Investoid

My apologies to the Canadian Capitalist (who uses this phrase for his weekly miscellaneous column), but this title seemed apt for this post.

I have been posting very infrequently during the summer. Part of the reason is that I’ve been fairly busy and haven’t found time to think deeply about what’s been going on in the markets. But I’ve also not wanted to discuss in detail my option trades. I’ve had quite mixed results, and didn’t want to put my failures on display. Instead I was writing in a personal trading journal so I could reflect on what I did right and wrong. While this has been instructive, I think it would be more helpful to talk about more of the trades in the open, so I’ll write more about my thinking on future trades. Right now I am not actively looking for setups, and am going to focus on doing some statistical analysis on index ETFs so I can determine the value of trading iron condors or calendar spreads on such stocks.

Also, I found out quite belatedly that the Globe and Mail published an interview they did with me last Saturday. For those who have found this site through that article, welcome. I’ll scan the article and put it up as soon as I can get a copy.

Over the summer the markets have faced a lot of turmoil. The credit markets have blown up and fear is prevalent. The commercial paper market is particularly sclerotic, which if it continues can materially affect the ability for many companies to function. This can be traced to the sub-prime mortgage mess in the US, which is based on the fact that hedge funds and the like would buy highly rated debt that was merely the collection of poorly rated debt (wonder if the ratings agencies will face more government regulation as a result).

As a result of this financial crisis, the market has been howling for a rate cut in the States. The Fed is keeping their true intentions close to the chest, although they have said they will reduce the funds rate ‘if necessary’. The market has priced in a guaranteed rate cut on Sept 18, and are now speculating on when the next cut will be. I am not certain that the Fed will bow to pressure from the financial community. If for some reason the Fed does not cut on Sept 18, expect a large drop in the US markets and around the world. As a result, I’m waiting for this event to pass before I look to make any short, medium, or long term trades.

If things do go south as a result of Fed inaction, I’ll be looking to pick up a lot of solid companies at a discount, particularly Canadian financials, income trusts, and energy companies that pay a healthy and stable dividend.

Sorry I haven’t posted for a while, I have been busy learning about options trading and risk management. It is definitely a different mindset compared to my long term buy and hold strategy, as well as my medium term stock picking. I’ve been learning about what it takes to be an effective trader, particularly from a psychological perspective. I have read several articles on the mistakes that traders typically make, and have read many personal accounts from people who had their habits and fell into the same trap over and over again.

One of the most important disciplines a trader needs is to be able to follow his or her trading rules. Most of the time, these trading rules involve some aspect of the trader’s investment strategy. However, since I have not decided on a trading method yet, my rules focus on overcoming the psychological barriers that I face when trading.

1. Accept profits when they present themselves. Despite the fact that people typically ‘leave money on the table’ by selling profitable positions too early, I think it’s important for traders to take profit once a position has turned out as expected. This may involve a combination of having a profit target as well as an informational target (eg. I expect XYZ to announce a new deal in the next two weeks, and for the stock to go up as a result). These have to be soft targets though, or else you may wait too long and lose your profit.
2. Take losses immediately when things don’t turn out as expected. This can be the hardest thing to do, but it’s paramount to ensuring that you can continue to trade the next day. If you were expecting a particular event to occur and it doesn’t, or if the stock/future/whatever reacts differently than you expected, get out now. Something has not gone according to plan and you can easily be wiped out if you continue to hold onto losers. Some options strategies will allow you to adjust to the new information and mitigate your losses. If you feel adept at making these adjustments, you can do this instead of pulling out of your position entirely. I would only recommend you start doing this once you’ve learned to take losses though. It’s the hardest thing to do but the most important piece of long term success.
3. Sell a losing leg before a winning leg. Many options strategies involve multiple options, which are often used as hedges against one another. This means that you typically have one or more options losing money even though the overall strategy is profitable. When you’re going to exit a position, you may be tempted to sell the winners and see if the losers will rebound so you can increase your gains. While this may work out in your favour, you may have fallen into the losing position trap, which will hurt you in the long run. As a result, you should always sell your losing legs first, which will compel you to sell your winning legs immediately as well so you don’t have realized net losses. Ideally, if you have a trading package that allows you to sell all the legs at once, you would use that to avoid any temptation.
4. When your asset/underlying asset becomes very volatile, sell. Unless you’re specifically attempting to capitalize on higher volatility, it’s important to realize when the market is in an adjustment period. This can happen when new information is being assimilated, such as when earnings are released. Based on my experience with the current earnings season, some stocks will ‘gap’ up or down significantly, and then could go either way. Some will continue to go up, while others will start to move in the opposite direction as people take profits. When volatility increases substantially in a very short time, it’s best to exit your positions and be satisfied with the profits you’ve made.
5. Live for the execution. Also known as ‘don’t count your chickens before they hatch’. When you’re trading, it’s important to stay on top of what is happening to your positions as they develop. The shorter term your trades are, the more concentration they require. Don’t ever expect a particular trade to go your way, and don’t think about what you’re going to do with all your profits. It’s important to think of each trade as sticking your head out of a trench in the middle of a firefight. Keep alert at all times and follow your rules to a tee. Try and block out all other influences while you’re trading, so you can stay focused on what’s at hand. Lastly, don’t simply set a limit order and expect it to get filled.

