Why you should invest in the stock market? Simple, financial freedom. What other investment form can you start off with $500 and possibly turn it in to millions. It’s a story you heard of 1000’s of times before.

You don’t have to open a corporation, have accounts and spend $1000 of dollars to open a store front, no products to buy, no employees to hire. You simple open an account with an Investment broker and you’re on your way. But what stocks to buy? First, knowledge is power, read, read & read. There are so many investment books out there to choose from. I would say three books on learning growth stocks, three on learning earnings reports and three on learning charting. The reason I suggest three books is that it will give you a few different views in each area and from the three of them you’ll be able to put your own winning strategies together.

After you read all the books you may find that you excel in one of them better then the others, for me it was the charting. It was like wow I can see it. What a turn on to look at a chart and say this company is going up or down in just a couple of minutes. It’s a feeling I would like all of you to have and once that happened for me I went out and got as many books on charting as I could find.

I have a friend who can read an earnings report as well as I can read charts. It’s amazing to see him work as he runs through the numbers like a machine. I came to the conclusion that everyone has their own strengths and weakness’. So after you read all the books, whichever one turns you on the most, consider on buying as many books as you can (or go to the library). I love the market and I hope you will to.

The DOW Takes Another Beating

After last week’s 512 point loss on Thursday, it was able to gain back 70 points on Friday. Standard and Poors released a report Friday night as to downgrading the United States credit rating from it’s traditional “AAA” rating down to “AA” rating with a negative outlook. S&P stated that they feel that the politicians in Washington DC have shown their incompetence towards working together and saving the deficit from getting worse. Over the weekend, S&P’s remarks about if the federal government doesn’t get a grip on it’s fiscal irresponsibility, they (S&P) may feel to lower the credit rating again within the next two years.

After all the weekend news and the lack of President Obama coming out to speak about the report, Wall Street and investors alike realize that the economy recovery that Obama has been talking about for the last two years is nothing but a charade. The DOW took an even bigger plunge today falling 632 points after it was all said and done. The DOW closed at 10,809, down 5.55% just for today’s trading period. Since July 21, just two weeks ago, the DOW has lost nearly 16%. A drop like this hasn’t been seen since the recession started almost three years ago. NASDAQ has lost over 6% just today alone and the S&P 500 shaved off 6.66%.

I’ve been talking about this day coming for almost a year. Yes there have been some great moves in the stock markets over that time, but unless you took all your money out of the markets two weeks ago, you lost all that was made during that time. There are many that think that they’re not involved in the stock market, but as they will find out soon enough, what happened on Wall Street these past two weeks has caused many people a major portion of their retirement fund and/or their pension. trillions of dollars of wealth have been lost in just a short period of time and with the actions of our politicians, who really knows how long this crap is going to go on. Japan went through the same thing almost twenty years ago and they’re just coming out of it now. The sad part about that is the fact that Japan is small when compared to the value and size of the United States of America.

We will have people, many of them part of the baby-boomer generation wanting to retire and not being able to cause to the damage to their retirement accounts. they will (in many cases) have to continue working a few more years to make up for the losses they’ve been dealt in these past few years. In turn it will make it harder for the younger generation to find employment, especially since the economy is so bad, that it will keep the unemployment rate somewhat in the same range it’s been in since Obama has been in office.

For those of you that are wondering what to do, if you’re young, keep doing what you’ve been doing as to putting money into your 401K and retirement funds. If you are within retirement age (15 yrs or less), I wish I had all the answers. Each person’s life is different and their needs during the later years differs from one to another. For the next two years (at least) I recommend buying into commodities. The U.S. dollar is going to continue to lose value as the Federal Reserve tries to save the economy with another round of quantitative easing (QE3). Gold and silver are the best hedge when face with these types of economic woes.

Gold Climbs Above $1600

Only three weeks ago I spoke about the price of gold falling below $1500 per ounce. What I said was if the economic woes continue even with all the hype of how our economy is improving, I expect gold prices to keep climbing. I also said that I don’t trust any government at this time.

Today gold prices climbed above $1600 after eleven straight days of climbing because of fears of the federal government will not be able to raise the debt ceiling. The precious metal hit an all time record high against the Euro and sterling. Gold has been strong ever since Europe has been trying to bail out Greece for the second time and to avoid the European debt crisis. Add to the fact that the Obama Administration and Congress have been unsuccessful in coming to an agreement to raising the debt ceiling.

