Soullfire's Mission: Financial Freedom!

Although you could have easily missed it with all the news about Tiger Woods and his auto accident, or the White House party crashers taking up the majority of the air time, there was some very interesting financial news the past week.

Dubai, the play city for the wealthy, has run into financial problems due to plunging real estate values and has asked its creditors for a delay in its debt repayment schedule. Okay, so the fact that Dubai is in danger of defaulting on their debt and facing bankruptcy is just the first part of the interesting news.

The next part, which I find even more interesting, is the fact that none of the other United Arab Emirates (UAE) initially stepped up to "save the day" and even stated that they wouldn't be stepping in for any bailout. How about that? Forcing Dubai to take responsibility for their own debt problems - what a novel concept!

Could that be a lesson for how the US and Europe should regard corporate debt problems? It would seem it's a lesson they still aren't ready to learn as the financial markets responded by falling last Friday and the major complaint/question repeated over and over again by the talking heads on financial and news media was "why wasn't the UAE going to bail Dubai out?"

This type of mindset angers me to no end. How is it that banks and corporations feel they are entitled to special consideration and being bailed out for the "good of the markets", and yet these same banks show little to no mercy for their own individual customers like homeowners who fall behind on their debt payments. Their level of hypocrisy knows no bounds, and is a clear example that the harsh realities of accountability don't appear to apply to rich corporations. It disgusts me.

Meanwhile, the news media would rather keep you updated on fluff news like Tiger Woods, and White House parties instead of news that could actually have an impact in your life. This is why you should NEVER depend on the news for advance warning- by the time it's becomes "worthy" of their attention, it will be too late to do anything about it.

Here are some of the questions you should be asking about the Dubai situation since most news media isn't doing it:

1) How does this affect me or my investments?

Just because Dubai is half a world away is no guarantee that their actions have no global impact. The failure of US investment bank Lehman Brothers last year should make that very clear.

2) Could this crisis impact my country?

All investors in Dubai could be impacted - which includes many international banks and investment firms. How much have these corporations loaned to Dubai- which translates into how much of their capital is at risk?

3) What does this say about the remaining "systemic risk" out there?

Think Dubai is the only city-economy in dire straits? Think again. Could there be other cities or nations on financially shaky ground?

4) Why does the news ignore this story for the most part?

You can find news on Dubai if you're on the financial news network or online service, but good luck finding it on regular TV news, where they would rather compete with Entertainment Tonight or TMZ, rather than give you useful information.

5) How does this affect overall market risk in general and risk to my investments in particular?

By effectively gauging risk, you will be ahead of the curve in keeping your long term investments safe from severe market turmoil.

Friday, 27 November 2009

*** Attention Bulls ***

*** Attention Bears ***

It should be obvious by now that the market will often behave independently of what the current market forces and economic conditions are. This can leave one at a loss for how to engage such a market rationally while still limiting the level of risk.

On the Bullish side:

Many of those who have subscribed to "buy and hold" have been burned badly as the market plummeted. Parts of the market has bounced back from the March lows, but other segments are still languishing.

On the Bearish side:

Many shorting or expecting the market to collapse have been stymied by the continued run up from the March lows with no sign of weakening. Anyone attempting to short this market has most likely been in a losing campaign.


In both the bullish and bearish scenario's listening to the news would not have helped you make sound decisions in the short term as there has been a mix of both positive and negative information, and not only that, the market seems to ignore the information most of the time.

In my research, I've found that the best way to invest in this market is to accept that fact that the market is bipolar, meaning its normal state isn't rational- either everything is great, or everything is rotten.

The next step is read the current financial data and make your own projections where the market "should" be going. You'll have to determine this yourself as the news always presents conflicting information and will only confuse you if you don't have a good grasp of the current state of the economy. This will tell you where the market is headed eventually- and here, the key word is EVENTUALLY- it could take some time for this to happen so consider it an "extended forecast".

