Sunday, October 14, 2007

Key psychological factors in stock market success

Much has been written on the part of psychology in stock market success. This lesson is probably the easiest to learn and hardest to implement. Psychology is everywhere in the stock market and effects all from the novice to the most professional (aside for computers).

Many investors make the same mistakes over and over again. Mistakes such as: selling profitable stocks too soon, holding on to losing stocks forever or lacking the discipline to stay in the market and avoid frequent buying and selling are all a result of poor understanding of key psychological factors required to succeed in the stock market. Common psychological factors at play in the stock market are:

Anchoring is a psychological phenomenon in which one judges data (a stock price or exchange rate) by comparing it to a certain anchored similar data. Is 1 euro for 1.4 $ expansive? Since it has been cheaper we tend to think it is more expansive now, but is it? Just because market prices are high it does not mean they can't get any higher.

Risk avoidance
Kahneman and Tversky have shown people tend to avoid risk in potential profits and prefer risks in potential losses (preferring a raffle to a certain loss for example). One must always consider the investment at hand from a statistical point of view regardless of irrationality forced by our minds at times.

Over confidence
A common psychological factor in investment is over confidence. We're always sure we're going to beat the market. Our investments are always good ones. We often accredit more to known factors about a stock then to the unknown and take little of the unknown into consideration.

After examining common psychological factors in the stock market we should examine key traits required in stock market success.

Self discipline
Be disciplined in your investment or trading techniques. Be consistent in your decisions and do not be afraid to back them up. Do not allow yourself to be intimidated and weakened by every event in the market. If you in there for the long term: stay there. If you have a stoploss use it.

Self confidence
Trust your experience and instincts (if they've proved to be right so far). Do not be afraid to follow what seems to be a promising investment and do not rush to sell when you've gained some return on investment. Believe in your analysis and in your decisions.

Successful investing requires patience. Do not have a peek at your portfolio's performance every other minute. Investing for the long term requires years to generate those fabulous high returns we always hear about

Some rules for speculating

If you're afraid to lose a significant share of your investment do not read on. If you're tempted by the potential of speculative investment and have the money to back it up by all means, read on. In order to achieve highly abnormal returns we need to take highly abnormal risks.

Please note speculative investing is very similar to gambling (if not the same). A speculator does just that: Speculates. This article should be read carefully and by no means be used a guide for investing soundly. If you are going for speculative investment following some of the following rules might help you along your dangerous journey.

Invest in trendy sectors
Commodities of Ecology have proved very profitable these last few years. Try and locate the more trendy sectors earlier on and invest in leading companies in those sectors. It is difficult to locate these sectors but by keeping up to date and with a little luck you might just invest wisely.

Buy OTM options
While more often then not buying out of money options will result in losses it might also land extremely high returns. Buying out of money options on the eve of a company's reports or conference call just might generate that return on investment.

Invest in hedge funds
These funds often utilize extraordinary investment strategies (usually accompanied by high risk levels) in order to generate high return on investment. While many have succeeded many more have failed. These funds suffer from poor regulation and as such one should take extra caution investing in them.

Sell short and leverage your portfolio
Another way to generate high returns is to sell stocks short and use the proceeds to finance the purchase of other stocks. As any other leveraged business the risk is greatly enhanced but so is the potential gain.

Buy stocks which have fallen sharply
While this advice is often handed the other way round buying a stock which has recently fallen sharply might generate high returns as it just might rebound back up. Sharp drops in stock prices are more often then not justified but occasionally a stock's price would fall for no reason at all other then panic.

The investment techniques detailed above are a handful but are sure to make high returns for the brave should they speculate correctly (otherwise, expect to lose most if not all of your investment). Another word of caution in conclusion: I believe everyone should invest according to their financial profile. Should you happen to be risk loving and rich by all means, speculate away.

Tuesday, October 9, 2007

Un Millennium development goals - Analysis and observation using Gapminder

Not many people are aware of the UN's humanitarian work. The image of the UN is most often that of the general assembly or Security Council unable to make progress or act on various global issues.

Even less are aware the UN has set explicit millennium development goals.

I've stumbled upon a very interesting tool available on the UN MDG (Millennium development goals) site. It's called Gapminder and it clearly visualizes the MDG over time, geography and income levels for each primary and secondary goals. It is a most important tool to learn of the world we are living in. For Gapminder follow this link.