While investing in general takes quite a bit of discipline, trading takes even more. I think it’s important for traders to start small but use real money, so they can learn from their mistakes and study how they react when things don’t go according to plan and they’re facing real losses. Disciplined trading is the key to long term success in the field.

Here are some tidbits to chew on this weekend. I look forward to reading about what you think in the comments below.

• According to EDC, the Loonie is expected to fall to 83 cents US or so by the end of next year. Do you think it’s going in that direction, or heading up?
• Lululemon has stated that they will offer about 16 million shares in their IPO, down from earlier estimates of 18 million. The majority of these shares are through the sale of existing shares. Is this a bad sign for the company’s prospects? If they’re supposed to be expanding globally and have great growth opportunities, why the massive insider exodus?
• How many of you watch BNN Market Watch and follow their picks? I’ve always wondered if anyone is comprehensively tracking their longtime performance using the database from mid-2005 that’s available on their website. I wouldn’t mind doing it at some point provided I can get a historical data feed at reasonable cost.

Have a great weekend everybody!

This is rather off-topic, but I needed to vent about the new that Albertans will have to perform 10 digit dialing for local calls next year. I won’t dispute the fact that we need more numbers for this province, but consider this:

1. We currently have about 3 million people living here, and up to 2 million possible numbers at the moment.
2. Assuming that we won’t go to exactly 1 number per person (including children), we need at least one more area code to handle the growth in population.
3. The last time they added an area code here (780), they split the province in two regions. Everyone north of Red Deer had to get a new area code. Thus is it technically possible to add another area code and switch over customers to the new code.
4. The new area code will be province-wide, meaning that the phone companies will have to sub-divide that code anyway to determine whether the call being made is local or not.

Why not just add 2 new area codes: one for Calgary and one for Edmonton. Switch over all customers to that code in those areas and use the additional numbers from the existing area codes for the rest of the province, keeping the same north/south split or adjusting it slightly to account for differential in population growth if necessary. Unless the cities hit 2 or 3 million (unlikely in the next 15-20 years), then based on current per-person rates and the growth in such per-capita figures, it is likely that this would solve the need for numbers for well over a decade.

I’m guessing that the solution they are using is cheaper to implement, and the CRTC just went along with their proposal without considering the merit of alternatives to the end consumer.

While most of the calls I make now are programmed ones (ie. dialed from a cell phone), I’m not looking forward to the day I have to ask for ten digit numbers when meeting someone new. It’s just another hassle. But thanks to the oligarchy that is the telecom sector, we are subject to their whims.

If you’re a Telus, Rogers or BCE investor, this is probably a good thing. They have the ability to pass along such measures with little impunity due to their stature in the marketplace. Like the banks, they enjoy special protection, although on their growth front (wireless), their protection is being threated by the possibility of new entrants getting spectrum.

Anyway, I might as well get used to the fact that I won’t be able to use the best pick-up line there is (”if I guess the first three digits of your phone number, can I get the rest?”), and prepare for ten digit dialing. (Kidding about the pick-up line, I’m happily married).

Thanks to everyone who participated in my contest. It was good to learn more about what motivates others to be do-it-yourself investors. I will also be using some of the suggestions for future blog posts over the next couple of weeks.

Congratulations to Wolf Stone, who won the contest. I picked the winner randomly (with a uniform distribution). Thanks again to everyone. I will e-mail Wolf details about his prize.

Because we changed our CIBC Investor’s Edge accounts over to electronic only communication, we received two subscriptions to the National Post online. for one year. I only need the one subscription, so I’ve decided to give away my second one in a contest. Thanks to Million Dollar Journey for the idea - he did this recently on his blog.

