Stock Trading Blog

Is There a Way to Predict or Avoid Black Swans?

calculating cost

Investing comes with risk. That shouldn’t be a surprise to anyone, but many investors think that simply diversifying a portfolio eliminates the majority of risk they’re taking on. Unfortunately, risk comes in many different shades and flavors.

Experienced investors know all-too well the many different types of risk that comes with investing in the stock market. There’s foreign exchange risk, geopolitical risk, industry risk, technology risk and much more to contend with. While diversification can help mitigate some of these risks, there’s one that’s hard to defend against – systemic risk.

The Unknown Unknowns

Systemic risk is a type of risk that affects entire markets, making diversification nearly useless as a risk avoidance tool. General market corrections are a common type of systemic risk that come naturally in the cycle of the stock market, but the most dangerous is called a black swan.

Black swans are unpredictable events that have a major impact on the markets and/or the economy as a whole. The idea was developed by Nassim Taleb, who researched past black swan events, such as the advent of the personal computer, the fall of the Soviet Union and the attacks on September 11th, 2001.

But the nature of these events, unpredictable and sudden, makes them hard to prepare for. Even if one takes into account every imaginary scenario, one cannot prepare for the unknown. If, for example, a a scientific breakthrough in a new type of energy made oil and gas irrelevant, the markets would undergo massive chaos as investors bail out of the energy industry.

Regression analysis and prediction models can only help spot trends and take from historical data. But designing a portfolio that accounts for all possibilities is not only virtually impossible, it’s counter-productive. Standard portfolio designs take data and make macroeconomic predictions and invest accordingly. This design allows for the maximum potential for profits while reducing unnecessary downside risks. But risk isn’t completely eliminated.

In fact, the only real way to avoid something like a black swan would be to avoid being invested at all – in which case, there’s no possibility of loss, but none of gain either.

While it might be nearly impossible to accurately predict a black swan occurrence, the good news is that you really don’t need to worry about them. Because they’re random happenings that affect entire markets, you won’t be alone when disaster strikes. More importantly, though, is that markets do recover from black swans. The sub-prime financial crisis in 2008 crippled the markets for a while, but just one year later, stocks were climbing once again. As an investor, staying in the markets and holding on even through downturns ensures you take advantage of all the upside gains the subsequent recovery has to offer.

 

Should You Use Leverage in Your Portfolio?

computer with graphs

There’s only one goal when investing in stocks – to make money. With that goal firmly in mind, investors have developed numerous methods and strategies intended to filter out winning stocks and execute trades in a timely fashion in order to maximize rises and minimizes falls in value. But even the most successful investors don’t break more than 12% annually on a regular basis without using leverage.

Leverage in a portfolio can boost returns significantly, but can make losses much larger, as well, making it a tool only for sophisticated investors. By borrowing money at a specified interest rate, investors can use the extra money in the hopes of earning a return greater than that of the interest rate on the loan. For example, if you take out a loan for 5%, but earn 10% on returns, you just profited 5% overall. But it also makes losses harder to handle since you lose not just the money on the investment, but the interest debt on the loan.

Kick your portfolio into overdrive

In order to begin using leverage in your portfolio, you’ll need to open a margin account. This allows you to take out loans to be used for investment purchases and also enables options and other derivatives to be traded. Like all debt instruments, having an excellent credit score gets you the lowest possible rate – something essential in order to boost returns.

So how much can you actually make using leverage? Let’s take a look at an example.

Imagine you have $10,000 you want to invest in a stock and decide to take out a loan for an additional $2,000 at 5% interest to bring your total amount to $12,000. If the stock rises 10%, you’ll have $13,440 – that gives you a return of 13.44%, instead of 10%. The minimal interest of $100 means your official return is $13,340 or 13.34%.

But stocks aren’t the only type of asset that you can use leverage on. Options are another way to boost returns. An option contract allows you the right to buy or sell 100 shares of stock within a set time-frame for a given price. This let’s you minimize risk to the purchase price of the option contract, without having to take on the risk of actually owning the stock. And lets you control 100 shares of stock for a fraction of the cost.

Other than leverage, checking margin debt levels on the exchanges is useful as a metric for gauging the risk and strength of the stock market. Historical data shows that rising margin levels often precedes stock market corrections. The higher the leverage in the market, the more money lost if the market turns south. But using leverage can be beneficial for investors who understand the risks and invest appropriately.

