Newbie Lessons - All your questions answered

[Gordon Gekko]

Hi Sir O,

Thanks for the time and effort involved in educating us newbies, it's really helpful indeed.

A question with regard to margin loans and strategy.

I have had a bad experience with FA's in the past in fact I would be completely broke if I had not sold out in Aug 07, more luck than management I might add. I was saving's gearing into a geared share fund.

I have bought back in in Aug 08 into Streettracks STW, catching knives all the way down. At the moment I am showing a loss of 19%.

I would like to get a new margin loan with an LVR of 25% and start a regular savings gearing of 50% per month. I.E I will borrow 3k and invest the same to keep the over all gearing at 25%. I will prepay interest at 6.90 for 12 months and claim it in this years tax.

The question I have and I hope you all can help me out is this. Is it wise to do the following, to average down my position or would it be more advantages to take the margin loan and spread it out over say 5 stock to try to catch some "alpha".
Sorry it might not be the correct terminology but I guess what I am trying to do is buy into 5 stocks that are oversold with a timeframe of 5 to 7 years even though I am 34 and have a long time before I need the money.

I not looking for any specific advise more so if some of you had a 100% core position would you continue with that or try to catch the upside on some individual stocks?
My newbie carefully selected stocks for the long term would be:
1. Westpac
2.Macq group
3.QBE
4.TLS
5.RIO

All the best of luck in 09

G

 

[Sir Osisofliver]

Hi Sir O,

Thanks for the time and effort involved in educating us newbies, it's really helpful indeed.

A question with regard to margin loans and strategy.

I have had a bad experience with FA's in the past in fact I would be completely broke if I had not sold out in Aug 07, more luck than management I might add. I was saving's gearing into a geared share fund.

So what you are saying is that you were gearing on your gearing with no reserves or exit strategy in place? Yeah you were lucky.

I have bought back in in Aug 08 into Streettracks STW, catching knives all the way down. At the moment I am showing a loss of 19%.

I would like to get a new margin loan with an LVR of 25% and start a regular savings gearing of 50% per month. I.E I will borrow 3k and invest the same to keep the over all gearing at 25%. I will prepay interest at 6.90 for 12 months and claim it in this years tax.

The question I have and I hope you all can help me out is this. Is it wise to do the following, to average down my position or would it be more advantages to take the margin loan and spread it out over say 5 stock to try to catch some "alpha".

Sorry Gordon - You're asking for specific advice - which is against the rules of this forum. I would however get you to consider the following points: -

1) What yield (Including any franking credits) do you currently get from your Streettracks STW?
2) What yield (including any franking credits) would you currently get from your specific stock selections?
3) What is the dollar value of the interest that you would pay?
4) What is your marginal tax rate?
5) After taking into consideration the above points are you positively or negatively geared?
6) Finally are you a trader, or an active or passive investor?
7) What happens if you lose the money?
8) What level of reserve are you comfortable with?

The above questions are designed to make you question what sort of investor that you are and what sort of risk tolerance that you have. Only then will you be able to answer your own question.

Sorry it might not be the correct terminology but I guess what I am trying to do is buy into 5 stocks that are oversold with a timeframe of 5 to 7 years even though I am 34 and have a long time before I need the money.

I not looking for any specific advise more so if some of you had a 100% core position would you continue with that or try to catch the upside on some individual stocks?
My newbie carefully selected stocks for the long term would be:
1. Westpac
2.Macq group
3.QBE
4.TLS
5.RIO

Once again me saying to purchase or not purchase the above 5 stocks counts as specific advice which is not allowed by this forum. I encourage you to examine what your underlying assumptions are in relation to the above stocks and ensure that you have considered both fundamental and technical factors and that you understand these factors.

All the best of luck in 09

G

Cheers

Sir O

 

[Sir Osisofliver]

Part 1b

OK so the second function of the ASX is to serve as a secondary market. A place in which the current shares of the company can be bought and sold. Prices will fluctuate on the market depending upon numerous factors which are material (or holders think are material) to the share price.

How does the market do this?

Years and years ago, the way this was achieved was through what was known as an open-outcry market. This is still the case in many parts of the world, where physical representatives of both the buyer and the seller gather and trades are conducted when the price of the sellers and buyers match. If you go into many of the Exchange buildings you can still sometimes see the chalk boards where prices were written.