So, if you’d like a subscription to the Post for one year, please do one of the following:

• Send me an article about “Why I like to invest”. I’m interested to know why others are motivated to take the time to do their own investing. If you have your own blog, I will link to it at the top of the article.
• Send me a question that you’d like me to answer in a post.

Please have your submissions in by Friday June 1. I will announce the winner on Monday June 4. Please contact me and include your e-mail address so I can send you the information you need to activate the subscription.

I look forward to reading your questions and articles!

Besides being super busy with my new house, I have been partially lackadaisical about investing due to the fact that I’m fully invested right now. I have all my RRSP money in stocks and ETFs at the moment, while my discretionary registered trading account is also maxed out.

This has caused my mind to wander away from investing for spurts. While I check up on how my investments are doing regularly, I don’t have as much mental energy as when I’m excited to look into a new investment. So, here are some tips to stay focused when you’re fully invested.

• Stay current: it’s easy to stop reading the business news, flip off BNN, etc. once all your money is in play (especially if you’re a long term investor). But it’s a good idea to check back once or twice a week to see if any major news has transpired that may affect your investments. Since proper financial investment decisions involve assumptions, you need to ensure that your assumptions are still valid.
• Pretend you still have more money: if you’re like me and really get into analyzing potential investments, it makes sense to keep doing this regularly once you’re fully invested. You might come across investments with higher return potential, and you may want to switch out of an underperforming asset. Be careful that you don’t start flipping assets too much though - only sell out of an asset if there’s a good reason (which is another blog post entirely).
• Periodically review performance: once you’ve made your investments, it’s good to review their performance on a quarterly basis. As I’ve talked about before, it’s important to look at holding period returns instead of the return since time of purchase. Look at all your investments over the same time frame. Make sure you don’t review too frequently though - you risk over-analyzing brief dips in performance.
• Do portfolio comparisons: when your portfolio is set, it’s good to look at the overall asset allocation and ensure you’re not too heavily weighted in one area. It also becomes an interesting exercise to look at the major holdings of portfolios you are interested in (be they active or passive) and see how your actual holdings, sector allocation, etc. compare. Even doing this with your friends’ portfolios can provide insight into what you’ve bought and why.
• Reallocate when necessary: it’s a good idea to rebalance holdings when you’ve had a strong period of performance from an asset class. Unlike performance reviews, I think this should be done on an as-needed basis. Have a target range for each holding/sector and rebalance once the asset is outside of that range. Bonus: since you have some funds when you rebalance, you get to do all the exciting “what should I invest in” analysis again!

The key is ensuring that you don’t face ‘portfolio drift’. By staying on top of your holdings, you will increase your returns and also keep you mentally in the game.

I just wanted to apologize for the sparse amount of posts the past couple of weeks. It has been very hectic getting ready to move, lining up contractors in this white-hot construction economy, and also working on my consulting work. I hope to rectify this next week once we are in our new house.

I’ve had a chance to read through the personal finance tour blog posts that are posted over at The Money Diva’s site. Here is my take on a selection of the posts.

Thicken My Wallet has a good post on how to improve your credit score. I must say I didn’t know all the details that he listed, so it was informative. I thought he might be keeping one too many credit cards around to basically maintain/improve his rating. My limited experience indicates that the scoring system is not linear: it is a lot harder to go from 750 to 800 than it is to go from 700 to 750 (if anyone knows better, please let me know). Thus it’s harder to improve your score and your efforts face diminishing returns. Furthermore, at some point your credit has reached a level that the incremental benefit is not that great. I’d rather ensure I have an upper echelon score and not overburden myself with the administrative hassle of maintaining too many credit facilities that I don’t really need. Overall, this is a very good piece.

Middle Class Millionaire has a post on financial commissions that is similar to the conclusion of my post on financial jargon. While I sympathize with the argument that most people don’t want to focus on investing and are willing to pay handsomely for someone else to do it, I believe that there is a lucrative opportunity for fee based financial advisors to offer quality service at a lower total cost to the client, while still maintaining a good income for themselves. I should rant on this in more detail at a later date.

