You have to position yourself if it happens and you have to do so in advance to protect your overall portfolio.

    Bottom line

    A trading plan should consist of all these factors mentioned above. The stock liquidity, volatility, risks, goals. Consider them when writing it. But even if you do this and more, there is no guarantee that your trades will make you money. As we said numerous times, the stock market is a zero-sum game. It is a system of winning and losing. You have to be prepared for that. One day can be extremely successful but the others could be a total disaster. There is no profit without risk and you can’t always win without an occasional loss. Remember, if you lose a battle, you may win the war. Don’t expect every trade to be a success and every stock in your portfolio to be a winner. Let your profits rise and lower your losses. That’s the way to win this game. 

    We hope you have a better picture of how to create a trading plan now.

  • Calculate Portfolio Performance

    Calculate Portfolio Performance

    Calculate Portfolio Performance
    Don’t base the success of your investment portfolio on returns alone. Use these three sets of measurement tools to calculate portfolio performance.

    The main goal to calculate portfolio performance is to measure the value created by the investor’s risk management. The majority of investors will judge the success of their portfolios based on returns. But it isn’t enough. To have a sense of how our investment portfolio is well-diversified and how much risk we take we need to calculate portfolio performance. In other words, we need a measure of both risk and return in the portfolio to judge its success. Until the 1960s no one paid attention to the risks involved in obtaining returns. But today we have several ways to calculate portfolio performance and measure it. 

    Our aim is to present you with these valuable tools. 

    Sharpe, Jensen and Treynor ratios pair risk and return performances, and unite them into unique value. Well, each of them operates a bit differently so we can choose one to calculate portfolio performance or mix all three ratios.

    Calculate Portfolio Performance Using Sharpe Ratio

    Sharpe ratio is the measure of risk-adjusted return of an investment portfolio. Or in other words, by calculating it we can find a measure of excess return over the risk-free rate relative to its standard deviation. It is common to use the 90-day Treasury bill rate as the representative for the risk-free rate. This ratio is named after William F Sharpe. He is a Nobel laureate and professor of finance, emeritus at Stanford University.

    The formula is:

    ​Sharpe ratio= (PR−RFR) / SD

    ​In this formula, PR represents the expected portfolio return, RFR is the risk-free rate, while SD represents a portfolio’s standard deviation which is a measure for risk. Standard deviation reveals the variation of returns from the average return. So we can say that if the standard deviation is great, the risk involved is also great. 

    So, you can see how the Sharpe ratio is simple to calculate since it has only 3 variables. 

    But let’s calculate portfolio performance more realistic. For example, our portfolio has a 20% rate return. The whole market scored 15%. So, we may think that our portfolio is greater than the market, right? But it isn’t a proper opinion. How is that? Well, we didn’t calculate the risk we had to take to earn such a great rate return. What if we took much more risk than we thought. That would mean that our portfolio isn’t optimal. Let’s go further in this analysis. Imagine that our portfolio has a standard deviation of 15% and the overall market has 8%, and the risk-free rate is 3%. This is just a random example. Let’s calculate portfolio performance now using the Sharp ratio formula.

    Sharp ratio for our portfolio: (20 – 3) / 15 = 1.13

    and

    Sharp ratio for the market: (15 – 3) / 8 = 1.5

    Can you see now?

    While our portfolio scored more than the overall market, our Sharpe Ratio was notably less. So, our portfolio with a lower Sharpe Ratio was a less optimal portfolio even though the return was higher. This means we took an excess risk without extra bonus. But it isn’t the same case when it comes to the overall market, it is actually the opposite. When the market has a higher Sharpe ratio, it has a higher risk-adjusted return. The best portfolio is not the portfolio with the highest return. Rather, an excellent portfolio has a higher risk-adjusted return.

    Sharpe ratio is more suitable for well-diversified portfolios because it more correctly considers the risks of the portfolio. 

    Jensen ratio

    The Jensen ratio gauges how much of the portfolio’s rate of return is attributable to our capability to produce returns above average, and adjusted for market risk. 

    The Jensen ratio measures the excess return that a portfolio produces over the expected return. This figure of return is also recognized as alpha. Let’s say that our portfolio has positive excess returns, so it has a positive alpha. On the other hand, a portfolio with a negative excess return has a negative alpha.