In those days you had a physical share certificate issued to you via the registry. For a valid transaction to occur the physical share certificate had to be returned to the registry for destruction by the seller with a new share certificate issued to the buyer.

Nowadays it's all much more advanced. The paper system has been replaced with CHESS (Clearing House Electronic Subregister System) and transactions are handled electronically, no physical delivery of stock certificates needs to occur, the buyer and seller are represented by merely an order in a computer system.

SRN - Stands for Security Holder Reference Number and is a unique 10 digit number that starts with an I - (yes I know on your statements it looks like a 1 - trust me - it's an I) to designate an ISSUER Sponsored Security. EG I0001428793. If you have issuer sponsored stock it means your stock is not sponsored by a broker and is held on the ISSUER Sponsored Subregister. For each stock you have - you will have a different SRN.

HIN - Stands for Holder Identification Number and indicates your stock is held by a broker and is held on the CHESS subregister. Your HIN number will be the same across all stocks that you hold with that broker.

When a Transaction occurs CHESS will transmit the data to the registry - who will then issue you with a HOLDING STATEMENT - which merely indicates your holding in a company.

Market Phases
7am to 10am (SYDNEY TIME) the ITS (Integrated Trading System) allows fresh orders to be entered into the system. This is called the Pre-open – My experience working for a large broking house is that in a great many circumstances there will volume that is “hidden”. An operator who has been given an instruction to buy a large quantity of shares will do so in a tight range using small lots. (designed of course not to ramp up the price too quickly – or let the sellers know that there is a massive amount of volume on to buy).
At 10 am (SYDNEY TIME) the market will begin to open in a staggered fashion, with 5 groups opening at the following times 10.00am A-B Stocks; 10.02.15am C-F stocks, 10.04.30am G-M stocks; 10.06.45am N-R stocks; 10.09.00am S-Z stocks.
Opening prices are calculated according to an algorithm – if you really want to get detailed you can find it here. http://www.asx.com.au/resources/education/basics/open_Close.htm – For simplicities sake – it’s just a volume weighted match price. The match price is usually displayed on most platforms so you don’t even need to do the calculation.
From 10am to 4pm (SYDNEY TIME) the market is in normal trading times where orders can be placed into the market directly into the ITS.
At 4pm (SYDNEY TIME) the market enters PRE-OPEN again for what is called the CSPA (Closing Single Price Auction) The same algorithm is used to calculate the closing prices.
The CSPA occurs at 4.10pm (Sydney Time)
Between 4.10pm and 6.50pm is the Adjustment Phase – during this time brokers can tidy up orders by deleting unwanted orders from the system (EG Day only transactions) , amending any orders etc. New Orders cannot be entered into the ITS and be executed.
If a broker wishes to make a transaction during this time, they must call the broker on the other side of the “transaction” to attempt to do the transaction. (ASX Market rules still apply). Trading during the Adjustment phase is known as overnight trading.
At 6.50pm (SYDNEY TIME) Old orders and those too far outside the market are purged from the system.
At 7pm the exchange is closed until 7am the next morning.


Lots more still to come on shares

Sir O

 

[mattlaw]

Thanks for all of this information and education much appreciated

 

[Sir Osisofliver]

Shares III

OK so the standard secondary market in Australia is made up of 2195 different listed entities that are classified according to a GICS rating (Global Industry Classification Standard). New shares are entered through listings (IPO's) and some shares drop off through de-listing. (This doesn't include futures market, derivatives or CFD markets. It also doesn't include small regional exchanges which have their own listings).

GICS is an industry classifications system that has been developed by Standard and Poors and Morgan Stanley Capital International (MSCI). It is these entities that are responsible for the publication of indicies data., Such as the ASX 200, All Accumulation Index etc etc. More information on Australian Indicies can be found here.
http://www2.standardandpoors.com/po...es_ei_au/2,3,2,8,0,0,0,0,0,0,0,0,0,0,0,0.html

There is a lot of useful information to be found at the Standard and Poors website about what goes into an index. The index used by industry professionals is the ASX200 rather than the All Ords. As the name suggests the ASX 200 is made up of the 200 Largest Stocks by market cap on our exchange. (Market Cap is simply the number of shares on issue times price of those shares) There are 10 main sectors of the market according to GICS classification.

Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities

(You also tend to see Financials broken into Fins-x-Reit and A-Reit which is that sector of the market minus Real Estate Investment Trusts, and REIT's on their own).

