Investment Vehicles Articles

Article / Updated 08-03-2022

The vast majority of bond offerings are rather staid investments. You give your money to a government or corporation. You receive a steady flow of income, usually twice a year, for a certain number of years. Then, typically after a few years, you get your original money back. Sometimes you pay taxes. A broker usually takes a cut. Beginning and end of story. The reason for bonds’ staid status is not only that they provide steady and predictable streams of income, but also that as a bondholder you have first dibs on the issuer’s money. A corporation is legally bound to pay you your interest before it doles out any dividends to people who own company stock. If a company starts to go through hard times, any proceeds from the business or (in the case of an actual bankruptcy) from the sale of assets go to you before they go to shareholders. However, bonds offer no ironclad guarantees. First dibs on the money aside, bonds are not FDIC-insured savings accounts. They are not without some risk. For that matter, even an FDIC-insured savings account — even stuffing your money under the proverbial mattress! — also carries some risk. Interest rates go up, and interest rates go down. And whenever they do, bond prices move, almost in synch, in the opposite direction. Why? If you’re holding a bond that pays 5 percent, and interest rates move up so that most new bonds are paying 7 percent, your old bond becomes about as desirable to hold as a pet scorpion. Any rational buyer of bonds would, all things being equal, choose a new bond paying 7 percent rather than your relic, still paying only 5 percent. Should you try to sell the bond, unless you can find a real sucker, the price you are likely to get will be deeply discounted. The longer off the maturity of the bond, the more its price will drop with rising interest rates. Thus long-term bonds tend to be the most volatile of all bonds. Think it through: If you have a bond paying 5 percent that matures in a year, and the prevailing interest rate moves up to 7 percent, you’re looking at relatively inferior coupon payments for the next 12 months. If you’re holding a 5 percent bond that matures in ten years, you’re looking at potentially ten years of inferior coupon payments. No one wants to buy a bond offering ten years of inferior coupon payments unless she can get that bond for a steal. That’s why if you try to sell a bond after a period of rising interest rates, you take a loss. If you hold the bond to maturity, you can avoid that loss, but you pay an opportunity cost because your money is tied up earning less than the prevailing rate of interest. Either way, you lose. Of course, interest rate risk has its flip side: If interest rates fall, your existing bonds, paying the older, higher interest rates, suddenly start looking awfully good to potential buyers. They aren’t pet scorpions anymore — more like Cocker Spaniel puppies. If you decide to sell, you’ll get a handsome price. This “flip side” to interest rate risk is precisely what has caused the most peculiar situation in the past three decades, where the longest-term Treasury bonds (with 30-year maturities) have actually done as well as the S&P 500 in total returns. The yield on these babies has dipped from over 14 percent in the early 1980s to just a little over 3 percent today. Hence, those old bonds, which are now maturing, have turned to gold. Will this happen again in the next 30 years? Not unless long-term Treasuries in the year 2042 are being issued with a negative 8 percent interest rate. Of course, that isn’t going to happen. More likely, interest rates are going to climb back to historical norms. Interest rate risk has perhaps never been greater than it is today. You would be foolish to put your money into 30-year Treasuries and assume that you are going to get 11.5 percent a year annual return, as some very lucky investors have done over the last 30 years. Chances are, well . . . anything can happen over 30 years, but keep your expectations modest, please.