    The formula is:

    Jenson’s alpha = PR−CAPM

    Here, PR stands for portfolio return and CAPM is risk-free rate+β( beta). We know that beta is the return of the market risk-free rate of return.

    ​By using Jensen’s alpha formula we can calculate an investment’s risk-adjusted value. It is also known as Jensen’s Performance Index or ex-post alpha. Jensen’s alpha tries to determine the unusual return of a portfolio no matter what assets it consists of. This formula was first introduced by the economist Michael Jensen. Investors use this formula to calculate portfolio performance by enabling them to discover if an asset’s average return is adequate to its risks.

    Regularly, the higher the risk, the greater the expected return. So, that’s why evaluating risk-adjusted performance is especially important for making investment decisions. It will allow doing this. 

    This Jensen’s alpha also can be expressed as 

    Jensen’s alpha = Portfolio return – ((Risk-Free Rate + Portfolio Beta x (Market Return – Risk-Free Rate))

    The alpha figure can be positive or negative. When it is higher positive values that suggest better performance in comparison to expectations while negative rates showed that the assets perform below expectations. Jensen’s alpha is expressed in percentages. 

    Let’s take the example of a stock with a return per day based on CAPM. And we see that it is 0.20% but the real stock return is 0.25%. So, Jensen’s alpha is 0.05%. Is it a good indicator? Yes, you can be sure.

    The purpose of this measure is to help investors to go for assets that grant maximum returns but with minimum risks.

    For example, you found two stocks that are offering similar returns. But one with less risk would be more profitable for investors than the one with greater risk. When calculating Jensen’s alpha you would like to see a positive alpha since that indicates an abnormal return.

    Treynor ratio

    The Treynor ratio is very useful to calculate portfolio performance. It is a measure that uses portfolio beta,  a measure of systematic risk. That is different from the Sharpe Ratio that adjusts return with the standard deviation. 

    This ratio represents a quotient of return divided by risk. The Treynor Ratio is named after Jack Treynor, the economist, and developer of the Capital Asset Pricing Model.

    The formula is expressed as:

    Treynor ratio = (PR−RFR) / β

    The symbols are well-known, PR stands for portfolio return, RFR refers to the risk-free rate and β is portfolio beta.

    We can see that this ratio takes into account both the return of the portfolio and the portfolio’s systematic risk. From a mathematical viewpoint, this formula expresses the quantity of excess return from the risk-free rate per unit of systematic risk. And just like the Sharpe ratio, it is a return/risk ratio.

    Let’s assume we would like to compare two portfolios. One is the equity portfolio and the other is the fixed-income portfolio. How can we decide which is a better investment? Treynor Ratio will help us pick the better one.

    To put this simply, assume for the purpose of this article only, the equity portfolio has a total return of 9%, while the fixed-income portfolio has a return of 7%. Also, the proxy for the risk-free rate is 3%. Further, let’s suppose that the beta of the equity portfolio is 1.5, while the fixed-income portfolio has a beta of 1.25

    Let’s calculate for each portfolio!

    Treynor ratio for a equity portfolio = (9% – 3%) / 1.5 = 0.040 

    Treynor ratio for a fixed-income portfolio = (7% – 3%) / 1.25 = 0.032

    So, the Treynor ratio of the equity portfolio is higher which means a more favorable risk/return option. Since the Treynor ratio is based on past performance it is possible not to be repeated in the future. But you will not rely on just one ratio when making an investment decision. You have to use other metrics too.

    For the Treynor ratio, it is important to know that the negative value of beta will not give exact figures. Also, while comparing two portfolios this ratio will not show the importance of the difference of the values. For instance, if the Treynor ratio of one portfolio is 0.4 and for the other 0.2, the first isn’t surely double better.

    Bottom line

    To calculate portfolio performance we have to determine how our portfolio has performed relative to some benchmark. Performance calculation and evaluation methods fall into two categories, conventional and risk-adjusted. The most popular conventional methods combine benchmark and style comparison. The risk-adjusted methods are focused on returns. They count the differences in risk levels between our portfolio and the benchmark portfolio. The main methods are the Sharpe ratio, Treynor ratio, Jensen’s alpha. But there are many other methods too.

