Tag: trading

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How To Read Stock Charts?

Stock charts will provide you the information about the stock’s past trading prices and volumes. This is a remarkable advantage when it comes to technical analysis.

By Guy Avtalyon

How to read stock charts and what they are trying to tell you? How can you use them in making your investment decisions? So let’s see the importance of price action and technical analysis. Because that’s it.

We are 100% sure you’ve already had the opportunity to see the stock charts, for example, Yahoo Finance is one of those places. If you want to get some experience with outlook and parameters, it is the right place. Also, you could see the stock charts when you examine the company’s stock you wanted to buy.

And what can you see?

There are two types of charts: line and candlestick. It looks so simple and a small graph but contains a lot of very important data. For example, you can see the opening and closing price, the lowest and the highest price of the stock, and plenty of other information set in that small image.

What trading charts can tell?

You must know, a chart is a visual illustration of changes in stock price and trading volume. They are not magical or scary. In essence, the charts do one easy job: They want to tell you a story about the stock. Stock charts will give you an objective picture without hypes and rumors. They will neglect even news and tell you the truth and what is really going on with your stock.

For example, when you learn how to read stock charts you’ll be able to notice if institutional investors are heavily selling. That will quickly provide you valuable info on what you have to do. The charts literally tell you that. If you see in the graph the investors are massively buying, what are you going to do? What do the charts want to tell you? They want to tell you: buy too. Or if you see they are selling: sell too. Those investors are heading the exits.

The institutional investors’ buying or selling will shift your stock up or down. And the charts will tell you that on time. So you’ll be ready for action. That is extremely important in the stock markets that are volatile and stock price can change in a second.

How to read stock charts

Reading charts is one of the most important investing skills. Stock charts will tell you if the stock is depreciating or appreciating because they are recording the stock price and volume history. Well, when you grow your skill in chart reading, you’ll be able to find more. You will notice some small, often indirect signs in the stock actions such as whether the particular stock showed some unusual activities.

You choose the type of chart that best suits you, a line chart or a candlestick. But the charts will show you the price of daily changes in its price area.

Let’s breakdown all these bars and lines

You will notice the vertical bars. They record the share price span for the chosen period. The horizontal dash that intersects within the price bar shows the current price. Also, it shows where a stock closed at the end of the day. If the color of the price bar is blue that means the stock closed up but if it is red the stock closed down.

In the volume area, below the horizontal line, you will also see bars but volume bars that represent the number of shares traded in some period, day, week, month, etc. The color of the bars tells us the same as price bars. Also, there you will see the average volume for some stock over the last 50 days.

Charts will tell you all about the average share price over the last 50 days and the last 200 days of trading. But by reading stock charts you will have the info about how the stock price moved compared to the market. It is a so-called relative strength line. When this line is trending up, we can say the particular stock is outperforming the market, the opposite means the stock is lagging the market.

Changing the time period

You can do that and have a look at the daily, weekly, monthly charts.

Daily stock charts will help you to measure the current strength or weakness of a stock. These charts are very useful for identifying the precise buy points and creating a short-term trading strategy.

Weekly stock charts will help you to recognize longer-term trends and patterns in stock prices. The weekly charts use logarithmic price scaling. So, you can easily make comparisons between stocks or the major market indexes.

Indicators in the stock charts

All the charts will come with them. Indicators are tools that provide visual representations of mathematical calculations on price and volume. Well, they will tell you where it is possible for the price to go further. The major types of indicators are a trend, volume, momentum, and volatility. Trend indicators show the direction of the market moving. They are also known as oscillators because they are moving like a wave from low value up to the high and back to low and high again as the market is changing.

Volume indicators will show you how volume is developing over time, how many stocks are being bought and sold over time.

Momentum indicators show strong the trend is. They can also reveal if a reversal will happen. They are useful for picking out price tops and bottoms.

Volatility indicators reveal how much the price is changing in a particular period. So, volatility isn’t a dangerous part of the markets, you have to know that. Without it, traders would never be able to make money! In other words, how is it possible to make a profit if the price never changes? High volatility means the stock price is changing very fast. Low volatility symbolizes small price moves.

Some traders don’t use indicators because they think the indicators can smudge the clear message that the market is telling. Well, that’s obviously an individual approach.

What are Support and Resistance Levels

Stock charts will help you to identify support and resistance levels for stocks. Support levels are price levels where you can see increased buying as support to stock’s price that will direct it back to the upside. Resistance levels, as the opposite, shows prices at which a stock has presented a trend to fall while trying to move higher, and switched to the downside.

Recognizing support and resistance levels is extremely important in stock trading. The point is to buy a stock at a support level and sell it at a resistance level. That’s how you can make money. If some stock has clear support and resistance levels, the breakout beyond them is an indicator of future stock price movement.

For example, you have in front of you the chart and you notice that the stock didn’t succeed to break above, let’s say $100 per share. And suddenly, it makes it. Well, in such a case you have a sign that the stock price will go up. You might see, as an example, that some stock traded in a tight range for a long time but once when it broke the support level, it will continue to fall until a new support level is established.

Bottom line

Knowing how to read stock charts will give you a powerful tool while trading. But you have to know that charts are not perfect tools. Even for the most experienced analysts. If they are, every stock trader and investor would be a billionaire.

Nevertheless, knowing how to read stock charts will surely help you. That may increase your chances of trading stocks. But you will need a lot of practice. The good news is that everyone who spends time and gives an effort to learn how to read stock charts can become a good chart analyst. Moreover, good enough to enhance the success in stock market trading.

Try to learn this. It can be valuable. We’re doing smart trading.

19th February 2020
Adjusted Closing Price – Find a Stock Return By Using It

A basic mistake is considering the closing prices of stocks for analysis instead of Adjusted closing price.

If you’re a beginner in investing, you probably already noticed the expression like “closing price” or “adjusted closing price.” These two phrases refer to different ways of valuing stocks. While with the term “closing price” everything is clear when it comes to the term “adjusted closing price” things are more complex.

When we say closing price it refers to the stock price at the close of the trading day. But to understand the adjusted closing price you will need to take the closing price as a starting but you’ll have to take into account some other factors too to determine the value of the stock. Factors like stock split, dividends, stock offerings can change the closing price. So we can say that the adjusted closing price gives us more exact the value of the stock.

What is Adjusted Closing Price

Adjusted closing price changes a stock’s closing price to correctly reveal that stock’s value after accounting for every action of some company. So, it is recognized as the accurate price of the stock. It is necessary when you want to examine historical returns.

Let’s say this way, the closing price is just the amount of cash paid in the last transaction before the closing bell. But the adjusted closing price will take into account anything that might have an influence on the stock price after the closing bell. When we say anything it is literally anything: demand, supply, company’s actions, dividends distribution, stock splits, etc. So, you will need adjustments to unveil the true value of the stock.

It is particularly helpful when examining historical returns. Let’s do that on an example of dividend adjustment calculation.