 

 

 

 

Going Green: Is It Actually Profitable?

electric car

When the green movement started, people assumed it would be a passing fad. But it’s obvious now that alternative energy and environmentally-friendly materials are the future of this planet, especially after the sudden leak of an important environment report presented to the White House that shows just how urgent the effects of climate change are. And as the green initiative continues to gain strength, investors are looking to the industry for new profit-making opportunities.

Considering that environmentally-friendly business practices aren’t always the most profitable, many investors are wondering if its actually a good move to buy stock in these types of companies. But as we’ve seen with the coal industry, other fossil fuel and polluting energy industries are beginning to fade away. Regardless of the current state of the industry, going green is the future.

Transforming Going Green into Making Green

When alternative energy industries began hitting the markets, the only appeal was technological. The cost of generating power with photovoltaics compared to traditional fossil fuels was so high, even government subsidies couldn’t effectively make up the difference. In solar, for example, the Investment Tax Credit covers 30 percent of the cost for solar installation and is scheduled to last until 2021.

But now, the costs for alternative energy are coming down. A report of energy prices in 2016 revealed just how low the different costs for each energy type are:

Coal – $0.06 cents per kilowatt hour
Steam – $0.05 cents per kilowatt hour
Natural Gas – $0.03 cents per kilowatt hour
Solar – $0.029 cents per kilowatt hour

This past year marked the first time solar took over as the cheapest relative energy source. Because solar power is considered a technology and not a fuel, prices will continue to fall as technological innovation makes more breakthroughs. With the majority of the world dedicated to replacing fossil fuels with alternative energy providers, green energy is destined to take over as the number one energy supplier.

Other industries are going through similar changes. Oil is still necessary for the automotive industry, although companies like Tesla are slowing gaining market share. Companies like GM and Toyota have similarly followed suit by offering more hybrid and electric vehicles as part of their lineup.

Again, technology is the key to the industry. Tesla may be an auto-maker, but the secret lies in battery technology. New developments have made batteries longer lasting and more energy efficient. Within the next decade, we could see electric vehicles take over traditional gas-power vehicles as the main source of transportation.

As new technologies emerge, the green industry will become more and more price competitive. And new technology means new applications for multiple industries. Supporting alternative energy is akin to investing in the tech industry. Going green could be a way for investors to actually make some green along the way.

 

 

What Market Capitalization Means for a Stock Trade

investment strategies

Investors analyze many different aspects of a stock before deciding whether or not it’s a worthwhile investment. Ratios such as price-to-earnings, price-to-sales and debt-to-equity are poured over while financial statements are reviewed from past quarters to determine trends. But one important thing that seems to go unnoticed often is the company’s market capitalization.

Market capitalization is the value of a company that’s traded on the stock market, which is determined by multiplying the total number of shares by the current stock price. So a company with one hundred million shares trading at $20 per share would have a market cap of $2 billion. It might seem superfluous to know what the market cap of a stock is, but it can actually reveal more about the company than you realize.

Market Capitalization as a Metric

Far from being insignificant, understanding market cap is essential in building an investment portfolio. Diversification doesn’t just mean investing in stocks in different industries, it also means investing in companies of varying size. Small cap, mid cap and large cap stocks all need to be present in a portfolio to truly be diversified.

Market cap is also correlated with volatility. Companies with a smaller market cap tend to be more volatile than larger ones. This can usually be seen by comparing market cap with a stock’s beta. By keeping your portfolio exposed to companies with varying market caps, you can take advantage of growth without taking on undue risk.

The size of the company tends to matter more for growth stocks than value stocks. Because growth strategies require fast growth from a company, a smaller market cap means more opportunities for growth, whereas larger companies might not have room for continued expansion at an accelerated pace. But companies that are too small might not have the ability to make investments or acquisitions that can generate the kind of growth needed.

Another important correlation is a company’s market cap and international exposure. Larger companies tend to have more international business dealings, leaving them vulnerable to foreign currency risks, whereas a smaller company might not have the resources to expand to overseas markets yet. Knowing the market cap of a stock can let you know how much foreign exchange risk might affect your portfolio.

Certain types of trades are dependent on market capitalization. Speculative stocks, for example, are almost always small cap stocks that have potential for exponential growth. Dividend paying stocks on the other hand are generally large cap stocks that have enough income to pay a dividend to investors.

When building a portfolio, it’s important to take market cap into consideration. Lowering risk through size diversification can prevent being overly exposed to a particular kind of risk.

 

 

Trading the Pink Sheets: Bold Move or Ill-Advised?

penny stocks

Public companies sell shares of stock to investors, giving them partial ownership in exchange for money used for capital investment purposes. These stocks trade on an exchange where investors can freely buy and sell shares. While most investors are familiar with the NYSE and NASDAQ exchanges, there’s another type of exchange that doesn’t receive the same amount of Wall Street coverage – the Pink Sheets.

