Starting Out

Why Invest?

TraderTan — Thu, 10 Jan 2008 23:01:31 -0800

Why would a person want to spend extra time learning about investments when he does computer programming for a living?!

I suppose that before reading this article, you would already have some answers to that question.

Investments is a very large term that emcompass things such as buying properties, investing in unit trusts and mutual funds, trading in shares, and even founding a business. All that they have in common, is just one thing: The desire that over time, whatever time and financial capital you have invested would significantly appreciate.

To be able to appreciate investments, we would have to look at the concept of active and residual income. In one of the more popular personal finance book, 'The Cashflow Quadrant' by Robert Kiyosaki, he talks about 4 different groups of people with their philosophy on generating income.

Active VS Passive Income

Basically active income is when you are paid linearly and instantly for the work you have done. An example would be, you work for 1 hour at a job that pays $10 per hour, then you would have earned $10. Or if your work pays you $2000 a month, then that is your active income. Simply said, active income is what you get when you are doing something. The other side of it, would be active income is what you don't get when you are not at work.

Passive income, is used to describe income that is paid when you may not be working on it at that point in time. Certain examples of these would be writing a book, coming out with a patent, creating a business, putting money into investments, etc.. For most of these, you would have to put a large amount of initial effort which pays very little (compared to active income proportionally), but as time passes, the income would continue paying even after you have finished the job.

When Robert Kiyosaki says that people who are on the left hand side of the Cashflow Quadrant(namely the employees and the self-employed) can't become wealthy, what he is trying to say is that you can't be depending on your work income all your life. Which makes sense really.. I don't think most people would want to be depending on work income when they are 80 years old.

Strategies

So the question would be, how do you build an asset that gives you enough income after X amount of years?

Of course, you could just take a proportion of your income every month and stash it under the pillow. 30 years later, you start to draw down on that income. Well, that might work, but theres really no passive income there and if you are living in places like Zimbabwe (with a hyper inflation of more than 900%) or a more moderate country like China (with inflations of 6-8%), those stash of notes under your pillow might not last you very long.

The next better way would be to put it in your bank account. Savings account in Singapore typically pay up to 1% per annum. While inflation usually tend to be lower than 1%, the growth rate isn't going to give you a spectacular amount of passive income. Assuming you would be able to live on $1000 per month, that would mean you need $1.2million in the savings acocunt to give you that.

Power of Compounding

One of the reasons why you should invest young is the power of compounding. When you put capital into an investment, the capital would generate a return year after year. But thats not all! The returns that you get after the first year, also generate a return for the next year onwards, and so forth.

Looking at it another way, lets compare 2 people and their lifetime savings habit. Peter does a lot of part time work and likes to read up on investments. Starting at 15 years old, he started to save $1000 a year in an investment that gives him 12% per year. After 10 years, he decides to enjoy life. Not putting a single cent into his investment account, he spends all his money travelling, partying and slacking. He did keep his investment account and swears not to ever touch it.

Bob is a good friend of Peter. Having been caught up with fashion trends and consumerism, he spends all the money he earns on toys, gadgets and parties. When he reached 40, he woke up. Both his parents are retiring and they barely have any money in their retirement account. He panics and then starts to save $10,000 every year for the next 25 years of his life.

Guess who has more when they are both 65 years old? Peter, after putting away $1000 a year for 10 years, has $1.6million by the age of 65, whereas Bob who scrimped and saved $10,000 per year for 25 years only has just under a $1million. While both of them aren't exactly going to struggle through retirement, but its obvious how the 50 years of compounding has helped Peter with his money.

Of course, 12% may sound wildly optimistic, but imagine if you invested continuously since you were 15 years old till you are 65 years old.

Earlier on, we looked at the different types of investments you can do. Now's the most important question, why stocks?

Stocks is a fairly interesting instrument actually. Its simple enough to understand, its easily accessible to most, if not all people. You don't need $300,000 to buy a position in stocks. (unlike a private hedge fund) Coupled with low transaction costs and the fact that the companies listed are companies you see in you daily life, it just makes sense to invest in Singapore stocks!

What is the stock market?

TraderTan — Fri, 11 Jan 2008 04:20:31 -0800

What is the stock market? To some people, it is a gold mine. To others, it might be a strange place that does not belong in their 'world' and thus, something that should not be explored. And to the rest, its basically a legal casino.