Article / Updated 08-03-2022

The vast majority of bond offerings are rather staid investments. You give your money to a government or corporation. You receive a steady flow of income, usually twice a year, for a certain number of years. Then, typically after a few years, you get your original money back. Sometimes you pay taxes. A broker usually takes a cut. Beginning and end of story. The reason for bonds’ staid status is not only that they provide steady and predictable streams of income, but also that as a bondholder you have first dibs on the issuer’s money. A corporation is legally bound to pay you your interest before it doles out any dividends to people who own company stock. If a company starts to go through hard times, any proceeds from the business or (in the case of an actual bankruptcy) from the sale of assets go to you before they go to shareholders. However, bonds offer no ironclad guarantees. All investments carry some risk, such as reinvestment risk. When you invest $1,000 in, say, a 20-year bond paying 6 percent, you may be counting on your money compounding every year. If that is the case — if your money does compound, and you reinvest all your interest payments at 6 percent — after 20 years you’ll have $3,262. But suppose you invest $1,000 in a 20-year bond paying 6 percent and, after four years, the bond is called. The bond issuer unceremoniously gives back your principal, and you no longer hold the bond. Interest rates have dropped in the past four years, and now the best you can do is to buy another bond that pays 4 percent. Suppose you do just that, and you hold the new bond for the remainder of the 20 years. Instead of $3,262, you are left with $2,387 — about 27 percent less money. This is called reinvestment risk, and it’s a very real risk of bond investing, especially when you buy callable or shorter-term individual bonds. Of course, you can buy non-callable bonds and earn less interest, or you can buy longer-term bonds and risk that interest rates will rise. Tradeoffs! Tradeoffs! This is what investing is all about. Note that one way of dealing with reinvestment risk is to treat periods of declining interest rates as only temporary investment setbacks. What goes down usually goes back up.

Article / Updated 08-02-2022

Some people are better at bargain hunting than others. What usually separates the clueless from the pros is that the pros know what something is worth. The same is true for finding bargains on Wall Street. You need to know what a stock is worth, and low price isn’t always a bargain. Value investors hunt for bargains, but they buy only after performing some careful research and crunching the numbers. When you spot a stock that seems to be underpriced, ask the following questions to determine whether it’s a real buy: Is this stock down due to market conditions? If the broader stock market is down, possibly due to an economic slowdown or recession, chances are good that most other stocks are down too. If the share price falls but the company’s fundamentals remain strong, this stock may be the bargain you’ve been looking for. (If the market is up but the stock is down, the stock isn’t necessarily a loser. The drop in share price may be an anomaly representing a good buying opportunity. Ask more questions.) When market conditions turn sour, a rational reason for indiscriminate selling is when investors experience a liquidity crisis. Desperate for cash but unable to sell their worst money-losing investments, investors in this situation sell what they can, typically their most liquid stocks and bonds. Often these may be their best investments, but the need for cash forces them to sell. This scenario provides a bargain for the value investor. Is this stock down because of sector news? If bad news comes out of one stock in the sector, traders may flee from stocks in the same sector. If a good company’s stock takes a hit because of another company’s misfortune, that’s a bargain waiting to happen. Is the stock down because it’s not in a sexy industry? At the peak of the tech bubble, anything that wasn’t a technology stock (pretty much anything that functioned as a part of the economy prior to 1980) was considered out of fashion, and their stock prices fell as a result. However, they continued to post earnings and revenue growth. The industrials, manufacturers, food processors, and other standard bearers became value stocks in the late 1990s. Value investors were rewarded for their patience and conviction when the tech bubble burst and investors returned to more traditional companies. Is this stock down because of problems specific to this company? If investors have fled for good reason, sell shares in the company if you own them or avoid buying if you don’t. However, keep in mind that the market tends to overreact and that some negative news can be very short-lived, especially if it’s not true. A passing bit of bad news can trigger a good buying opportunity, but if the news points out fundamental problems in the company’s success or operations, watch out. Be wary of the following: Declining sales or earnings Excessive debt Little or no cash flow Scandal Illegality, such as falsifying documents or insider trading If this stock has a lot of issues, the beautiful thing about the stock market is you don’t have to hang around. Money can stagnate or even rot in a dead stock, but if you sell and put the money into a true value stock, you may be able to recoup some of your losses.