In order for a company to list stock on an exchange like the NYSE or NASDAQ, the company must comply with extensive financial reporting requirements intended to make information as transparent as possible for investors to reduce fraudulent activity. These requirements come with other restrictions, such as a minimum market capitalization and minimum stock price. The pink sheets, or over-the-counter exchanges on the other hand, don’t have the same amount of regulations in place, allowing companies to list stock without complying with financial reporting requirements.

The lack of coverage means investors can buy stocks at just pennies per share, giving stocks that trade on the pink sheets the nickname “penny stocks.” Because these companies don’t have to report to the SEC, risk is much higher than normal, but so is the potential for profit.

Pink Sheet Trades

Penny stocks don’t have to submit to the same reporting requirements that stocks on the NYSE or NASDAQ do, making them highly risky trades. But it also gives investors an opportunity to take advantage of market inefficiencies that can’t exist in other, more reputable exchanges.

The pink sheets contain roughly 15,000 companies that range from small speculative stocks to large foreign companies. These companies trade on the pink sheets for a number of different reasons. It could be because the company doesn’t meet listing requirements or because the stock isn’t priced high enough. Often, companies that trade on the larger exchanges find themselves downgraded to the pink sheets as their stock price falls below the threshold value. Foreign companies might not have the ability or resources to meet certain listing requirements and choose to trade on the pink sheets instead.

Just because a stock trades on the pink sheets doesn’t mean it’s fraudulent or a poor investment choice. Many name-brand foreign companies like Nintendo and Volkswagen trade on the pink sheets. Other types of companies, like those that deal in Marijuana, don’t meet Federal regulations and can’t be listed anywhere else.

Investing in over-the-counter stocks comes with a high degree of risk and exposure to fraudulent trading activity. One of the most common, known as a pump and dump scheme, operates best with penny stocks. False recommendations or statements about a company is disseminated to investors with the intention of boosting interest in the stock and raising its value, so sellers can sell their shares at inflated prices.

Investors interested in trading penny stocks should use extreme caution and perform due diligence above and beyond what they would normally do in order to ascertain a stock’s true value. While higher profits can be made, investors shouldn’t make pink sheet companies a large part of any investment portfolio.

 

 

 

How the Fed Impacts Markets

US dollar

The stock market is a sensitive and fickle thing. The quietest whisper of a merger rumor can impact dozens of companies, while central bank policies on the other side of the globe can affect entire industries. Every new bit of information that comes up is analyzed by investors where predictions are made and stock prognosticators attempt to beat others to potential profit-making changes. And, while this happens almost constantly everyday on Wall Street, there’s nothing that can make investors stop and reassess their beliefs quite like the Federal Reserve.

The Fed has the ability to control the money supply, interest rates and influence inflation – three critical pieces of data that impacts every corner of every industry in the stock market. As such, when the Fed makes an announcement or lets investors in on what it’s thinking, investors take it seriously.

But despite the Fed’s influence and apparent impact on market movements, one of the biggest questions investors have is exactly how powerful the Fed really is. How does the Fed actually influence markets?

The Fed’s Power Tools

The Federal Reserve’s stated purpose is to maximize employment, manage inflation and create a stable financial system. To this end, it utilizes three powers – it sets banking reserve requirements, buys and sells treasuries in order to control the money supply, and sets the federal funds rate, which in turn impacts interest rates.

The most commonly used ability by the Fed is its open market operations, which buy and sell treasury securities. Purchasing these treasuries injects more money into the banking systems, thus increasing the money supply, while selling them removes money from the banking system and reduces the money supply.

Setting the federal funds rate is the Fed’s way of influencing interest rates. The federal funds rate is the rate charged to banks to borrow money from the Fed. This method is the one the Fed uses to manage inflation. Lowering the fed funds rate stimulates investment activity and attempts to increase growth and inflation, while increasing the fed funds rate curbs investment activity and attempts to lower inflation.

Finally, the tool least used by the Fed is setting margin requirements for banking institutions. This tells banks how much they must hold in reserves relative to how much they loan out in order to control the money supply. A low reserve ratio increases the money supply, while a higher one lowers the money supply.

The Fed uses all three tools in combination in order to manage inflation and economic growth, while keeping the financial system stable.