The UN's millennium development goals are:

1. Eradicate extreme poverty and hunger
a. Reduce by half the proportion of people living on less than a dollar a day
b. Reduce by half the proportion of people who suffer from hunger

2. Achieve universal primary education - Ensure that all boys and girls complete a full course of primary schooling

3. Promote gender equality and empower women - Eliminate gender disparity in primary and secondary education preferably by 2005, and at all levels by 2015

4. Reduce child mortality - Reduce by two thirds the mortality rate among children under five

5. Improve maternal health - Reduce by three quarters the maternal mortality ratio

6. Combat HIV/AIDS, malaria and other diseases
a. Halt and begin to reverse the spread of HIV/AIDS
b. Halt and begin to reverse the incidence of malaria and other major diseases

7. Ensure environmental sustainability
a. Integrate the principles of sustainable development into country policies and programs; reverse loss of environmental resources
b. Reduce by half the proportion of people without sustainable access to safe drinking water
c. Achieve significant improvement in lives of at least 100 million slum dwellers, by 2020

8. Develop a global partnership for development

The UN works towards these goals mainly through the organization's agencies such as: UNRA, UNESCO, UNDP, UNICEF, UNFPA, FAO, WFP and many more.

Monday, October 8, 2007

Switching to CFL (compact fluorescent lamp)

According to Wikipedia: "A compact fluorescent lamp (CFL), also known as a compact fluorescent light bulb is a type of fluorescent lamp designed to replace an incandescent lamp. Many CFLs can fit in the existing incandescent light fixtures."

An interesting article I read today mentioned the following facts:

1. CFL's take up to 70%-80% less electricity compared to incandescent lamps.
2. CFL's living span is up to 6 to 10 times that of an incandescent lamp.
3. 11w of CFL power is equal to 60w of incandescent lamp power.
4. Changing 10 lamps to CFL's will result in a yearly saving of up to 150$.
5. Most of the power in an incandescent lamp is wasted on heat not light.
6. California will soon ban the use of incandescent lamps. In Europe a similar law is currently drafted and in Australia the use of these lamps will be banned by 2010.

A classic win win situation in my opinion.

How to tell if a mutual fund is well managed

The only way to tell if a mutual fund is well managed is to benchmark its performance against the performance of similar mutual funds in the same time frame and against the return achieved by the index or financial asset in which it specializes. Similar mutual funds for this matter are funds invested in the same financial assets whether it's bonds, stocks or any other financial asset such as derivatives.

If we wish to determine if a certain mutual funds which invests in NASDAQ stocks is well managed we should first and foremost compare it to other mutual funds invested in NASDAQ stocks.

When trying to determine if a mutual fund is well managed we should ask the following questions:

Did the fund beat the market?

Mutual funds charge management fees. As a result we expect them to beat the return achieved by the specific index in which the fund specializes. Otherwise we should invest in the index directly by ETF's for example.

What is the relation between market return (and other mutual funds) and the fund's return on investment?

Some funds may generate returns of 3%-5%. The return itself is insignificant when trying to decide if the fund is well managed. It only has meaning when compared to the market return (or the return of other mutual funds). If the specific index this fund specializes in has generated a 1% return then the fund is probably well managed.

How much risk did the fund's manager take in order to generate a certain return on investment?

Say a certain mutual fund has generated a high return on investment compared to other mutual funds in the same category. This is still not enough to determine it is well managed. We should look in to the risk we took by investing in that mutual fund. A well known rule of investment is the direct link between risk and return. A mutual fund might generate higher returns by exposing us to higher risks which we are not necessarily willing to take.

Is the performance of the mutual fund, risk and return wise, consistent?

Even a broken clock shows the right time twice a day. In order to determine if a mutual fund is well managed we should look for consistently high performance over time.

There are two more common indices used in determining how well mutual funds are managed. These indices are:

Sharpe's Index - Used to determine the ratio of return to risk (measured in variability) this index is basically the return on investment of the fund minus the market's return divided by the standard deviation of the portfolio. The higher the result the better More return per unit of risk.
Jensen's performance measure - This index measures the excess return of a portfolio according to the CAPM model. This measure is less common.