Article / Updated 07-19-2022

Gold is a finite element (literally — it’s the symbol au on the table of elements) and has all the necessary qualities needed as money. It’s durable, portable, and divisible. It’s malleable enough to turn into coinage. It doesn’t decay or tarnish and is indestructible. In ancient times, it became an ideal medium of exchange and a store of value ever since. In short, it’s nearly an ideal form of money, especially when compared to other forms of money (such as paper and digital currencies). When you juxtapose gold against modern world currencies, such as the U.S. dollar, the euro, the British pound, and the Japanese yen, you come away with some compelling points. The following figure provides a snapshot of gold’s price performance since the beginning of this century (as of the first trading day in January 2000). Gold began in early 2000 at a price of $288, and when you measure its performance with the price in mid-2020 (June 30, 2020) — $1,817.50 — you get a 531 percent total gain (sweet!). But how well did gold do against other conventional investment assets? Take a look in the following sections. Gold versus the financial world in general So how did gold stack up versus the titans of the financial world? Gold’s “Tale of the Tape” Asset Price Jan. 2, 2000 Price June 30, 2020 Total Gain/Loss Dollar Amount $ Total Gain/ Loss Percentage % Gold $288.05 $1,817.50 $1,529.45 530.97% Silver $5.29 $18.58 $13.29 251.22% Dow Jones Industrial Average (stocks) $11,501.85 $25,812.88 $14,311.03 124.42% Nasdaq (Stocks) $4,186.19 $10,063.67 $5,877.48 140.40% S&P 500 (Stocks) $1,455.22 $3,100.29 $1,645.07 113.05% Average Savings acct* $100 $120.50 $20.50 20.5% Inflation** $1.00 $1.53 $0.53 more 53% * Assuming a savings account balance of $100 for comparison purposes. ** Inflation rate for the sake of comparison. What would $1.00 buy in January 2000, and what would it cost to buy that same item in June 2020? (source: www.bls.gov/data/inflation_calculator.htm) Well, well, well. The table speaks volumes about the past 20-plus years. How many people knew that gold — a dead rock — outpaced the stock market so dramatically?! Time to break it down: Gold crushed it! Generating a gain of more than 530 percent is awesome — who would have thunk it? It beat everything by a country mile. Our companion metal, silver, came in second place with a 251 percent gain — not too shabby! Next comes the primary stock indexes. Nasdaq came in at 140 percent, then the Dow Jones (DJIA) at 124 percent, with the S&P 500 index coming up at 113 percent. The savings account is there for those folks too skittish at investing and playing the safe route. But safety often means that you settle for a much lower return. In this case, you’re getting an average of 1 percent per year, ending up with 20.5 percent. And it didn’t beat inflation. Inflation — our yardstick and the nemesis of savers everywhere — was up 53 percent for the same time frame. The amazing thing is that the general public barely noticed the blistering performance of gold (and silver, too) during that time frame. The question is, how high can gold go once the general public starts to participate? Gold versus stocks versus currencies You see in the prior section how gold was the 800-pound gorilla in the battle royale versus other mainstream investment vehicles, but it’s important to measure gold versus its primary competitors such as stocks and currencies. In this, you’re comparing “apples to apples.” When you’re comparing gold to stocks, for example, I don’t advocate that you should be 100 percent in one or another. I could put on my “stock hat” and make a strong case for stocks in some economic conditions (such as the 1980s), and I could put on my “gold hat” and make the case that gold is superior in other conditions (such as 2020–2025). The bottom line is I think both stocks and gold are important and needed in your portfolio. The only thing is that you rebalance the percentages of your portfolio between regular stocks and gold-related investments. You keep more in stocks when times are good for stocks and more in gold when times are good for gold. But always have something in gold (say 2 to 5 percent of your investable assets at a minimum), even when it’s not doing as well because it excels as a hedge and a backup form of “portfolio insurance.” Sometimes you don’t see the market crash or financial crisis coming, and afterward you’ll be glad you were diversified and had some gold and/or silver on hand. Gold plays an important role as money and as a hedge against the issues of government-issued money, which is also referred to as fiat money. As this article is being written, all the major currencies — the U.S. dollar, the euro, the British pound, the yuan, the Japanese yen, and other currencies — are losing their value (depreciating) slowly but surely. Some currencies are rapidly losing their value such as those in Venezuela, Zimbabwe, and Argentina (more to come!). The main reason currencies lose their value is because they can easily be overproduced by the country’s central bank and typically at the behest of the country’s political leaders. Because paper currencies are easily inflated, each unit of currency (dollar, euro, yen, and so on) loses value — not so for gold. As the data from the World Gold Council (WGC) confirms, the mining of gold typically adds about 2 percent to the above-ground global supplies of gold. It’s very difficult to extract it from the earth, which is part of the reason gold can retain its value versus central bank–issued currencies. You can use this article to find out how gold stacks up as a tangible investment amidst all the investment choices available today. Part of what makes “money” retain value is scarcity. If it ceases to be scarce and easily created (usually leading to overcreating it), then this leads to its diminishing value. Some gold experts even make it a big point of their speeches that a paper/digital currency will always revert to its intrinsic value, which is “zero.” Gold, meanwhile, outlived every currency in the past two millennia and likely will do so in this millennium.

