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The Only Way the 99% Should Invest in the Stock Market

April 3, 2016 by 3 Comments

I often get random questions from family members, friends, colleagues and social media followers that sound something like this: “I want to invest but I’m not sure what to buy, so can you recommend a few stocks.”

Or

I am saving for retirement (college fund, etc.), so where should I place my money (funds that they need to invest, commonly from an old 401k, a recent bonus, an inheritance, a stale IRA or whatever…).

They tell me that they trust my advice because I seem to know what I am doing. Perhaps it’s because I have a blog, twitter account or a Stocktwits following but I immediately reply by saying: well, be careful because I am not independently wealthy (yet), based solely on my market investments so take my advice with a grain of salt. I then go on to say: But if you are asking…

Index Funds!

What? INDEX FUNDS!

Says the guy who writes about stock investing and trading…?

I strongly suggest that the majority of people stay away from actively managed mutual funds, active investment managers, day trading, swing trading, trend trading, any trading, etc. I am not opposed to individuals buying and holding a handful of dividend paying blue chip stocks but why bother with the headache; go for the index fund and save your time for doing something fun.

2016_04-03_Actively-Managed-Odds

Place at least 90% of your available investment cash “the serious money” into index funds and then actively speculate with no more than 10% of the rest. This 10% can be used to buy your speculative investments like $FB, $AAPL, $GOOG, $AMZN, $TSLA, $V, etc…

William Bernstein (author of The Four Pillars of Investing) once wrote:

“It’s bad enough that you have to take market risk. Only a fool takes on the additional risk of doing yet more damage by failing to diversify properly with his or her nest egg. Avoid the problem – buy a well-run index fund and own the whole market”.

I agree: invest in one or more well-run index fund(s) that will promise a market return but with significantly lower fees. The average guy or gal in the 99% is not smart enough to “pick” the right stocks or mutual funds (or manager) at the right time. Heck, most fund managers in the 1% (Wall Street professionals) can’t do this either (data shows that greater than 80% of all fund managers fail to outperform the market over time).

Warren Buffett once noted that the moral of a story, as told in his 2005 Annual Report, is:

“For investors as a whole, returns decrease as motion increases.”

What does that mean? Well, let’s use a recent example of a bet Buffett made with a bunch of hedge fund managers back in 2007. The bet shows how an index fund mirroring the S&P 500 can outperform their actively managed funds, after fees, over a ten year period. They made a million dollar bet (winnings will be donated to charity) based on this premise and as of February 2016, eight years into the bet, Buffet is beating the all-star hedge fund managers 65% to 21%.

His Index Fund selection is crushing them and all he had to do was make a click or call to purchase the index fund and then he was done (not another minute was spent worrying about the investment). These managers (charging 2% on assets + 20% of performance) manage their funds daily and they are only 1/3rd of the return of Buffett’s choice (to date). So not only are they losing, they have spent eight years in their “professional job” losing to a fund that mimics the market.

Time = money so how do we even begin to quantify the hours spent by the hedge fund managers vs. the cumulative time that Buffett has saved doing other things. The extra time value is overwhelming so Buffett is much further ahead based on this ancillary bonus.

John Bogle (the founder of Vanguard) explains it this way in his book, The Little Book of Common Sense Investing:

“The way to wealth for those in the business is to persuade their clients, “Don’t just stand there. Do something”. But the way to wealth for their clients in the aggregate is to follow the opposite maxim: “Don’t do something. Just stand there.” For that is the only way to avoid playing the loser’s game of trying to beat the market.”

It means that the higher the level of investment activity, the greater the cost of investment fees and taxes, which ultimately results in a lesser net return for the investor.

I am an architect by degree so when I recall the famous quote by Ludwig Mies van der Rohe, “Less is More”, I suggest everyone apply it to investing as well.

Less activity equals more return for the investor while more activity results in more profit for the fund managers leaving you, the retail client, with less retirement money in your pocket (see the charts and expense ratio matrix below).

2016_04-03_Expense-Ratio-Chart-Diff

Charlie Munger stated:

“The general systems of money management [today] require people to pretend to do something they can’t do and like something they don’t. That is a funny business because on a net basis, the whole investment management business together gives no value added to all buyers combined. That’s the way it has to work. Mutual funds charge two percent per year and then brokers switch people between funds, costing another 3-4 percentage points. The poor guy in the general public is getting a terrible product from the professionals. I think it’s disgusting. It’s much better to be part of a system that delivers value to the people who buy the product.”