The adjusted closing price for dividends

When a stock increases in value, the company may reward stockholders with a dividend. It can be in cash or as an added percentage of shares. Whatever, a dividend will decrease the stock’s value since the company will get rid of the part of its value when paying out the dividends. So, the adjusted closing price is important because it shows the stock’s value after dividends are posted.

Subtract the amount of dividend from the previous day’s price. Divide this result by the same day’s price. Finally, multiply historical prices by this last figure.

For example, the prior trading day was Tuesday and a stock closing price was $50. The day after, on Wednesday, it starts trading at a last price minus dividend, for example, trading ex-dividend based on a $4, so the stock will be trading on Wednesday at $46. If we don’t adjust the last price the data, for example, the charts will show a $4 gap.

What do we have to do?

We have to calculate the adjustment factor,

So, by following already described we have to subtract the $4 dividend from the closing stock price on Tuesday (in our case)

$50 – $4 = $46

Further, we have to divide 46.00 by 50.00 to determine the dividend adjustment in percentages.

46.00 / 50.00 = 0.92

The result is 0.92.

Let’s see how to adjust the historical price.

The next step is to multiply all historical prices preceding the dividend by this factor of 0.80. This will alter the historical prices proportionately and they will stay logically adjusted with current prices.

After stock splits

Stocks split occurs when the price of individual shares is too high. So, the company may decide to split stocks into shares. When the company increases the number of shares, the logical consequence is the value of each share will decrease due to the fact that each share factors a smaller percentage.

In our example, if the company splits each $50 share into two $25 shares, the adjusted closing price from the day prior to the split is $25. The adjustment reveals the stock split, not a 50% decline in the share price.

New Offerings

For example, the company decided to offer extra shares to boost capital. This means the company issues new shares of stock in a rights offering. The right offering means that the shareholders have the chance to buy the new shares at lessened prices.

But what happens when new shares come to the market? The price of the shares, of the same company, that are already on the market will drop. How is that possible? Well, think! The number of shares is increased and each of them now cost less. It’s almost the same with a stock split.

The adjusted closing price values the new offerings and the devaluation of each individual stock.

Find a stock return

A stock’s adjusted closing price provides you all the info you need to watch closely to your stock. You can use some other methods to calculate returns, but adjusted closing prices will spare you time. As we see in the text above, adjusted closing prices are already adjusted. The dividends are posted, the stock’s splits are done, the rights offerings also. So we can make a more realistic return calculation. The adjusted closing prices can be an excellent tool that can help us improve our strategies. Moreover, we can do that in a short time since the adjusted closing price already took into account almost all factors that directly impact the overall return. For example, just compare the adjusted price for a particular stock over some given period and you will find its return.

It’s easy to find historical price data, just download it. Further, mark the column of dates and a matching column for adjusted closing prices and set up in descending order. For example, you want to examine a period from March to October. On the top, you should have data for March and below data for April and so.

Let’s find the return

Firstly, compare the closing price in one month to the closing price from the prior month. To unveil the percentage of return you have to divide the chosen month’s price by the previous month’s price. Subtract the number 1 from that result, then this new result you have to multiply by 100 to turn it from decimal to percentage form.
It should look like this:
In March stock price was $50, in April it was $55, so the return was 10%

((55/50)-1)x100 = 10

Since you have to do this calculation for each month add the column for return if you are working in a spreadsheet.

To calculate the average return for the given period, from March to October, just sum each return for all months you observe and divide the result by the number of months.

Simple as that.

Bottom line

The adjusted closing price is a stock’s closing price on any chosen trading day but altered to cover dividends posted and the company’s actions like split shares and the rights offerings that happened at any time former to the next day’s open.

So, you can see that for serious analysis, the closing price will never reveal the real value of the stock, the stock’s value after considering any company’s actions. So it is always suggested to use the adjusted closing price if you want reliable analysis.

You might also like:

>>> Best Trading Strategy Without Indicators In Forex

>>> How to Use Technical Indicators to Analyze Stocks?

>>> MACD Indicator – Moving Average Convergence Divergence

>>> Indicator Trading And How To Use It

>>> P/E Ratio An Quick Method to Value a Stock

13th February 2020
The 60/40 Portfolio is Dead – How to Replace It

Bonds and stocks have only interacted negatively in the past 20 years. Their average correlation throughout the previous 65 years was positive. When this correlation isn’t negative, the 60/40 portfolio is weak in protecting your investment.

We all had believed, for a long time, that the ideal is a 60/40 portfolio, which consists of 60% in equities and 40% in bonds. That excellent combination provided greater exposure to stock returns. At the same time, this mix gave a good possibility of diversification and lower risk of fixed-income investments.

But the world is turning around and markets are changing too.

Experts recently noticed that this 60/40 portfolio isn’t good enough. Portfolio strategists claim that the role of bonds in our portfolios should be examined. They argue we need to allocate a bigger part toward equities.

Strategists report

Bank of America Securities (a.k.a. Merrill Lynch) published research last year named “The End of 60/40”. The strategists Jared Woodard and Derek Harris wrote:

“The relationship between asset classes has changed so much that many investors now buy equities not for future growth but for current income, and buy bonds to participate in price rallies.”

That note by Merrill Lynch caused great turbulence among investors. The point is that your conventional sense of investing 60% of your portfolio in stocks and 40% in bonds is no longer so smart.
Merrill Lynch strategists explained that there are grounds as to why the 60/40 portfolio will not outperform portfolios with more stocks versus bonds in it. Therefore, investors have to allocate a bigger percentage of equities to their portfolios instead of bonds.
This is the opposite scale compared to what investors used for many years. They were investing in equities for price rallies and buying bonds for current income.

How did the 60/40 portfolio die?

For the last 20 years, the golden rule was a portfolio of 60% stock and a 40% bond. Everything was good with that: investors had the bonds in portfolios, a 60/40 portfolio provided them the upside of equities, their investments were protected from downturns. But they gave evidence to investors as to why this ratio should be changed and why they have to add more equities than bonds.

Here are some. Data is for the markets globally. During the last year, $339 billion were in inflows to bond funds but almost $208 billion were in outflows from equity funds. So, we now have a tricky situation. Bond yields had fallen. The consequence is that we have about 1.100 global stocks that pay dividends higher than the average yield of global government bonds.

The global economy slows

We must have in mind that the global economy lags due to the aging society and there were rallies in bonds almost all over the world. It was like a bubble. Hence, the investors who manage a traditional 60/40 portfolio are in a situation that threatens to hinder returns.

“The challenge for investors today is that both of those benefits from bonds, diversification and risk reduction, seem to be weakening, and this is happening at a time when positioning in many fixed-income sectors is incredibly crowded, making bonds more vulnerable to sharp, sudden selloffs when active managers rebalance,” said strategists from Merrill Lynch.