Article / Updated 07-19-2022

If you’re more interested in cannabis-focused exchange traded funds (ETFs), venture capitalist (VC) funds, or private equity (PE) funds, than you are in individual cannabis stocks, you can find the best tools for tracking down cannabis funds. Most websites and online brokers that feature stock screeners also include an ETF screener, but they rarely include screeners specifically for cannabis ETFs or for VC or PE funds, which makes the Daily Marijuana Observer’s investment fund databases so unique and so useful to you as a cannabis investor. Before you invest in any fund, research the fund manager as thoroughly as you would research the founders and managers of a business. Make sure the person knows the cannabis industry inside and out. A fund’s return depends directly on the people who are choosing where to invest the fund’s capital. What to screen for Screeners typically feature a variety of filters that enable you to focus on securities based on different parameters, such as region or country, market capitalization, price, sector, and industry. You set the parameters and execute your search, and the screener displays a list of only those securities that match the specified parameters. Not all screeners use the same parameters. In fact, the two screeners covered in this article that are most useful for identifying cannabis investment opportunities support very few of the parameters I describe next. However, if you use one screener to find a stock and another to dig up more details about it, having an understanding of these parameters will help. In the following section, I use the Equity Screener at Yahoo! Finance as an example. First up: The major categories When you first access a market screener, you usually enter some general parameters first to start the process of narrowing your list of candidates. For example, if you go to Yahoo! Finance, click Screeners in the menu at the top, and click Equity Screener, you’re prompted to specify the following parameters (see the following figure): Region: Here you enter data about your chosen country to refine your search. If you’re looking for U.S. stocks, the choice, of course, is “United States.” For cannabis stocks, you probably want to focus on the U.S. and Canada, and perhaps Australia, Germany, and Israel. Market Cap: In the Market Cap category, you choose the size of the company—Small Cap, Mid Cap, Large Cap, or Mega Cap. Looking for growth potential? Go for small cap or mid cap. Looking for more safety? Go to large cap or mega cap. Price: In the Price field, enter a minimum and maximum. For example, if you’re interested specifically in penny stocks, you can enter a maximum of $5. Sector and Industry: A sector is a group of interrelated industries. For example, the health care sector has varied industries, such as hospitals, medical device manufacturers, pharmaceuticals, drug retailers, and so on. After choosing a sector, you can narrow your search further by specifying an industry within that sector; for example, if you choose health care as the sector, you can then choose biotechnology or drug manufacturers as the industry. The main event: specific filters After specifying your preferences, you can click + Add Another Filter to display a pop-up menu containing many additional filters broken into several groups, including Fair Value, Share Statistics, Balance Sheet, Income, and Valuation Measures (see the following figure). Using these filters, you can further narrow the list of stocks. Every screener has a different way to access these filters, and some may not offer certain filters. Share statistics The group of filters labeled Share Statistics contains more than 40 stock-related criteria ranging from share price action (the 52-week high or low) to fundamentals, such as total assets or total liabilities. One area I like to focus on is the price-to-earnings (P/E) ratio. This ratio is one of the most widely followed ratios, and I consider it the most important valuation ratio (it can be considered a profitability ratio as well). It ties a company’s current stock price to the company’s net earnings. The net earnings are the heart and soul of the company, so always check this ratio. All things considered, I generally prefer low ratios (under 15 is good, and under 25 is acceptable). If I’m considering a growth stock, I definitely want a ratio under 40 (unless there are extenuating circumstances that