While the Fed does have the ability to influence economic activity and the stock market, much of the Fed’s power simply lies in the belief of the investor. For example, despite inflation levels under 2 percent in 2015, the Fed still increased interest rates, which led to investors believing that the Fed had faith that the economy was strong enough to require a rate hike.

Whether that was a way to convey belief to investors, which in turn caused inflation to go higher, or whether the fed really thought the economy was strong enough is a hotly debated subject. Recent failings by the Fed to properly convey future economic policy changes and actions has led some investors to doubt the ability of the Fed to properly manage the economy. As time goes on, the Fed’s ability to influence markets may become weaker.

 

Does the Value of the Dollar Really Matter?

US dollar

The value of the U.S. dollar is quoted daily on wall Street and even used by some politicians as a way of assessing America’s strength around the world. But considering that currency values are always in flux and dependent upon the relative value of another currency, does the actual value of the U.S. dollar really matter?

There are four major segments of the stock market – equities, bonds, currencies and commodities. In general, there’s a pattern that these assets follow. When bonds’ prices rise, so follows equity prices and currency prices, while commodity values fall and vice versa. So if currency values are all just part of the natural cycle, the U.S. dollar shouldn’t hold a special place in the markets. But as it happens, the dollar is followed not just by U.S. investors, but by investors all around the world.

The U.S. Dollar as a Benchmark

While currency values fluctuate relative to one another on a daily basis, the U.S. dollar is arguably the one investors pay the most attention to. For one, the dollar is the benchmark upon which most other currencies are measured. Backed by the full might of the United States, it’s viewed around the world as a safe haven currency with multiple countries owning billions of dollars worth of U.S. treasuries and other U.S.-based assets.

Regardless of how other currencies are performing, the dollar is seen as a stable currency and can be a source of wealth preservation during difficult economic times. When the economy of Greece collapsed and the European Union tried everything it could to stabilize its financial system, interest rates dropped to negative values and the Euro become a poor investment. The dollar on the other hand, was far more stable.

Because the dollar is ubiquitous throughout the globe, commodity values are generally based off the dollar. This creates an inverse relationship – when the dollar is strong, commodities are weak and when the dollar is weak, commodity values are high. Commodities are used as a safe haven instead of the dollar when its value is relatively low.

So for commodity traders, the value of the dollar is very important in order to know when to buy or sell different commodities. But, while the value of the dollar might be important, it doesn’t matter whether the value is high or low.

On a macroeconomic scale, the dollar is often used for political reasons. A strong dollar means that U.S. money goes further when it comes to importing goods and services. The higher the relative value of the dollar, the cheaper foreign goods become. But it also makes American manufacturing weaker, since it means consumers in countries with a weaker currency have to spend more in order to buy American goods. That’s what makes a weak dollar good for the manufacturing base. There can’t be both a strong national currency and a strong export industry, since those relationships are inversely related.

 

 

Understanding Currency Carry Trades

currency trades

There are many different types of assets to choose from when investing. The most common are stocks and bonds, but there are other types of assets for the more advanced trader, like commodities and currencies. Investing in stocks, bonds and even commodities is relatively simple. As an investor, you purchase the asset with the expectation that it will will rise in value over time. But currencies don’t appreciate in a vacuum. Investing in currencies means understanding one currency’s value relative to another currency and profiting from the difference.

One of the most common ways to invest in currencies in known as the currency carry trade. A detailed knowledge of interest rates and yields of two or more countries is necessary to initiate a currency carry trade, making it an investment strategy for the more experienced trader.

The Currency Carry Trade in Detail

In order to execute a currency carry trade, an investor must first short sell a currency with a low interest rate and purchase a currency that carries a higher interest rate. The difference in rates is where profits are made and leverage can be utilized, making it a very lucrative, risky trade.

Exchange rates fluctuate on a daily basis, which adds to the risk of a currency carry trade. Profits can go up or down rather quickly depending on how the exchange rate moves. Considering that leverage of 10-to-1 or even higher is usually used, this trade can result in large gains or losses in a short amount of time.

Let’s walk through an example to illustrate how a currency trade might work.

A trader decides to initiate a currency carry trade between the Japanese yen where rates are at 1% and the U.S. dollar, where rates are at 5%. The difference of 4% between the two rates is where the trader expects to profit.

To start, the trader must first sell yen and transfer it to U.S. dollars. Assuming that the exchange rate is 100 yen to 1 U.S. dollar and they wanted to short $100 million yen, this would result in $1 million U.S. dollars.

After one year of being invested in the dollar at a 5% rate, the trader would have $1,050,000. But they still need to pay back the yen they shorted at 1%, which would be $101 million yen, or $1,010,000 U.S. The difference between the two is $40,000 – the total profit of the trade and the exact 4% expected at the start of the trade.

