Critical Trading Approaches

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do

things differently”. Warren Buffett

IndexAsset Allocation

Venture Capitalist and the IPO

The Selection Process

Designing your own portfolio

Portfolio Analysis

Dealing with loses

Rules of the trade

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Asset Allocation

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• Term that describes the diversification of your investment dollars in order to mitigate risk, as well as, take advantage of market cycles and trends

• One of the most important concepts in investing is asset allocation. Once you have determined your time horizon and the risk tolerances you can live with, it’s time to determine what sector or group of stocks is attracting the most investment dollars

Asset Allocation

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– asset allocation: 30 + years to retirement• % aggressive/small cap – 25%• % growth / large cap – 25%• % international – 20% • % bonds – 15%• % cash – 15%

– asset allocation: 20 + years• % aggressive/small cap – 25%• % growth / large cap – 30%• % international – 15%• % bonds – 15%• % cash – 15%

Asset Allocation

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– asset allocation: 10 + years• % aggressive/small cap – 20%• % growth / large cap – 30%• % international – 15%• % bonds – 20%• % cash – 15%

– asset allocation: retired• % aggressive/small cap – 5%• % growth / large cap – 30%• % international – 5%• % bonds – 50%• % cash – 10%

Asset Allocation

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• Volume increases: helps determine which sectors are on the move (www.equitytrader.com)

• Life cycle funds: funds that are monitored (age and risk tolerance)– invests money as a lump sum or monthly savings into strategic

portfolios that take into account interest rates, bull and bear markets, big-and small-cap stocks, bonds and cash

– problem is that these funds are too diversified to be effective– too much diversification means being in a good sector and a bad

sector at the same time, the two performances cancelling each other out

Asset Allocation

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• Age = under 30 – investment position: lump sum to invest

• 60% aggressive growth fund / 30% moderate or big cap growth fund• rest in cash

– investment position: no funds available• save on a monthly deposit plan with aggressive growth fund• investing once a month, dollar-cost averaging

– when the market is high, you buy fewer shares– when the market is low, you buy more shares– your investment amount is constant– trick is not the rate of return , it is the number of shares you own– every uptick: more cash, downtick: buying opportunity

Asset Allocation

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• Age = 35 to 45– investment position: lump sum to invest

• keep 10 % cash• split remaining 90% into two growth funds, preferably in two

different fund families• 2 funds, 2 families spreads the risk

– investment position: no funds available• if you start from scratch, get aggressive, but not stupid• invest in aggressive fund ($2K), same amount into a less aggressive

growth fund• when you have done that, keep splitting your deposits between the

two as long as you can

Asset Allocation

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• Age = over 45– investment position: lump sum to invest

• 60% growth fund / 35% reputable bond fund (reinvest dividends)

• keep the rest in cash/keep saving

– investment position: no funds available• need a killer offense and an even better defense• each month’s deposit in an aggressive growth fund• save a minimum of 20% of your gross income• let the money that earns interest earn more interest• Benjamin Franklin called compound interest one of the

greatest inventions ever (which one would you choose $us. 500,000 vs. 1 cent a day for 31 days)

Asset Allocation

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• Trends on the market:– identifying the general trend of the

market is an important factor every investor needs to determine

– not enough to just review the prices of some stocks you are interested

– market trends have life spans marked by a beginning, midlife and an end

– watch market averages a.k.a stock indexes (http://money.cnn.com/data/us_markets/)

Asset Allocation

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• Stock Indexes:– each index supplies vital

information as to the nature of each day’s trading

– by watching them you can get a feel for the broad market’s performance

“Its better to be out of the market wishing you were in, than to be in the market, wishing you were out”

Asset Allocation

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• Stock Indexes:• Dow Jones Industrial Average($INDU)– represents only 30 stocks

• Nasdaq Composite ($COMP)– all domestic and foreign listed on Nasdaq exchange

• S&P 500 ($SPX)– tracks the movement of 500 companies

• Russell 2000 ($RUT)• NYSE Composite ($NYA)• Dow Utilities ($DJU)

Asset Allocation

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• Market Action:– 3 out of 4 stocks follow the general trend of the market, thus

assessing overall market action on day to day basis is key– moving averages: (www.quote.com)