    But one is sure, portfolio performance calculations are a key part of the investment decision. Keep in mind, portfolio returns are just a part of the whole process. If we never evaluate the risk-adjusted returns, we will never have the whole picture. That could lead to wrong decisions and losses, literally.

  • What Is Alpha In Investing – How to Beat the Market

    What Is Alpha In Investing – How to Beat the Market

    What Is Alpha In Investing
    Alpha represents a measure of an asset’s return on investment compared to the risk-adjusted expected return.
    Beta represents a measure of volatility. Beta measures how an asset moves versus a benchmark.

    What is Alpha? Alpha is a measure of the performance of an investment in comparison to a fitting market index, for example, the S&P 500. The base value is zero. And when you see the number one in Alpha that means that the return on the investment outperformed the overall market average by 1%. A negative alpha number shows that the return on the investment is underperforming in comparison to the market average. This measure is applicable over a strictly defined time frame.

    What is Alpha more? It is one of the performance ratios that investors use to evaluate both individual stocks and portfolio as a whole. Alpha is shown as a single number, for example, 1, 2, 5 but expressed as a percentage. It shows us how an investment performed related to a benchmark index. For example, a positive alpha of 4 (+4) suggests that the portfolio’s return outperformed the benchmark index’s performance by 4%.  But the alpha of negative 4 (-4) means that the portfolio underperformed the index by 4%. When alpha is zero that means that your investment had a return that met the overall market return.

    What is Alpha of a portfolio?

    It is the excess return the portfolio yields related to the index. When you are investing in some ETF or mutual funds you should look if they have high alpha because you will have better ROI (Return on Investment).

    But you cannot use this ratio solely, you have to use it together with a beta. Beta is a measure of investment volatility. The beta will show you how volatile one investment is compared to the volatility of, for example, the S&P 500 index.

    These two ratios are used to analyze a portfolio of investments and assess their theoretical performance.

    How to calculate?

    First, you have to calculate the expected rate of return of your portfolio. But you have to do that based on the risk-free rate of return, market risk premium, and a beta of the portfolio. The final step is to deduct this result from the actual rate of return of your portfolio.

    Here is the formula

    Expected rate of return = Risk-free rate of return – β x (Market return – Risk-free rate of return)

     and

    Alpha of the portfolio = Actual rate of return of the portfolio – Expected Rate of Return on Portfolio

    The risk-free rate can be discovered from the average annual return of security, over a longer period of time.

    You will find the market return by tracking the average annual return of a benchmark index, for example, S&P500. The market risk premium is calculated by deducting the risk-free rate of return from the market return.

    Market risk premium = Market return – Risk rate of return

    The next step is to find a beta of a portfolio. It is determined by estimating the movement of the portfolio in comparison to the benchmark index. 

    So, now when we have this result, expected rate of return, we can calculate further. We have to find the actual rate of return. It is calculated based on its current value and the prior value.

    And here we are, we have the formula for calculation of alpha of the portfolio. All we have to do is to deduct the expected rate of return of the portfolio from the actual rate of return of the portfolio.

    That was a step by step guide for this calculation.

    Becoming an Alpha investor

    There is a great discussion about should the average investor look for alpha results of a portfolio. But we can hear that investors mention alpha. This is nothing more than the amount by which they have beaten or underperformed the benchmark index. It can be the S&P 500 index if you are investing in the US stock market. In such a case, that would be your benchmark.

    For example, if the benchmark index is up 4% over the period, and your portfolio is up 6%, your alpha is +2. But if your portfolio is up 2%, your alpha is -2.

    Of course, everyone would like to beat the benchmark index all the time. 

    What is the Alpha investing strategy?

    We know that Alpha is a measure of returns after the risk is estimated. Risk is determined as beta, a measure of how volatile one investment is related to the volatility of the benchmark index.

    Alpha strategies cover equity funds with stock selection. Also, hedge fund strategies are a popular addition in alpha portfolios.

    Something called “pure alpha” covers hedge funds and risk premia strategies. The point is that by adding an alpha strategy to your overall portfolio you can boost returns of the other investment strategies that are not in correlation.

    Alpha is the active return on investment, measures the performance of an investment against a market index. The investment alpha is the excess return of investment relative to the return of an index.