 

While a currency carry trade can be a good strategy for investors, it comes with exceptional risks. In the earlier example, if the yen grew stronger, profits would lessen and that investor may actually lose money, depending on the yen’s growth rate.

For interested investors, a currency carry trade can be a great addition to a portfolio – so long as you take proper due diligence.

 

 

 

Investing in Stocks with Negative Earnings

business-man

Investing in a stock comes with one simple goal: profit. Stocks move higher as companies grow and profits increase, making shares more valuable as a result. But sometimes, companies that post positive earnings have a losing stock performance and companies that post losses can end up with winning stock performances.

Analyzing a stock with positive earnings is a fairly straightforward process. Quarterly earnings results are used to determine how much the stock is worth relative to its stock price. The price-to-earnings ratio, or P/E, is a benchmark commonly used by investors to identify whether a stock is a growth or value stock. Without earnings, valuing a stock becomes more difficult.

Negative Earnings Doesn’t Translate to Losses in the Market

A company issues stock in order to finance further growth. Sometimes, the company is already profitable, but many times the only thing a company really sells to investors is future growth. In this case, investors will need a thorough understanding of the underlying company’s business model in order to project future growth prospects.

Projecting earnings isn’t difficult. All it takes is a simple regression model that takes into account past performance in order to predict future performance. Investors need to assume a fair growth rate, which will decline as the company grows so estimates become more difficult to predict the further out you go. One of the biggest dangers to this method is assuming too high of a growth rate or picking a stock that takes too many years to actually post positive earnings.

Negative earnings mean different things depending on the industry, as well. Companies leaden with debt like those found in the utility sector are poor investment choices if they have negative earnings. The difficulty of managing interest debt and low growth makes negative earnings a virtual death sentence. The tech industry, on the other hand, isn’t affected very much by negative earnings. A lack of overhead expenses and fast paced growth environment means companies outgrow early negative earnings rather quickly.

One thing investors should be wary of is companies that were profitable, that now post negative earnings. While turnaround stories do happen, the lack of growth and poor performance is usually indicative of a larger problem that can’t be attributed to a temporary bear market.
Investors should always perform due diligence before putting actual money into a stock. Stocks with negative earnings should be viewed cautiously, but not avoided entirely. While value stock investing generally avoids negative earnings, growth stocks often have negative earnings. High enough growth will outweigh any current negative earnings results when positive earnings are expected at a later date. As with most stocks, growth is key in picking the right stock with negative earnings.

 

 

 

 

What is Efficient Market Hypothesis?

cellphone stocks

Investors look for any advantage in order to turn a profit in the stock market. And that includes doing research and developing theories in order to explain market movements and behavioral patterns. Perhaps the most well-known is EMH or Efficient Market Hypothesis.

Like many market theories, EMH attempts to explain how stocks are priced and how investors can take advantage. Some ideas suggest that markets are fairly priced and offer no advantage to investors, while others indicate just the opposite. Investors that want to understand markets better need to know what EMH means and how it applies to investing.

Breaking Down Efficient Market Hypothesis

There are three forms of EMH: strong form, semi-strong form, and weak form. Each type makes different assumptions about the market and investors in an attempt to explain pricing inefficiencies. In essence, EMH theorizes that markets as a whole are efficient and investors cannot make a profit from undervalued stocks and can only profit from taking on higher risks.

Strong Form EMH

The strong form hypothesis states that all possible information, public and private, is always reflected in a stock’s price. This means that investors can’t have insider knowledge that allows them to profit, since the price always reflects a fair value.

Semi-Strong Form EMH

In the semi-strong form of EMH, technical analysis is assumed useless, but fundamental analysis is still valid. The stock’s price reflects all publicly available knowledge, so insiders would be able to profit from information that others do not yet possess. It also assumes that any new information is automatically processed, understood by all at the same time and reflected in the stock price.

Weak Form EMH

Finally, weak form EMH states that stock prices reflect all historical data, meaning that past knowledge and information cannot be used to predict future price movements. In other words, this form assumes that future price movements are more or less random and can’t be predicted by analysts who use past data to make assumptions about the future.

Flaws in the System

While EMH may help explain certain unexpected price movements and patterns in the markets, it has several glaring holes in its logic. The biggest problem with EMH is that it assumes all investors are unbiased in their analysis, make no flaws and act rationally in response to information. However, as the newly formed field of behavioral finance shows, investors do not always act rationally or make decisions based on logic. Furthermore, a single piece of data isn’t always viewed the same. Many times, new information sparks conflicting views, leading to pricing inefficiencies.