I like and that aren’t reflected in the P/E ratio). Cannabis stocks tend to have much lower P/Es than those of well-established companies in well-established industries, because the cannabis industry isn’t mature yet. More private companies have earnings at this point than do publicly traded companies. Make sure your search parameters have a minimum P/E of, say, 1 and a maximum of between 15 (for large cap, stable, dividend-paying stocks) and 40 (for growth stocks) so that you have some measure of safety (and sanity!). If you want to speculate and find stocks to go short on, two approaches apply: You can put in a minimum P/E of, say, 100 and an unlimited maximum (or 9,999 if a number is needed) to get very pricey stocks that are vulnerable to a correction. You can put in a maximum P/E of 0, which would indicate that you’re searching for companies with losses (earnings under zero). Income The Income group offers some important filters tied to sales and profits. Keep in mind that income in terms of sales and profits is one of your most important screening criteria. Sales revenue (called Total Revenue in the Yahoo! Equity Screener) may be expressed in absolute numbers or percentages. In some stock screeners, ranges may be described as something like “under $1 million in sales” up to “over $1 billion in sales.” On a percentage basis, some stock screeners may have a minimum and a maximum. An example of this is if you were searching for companies that increased their sales by at least 10 percent. You’d enter 10 in the minimum percentage and either leave the maximum blank or plug in a high number, such as 999. Another twist is that you may find a stock screener that shows sales revenue with an average percentage over three or five years so that you can see more consistency over an extended period. Profit margin (called Net Income Margin % in the Yahoo! Equity Screener) is, basically, the percent of sales representing the company’s net profit. If a company has $1 million in sales and $200,000 in net profit, the profit margin is 20 percent ($200,000 divided by $1,000,000). For this metric, you’d enter a minimum of 20 percent and a maximum of 100 percent because that’s the highest possible (but improbable) profit margin you can reach. Keep in mind that the data you can sift through isn’t just for the most recent year. Some stock screeners give you a summary of three years or longer — such as what a company’s profit margin has been over a three-year period — so you can get a better view of the company’s consistent profitability. The only thing better than a solid profit in the current year is a solid profit year after year (three consecutive years or more). Valuation measures For value investors (who embrace fundamental analysis), the following parameters are important to help home in on the right values. In Yahoo! Equity Screener, all of these are in the group labeled Valuation Measures: Price-to-sales ratio: A price-to-sales ratio (PSR) close to 1 is positive. When market capitalization greatly exceeds the sales number, the stock leans to the pricey side. In the stock screener’s PSR field, consider entering a minimum of 0, or leave it blank. A good maximum value is 3. P/E/G ratio: You obtain the P/E/G (price/earnings to growth) ratio when you divide the stock’s P/E ratio by its year-over-year earnings growth rate. Typically, the lower the P/E/G, the better the value of the stock. A P/E/G ratio over 1 suggests that the stock is overvalued, and a ratio under 1 is considered undervalued. Therefore, when you use the P/E/G ratio in a stock-screening tool, leave the minimum blank (or at 0), and use a maximum of 1. Price/Book Value (P/B): This ratio compares a company’s market value (share price multiplied by number of outstanding shares) to its book value (net assets of the company). Anything under 1.0 is considered a great P/B value because it indicates a potentially undervalued stock. A P/B value of 3.0 or less is good. Financial highlights In the Financial Highlights group, Return On Equity % is a useful filter. ROE is a good measure of how wisely a company uses its equity (original investment plus any money it borrowed) to generate profits. Because this is an average (in percentage terms) over five years, do a search for a minimum of 10 percent and an unlimited maximum (or just plug in 999 percent). If you do get one that’s anywhere near 999 percent, by the way, call me and let me know!

