Cuapa Asset Management

Archive for the ‘Advanced Investing’ Category

A lot of people who invest don’t realize that although holding investments may often be better than straight cash, they may not give the greatest yield unless careful thought is made in how to purchase them. Here are a few strategies for different investments that you should consider when purchasing them.

Stocks—Value Investing

Value investing is one of the safest ways to invest in equities while ensuring a massive return over time. It has been used and time-tested by investors like Warren Buffett and Benjamin Graham, with great results.

The idea is simple: Ignore all of the technical charts of a company’s market price, since they mean nothing. Instead, focus on the basics as though you were buying an everyday business, because that’s exactly what you are doing when you become a shareholder.

Look at the balance sheet of the company. Is it earning well? How has it earned for the past five or ten years?

What about the product the company sells? Is it really a stable product to be selling? Consider that plenty of tech stocks were booming in the late nineties, simply because of the credit bubble which had formed, but that in a normal economy, nobody would need them. On the other hand, a company whose sales consist of the basics like food, oil, and metals, is usually a much more reliable long term in investment.

After determining that a company sells a needed product and has been competitive for a long time and will be in the future, and has a record of positive earnings, look at the book price, which is the actual value per share of the company that a stockholder would get if the company was liquidated today. If it is less than the market price, or only slightly above when one considers the current earnings per share, it is likely a good buy and it will maximize the return on investment over time.

Mutual Funds—Value Investing

Mutual funds don’t require much explanation. Since they usually consist of mostly equities, it is important to apply the same value investing principles as when purchasing stocks. Examine the holdings of the mutual fund, and if there are too many overvalued stocks in the company compared to the fund price, you should avoid investing money in the fund.

Bonds—Real Return

Cash is rarely a good way to hold currency these days because it is no longer backed by gold or silver, so it is subject to inflation and a loss of its value over time. People often buy bonds because they are stable and give a set interest rate, but they don’t realize that if the inflation rate varies, the bond’s interest varies in a hidden way.

For this purpose, it is advisable to purchase real return bonds. Real return bonds are adjusted for changes to the CPI, and therefore their interest remains constant since it is based on the real original purchasing value of the bond.

Many are attracted to be investors because they feel bullish about an investment and want to buy it, hoping that they can cash out in the future for a greater amount. But what if someone believes the economy is in the tank and they would rather bet that an investment will fall in its value over time than rise? As luck may have it, this kind of investor is able to do so through a process known as short selling.

There are two types of investing related to equities: Long and short. Long selling means that the trader is buying the stock and holding it. Short selling means that the trader is selling shares of the stock which the seller borrows from someone who holds the shares, with the intent to cover the short sale of those stocks at a lower market price in the future.

The difference between the two sales is that an investor who goes “long” believes the stock will be bullish, while an investor who goes “short” believes the stock will be bearish. An investor who goes “long” has no future obligations because they own the shares they purchased, while an investor who goes “short” has to repurchase the same amount of shares they sold in order to return them to the person they borrowed them from.

If a share price goes up, the short seller loses money, whereas if it goes down, the short seller makes money. Here’s an example of how short selling works:

Assume Joe Trader thinks the price of Widgets Incorporated on the Imaginary Stock Exchange is going to plummet in the next few weeks. Joe decides to sell 10,000 shares of the company at $1 each, which puts $10,000 into his portfolio, and makes Joe liable to purchase 10,000 shares in the future to cover his short sale. It turns out that Joe Trader was correct, and Widgets Incorporated drops down to $0.40 per share. Joe purchases 10,000 shares at the new market price of $0.40 each, for a total of $4,000. The amount he originally sold the stocks for ($10,000), minus the amount he had to pay to cover the shorted stocks ($4,000), comes to $6,000, which is Joe’s profit on the trade.

If, however, the stock price shot up to $1.50 and Joe got nervous and had to cover it, he would end up paying $15,000 to cover 10,000 shares at the market price of $1.50, and would have only originally gained $10,000. This would result in a loss of $5,000 for Joe, but a trader who went long on the same trade Joe shorted would profit $5,000.

Remember, short selling can be risky since the investor does not actually own the shares that they sell and is therefore not able to weather unforeseen market fluctuations like someone who goes long. Make sure you only short a stock if you have enough money to cover it at a loss without going into severe debt.

So you want to get into stock trading, but you don’t have enough cash to make any meaningful gains even if you were to call the market correctly every day for a month. Fortunately for you, it is possible to trade buy stocks on margin, enabling you to maximize your gains even if you only have a couple thousand dollars to invest.

So what exactly is margin trading? Margin trading involves purchasing stocks on credit from the trader’s broker rather than with the funds a trader already has in his account. The margin trader uses equity or cash in his account to “leverage” his portfolio by using it as collateral to invest more cash than he actually possesses. Most brokers have a few requirements:

-Creditworthiness. A credit check is often run on prospective margin traders to ensure that they can pay their debts. Make sure that prior to applying for a margin trading account, that you don’t have any outstanding debts which you have failed to make payments on.

-Suitability for the trader. Brokers will want to know that you aren’t getting in over your head. Build up some time on a cash account basis first so that you have some experience to fill out on your trading profile and the broker will be willing to give you the higher trading level of “margin.” Otherwise, they may want to stick you in a cash account first prior to letting you make riskier trades.

-Minimum opening balance. Because margin trading would be useless without being able to cover the commissions, most brokers require a minimum balance to trade on margin. This can range from $1,000 to $2,500 or even higher depending on the broker and the region’s exchange regulations, so make sure you have enough to meet the minimum opening requirement.

-Initial margin. You must initially have a minimum of 50% collateral for your margin trade within your account, as required by law in US trading accounts. Your broker may require that you have even greater collateral when you initially purchase the stock.

-Maintenance margin. Under US law, you must maintain at least 25% collateral for the stocks you hold on margin, but as with the initial margin, brokers may increase this requirement.

The creditworthiness, trader suitability, minimum opening balance, and initial margin requirement are all fairly straightforward, but what happens if the stock falls and the trader meets to meet the maintenance margin requirement?

Failing to meet the maintenance margin means that there will be a “margin call” by the broker. The broker will force you to sell the holdings you have to protect against complete loss, and you will have to cover the losses by paying back the broker.

Remember to ensure that your stock is not so volatile that you could quickly fail to meet your maintenance margin requirement and be forced to cash out prior to the upswing of your investment. This will protect you against constant losses and no gains.