Behavioral finance is quickly replacing EMH in terms of being the premier trading philosophy used by major institutional investment companies. For everyday investors, this means undervalued stocks exist on a daily basis and using fundamental analysis can reveal pricing inefficiencies that investors can take advantage of. Regardless of what others might say, the markets operate based on human behavior. And human behavior is often irrational and impossible to predict.

 

 

How to Profit from a Stock that Does Nothing with Options

phone with performance graphs

There’s a popular saying on Wall Street: bulls make money, bears make money and pigs get slaughtered. Regardless of where you think a stock is going, you can make money – just as long as you aren’t greedy. But what about those stocks that really don’t move at all?

Conservative investors might suggest that investing in stocks with low volatility, as long as they offer a dividend, is a good strategy. But stock yields rarely exceed 4 percent and with yields on the 10-year treasury at 2.35 percent and rising, investors are looking for a better way of dealing with stocks that refuse to react to either bullish or bearish conditions.

One way to play these types of stocks is by using options. There are a number of strategies you can employ that will end up in a profit, as long as the underlying stock doesn’t move beyond a certain range.

Here’s a list of strategies you can use in your portfolio to broaden your horizons.

The Covered Call

As a general rule of thumb, stocks tend to rise in value over time. So if you find a stock that you think will go higher over a long period of time, but will do so slowly rather than jump up in a few months, then covered calls could be just what you need to beef up your profits.

A covered call is when you sell a call with a higher strike price than the current price of a stock you already own. Setting a target date of just a few months out on stock with low volatility will ensure you won’t have to sell your stock because it rose in value too fast, but still nets you the gains received from selling a call.

The Naked Put

If you see a stock that you wouldn’t mind owning if the stock price dropped from its current level, you might consider a naked put. In this type of option strategy, you simply sell a put at or near the current price of a stock you don’t own. If the stock does nothing or goes higher, you keep the profits made from selling the put. If the stock goes down and passes the strike price you sold the put at though, you’ll be obligated to buy the stock at that price. However, if you’ve already done your due diligence and came to the conclusion that the stock is worth owning at that price, then even the worst case scenario might end up being a good decision in the end.

The Short Straddle

For investors willing to take on more risk, a short straddle could be a good option strategy to use on stocks that don’t move. For this high risk strategy, both a call and a put are sold on a stock you don’t own. This leaves a small range in which the stock needs to stay to make a profit, but comes with  high risk as large movement in either direction will end up in a loss. Because of the large degree of risk involved, this strategy is best left to investors who have a deep understanding of option trading and understand the risks involved.

There are many other creative option strategies that can be used to take advantage of stocks with low volatility. Multiple combinations can be used to generate profits from any given scenario. If you want to try your hand at options on a stock that doesn’t move, make sure you perform your due diligence before making any investments.

Stock Trading 101: Value Investing vs. Growth Investing

investing

Stock trading isn’t done blindly, at least not by those who are successful in the markets. It takes planning – developing a winning strategy that identifies which stocks have the potential to go higher. You’ve most likely seen or heard of the most commonly used strategies already: growth investing and value investing. What you might not know is what the difference is and which one works best for your portfolio.

One of the most common misconceptions about stock strategies is that only one can be used at a time. But growth investing and value investing only apply to individual stocks, not an entire portfolio. One of the best ways to diversify is to mix up the types of stocks you hold in order to minimize risk and maximize profits. Understanding how each type works is your key to building your ideal portfolio.

The Value Approach

Value investing has a lot of popular practitioners on Wall Street, such as Warren Buffet and Peter Lynch making it a favorite for many beginning investors. The underlying idea is to spot stocks that haven’t reached their true potential yet with a stock price that’s discounted relative to it’s real value. It tends to be a low-risk approach that resonates with investors who dislike the idea of high-risk investment moves.

Value investing involves being able to figure out a stock’s intrinsic value. The most common key metrics used are the price-to-earnings ratio, price-to-book ratio, total debt level, dividend yield and payout ratio, and earnings growth.

Here’s how each metric is applied to a value stock.

Price-to-Earnings: This ratio is used to determine what multiple investors are willing to pay for the stock. The lower the figure, the cheaper the stock is relative to its future earnings potential.

Price-to-Book: This ratio tells investors how much the stock is currently trading for relative to its overall book value, or value of the company if all assets were liquidated. A low ratio tells investors that the company might be undervalued.