The last step is to understand "Trend Line Analysis" and "Support and Resistance" areas specifically as well as the art of technical analysis in general. You will need to know this area in order to determine when to buy or sell.

So putting it together, we have three main components to achieve success:

1) Accept the market is irrational (Bipolar)
2) Determine the "extended forecast" of the market.
3) Know Trend line and Technical Analysis

This is how you put them together for more successful investing experiences:

Knowing the "extended forecast" of where you think the market is headed will be invaluable for your long term (at least 1 year or more) investments. It will provide you with an early alert on whether you should be adding to your position or reducing it and moving it somewhere else. If done right, you should be able to avoid being caught in major market crashes as well as keeping your assets in stronger investments.

For short term trading/investing, knowing where the market is headed with your financial extended forecast information won't be as helpful due to the bipolar nature of the market. The market has the uncanny ability to keep moving in one direction regardless of the current financial conditions. There is also an abundance of automatic computer trading going on which makes decisions on other things besides current news. The media, looking to explain any market movement with current news only adds to the confusion and you wind up with ridiculous "can't lose" scenarios. Here's one example:

The national unemployment numbers for October went up to 10.2%, which was higher than expected, but the market was seemingly unaffected and rallied. The financial news media stated that the market rallied because that higher unemployment number means interest rates will remain low. This makes no sense as the negative of a higher unemployment rate is of a higher magnitude that the positive of lower interest rates. Now on the other hand, had the unemployment number been lower than expected, the market would have rallied and the media would have proclaimed that it was due to signs that the recovery was taking hold, ignoring the interest rate angle altogether. Therefore no negative scenarios exist in this case that would result in a negative market move. This makes no sense in a rational market, but behaves as expected in a bi-polar market.

The way around this situation in the short term is to focus primarily on technical analysis (TA) instead of the news. If TA dictates the trend is up, go long. If TA points down, go short. In each case include a protective stop loss trigger as a risk limiter. This technique should keep you on the right side of trades in the short term while you're waiting for your long term forecast to come to pass.

Long time readers know my investment philosophy subscribes to the old axiom- "If you want something done right, you have to do it yourself."

At the end of the day, the person who has the most to gain or lose from your investment nest egg is you- not a financial adviser or any other person offering investment help.

Well, a study was done that compared the investment returns of those who used investment advisers and those who didn't, and the results were very interesting. On just the surface view and analysis, those who had a financial adviser manage their assets appeared to have superior performance and lower risk compared to those without an adviser. However it was found that financial advisers are more often paired with older, richer clients rather than younger, less affluent ones. Taking these differences into account results in a different outcome. From the study:

"Once we control for different characteristics of investors using financial advisors, we discover that advisers actually tend to lower returns, raise portfolio risk, increase the probabilities of losses, and increase trading frequency and portfolio turnover relative to what account owners of given characteristics tend to achieve on their own."

Now this makes sense when you think about it. Financial firms are going to give their older, wealthier clients their best financial advisers to keep them from going to another firm. The newer, less experienced/seasoned advisers are more likely to be assigned to smaller accounts that correspond with a younger investor with smaller assets. This results in these accounts being the "training grounds" of newbie/inexperienced financial advisers, with often mediocre or poor returns to show for it.

When it comes to investing talent, not all financial advisers are the same.       

The study concludes:

"Based on the findings, it should not be taken for granted that financial advisers provide their services to small, young investors typically identified as in need of investment guidance. Indeed, the opposite is true. Even if advisors add value to the account, they collect more in fees and commissions than they contribute."

The bottom line is you are not automatically well served letting someone else manage your money. If you don't want to manage your money, the key is picking a good financial adviser, and to do that, you need to have at least a solid basic understanding of investing yourself. I know it's easy to say we're too busy and to ignore boring things like finance and basic investing skills, but then again, we ALL want to retire early with lots of money- we can't have it both ways.