Article / Updated 07-19-2022

Tools, data, and analysis previously accessible only to investment professionals are now readily available on the Web 24/7 and are better and faster than ever. Many Web sites even provide free stock screeners that enable you to search for stocks by price, dividend yield, price -to-earnings ratio (P/E), earnings per share (EPS), and more. Using the Internet’s rich financial resources, you can quickly whittle a list of 4,000 stocks down to about 25 in less than a minute. Hunting on Yahoo! Finance The first finance aggregator (easily accessible collection of headlines, articles, and other newsworthy materials from a wide variety of sources), Yahoo! Finance remains the king. It’s chock-full of information on every company, with news and commentary from 45 well-known financial Web sites. It also provides personal finance stories and exclusive videos. To narrow your list of candidates, you start by entering selection criteria in Yahoo’s Stock Screener. Go to finance.yahoo.com, mouse over the Investing tab, click Stocks, click Stock Screener, and then click Launch HTML Screener. The Stock Screener appears, prompting you to enter selection criteria. The Stock Screener displays a list of companies that match the search criteria you entered. Click the ticker symbol for one of the companies in the list, and a new browser window opens with charts and information about the stock and the company. Googling on Google Finance Fans of Google can celebrate the fact that in addition to serving as a killer search engine, Google offers an outstanding and very easy-to-use stock screener. To access it, fire up your Web browser, go to google.com/finance and click Stock Screener so that the Google Stock Screener appears. You can start narrowing your list of candidates by entering selection criteria near the top of the page. As you adjust your criteria, Google’s Stock Screener updates a list of all and only those stocks that match your search criteria. (If the list doesn’t automatically update, press Enter after you change your criteria.) For a quick stock price, go to the Google Finance homepage, type the ticker symbol into the search box, and click Search. Shining a light with Morningstar Well known as the one of the best firms for the analysis of mutual funds and exchange-traded funds, Morningstar also analyzes individual stocks. On top of a stock screener and much of the same information provided by Yahoo! Finance and Google Finance, Morningstar also provides a staff of unbiased analysts offering commentary on the markets and 1,700 individual stocks. Check it out at http://morningstar.com/stocks. Finding the real data at the SEC No matter where you get your stock ideas from, the real hardcore data comes from the companies themselves. According to U.S. law, all publicly traded companies must file financial statements with the Securities and Exchange Commission (SEC) every quarter. These quarterly reports contain the company’s income statement, which tells you if the company posted a profit, and its balance sheet, which lists the company’s assets and liabilities. You can also find filings listing all legal stock sales and purchases by company insiders.

Article / Updated 07-19-2022

Here’s how you start thinking about how to achieve your investment goal, whatever it may be. You may be saving and investing to buy a new home, to put your kid(s) through college, or to leave a legacy for your children and grandchildren. For most people, however, a primary goal of investing (as well it should be) is to achieve economic independence: the ability to work or not work, to write the Great (or not-so-great) American Novel… to do whatever you want to without having to worry about money. For now, the pertinent question is this: Just how far along are you toward achieving your nest-egg goal? Estimate how much you’ll need Please think of how much you will need to withdraw from your nest egg each year when you stop getting a paycheck. Whatever that number is ($30,000? $40,000?), multiply it by 20. That is the amount, at a minimum, to have in your total portfolio when you retire. (Or even 25 times, preferably.) Now multiply that same original-year withdrawal figure ($30,000? $40,000?) by 10. That is the amount, at a minimum, to have in fixed-income investments, including bonds, when you retire. We’re assuming here a fairly typical retirement age, somewhere in the 60s. If you wish to retire at 30, you’ll likely need considerably more than 20 times your annual expenses (or else very wealthy and generous parents). Assess your time frame Okay. Got those two numbers: one for your total portfolio, and the other for the bond side of your portfolio at retirement? Good. Now how far off are you, in terms of both years and dollars, from giving up your paycheck and drawing on savings? If you’re far away from your goals, you need lots of growth. If you currently have, say, half of what you’ll need in your portfolio to call yourself economically independent, and you are years from retirement, that likely means loading up (to a point) on stocks if you want to achieve your goal. Vroom vroom. If you’re closer to your goals, you may have more to lose than to gain, and stability becomes just as important as growth. That means leaning toward bonds and other fixed-income investments. Slooow down. For those of you far beyond your goals (you already have, say, 30 or 40 times what you’ll need to live on for a year), an altogether different set of criteria may take precedence. Factor in some good rules No simple formulas exist that determine the optimal allocation of bonds in a portfolio. That being said, there are some pretty good rules to follow. Here are a few: Rule #1: You should keep three to six months of living expenses in cash (such as money market funds or online savings bank accounts like EmigrantDirect.com) or near-cash. If you expect any major expenses in the next year or two, keep money for those in near-cash as well. When you read near-cash, think about CDs or very short-term bonds or bond funds. Rule #2: The rest of your money can be invested in longer-term investments, such as intermediate-term or long-term bonds; or equities, such as stocks, real estate, or commodities. Rule #3: A portfolio of more than 75 percent bonds rarely, if ever, makes sense. On the other hand, most people benefit with some healthy allocation to bonds. The vast majority of people fall somewhere in the range of 70/30 (70 percent equities/30 fixed income) to 30/70 (30 percent equities/70 fixed income). Use 60/40 (equities/fixed income) as your default if you are under 50 years of age. If you are over 50, use 50/50 as your default. Tweak from there depending on how much growth you need and how much stability you require. Rule #4: Stocks, a favorite form of equity for most investors, can be very volatile over the short term and intermediate term, but historically that risk of loss has diminished over longer holding periods. Over the course of 10 to 15 years, you are virtually assured that the performance of your stock portfolio will beat the performance of your bond-and-cash portfolio — at least if history is our guide. It shouldn’t be our only guide! History sometimes does funny things. Most of the money you won’t need for 10 to 15 years or beyond could be — but may not need to be — in stocks, not bonds. Rule #5: Because history does funny things, you don’t want to put all your long-term money in stocks, even if history says you should. Even very long-term money — at the very least 25 percent of it — should be kept in something safer than stocks.

