Many of the comments in my articles have surprised me by asking what are relatively fundamental questions in regards to investing. It's taught me that the audience of this site is not only financial experts.
In my quest to provide alpha for all investors, novice to expert, this is a look into everything I've learned in over thirteen years of being involved with finance and investing, condensed into 17 concise points that all investors can hopefully benefit from. These are my definitive 17 cardinal rules for investing success.
1. Carry a Considerable Dividend & Cash Position
When managing any amount of money, two of the most conservative strategies that you can take are placing money into blue chip stocks that pay out handsome dividends and keeping cash available. Dividend stocks are generally reliable, but you want to make sure you're investing in companies that have been around for many years, are extremely stable, and are extremely low risk. Here are 19 things to love about dividends, if you're not sold on them yet.
Keeping a large cash position can be beneficial for a couple of reasons:
- If you're using an interest-bearing account, the money is accruing interest (albeit, probably a very small amount).
- You have money to invest with, should an opportunity arise. Nothing worse than getting a great strategy in place and then having to sell off another position you also like and aren't ready to sell to enter a new one -- you can throw that commission money directly down the toilet.
- If you're using an FDIC-Insured account especially, but even otherwise, it's almost completely risk free. One less chunk of money for you to have to worry about. That frees up space on your mind for due diligence and analysis of new ideas.
Other low risk items you can put into this category include commodities like gold & silver, bonds, and conservative mutual funds. You can buy these items directly, or through ETFs.
2. "Fade the Public"
"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."
- Warren Buffett
In sports betting, when one side of a game is overwhelmingly being bet on by the public, the line on the game moves. Similar is the way the price of a stock moves in accordance with the demand. More sells than buys, price moves down. More buys than sells, price moves up.
"Fading the public" simply means doing the opposite of what the public's doing. It's important to not blindly just do the opposite of what the public's doing; the public creates important trends that need to be respected and noticed. In the world of sports betting, the benefit is usually a couple extra points on a line; in finance, the benefit is usually a cheaper share price to buy at or a higher share price to sell at. Keeping your emotions in check is vital, as I'll discuss later. These strategies play off the emotional instability of the common investor.
Keeping yourself in this mindset of doing the opposite of the public is how big money makes money, and how you can, too. The sooner you start to think like one of the sharks, the less chance you have of becoming eaten alive.
3. Watch for "Coincidences"
In regards to Celsion, I spoke about how ahead of a binary event, I watched what appeared to be a massive sell-off and ignored my instincts, remaining long. It cost me. I commented:
A 900k share order goes off at market, destroying the bid and causing a halt. Could this have been someone wanting to make their exit quickly? With the pending class action investigation now taking place, I'd be interested to see the results of a full investigation of when the company actually had the data in hand in comparison to the analyst downgrades and "bear raid". I hate that I'm even writing that, as someone who truly believes in the integrity of the company and executives; and their mission. But sometimes, if it walks like a duck and talks like a duck...again, "there are no coincidences".
On Knight, I commented about the day of their fund-crippling algorithm error:
I knew something was wrong at Knight Capital the day of their algorithm error, because the stock was getting crushed down to $9 on massive volume almost an hour before the story ever even hit the newswire. After investing long enough, I've started to learn, "there are no coincidences". I was able to trade the Knight disaster accordingly just by watching the volume. I took my short position, they released the news, the rest is history. The pre-news trading tipped me off. If you don't think there were insiders that dumped into that news, then I have some real estate in rural Alaska to sell you.
As I state above, these were two massive signs; one I followed and made some substantial money, one I ignored and lost money on. The market is chaos, this is true, but there is a cause and an effect to everything that happens in the stock market. Pay attention to these "coincidences" and follow in the direction they lead you.
4. Always Hedge
In life, we hedge. We carry car insurance, homeowners insurance and life insurance. We want to be prepared for type of disaster that life may throw at us. It's important to take this concept and carry it over to your investing portfolio.
Methods of Hedging
There are countless numbers of ways to hedge, using ETFs, stock positions and options.
- Against a long position, one might acquire cheap premium put options to protect against the value of the equity that one is holding.