Stocks, in a very general concept, represent ownership in a company. A stock market is not unlike a wet market where you bought your groceries from. The only difference, is that the people wear suits and they don't smell like fish.

Buying stocks in a stock market is very much like buying apples. Everyday, when the stock market opens, people who want to buy apples or sell apples will then gather in a large open field. Everybody's very civilised here, so they will queue up. At the front of the queue, it will be a big signboard saying how much this particular queue of people are willing to buy or sell apples at.

Lets say that today apples are currently worth 50cents. At the side where people want to buy apples, there are people lining up in the 49cents queue, the 48cents queue, the 47cents queue, and so on. On the side where people want to sell apples, there are people lining up at the 51cents queue, the 52cents queue and so on.

When a buyer who is queuing up decides he's really hungry and he wants an apple now, he will then go to the 51cents seller and buy the apples from him. Likewise, if a seller really wants to sell an apple, maybe because he ate apples for the past 20 years of his life, he goes to the buyers at 49cents, and sells to them his apples. When that happens, the price transacted at will be known as the last done price.

And that would only be for apples, which is liken to just a single company on the stock market. Thus, the stock market on the whole, is just like a really really huge wet market, with tons of different kinds of fruits, and thousands of buyers and sellers everyday.

How to trade on the Singapore stock market?

TraderTan — Sat, 12 Jan 2008 07:14:29 -0800

The stock market is a place where companies offer shares to public. What this means is that when you buy a share, you own a part of the company, in terms of any future gains or losses.

Its sort of like pooling money together to start your own company, but on a much bigger scale. And unlike your own company, the shares you buy are usually a very very small fraction of the total number of shares available.

In Singapore, a scripless system is used. What this means is that, unlike the old days where you will have a certificate whenever you buy shares in a company, all the shares you buy is accounted for electronically by The Central Depository (CDP).

However, you don't actually buy or sell shares through the CDP. Instead the trading of shares is done on an exchange. In the case of Singapore, it is the Singapore Exchange Ltd (SGX).

Even then, to make things more complicated, you are not able to open an account with the SGX. You would have to open an account with a member firm, or also known as a stock brokerage company.

So basically, to trade on the singapore stock market, you go to any of the brokerages(as listed on the links) and tell them you want to open an account. At the same instance, you would actually open an account with the brokerage firm, and also apply for an account on the CDP.

Very simple.

Or is it?

Choosing a brokerage house

TraderTan — Sun, 13 Jan 2008 06:17:30 -0800

Setting up an account to buy shares in Singapore, is actually a relatively simple process. You just have to walk into any of the brokerage houses (Some of them even have branches in the heartlands!), say you want to open an account, and the nice lady will hand you all the forms to open an account.

And forms, primarily is the brokerage account form, CDP form, and also an electronic payment for shares (EPS) form. This is primarily to let you pay from any ATM or internet banking rather than sending them cheques everytime you wanna buy something.

In short: Walk in, say you want to open an account.

The more pressing question would be, since there are so many brokerage houses, which one should you choose?

Over the last few years, the entire banking and finance industry in Singapore went through quite a number of shake ups, mergers and acquisitions. What used to be Vickers Ballas became, DBS Vickers. What used to be OUB Securities, Kay Hian, and a few others, eventually became UOBKayhian. As such, whats left, is pretty much the list you see on the left.

Just a quick summary, we have:
DBS Vickers (Part of DBS)
UOBKayhian (Part of UOB)
iOCBC (Part of OCBC)
Kim Eng (Independent)
Goh Direct (Used to be GK Goh, bought by CIMB Malaysia)
P.O.E.M.S (Part of Philips Capital)
Fraser (Independent)
DMG (Linked to Deutsche Bank)
Lim & Tan (Independent)

We would not delve into details regarding foreign brokerage houses in Singapore, simply because it would be difficult to open an account with them. (And if you are opening an account with them, then this article's not for you!)

In terms of choosing a brokerage firm, theres actually quite a bit to consider. In fact, if you don't mind the hassle of visiting all of them, you should open an account with everyone of them. Reason being that each of them tend to have a certain set of specialties. Also, given that the market has become relatively competitive, most brokerage houses do not require you to place a deposit if you are going to open a cash account.

So, as a retail trader/investor, what should you look for in a brokerage house?