Article / Updated 07-14-2022

Some investors think that “futures and options” and “commodities” are basically the same, but they’re not. Commodities are a class of assets that includes energy, metals, agricultural products, and similar items. Futures and options are investment vehicles through which you can invest in commodities. Think of it this way: If commodities were a place, futures and options would be the vehicle you’d use to get there. In addition to commodities, futures and options allow you to invest in a variety of other asset classes, such as stocks, indexes, currencies, bonds, and even interest rates, often referred to as financial futures. In Wall Street lingo, futures and options are known as derivatives because they derive their value from an underlying financial instrument such as a stock, bond, or commodity. However, futures and options are different financial instruments with singular structures and uses. Futures and options conjure up a lot of apprehension and puzzlement among investors. Most investors have never used them, and the ones who have often come back with stories about losing their life savings trading them. Their negative aspects are slightly exaggerated, but trading futures and options isn’t for everyone. By their very nature, futures and options are complex financial instruments. It’s not like investing in a mutual fund, where you mail your check and wait for quarterly statements and dividends. If you invest in futures and options contracts, you need to monitor your positions daily — or even hourly. You have to keep track of the expiration date, the premium paid, the strike price, margin requirements, and other shifting variables. That said, understanding futures and options can be beneficial to you as an investor because they’re powerful tools. They give you leverage and risk-management opportunities that your average financial instruments don’t offer. If you can harness the power of these instruments, you can dramatically increase your leverage — and performance — in the markets. The futures markets are only one way for you to get involved in commodities. Because they’re fairly volatile, it’s important that you have a solid understanding before you jump in. Although several books deal specifically with futures and options, check out Options Trading For Dummies, 4th Edition. For a comprehensive list of money managers who specialize in helping investors invest in the futures markets, check out Commodities Investors LLC.