Total Debt Level: Value investors like to identify stocks that have a large cash flow and low debt obligations in order to spur future growth and avoid being saddled with high interest payments.

Dividend Yield and Payout: Most, but not all value stocks come with a dividend yield. It’s important that the company have a low payout ratio though or else it would need to cut its dividend in order to stay solvent.

Earnings Growth: Like all stocks, future earnings growth is ultimately what determines the stocks value.

The Growth Approach

Unlike value investors, growth investors are focused on fast growth – fast enough that the company can outgrow other concerns, like debt. Growth investors aren’t worried about finding cheap stocks whose stock price is discounted, they’re focused on the companies ability to rapidly increase earnings.

The growth approach is seen as a more risky strategy, since most stocks that fall into this category have a high price-to-earnings multiple, which makes them vulnerable to bear markets. Growth is critical – a company that hits a snag or slows down will see its stock price drop quickly. Unlike value stocks, growth stock have far fewer key metrics. The most common ones used in this type of investing strategy are simply the price-to-earnings ratio and earnings growth.

Price-to-Earnings: In a growth stock, this ratio tends to be high, reflecting investors belief that the company will eventually grow its earnings high enough and fast enough to justify the higher multiple being paid.

Earnings Growth: Earnings are everything for a growth stock. A high-estimated EPS growth rate is what drives the stock’s price higher. Companies that can accomplish this make all other ratios irrelevant, since they change radically in a short amount of time.
Whether you tend to investing in value stocks more than growth stocks or vice versa, it’s a good idea to keep a mixture of both in your portfolio. Both strategies have their strengths and weaknesses and neither is necessarily better than the other. The trick is to figure out which type of strategy you should use when valuing a potential stock investment. With practice, you’ll be able to quickly identify which strategy to use and take your portfolio to the next level.

 

 

The Future of Bitcoin and Other Cryptocurrencies

bitcoin-min

The technology industry is arguably the fastest growing segment of the economy and the one industry that can affect all others through innovation and new breakthroughs. IoT (Internet of Things) promises to bring about a new paradigm in the way we live our everyday lives with technologies like self-driving cars and smart tech that can analyze and solve problems before they even become an issue. And, in a world where fiat money is king, the gold standard is gone and banks have the ability to control the money supply, technology has come up with a new way to transact business – cryptocurrencies.

The first and most popular cryptocurrency known as Bitcoin was released in 2009, sending ripples through the banking industry, which didn’t know how to regulate or monitor this new form of currency. Since than, a slew of other cryptocurrencies have been introduced and investors are wondering how they work and whether or not they should be diversifying into them.

The Digital Age of Money

A cryptocurrency is a type of digital currency that uses cryptography for security, making it nearly impossible to counterfeit. It’s also issued independently of a central banking authority, thereby eliminating government manipulation practices. Because of its independent nature, financial transactions between two parties using cryptocurrencies have extremely small processing fees, simplifying the transfer.

The benefits of digital currency that holds an online ledger and comes with a high level of security has caught the attention of major banking institutions, like JPMorgan Chase, who see the benefits of digital currencies and their ability to streamline transaction costs.

But widespread usage of Bitcoin and other cryptocurrencies has yet to take place. Despite the potential, the fact that they behave according to the laws of supply and demand make them extremely volatile. Their radical fluctuations in value have limited their use as a stable store of value, although many merchants, including PayPal and Microsoft, have started to accept Bitcoin as a legitimate means of currency.

The volatility of cryptocurrencies continues to be its greatest weakness, however. According to research done in 2014 by financial analyst Mark Williams, Bitcoin is seven times more volatile than gold and eight times more volatile than the S&P 500.

 

Diversifying your portfolio by adding some crytocurrencies into the mix could help mitigate systemic market risk and create a new type of safe haven asset outside of gold and silver. However, the unregulated nature of the market leaves it vulnerable to heavy swings in volatility, making it a safe haven asset only in the sense that its value doesn’t correlate with stocks and bonds.

Investors considering adding Bitcoin or other type of cryptocurrency to their portfolio shouldn’t invest more than 5 percent of their total assets, the same rule of thumb for investing in physical gold.

How to Spot Potential Buyout Targets

potential buyout targets

When it comes to investing, being the first one to notice something positive before everyone else is the key to making big profits. Value investors pride themselves on spotting intrinsic value in undervalued equities, while growth investors are able to spot long term trends and take advantage of momentum.