There was an interesting post in life insurance as well. This is an interesting topic, and as the post says I haven’t seen it come up on most blogs yet. Personally, my wife and I have a Universal Life policy and now that I have a house we are taking out term life policies as well. While I know the premiums on these policies are designed to provide a certain (good) return on capital for the underwriters, and I know that my advisor is getting some pretty sweet fees on these policies (particularly on the UL policy), I am compelled to maintain them. Why? Because they offer the best possible return in the event of catastrophe for me. For me, peace of mind is worth the premium. Others are willing to take the chance and I think that’s fine, but they need to be cognizant of the potential costs to their family members if they die and have outstanding debts (particularly a mortgage and you have children). I also pick up travel insurance when we go on holidays outside of Canada, due to the high health care costs abroad. Again, this is an expensive product (I know how much commission is doled out on this since we have a part-time travel agency), but it’s still something that I use to ensure I don’t have to worry about the worst case scenario.

Lastly, NonyMous posted about picking stocks based on what professionals are choosing. This is similar to my post on the lazy active portfolio. I think it’s a good idea to look at what professionals are investing in, once you’ve established that the professional is someone worth following. If there’s a mutual fund you like but you don’t want to pay the MER, take a look at their top holdings and see if you can replicate them. Alternatively, take the top holdings or recent purchases and see what other funds are holding them. If a lot of funds you like are purchasing the same stock, chances are it’s a good time to buy.

All the posts were very good in this tour, I just don’t have time to write about all of them. Take a look at them yourself and see what you think.

I was reading the new Thicken My Wallet blog (an excellent read, I highly recommend it), and was commenting on the writer’s use of financial terms in his (or her, but I’ll use the masculine from here on in) stock investing series of posts. For instance, he uses the terms ‘non-technical factors’ and ‘technical factors’ when they would typically be defined as ‘qualitative analysis’ and ‘quantitative analysis’ respectively. When I commented on his blog about this, he agreed that his use is non-standard, but that his definitions are more approachable to the novice user who has little knowledge of investment jargon. He goes on to state that the use of such jargon is one of the main barriers to increasing the do-it-yourself crowd, and is a defensive measure used by the financial services industry to make it look like what they do requires extensive expertise.

I think he brings up some very good points. I agree that many people can feel intimidated by the vast amount of finance jargon out there, whether it’s in the media, financial advertising, or spewed out by advisors and other experts. I also think this can be an artificial barrier used by advisors and others to ensure they are viewed as sage gurus, and thus attempt to justify their compensation for selling what should be relatively straightforward products.

That said, I don’t think that it’s necessary to re-define pretty straightforward concepts for several reasons. First, if you’re ever unsure of a term, you can go to Investopedia and have it defined for you in an instant. They have a fairly comprehensive database of terms, and now that Forbes owns a chunk of them, they will be adding more terms at a faster rate (if you want them to define something that they haven’t already, go to their contact page and make a suggestion). Secondly, many terms have been defined via academia or in the field by those that practice financial analysis and/or accounting. Like any other field, industry specific terms help reduce confusion for those practicing in the industry. I’m not saying that all the terms are useful (particularly ones that were invented by services companies geared specifically for their products), but I don’t think that people would want the accounting, mathematics or medical industries to have solely plain-talk definitions for all the aspects of their field.

In a bigger context, even if there was a ‘level playing field’, with less financial jargon, I don’t know if you’d see a major increase in the the percentage of do-it-yourself investors. I am an ardent do-it-yourself believer, and was even pushed further in that direction given our commission based and oligarchical financial services industry. But I think do-it-yourself investing comes down to personal interest and motivation. And like any other area of our life where we have to intersect with out of necessity (eg. taxes, transportation, etc.), some people will be driven to do it themselves while others will want it handled for them, regardless of how easy it could be to do it themselves.

For instance, I always take my car to a mechanic and/or dealership, even if it’s for something routine like an oil change. I have many friends who love to tinker with cars and know a lot about them. They have told me how easy it is to do a lot of the things I pay others good money to do, given the right tools and a fairly straightforward (and brief) education on how things work. Yet I have no interest in learning the required knowledge nor spending the time to do any work on my car. It’s not my passion area, but rather something that I need to have done in order to go about my life. I think many other people view their finances in the same way, and I think that there’s nothing wrong with that.

What we need to see is a way to reduce the high costs associated with assisted financial services in this country (and the world as a whole). A higher incidence of fee-based advisors for the masses would be great, who can still earn a good wage for their expertise and training and who are compensated based on their performance. I think financial advisors should be less salespeople and more like other professionals (lawyers, accountants, etc.), and need to be compensated as such. Unfortunately there are strong incentives for the status quo to remain, not the least of which is the regulatory hurdles to start a new advisory company.

I’m looking forward to seeing what new product Thicken My Wallet is involved with, and hopefully it will assist the do-it-yourself population in their investment goals.