• versatile technical indicator used to track price changes using time lengths

• basic method of determining performance: review a price chart

• prices plotted every day with volume to create a visual picture of the stock movement

• 50 day moving average (50 DMA): take the last 50 days’ closing prices on either a stock or index – add them and divide by 50, each day the oldest price is dropped and add the newest

Asset Allocation

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• Market Action:– bull market: Many an optimist has become rich by

buying out a pessimist.” Robert G. Allen• bar graph of daily prices are above 200 day moving average• interest rates are steady or declining• unemployment numbers are increasing• inflation steady or dropping• earnings increases compared to same quarter last year• advance/decline line is clearly positive (more winners than losers)• market closes at high for the day• strong volume on up days – rallies for several days in a row• trend line is clearly positive• pessimism still exists (fear still exists)

Asset Allocation

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• Market Action:– bear market:

• bar graph of daily prices are below 200-day moving average• interest rates are increasing• inflation is on the rise• earnings are declining when compared to last year• advance/decline line is negative (more losers than winners)• market sells off toward the close or at the lows for the day• weak volume on up days, big volume on down days (selling-off)• trend line is clearly negative• optimism is still clearly evident (greed still exists)

Asset Allocation

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• Market Action:– signal to buy or sell occurs when a shorter average crosses

a longer one

Asset Allocation

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• Market Action:– a stock will bounce or rise again when it reaches the 50-day

moving average (investors feel crossover confirms the support level and once again buy the stock)• support level – historical price level at which falling prices

stop falling– on the other hand the stock may continue to sell off if the

50-DMA drops below the 200-DMA (in this case, the sell off sends the stock down sharply in a no confidence vote) • the 50-DMA serves as a resistance point instead• resistance level – historical price level at which rising prices

have a hard time breaking through the upside

Asset Allocation

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• Trading Approaches: (growth / value / momentum)– growth investing: a relatively new stock that continues to

show healthy expansion and strong earnings • invests its profits rather than providing dividends• earnings are growing more rapidly than the average• develop new products and services• usually priced higher (terms of P/E ratios) than value

stocks• as long as earnings grow, investors assume the price of

the stock will grow as well

Asset Allocation

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• Trading Approaches: (growth / value / momentum)– value investing: investor concerned with a company’s

tangible assets and not concerned with future earning prospects• value stock signifies bargain because stock appears to be

priced below its real worth• value investors look to a company’s balance sheet• finding value means discovering something others have failed

to see that provides hidden value to the company• primary objective of a value investor is to use fundamental

analysis to buy a company for less than what the investor thinks it is really worth

Asset Allocation

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• Trading Approaches: (growth / value / momentum)– momentum investing: investor is technically oriented than

value investors (technical analysis)• market continues in same direction for a certain time frame,

the market is said to have momentum • utilizes price and volume statistics for predicting the strength

or weakness of a current market• concerned with the stock’s price pattern rather than the

company’s earnings, (P/E) ratio or other• shorter term and looks for results immediately• look for overbought or oversold stocks: locate turning points• momentum charts and rate of change (ROC) can help initiate

momentum investing

Asset Allocation

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• Trading Approaches: (growth / value / momentum)– momentum investing:

• ROC: makes directs comparisons between current and past prices on a continual basis

• oscillators: indicators used to identify stocks and options with overbought or oversold prices that may trigger a trend reversal

– the trick to momentum investing is being able to anticipate when the primary trend is going to reverse, so the investor can get out of the position profitably

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Venture Capital and the IPO• business is unproven, bank is unlikely

to lend money to a new concern without substantial security

• many business turn to VC’s (Venture Capitalists), because new businesses are considered high risk investments

• VC will invest in stages as more capital is needed and certain benchmarks are achieved

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Venture Capital and the IPO– each stage brings increasing percentages levels of

equity to the VC– VC’s have to have a way to convert their investments

back into cash – this is usually done through some sort of exit strategy – most commonly an initial public offering (IPO) or some merger

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Venture Capital and the IPO– IPO is the first time that shares are made available to the

public– before the offering, the company has to comply with a

wide range of rules and regulations from the SEC (Prospectus)• prospectus : a formal written

document that describes the plan for a proposed business enterprise, that investors need to make an investment decision

