Happy New Year!

As we begin the new year, let us resolve:

1. To be disciplined in our trading

2. Not to trade more than we allow ourselves to risk

3. Never be emotional about our trades

Have a wonderful profitable year ahead!!

It has been a little more than a year since the sudden collapse of Lehman Brothers sent shockwaves across the markets. Then, global markets went into a state of panic and the Dow Jones Index fell to near 6500pts. Central banks cut interest rates rapidly and rushed to put together stimulus packages to revive the economy while investors wonder which corporate giant will be the next to go…

Fast forward to a year later, liquidity is back in the markets and the Dow Jones is closing in on the 10,000 mark after recovering more than 50% from the lows. With interest rates at record lows, investors do not want to leave their savings in the banks and are back in the markets. With fast money to be made, the lessons from Lehman will soon be forgotten.. until the next crisis.

I met a ‘trader’ recently, Mr X who has just started trading in shares without much trading experience. On that particular day, he was telling me about counter ABC which all his research have shown to be a buy.

The share was then trading at 7cts, which Mr X said: ‘I’m not greedy, I’m only buying for a small profit of 1 ct’. When I asked, ‘what if the price come off?’ He replied, ‘That will not happen. All my research shows that it is going up’.

Many people trade knowing exactly where to take profit, but do they know when to cut their losses? Each trade has a 50-50 chance of going either way. It is by minimising the losses on the losing trades and maximising the gains on the winners that you can be profitable in trading.  Always be prepared.

The stock market is the most commonly traded investment and is known to give the best returns over time. It is easy to trade and investors just have to buy and hold, for capital appreciation or for dividends.

Yet, two recent events have shown that it is not as simple. One, the decision by the major shareholders of CK Tang to privatise the company. And two, ATIC’s ( Advanced Technology Investment Co, the technology investment company of the Abu Dhabi government) purchase of Chartered Semiconductor with plans to delist the stock from SGX and Nasdaq. 

These events reminds us of a risk in share investing that is not known or often ignored by many investors. When investing in stocks, you are buying into a business as a shareholder and you stand to lose your entire investment should the company goes belly-up. However, as a small shareholder, you have no say in how the company is run. Therefore, you are putting your money in the hands of the people running the company. Should the major shareholders choose to privatise the company, you will be forced to exit prematurely. Thus, the odds are stacked against the minority who will not stand a chance up against the bigger players.

 “I felt very emotional, on behalf of some of the older minority shareholders. This is a lesson in investment. You must know what you are putting your money into.”

Alan Goei, one of the minority shareholders of CK Tang which recently announced its decision to delist from the Singapore Exchange.

http://tankeewee.com/Money-Talks,09Jul09-The-King-of-Currency.html

An interesting article from Dr Tan Kee Wee.

Dr Tan is an economist who makes complicated economic theories simple enough for you and me.

2 prominent cases came to a close recently. In Singapore, MAS, after much investigation, banned several financial institutions from selling structure products. And in the US, Bernard Madoff was sentenced to 150 years jail for fraud involving a ponzi scheme.

The actions taken may be stiff but it did nothing to relief the pain of the thousands of investors who lost their savings in the 2 cases.

Yet for others who were not affected, are they wiser from the experience of the unfortunate ones? Each day, investors continued to be offered opportunities of better returns. It can be the property agent who offers you the chance to buy a property to ‘flip’, the friend who offers you the hot tip about a certain stock or the guru who has a trading formula to share.

How many investors who were sold Lehman-linked investments actually know what they invested in or were they simply sold to the idea of ‘better than bank deposits’ returns?

I can never emphasize enough on the importance of understanding what you are putting your money in. No one can force you to part with your money if you do not want to. Do not be taken in by easy returns or ignore the fact that with higher returns come higher risk. Do your research before writing your cheque!

“They’re doing things, but they take awhile to have an effect. You can’t produce a baby in 1 month by getting 9 women pregnant”

Warren Buffet, on US government efforts to stimulate the economy

Every first friday of each month, the market holds its breath and await the release of US employment data. Considered to be one of the most important data each month, investors will watch out for the change in non-farm payrolls and the unemployment rate.

Statistics show that Singapore is in a reccession. The government has been coming up with measures to help Singaporeans and the newspapers have been reporting of job losses and weakening exports. Economists are divided if there are enough ‘green shoots’ to signal an economic recovery. There is a big, bad, deep reccession going on.

 Yet, while I was at Paragon a few days back, the restaurants were packed with people. A friend who wanted to buy a branded $2000 handbag had to be put on a waiting list. The malls were all crowded with people picking up bargains at the Great Singapore Sale. Another friend bought a pair of shoes on sale - for $350!

Someone said economic crisis??