    You can generate alpha if you diversify your portfolio in a way to eliminate disorganized risks. By adding and subtracting you are managing the risk and the risk becomes organized not spontaneously. When alpha is zero that means the portfolio is in line with an index. That indicates that you didn’t add or lose any value in your portfolio.

    When an investor wants to pick a potential investment, she or he considers beta. But also the fund manager’s capacity to generate alpha. For example, a fund has a beta of 1 which means it is volatile as much as the S&P index. To generate alpha, a fund manager has to generate a return greater than the S&P 500 index.

    For example, a fund returns 12% per year. That fund has a beta of 1. If we know that the S&P 500 index returns 10%, it is said the fund manager generated alpha returns.

    If we consider the risks, we’ll see the fund and the S&P index have the same risk. So, the fund manager generated better returns, so such managers generated alpha. 

    Alpha in use

    You can use alpha to outperform the market by taking more risks but after the risk is considered. Well, you know that risk and reward are in tight relation. If you take more risks, the potential reward will go up. Hence, limited risks, limited rewards.

    For example, hedge funds use the concept of alpha. They use beta too, but we will write later about the beta. The nature of hedge funds is to seek to generate returns despite what the market does. Some hedge funds can be hedged completely by investing 50% in long positions and 50% in short positions. The managers will increase the value of long positions and decrease the value of their short positions to generate positive returns. But such a manager should be a ninja to provide gains not from high risk but from smart investment selection. If you find a manager that can give you at least a 4% annual return without a correlation to the market, you can even borrow the money and invest. But it is so rare.

    Alpha Described

    What is alpha more? It is often called the Jensen index. It is related to the capital asset pricing model which is used to estimate the required return of an investment. Also, it is used to estimate realized achievement for a diversified portfolio. Alpha serves to discover how much the achieved return of the portfolio differs from the required return.

    Alpha will show you how good the performance of your investment is in comparison to return that has to be earned for the risk you took. To put this simply, was your performance adequate to the risk you took to get a return.

    A positive alpha means that you performed better than was expected based on the risk. A negative alpha indicates that you performed worse than the required return of the portfolio. 

    The Jensen index allows comparing your performances as a portfolio manager or relative to the market itself. When using alpha, it’s important to compare funds inside the same asset class. Comparing funds from one asset class, otherwise, it is meaningless. How can you compare frogs and apples?

    What is beta?

    When stock fluctuates more than the market has a beta greater than 1.0. If stock runs less than the market, the beta is less than 1.0. High-beta stocks are riskier but give higher potential returns. Vice versa, stocks with lower beta carries less risk but yield lower returns.

    Beta is usually used as a risk-reward measure. It helps you determine how much risk you are willing to take to reach the return for taking on that risk. 

    To calculate the beta of security, you have to know the covariance between the return of the security and the return of the market. Also, you will need to know the variance of the market returns. The formula to calculate beta is

    Beta = Covariance/Variance

    ​Covariance shows how two stocks move together. If it is positive that means the stocks are moving together in both cases, when their prices go up or down. But if it is negative, that means the stocks move opposite to each other. You would use it to measure the similarity in price moves of two different stocks.

    Variance indicates how far a stock moves relative to its average. You would use variance to measure the volatility of stock’s price over time.  

    The formula for calculating beta is as shown above.

    Beta is very useful and simple to describe quantitative measure since it uses regression analysis to gauge the volatility. There are many ways in which beta can be read. For example, the stock has a beta of 1.8 which means that for every 1% correction in the market return there will be a 1.8% shift in return of that stock. But we also can say that this stock is 80% riskier than the market as a whole. 

    Limitations of Alpha

    Alpha has limitations that investors should count when using it. One is related to different types of funds. If you try to use this ratio to analyze portfolios that invest in different asset classes, it can produce incorrect results. The different essence of the various funds will change the results of the measure. Alpha is the most suitable if you use it strictly for stock market investments. Also,  you can use it as a fund matching tool or evaluating comparable funds. For example, two large-cap growth funds. You cannot compare a mid-cap value fund with a large-cap growth fund.

    The other important point is to choose a benchmark index. 