The 60/40 portfolio canceled

The popular rule of thumb: investment portfolios 60% in stocks and 40% in bonds, is smashed. The finance industry did it. Moreover, financial advisors urging investors to hold riskier options since, as they claimed, bonds no longer offer diversification. Hence, bonds will be more volatile over the long run. Further, the 60/40 portfolio has sense in the market conditions when stocks and bonds are negatively correlated. The stock price falls – bonds returns rise both serving as a great hedge, bonds against falling stock prices, and stocks as a hedge against inflation. According to strategists, no more.

This will completely change the portfolio management.

The benefits from bonds, diversification and risk limitation, seem to be missing. The bonds are more vulnerable to unexpected selloffs. The mentioned rule of thumb was accurate for 20 years but not for the past 65. Also, it is noticed that this period of negative correlation between bonds and stocks is coming to an end.

Also, Morgan Stanley warns that returns on a portfolio with 60% stocks and 40% bonds could drop by half in comparison to the last 20 years. Earlier, the analysts and strategists from Guggenheim Investments, The Leuthold Group, Yale University, also prognosticate distinctly lower returns.

How to replace the 60/40 portfolio?

The 60-40 portfolio is dead and it is a reality.

Be prepared, you have to replace it. Some experts suggest keeping 60% in stocks but to hold a position shorter, as a better approach.

But you have to hedge your portfolio. Experts suggest single-inverse ETFs and options for that purpose.

The others think the best way is to replace the 60/40 portfolio with some hedged equity portfolio. This actually means you should have more than 60% in stocks since the stock market is more liquid in comparison to the bond market. For this to implement, it is necessary to have tools. Also, the knowledge on how to use them. From our point of view, it seems that time to forget the 60/40 portfolio is here. All we have to do is to change the mindset and stop thinking about the mix of stocks and bonds. Instead, it looks like it is time to think about changing the net equity exposure.

Maybe it is the right time to hold more cash, which can be a tactical defense. For example, cash can be a part of your 60% holdings when you are not fully invested in stocks. Or you can hold cash in the percentage that previously was in bonds. Also, you can combine it. You MUST build a hedged portfolio to avoid the 60/40 portfolio hurricane that is likely coming.
For example, build a portfolio of, let’s say 75% stocks and 25% your hedge combination. This range can be tighter also.

Honestly, it is so hard nowadays to fit the excellence of the 60/40 portfolio.

Bottom line

The 60/40 portfolio was really good but it had a wild side too. The stock portion was down over 25 years of its 91-year existence. Over those 25 years, the average loss was above 13%. But there were bonds with a gain of above 5%, which reduced some of the losses. This portfolio was stable and reliable and you could use it for a long-time.

The other problem with the disappearance of the 60/40 portfolio is diversification. Is it dead too?

Peter L. Bernstein said, “Diversification is the only rational deployment of our ignorance.” Investors have to figure out different access if stocks and bonds no longer balance one another. This great portfolio will miss everyone. Maybe, one day, we will meet again. But some conditions have to be fulfilled. The interest rates should be 6% again, the stock market valuations shouldn’t go over 15x the previous 10 years’ worth of average earnings. That is hard to achieve now.
R.I.P. the 60/40 portfolio.

10th February 2020
Expect More Volatility In the Stock Market This Year

This year could be a volatile period for investors given the fact that a global financial crisis could be in the offering in the next several years

Last year showed the best look and we are not here to destroy the joy. Yes, we all can expect more volatility in the stock market this year. But don’t be afraid. The volatility in the stock market can be a stimulus. How is that? If you expect more volatility in the stock market that is the sign you understand the market’s behavior. The volatility of the stock market is normal and part of investing. When the market shows the volatility means the market is operating logically. You are not sure? Let’s say this way. The volatility runs both ways. It gives kicks to the downside and successes to the upside over the short-term periods. When volatility occurs, experts advise it is best to stay calm and let the volatility proceed its way. But you have to prepare your investments for that. Even more, you have to learn how to profit from stock market volatility.

Why do we think we can expect more volatility in the stock market in 2020?

We can’t neglect history, for example.

Look at the S&P 500 over the last 38 years. You can see that the market corrections were so frequent that they became the norm. The average yearly correction is -13,9% over the last 30 years. The historical data shows that there were only a few years when the Index didn’t drop at least -5% for one year. Actually, it happened the Index had a decline of 5% only two times, 1995 and 2017. Last year, it was -7%, it was below average for market volatility.

The second reason to expect more volatility in the stock market this year is that high volatility always comes after low volatility. If you look closer to the S&P 500 Index, you will not see any move more than 1% in any direction during any single trading day since October last year.

Such a low volatility period wasn’t seen in the last 50 years and it marks the constant move higher. All data shows that these long periods of low volatility are followed by periods of high volatility.

The last time we could notice similar before January 2018 and October 2014, both were followed by sharp corrections.

How to prepare investment for stock market volatility?

When the stock market starts falling, we are all faced with bad news on a daily basis. We may feel anxiety, uncertainty, fears. The downside is that it triggers drastic decisions. Even the most experienced investors may panic. Is panic a strategy? Not at all. You must stay calm when expecting more volatility in the stock market. There are some techniques and strategies to use when volatility appears.

It’s absolutely true that short-term losses can cause anxiety. But the worst decision is to let emotions drive you, it may cost you a lot of your money. So, stay invested, don’t pay attention to daily impacts, stay focused on your long-term goals. Yes, it can be difficult but you may have more choices with that.

The short-term volatility fluctuations can be hard to look at, but it’s essential for long-term investors to continue. Even if you want to pull out of the stock market and think it is the best choice, just think, what if you miss out on a market rebound? Such a great opportunity! The gains while you are on the sideline.

The historical data for the S&P 500 Index shows positive total returns for 24 out of the last 30 years.

How to survive market volatility

Advanced investors know that the best way to survive volatility is to stay with a long-term plan and a well-diversified portfolio. Yet, it is easier to say than to do, we know that. But can you find a better way? Diversification is the essence of investing. Hence, when the markets shift, you might have to rebalance your portfolio. So, market volatility could be a great time to mix your assets. Just don’t be lazy. It is your money in the play. Of course, you have to know your risk tolerance.

Day traders can profit from the stock market volatility

The coming back of volatility is bad news for some, but day traders can profit from market volatility. If you are one of them or want to try your hand just start small, big games are not suitable for volatile conditions. Day traders should limit the size of trade to limit the size of losses. To be honest, if you want to learn how to be a good player in this game, you have to experience the pain. What we want to say is, you have to lose some money to be able to be happy when you make a great gain. Don’t you agree?

Further, never place too many trades per day. You have to think about each trade separately. Too many trades mean the bigger potential for losses and more headaches with empty accounts. Trade only a few stocks per day. This doesn’t mean you are without confidence. Contrary, this means you are a reasonable trader. Modesty isn’t IN today, but with this approach, you may have constant profit for a longer time. Just stick to your strategy and always plan your exits. Moreover, now you have this app to check them even before you open the position.

You know very well the trading is risky, especially if you trade for a living. That’s why you have to develop a strategy, with the possibility to test it now and follow it.

