Posted: September 30th, 2008 | Author: Joe | Filed under: Investing | Tags: Building Wealth, Investing, Stocks | 8 Comments »
People complicate investing with various concepts, philosophies and principals. There’s diversification, dollar cost averaging, P/E ratios, yield, growth vs. value, sector rotation, and on and on. But when you strip away all of these layers of complexity, you are left with one cardinal principal of successful investing:
Buy low, sell high.
It’s really that simple when you get down to it. You can follow all the other practices and techniques, but for the most part you don’t make a profit if you don’t sell for more than you buy. Yes, I know there are ways to make a profit when stocks fall, but this is more about the simple and straightforward investor.
Before I move any further, I want to be clear about one thing: What I am about to discuss is primarily for the small investor, and should not be considered for your retirement savings (401(k), IRA, etc..). For those, you should stick to tried and true sector/capitalization diversification, or maybe go with a super-simple portfolio. This is about how to buy low and sell high when trading stocks, not investing for retirement. Now, without further ado, on with the post…
I know, it sounds trite and perhaps a bit condescending to say “buy low and sell high”, but it is often taken for granted. In other cases it can be misconstrued to support market timing, which rarely succeeds over extended periods of time.
I’ve heard buy low sell high sometimes referred to as “buy high and sell higher”, and that’s ok too because it’s the profit we’re after in the end. We don’t want to be concerned with finding the bottom price of a stock per se, just a price that’s lower today than it will be in the future.
The trick of course is knowing when to buy and when to sell a given stock. There’s a Kenny Rogers quote in here somewhere, but I’m going to resist making it. You can thank me later.
As I was saying, this is where many people get into market timing and trying to guess when a stock is at its peak price and they should sell, or conversely when a stock can go no lower and it’s safe to buy. Timing the market is notoriously difficult to do successfully. This is one of the reasons most day traders never become wealthy (fees and commissions on excessive trades is another).
So, if you can’t time the market, how then can you be sure to buy low and sell high?
Well, you can’t be sure. Nothing in the stock market is a sure thing, but there are a few tools you can use to help increase your chances. Actually there are two basic tools, and they exist to help the investor minimize loss and maximize gain. They are the Limit Order and the Stop Order.
Market Orders
To understand a stop order it is first necessary to understand how shares of a stock are purchased normally.
When an investor buys x shares of ABC corp stock, it is executed as a market order (unless otherwise stated). A market order is simply a request to purchase (or sell) shares of a stock at the going price at the time at which the order is processed. It’s that last bit that can get dicey. For instance, you may place an order to purchase stock when you see that the price has fallen to what you consider affordable and close to intrinsic value, but by the time your brokerage firm executes the order the price may have already jumped 5%, thus making you late to the party and missing the boat on that 5% profit. It should be noted that in today’s market where orders are processed much more efficiently and by computer instead of a human, the price differences tend to be less for highly traded stocks. However, for smaller stocks the price fluctuation can still be quite large.
Ok, so that’s the general concept of a standard purchase order. Now on to a Stop Order.
Stop Orders
As an investor, you can’t control when a market order is executed, but you can dictate the price at which the order should be executed.
A stop order is essentially a market order that can only be executed after the share price has passed a specified threshold, as set by the investor.
For example, say you are interested in buying x number of shares of HotStock Inc. It currently trades at $20 per share, but you think it would be a bargain at $15. You would place a stop order for x shares of HotStock Inc at $15 per share. The means that once the share price dropped to $15, your stop order would become a market order and you would buy x shares of HotStock Inc at the current market price.
Conversely, say you already own x shares of HotStock Inc. suppose you bought them at $15 per share and the price is currently $25 per share. You might not want to watch HotStock Inc every minute of the day, but you want to ensure you get some profit on your smart stock pick. You would set a stop order at $20 per share. That way if the price dropped to $20 per share, you would sell your stock, making a $5 per share profit. This is also known as a Stop-loss order, because you are (in theory) stopping your losses before they get too large.
But what happens if the price dropped from $23 per share to $9 per share before your order was executed? In short, it sucks to be you. Your $5 per share profit just became a $6 per share loss. And in the example of using a stop order to buy x shares of HotStock Inc at $15 per share… you could end up buying it on its way to the basement.
This is where Limit Orders come into play.
Limit Orders
A limit order is essentially a stop order with an additional price limit specified by the investor. This additional limit is the price at which the order will be canceled, thus giving additional control and protection over stop loss orders. You can effectively bracket your target price with upper and lower trigger points.