    Since the alpha is calculated and compared to a benchmark that is thought suitable for the portfolio, you should choose a proper benchmark. The most used is the S&P 500 stock index. But, you might need some other if you have an investment portfolio of sector funds, for example. if you want to evaluate a portfolio of stocks invested in the tech sector, a more relevant index benchmark would be the Dow technology index. But what if there is no relevant benchmark index? Well, if you are an analyst you have to use algorithms to mimic an index for this purpose.

    Limitations of beta

    The beta is good only for frequently traded stocks. Beta shows the volatility of an asset compared to the market. But it doesn’t have to be a rule.  Some assets can be risky in nature without correlation with market returns. You see, beta can be zero. You should be cautious when using a beta.

    Also, beta cannot give you a full view of the company’s risk outlook. For short-term volatility it is helpful but when it comes to estimating long-term volatility it isn’t.

    Bottom line

    What is alpha? It began with the intro of weighted index funds. Primarily, investors started to demand portfolio managers to produce returns that beat returns by investing in a passive index fund. Alpha is designed as a metric to compare active investments with index investing. 

    What is the difference between alpha and beta?

    You can use both ratios to compare and predict returns. Alpha and beta both use benchmark indexes to compare toward distinct securities or portfolios.

    Alpha is risk-adjusted. It is a measure that shows how funds perform compared to the overall market average return. The loss or profit produced relative to the benchmark describes the alpha. 

    On the other hand, beta measures the relative volatility of assets compared to the average volatility of the entire market. Volatility is an important part of the risk. The baseline figure for beta is 1. A security with a beta of 1 means that it performs almost the same level of volatility as the related index. If the beta is under 1, the stock price is less volatile than the market average. And vice versa, if the beta is over 1, the stock price is more volatile. There is some tricky part with beta value. If it is negative, it doesn’t necessarily mean less volatility. 

    A negative beta means that the stock tends to move inversely to the direction of the overall market.

  • Asset Allocation Models – Protect Your Investment

    Asset Allocation Models – Protect Your Investment

    Asset Allocation Models
    Here is how to protect your investment with different models of asset allocation

    By Guy Avtalyon

    Asset allocation models are the way to split your investment into different asset classes: stocks, mutual funds, bonds, private equity, etc. That will give you the possibility to lessen the risk of your investment. Every asset class carries some level of risk but different. For example, if the value of bonds rises, the stocks will fall. When the market is falling, real estate may provide you a nice return.

    The point is to have a diversified portfolio built by the asset allocation model among asset classes. Every investor has its own model of asset allocation. It is based on individual investing goals and risk tolerance.

    Also, personal asset classes can be separated into different sectors.

    You can use different types of asset allocation models.

    Asset allocation model created by your needs

    For example, for some investors equities are more favorable than other asset classes. Or if you are in serious ages you may prefer to put your money in some source of fixed income that can provide you stable retirement income because your goal is to save what you earned during your working life. Thus, you are not worried about market fluctuations. So, you may have the majority of your portfolio in stocks.
    But if you are a younger investor you may prefer some investment with faster returns.

    What are the different models

    Most asset allocation models come into four models: growth, preservation of capital, income, balanced.

    The growth asset allocation model is suitable for beginners interested in long-term investments. If you are at the beginning of your professional career you will be interested to deposit some amount every year in long-term investment such as common stocks that may not pay you dividends but can be good in the long run. Fund managers could advise you to invest in some foreign equities to diversify your portfolio.

    But if you want to preserve your capital you will like some other model of asset allocation, like preservation of capital. This model will suit you if you want to avoid risk to lose even a small part of your investment because you would like to use it in the next 12 months, for example, to buy a house. In this case, your investment portfolio will have about 80% in treasuries or commercial papers. There is some risk in this model of asset allocation due to the inflation that can lessen your buying power. Think about that.

    Income as an asset allocation model

    The usual income investor comes from a group of people near retirement because the need for cash in hand is of essential importance.

    The balanced model of asset allocation is kind of halfway between income and growth. It is a compromise between long-term growth and current income. This mixture of assets that can provide cash but also the growth of principal value.

    Balanced portfolios is built of medium-term investment and stocks of well-established companies.

    The investor’s needs may change during the time.