Certain global characteristics are going to influence sectors of the market differently. There are a great many influences over our market, which can rapidly influence prices on our exchange. This is why so much attention is given to major economies that have the capacity to influence the world economic conditions.

There is so much data out there that even if you gave up sleeping altogether, you wouldn't have enough time to read everything. So it becomes a matter of experience to know what is important and to understand what these influences are and how they work to influence our market. Use whatever you feel comfortable with. Personally I look at the following: -

Bond Yields
Interest Rates (Local and International)
International Reserves
Commodity Prices
ASX200 Index

To give me a general sense of how our market is tracking at any particular point in time.

Ok I've got lot's more to say about shares (LOTS more trust me) - but It's time to move onto property or I'm never getting this finished.

Cheers
Sir O

 

[bossman]

Sir O,

My thanks also for this thread have been checking it daily looking forward to the next lesson but alas, no knowledge has been imparted for 10 days - hope you are well and able to continue our education in the not distant future.

BM

 

[Sir Osisofliver]

I haven't forgotten you guys, I've just been a bit busy - gotta do things that pay the bills (and my wifes credit card) every now and then.

So Property Asset Class (Not my area of Specialisation so if any of you property moguls feels like pitching in - feel free)

Property can be broken down into the following areas.

Listed (Because the share market wants as much of your dollars as possible so you have Listed Property Trusts on the market to give you exposure should you wish to not purchase property directly)

Unlisted (because...actually I'm not sure why you'd look into unlisted property trusts. It seems to be the area where dodgy brothers always set up unsecured mezzanine finance arrangements and milk people of their hard earned dollars, and niave investors get fooled because they think they are investing in bricks and mortar. Maybe I'm biased.)

Residential (my preferred area) - I like this area because with a few simple rules you can generally choose nice assets that return well over time and have simple optimisation strategies behind them.

Commercial (also an area I've dabbled in) - needs specialized knowledge so don't touch it directly unless you know what you are doing.

Property like shares is a cyclical asset. There are periods of time where a property investment will outperform a share investment. When the share market begins to retrace there is a significant portion of investors who flee towards the safety of bricks and mortar. (Increased demand on a limited supply)

Property unlike shares (in Australia at least) doesn't have the same retracement levels that the share market does, except at the high end of the market. IE If you are buying that 3 million dollar penthouse apartment and the market turns on you, expect to get savaged if you try and sell it. It is much more likely that instead of large price retracement in the market, there is a period of price stagnation. There are a couple of simple reasons for this.

Price and liquidity - individual property lots have higher single unit dollar values than shares. As such generally they are much less liquid but also more price stable.

Population growth - has absolutely no direct correlation to the share market. With property there is a direct correlation between population increase and average property prices.

Population density - right now interest rates are low and dropping, in plenty of places we are seeing that it is cheaper to buy than rent because of this monetary policy of the Reserve Bank. A little while ago, high interest rates and rental rates, encourage populations to move to more affordable areas (generally further away from the main city) which can create localized areas of cyclical property demand.

So as you get this fleeing towards the property market (and the price increases), the Govmint, see that sector of the economy as overheating, (They know from past experience that allowing things to get too hot and heavy makes the inevitable downwards correction that much worse). The recession we had to have anyone? To combat this overheating they generally increase interest rates (Or in the latest cycle - leave them at their already reasonably high levels) to attempt to slow the economic activity a bit.

So we end up with the situation that Shares looks rubbish (Unless you are a short seller that is), Property looks too expensive (because of high interest rates) and people start to hoard their cash (fixed interest hits it's stride).

Some general rules I use for property..

Always be aware of opportunity in the real estate market. Unlike Shares which has more noticeable cycles, the Property market is a WEAK EFFICIENCY market. It's possible to know something that in shares would be considered insider trading in the share market (such as the proposed construction of a new road or development corridor). Also the depths of recession when interest rates are very low and forced sales are occuring may represent an excellent time to secure property assets at very cheap prices. (Be careful to use your reserves I spoke about in risk management and optimisation to make sure you are protected in this environment).

A Real Estate agent can always find something for you to buy, just like a share broker can always find something for you to buy. It's a rare agent or broker that will tell you to hold off because of the way that commission and their employment works. Realize that most "advisers" have a vested interest in their chosen asset class so especially when you are purchasing a large priced asset - DO YOUR OWN RESEARCH.