If you didn’t think it could climb any higher, I would seriously take a look at the technical charts which seem to point to gold moving above $1700 as soon as this fall and many think a move to over $2000 per ounce isn’t too far fetched as it once was.

When you think about adjusting for inflation, gold is still not as high as it could be in relation to the price in 1980 near the end of the Carter Administration. As I said three weeks ago, I don’t have faith in the federal government to do the right thing and lower the spending and not to raise the debt ceiling. With that in mind, I still think that gold is a great investment at this point. I feel it will remain high until after next year’s election. If for some reason the government can put some sort of plan in motion to reduce the deficit, gold will take a plunge and a big one at that.

In the meantime, silver has also done well over the last three weeks when it closed at $33.59. It closed today at $40.27, topping the $40 mark for the first time since May. Silver has climbed more than 15% in just the last two weeks.

When talking to lay people who have absolutely no clue about stock market investing, one theme keeps coming up repeatedly – “stock market is a gamble”. Well, it is beside the point that a lot of people who are “in the market” are totally clueless as well. For now let us stick to “stocks are mysterious” kind of lay people.

“I stay away from stock market, I don’t gamble” they say. And then they almost inevitably talk about bank FDs – which is the only known investing mechanism for them. Their well meaning, but totally useless advice is “stay away from stock market”.

Then they on to relate horror stories of how their friend or relative or more likely friend’s friend or cousin’s friend’s father or friend of brother’s colleague’s father managed to run an otherwise prosperous family to utter ruin thanks to gambling in the stock market. That gentleman gambled and the family paid for it. The individual anecdotes vary but the overall theme is constant – stock market, like horse racing, is evil and one needs to avoid it like plague.

To talk about stock market investing in a manner that they would understand would be a herculean task. There was a time when I used to try explaining how “investing is not gambling”. I would talk about “value”, how buying a stock is buying a business, how it could be thought of as being similar to real estate, how one gets dividend etc.

But these days, I generally don’t even try. Everyone is entitled to their opinion (even if incorrect). Whenever I encountered such kind of people, I politely try to steer the conversation away from stock market to other relatively benign ones where complete agreement is possible and likely (eg. Weather or Sachin Tendulkar. For instance, every summer, the  best bet is to proclaim “this is the hottest summer EVER” ).

I know and you know as well, that stock market investing is NOT quite gambling.

Well, actually that is an idea I killed recently. I now think of my investing pursuits as an activity of gambling.

To me an idea or concept is not something etched in stone – its relevance is in its utility. Does the idea or concept help me become a better investor (err. sorry. I meant to say gambler)? I don’t care what academics say or think, I don’t care what the popular folklore is; I don’t care if an idea sounds bizarre – all that really matters to me is the practical utility that it brings to the table. I am slow at giving up ideas (especially the ones that have worked really well) but given data, reasoning and insight, I can make dramatic shifts quickly.

One such shift is to think of investing as gambling. Why think of investing as gambling?

It breaks the concept of any structure in the market. Like Gunther says in The Zurich Axioms (Kindle Edition): Chaos is not dangerous until it begins to look orderly.

Gambling forces you to think differently. Preexisting concepts, ideas, notions and rules melt away. The only thing that matters is “are you making money” or “are you losing money”. It is the ultimate form of zen like investing. While one might have a repertoire of ideas on how the stock market works, gambling forces you focus only on the chips (your portfolio) – everything else is extraneous, irrelevant or tangential at best. There is no loyalty to any particular idea. A good idea is one that makes money. A bad idea is one that loses money. Period. End of story. There is no psychological baggage that one has to deal with. There is no steadfast, “this is my way”.

When I say I am a “value investor”, I am taking a stand that indirectly says “value is the anchor for performance”. And with that one idea, I inherit a bunch of other ideas as well:

1. Other things being equal, lower price is better value.

2. Fall in price is a good thing.

3. If fundamentals don’t change, one should buy more if price falls.

4. The more the discrepancy between value and price, the “better” a stock is.

5. Diversification is a good thing.

I am not saying that any of the above ideas are wrong or incorrect. I am just trying to highlight the subtle cascading effect of loyalty to a particular philosophy of investing. Thinking of one as a value investor is akin saying “This is how the stock market works. It works based on value.” Nothing wrong with it per se. Actually, it is a pretty darn good way of looking at things. It has worked for me amazingly well.