So based on what Buffett, Bernstein, Bogle and Munger have said…

Where do you now think the 99% should invest their money? What should YOU be doing with your money?
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Filed Under: General Market, Index Funds, Wall Street

16 Trading Quotes & Books for 2016

December 30, 2015 by Leave a Comment

“The obvious rarely happens, the unexpected constantly occurs.” – Jesse Livermore

“A speculator is a man who observes the future, and acts before it occurs.” – Bernard Baruch

“What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower.” – William O’Neil

“Successful speculation implies taking risks when the odds are in your favor.” – Victor Sperandeo

“Stocks are bought not in fear but in hope. They are typically sold out of fear.” – Justin Mamis

“Accepting losses is the most important single investment device to insure safety of capital.” – Gerald M. Loeb

“To me, the “tape” is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!” – Martin Zweig

“You have to master your ego & realize that being profitable is more important than being right.” – Martin Schwartz

“Losing a position is aggravating, whereas losing your nerve is devastating.” – Ed Seykota

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” – Peter Lynch

“Risk comes from not knowing what you are doing.” – Warren Buffett

“You must learn that the market is a discounting mechanism, and that stocks sell on future and not current fundamentals.” – Stan Weinstein

“I was successful in taking larger profits than losses in proportion to the amounts invested.” – Nicholas Darvas

“The first rule of trading – there are probably many first rules – is don’t get caught in a situation in which you can lose a great deal of money for reasons you don’t understand.” – Bruce Kovner

“Intellectual capital will always trump financial capital.” – Paul Tudor Jones

“I have noticed that everyone who has ever tried to tell me that markets are efficient is poor.” – Larry Hite

Filed Under: Books, Education, General Market, Psychology, Wall Street

Market Overview: Identifying a Change of Trend

August 7, 2011 by 6 Comments

Standard & Poor’s said it downgraded the U.S. government’s credit rating from AAA to AA+ because it believes the U.S. will keep having problems getting its finances under control and pointed to the lack of leadership in Washington. Per Yahoo Finance: “The Obama administration called the move a hasty decision based on wrong calculations about the federal budget. It had tried to head off the downgrade before it was announced late Friday.”

Politicians lie and markets do not so ignore Washington and focus on PRICE and VOLUME action!

So, with that said, what does last week’s action across the US and global market truly mean? The $DJIA was down 5.75% on the largest volume since last summer, the $COMPQ was down 8.13% on the largest volume since May 2010 and the $SPX was down 7.19% on the largest volume since May 2010.

All three major markets confirmed a Dow Theory Reversal, a “Change of Trend”. In addition to the major indexes, the Dow Transports TRAN also confirmed a Dow Theory Reversal by breaking support and making a lower low.

Emotionally, I suspect that the market will bounce and that many stocks and indexes are “oversold” but this will most likely only be short term. Long term, the trend HAS CHANGED according to the charts. And until the charts show a new trend to the upside, all moves up are suspect. No one has to pick the exact bottom or top of a market so be grateful to recognize a trend and grab 60-80% of the move. It’s a lot safer and less risky to jump on board once the trend is confirmed rather than play a guessing game that can get you caught in a 500 point slide, similar to last Thursday. Markets can change on a dime so be prepared at all times but longer term trends stay intact for months, if not years.

I made a mistake in my general market analysis by not paying enough attention to my New High – New Low (NH/NL) Indicator. And it cost me because I put on positions in $RENN and $DANG in recent weeks after warning signals had been given. I did avoid a new position in $LNKD and saved money heading into the earnings announcement. Overall, shame on me but I didn’t lose too much because rules were followed and I am digging deep to listen to my indicators. Regardless of what “ I think may happen”, I am listening to my indicators and charts 100%!