Article / Updated 05-26-2022

Many trend‐following trading systems use a moving average for their starting points. In this trend‐following example, the system is designed for position trading, which means you use a relatively long moving average. Short selling isn’t permitted with this simple system. The first step is to define buy and sell rules for your initial testing. The actual code for defining these rules depends on your specific system‐development package. Therefore, trading rules are described as generally as possible. The rules for an initial test may look like this: Buy at tomorrow’s opening price when today’s price crosses and closes above the 50‐day exponential moving average (EMA). Sell at tomorrow’s opening price when today’s price crosses and closes below the 50‐day EMA. To test whether using a moving average as a starting point is a good idea in a trend‐following system, apply these two rules to ten years of historical data for the stocks of your choice. After testing this idea, you find that this simple system works fairly well when stock prices are trending, but it’s likely to trigger many losing trades when the prices of stocks are range bound. You can try to avoid these losing trades, and possibly improve your overall trading results, by filtering out trading‐range situations. One way to accomplish that goal is by changing the buy rule to read as follows: Buy at tomorrow’s open when the following conditions are true: Today’s closing price is above the 50‐day EMA. The stock crossed above the 50‐day EMA sometime during the last 5 days. Today’s 50‐day EMA is greater than the 50‐day EMA from 5 days ago. These added conditions serve as signal confirmation. When you test these rules, you find they reduce the number of whipsaw trades for most stocks, but they’re also likely to delay buy and sell signals on profitable trades and thus usually result in smaller profits on those trades. However, this adjustment makes the overall system more profitable because the number of losses is reduced. You can find out whether other changes that you can make in your simple system can actually improve profitability. You may, for example, test different types of moving averages. Try, for example, a simple moving average (SMA) instead of an exponential moving average (EMA). Or you may want to try using different time frames for your moving average, such as 9‐day, 25‐day, or 100‐day moving ­averages. Identifying system‐optimization pitfalls Most system‐development and testing software comes equipped with a provision for system optimization, which allows you to fine‐tune the technical analysis tools used in your trading system. You can, for example, tell the system to find the time frame of the moving average that produces the highest profit for one stock and then ask it to do the same thing for a different stock. Some systems enable you to test this factor simultaneously for many stocks. Although this approach is alluring, using it is likely to cause you trouble. If you find, for example, that a 22‐day moving average works best for one stock, a 37‐day moving average works best for the next stock, and another stock performs best using a 74‐day moving average, you’re going to run into problems. The set of circumstances leading to these optimized results won’t likely repeat in precisely the same way again in the future. It’s almost guaranteed that whatever optimized parameters you may find for these moving averages won’t be the optimal choices when trading real capital. This is a simple example of a problem that’s well known to scientists and economists who build mathematic models to forecast future events. It’s called curve fitting because you’re molding your model to fit the historical data. You can expend quite a bit of effort fine‐tuning a system to identify all the major trends and turning points in historical data for a particular stock, but that effort isn’t likely to result in future trading profits. In that case, your optimized system is more likely to cause a long string of losses rather than profits. Testing a long moving average and comparing the results to a short moving average is fine, and so is testing a few points in between a long moving average and a short moving average. As long as you use this exercise to understand why short moving averages work best for short‐term trades and why longer moving averages work better for traders with longer trading horizons, you’ll be fine. Otherwise, you’re probably moving into the realm of curve fitting and becoming frustrated with your actual trading results. Testing with blind simulation Blind simulation is a method for setting aside enough historical data so you can test your system‐optimization results and avoid the problem of curve fitting. For example, you may test data from 1990 through 1999 and thus exclude data from 2000 through the present. After you’ve developed a system that looks good enough for you to base your trades on, you can then test your system against the data that was excluded. If the system performs as well with the excluded data as it did with the original test data, you may have a system worth trading. If it fails, you obviously need to rethink your system. Another approach is choosing your historical data with extreme care. You can expect trend‐following systems like a moving‐average system to perform well during long, powerful trends. If your stock had a strong run up during the long‐lasting 1990s bull market, that kind of price data can skew your results, magically making any trend‐following system appear profitable. Whether that success actually can be duplicated during a subsequent bull market, however, must first be thoroughly tested. If the majority of your profits come from a single trade or only a small number of trades, the system probably won’t perform well when you begin trading real money. You may want to address this problem by excluding periods from your test data when your stock was doing exceptionally well or when the results of any trades were significantly more profitable than the average trade. This technique is a valid approach to eliminating the extraordinary results arising from extraordinary situations in your historical data. Using it should give you a better idea of your system’s potential for generating real profits in the future.

Cheat Sheet / Updated 05-03-2022

Make smart trading decisions using candlestick charting. This cheat sheet shows you how to read the data that makes up a candlestick chart, figure out how to analyze a candlestick chart, and identify some common candlestick patterns.