I've found the most consistent residential investment properties are those that are average. Average in terms of block size, number of rooms, features etc. Average means that it will be the most suitable house for the average family. Average may not be sexy - but it's consistent over the long term. (Shoot me I find consistency sexy).

As I said property is not my speciality so any property magnates out there who want to expand on this feel free - I'll be moving on to fixed interest now.

Sir O

 

[Go Nuke]

Can someone answer this for me please?

Because of all the buying and selling I did last year, I have become a "trader"

To be honest I cant remember how it affects my tax ..ie my losses reduce my taxable income from wages etc..anyway...

what i want to know is, as a "trader" do I still qualify to only pay 50% tax if I hold a stock for longer than 12months?

I THINK, i basically have to seperate my "trades" from my "investments" when I do my tax.

Any help to understand this would be great.

Thx for your time.

ps, if this question is inappropriate for this thread I apologise and will post it elsewhere.
thx

 

[Sir Osisofliver]

Can someone answer this for me please?

Because of all the buying and selling I did last year, I have become a "trader"

To be honest I cant remember how it affects my tax ..ie my losses reduce my taxable income from wages etc..anyway...

what i want to know is, as a "trader" do I still qualify to only pay 50% tax if I hold a stock for longer than 12months?

I THINK, i basically have to seperate my "trades" from my "investments" when I do my tax.

Any help to understand this would be great.

Thx for your time.

ps, if this question is inappropriate for this thread I apologise and will post it elsewhere.
thx

Go Nuke - The internet is your friend

http://www.ato.gov.au/corporate/content.asp?doc=/content/76071.htm

and

http://www.ato.gov.au/individuals/content.asp?doc=/content/36682.htm

 

[Sir Osisofliver]

Fixed Interest

I'm covering off against the major stuff here - but remember that the rule that the higher the return the higher the risk applies to fixed interest just as much as any other asset class.

Bonds are a debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed*interest rate. Bonds are used by companies, and governments to finance a variety of projects and activities.
The indebted entity (issuer) issuesa bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is commonly paid every six months (semi-annually). Two most important features of a bond - credit quality and duration - are the principal determinants of a bond's interest rate. Credit rating In Australia is carried out by Fitch, Moody’s Investor Services and Standard & Poors.

Bank Bills (Or Treasury Bills) are short-term debt obligation backed by the corporate or government issuer, generally with a maturity of less than one year. Bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bill provides the return to the holder.

Debentures are a type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Debentures have no collateral. Buyers generally purchase debentures based on the belief that the issuer is unlikely to default on the repayment.

Term Deposit is a deposit held at a financial institution with a fixed term. These are generally short-term with maturities ranging anywhere from a month to a few years. When a term deposit is purchased, the lender (the customer) understands that the money can only be withdrawn after the term has ended or by giving a predetermined number of days notice. Term deposits are considered an extremely safe investment and are therefore very appealing to conservative, low-risk investors. By having the money tied up you'll generally get a higher rate with a term deposit compared with a at-call deposit.


Fixed Interest Strategy.

So cast your mind back a year or so ago... In March 2008 (After the market had ALREADY HAD SIGNIFICANT FALLS), the RBA increased the cash rate to 7.25 percent, the highest it had been since 1994. Why are they doing this?

Money is moving away from the share market, and a lot of that money is moving into Property (as I explained last lesson) and in an effort to cool the economy, interest rates are increased. It was obvious however that the rate would need to drop to begin stimulating the economy once again.

I'm going to steal a phrase from Tech/A here...

Many see an opportunity
Few know how to take advantage of it
Fewer still actually do something.

So when we have the above situation, with high interest rates and an extremely high probability that those interest rates would begin falling, how do we take advantage of it?

Lets say we have $100,000, that our coupon rate on the bond is 6% and we can borrow for 7.5%, and over the course of a year the interest rate drops to 3.25%, we sell the bond just after 12 months.

Scenario 1
We purchase $100,000 of $100 face value bond paying a yield of 6%
We receive $6,000 in coupon payments over the course of the year.
As the RBA interest rate drops to 3.25% the value of our bond increases (Because it is paying a higher coupon rate than the current rate) so the value of the bond increases to...about $185... we have a capital gain in value of our investment of $85,000.00 and an income of $6,000.