What long-term investors have to do while the market is volatile

A normal reaction to market volatility is to reduce any exposure to stocks. Will it make any sense? Long term investors must stay calm when stock market volatility comes. Don’t make radical changes to the portfolio. It can be harmful to your wealth. Meaning, don’t invest more in stocks because the exposure to more stocks could be risky for your investments as a whole.

You have worked hard to build your portfolio. Just stick with your plan and stay calm. Market volatility is usually a temporary event. Don’t panic.

Bottom line

Expect more volatility in the stock market this year but, to repeat, volatility is completely natural and expected. The S&P 500 could experience a correction this year in the –10% to –15% range. That is the average correction. Stay focusing on economic indicators and be patient if you are a long-term investor. If you are a day trader just trade a few stocks daily. Until the volatility goes. Eventually, it will, sooner or later.

9th February 2020
Stock Market Bubble How to Recognize It

What is a stock market bubble? How a stock market bubble is created? What is the definition?

We are talking about a stock market bubble when the prices of stocks rise fast and a lot over the short period and suddenly start to drop also quickly. Usually, they are falling below the fair value.

A stock market bubble influences the market as a whole or a particular sector. A bubble happens when investors overvalue stocks. Investors can overestimate the value of the companies or trade without reasonable estimation of the value.

How does this thing work?

Let’s say investors are massively buying some particular stock. They become overly eager to buy. How does that affect the stock price? The stock price is going up. The traders notice the growing potential and believe that the stock price will rise more and they are also buying that stock with an aim to sell it at a higher price.

This trading cycle has nothing with the usual criteria related to trade. When this cycle lasts long enough it can extremely overvalue the stock or some other asset, generating a stock market bubble that will burst.

Because a stock market bubble is a cycle defined as speedy increase, followed by a decrease.

We would like to explain this in more detail. When more and more traders enter the market, believing that they also can profit and perhaps go on the double, but we have a limited supply of some stock, it isn’t unlimited. So, on one side we have an enormous number of traders willing to buy a stock, and on the other side is a limited number of particular stock they are interested in. The consequence is that the stock price will rocket. That sky-high price isn’t supported by the underlying value of the company or stock.

Finally, some traders realize that the growing trend is unsustainable and start selling off. Other investors start to follow that and catch on and start draining their stocks, in hopes to recover their investments. And here we come to the main point.

The declining market isn’t investors’ darling. The stock prices are dropping, traders who enter the market too late have losses, the stock market bubble bursts or in a better scenario, deflates.

Actually, we can easily say that behind the stock market bubbles lies a sort of herd mentality. Everyone wants a piece of high returns, it’s logical, right? Well, it continues with a downward run.

What causes it?

When eager investors are pushing the value of the stock, much over its proper value, we can say that we have a bubble. For example, the stock proper value is, let’s say $50 but investors boost it at $150. You can be sure the price will go back to its proper value, soon and extremely fast. The bubble will pop.

A good example is the dot-com bubble of 1999/2000. The markets were cut from reality. Investors accumulated dot-com stocks so wildly. How was it possible when they knew that a lot of these companies were worthless? They didn’t care.

That pushed the NASDAQ to over 5.000 points in a short period. That was the bubble and everything got apart very fast and painful.

One of the most famous market bubbles took place in the Netherlands (former Holland) during the early 1600s. It is the Dutch tulip bulb market bubble or ‘tulipmania’.

What happened?

The speculators pushed the value of tulip bulbs sky-high. The rarest tulip bulbs were worth six times more than the average yearly salary. Today, tulipmania is in use as a synonym for the traps due to extreme greed.

That can happen when someone follows some investor and notices how good it is and suddenly that one decides to do the same. But such copycats are not single individuals in the stock market. There are millions doing exactly the same thing. In a short time, everyone is plunging the money and the market reacts respectively by inflating prices. And eventually, the bubble will burst.

A stock market bubble as positive and negative feedback loops

Whatever has begun to shift stock prices up to become self-sustaining is a positive feedback loop. For example, investors hunting higher growth. When prices increase, investors are selling stocks. The others are buying them to profit on the growth. Someone will ask what is wrong with that. Well, new purchasings are driving the prices up higher and more investors are seeking those profits. The cycle is starting. And it is good but only when this positive feedback loop, as economists call this, comes as a reflection of reality. But when the feedback loop is based on fake data or questionable ideas it can be very dangerous. A great example is the Stock Market Crash of 1929. That was a time of blooming speculators in the markets. Speculators are trading stocks with borrowed money. The loan is paid from profit. When speculators have good trades they can make a fortune. In a different scenario, when they try to limit losses on debt, they can lose the shirt.

The stock prices will go down, the other investors will quickly sell with the same hopes to mitigate losses. The prices will go down further and create a “negative feedback loop” and poor market conditions will bloom. This is exactly what happens when the stock market bubble bursts. The stock prices are going down further as investors try to sell their stocks to cut losses.

Bottom line

As you can see, a stock market bubble happens when investors are buying stocks neglecting the value of the underlying asset. It is caused by a kind of optimism, almost irrationally, despite the rule of thumb: avoid impulsive trading.

The crucial nature of a stock market bubble is that trading can go in a direction that is not in your favor. Optimism can fade. Investors seeking higher profits easily can see their own disaster when the growth starts to slip. Why should they stay in positions any longer? They will not, of course. It is opposite, the selling off will start and the stock market bubble bursts. And it can do it for random reasons. Be careful, you can recognize a stock market bubble when everything is done. Only rare investors are able to anticipate it is coming. Well, that’s why they are successful and rich.

7th February 2020
UGAZ Stock and DGAZ Stock The Differences and Relations

The principal objective of UGAZ is to increase the daily performance of UNG by 3 times. The main objective of DGAZ is to produce profits from the losses in the UNG fund.

For everyone who wants to trade UGAZ stock and DGAZ stock the essential part is understanding the nature of them.

First of all, there is no dilemma should you invest in or trade UGAZ stock and DGAZ stock. There is no such thing as investing in UGAZ stock or DGAZ stock. Forget them if you are an investor, they are not for a long haul. The expense ratio is 1.65% so it is more likely that you will have zero chances to be profitable if you try to invest in them. Let’s say this way, according to historical data, over a period of one year they had a negative return of almost 56% and the negativity is increasing as times go by. For three years, for example, you can lose around 90% of your investment.

So, to summarize, UGAZ stock and DGAZ stock is for short-term trading.

Catch the trends

Trading UGAZ stock and DGAZ stock can turn into a profitable project since you can efficiently track the supply and demand. So, it isn’t hard to catch the trends and make a fortune. Maybe not quite a fortune but a lot of money for sure.

Remember one extremely important thing linked to UGAZ stock and DGAZ stock trading: there is an extremely high risk involved. No one will recommend you trade them but still, there are so many traders doing so.

How to trade UGAZ stock and DGAZ stock?