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Venture Capital and the IPO– IPO is a liquidity event for the initial investor– determining initial sales price for an IPO is

an art and a science– nearly impossible to tell how reasonable the initial price is beforehand– pre-IPO hype creates a huge demand for shares– sometimes the price stays higher than the

IPO price, other times it sinks to never recover

– very aggressive game

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The Selection Process

– basics any buyer wants to see before investing in stock:• market sector it is in and what is the

competition like?• how entrepreneurial minded is the

management?– Apple/Steve Jobs (turned sinking ship)– GE / Jack Welch (mature company into a

growth machine)

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• many ways to select a stock from the obvious to the balance sheet

The Selection Process– do you understand what they do?• high tech companies attracted and burned tons of

investors, who bought anything with a dot-com– focus in a few sectors• trying to learn about the entire market is virtually

impossible– find out what the experts think• brokerage’s firm research–www.zacks.com

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Designing Your Own Portfolio• personal choice is the landmark

of portfolio design– create a hypothetical example with

3 stocks: • growth and income –

telecommunications - AT&T (NYSE:T)

• growth only (no income) – coffee company - Starbucks (Nasdaq:SBUX)

• aggressive growth – newly formed co’s. – Facebook (Nasdaq:FB)

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Portfolio Analysis• method for keeping track of portfolio is subjective:

adhering to objectives and risk tolerance is one of the keys to success– changes in valuation can skew this balance to a more

aggressive one weighting than originally planned– example:

• GM $72 x 500 shares = $36,000- 80% of portfolio• RMBS $18 x 500 shares = $9,000 – 20% of portfolio• GM goes up to $74 and RMBS goes up to $73• > GM = 37,000 and RMBS = $36,500 for a 50% / 50% portfolio

(number of shares unchanged)• aggressive portfolio and time horizon will define how you

rebalance it

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Portfolio Analysis– beta: a stock volatility is

measured against the overall market• if it is more volatile than the Dow –

beta greater than 1.0• if it is less volatile than the Dow –

beta smaller than 1.0

– besides price, it makes sense to monitor the sectors your stocks are in – Value Line web site (www.valueline.com)

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Dealing with Losses• no matter how careful your investment choices are,

you are still going to pick a loser now and again– Investor Business Daily’s William O’Neil: recommends selling

a stock once you’ve incurred a 7% to 8% decline from the purchase price

– the market will humble you• you’ll sell too soon and the stock will continue on to

make a monster-sized move (British Energy / own experience) • you’ll buy at the top and take a painful, embarrassing loss

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Dealing with Losses– you won’t buy, trying to

outsmart the market and it will leave the station without you

– if you invest long enough, these circumstances will beset you

– “cut your looses early”– preservation of capital: most

important thing you can master

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Dealing with Losses– control your loses:• stock has lost value from the time

purchased • how has the overall market perform

during the same time?• if market has done better than your stock,

do not double down (to buy more to lower your price basis – tax implications)• know your parameters before you buy a

stock – if it drops this much, I am selling

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Rules of the Trade• If you are a novice, these rules might help you to stay

in the game long enough to get good at it

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– stay away from chat rooms– avoid stock tips from magazines

(top 10 stocks to own today, how about tomorrow?)

– use education not magazines – read Barron’s, FT, WSJ

– be selective in the counsel you seek – use a few people to bounce your ideas

Rules of the Trade– know your competition– predetermine your exit point prior to

opening a trade – maximum loss– use caution when you average down – be a gracious loser and take your looses easily – never try to

justify a bad trade by trying to convince yourself it will turn into a winner – loosing trade is to be viewed as overhead

– don’t fight the trend, don’t get sucked into believing you are smarter than the market – costly mistake

– missed opportunities exist only in your mind – like a “trufi”, another will come

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Rules of the Trade– the human side of every person is the worst enemy to

successful trading – fear and greed can not be avoided, but they can be minimized by planning your trade and trading your plan

– never risk more than you an afford to loose –heart of low risk trading

– become a proficient computer geek

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THANK YOU VERY MUCH