- Against a short position, one might buy vanilla calls or write puts.
- Ahead of a binary event, one might play an options strangle or straddle, even in conjunction with taking a position in the equity
- Sector-wise, diversification. Money spread across several sectors protects against an industry crippling event.
- Money-wise, more diversification. Utilize bonds, funds, stocks, options, futures and commodities to make sure your style doesn't get too aggressive or conservative. Maintain balance.
When hedging, it's important to understand your potential loss in each situation. There are no real situations where you're guaranteed to make money, unless you're already in the money on a position. Things like options spreads offer the feel of guaranteed wins sometimes, but the seductive nature of those positions often leads to people scratching their head when occasionally their entire position is wiped out. Do your research.
5. Beware of Binary Events
What is a binary event? A binary event is simple, it's an upcoming event that is going to have two possible outcomes: one potentially to the extreme upside and one potentially to the extreme downside.
Examples of Binary Events
- Heavily watched and sought after earnings report
- Biotech stock waiting on FDA approval of a drug
- Company awaiting a necessary financing to continue operations
- Awaiting the results of serious litigation
Two of these I touched on in an Instablog post recently. On coming up to Apple's (AAPL) last earnings, I stated:
Volatility and emotion have never been more pronounced than in this past week following earnings. The stock is trading consistently well above it's 22 day and 100 day averages; the blogs and analysts are screaming bearish and bullish arguments at each other more so than pre-earnings, showing that the war over Apple is still waging on.
For equity traders, I like buying Apple shares long here with dividends coming up on 2/7/13 to the tune of $2.65/share. It's never been a better time to pick up cheap shares of Apple that you can write contracts against.
For options traders, I like a straddle with plenty of time value built in. Consider the March 13 $440 options. Options guru Dr. Terry Allen pointed out this strategy pre-earnings, but I think it holds value post-earnings as well. As of 1/28 pre-market, $440 puts are trading at $20.30 and calls are trading at $18.85. This puts your breakeven points at $479.15 and $400.85 with about seven weeks of trading to go. This is a great opportunity to pocket from both sides of this straddle due to the fact that Apple is heavily covered and moves quickly on news. (see: iPhone 5 supplier orders cut news before earnings that moved Apple down 6%).
I then discussed a massive binary event for Celsion :
What does this mean for traders? It means the implied volatility on the stock is massive (as are the option premiums accordingly), but with this being either a total success for the company as a whole or total implosion for the company as a whole, we can expect the $7 price tag on Celsion stock to not last through the end of this upcoming week. This investor thinks that price targets of either $1 or $20 depending on the news are not too farfetched.
There was money to be made on both of these binary events. Investors need to understand that binary events have an extreme effect on the price of a stock. If you don't know some of the smart ways to play binary events (this investor loves options spreads or writing options that have massive premiums due to volatility built into the intrinsic value), take your position off the table and get out of the way.
Binary events carry massive upside potential, but also massive risk. You need to know when these are going to occur for positions you hold so you can plan accordingly. You don't want to be on the long end of bad news or the short end of good news without ever having a clue that it was coming down the pipe.
6. Know Your Fundamentals & Be Vigilant
"Risk comes from not knowing what you're doing."
- Warren Buffett
Before you get into the investment game, you have to know your basics. Investing is a fun, lucrative and dynamic way to spend your time. For people that have the itch to gamble and the love of money, it's unrelenting, seductive, calculating and vicious in its appeal.
Having said that, it's a big boy & big girl adult game that is played. The losses are every bit as painstaking as the gains are amazing. One minute, you can feel like you're cheating the world with how much money you're making; the next, you could be wondering where it all went wrong. The market is an extremely unforgiving teacher.
Listen up, maggots. You are not special. You are not a beautiful or unique snowflake. You're the same decaying organic matter as everything else.
- Fight Club
Even if you don't think you are, you are part of the mass pool of money that makes up retail investors USA. Everything that you're looking at has already been looked at fifty times over by some analyst somewhere at a fund or firm. You are one of the sheep. Your retirement accounts and your hard earned money that you've saved with your blood, sweat and tears are gambled with on a daily basis by banks.
