Only a few of us are born with investing qualities. Even the greatest investor of all times, Warren Buffet, made a number of mistakes before getting on the right track. The difference between a successful investor and an unsuccessful one is the ability to learn and avoid the mistakes other people have made.
It’s no secret that many investors focus obsessively on one investment that’s losing money, even if the rest of their portfolio is in the black. This is one of the most famous mistakes, called loss aversion. Like this mistake, many investing mistakes are related to our physiological nature as human beings. Here are two more main behavioral mistakes that you should avoid.
Overconfidence
Overconfidence refers to our boundless ability to think that we’re smarter or more capable than we really are. Optimism isn’t a bad thing; however, overconfidence can harm you as an investor when you believe that you are more capable of spotting the next Microsoft than another investor. You have to recognize that you are probably not (nothing personal…).
Overconfident investors tend to trade more frequently because they think they know more than the person on the other side of the trade. The commission and tax drawbacks of trading too frequently are the number one factor for shrinking the portfolio of these traders.
To avoid overconfidence in your investing, document and review your investment record over time. It’s easy to remember your one stock that gained 50% in a short period, but records may reveal that most of your investments have overall negative returns for the year. Also, even if you’re an expert, remember that the investor on the other side of the trade is no less smart than you; always consider the odds that he can be right and you can be wrong.
Anchoring
Ask an American to estimate the population of Spain and they will anchor on the number they know, the population of the U.S., and adjust it down, but not enough. The opposite will also happen if you ask a Spaniard about the population of the U.S. This anchoring will happen to any one of us when trying to estimate things that are unknown.
The same thing happens to many investors. They buy a stock and anchor on the price they paid for it or on the financials of the company when they bought it. As a result, if the stock price went down, even if the company is not attractive any more, they continue holding on to the stock. They anchor on last year’s earnings and on the buy price, hoping that the stock will return at least to the point where they bought it. For the most part, it won’t happen and the deterioration of the business was translated into price reduction; thus, years could elapse before the stock returns to that point, if at all.
In order to avoid that, ask yourself a simple question: “Based on the current valuation of the company, would I buy this stock now?” if the answer is yes, it is rational to keep it; otherwise, realize that you have lost some money, then sell it and move to other stock. Remember that the loss from this investment can be used to reduce tax payments on other investing gains.
It’s easy to recognize these mistakes but harder to avoid them in your investments. The best way to overcome these mistakes is simply by practicing in similar situations. Obviously, it isn’t wise to practice in your real investment account so you are encouraged to practice it in Yalicoo stock trading competitions. At the beginning, it is possible that you’ll make mistakes in many of the games that you’ll participate in. In time, you’ll become much more experienced and aware of these behavioral mistakes, and eventually learn to avoid them.
September 14th, 2008
It could be the overly high expectations of growth from high-tech companies or the excessively large loans that were given to home buyers; every recession is caused by different reasons that cannot be predicted in advance. However, there are always stocks that perform well even during these bearish periods. They are usually called ‘defensive’ companies, and if you have never heard of them, you should carefully read what comes next to be prepared for the next recession.
Looking at the year-to-date performance of the 30 Dow Jones members (taken from Bespoke Investments) can teach us an important lesson about investing during a recession. Without looking at the chart below, can you guess which company’s stock had the best performance?
No matter what the reason for the recession, people will always have to buy home equipment and groceries; also, since your budget is limited during these periods, you’ll probably choose to buy in a discount store. This is exactly why sellers of cheap goods and food such as Wal-Mart (WMT) and McDonald’s (MCD), have thrived. The defensive stock story is a common recession theme, but it was clearly a winner this time.
All seven stocks that had positive returns for the year are defensive stocks. We already mentioned Wal-Mart and McDonald’s; IBM, the (relatively) cheap computer equipment seller is also placed higher on this list, as well as the giant healthcare products manufacturer Johnson & Johnson (JNJ), and the home improvement retailer Home Depot (HD). Despite the recession, people always have to have at least some fun during their vacations, and it should be not too pricy; thus, it is not surprising that we see the most well known entertainment company Walt Disney Company (DIS) closing the list of successive stocks.
Finally, if you want to remember only one thing from this short article, remember this: during a recession, the companies with the highest chance of yielding a positive return are the low-priced retailers with the most recognizable brands.
Tags: Recession, stocks
September 4th, 2008
There are lots of services on the Net claiming they can ensure that you’ll beat the market. Beating the market means achieving an average return higher than the market performance during the same period. It might seem easy to do, but it’s a very hard task that only a few services manage to do in the long run. So, where can you find such successful services?