Are Singaporeans simply taking an ostrich approach or the statistics are wrong? Well, it seems to me that only Wall Street is hurting, but Main Street remains unaffected. Everyone in the financial industry is feeling the pain, with stock prices coming off, property prices coming off, increased volatility and jobs at risk. However, on the Main Street, the rest of Singaporeans would have leftovers from the spoils of the economic growth over the last 5-6 years. If you still have your job and have not made much investments, life simply goes on as usual.

It was reported last week that Temasek Holdings had divested all of its holding in Bank of America (BoA) in the first quater of this year and could have lost at least US$2.3 billion. Perhaps it is due to the change in Temasek’s investment objectives from developed markets to emerging markets. Or perhaps due to the different business stucture of BoA from Merill Lynch which Temasek had originally invested in. 

I am not an economist or analyst, so I shall reserve my speculation. However, what we do know is that Temasek first  invested into Merrill Lynch in late 2007, which was when the crisis was just unfolding and markets were still trading at the highs (as compared to current levels). And when they liquidated their holdings the last quater, March 2009 was the lows we have seen so far in the crisis. This brings to mind the trading pattern of many retail investors.

Of course it is difficult to predict where the market will be, and only after the highs or lows have been formed, then we can look back and say a top or bottom has been formed. Therefore, we cannot fault one for his entry level as high can go higher, and low can go lower. However, one do have control over how much he can lose. Investors often, for the fear of losses, hold on to their bad positions longer than they should. And when the pain becomes unbearable that they have to cut, its at the worst levels before market reverse like when Temasek sold BoA just before the market rallied sharply in the 2nd quarter. A successful trader should have in mind how much losses he is willing to take when he initiates his position so that he will not be unprepared when market turn against him. Only when you know your potential losses, then you can act to preserve your capital and fine-tune your trading to grow your account.

Bank of America   -  Judged to need roughly $34.0 Billion in additional capital
Wells Fargo  -  Judged to need roughly $15.0 Billion in additional capital
GMAC  -  Judged to need roughly $11.5 Billion in additional capital
Citigroup  -  Judged to need roughly  $5.0 Billion in additional capital
Morgan Stanley  -  May need to raise between $1 to $2 Bln in additional capital
Goldman  -  Judged not to need to raise additional capital
MetLife  -  Judged not to need to raise additional capital
JPMorgan Chase  -  Judged not to need to raise additional capital
Bank of NY Mellon  -  Judged not to need to raise additional capital
American Express  -  Judged not to need to raise additional capital

TOTAL 65.5 billion required. (And the market rallied last night on the good news that its not as much as expected?!)

Like 2 sides of a coin, there are stocks that go up and there are stocks that go down. In the face of the flu pandemic, health stocks are up, airline stocks are down. While retailers are affected as people stay home, DVD rentals, home food delivery are doing a brisk trade.

So when will you ever know which is the ‘right’ stock  to buy? Which is the ‘right’ stock to hold?

Instead of always trying to hit the jackpot by picking THE stock, why not trade the stock index as a futures contract? In the midst of a crisis, some sectors will benefit and their stocks will go up, but the general market weakens. Similarly, during boom time, defense stocks may lag as the general market favours the faster movers. Trading the stock index allows you to focus on the direction of the market without sweating over which stock to pick. Now, you no longer have to ask “which stock to pick?”

Here’s a new movie coming up. Titled Floored, its a movie about traders on the trading floor.

But really, I think one of the best things to happen to retail traders is the moving of trading from the floor to electronic. Market legends often has it of traders who traded with guts and had their glory in the millions they made, yet, this money made is paid for by players who do not have access to the trading pits.

Electronic trading levels the playing field. The retail investor trading 1 lot is not just equal to the professional trading 10 lots but also to the institution trading 1000 lots. He no longer has to feel shy of his trading size or be discriminated against. Behind the screen, he has the same chance of making what is previously accessible only to the floor traders.

Goodbye floor, electronic is the new king!

You spend long hours at work each day but are you being compensated enough for your efforts? Unless you have your own business, working only profits your boss. Coupled with the current economic conditions, your income becomes dependent on the business of your boss.

Given a choice, most people would like to have their own business, to be their own boss. But it is not easy starting a business. Say, you want to set up a fruit juice stall to market to the working class. First you need to have a sum of capital and find a place to set up your business. You have to worry about sales, worry about costs, worry about rental, worry about competition etc etc. There are endless things that a business owner have to worry about.

This is why my business is trading. There is a start-up cost but my income depends solely on me, and not on any other external factors like sales and cost. I am my own boss but I do not have to worry about poor business or rising rental, or sweat over employee problems. The trading market is transparent and liquid, so the performance of another trader will not eat into my profits and I do not have to worry about another trader trading better than me. Trading may have its risks, but so do any other business. The important thing is to know and understand your business, put in enough hard work in research and studies and you will do well.

The scientific defination of leverage is the use of a smaller energy force to move an object of a greater energy force. Since the age of cavemen, the use of leverage in the form of simple tools has made the lives of mankind much easier.