But I feel that having a “value based philosophy” can have limiting side effects as well:

Value investors will sometimes avoid buying an otherwise good company because it is not “value”.
When stocks move beyond the comfort zone of “value”, value investors either sell the stock.
As the stock price keeps falling, value investors are comfortable with buying more and more. This can, in some cases, prove detrimental.

There are different types of investing, most of them are valid and can be used profitably if one understands the core idea behind it well and follows it diligently. But inevitably being loyal to a philosophy becomes like being in a cult. And the more successful one becomes, the harder it becomes to accept contrary thoughts – even valid ones.

For instance, I had a very very tough time accepting the validity of technical analysis. It took me a loooooong time to get convinced about the utility of adding technical analysis to my value based stock selection. The main reason for the delay was my core philosophy of value investing scoffs at all things technical. My value investing philosophy was very clear in its judgment – it is the stuff for charlatans. Beware the snake oil salesmen peddling technical wares!

And all this in spite of me being quite deliberately and carefully open to new ideas.

If I had come across “technical analysis” before I encountered “value investing” and if I had become successful in some form of its application, I would probably have had even greater scoff for fundamental investors. “Price is the only thing that matters” would have been my core philosophy. And anything and everything that contradicted that core belief would have been “nonsense”.

And likewise, when one thinks of oneself as a growth investor, contrarian investor or momentum investor, one is basing one’s investing activity on a core premise. One automatically inherits a bunch of related ideas. This, in turn, leads one to become closed to any idea or concept that is not supported by the core premise.

Labeling oneself a particular kind of investor is like being in an intellectual prison. One becomes comfortable only the prison inmates.

Now, one might argue that there is nothing wrong with being in an investing prison – as long as it works. Even better if it actually works well. If it ain’t broken, don’t fix it. And I would heartily agree with such a conclusion. If what works, works for you, sticking to it is the best thing.

The reason I have personally chosen to drop the complete loyalty to any particular investing theme is:

1. Markets change.

While one can practice any form of investing quite well in the long run, there are times when one works much better than others. And sometimes (but definitely always) it is easy to spot alternative investing mechanisms that work.

2. More flexibility

If you read “Market Wizards”, you will find that it is comprised of a motley of people, some of them having diametrically opposite strategies. One buys only stocks hitting 52 weeks high while another has never held a stock that made a 52 week high. But both of them have done incredibly well. Wouldn’t it expand one’s universe of investible stocks if one allowed for such paradoxically opposite strategies simultaneously?

3. Participating in Manias

I am definitely going to participate and take advantage of the next mania. It might seem crazy to talk about mania when the bear is growling right now. But trust me, a bull market will come soon (how soon, I have no idea!). A mania will come again just as well. Again, when – I have no idea. But it will come with a mathematical certainty. Every generation goes through at least two manias before realizing what they are. When such a situation presents itself and if I am intelligent enough to spot it, “I want in”.

For someone totally used to averaging down, averaging up as an valid idea is tough to fathom. Even after giving it validity, it became tough for me to accept it. Even after accepting the idea intellectually, I found it very tough to internalize it. I had a torrid time internalizing “averaging up” as a strategy. It went totally against my core, long held and well cherished belief – “lower prices are good”. The lower the price, the more the value. Buy more as price keeps falling.

I always visualize and run through my strategies mentally before applying them. I try to “break” the ideas mentally before accepting and applying them. Even just imagining about myself averaging up on a hypothetical stock was a difficult task for me. There was no way I could actually go ahead and be successful unless I was psychologically comfortable with the new way of doing it. I did not want to drop my core approach of value investing – it had worked amazing well. I just wanted to augment it with strategies that went beyond value and sometimes contrary to it.

My breakthrough came when I started thinking of my stock market activities as gambling. In one swell swoop I was able to get rid of any and all kinds of psychological limitations. I was easily and effortless able to hold diametrically opposite thoughts about the stock market simultaneously – quite naturally even.

Advantages of thinking of investing as gambling:

With gambling as the core idea one gets tremendous flexibility towards things. One is no longer bound by any one idea. One becomes more responsive to what is working and what is not working. If there is a better approach, one that might currently work better, it is accepted with ease.