Okay, let’s look into the Natural Gas Sector. For that, we have to get into UNG, which is the United States Natural Gas Fund. It is an ETF composed to give investors exposure to natural gas and it is a highly volatile fund to trade. If you don’t have a stomach, forget the profit gained from this trading. Modern portfolio theory says that UNG is a fantastic solution for traders who are 100% sure that natural prices are able to rebound. Anyway, traders have to track the prices of natural gas, weather reports (that will give you a view into supply and demand). Don’t be confused!

Cold weather suggests an increased demand for natural gas, hence the rising prices.

Is UGAZ an ETF?

There is a lot to misunderstand energy ETFs and ETNs (exchange-traded notes).

The main energy ETFs are The United States Natural Gas Fund (UNG) and The United States Oil Fund (USO). And there are leveraged energy ETNs that tracking natural gas prices. These cover the VelocityShares 3X Long Natural Gas ETN (UGAZ) and VelocityShares 3X Invest Natural Gas ETN (DGAZ).

Let’s make clear what is an energy ETF. It couples investments in oil, natural gas, and alternative energy. So, it isn’t hard to diversify your energy investment portfolio.

Supply and demand have a great influence on crude and natural gas prices. Their prices tend to fall when the supply is bigger than demand. When we have more supply than demand in the market, the prices will rise.

Politics and crises also can affect these prices. Any uncertainty on the political field such as wars, governmental changes or even tensions will send the crude oil price higher.

We mentioned the weather. The crude oil and natural gas prices will go higher when temperatures could cause a spike in price. But also, when the over the warm periods, when we have an increasing demand for cooling, the price of natural gas can rise.

How to trade UGAZ and DGAZ

Both UGAZ and DGAZ strictly watch UNG stock.

The principal target of UGAZ is to increase the daily performance of UNG by 300% or 3 times. For example, if UNG price raises 1%, UGAZ will manifest a daily gain of 3%. It is better to trade UGAZ when there is bullish sentiment on UNG.

The main objective of DGAZ is to produce profits from the losses in the UNG fund. DGAZ increases the losses by 300% inversely. For example, if UNG price drops by 1%, DGAZ will bring you a profit of 3%. Trade DGAZ when there is a bearish sentiment on the UNG fund.

It is obvious that UGAZ and DGAZ have 3:1 leverage. Great, because that might boost your profit. But, keep in mind, that profit is in direct proportion with the risk.

Trading UGAZ stock and DGAZ stock means to pay attention to the UNG fund. It is the prime ETF that handles UGAZ and DGAZ as leveraged ETFs. That will provide you a view into the direction that this market is going. You have to evaluate should you trade UGAZ or DGAZ because they will give you a profit for opposite moves.

UNG is really a difficult exchange-traded fund.

Firstly, natural gas is a very volatile stock. Further, UNG isn’t directly related to natural gas in the physical sense of it.

Moreover, it doesn’t pay dividends. It uses future contracts and OTC exchanges to detect the natural gas price. Despite the fact that UNG may not be a good investment, UGAZ and DGAZ may be a good fit. How is that? As we said before, UGAZ stock and DGAZ stock are not suitable for long-term investing. And since you will hold your position for a few days or less, you are not interested in dividends and moreover, if the UNG fund has long-term decline, that will not affect the short-term volatility.

How all of this work?

ETNs provide tripled leverage for one trading day. Let’s say the natural gas price increases by 3%, UGAZ will grow by 9% and DGAZ inversely will drop by 9%. That’s why trading UGAZ and DGAZ stock is for short-term traders only. If you plan to invest in them for the long-term, your chances to make a profit are zero.

Think about UGAZ and DGAZ as up-gas and down-gas. When the natural gas price is going up, it will like UGAZ. Hence, when the price is going down, you will profit from trading DGAZ. Simple!

Real-life example

On January 30, DGAZ traded $285.20 which was $18.88 more from the prior trading day. DGAZ stock rose by 6.62%.

It rose from $267.50 to $285.20 and gained 3 days in a row. Will it succeed to continue gaining or take a break for the next few days? We’ll see. Maybe the best example of how this stock is volatile shows the fact that during the trading day the stock oscillated 8.08%. A day low was at $271.09, a day high was at $293.00. In six of the past 10 days, the price up by almost 44%. But volume fell by almost 20.000 shares and it can be a sign that something is going to change in the next days. Falling volume is always a signal of such occasions.

The price of natural gas went lower over the past 3 months, above the 5-year average. Increasing sellings are noticed in the futures market. The current data was not bearish, but the market reacted negatively.

That is how UGAZ stock and DGAZ stock work.

Can you short UGAZ stock?

You can always go short with the leveraged ETF pairs. A popular strategy over the years has been: short both sides of a paired leveraged ETF or ETN, and get the cash. The point is to short the long position on leveraged ETF and short leveraged ETF for the same sum. After that, just watch how volatility can benefit you.

For instance, if we examine imaginary the leveraged ETFs associated with natural gas and we see one is down almost 55% over the last 12 months, while the other has fallen 75%. A trader can short both sides for, let’s say $10,000 each, they easily could find themselves up to $12,900 off the $20,000 total short position. That’s a pretty good gain.

This is true most of the time. But you have to guess the right time frame. Of course, it is always a matter of how fat your account is. Everyone who can stay in the game long enough will be a winner. But it is a big challenge.

Shorting both sides isn’t an easy money way. Shorting makes sense only if you do it with a small part of your portfolio and you have a lot of cash. In any other case, it can be extremely dangerous when shorting both sides of a leveraged ETF.

31st January 2020
Volume Weighted Average Price (VWAP) – All Calculation, Practices, and Mistakes

Volume Weighted Average Price is an indicator that takes into account both stock price and trade volume.

For all of the indicator followers, Volume Weighted Average Price is a very important indicator. VWAP (Volume Weighted Average Price) is quite simple to calculate. Traders are using Volume Weighted Average Price to check if the price at which they traded was good or maybe the price was not and they made a wrong trade. Also, intraday traders will use Volume Weighted Average Price as a kind of indicator. As a contrast from the moving average, VWAP provides traders to get price points of interest, to estimate relative strength, and recognize best entries and exits. They will buy when the price is above the VWAP.

What is the Volume Weighted Average price exactly?

Окаy, let’s say you have to compare two obviously good stocks. What you have to do? The answer is logical, you have to check its price trend and the trading volume. Checking the price is reasonable, but why would you check the volume?

Well, the volume is important because it shows how many takers the stock has. Who would like a stock with a few traders? No matter if you think the price is reasonable, you would like to know the volume. Therefore, the VWAP was designed to give traders an insight into the stock price and volume. These are very important info that provides every investor should make a decision whether to buy or not a particular stock.

The formula for calculating VWAP is

VWAP = (Cumulative (Price x Volume)) / (Cumulative Volume)

It will show you the average price that investors have paid for that stock during the trading day. So, you will know how other investors are positioned. Moreover, this measure is used by algos also. They use it to scale into positions. By using it, the algo can break up its position size into segments so as to reduce its impact on the market.

Well, the philosophy of how VWAP is used can lead to various types of trading systems.