To conclude, when trying to determine if a mutual fund is well managed we should look for:

1) High consistent performance over time compared to the market and other mutual funds
2) High return for unit of risk (measured by Sharpe's Index)

Sunday, October 7, 2007

Investing mistakes to avoid

Surprisingly, investors often make the same mistakes. It is even more surprising to find out even veteran investors often repeat the same mistakes over and over again. It is hard to resist our human nature but one must overcome one’s urges in order to become a successful investor. Here are the top 10 mistakes to avoid in my opinion:

1) Investing in stocks for terms shorter then 5 years – A thumb rule of investing is the relation between term of investment and the percentage of the portfolio invested in stocks. Usually, the share of your portfolio invested in stock should be around 100% minus your age (for long term only).

2) Thinking you can outsmart the market – Look for long term return on investment.

3) Acting on the latest fad – Do not take shortcuts. Check for fundamentals. If the talk of the day is the stock market, keep away.

4) Frequent Trading – Constantly buying or selling does not improve returns and is costly in terms of commissions.

5) Constantly checking portfolio performance – Don’t allow yourself to be dazzled by good or poor performance on a daily basis. Ignoring noise (or variability) is a sure way of generating high returns in the long term.

6) Selling winning stocks too fast or holding on to losing stocks – Many investors often sell winning stocks too early and losing stocks too late thinking either the return on investment is enough or that their losses will be regained. More often then not winning stocks will continue to generate high returns and losing ones will continue to lose.

7) Not diversifying –Investors are usually exposed to astounding amounts of information at first from articles on certain stocks to analyst reports recommending other stocks. The hope of getting rich fast (or high return on investment) is usually a false one. It is possible to gain high returns in short times but very much like a casino you might also lose all your money due to the risk involved. Diversification or the purchase of a great amount of various financial assets enables investors to lower risks and smooth return on investment almost regardless of how a specific company performs.

8) Thinking in term of “All or nothing”- A mistake usually common in derivative traders “all or nothing” is simply taking unnecessary risks.

9) Investing with out a plan – Take the time to formulate an investing plan and investment goals. What are the risks you are willing to take? What is you term of investment? Answer these questions before building a portfolio.

10) Trying to time the market – It is time in the market, not timing the market. Decide on long term goals.

Thursday, October 4, 2007

Pros and cons of reverse mortgages

The significant advantage of reverse mortgages is clear. This financial tool enables seniors to make use of their home equity in order to increase their standards of living in their senior years which are often characterized by a shortage of liquidated financial resources. This is especially valuable when other family members are unable or refuse to aid the senior with his financial situation.

A reverse mortgage requires no guarantees on the side of the borrower aside from the property itself.

Another advantage of reverse mortgages is that it enables seniors to support other family members today instead of as an heirloom. It enables seniors to decide how and when to aid the potential heirs and is especially valuable when seniors still support their families.
A reverse mortgage might also assist financing required payments for health care or nursing and also help finance the move to a retirement home.

Last but not least a reverse mortgage is a great solution to avoid taxes on payments made to the borrower.

Although reverse mortgages have many advantages considering and understanding the disadvantages of a reverse mortgage is highly important as they are no less significant.

One of the primary disadvantages is that family members might often requires financial assistance with either buying a house, college funds or more. In case of a lump sum reverse mortgage the senior might find himself spending the money unwisely as one might not be accustomed to receiving a large sum of money at once.

As the debt compounds with time it is more then possible that at repayment most of the property's value will be used to repay the loan leaving only a fraction of the original value to the heirs.

Generally, reverse mortgages tend to be more costly then regular ones as they are rising debt loans with interest added to the principal loan balance each month.

There are other alternatives then reverse mortgages. Some might be more financially sound. A senior should consider selling the property himself and rent an apartment instead and by doing so save the compounding interest and make his decisions regardless of a loan to be repaid. This is quite difficult; however, as most seniors would prefer to remain in what has been their home for many years.

One should also consider the relatively high rates paid for closing a reverse mortgages, often a percent of the property's value. As a result a reverse mortgage is not suitable for seniors who intend to leave their home in the near future (3 years being the rule of thumb).

Wednesday, October 3, 2007

Radiohead to release new album online - You name the price

Radiohead has scheduled to release the band's new album online on the 10Th of October. The album will be available for download here. The exciting and baffling part is for the first time the consumer will decide how much to pay for the right to download the songs. In my opinion this innovative initiative just might work.

In order to examine the economic feasibility of this initiative we need to examine it more closely. Radiohead's initiative is literally changing the value chain in the music industry. There is little debate that the sales generated by this initiative will be considerably smaller. But there is more to the equation. By releasing their album directly online Radiohead actually gains the following:

1) Shortening the value chain to the customer and making record companies redundant in the process. The drop in sales has a good chance to be compensated by the direct payment from the customer to the band.