So you ask: What warning signals?
The first signal was given by the Dow Jones NH/NL 10-day average differential (Diff) (chart above). The 10-d Diff started to make lower lows as the Dow was making higher highs, a clear divergence that warns the underlying stocks are weakening while the overall market is making a new high. This one signal alone should have put me on caution while entering new positions. It didn’t because the NH/NL 10-d Diff was still above the critical level of zero. Well, the market took care of that this week by plunging below the zero level, closing at -203 on Friday for the Dow. Consider this, it closed at +15.1 last Thursday ( 7/28) but went red the following day at -2.5 (last Friday, July 29, 2011). The divergence and the reading below zero was now screaming MOVE TO CASH and gave us enough time to do it before the end of the week romp! We all had time to get out without taking a loss. As it stands now, the 30-d Diff is also below zero with a reading of -21.47, the first reading below zero since July of 2010.

It’s interesting that the markets topped in May, just as Osama Bin Laden was killed – I must give a HT to Howard Lindzon for coining the Osama Bin Laden Top (he may have nailed it) and closing his blog post with this statement:

With the mood of financial markets quickly turning negative, the horrific price action of financials, the silliness of IPO valuations and some Bitcoin mishigas, you may not soon forget the ‘Osama’ top.

Now, let’s take a look at a number of charts and see what they “were” saying and what they “are” saying right now, as we head into next week (ahead of the market reaction to the US credit downgrade). NOTE: I personally believe that the downgrade is mostly priced into the market but I am sure we will still see some further selling pressure before a normal bounce.

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Filed Under: 1-2-3 Pattern, General Market, NH-NL Ratio, Wall Street

Trading and Poker

July 13, 2010 by 12 Comments

FYI: This is an update to an article I had published in November 2006 in The Trader’s Journal: How the Poker craze can Help you Trade

I have been trading my own accounts for a decade now and I continue to learn more with each passing day. However, I never thought that a game, a hobby of mine, would advance my understanding and the importance of expectancy and position sizing as much as playing poker. Trading the markets and playing poker both require strict money management rules, stable emotional balance and a solid game plan. If you don’t consider and employ these tools, you will most likely fail sooner rather than later and lose a lot of money along the way.

So, how could a person learn so much from a game that most people consider luck? And why do some traders continually profit year after year while others lose their shirt while making the same mistakes? I will discus the basics of position sizing and expectancy and show you how both items are extremely important when trading and playing poker for profits. I will also close the gap of how each entity (trading and poker) have helped me become better at both.

Many people consider trading and poker pure luck but this is not an accurate observation. Average traders and average poker players taint the outside world with images of luck, quick riches and pure fantasy of the actual grind that is required to succeed. Many factors run parallel with poker and trading but the average Joe would never understand ‘why’ because he or she just listens to what the “talking heads” of television say. Luck may and will play a small part under certain circumstances but rules, odds, risk and money management are the largest components of the two entities.

It’s a grind; trading for a living and playing poker for a living is a grind – a full time business.

I don’t trade for a living but I do trade/ invest to grow my personal wealth. The savings and income from my main career is put to work through investing.

When investing in the stock market, it is essential to have a sound set of rules or a system that has been tested in real time, (back testing or historical testing is not required but can be used, my opinion of course). Back testing helps but playing sports has taught me that Monday morning quarterbacking is for theorists. Once a system has been tested profitably in real-time, the trader or poker player must follow clearly defined rules in order to preserve capital and cut losses. Both traders and poker players must consider the odds of their stock or hand making a gain or making a loss. Price objectives and targets should be a large part of every investor’s system but it is not the essential ingredient to success. Understanding how much to trade or how much to bet and exactly when to make that bet will be based on the system’s expectancy – and this should be the top priority.

So where does system development start? It starts by properly understanding position sizing techniques and calculated expectancies. Using these tools, the investor will be armed to trade only in situations where the odds are in his/her favor. A system that has been tested will have an approximate expectancy that will tell the trader or poker player how much will be gained or lost during each trade or hand over a period of time. Using this as one part of the equation, the investor or trader will now determine how much risk to undertake by calculating a position sizing algorithm that tells them how much to place on a specific trade or poker hand. The word “algorithm” may scare many people away but I have developed very simple position sizing and expectancy spreadsheets that can be found as a link on my blog. They can be downloaded, studied and tweaked without any advanced mathematical experience. This spreadsheet is strictly for trading, not poker.