    The asset allocation will follow that change. For that reason, it is always smart to switch a portion of your investments before the important life changes. Do it occasionally. For example, you could move 10% of your investments to the income allocation model yearly as you are approaching retirement. So, you will have the whole of your portfolio adjusted to your new goals.

     

  • Stop-loss Order Means How Much Are You Willing to Lose On a Trade

    Stop-loss Order Means How Much Are You Willing to Lose On a Trade

    Stop-Loss orders To Limit A Risk
    Stop-loss order is an easy and powerful tool when used properly. Find how to do that.

    By Guy Avtalyon

    Stop-Loss orders are suitable when conditions in the market get a bit out of control. If you never place the stop-loss order the risk potential is huge. You may lose everything. 

    The main characteristic of a stop-loss order is that it becomes a market order. It can happen when the price of your security is selling at or under the stop price. So, a stop-loss order is a great protection against falls in the value of your stock. Stock investing is risky, but you can control it and protect it with a stop-loss order. Wise investors always use stops. The others stay with losses. The stop-loss is an easy but powerful tool that will protect you when an unexpected turn in the market occurs.

    How does Stop-loss Order work?

    For example, you hold a stock of some company and it is currently trading at $30. But your stock is volatile and you place a stop-loss order at $20. If the price of your stock drop at or below $20, your order will become a market order and you’ll be able to sell your stock instantly at the best possible price.

    If you want to be a day trader, for example, you have to place a stop-loss order on your every trade. The stop-loss order will tell you how much you can lose on a trade. So, you have to know how to calculate your stop loss. You have to determine precisely where your stop-loss order will go.

    Basically, a stop-loss order is a method of investment risk management.

    A stop-loss order is when you define a particular step to be taken at a particular price. For example, you bought a stock at $50 and you placed a stop-loss order at $40. This means your stock will be sold when the price drop to $40. Of course, you may place the stop-loss order at any price. 

    But not all is ideal with this order.

    Stop-loss orders are static. They don’t move. Imagine the following situation. You set a stop-loss order at $40 but the stock price goes up at $80, which is much more than you bought it. In this case, when your stop-loss order is at $40 your protection is worthless. 

    How to calculate stop-loss?

    A stop-loss order is created to reduce your loss. For example, if you place a stop-loss order for 15% below the original purchase price, your potential loss will be limited to15%. For instance, you bought a stock at $100. What you have to do is to set a stop-loss immediately after buying and you set it at $85. This is important in case the price of your stock falls below $85. Your stop-loss will automatically be recognized as market price and even if the stock continues to fall, you will obtain your $85 per stock or the amount close to it.

    You may choose whatever percentage you want, all is up to you.

     

    Some advisors will tell you to set a stop-loss order at 10%. But if you think your stock is a good player you may decide to take more risk and set a stop-loss at 20, 30, or even 50%. For long-term investors, this may be a good solution, the bigger percentage will give space to the range and enough time to annulate the losses that can occur over time because they have a bigger investment horizon and have hope for a great return one day.

    But if you are a day trader just avoid big percentage, 10% of the initial price is quite a good solution to protect your trade.

    Defining a stop-loss order placing is all about targeting an individual risk potential. You should determine this price to limit loss. That’s the point.

    How to place stop-loss orders when trading

    Stop-loss orders are usually market orders, as we said. But if your stock doesn’t have a buyer at that price you may end with a lower price. That is slippage. 

    Stop-loss points shouldn’t be set at unplanned positions. Placing them is a strategy that should be based on your experience with different methods. This means you must have a trading plan. You have to know how to find the best way to enter the trade, how to control the risk, and how and when to exit the trade.

    If you are a beginner, just use a simple stop-loss strategy. That will give you the opportunity for the price to move in your benefit. Also, the simple stop-loss strategy will diminish your loss promptly if the price goes against you.

    Where to set stop-loss orders when buying

     

    One of the easiest ways is to set it below a swing low. A swing low happens when the price drops and then hops. That is the price support at some level.
    When you buy, the swing lows should be going upward. 

    Where to set a stop-loss order when selling

     

    Set it above a swing high. A swing high happens when the price grows and then drops. That is resistance.
    If you want short selling the swing highs should be going downward. 