It turns out that one of the best places to look for stocks that will beat the market is stock picking communities. These communities gather many excellent traders and investors that trade and invest using various strategies, trying to achieve the highest returns possible over time. They hold virtual portfolios that can be tracked and followed. One of these stock-picking communities is Yalicoo.com, where investors compete against each other, aiming to yield the highest return during the competition period (daily, monthly and quarterly competitions). The unique advantage that Yalicoo has over other sites is that every thing is done in real time. This means that you trade stocks (virtually) in real market prices and can see all the other investors’ moves in real time. This allows you to copy the moves of the investors you like into your real money portfolio.
The statistics shown in Yalicoo are quite impressive and hard to ignore. The winner of Yalicoo’s last monthly stock market competition had a return of 40%; in the previous monthly competition, the winner ended with a return of 17%. One month earlier – 22%, and the month before – 14%; and this goes on and on… If you followed these winners’ moves (and it’s easy, since you can see every thing they do in real time at Yalicoo), your real money portfolio could have grown dramatically.
In the last year or so since Yalicoo was launched, Yalicoo investors have been consistently beating the market in almost every time frame I checked (!). Obviously, there is no guarantee for future success in the stock market, but in light of the results shown here, these higher returns of Yalicoo’s investors definitely show a clear trend of success.
The number of educational sites on the Internet is enormous, but I encourage you to visit as many of them as you can to continuously educate yourself. Still, places like Yalicoo are excellent complementary arenas for investors who aspire to maximize their returns over time.
September 4th, 2008
The Earning Per-Share (EPS) by itself does not mean much. Most investors employ the Price to Earnings (P/E) ratio to examine a company’s earnings relative to the price of its shares. The P/E ratio, often called “multiple”, divides the stock price by the last four quarters’ EPS (this is the same as dividing the market capitalization of the company by its total earnings). For instance, if ABC Corp. is currently trading at $15 a share and its last four quarters’ EPS is $1, it would have a P/E of 15. It could be a surprise for many of you, but this well-known ratio has substantial drawbacks that Wall Street analysts, who frequently use it, won’t tell you.
The P/E is used by many analysts and investors to trace bargain stocks. The underline assumption is that companies that run similar businesses (i.e. are from the same industry) should have a similar P/E. Therefore, low P/E stocks are often considered a bargain. Is it really true? Not always.
While some low P/E stocks could be cheap, many of them are not such attractive investments. For example, consider a company with a low P/E that has a large debt. In this case, the market cap of the company does not truly reflect its real value. The company’s real Enterprise Value (EV) would be the sum of its market cap and its debt (minus the company’s cash), making the numerator larger, thus the P/E will be larger than what it was initially calculated to be.
Simply stated, it means that the real price of the stock is not as cheap as it seems to be. On the other hand, if a company has a higher P/E ratio, it doesn’t necessarily mean it is not cheap. If this company is loaded with cash, then again its market cap wouldn’t reflect its true value; in this case the EV of the company would be its market cap minus its cash, thus dramatically lowering the P/E value. In order to avoid this problematic feature of the P/E, it is wise to use a different ratio, called the Earning Yield (EY), which is calculated by dividing the earnings of the company by its EV.
Another problematic feature of the P/E is its dependence on the company’s past performance. The earnings of the past 12 months are not necessarily an accurate prediction of future earnings. A company could have a uniquely profitable year for many reasons but its future earnings could be ambiguous. Therefore, looking only at the trailing 12 months’ P/E is kind of like driving while looking out the rearview mirror- it is important, but the obstacles you need to be careful of lie ahead of you. In other words, many stocks that are traded with low P/E these days often deserve to have a low P/E because of their questionable future prospects.
One of the not so commonly used ratios, which can solve this issue, is the Price to Earning Growth (PEG) ratio (The PEG is calculated by dividing the P/E ratio by the company’s predicted annual growth rate). The PEG simply takes the annualized rate of growth out to the furthest estimate and compares this with the current stock price. Since it is future growth that makes a company valuable, the PEG ratio makes a lot of sense. But this is not the end of the story, since the PEG also has a crucial problematic feature – it depends on the assumed growth of the company, a parameter which is obviously unknown by itself.
In any case, considering a low P/E ratio as an initial screening criterion for finding bargain stocks could be useful. However, this by itself does not assure a cheap stock, and additional criteria must be considered in order to find a true bargain (e.g., stocks with low Price/Book Value).
Tags: EPS, PEG, Price ot Earning
August 26th, 2008
Everyone agrees that the market is continuing to decline and some of the analysts are even considering a much longer recession period in the U.S. Does this mean that you have to close all your stock positions and divert your investments into a low yield government bonds shelter?