Scenario 2

We purchase $500,000 of $100 face value bond paying a yield of 6%, using $100,000 of our own money and borrowing $400,000 at an interest rate of 7.5% (in this example it's fixed - you want however to use a variable rate)
We receive $30,000 in coupon payments over the course of a year, and pay interest payments of $30,000.
As the RBA interest rate drops to 3.25%, the value of the bond increases to $185... meaning the value of our investment has increased to $925,000. We sell the bond at this point, pay back the borrowings of $400,000 leaving us with a $525,000 capital gain and nil income stream.

Cheers

Sir O

 

[skc]

Fixed Interest Strategy.

So cast your mind back a year or so ago... In March 2008 (After the market had ALREADY HAD SIGNIFICANT FALLS), the RBA increased the cash rate to 7.25 percent, the highest it had been since 1994. Why are they doing this?

Money is moving away from the share market, and a lot of that money is moving into Property (as I explained last lesson) and in an effort to cool the economy, interest rates are increased. It was obvious however that the rate would need to drop to begin stimulating the economy once again.

I'm going to steal a phrase from Tech/A here...

Many see an opportunity
Few know how to take advantage of it
Fewer still actually do something.

So when we have the above situation, with high interest rates and an extremely high probability that those interest rates would begin falling, how do we take advantage of it?

Lets say we have $100,000, that our coupon rate on the bond is 6% and we can borrow for 7.5%, and over the course of a year the interest rate drops to 3.25%, we sell the bond just after 12 months.

Scenario 1
We purchase $100,000 of $100 face value bond paying a yield of 6%
We receive $6,000 in coupon payments over the course of the year.
As the RBA interest rate drops to 3.25% the value of our bond increases (Because it is paying a higher coupon rate than the current rate) so the value of the bond increases to...about $185... we have a capital gain in value of our investment of $85,000.00 and an income of $6,000.

Scenario 2

We purchase $500,000 of $100 face value bond paying a yield of 6%, using $100,000 of our own money and borrowing $400,000 at an interest rate of 7.5% (in this example it's fixed - you want however to use a variable rate)
We receive $30,000 in coupon payments over the course of a year, and pay interest payments of $30,000.
As the RBA interest rate drops to 3.25%, the value of the bond increases to $185... meaning the value of our investment has increased to $925,000. We sell the bond at this point, pay back the borrowings of $400,000 leaving us with a $525,000 capital gain and nil income stream.

Cheers

Sir O

Just want to add a little bit to the simplified examples above...

- Depending on the maturity terms of the bond, the movement in the capital value of the bond will not nearly as linear as the change in interest rate. The shorter the bond duration, the closer it is to linear. But a 10-year bond will not double in value just because the interest rate is halved.

- There is always the risk that interest rate would rise as well. Back in Jan 2008, people were more worried about inflation, and the next interest rate move was going to be up. Your bond would be fixed at the lower interest rate, and you will either have to sell at a capital loss, or hold until maturity.

 

[Sir Osisofliver]

Just want to add a little bit to the simplified examples above...

Yay someone else is contributing. Yes they are very simple examples, just to show the principles.

- There is always the risk that interest rate would rise as well. Back in Jan 2008, people were more worried about inflation, and the next interest rate move was going to be up. Your bond would be fixed at the lower interest rate, and you will either have to sell at a capital loss, or hold until maturity.

Yeah but in January the full impact of the negative effect on our market had not been felt...by March there was a definate sense of how bad this was and the need for the RBA to drop rates (at some point in the future). This is why I normally look at a 3 or 5 year bond when using leveraging, to give myself time for the cash rate to unwind.

Here's where to look for cash rate data.
http://www.rba.gov.au/statistics/cashrate_target.html

Cheers
Sir O

 

[kincella]

Sir O, that was an excellent observation about property....
the only thing I would add at this time is....if you have successfully held resi properties, and are experienced, and happy with the returns, and would prefer a little challenge in your life.....
then spend the time doing research on a small commercial property, again its all about location, not the strip shops.....not sure there is much out there for 1 mill or less....
its a great learning curve...and better returns for both income and capital...if you get it right
I did my research, then pin pointed the exact location for my first commercial property venture....I had to wait 5 years for one to come onto the market,
there have been challenges,,, mainly a problem tenant....but otherwise the returns have enabled me to semi retire much earlier than I ever anticipated

 

[Sir Osisofliver]

Sir O, that was an excellent observation about property....
the only thing I would add at this time is....if you have successfully held resi properties, and are experienced, and happy with the returns, and would prefer a little challenge in your life.....
then spend the time doing research on a small commercial property, again its all about location, not the strip shops.....not sure there is much out there for 1 mill or less....