    What is important with stop-loss orders

    There are several things you have to know about stop-loss orders.
    They are not suitable for dynamic traders and large chunks of stock because you can lose more in the long run.
    You must be sure that your stop-loss order has confirmation, never assume.

  • Investing in Cryptocurrency – The Pros and Cons

    Investing in Cryptocurrency – The Pros and Cons

    2 min read

    The Pros and Cons of Investing in Cryptocurrencies 2

    Investing in cryptocurrencies is generally a risky investment. Investing in cryptocurrency could be a good investment, or it could not. It depends on you and your attitude. In crypto’s early days there is no yes or no answer about the wisdom of investing in cryptocurrency. With this in mind, we will cover some pros and cons and give friendly advice. Remember, this isn’t professional advice, we don’t offer professional legal, investment, or tax advice.

    If you don’t just want to buy, sell, or invest in cryptocurrency. If you want to invest in cryptocurrency, you have several options.

    First comes first: You need to start investing in cryptocurrency with some flexibility. You have to be prepared to lose everything you invest in cryptocurrency. It probably won’t happen, but be careful. The least risky coins are the coins that are present the longest time and have the highest market cap and highest volume. Anything other than Bitcoin, Litecoin, or Ethereum is riskier. Bitcoin is the current top coin for resilience, market cap, and volume. Also the most expensive.

    There are several pros and cons to review before investing in cryptocurrency.

    CONS:

    The cryptocurrency market has been very volatile since its beginning. The price of Bitcoin can swing up or down hundreds of dollars in one day. We have already seen a few bubbles and busts in the past. There is a risk of the venture on a given coin even if cryptocurrency is prosperous. Even if cryptocurrency is a good long-term bet, we don’t know if any coin will be the one that sticks around. Even more true for the countless less popular coins with smaller market caps.

    The Pros and Cons of Investing in Cryptocurrencies 1Those with low-risk tolerance have a difficulty; they are inclined to getting weakness and pulling out at a loss while the market is fixing up or going down. An investor needs to be prepared to take a loss or sit on a loss for a while if the market goes down. That requires a certain type of mindset and expendable funds. There are some psychological factors to consider along with economic ones.

    The only way to trade cryptocurrency on the stock market is to buy GBTC (Grayscale Bitcoin Investment Trust), which trades at a premium. The simplest way to buy a cryptocurrency for a novice aside the stock market is via some company. They charge some fees for that, but the lowest fees are on the open exchanges of the internet. Between premiums and fees and finding a broker, all options for trading have costs and it isn’t easy to calculate.

    Spirit level of crypto investors is changeable. Like the Moon. Bad news in term of regulations can send crypto value to drown in one day. But the same news another day may have no effect. If you join some cryptocurrency group on social media, and you’ll note it goes from hot-to-cold with the weather. The market is a bit fussy, I think.

    PROS

    The cryptocurrency market is still young, and the most optimistic investors are predicting future prices, some of them claim that it can be for e.g. Bitcoin, $220,000 by 2020. Cryptocurrency is a very risky but potentially rewarding bet. More, if cryptocurrency is in a bubble, the trend could very well be toward cryptocurrency being an important medium of exchange and store of value in the future if the current price is lower than the highest price we will ever see. That makes it a good long-term bet. You can often buy high low and sell high. There is money to be made.

    The Pros and Cons of Investing in Cryptocurrencies 4
    Despite all its risks, crypto is possible the most exciting asset 21st century. It is decentralized, works on blockchain technology which is here-to-stay. You can find billions of motives about why everyone has to be excited about crypto. As much as reasons to be conservative in your investment.

    Don’t dump your whole saving into crypto, but don’t hesitate to put a small investment you are ready to lose, just to learn and have fun on your beginning. Later you will have the know-how.

    TIP

    If it is the bubble, then pop it!

    One of the reasons for taking extreme caution is the current potentially high price. If the price goes back down to 2015 levels, then the number of PROS will increase. The unknowns and high price and volatile market make it risky, but there are plenty of reasons to be excited despite all that especially long-term.

    Investing in cryptocurrencies is very risky, markets are volatile and the technologies are still quite young.

    But, they are still a great opportunity for anyone interested in investing.

    Treat them as you would any investment and do your own research.

    Step into this new world while is time.

    Risk Disclosure (read carefully!)

Traders-Paradise