Broker

Personally, I feel the broker would be one of the key criteria. Usually, there will be a person, called the broker, who will manage your account. Given the competitive environment, most brokers do provide additional value added aspects in order to retain you with them. Some include a form of trading journal, which allow you to see how they would choose stocks. Others could be regular reports sent straight to your mailbox. Some brokers tend to be more of value traders, others could be momentum traders, so after corresponding with them for a while, you might know if their style is similar to yours. (Of course, no harm learning different ways)

Research Reports

As mentioned above, brokers usually would send you certain reports. Usually, the brokerage houses would also have their own reports available online for their clients. For those, you have have to judge for yourself. A good report, delivered at a correct time, can help you make informed decisions on any investments or trades.

Internet Trading Platform

Well, face it. Most of the people here, would most likely be trading over the internet. It has proven to be the most accessible and cheapest way to trade. Most of the brokerage houses have significantly different features on their platform. Seriously, the only way to see if you like it is to open an account and try it out.

Certain things to consider would be if the platform is catered to your use? As a long term investor, you might not have too much need for speed, but might prefer more alerts or research reports. To a trader, you might have a preference for certain tools. We would discuss more about the tools in another topic on another day :)

IPOs

Initial Public Offering (IPOs) can also be a consideration. Certain brokerage houses have a higher likelihood of giving you IPO shares. This mean you don't have to go to the ATM to ballot for those shares. Usually houses that take on underwriting of IPOs would have some placement shares for their own clients. Don't be afraid to sound off to your broker that you want IPO shares. Usually, the more you trade, the happier your broker is, the more likely you will get IPO shares. But don't be afraid to ask, even if you don't trade much through them.

Commissions

Most brokerages in Singapore offer fairly similar commission charges. Usually, through online/internet trading, it would be $25 minimum or around 0.275% to 0.28%. If trading through a broker, it would be around $40 minimum or around 0.4% to 0.5%. However, if you are a frequent trader (meaning $50k trade size, or high trading volume per month), you would usually be able to negotiate for a lower rate. Like 0.2%

In this article, I've just highlighted a few points to consider in choosing a brokerage house. However, if you don't mind the hassle, it can really be better if you were to open an account with all of them to try out their system.

Personally, I have an account with quite a few of them. But over time, you would tend to drift to the platform and broker you are more comfortable with.

Investment styles I (Time)

TraderTan — Mon, 14 Jan 2008 22:28:41 -0800

So what kind of investor are you? Are you a typical 25 year old with not much spare cash, some debts, willing to take lots of risk, and will put in money every month? Or are you a 50 year old, semi retired, got $500k in the bank, and looking for stable but not necessarily high returns.

Those are some of the questions you've gotta ask yourself before you start to invest. Questions pertaining to: Time horizon, Risk portfolio, Active/Passive investing, types of research, amount of capital, etc..

While I won't go into all those topics on personal finance (for now), lets just look at how all these factors do affect your investment styles.

Time

Time is a very important element of investments. It is time that actually gives us the exponential growth of the compounding effect. As you would have already read about the compounding effect in the first article, you can see how making profitable investments as early in life can result in a large fortune 30-40 years down the road.

When most people talk about time in investments, they usually look at the time horizon. This basically means, how long are you able to hold the investments for. This doesn't mean how long are you going to hold the investment for. It just means, given that all the conditions for that particular investment is correction, will you continue holding it for 1 year, 5 years, 10 years? An investor with a long time horizon might decide to get out of the investment after 1 month, because he decided that the conditions present when he first made the investments is now gone. An example could be investing in the middle east could have been a good investment for the long term, but suddenly when there is a war, then it would probably be prudent to get out of there.

Just looking at this, it can generally be said that younger people would have a longer time horizon than older folks. A person can't just base his time horizon on that though. Perhaps, you are 25 years of age, and you are looking to get married in 5 years time, have 2 kids, and planning to buy a condominium. Then in fact, for a large part of your capital, your time horizon is only about 5 years at most.

On another aspect, time is also a factor in deciding your investing style. That is, your trade time span. Here would be where you determine if you are a day trader (who is someone who buys and sells within the day), or a buy-and-hold investor (someone who buys and hold till he dies). Of course, you can be anywhere in between, from the scalpers to the swing traders, to the sector players, to the cycle traders. Lets look at some of them.

A day trader is basically a person who does not hold any position overnight. The idea of this is that you are not able to quantify the external risk caused by the overnight movements. So the day trader might buy a stock in the morning, and sell it buy lunchtime, or maybe before market closing.