How to Invest

As a start the easiest thing to do is invest in the index funds like those that follow the S&P 500 or NASDAQ. Your investing will then directly follow the market indexes for better or worse, with no financial adviser needed. From a long term perspective, the market has been historically bullish so it works out.  That would get you started as you learn more about the market and investing. The best time to use a financial adviser is when you are savvy enough about investing to know what you want to do, but don't have the time to do it, so you can give your financial ideas to the adviser and let them execute it for you.

How to Spot a Good Financial Adviser

How can you tell if a financial adviser is good or not? You can ask to see their track record of performance. As a quick check, you can ask them how they fared in the market from 2007 - now. We have seen some turbulent times in the market which serves as a great litmus of the true skill set of the financial adviser in question. Compare their performance to that of the market index funds. If they can't beat the index fund performance, then they aren't adding any value with their management skills, and should be avoided.

Today marks the one year anniversary of Lehman Brothers' failure, the largest bankruptcy in US history, which began the acceleration of the chain of events which led to Wall Street's worst crash since the Great Depression (so far).

At this point we can look around and see if any lessons have been learned by the banks.....

....and the current answer looks like....NO.

We still see the same uber $$$ salary structures in places that reward risk-taking over performance with safety. The surviving banks are now even larger and have an even bigger claim to being "too big to fail". We shouldn't really be shocked at this, since the banks have shown us that they can't be trusted to govern themselves to the point of near suicidal risk taking were it not for the government rescue.

Now the government has begun discussing how to unwind itself from these institutions as well as creating new regulations to keep banks from taking on excessive risk.

Of course the banks don't want any new regulations as that would mean less profits, so they will push back. Expect to see banks start barraging the airwaves with anti-government commercials trying to stop any changes from happening beyond the most superficial.

Their task won't be easy since the effects of their risk taking are still being felt all around, but they will try. I sincerely hope we're smart enough to let let them succeed in keeping the status quo in place.

This year I'm ahead of the time curve and managed to completed my tax calculations for 2008. I paid extra care in making sure I included everything so as to avoid any more unintended "stimulus notes" from the IRS such as my experience last year.

Well comparing the current years return with last year's provides some interesting info for my short term trading account......

In 2007, I traded stocks amounting to $300K in transactions. Note, I said "transactions", not sales, as in I didn't make $300K...although that would have been awesome if I did.   For 2008 my stock transactions went up to over $3 Million - a great than 10X increase.
The explanation for that has to do with the fact that I added more money to my account so I had more liquidity to do extra trades, and I had less overtime at work which allowed me to spend more time focusing on trading.

Now for performance: in 2007 my net return was about 15%, and my goal at that time was to improve on that. Well, 2008 was the year of Wall Street's meltdown so was I able to get a better return? The answer is...my return for 2008 was over 35%!!  Not only that, but it would have been even more had I not taken some big losses in day trading mistakes.

The time I was able to spend indulging in additional trading has painted a clearer picture of where my strengths lie. I now know that I don't really excel at "day trading", as in buying and selling stocks on a minute by minute basis constantly watching the stock chart during the day. In my opinion, it's too close to Vegas style gambling and comes with all the emotional excitement - and emotions are a bad thing when it comes to trading stocks. My biggest losses last year were the result of day trades going from bad to worse. The worse thing is, I look back and can clearly see they were stupid trades from a longer term view. As punishment, I made a "play by play"chart of those big losses so I can always see them and never forget what happens when you make stupid mistakes.

On the other hand, I also now know where I my true strength in trading lies - longer term position trading. This is where you analyze a stock and make a forecast for it's future movement based on current business and market conditions. It typically takes longer for trades to pan out - on the order of weeks to months, so there's no day trading immediate excitement, and in reality that's a good thing. The excitement comes later if your trade performs as expected and results in a good profit.

My goal for this year is to take what I learned from all that trading last year, and apply it to this years trades. It's all about striving to gain the superior skills that come from combining book smarts with actual experience. Even in today's rocky economy, there are a ton of opportunities to make money in this market.