It's probably what you don't want to hear, but you need to know this going into the game. You also need to know that if you don't understand what the fundamentals of the market are, you don't belong anywhere near it. Put your money in a savings account, and grow it the old fashioned way.
You need to have a super firm grasp on all of these, at bare minimum:
- Long vs. Short
- Bid vs. Ask
- 52 week highs and lows
- What a derivative is
- Market Cap
- Earnings per Share
- Share Structure and why stocks trade at the price they do
- Balance Sheets, Income & Cash Flow statements
- Regulatory filing requirements with the SEC (8-Ks, Form 4s, 10-Qs, 13-D, etc)
If you can't explain all of those to someone right now, simply, you don't belong with money in the market. The market is a destitute cesspool, full of dirty tricks like market manipulation, naked short selling, cellarboxing stocks, and derivatives.
The financial world is a dark world that exists on backstabbing, complex vocabularies and secret handshakes. These things all occur under the cloak of secrecy in the secret fraternity that is Wall Street, and if you don't have even the least bit of education on the fundamentals going in, you'll never understand the complexities; and your life savings will be systematically bilked from you and will go towards some billionaire's landscaping bill.
"Listen, here's the thing. If you can't spot the sucker in the first half hour at the table, then you ARE the sucker. "
7. Be Aware of Charting & A Couple of Basic Technical Indicators
I've laid out in a previous article exactly how I feel about charting:
Charting, as I often state, is a love/hate relationship. I dislike it because I don't like the notion of trading a company based on the chart without the fundamentals, but in the computerized algorithmic world of trading that exists nowadays, it's a necessary evil. You have to think like a machine in order to make moves that will preempt computerized runs and raids of stocks -- and that's why I think charting is a necessary evil.
I'll be frank. My use of charts is strictly supplemental to the way I trade. The most value I've found in charting is with these three technical indicators, as defined by Investopedia:
- RSI (Relative Strength Indicator): A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. It is calculated using the following formula:
RSI = 100 - 100/(1 + RS*)
*Where RS = Average of x days' up closes / Average of x days' down closes.
As you can see from the chart, the RSI ranges from 0 to 100. An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued.
- Stochastic Oscillators: A technical momentum indicator that compares a security's closing price to its price range over a given time period. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. This indicator is calculated with the following formula:
%K = 100[(C - L14)/(H14 - L14)]
C = the most recent closing price
L14 = the low of the 14 previous trading sessions
H14 = the highest price traded during the same 14-day period.
%D = 3-period moving average of %K
- Moving Averages: An indicator frequently used in technical analysis showing the average value of a security's price over a set period. Moving averages are generally used to measure momentum and define areas of possible support and resistance.
It's important to hammer home the sentiment that I use charting as a supplemental tool, and you should do the same, too. Never base decisions strictly on how a chart seems to look -- RSIs can stay oversold/bought, stochastics the same. There are no definites with charting and technical analysis, don't forget that.
8. Know When Not to "Chase" & 9. Know When to "Chase"
The saying is "never catch a falling knife" and there are tons of instances where companies take dives, find what appears to be a bottom, and then plunge even further into the abyss. Traders get crushed daily trying to play quick scalps on bounces after losing on a long position or trying to buy into rallies to cover a short position. Real investors make their money by frontloading or frontselling; buying or selling ahead of the market. Getting caught the wrong way in a trend can prove to be brutal for some traders who are too hardheaded to concede defeat in a position. There are times to cut losses and move on to prevent disaster or ruin.
Conversely, there are times to do just the opposite. If you're extremely long a position, meaning you believe in it long-term (and the company's fundamentals are sound -- like Apple), dollar cost averaging can be one of your finest resources as an investor, and can yield you serious profit from it.
Analysis of the fundamentals is the key here. If the fundamentals are concrete on a company that's just taken a loss, dollar cost averaging can be the right move. Again, on the other hand, you don't want to get caught trying to jump in the back end of a trend to make a quick buck without doing fundamental research and getting burned.
10. Apply Common Sense to Your Positions
"Why not invest your assets in the companies you really like? As Mae West said, 'Too much of a good thing can be wonderful'. "
- Warren Buffett
If you consider yourself a sensible, logical person who prides themselves on their common sense skills, this is a great segue into your portfolio.