VWAP calculation

It is done by charting software and reveals an overlay on the chart representing the calculations. This design is in the form of a line, similar to the moving average. How to calculate that line?

You have to determine your time frame, for example, 1 minute.

Find the typical price for all periods in the day. You can calculate the typical price when adding the high, low and close prices and that sum you have to divide by 3.

The formula is

(H+L+C)/3

H – high
L – low
C – close

It’s not finished yet. The number you got as a typical price now multiply by the volume for the chosen period.

TP x V

TP – typical price
V – volume

Now, you will need a cumulative TPV. You will attain this by constantly adding the most current TPV to the earlier values. The exception is the first period from obvious reasons, there was no prior value. This number is becoming larger as the day is coming to an end.

Calculate VWAP based on your data and use this formula:

cumulative TPV/cumulative volume

This will give you a volume-weighted average price for each period. Now, based on this data you can create the line that covers the price data on the chart.
It is better to use a spreadsheet to track the data in case you are doing this manually.

Time to buy according to VWAP

The best time to buy a stock is when the price goes above VWAP. It is a sign that buyers are in control and the majority of intraday positions are in profit. But if the stock price is below VWAP it means that traders have bad trades and losing money on them.

The Volume Weighted Average Price unlike other technical analysis tools, it is best adapted for intraday examination. It offers a good way to identify the underlying trend of an intraday. So, as you can see, when the stock price is above the VWAP, that means the trend is up. Contrary, when the stock price is below the VWAP, that means that the trend is down.

But remember, indicators are using past data to calculate the average. Every indicator starts to calculate at the open and stop to calculate at the close. And as you come closer to the end of the day, the indicator will have more lags. In intraday charts that use very short time frames, you have hundreds of periods in a single day.

Use Volume Weighted Average Price as trend confirmation

We have already said, VWAP provides traders info related to volume and price. But, it will help traders to confirm the appearance of trends that might be rising or going down over the day. For example, you see in the chart VWAP is rising despite the swings in the closing price. You can be sure that there are less sellers than buyers for that stock.

Thus, a rising VWAP indicates a bullish period, while a decreasing VWAP indicates a bearish period.

It can be a trade execution strategy

VWAP is helpful for institutional investors as they need to buy or sell a huge amount of shares but they want to avoid a spike in the volume. They don’t want to attract attention and influence the price.

For example, some institutional investors want to buy 10.000 shares of some companies. If such an investor sets the buy order of 10,000, the consequence will be a spike in the price in the moment of filling the order. So, when other investors recognize that big demand, they would also like to buy the same stock and at a higher price than the bid price of an institutional investor. Of course, traders would sell the stock back at a much higher price. That’s how the stock price rises in a particular case and dramatically increases the “ask” price of the stock. As we mentioned before, some software is able to divide these huge amounts of shares into smaller blocks and execute the trade and not let the closing prices go far from the VWAP. It is important to keep the closing price as much as possible near to the VWAP.

Bottom line

As we explained, VWAP is a lagging indicator. So, don’t try to use it for more than for one-day frame, because it will not show you the right trend. It is good for intraday trading. Also, when the stock or, in some cases, the overall market is bullish, you will not be able to find crossovers for the whole day. So, you will have poor data. By the way, VWAP isn’t able to give you much historical data.

The VWAP provides valuable information, more than the moving averages. Also, it isn’t a tool for a long term investor.

29th January 2020
Coffeehouse Portfolio The Lazy Portfolio

This is another in a series of lazy portfolios and one of the most popular. There is no single “coffeehouse portfolio” and an investor can adjust the basic version to own needs and investing goals.

This lazy portfolio, Coffeehouse portfolio, that financial advisor Bill Schultheis made famous in his book “The Coffeehouse Investor” is so simple.
The Coffeehouse portfolio is built of 7 funds. The basic version starts with the composition of 60/40 stock/bonds. The fixed income part is put into a bond fund (you have to choose). The 60% in stocks is divided equally between six index funds. That index funds are a large-cap value fund, a small-cap fund, a small-cap value fund, a foreign fund, a REIT fund, and a large-cap fund.

“Investing should be dull,” said Nobel economist Paul Samuelson. Yes, some would say the same. But we have to be honest. This kind of portfolio maybe isn’t suitable for some Millennials experienced in investing. The Coffeehouse portfolio is too much dull. On the other hand, it is good. All you have to do is to set it up and live your lives.

And this discovery is amazing.

You can hear investors saying the same thing again and again: You need some simple but well-diversified portfolio. You don’t need more than several funds (4, 5, 9 whatever), but pay attention, as you are a novice, they have to be low-cost and able to create winners during both bear and bull markets.

That’s the point with lazy portfolios. There is no active trading, no market timing, and of course, no commissions. Moreover, they are simple. Well, someone may ask what happens with assets absent from such a portfolio. Forget it! You don’t care!

How to structure Coffeehouse portfolio

It is quite simple, as we said and here is one example:

10% Vanguard 500 Index
10% Vanguard Value Index
10% Vanguard Small-Cap Index
10% Vanguard Small-Cap Value Index
10% Vanguard REIT Index
10% Vanguard Total International Index
40% Vanguard Total Bond Market Index

Or

10% Large-Cap Stocks
10% Small-Cap Stocks
10% Large Value Stocks
10% Small Value Stocks
10% REITs
10% Total International Stocks
40% Bonds

As you can see in this portfolio, it is massive on the REITs, is slight on international stocks, and misses diversity on the fixed income side.

Roll the dice

Basically it is a “slice and dice” portfolio. So we can say it isn’t a “total market” example of the portfolio. A total-market portfolio consists of 1/3 equal parts of a total bond market index, total stock market index, and total international stock market index. But this “slice and dice” portfolio seeks to benefit from the higher returns. There is a higher risk when investing in value stocks and small stocks. And, as you can see, this portfolio has a massive collection of both small, and value stocks.

The 60% piece of the Coffeehouse portfolio represents 6 different funds that cover a different part of the market. That is a really good part of this portfolio since it is adding to the diversity.

The rest of the 40% of the portfolio is a total bond fund that includes the whole of the bond market.

It is recommended to rebalance the Coffeehouse portfolio every year. That secures that the asset allocation percentages are held at the accurate amounts. But it can be an individual decision for every investor, there are no rules what is the accurate amount.

Modifications of this lazy portfolio

As you can see this portfolio holds more bonds. It is more than some average investors would like to hold, especially if you are young. To make a comparison, the target-date funds, for instance, for Vanguard hold 10% bonds until investors are 45. We found some of the Trinity University studies and one shows that even investors in retirement should own 50/50 portfolios or even more aggressive.

Honestly, the Coffeehouse portfolio favors small-cap and value stocks. And do it with reason. Historically they have had higher returns and which means higher volatility too. But you can tweak the portfolio.

How to adjust the Coffeehouse portfolio

One method is to reduce your exposure to bonds (for example you could hold 10% of them) and split the rest of the portfolio equally into six funds. In this way, you’ll have a much more aggressive portfolio if you like that. But keep in mind, that is riskier at the same time and you must know how much risk you are able to handle.