2) Creating a product in the form of a download able music file no longer a part of an entire album to be purchased as a whole.

3) Enjoying new potential markets such as contextual advertising, social networks and more.

It is an interesting experiment to watch.

Tuesday, October 2, 2007

What is offshore banking?

Offshore banking simplified is utilizing financial and legal advantages available in a country outside the beneficiary’s country of residence. These banks are located at countries with low tax jurisdiction and more discreet privacy laws. The most infamous of these countries is Switzerland. Other countries which fit the profile characterized are Luxemburg, Andorra and the Cayman Islands.

The advantages sought after by clients of offshore banks are mainly:
1) Privacy and bank secrecy
2) Lenient tax regulations and zero tax rates
3) Easy and discreet access to accounts

The term offshore is also used to describe sophisticated tax planning designed to lower tax liability of various companies by registering them in the countries with the most suitable tax regulations.

Offshore banks provide other advantages such as stability for residents of unstable countries, lower costs base and higher interest rates, potential for combining offshore tax planning and banking, creating competition in the banking industry. Among the disadvantages of offshore banking is mainly the place of offshore banks in money laundering and organized crime and also as a safe haven for corrupt leaders. Other disadvantages include high entrance fees (offshore banks are inaccessible to the common depositor) and their remote location.

How to put your money to work

Your money working for you. Sounds wonderful, doesn't it? “How do we make our money work for us?” is a simple question with simple answers. Save early, save often and invest wisely.

Saving early and often sounds simple enough but is it? Saving early and often are the hardest parts of getting your money to work for you. It's never too early to start saving. “The most powerful force in the universe is compound interest" Einstein is often quoted for saying. Every 100$ saved for 10 years with 10% yearly interest will be worth 2.5 times more. Save for 20 years and earn 6.7 times the amount.

When we’re young consumption levels are naturally high as we are making our first steps in life. Making a habit of saving is a must in order to achieve the status discussed at this article. There are several ways of making a habit of saving: A fixed sum automatically saved at the beginning of each month is one, planning a monthly and yearly budget is another and more are available. The point is, make use of any tool which allows you to save at least 10% of your monthly income.

How do we invest wisely? When discussing your money working for you we’re discussing long term investment (Over 10 years). In this case the best advice, based on market performance so far is: make long term diversified investments in stocks. The stock market has proved to provide the highest available return on investment - not without risk of course. This is where long term and diversification come to play. By diversification I'm referring to investments across various industries, geographies and financial assets (stock, bond, ETF etc.). Further reading in these subjects is highly recommended.

The combination of saving early, often and investing wisely by making long term diversified investment really kick in the long term. For example: Saving 1,000$ annually between the ages of 19-25 (for a total of 7,000$) with a yearly 8% return will be worth approximately 30,000$ by the age of 41. If you start saving the same annual amount when you're 26 it will take you 2.3 times the time, or 16 years to reach the same total.

Some last words of warning. Don’t take unnecessary risks trying to achieve higher return on investment. It is possible to achieve unbelievable returns but it is also possible to lose all of your initial investment easily. Consult with professional while following the basic guidelines outlined in this article. Remember, we are here for the long term.

Peak Oil - How close are we?

Peak oil, according to Wikipedia, is: "The point or time frame at which the maximum global petroleum production rate is reached. After this time frame, the rate of production will enter terminal decline. According to the Hubbert model, the production rate will follow a roughly symmetrical bell-shaped curve. This does not mean oil will suddenly "run out", but the supply of cheap conventional oil will drop and prices will rise, perhaps dramatically. The following is an illustration of Hubbert's model:

According to the assumption of market efficiency these price increases will occur some time
before the actual peak. Has peak oil production already happened? Are current price increases a part of the process? The following is an illustration of world crude oil production from 1960-2005:

Hard, even impossible to tell. Hubbert originally estimated 1994 to be the year of peak oil production. Some economists and Geo-physicists estimate 2020-2030 as the years of peak oil production. Other economists rely on oil reserves buried deep in glaciers or ocean floors. These reserves might be used as price levels justify the investment required to extract them.

Regardless, as the Geo-political and ecological trend strengthens oil consumption levels will drop thus postponing peak oil production and the economic havoc which might occur as a result.