Invest in the things you see everyday, have to purchase and like purchasing, and will be around for a while. The products you buy and use every day contribute to the wellbeing of the company that you're invested in. Help your own cause and go long on the items, companies and CEOs that you're comfortable with.
Almost all of my position and involvement in Sirius (SIRI), was because I felt I had a good read on Mel Karmazin and someone who absolutely loathed failure and was constantly on overdrive for success. In an article about Sirius, I wrote:
I held long Sirius a long while ago, before the merger and before Liberty bailed them out. I was lucky to ride the stock from pennies to near the $2 region, where I exited. I was always long-term bullish on Sirius; I loved Mel Karmazin, the original merger man. There was an intangible about Karmazin that I supported -- he seemed hell-bent on success, stood his ground against media titan Sumner Redstone, and brought with him a track record of success in radio that started as early as the late 60s.
Karmazin and Liberty CEO Greg Maffei traded quips upon him leaving Sirius; Karmazin claiming he'd be too expensive for Liberty to keep him on and Maffei claiming that no CEO is irreplaceable. With the stock at a significant multi-bagger since my first long sentiments, the introduction of Pandora (P) in recent years and the powerhouse CEO stepping down, I started to think about getting back into Sirius, only with a short position this time.
The point? Make your decisions based on the people and products that you like. Your instincts often lead you down the correct path in this regard.
11. Know How to Leverage and When
Investopedia defines leverage as:
Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses. In the business world, a company can use leverage to try to generate shareholder wealth, but if it fails to do so, the interest expense and credit risk of default destroys shareholder value.
Leverage is extremely important if you're a small investor, like myself, looking to make moves. A classic example would be if you had $5,000 that you wanted to invest in Apple, you'd be able to purchase about 10 shares. On margin, about 20. Instead of purchasing the equity, you can purchase 20 options contracts, which carry substantially more risk but now give you control over 2,000 shares of Apple.
Use leverage responsibly to help continue to build your portfolio to a point where you hopefully no longer need the undue risk it carries.
12. Due Diligence is Your Right as an Investor
"If you don't study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards."
- Peter Lynch
No matter what company you're invested in, remind yourself that by holding a position in that company you are taking ownership of a certain percentage of the company. Similarly, take ownership of your investment by doing as much due diligence as legally available.
Pride yourself on furious, unrelenting due diligence. Crunch the numbers, then crunch them again. Then again. Use the products the company makes, visit headquarters if they offer tours, and utilize investor relations to get editorialization on filings and things you may have questions about. Those resources are there for you as an investor, and being scared to use them results in you missing out on potentially important information.
13. Always Take Profits
You don't lose money any time you take profits. Read it again : You don't lose money ANY time you take a profit. Novice investors see profit in their account sometimes and proceed to just stare at it, allowing this unrealized gain to sit, gestate, and eventually disintegrate. Too many people wait fruitlessly for their profits in one position to make them their entire fortune. This almost never happens.
No matter what an investor or analyst tells you, we're all guilty of it. Starting out, with no basis in reality, you wait and wait and wait for stocks already in green to make even bigger percentage gains, never pulling the trigger to sell. When you see enough green to meet your preset caveats, pull the trigger and sell. Make your moves with discipline and precision; the investor with a plan makes money while the meek and unplanned are annihilated.
Emotion plays a part here, as I'll discuss later. People sometimes make the mistake of getting attached emotionally to companies, and, while there's sometimes exception to this rule, disciplined traders are cutthroat -- taking profits wherever, whenever, and however they can.
14. Aggressively Monitor Your Investments
The ever prolific and eloquent hip hop artist Snoop Dogg once thoughtfully quipped the following well thought out financial:
"I've got my mind on money and my money on my mind."
Though I'm not quite sure that Snoop Dogg has a firm grasp on how his 401k may be currently performing versus the Lipper average, he's got the general idea down.