A scalper, is a specialised typed of day trader. The idea behind that of a scalper is to catch small movements that happen regularly in the day, by taking huge positions. For example, a scalper might buy a stock at 50cents, and sell it at 50.5cents. Though, he would probably buy a huge amount to justify his time and effort in that trade.

A swing trader, is a person who believes prices have some form of momentum behind it. Thus, he might buy a stock, and hold it for a couple of days, to a week or 2 at most. He would exit the position when he feels that the momentum behind it has waned or reversed.

A cycle trader/sector player, believes that the market moves in cycles or waves. As such, he would try to position himself at the beginning of a cycle/sector and ride it all the way to the top. Most of the time, the holding period could be days, weeks, or sometimes months.

A value investor, could be a person that seeks for companies that seem to have its value mispriced to the market. As such, he tries to position himself into such stocks, and would sell of when the stock becomes fairly priced. These kind of plays, are usually weeks to months usually.

A buy-and-hold investor, someone like Warren Buffet, is someone who believes that only companies with future growth potential should be bought, and that companies currently in vogue should not be bought just because its the new hot stories. To someone like him, its basically companies that will survive the economy for many years to come. Such investors, generally buy good companies, and plan to hold it forever, while collecting any dividend payouts and capital growth.

While the descriptions above seem to be fairly rigid, traders and investors actually fall into many categories at the same time.

Investment styles II (Risk)

TraderTan — Wed, 16 Jan 2008 00:35:43 -0800

In the earlier article on investment styles, we talked about time. In this article, we will be looking at risk.

What is risk? Risk essentially just means uncertainty. When something is deemed high risk, it just means you are very uncertain of the outcome. For stocks like Singapore Post, they are deemed low risk, because you are pretty certain on the outcome. Do note this really does not say anything about the returns.

When a person invests, what he wants to do is to obtain as high a return while risking as little as possible. While it might sound obvious, most people actually do the opposite. They take big risks, and when the stock does turn a small profit, they take the profit and run.

And because of the fact that people have different risk profiles, it results in a few types of investment styles.

Scalping, as we mentioned in the first investing styles article, involves placing large amount of money for a small profit. At first glance, it may look risky, but it fact, since most professional scalpers have strict cut loss, the uncertainty factor is really not that large. Especially since they would be playing with the momentum in their favour.

High probability, short term trading, is another style that has become popular. The basic concept behind this is that you want to catch many short term trades with a high probability of profits, but that the profits are not necessarily high. A great book to read on this style would be "Street Smarts: High Probability Short-Term Trading Strategies"by Laurence Connors & Linda Raschke.

Low probability, long term trading, is a style that is used quite often in system trading. An example of this would be the turtle trading system. The concept behind this is that while you do control the risk you take by having cut loss, and that you would actually have a very long string of losses before you actually get a winning trade. But when you do get a winning trade, the profits from that trade would more than cover all the previous losses. There is a free ebook available online. Go google.

Multibaggers doesn't exactly explain risk control, but it is similar to that of low probability long term trading. In this case, it can be said that there isn't really any risk management per se, because you are so sure of the stock that you are willing to hold it over the bad times, until it turns a multi triple digit percentage returns. A multibagger is called a multibagger, because a one bagger basically mean the stock turned a 100% return. So a multibagger is a stock that turned multi triple digit percentage return.

Arbitrage is a very interesting form of trading. In a true arbitrage, risk is zero. How can risk be zero if you are investing? In an arbitrage trade, essentially you will do a series of trades immediately when you decide to take a position, such that the profits is actually secure when you made the opening trade. This is different from the other methods above, because in the above examples, profit is only made when you close the trade. How does this work? Just a simple example. Imagine you have a friend that promises to buy stock X from you at $1, 1 month later. Today, you found someone willing to sell it to you at 90cents. So, the moment you can get your friend to promise to buy from you the stock, as well as purchasing the stock at 90cents today, your profit is locked the moment you open a trade. When you close the trade, all you do is unwind that position. Of course, true arbitrage is more complicated than that. I suggest you read a book if you want to know more.

A book I would really recommend in term of risk control is "Trade Your Way to Financial Freedom" by Van K Tharp. A very very good book on psychology, risk management and position sizing.