Why not invest in the Coffeehouse portfolio

Firstly, for some investors, this portfolio hasn’t enough international exposure. It holds only 10% of Total International Stocks. Secondly, the 40% bond allocation will reduce your returns, you can be sure. Also, rebalancing can be expensive. There are too many funds to set them up.

For young investors, it isn’t so easy to just buy and hold. What if the prices are going up and down frequently? How to stay calm and do nothing? That’s the tricky part of any lazy portfolio.

Also, as we said above, the Coffeehouse portfolio can be too conservative for some investors. Where has the excitement of investing gone? Yes, you can adjust the portfolio as we described but still. Hence, to be honest, the one size that suits all methods sometimes don’t work for everyone. Especially if you prefer to be a more aggressive investor.

Why invest in this portfolio

Allocation on the value stocks is an advantage. The value stocks have outperformed growth stocks for 20%, according to historical data. Also, since this portfolio holds 20% small-cap stocks, it is good because they have outperformed large caps. Historically speaking, of course. By being a lazy portfolio and holds 40% in bonds, the Coffeehouse portfolio is less risky.

Bottom line

A creator of this portfolio is Bill Schultheis. He wrote a book about dullness investing. He had found that when you simplify your investment decisions, you end up with better returns.

His book “The Coffeehouse Investor” explains why investors should stop holding top-level stocks or mutual funds, and stop attempting to beat the stock market. Instead, keep stick to three clever principles:

1) There is no free lunch
2) Never put all eggs in just one basket
3) Save for rainy days

Sure, there is one more. Don’t pay too much attention to daily ups and downs in the stock market. It can ruin your life. But with investing in the principle buy-and-hold, with an annual rebalancing of your portfolio, it is more likely that you will build your wealth. There’s nothing wrong with adjusting the CoffeeHouse portfolio. It’s more important that you stick with your plan. The weighting of your allocations is less important but has to be reasonable. And a note for newbies, sometimes it is smarter to be a bit conservative especially in the stock market.

And here is a bit of statistics. Behavioral finance professors Brad Barber and Terry Odean discovered: “The more you trade the less you earn.” Buy-and-hold investors are doing better than traders. Active traders can lose a lot of money paying transaction costs and taxes.

The truth is that active traders can turn their portfolios over for more than 250% per year, but their returns can be just like 11% after paying tax. Opposite, buy-and-hold investors can turn their portfolios over a bit around 2%, making around 18% returns.

Finally, this is just one of the numerous approaches to investing. You are the one who has to choose. It’s all up to you.

28th January 2020
The Barbell Portfolio – Strategy Of A Balance

The barbell portfolio holds only short term and long term bonds and generates fixed income. A flattening yield curve situation is the best time to use this strategy, while a steepening curve is harmful to the strategy.

The barbell portfolio was invented by bond traders. The strategy means to hold safe short-term bonds and riskier long-term bonds. Put them together and that is the barbell portfolio. This also means that you are betting on both sides. But your barbell portfolio gives you protection since you have extremely safe short-term bonds. Yes, they will provide you with less profit but the profit is compensated from the other side of your portfolio – by long-term bonds that are extremely risky but provides a great profit.

Building a barbell portfolio, you will give your investments a balance that can run you through different circumstances, even extreme ones. The barbell portfolio is a very simple investment allocation actually. But the barbell portfolio is heavily weighted on two ends, just like a barbell. This concept is easy to understand and we want to explain it by using bonds. You can create this kind of portfolio with cash and stocks, also it can be a nice substitute to a 60/40 stock/bond portfolio.

How to structure barbell portfolio

Let’s say the short-term bonds are risk-free. But you will not earn a lot by holding only them. To have a profit you must add something riskier to your portfolio. So, you can do it by holding long-term bonds. You see we are not considering mid-term bonds. There are long-term bonds to provide the yield to your portfolio.

Yes, they are the riskiest but also give the highest returns.

The idea of this kind of portfolio is to bypass and avoid the risk on one side of the barbell portfolio and to do it as much as possible but to put more risks with long-term bonds.

For every investor, the risks diversification is one of the most important parts. So how to do that with a barbell portfolio? For example, you can build it if one half of your portfolio is in bonds with 5 years maturities and the rest is in bonds with 15 years maturities. The point is to put weight on both ends of your portfolio. But it hasn’t to be equal weight. it can be turned in one direction or another. Of course, it depends on an investor’s vision and yield demands.

You have to pay attention to the bond barbell strategy. It isn’t a passive strategy. You will need to monitor short-term bonds and adjust them frequently. Also, the other end with long-term bonds should be adjusted from time to time because of their maturities shorten. Some investors will just add new bonds to replace the existing.

Barbell Investing

It is all about aiming to balance risk in your investment portfolio. For example, if you put bonds on the left end of the barbell portfolio you might be faced with rising interest rates. So, the value of the bonds could decline. In order to balance the weight, you can replace them or part of them with, for example, with dividend-paying stocks, or some other ETFs. This left side has a great role. It has to protect your wealth so the savvy investor will always choose low-volatile and low-risk assets for the left end.

The right side’s role in your barbell is to give you high profits. That is your financial goal. So you can add some aggressive stocks there instead of long-term bonds.

The barbell strategy is actually a simple investment allocation. Two ends, two sides of your portfolio are designed like opposite ends. What you have to do is to allocate your capital between safe and aggressive sides. Some experts recommend holding 80% treasury bonds and 20% stocks.

Some may ask why to diversify like this. Here is why. Let’s say you have invested 100% in different stocks. Yes, you have a diversified portfolio but you are, at the same time, 100% exposed to downside risk and you are at risk to lose all your capital invested.

But if you build a barbell portfolio with 80% bonds and 20% stocks your downside risk can arise on your risky part of the portfolio. That is 20% of stocks. But the point is that the majority of your portfolio will be in safe investments. Moreover, bonds will give you interest too.

Why use this strategy?

Because it can lower risks for investors. At the same time, it can provide exposure to higher yield bonds. Higher yields will compensate for the higher interest risk rate. So that is the first benefit. This strategy allows investors to have access to higher yield long-term bonds. The other benefit is that this strategy reduces risks because the short-term and long-term bonds’ returns favor being negatively correlated. In other words, when short-term bonds are doing well, the long-term bonds will have difficulties. When you hold bonds with different maturities it is more likely to have less deadfall risk. Let’s say when interest rates grow, the short term bonds are rolled over and reinvested. Of course, at a higher interest rate. That will compensate for the drop in the value of longer-term bonds. Opposite, when interest rates are lower, the value of the longer-term bonds will grow. Simple as that.

But remember, it’s so important to manage the weight of both ends. And to do it actively. The contrary will never produce long-term returns. If you notice that the assets on one end of your barbell portfolio somehow look expensive you have to change it and balance by leaning toward less expensive assets on the other end. Well, if the prices are expensive on both ends, you will need to reduce overall portfolio risk.