Yet, in the financial markets, leverage is associated with high risk and investors often shunned leveraged products. The recent volatility in the markets also had many investors pointing their fingers at leveraged traders cutting losses to meet margin calls.

Indeed it is true that leverage trading carries a certain level of risk. With the investor only putting up a percentage of the total contract value, he runs the risk of losing his entire investment and more. For example, to trade 1 lot of Emini S&P at price 800, the contract value is Usd40,000 (usd50 x800pts), but the investor only has to have Usd 5000 to initiate a position. If the contracts falls by 100pts, the contract value drops by 12.5%, but the investors loses 100% of the amount he invested.

But to avoid the use of leverage is like not using fire to cook for the fear of burning your house down. The use of leverage in futures trading carries no financiang cost. The investor can use a small amount of deposit to trade a larger contract size, thus increasing his wealth exponentially. In the above scenario, the investor will be able to double his investment on a 12.5% increase in the contract value. If not for the use of leverage, he would have to save up to Usd40,000 before being able to trade. Or if he had chose trade using his exiting Usd5000, say 10 lots of ABC share at $5 each, the shares will have to double to $10 for a 100% return.

Therefore, for normal investors, leverage in futures trading offers a fast and cost effective way to increase wealth. The question is not whether to use it or not, but how to use it to your advantage.

Throughout my broking career, I often have clients lamenting that the increase in margins have made it very difficult for them to trade. The local broking firms, under the regulations of MAS, require clients to put up the required margins before they can initiate a position. When I joined the futures broking industry in year 2000, the margins required for 1 lot of SiMSCI is abt 5% or S$2000, but due to the current market volatility it has tripled to almost 15% or the current S$6000 despite the falling contract value.

Increases in margins are often viewed as a hindrance to futures traders seeking to maximise their profits through the use of leverage. The higher the margin requirements, the lesser the leverage.

However, traders must take a step back and look at it at a different light. Margins serve as a check for clients so that they do not over-leverage and lose their entire investment. Say, a trader has S$12,000 in his account, if margins are at 5% of the contract value which is about S$2000 and he choose to maximise his leverage by trading 6 lots of SiMSCI, his account would be wiped out if he had shorted at 2000 and the market rallied to 2100. At 15% margins, he can only trade 2 lots, and had market rallied to 2100, he loses S$4000 and preserves his capital for another trade to be able to recover his losses. Therefore, higher margin requirements is indeed a bitter pill, yet it is for your benefit.

Having said that, clients should not base their trading size according to margin requirements. Successful traders have a strategy and trade according to what their risk level allows them and will not max out their account to maximise their profits.

In my many years of broking, clients never had much trouble taking profits, afterall, ‘a bird in hand is better than 2 in the bushes’.  It is never too difficult to decide how much to take off the table.

However, when it comes to losses, it is a totally different story. Traders, retail or institutional, often find it very difficult to cut losses, holding on to a false sense of belief that it is a retracement and market will move back in their favour again. Why? It can be due to ego as cutting a loss means that the trader had picked the wrong trade, a losing one. Or it can be due to money, with the pain of losing x amount could be so great that the trader choose not to realise the loss and instead hold on to hope for a smaller loss. Whatever the reason, traders who have lost money very often regretted their lack of disclipline in trading, for holding on to a losing position longer than they should have.

Sadly, this does not just affect traders. When the US crisis escalated, the US governemt proposed for a vehicle to be set up to soak up toxic assets from the banks, but the banks refused. The assets will be sold at marked-to-market prices which were drastically lower than their book values and the banks did not want to realise the loss. Recently, as valuations continued to spiral downwards, talks emerged that the banks should be nationalised but the government did not want to do that. Nationalising the banks will result in shareholders, especially the Sovereign Wealth Funds who invested billions, losing their investments. But with the current market capitalisation of Citigroup and BoA combined at less than 30 billion, there is really very little left of the investments.

So, if you have not been very disciplined, you are not the only one. But its not too late to start now!

In the news recently for the wrong reason is ‘Dr’ Clemen Chiang, an options trading ‘expert’ who misrepresented himself with a phD from an uncredited university. Many who have attended his course are now claiming for their money back. He is one, but there are many others. Why are there people who are willing to fork out $3-4k or more for a trading course? Open the newspapers and you will find many of such ads, trainers who claim to have made millions and promising a trading formula that will make you a millionaire too!

Many new investors are sucked in by the allure of fast & easy money from trading, thinking that there must be a secret formula and once u apply it, money will come rolling in.

However, the secret is that…  there is no secret!

Trading is an art and not a science, market conditions are constantly changing. A successful trader is one who makes money consistently day after day, year after year. Those who are seeking to make a million in 6 months should try their luck at buying lottery instead. Successful trading requires skills, knowledge, hard work, discipline, practice, account & risk management etc. There are no short-cuts.