Investment styles III (Research)

TraderTan — Fri, 18 Jan 2008 10:14:48 -0800

In the earlier 2 articles on time and risk, basically that is about how you invest, or trade. After choosing a certain time horizon, time span, risk profile and risk management style, you decide on how your investment style is like. When you start talking about research, that determines how you decide your entry, exit, and what you look out for in your investment style.

Generally speaking, there are 2 main investment research styles. Fundamental Analysis is the art of looking at a company's management and finances, and possibly future potential, before deciding if the price is right for buying. Technical Analysis is the art of looking at the price movements of the stock, before deciding if the timing is good. However, just by saying that 2 statements, is barely scratching the surface.

Fundamental Analysis

Fundamental Analysis, as mentioned, is the art of looking at a company's (or country's) management (or economic condition), financial statements, competitive advantage. This can include many things like its competitors, its credit risk, etc.. This is done mainly by looking at its historical performance, and by using that as a basis of forecast, attempt to predict the company's future potential. Usually it is in this form of analysis where you will see financial ratios such as Price/Earnings (PE), quick ratio, sales turnover, price to book value, etc.

The basis behind fundamental analysis is also one that makes sense. That, while a market might misprice a stock over the short term, if the stock truely has value in it, then eventually the correct price would be reached. Thus, different types of investment styles will develop.

Buy and Hold investors basically believes in looking at the company's business and management, and if it can be seen that there is a large future potential for that business, they would buy into it. In that sense, they look upon themselves as co-owners to the business and that they are going to hold a stake in the company for a very long time. The best example for this is Warren Buffett. Warren Buffett believes into buying simple businesses, with fantastic management. As such, he managed to build huge stakes into companies such as Coca-Cola, See's Candy, American Express, Gillette.

Value investors are investors who find specifically for companies that are undervalued relative to the current price. Such cases could happen because of obscure businesses, or that the company has assets worth more than the total value of the shares, or that it was irrationally affected by broad market sentiments. As compared to buy and hold investors, value investors are looking for companies undervalued at present. Buy and hold investors, tend to look more at the future potential.

News investors are investors who look at immediate developments in the economy or sector, and tries to see how it would affect companies. An example could be looking at the growth of China, and decide that the shipping or commodities industry might be worth looking at. In a sense, they look at where the near term growth potential will be at, and focus at that area. And while a company might be a good company with great management and vision, it might actually languish for a long while. As such, most news investors like to look for catalysts. Catalysts, or events which sudddenly cause a stock or sector, or economy to come into the spotlight.

Technical Analysis

Technical Analysis, is the art of looking at the stock's current and historical price movements, before deciding if the timing is right. Over in this type of analysis, you would see things like candlesticks, fibonacci, chart patterns, moving averages, etc..

The proponents of technical analysis also have a pretty strong argument. The key point being that, a stock price is not related to a companies value. And that it is a number driven primarily by supply and demand and the psychology of the investors in the stock market.

Indicators are used quite frequently for analysis. Most charting softwares, comes with indicators such as stochastics, moving averages, histograms, volume, bolligner bands, etc.. Such indicators can be used for various objectives, such as measuring the momentum of the market, anticipating reversals of market trends, etc.. An example of using indicators could be, when the short moving average line crosses above a long moving average line, the trader buys the stock, and vice versa. We won't go into details here. Watch out for the future articles on Technical Analysis.

Chart patterns is a very interesting concept in technical analysis. Many analyst have observed that because the market is driven by market supply and demand and also by herd instinct, there are certain patterns formed in the prices. The observation behind this is that price movements of a stock is not a random process, and that while a market is made of many individual participants, it actually has a kind of intrinsic memory which 'remembers' certain prices. Such examples of this is when a price approaches a certain level, it tends to reverse, or have difficulty moving through. Thus, concepts such as support lines, resistance lines, fibonacci lines, head and shoulders formation, flag and pennants, triangles are created.

Statistics is yet another way of technical analysis. Statistics, or also called quantitative finance, believes that prices can be constructed into a model. A model that uses mathematical formulas, derivatives, and probability theory, to obtain future prices. Though not so commonly used by retail investors, quantitative finance has become a large part of robotic trading in an investment bank, especially when all you have to do is hire masters graduates and program a big supercomputer that does trading all by itself.

While the many types of investment styles seem so diverse and different, most investors and traders usually use more than 1 style at the same time. The question now is, what is the style that would suit you?