While thinking of investing as gambling, one is actually being very humble. One doesn’t have the rigidity of “I know it – this is THE way stock market works”. It is like admitting “I really don’t know how things work”. I “think” what I am doing is right, but if does not prove to be so, I am equally prepared to seek what does work.

So the next time someone mentions “stock market is gambling”, I am likely to agree with them. But equally, I hope to become a very good gambler.

Just how do we go about finding a great trade?

If you’re getting your trading ideas from friends, your barber or individuals you meet in your everyday life you are up the creek without a bank account.

The next place on the list of worst places to get trading ideas would be free financial chat rooms. Most of these are either the blind leading the blind or a pump and dump scheme.

The blind leading the blind is a room full of neophyte traders (also called green peas) getting ideas from financial websites, magazines, their brokers, etc. Some of these may actually be good trades but nobody in the room knows where the entry, stop loss or exit should be.

The very worst are the penny stock trading rooms. These may be chat rooms, email alerts, newsletters or whatever. The slower the notification system the worse they are.

Penny stocks are worthless stocks. That’s two words. Worth—less. Most often worth less after you buy them. The reason they are a dime or a quarter or even a buck is for a good reason. They don’t have a viable competitive product, terrible management, not enough cash to run the business or a myriad of other fatal business problems.

Yes, occasionally one will take off, but that is attributable to a change in circumstance within the company. If you find one of these before everyone else knows, please let me know and I will join you in that trade.

These are favorites of the pump and dump crowd. If a stock is only a dime a share even someone with only a few hundred bucks in a trading account will buy thousands of shares. Pump and dump is not limited to penny stocks. If you can’t verify a story through normal news channels it’s probably bogus.

If the pumper is highly followed all they have to do is say they bought and everyone else jumps in. Normally they heard a rumor, an employee told them things are about to pop, (blowup???) or as many reasons as you can dream up. Your buys, and hundreds or even thousands of others, drive the price higher, usually very swiftly.  While you’re buying the pumper is selling you his shares.

Brokers want you fully invested so they can draw their commissions. Fully invested means all your capital is in the market. They also believe that you cannot time your entries and exits and thus believe you should stay in the market even if the indices fall by 50 % or more. They seem to think that if the market is down 25 % and your account is only down 22 % you are doing well. They also are true believers in a diversified portfolio. Whether you are in an index fund (Dow Jones-S&P-Nasdaq or many others) or in a diversified portfolio (15 to 100’s of stocks) the broker’s primary concern are their commissions.

All this and more before you ever make a trade.

As a value trader I may have eight or ten positions open but there is no relationship to diversification.

In this series of posts I will attempt to explain to you the various factors I am paying attention to as I enter and exit a trade. These will not be real time trades but the entries will have been posted in real time.

With so much buying and selling occurring in day trading, things can get very confusing. A day trader must keep up with all of their trades and make sure all of the transactions have been completed. Just because a trade has been submitted, does not mean that it will immediately effect their account. Watching out for details when day trading is extremely important. Overlooking a couple of stocks can be costly for a day trader.
While stock market charts are important for any trader, they are especially important for day traders. Using a chart correctly can indicate what the short term move of a stock is going to be. Since a day trader is trading daily, they really need to know what the stock is doing constantly. Even though reading a stock’s chart is not foolproof, it can help a day trader confirm any feelings that he is having about a stock. There are many different technical indicators a day trader can use. The more indicators that signal the same move, the better a day trader can feel about their current investment.

Stock options are a great way for a day trader to make money. This is because options eventually expire and need to be watched constantly. Stock options are not a long term investment because they will lose their value. Short term traders can watch the stock options to make sure it is moving the direction they need. If it is not, they can trade and find a different invest. Since day traders are trading often they will also be able to see if options are over or undervalued. Even if the stock has not moved greatly, if the stock option they have purchased becomes overvalued they can turn a profit. This could simply be because of rumors or news that is currently surrounding the stock.
Risk and reward ratio.
With some stock options overpriced, a day trader can have a hard time making a large profit. It is important for them to compare stocks to see which has the largest reward with a limited risk. To make money with some stocks, they must move dramatically. Others can make a small move and give the day trader a large payoff. By comparing different stocks, they will be able to differentiate which would be a better fit for them. The more stocks that are researched will better their chances of finding their best investment. Once an investment with the right risk to reward ratio has been found they can begin to invest. But even after investing it is important for them to continue to research. What is a great stock one day can be horrible the next.