As an investor, you need to be on top of what's happening with your positions every single day. Ever look at a trading desk picture and think that 15 monitors is a bit overdone? It's not. There's infinite sources of news and analysis on the positions you hold, and your job is to let that information all permeate your head on a daily basis. Know what your company's chart looks like, know the latest SEC filings inside and out. Know what their latest press release was, what their average volume is, and how they're trading in relation to all of that right now.
Know that as you sleep, things are taking place overseas that are going to shape the way that your investments react the following day. In other words, keep your mind on your money and your money on your mind.
15. Separate Emotion from Your Trades
Emotion is what prevents real success for many novice traders. Emotion is the catalyst behind making trades that make no sense on paper. Emotion is why people sell off positions after the crash and why they baghold buying at the tail end of rallies. Emotion makes idiotic things run through your head, like:
"This stock may never stop going up! Better get in no matter what cost!"
"This company is doomed! We are going to zero right here, right now, on this crash!"
This may seem like idiocy when you read it now, but even the savvy investors know this voice still comes out in their head when they're in the midst of a rally or crash.
As an investor, I love playing the opposite trend of the public a lot of times and will often buy on bounce plays and short into a buying panic. While I consider the 40% increase to be alright and somewhat priced in correctly, today's buying is strictly on hysteria and mania. The ask is being systematically mowed down today as retail buyers watched the spike earlier in the week and want to be on the next Netflix gravy train to leave the station. At almost ten times its 22-day volume average right now, it's safe to say that the retail buying bubble is getting so big, it's not long before a correction.
To be fair, after a short correction, Netflix is still trading about where it was when I put this article down. The point, however, is to show that like anything else in the economy, stocks face bubbles of being overbought and oversold. Emotion creates these bubbles, and you need to be the one to realize when it's happening, so you can be on the upside. Times like these are the times to leave emotion at the door.
16. Realize that Analysts Always Have a Stake in the Game
As much as I hate (read: love) to bash Jim Cramer in two successive articles, he's the pinnacle example of this rule. Much of the public was absolutely flattened when they watched his interview a couple of years back on the Daily Show. In this interview, Jon Stewart played back for Cramer a YouTube video of himself openly admitting to making up and disseminating rumors about about companies when his hedge fund was short them. This was the public's first glance into the dirty work that goes on behind the scenes at hedge funds; if they knew the down and dirty details, jaws would drop all the way to the ground.
The lesson I hoped the public learned from this is that 95% of the people feeding you advice; whether it's here on Seeking Alpha, on CNBC, or in the Wall Street Journal all have agendas and positions that they're trying to make money on. Believing these people disclose these positions all the time is laughable. Take everything, including what I write, as a sales pitch. Go in as a skeptic and question motives. Again, finance is a lesson in cutthroat 101.
17. Trust Yourself and Your Decisions
This was the first and most devastating lesson I ever learned. The first time I ever made an investment was thirteen years ago when I walked into my local A.G. Edwards office with a pocket full of $1,700 in cash and asked a typical, middle aged, greasy looking broker to put all into a company that I picked. It was a company that I had loved and adored for years and even though it was going through hard times, it was a product I used and a CEO that I believed in. It was a company I would eventually go on to work for a couple of years later.
At this point in my life, I knew nothing of investing, and I let this broker talk me into putting my money into the QQQ index fund and two other companies aside from the one that I wanted in. He claimed the company that I wanted all of my money in was in turmoil and ruin, a terrible investment. I argued for the company, defending their recent product line and CEO change. But, knowing precisely nothing about the market aside from the fact that there was a company that I supported and wanted to help out, I listened to him. $200 in commission later, I walked out of the office, already down over 10% without even knowing it. I made barely any money on what I held and cashed out several years later.
Need a reminder to trust myself that I carry on an everyday basis? At the stock's 52 week split adjusted high, my $1,700, if left alone for 13 years would have been worth an astounding $470,000. That's 453,000 reasons that I remind myself to trust decisions. On the heels of that, I remind myself daily that no one knows what the market is going to do definitively. It's a mystery that we're all trying to decode, but what you should take from this story is this one simple fact:
If all of these people out there can find success in the market, you can too.
Go forward with confidence now. I hope this article has given you at least one or two new nuggets of information, and I look forward to hearing your feedback. Best of luck.