Actually Kincella, as I said I've dabbled in Commercial property - Since it is an area in which I have limited understanding (but understand enough to make a judgement call), I take advice from an old friend who is a commercial property agent. The way that he does business is that he has a group of friends/investors (which includes himself) that set him up with a slush fund of about $100k. He'll look over a bunch of commercial property and vacant land suitable for commercial sites, and if he thinks there is value there will contract an option over the site/building using the slush funds. We then all get together and decide on the viability of the project and if he gets the go ahead will seek out key tenants on the property before purchase. Once key tenant is in place, we exercise the option (and front up the moolah) to purchase the property/make any improvements or building necessary on the project, fill in the remaining blanks with other tenants at higher rates and raise the yield profile of the project and then sell it at a premium.

Done this a few times now and the returns have been fairly impressive. (300%-1000%) Using a group to purchase means you don't take all the risk and can spread the expense out...gotta trust the group though

Sir O

 

[kincella]

Sir O...trusting the group is the thing...been there done that....in my case found it was more trouble than its worth....I am more interested in say a single retail shop in a good location..eg Chapel st, or the busiest centre in the centre of town....do it on my own....under my control, use all the professional help I need...
done one...and it will be locked away , passed onto the kids....meantime hoping to teach them the tricks...so they benefit from my experience and can use the experience themselves...
on the lookout for another shop...
here is an example of what not to look for....Toorak Rd shopping...
it is strip shop location.....apart from safeway, the banks, the restaurants (one good...the rest mediocre) and the PO...I do not shop there...noticed 3 shops past the PO all vacant...suddenly...
I class those shops as the 'fringe dwellers', expensive items, and targeted to the tourists...or the very few old ladies that keep faith...
not surprised to see them go belly up....most of the shops there have a very limited customer...and when that type of customer goes...so too does the business
chapel st is very different...not a strip, all types of shops there for all types of customers....cheap and expensive..lots of clothing and restaurants...
but probably in trouble if gen Y and gen x stop spending there...I am hoping to snap a bargain there

 

[Sir Osisofliver]

Sir O...trusting the group is the thing...been there done that....in my case found it was more trouble than its worth....I am more interested in say a single retail shop in a good location..

Well so far I have to say I haven't any problems. The RE guy has good wanker detection skills and the group have all been dealing with him for a decade. They are a nice bunch of guys (and one lady). I just got a look in because I recommended him into some very nice returning stocks. (In one instance his orginal $9,000 investment is worth close to $400 k). He likes me So he's put this group of high net worth individuals together and we get access to the best deals he does.

A lot of what he's been doing is regional stuff where populations have increased, but infrastructure isn't there yet, he'll go source land in nice locations and sit on the options for a while until he gets what he's after. After observing what he does I have to say it looks like higher probability of success than metro developments, but he does make it look easy...suppose that is the mark of a craftsman really, making it look easy.

Sir O

 

[kincella]

I pride myself on my 'wanker detection skills'

that probably should be no. 1 on the list for newbies....no matter what you do in life...learn to recognise the 'wankers' out there....

parents taught me the saying....you dont suffer fools gladly

 

[Sir Osisofliver]

OK Newbies...time for another lesson.

what's it going to be..

Economic Cycles and How to recognise them or

Fundamental and Technical Analysis techniques? (Newbie Version) (I'm thinking that once I get to the end of this I might start a Not so newbie but still learnin' thread - so don't expect any great depth to this topic)

once again First In wins

Sir O

 

[superkrusty]

Please Sir, Can I have some more...

Fundamental and Technical Analysis techniques

Thanks Sir O for your time and effort.

 

[Sir Osisofliver]

OK Basics of Fundamental and Technical Analysis it is.

What are we trying to do with fundamental and/or technical analysis? The simple answer to that question is to heighten our probability of a beneficial outcome. We search for "alpha" - an outperformance over the market. That is why we pay fund managers five figure salaries with multi-million dollar bonus schemes after all - to find a performance level that we ourselves cannot achieve. Otherwise we would simply replicate the market (much as some index funds do). In that case we don't (or shouldn't) pay the fund manager massive salaries because he's just a monkey pressing the buttons to make sure the index and the fund are the same. My ten year old could do it.

