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Top-Down Analysis: Finding The Right Stocks And Sectors
The top-down investment strategy is based on determining the health of the economy (and whether you want to even be investing at that time), the strength of different sectors and then picking the strongest stocks within those sectors to maximize returns. In this article you will learn how to pinpoint the hottest sectors leading the market higher (or lower in a bear market) and how to find stocks within those sectors that will potentially maximize returns.
If your market analysis has determined that the market is in an uptrend and likely to continue for some time, you want to buy stocks that are showing the best potential to be big winners in the uptrend. Just because the market is moving higher does not mean that all stocks will perform well, and some will greatly outperform others. If we are in a bear market and the investor is not opposed to short selling, we can look for stocks that will likely perform the worst, therefore making a nice profit on the short positions as prices fall. For the remainder of this article we will only focus on uptrends, but the same principles apply to downtrends.
Pick the Right Sectors
If the market is moving higher, we can begin to look at different sectors to find which ones will provide us the greatest potential for profits. Certain sectors perform better than others, so if the market is heading higher, we want to buy stocks within sectors that are performing the best. In other words, we want to invest in sectors that are outperforming the overall market.
To find the hottest sectors, we will want to look at several time frames. Looking at two or three time frames will allow us to pick sectors that are not just performing well right now, but that have been showing strength over a longer time frame. The time frames looked at will vary from person to person depending on their overall time frame.
We only want to pick the sector that appears most often at or near the top of the list for top performing sectors. The top two or three sectors can be picked if some diversity is desired. It is within these sectors that we will be placing our investment dollars.
We can also view the charts of sector ETFs. The trend should be defined by a trend line, with the ETF showing strength as it rises off the trendline. But more importantly we want to narrow our focus to specific stocks.
Pick the Right Stocks
We could simply buy a basket of stocks reflecting the entire sector, and this could do reasonably well, but we can do better by just picking the best stocks within that sector. Just because a sector is moving higher does not mean that all stocks in that sector will be great performers, but a few will outperform; those are the ones we want in our portfolio.
One process for finding individual stocks is the same as the process for sector analysis. Within each sector, we want to find the stocks that are showing the greatest price appreciation. Once again, we can look at multiple timeframes to make sure the stock is moving well over time. The stocks that have performed the best over two or three timeframes are the stocks we will buy for our portfolio. Examine the charts of top performers by placing trending lines on the chart. The price trend should be defined and profit objectives based on chart patterns should indicate high gains relative to risk on the upside. (For a complete overview of other major strategies to compare to the technical top down approach, refer to our Stock-Picking Strategies Tutorial.)
It is important to note that there are some other factors to consider when buying a stock. Additional criteria to look at before you buy includes:
• Liquidity: Buying stocks with little volume makes it hard to sell at a fair price if quick liquidation is required. Unless you are a seasoned investor/trader, invest in stocks that trade over a couple hundred thousand shares a day.
• Price: Many investors shy away from high-priced stocks and gravitate towards low-priced stocks. Trade in stocks that are above $5, or preferably higher. This is not to say there are not good cheap stocks, or not bad expensive ones, but do not shy away from a stock just because it is a high price, or buy a stock just because it is cheap in dollar terms.
One additional note is that ETF trading has come a long way in recent years. If you do not want to hold multiple individual stocks, you may be able to find an ETF that will give you reasonably close results. There is no problem buying specific ETFs, if that is preferred, which can reasonably mirror what individual stocks would have been selected.
Exiting and Rotating
While going through this process cannot guarantee that you will make extraordinary returns, it does offer you a good chance to make better-than-market returns. Some monitoring of positions will be required to make sure your sectors and stocks are still in favor with the market. The investor must also be aware of overtrading, which can result in excessive commissions; this why we use multiple timeframes.
If your stocks or sectors begin to fall out of favor across the timeframes in which you were analyzing them, it is time to rotate into the sectors that are performing well. Your overall market analysis will also give you a guide of when you should exit positions. When major trend lines within the stocks being held, or sectors being watched, are broken, it is time to exit and look for new trade candidates. (Learn more about rotating sectors in our article Sector Rotation: The Essentials.)