Over the past decade, the market has seen both bullish runs and bearish ones; dot-com irrational exuberance; corporate corruption and the resulting legislation; 9/11 and the following consequences; and now a global sub-prime credit crisis. Despite all of these, the market has been more up than down.
Since it is impossible to predict in advance when a bearish or bullish period starts or ends, the conclusion is that in the long run you have to stay in the stock market in order to benefit from its overall increment throughout the years. This is not meant to suggest that you should never sell stocks; it is just that you should continuously learn stock investing strategies, improve your investing skills, and invest with your brain, not your emotions.
You can choose to hold an Index Fund or an Exchange Traded Fund that will match the market return; but, in case you want to beat the market return and gain larger profits, there are generally two ways to consider. The first is to buy stocks and hold them for a longer period of time; this is the value investing way and it is used by great investors such as Warren Buffet, Bill Miller, and a few others. This strategy includes analyzing the fundamentals of the company, such as its financial condition, its management and other essential issues, in order to estimate the company’s intrinsic value and understand if its stock is currently undervalued, which means the price is right for buying.
The second way is to try and gain from the short term volatility of a given stock price by using Technical Analysis indicators. Technical Analysis is based on the assumption that all the information about a stock is reflected in its price; thus, by analyzing the movements of the price or the changes in the trading volume of the stock, one can predict the future short term behavior of the stock price. As in the previous strategy, this too requires self-education and practice.
No matter which path you choose, you’ll need to find the right stocks for your portfolio and know when to buy and when to sell them. The Yalicoo arena is a great place to provide these needs. Yalicoo has thousands of registered traders holding many winnings stocks. Yalicoo’s leaders have proved in the past that they can definitely beat the market at any given time by picking the right stocks and holding them for the right period of time.
In any virtual stock trading competition that you join, you will immediately see the five top leaders in the competition, including all their transactions - live. Besides the cash prizes you can win in these competitions, copying Yalicoo leaders’ stocks into your real money portfolio can increase your actual profits by hundreds and even thousands of dollars. This will dramatically simplify the process and time required to choose the right stocks for your portfolio. In any case, remember one thing: monitoring the leaders’ moves should be regular and persistent in order to achieve consistent profits.
Tags: stocks
August 24th, 2008
It’s Only “Monopoly Money”
Playing the stock market as a virtual trader can be fun. There’s no money at stake and one can gain experience in trading shares using actual prices under realistic market conditions. Virtual stock trading or “paper trading,” is done by the manipulation of imaginary money and investment positions that behave in a manner similar to the real markets. Before the widespread use of online trading for the general public, paper trading was considered too difficult by many new investors. With computers now doing most of the calculations, novice investors can practice making fortunes over and over again before making any financial commitment.
Stock, Options, Calls—Whatever You Choose
Virtual stock markets allow you to trade stocks, options, spreads, straddles and covered call trades. Investors with more experience use paper trading to test new and different investment strategies. For example, investors can create several different positions simultaneously to compare the performance and payoff characteristics between multiple strategies. Writing a covered call is technically the same as writing a naked put, but in practice there are subtle differences. With a paper trading account, an investor can set up a bull credit spread and a bull debit spread simultaneously and analyze the payoff for each position change as the market moves. Investors can “virtually” test advanced strategies such as leverage, short selling, forex and derivatives trading without the risk involved in real trading. Many virtual markets include stocks traded on NYSE, NASDAQ and AMEX and allow trading at any time, even when the real markets are closed. They also permit the purchase of unlimited shares of any stock at the Last Price, an action not allowed in real life where shares are limited and certain prices are not guaranteed.
Various companies and online trading simulation tools offer paper trading services, many are free, others charge. Some virtual stock markets offer research data such as integrated stock and option quote detail screens and quotes in real time. Traders can analyze their performance, have available live chats with people “in the know,” and be sent reminders on their stock positions.
Virtual Stock Games and Competitions
Virtual Stock market games and virtual stock competitions allow the trader to create public or private games with a pre-arranged cash balance or he can choose from thousands of available games. Stock market games are relied upon by investors of all levels including MBAs, financial professionals, investment clubs and college-students. Competitions can be weekly, monthly or quarterly and can start with as little as $10,000 and go as high as $500,000 per game.
August 13th, 2008
Many investors think that the current financial crisis is much more significant than previous ones. However, as you can understand from the documentary movie below, this crisis has many features that former crises such as the Enron crisis have witnessed. There might not be any accounting frauds, but there was probably inappropriate financial behavior, which received legitimization from the inspecting authorities.