So we are trying to get a return better than the market. That by this analysis we can somehow achieve a performance greater that simply whacking our money in an index fund and forgetting about it. By doing so both fundamental and technical analysis go against one of the basic tenets of financial and portfolio management...The Efficient Market Hypothesis.

EMH - is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, this means that stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. For a full explanation of EMH go to http://www.investorhome.com/emh.htm

Some quotes about Technical Analysis and EMH for you.

"The central proposition of charting is absolutely false, and investors who follow its precepts will accomplish nothing but increasing substantially the brokerage charges they pay. There has been a remarkable uniformity in the conclusions of studies done on all forms of technical analysis. Not one has consistently outperformed the placebo of a buy-and-hold strategy." (Princeton Professor Burton Malkiel)

"The only thing we know for certain about technical analysis is that it's possible to make a living publishing a newsletter on the subject."
Martin S. Fridson, Investment Illusions

"Technical analysts are the witch doctors of our business. By deciphering stock price movement patterns and volume changes, these Merlins believe they can forecast the future."
William Gross, Everything You've Heard About Investing is Wrong!

"Technical analysis is doomed to fail by the statistical fact that stock prices are nearly random; the market's patterns from the past provide no clue about its future. Not surprisingly, studies conducted by academicians at universities like MIT, Chicago, and Stanford dating as far back as the 1960s have found that the technical theories do not beat the market, especially after deducting transaction fees. It is amazing that technical analysis still exists on Wall Street. One cynical view is that technicians generate higher commissions for brokers because they recommend frequent movement in and out of the market."
William A. Sherden, The Fortune Sellers: The Big Business of Selling and Buying Predictions

Wow them's fighting words for a bunch of academics eh? Mind you I think I just heard Tech/A's heartbeat hit the roof so let me reassure you that EMH does have it's critics, me among them, but let me remind you that what we are attempting to achieve through the use of technical and fundamental analysis "alpha" is an elusive and oft misunderstood beast. This is why I firmly believe that if you do not KNOW what you are doing, the search for Alpha will chew you up and spit you out. PRACTICE, PRACTICE PRACTICE and learn from your mistakes now you hear?

Technical V Fundamental

At it’s most basic level, a technical analyst will look at a stock’s probability of a beneficial outcome from looking at it’s chart, and a fundamental analyst starts by looking at the company balance sheet. Without a doubt the majority of analysts around the world look at fundamental factors over technical factors. Some do use technical factors, but it's rare to find an analyst who will stake their reputation purely on the technical features of a stock. If you are wondering why that is, perhaps I should direct you towards the quotes above again. Technical Analysis tries to read emotion in the marketplace and emotion is one of the most chaotic forces that influence our market.

Fundamental Analysis.
By looking at things like the balance sheet, cash flow statements, income statements or income projections, industry environment, cash burn, and other factors the fundamentalist tries to determine what a companies value is. (If you have ever heard of value investing this is what they are talking about – trying to find companies whose value is significantly above the current share-price). So for a fundamentalist if a stock trades below it’s intrinsic value, it’s a good investment.

So how does an analyst determine what is the intrinsic value for a company. If you've ever looked over one of those research notes put out by a major broking house, you can see what sort of metrics or measurements are used by fundamental analysts. Without a doubt the majority of analysts employed by big business use fundamental analysis. Here are some common metrics used.

P/E (Price to Earnings) Ratio - http://www.investopedia.com/terms/p/price-earningsratio.asp
EPS (Earnings per Share) - http://www.investopedia.com/terms/e/eps.asp
ROE - Return on Equity - http://www.investopedia.com/terms/r/returnonequity.asp
PEG ratio (Price/earnings to Growth) - http://www.investopedia.com/terms/p/pegratio.asp


Of course a fundamentalist is spoilt for choice at present – in the current economic climate just about everything is below it’s intrinsic value. So THIS is the major criticism of fundamental analysis is that it doesn’t take into consideration emotion and subjectivity, and greed and in this case fear are powerful forces in the marketplace. So how do you try and quantify such chaotic forces as human emotion? Why by using Technical Analysis, which we will cover in part deux.

Cheers

Sir O