For example, if you want to buy x shares of HotStock Inc. stock, but only if it falls below $15 but not less than $13 per share, then you would place a limit order for x shares at the price of $15 with a limit of $13. If the stock falls below $15 per share, then your order becomes active, but if the price falls to $9 before the order is executed then it will be canceled and no purchase is made. Of course, if the price hovers at $14 and then drops to $9 after you purchased it, you are still at a loss.
You may be wondering if this technique is really that helpful when buying on the upside. After all, what if you set a price of $15 per share on a small company that is not traded heavily and the price has jumped to $25 before your order is executed? You would have bought high and paid much more than you intended. This is where a Stop-Limit Order comes into play.
This is a limit order that has a trigger point (just as any limit order) but also an upper limit at which the order becomes nullified. Think of it as a sort of kill switch. For instance, say you are a momentum investor and want to buy a stock only after it has shown some renewed signs of life. You want to buy x shares of HotStock Inc. stock if the price goes above $15 per share, but less than $17 per share. This way if the stock price has jumped to $25 before your order is placed, your order has been canceled and won’t be placed.
Final Thoughts
Stop and Limit orders are not a magic bullet. They will not make you a successful investor on their own – you still need to do your homework. For instance, you can still guess wrong when determining where to put your stops and limits. Cheap and expensive are subjective terms, and subject to error. But the point is that it does give you some control over what you pay for a stock and how much you will sell shares for. The rest is up to you.
Photo by thelastminute
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Posted: September 29th, 2008 | Author: Joe | Filed under: Economy | Tags: bailout, Economy | 3 Comments »
"The Final Meltdown"?
Naturally there is a lot of chatter on the blogs about the $700 Billion bailout. Let’s face it: if you have a blog, you have an opinion. And there are a great many people expressing their opinions about the unprecedented bailout.
I am no different, except I maybe have more questions than opinions because, quite frankly I’m not entirely sure I understand the problem. I mean, I get the bad loans. I understand why loaning money to people who can’t pay you back is bad for business, but once you start talking derivatives, credit swaps and the like I get a bit befuddled.
Some questions I’ve been dealing with of late are:
- How did we get into this mess?
- What does it mean to the man on the street?
So, here are some items I’ve found in my quest for the answers. Perhaps they will help you too, or perhaps you have some of your own links you’d like to share?
How did we get into this mess?
Ron, over at The Wisdom Journal, has an excellent post detailing the road to ruin titled The Mortgage Meltdown Signs Were There All Along.
For a description of why the problem has become bigger than simply bad mortgage loans, check out Another devil in the financial crisis.
What does it mean to the man on the street?
I mean Main street here, not Wall street . It’s obviously bad news for Wall street, but they had a hand in creating the mess so I’m not too concerned about them. But I happen to live on main street, in a place called reality I want to know how will this affect me?
Well, in short, think recession. Bad recession. High unemployment, high interest rates (especially for those with poor credit ratings). You can read What’s at stake for the economy for greater detail.
What can we do about it?
Ron at The Wisdom Journal said it best in Where Do We Go From Here? How About Back To The Basics. Essentially, live within your means, fund your emergency savings, and jettison the debt. Oh, and while we’re at it – how about changing our life style so we don’t rely so heavily on credit and buy things today with tomorrow’s money:
“He who spends more than he earns is sowing the winds of needless self-indulgence from which he is sure to reap the whirlwinds of trouble and humiliation.”
-Arkad, the Richest Man in Babylon.
Photo, “The Final Meltdown”, by Jill Greenseth
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Posted: September 26th, 2008 | Author: Joe | Filed under: Economy | Tags: bailout, Buffet, Economy | No Comments »
Is there a Bull on the horizon for the stock market?
I wrote a post last week called “Waiting on Buffet“. The general point of that post was that many experts have put forth the proposition that the stock market will be at or very near its bottom when two basic events happen, specifically:
- A big fish needs to go under.
- Warren Buffet needs to take an interest.
Since that time, it appears very likely that these two indicators have revealed themselves. First, with Buffet announcing his $5 Billion stake in Goldman Sachs and now with the Washington Mutual failure.
As the article at the link above notes, WaMu is the biggest bank to fail in US history. I’d say this qualifies as a “big fish”, and $5 Billion (even from Buffet) is no small interest. Could this mean we have bottomed out and the rise of a new bull is on the horizon?
Maybe, but even with these indicators met I think there is still so much fear and paralysis in the financial market that some form of Government action will still be required to kick start the financial sector again – both domestically and abroad.
Here are some articles that put the whole mess in perspective:
I am by no means a fan of expanding governmental control – especially of the financial market – but it seems likely that some form of government expansion will occur. At any rate, it certainly seems like some action on the part of the Government is needed, at least in a psychological sense to calm fears and uncertainty in the markets and for ordinary citizens to regain faith in the banking system in general.