Most traders and poker players look for three major factors when developing a system:

  • How much to trade or bet
  • The right odds or positive expectancy
  • Multiple trades or hands to play (opportunity)

How do we Calculate Position Size (stock trading example)?

[Read more…]

Filed Under: Expectancy, Poker, Position Sizing, Psychology, Wall Street

Calling Tops and Bottoms: Trend Changes

April 10, 2009 by 2 Comments

Every once in a while you like to look back and review your notes to locate where your research was right and where it was wrong. The simple technique of following stock market leaders and the NH-NL ratio nailed the period of time when the market transitioned from an up-trend to churning to the “Big Decline”. We nailed it here on this blog and every reader was prepared for the imminent decline. No one can dispute that. Readers of this blog were told to move to cash to preserve capital in late 2007 and early 2008. Now, I am not talking about day traders but longer term traders or investors that work full time and do what I do.

The chart highlights in red where I was making the sell posts (the articles are listed below):
041009_trend_change

Anyway, I have been posting twits about the strengthening of the NH-NL ratio which is starting to tell me that the newest trend change is beginning. Yes, this is my first major blog post saying that my screens (market tools) are telling me to wake up because things are starting to change. It’s not time to jump in with both feet and buy every stock that’s up on above average volume but it’s time to sharpen the skills and be ready. We may look back and point to March and April of 2009 as the bottom of the market or at least the start of the changing trend.

We don’t have market leaders yet but when they appear, I will locate them, post up charts and talk about them nightly on twitter (twitter.com/cperruna). Too many stocks still have their 50-d moving averages below their longer term 200-d moving averages and new highs are still limited. However, new lows have dried up considerably and the NH-NL ratio has a moving average that is trending higher for about a month now. That’s the most sustainable trend for this ratio since the big decline started.

Stay tuned to the blog and my twits for follow-ups to my research on individual stocks and the overall trend.

In the meantime, take a look back at the numerous blog articles I posted in 2007and 2008 talking about a market decline, shorting stocks and selling in general. Learn from what the simple tools were telling us. I am far from a market genius and far from rich but I can make a few dollars following the leaders and the NH-NL ratio.

A Review of Articles Pointing to a Stock Market Decline in early 2008:

  • May 23, 2008: Smelling Trouble

    The bottom line or point of today’s rant is the fact that I still feel that the market is headed for a decline or as I phrased it a couple weeks ago: The Big Decline (long term perspective of course).

  • May 8, 2008: Market Distribution

    I originally started to point out market troubles back on March 14, 2008 in a post titled Snapshot Friday; I highlighted both the Dow Jones and NASDAQ with clear yellow shaded areas showing the 200-day moving averages pointing down for the first time since 2003 (that’s huge if you ask me).

  • May 7, 2008: The Big Decline

    I am a positive person by nature and I prefer to buy stocks going up but I am starting to see several leading stocks struggle to hold new highs or fail to challenge recent highs. These patterns are familiar and they are suggesting that the recent bounce is the final stage before a possible market decline.

  • January 23, 2008: Setups for Selling Stocks Short

    I wrote an article on October 15, 2007 titled How to Make Money Selling Short, precisely when the general market indexes were topping. I am not going to take full credit but subconsciously my charts were giving me signals that the market was showing the major red flags and signals of what we are seeing today.

A Review of Articles Talking about Selling, Profit Taking and Market Distribution in late 2007:

  • 10/03/07: Is Shanghai a Nasdaq Déjà vu

    Well, the current two year rise of the Shanghai Stock Exchange Composite Index looks remarkably similar to the rise of the NASDAQ of the late 1990’s and the charts below explain better than I can!

  • 10/04/07: A Technique for Profit Taking

    What do you do in a market like today when you have profits in multiple positions but you don’t want to give it all back? You want to continue to ride the winners but at the same time, you want to maintain the unrealized gains in your account. HOW?

  • 10/12/07: Distribution Day

    This was the largest showing of volume in two months and is not healthy because it was pure distribution. It was only the second distribution day over the past month so we can’t call this a bear run but please be on the lookout for a possible correction of 5%-10%. Technology stocks led the decline as BIDU gave back 10% of its amazing run.

    • [Read more…]

Filed Under: General Market, NH-NL Ratio, Selling, Technical Analysis, Wall Street
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