While both strategies are valid and serve the purpose of steady returns over time, investing in a stock that get’s bought out at the right moment can have an immediate and often fortuitous effect. These deals are hard to predict and shouldn’t be used as a sole means of investing, but knowing what to look for in advance can improve your odds of owning a stock that could skyrocket in value overnight.

Ripe for the Picking

Companies make deals all the time on Wall Street – sometimes good, sometimes bad. But these buyouts and mergers generally prove beneficial for stockholders of the company that’s being bought. For investors, understanding what makes a company attractive to another is critical in getting the upper hand before anyone else.

The first thing you’ll notice about buyouts is that in almost every case, a larger company buys a smaller company in the same or similar field. For example, a software development company might buy out a smaller competitor to gain market share, or it might want to expand its reach and buy a company that makes processors in order to improve efficiency and broaden their sales base.

For the smaller company, a profitable balance sheet with lots of cash on hand is idea. No company wants to buy something laden with debt, so the fewer debt obligations a company has, the better. It also helps to be under a certain size – general rule of thumb is less than $2 billion. Companies that are too large become difficult to purchase because it means more capital expended or loans to acquire in order to make the deal. Not that these deals don’t happen – anyone who lived through the financial crisis in 2008 saw this with the banking industry.

Finally, a solid buyout target often has market share in a difficult space or occupies a business niche that other companies want. This can be difficult to spot and requires a lot of due diligence and an understanding of the industry environment to get a good read on it.

While finding yourself holding a stock that’s getting bought out can feel a lot like winning the lottery, deals change all the time. There’s a popular saying on Wall Street, buy the rumor, sell the news. In other words, even the hint of a buyout can cause a stock’s price to rise. If the deal goes through, the gain already prices in, but if it falls through, the stock will drop. For investors, that means once a rumored deal is out there and the stock takes off, it might be best to take your profits and move on to the next investment.

Everything You Need to Know about Retirement Planning

retirement planning

Here’s a question for you – what would you do if you no longer had to work to pay your bills? Maybe you’d rebuild a car in your garage, plant a vegetable garden, or maybe you just like the idea of day-drinking on a Monday. It might sound like I’m trying to pitch winning the lottery, but I’m actually talking about something everyone should look forward to: retirement.

Retirement is a dream we all share, but for most Americans, that dream stays in the realm of fantasy. According to Bloomberg, the average American couple only has $5,000 tucked away for retirement. Even worse, less than a third actively participate in an employer-sponsored retirement plan. That’s like being given all the ingredients you need to make a meal, but going hungry anyway.

In order to make your dream a reality, you’ll need to set up a solid retirement plan as soon as possible. If you’re unsure as to what kind of accounts you’ll need, here’s a quick guide so you know how each type works.

Retirement Planning 101

All retirement accounts share some similarities. All allow for investments to grow tax-deferred, which let’s your money compound as much as possible without having to claim capital gains on your tax return every year. You’ll also get hit with a 10 percent penalty fee for making any withdraws before you turn 59 ½ years old, so make sure the money you invest in a retirement account won’t be needed for something else.

The 401k/403b

It’s probably the most well recognized retirement account in the Unite States, and for good reason. The employer-sponsored retirement account allows contributions to be made pre-tax, which helps lower your tax bill immediately. And, depending on your income, it could even drop you down to a lower tax bracket. But the biggest benefit to this type of account in the employer-match feature.

Most 401k’s or 403b’s have a match program that contributes money alongside with you. For example, if your company agrees to pay dollar for dollar up to $100 per month, then as long as you contribute $100 a month, you’ll essentially have $200 a month being put into a retirement account. That means that, even if your investment turns out to have a zero percent return for the year, you’ll still be pulling down a gain of 100 percent.

The IRA/Roth IRA

The traditional IRA operates much like a 401k/403b, albeit without the employer match feature. But before you pass on this retirement account, keep in mind you can have both a 401k and an IRA at the same time. And unlike your employers plan, an IRA usually has far more investment options available, allowing to diversify your portfolio.

The Roth IRA however, is a different sort of animal. Unlike other retirement accounts, contributions made to a Roth IRA are post-tax, which means you don’t get an upfront benefit. But it also means that withdraws you make are made completely tax-free after they’ve grown. Essentially, you could make a $100,000 withdraw after you’ve reached 59 ½ and owe nothing to the IRS.

 

Retirement accounts are the first things you’ll need to set up in order to get your retirement plan started. But you don’t have to stop there. You can also set up a brokerage account and trade stocks, bonds, futures and whatever else suits your investment style. It might not have the same benefits as a retirement account, but the more money you can stash away, the better.

Get started as early as possible and make retirement a reality!