I think my biggest fear in all this mess is not that the economy will fail, or fall into recession, but that the governmental cure may be worse than the disease.
Photo by bastian.
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Posted: September 25th, 2008 | Author: Joe | Filed under: spending | Tags: Buying, Opinion | 6 Comments »
Photo by David Clanton
GM has a radio ad for the new Saturn Astra compact which uses a “neutral transmission” at stops and gets 30 MPG highway. Why is this the best U.S. auto manufacturers can do ? It’s pathetic. My 1999 Honda Civic gets 34 and it’s a vanilla (10 year old!) 4 cylinder!
Here’s my thinking on patriotic consumerism:
I buy the best product. Period.
I think that’s best for a free market.
If you want people to buy your product, be better than the competition. It’s that simple. Of course “better” is a complex result that represents a myriad of smaller aspects of a product, such as price, construction, performance, etc..
I would prefer that the best product in a given market is American made, but don’t think you can phone it in, give me some sub-standard product and expect me to buy it just because it’s made in America. You still need to earn it, damn it.
As an American, I don’t want people to buy American products because they were made by Americans. I want Americans to make the best products, and have people buy American because it’s built to last, out performs and is fairly priced.
Let’s consider automobiles, because it seems to be one of the few things that are sometimes still made in America ever since manufacturing made a mass exodus to cheaper and less regulated locales overseas.
Personal Experience.
I’ve owned 4 cars in my life. The first 2 were American made (Buick and Ford). The last 2 have been foreign (Hondas and Subaru). The Buick was a piece of junk, I’m sad to say. It topped out at 89,000 miles. The ford made it to 109,000 miles before it basically rusted away around me. I was told by the mechanic that it was quite exceptional to break the 100k mark in a ford. This did not make me feel better.
The Honda is my commuter car. It’s not as spacious and luxurious as my Buick was, but it gets 34 mpg, just broke the 145,000 mile mark and is still going strong. In fact, a mechanic recently told me it was “just broken in.” The Subaru is our family car. It’s got many warts. Those are the result of striking a deer, and having children. It’s recently hit the 119,000 mile mark and is still plugging away. I should say that the Subaru is an Outback, is a 1999 and gets better gas mileage than many automobiles domestic manufacturers are touting today as “efficient” – and that’s with full time all wheel drive!
Anecdotal Experience.
On our recent camping trip I was lamenting the fact that foreign cars are just plain better than domestic, despite the price. One of our friends told us the story of his Dodge Neon. He absolutely loved that car and was quite upset when he had to buy a new car, but he had little choice. It needed more repairs than it was worth and he had to trade it in. The dealer actually told him the car had been very good to him at 79,000 miles. Yes, you read that right. 79,000 miles.
I had a co-worker last year who owns a Ford Taurus. He’s had to effect major repairs on this car over the past year. Something to the tune of $2,000. He was just told that it needed a new transmission. It has something just shy of 100,000 miles on it. He’s a middle-aged, father of 2 and does not drive like he’s qualifying for Nascar.
Now, I know that these are probably not what would be termed the statistical norm, but the track record is not a good one in my experience. And it’s about the same for everyone I talk to.
The Problem.
So, American made cars suck. But why?
Well, let’s look a GM. General Motors was once the icon of American engineering. The pinnacle of automotive excellence in the world. General Motors has bet the farm on it’s line of trucks and SUV’s. There’s nothing wrong with that – as long as that’s what is selling. It doesn’t take a genius to see that with gasoline at $4 per gallon, trucks and SUV’s have lost their luster. It also didn’t take a clairvoyant to see this a few years ago.
So, I suppose at some level management is to blame. But so are the Unions in my opinion.
According to an article in the NYT from 2005, G. M. and Union in a Deal to Cut Health Benefits :
“It will also cut G. M.’s annual health care expenses by $3 billion before taxes, and save it about $1 billion a year of cash, out of a nearly $6 billion annual medical bill.”
That’s essentially $6 BILLION in the hole that GM began each year with prior to this agreement. This has led some to ponder whether GM is an auto manufacturer, or a health care provider. Still, acerbic commentary aside you can see that you’ve got a company in highly competitive sector playing with a deck stacked against them. And that’s not taking into account the cost of Union Strikes.
Your Take.
What’s your take on all this?
Am I way off base? Am I basing this on flimsy evidence and dealing with data that’s out dated? Please tell me that U.S. Auto makers have turned the corner, gotten their collective act together and are on the fast track to marketplace supremacy once more. Please.
Photo of American Flag made out of cars by David Clanton
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