Is there any risk?

Yes, interest rate risk no matter do you hold both long term and short term bonds. If you buy the long-term bonds while the interest rates are low they may lose value quickly when the interest rates increase.

An additional risk of the barbell strategy comes from the investors’ limitation, this portfolio doesn’t include intermediate-term bonds so you will not have exposure to them. And we all know that intermediate-term bonds give better returns than short-term bonds. Yes, they are riskier but not too much. In comparison with long-term bonds, intermediate-term bonds will offer a bit lower returns. That is the downside of the barbell portfolio because you don’t have an opportunity to earn on these returns.

Well, the main risk of the barbell strategy lies in the longer-term bonds. They are more volatile than their short-term bonds. As we said, you will lose if rates rise and you choose to sell them prior to their maturity date. If you keep the bonds until the maturity date, the fluctuations will not influence negatively.

The worst scenario for the barbell is when long-term bond yields are rising faster than the yields on short-term bonds. That is the steepening yield curve. The bonds that make up the long end of the barbell drop in value. So, you may be forced to reinvest the profits of the lower end into low-yielding bonds, to balance the portfolio.

But the flattening yield curve, if yields on shorter-term bonds rise faster than the yields on longer-term bonds you will earn. That is an advantageous part of the barbell strategy.

Bottom line

The benefits of the barbell investing strategy are numerous. Firstly, you will have a better diversification of your investments. Also, you will have more potential to reach higher yields with less risk. If interest rates are falling all you have to do is to reinvest at lower rates when the maturity date of that bond comes. In case the rates are rising, you will have the chance to reinvest the profits of the shorter-term securities at a higher rate. Since the short-term bonds mature frequently, that will provide you the liquidity and adaptability to solve emergencies.

27th January 2020
Black Swan Investing Strategy To Reduce The Risk

Predicting when the next black swan event will happen is the mission impossible. But you can create a portfolio created to reduce the risks related to black swans.

Black Swan investing isn’t quite a strategy, it is more a trading philosophy. Actually, it is a method of predicting the occurrence of black swans. The black swan is an unplanned, unexpected event in the markets. Such events come as a sudden blow and may influence the market. But black swan also can have both a positive and negative impact and we are going to discuss them here.

An example of a negative black swan is the crisis of 2008.

Black Swan investing is a trading philosophy based completely on the probability that some accidental event will hit the markets. To avoid losses caused by a black swan, traders who are trading based on black swan strategy always are buying options, never sell. They never estimate will the market go in one or another direction, up or down, they are buying. These traders are actually betting on the chance the market will move both up and down.

Protection of investments

Behind that behavior is investors’ need for insurance for their portfolio to protect against another black swan event like it was financial crisis 2007-2009.

They are afraid of is losing money as they did at the time of the crash. But losing money is a risk that you have and can determine. The black swan is a risk that you can not determine or predict. How can you plan some sudden and hidden events ahead? Hence, we can’t hedge out the risk of secret and unknown events. All we can do is analyzing past events.

The black swan investing theory is based on an old saying that presumed black swans did not exist. Nassim Nicholas Taleb developed black swan theory but in his book The Black Swan he also recommended traders to fire their advisors claiming that they don’t know enough or know a bit about investing. Brave claim indeed. His belief in the incompetence of financial advisors is based on their disregard for Black Swans.

Is it possible to predict the next event?

It sounds like an impossible task because it is. As we said, how can you predict something unknown? But what you can do is to build a well-diversified portfolio to reduce the risks. Also, now you have this tool to determine when to exit your trade and avoid money losses. Moreover, you can determine when to do that in profit.

Yes, your portfolio can be structured to reduce risks linked to black swans.

Positive or negative black swans

Okay, you would like to know how to invest for positive or negative black swans. So, first of all, you have to understand how not to depend on catastrophic predictions. Let’s say, you invested with the belief that the stocks will grow forever. Also, you are pretty much sure that the financial crisis will never come, or the company will never bankrupt. Well, something has to be changed in your beliefs. The truth can be very painful for you at this very moment. Stocks will not rise all the time. Not even in the next 20 years or even five. They will go up and down.

The main point of black swan investing is to profit from unpredictability. But such events come suddenly, they are surprising, so how can we invest in it? We cannot do it directly. All we can do is to be ready for them, meaning to be exposed to such exceptional but extremely impactful events.

How to expose to a positive black swan

How to do that? How to take advantage?

If you follow Taleb’s definition it is quite clear what to do to positive events. If you can seek exposure to something you can not predict, then seek out exposure that is unrestricted to the upside. Well, there is no need to know will some event come or not, or when it is going to happen. All you have to do is to detect exposures that have the potential to blast if meet the proper conditions.

Exposure to positive black swans may sound a bit esoteric. Some investors that are practicing a black swan strategy like to say that it is necessary to build a portfolio that is able to “invite” positive events, amazing and unexpected. We don’t have material proof that it works.

Their idea is to give a portfolio a chance by setting up limited sums of money or scale it up. If it works, it’s okay. If it doesn’t work, just give up and risk later.

This stands in firm contrast to traditional investing advice.

Behind this idea

For any trader who wants to implement the black swan investing strategy, it is necessary to create a barbell portfolio. This kind of portfolio was created by bond traders. This strategy requires owing safe short-bonds on one side of the barbell, and on another side to balance the weight of investments, riskier long-dated bonds.

By building a barbell portfolio, you’ll have very safe investments on one end and notably risky investments on the other end. The safe investments virtually don’t have risk. They will survive even a black Swan. The risky side of the portfolio opens it up to the endless upside. This kind of portfolio advances despite any circumstances in the market. That’s according to Taleb.

Black Swan investing

Since black swan traders never sell and they are counting on the crash, they are buying out-of-the-money options.

But one question arises. Can any empirical evidence account for black swans? We are afraid the answer is no. So, we cannot predict the market. Why there are still people trying that? Because we all need progress in this field. Yes, we have algos, AIs, learning machines, automated trading, etc. But yet, no one can predict the market. And it is a great challenge. By fair, that moment isn’t so far from us. One day someone will find some formula for that. Frankly, how many people were able to predict all possibilities of the internet? A very small number. Today it is part of our daily lives.

Yes, we truly believe that one day, somewhere, someone will find a way to predict market movements. Meanwhile, there is no need to give up from investing because of the lack of unreachable knowledge. Just work with what you have and know. That would be enough. At last, it was enough for the past 200 years.

Pro tip: Develop an efficient portfolio on a demo account first; (1) Examine how well it guards you from random Black Swans (2) optimize (3) only then risk real funds.

Bottom line

Banks are a negative black swan business. The upside is inadequate and the downside is complete. The examples of positive black swan investing biotechnology stocks, venture capital, publishing, etc.

The venture investor that invested in Uber in its beginning was exposed to a positive black swan, but today would be more exposed to a negative black swan with the same investment.

The key principle in black swan investing is to find extremely aggressive as unreasonable as possible assets. Hence, when you find that chance, take it.

26th January 2020