Financial banks that give unlimited credit to every home buyer without considering his ability to return his loans, and rating companies that give higher rates to these banks could be the main causes for the current crisis.
The current level of government regulation is still on debate and will probably not increase in the near future. Therefore, the best way to reduce the risk involved in investing in these kinds of companies is by learning how to value stocks and knowing the right time to buy and sell. Watching and learning from other investors in a virtual stock trading community such as Yalicoo can teach you these things, and dramatically increase your chances of avoiding investing in dubious companies such as Enron.
August 13th, 2008
If you’re someone who doesn’t enjoy analyzing securities in your spare time, Exchange Traded Funds, or ETF for short, offers a terrific way to put your stock market investments on autopilot. ETF is a security that tracks an index, a commodity or a blend of assets like an index fund, but trades like a stock on an exchange. By owning an ETF, you get the diversification of an index fund but under much lower expenses than those of the average mutual fund.
These days, the variety of ETFs is so wide that there are more than 60 companies offering hundreds of ETFs in the U.S.; there are ETFs that invest in commodities, technology, health care, real estate and even in currencies. The variety is so huge that it can be confusing even for the experienced investor. However, there is one ETF that invests in one specific sector that I think has very promising long term prospects – the PHO ETF, which concentrates on the water industry.
Unlike oil, water will not run out, as it covers 70% of our planet. However, 97% of this water is saltwater and not drinkable. The tiny fraction of potable water is decreasing every day and will run out in the not too distant future. Therefore, companies are developing technologies to purify the unlimited amounts of saltwater, which can then be bottled and sold at prices much higher than the price of the tap water we drink. Drinking water won’t run out tomorrow, however, a long-sighted investor sees this supply shortage and the growing purified and bottled water industry as an interesting investment opportunity. Many investors have already identified this opportunity and the stocks of the water industry companies have risen sharply in the past few years.
Obviously, it is hard to guess which company from this sector will become the next Starbucks of the industry; thus, the PowerShares Water Resources (PHO) ETF holds a combination of leading and promising companies from the water industry, giving you the opportunity to benefit from the growing water industry, while holding a diversified non-risky portfolio of water-related companies. The PHO tracks the Palisades Water Index, which beats the S&P500 index dramatically, as can be seen in the figure below.
Economists estimate $500 billion will be spent in the next 25 years on research and infrastructure related to clean water initiatives and an additional $100 billion for researching health concerns regarding water pollution. In addition, the recent bearish market had substantially lowered the prices of most over-valued water stocks. Combining all these considerations, I feel confident saying that the current (long-term) buyer of the water PHO ETF will beat the market in the long run.
August 7th, 2008
Let’s face it, we all enjoy having money. However, most of us would prefer not having to work a nine-to-five job in order to accumulate a pile of greenbacks. Stock markets all over the world offer financial opportunities beyond our wildest dreams. Buy a few good stocks, sit back, hit the jackpot and the money will come rolling in. While it is true that some people who “play the market” have made millions, the real truth is that the great majority of “players” have lost their shirts.
Look to the Internet
For those who envision a rewarding future but have little or no experience in the stock market, the World Wide Web is the place to be. The Internet offers a variety of virtual stock market programs for self-instruction on financial markets and financial instruments and provides the trading experience necessary before moving on to the real thing.
Virtual Trading
Online financial stock games are a great way to learn the realities of a capitalist world without suffering through bankruptcy, insolvency, mortgage foreclosures and other Internet stock market games such real world hardships. There are several available Internet stock market games and stock market competitions. Virtual stock markets allow you to practice buying and selling real stocks using imaginary money for the purpose of gaining experience with stock trading. This is also known as paper trading or fantasy trading. Online stock simulation trading games provide the tools whereby “traders” can build and manage their own portfolio and compete in games against friends, classmates, colleagues or other players risk free. Online investment and trading workshops, seminars, conferences and live events abound, and they are all easily accessible. Many of them are even free! There are also virtual sites offering educational and challenging stock simulation specifically for high schools and college students, preparing them way in advance for the real world ahead.
Many virtual markets include stocks traded on NYSE, NASDAQ and AMEX and allow trading at any time, even when the real markets are closed. They also permit the purchase of unlimited shares of any stock at the Last Price, an action not allowed in real life where shares are limited and certain prices are not guaranteed.
Stock market competitions provide traders the opportunity to speculate on a variety of different financial instruments including stock, options, spreads, straddles, covered calls and even the future of popular blogs!
So put down the Wall Street Journal, warm up your PC and start trading!
August 3rd, 2008
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