Summary
This strategy does require some turnover of trades, as sectors and the leading stocks within those sectors will change over time. The object is to be in stocks that are leading the market higher in bull markets, and if you are not opposed to short selling, being short in the weakest stocks that are leading the market lower during bear markets. We do this by finding the hottest sectors (for a bull market) over a period of time and then finding the best performing stocks within that sector. By continually transferring assets into the best performing stocks we stand a good chance to make above average returns.
A daily chart that displays 100 days would represent about 5 months. There are about 20 trading days in a month and about 252 trading days in a year.
For thou convenience $BULM BarChart Technical Analysis NITE-LYNX
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The broker should ask you about your investment goals and personal financial situation, including your income, net worth, and investment experience, and how much risk you are willing to take on. Be honest.
The Dangers Of Over-Diversifying Your Portfolio
Weve all heard the financial experts expound on the benefits of diversification, and its not just talk; a personal stock portfolio must be diversified to some degree. After all, none of us wishes to put all our eggs in one basket and expose ourselves to the inherent risk of holding only one stock. But can you go too far in spreading your bet? Indeed you can. Here well show you how investors tend to become overdiversified and how you can maintain an appropriate balance.
What Is Diversification?
When we talk about diversification in a stock portfolio , were referring to the attempt by the investor to reduce exposure to risk by investing in various companies across different sectors, industries or even countries. Most investment professionals agree that although diversification is no guarantee against loss, it is a prudent strategy to adopt toward your long-range financial objectives. There are many studies demonstrating why diversification works, but to put it simply by spreading your investments across various sectors or industries with low correlation to each other, you reduce price volatility. This is because different industries and sectors dont move up and down at the same time or at the same rate - if you mix things up in your portfolio, youre less likely to experience major drops, because when some sectors experience tough times, others may be thriving. This provides for a more consistent overall portfolio performance. (For background reading, see The Importance of Diversification.)
That said, its important to remember that no matter how diversified your portfolio is, your risk can never be eliminated. You can reduce risk associated with individual stocks (what academics call unsystematic risk), but there are inherent market risks (systematic risk) that affect nearly every stock. No amount of diversification can prevent that.
Can We Diversify Away Unsystematic Risk?
The generally accepted way to measure risk is by looking at volatility levels. That is, the more sharply a stock or portfolio moves within a period of time, the riskier that asset is. A statistical concept called standard deviation is used to measure volatility. So, for the sake of this article you can think of standard deviation as meaning risk.
According to the modern portfolio theory, youd come very close to achieving optimal diversity after adding about the 20th stock to your portfolio. In Edwin J. Elton and Martin J. Grubers book Modern Portfolio Theory and Investment Analysis, they conclude that the average standard deviation (risk) of a portfolio of one stock was 49.2%, while increasing the number of stocks in the average well-balanced portfolio could reduce the portfolios standard deviation to a maximum of 19.2% (this number represents market risk). However, they also found that with a portfolio of 20 stocks the risk was reduced to about 20%. Therefore, the additional stocks from 20 to 1,000 only reduced the portfolios risk by about 0.8%, while the first 20 stocks reduced the portfolios risk by 29.2% (49.2%-20%).
Many investors have the misguided view that risk is proportionately reduced with each additional stock in a portfolio, when in fact this couldnt be farther from the truth. There is strong evidence that you can only reduce your risk to a certain point at which there is no further benefit from diversification.
True Diversification
The study mentioned above isnt suggesting that buying any 20 stocks equates with optimum diversification. Note from our original explanation of diversification that you need to buy stocks that are different from each other whether by company size, industry, sector, country, etc. Put in financial parlance, this means you are buying stocks that are uncorrelated – stocks that move in different directions during different times.
As well, note that this article is only talking about diversification within your stock portfolio. A persons overall portfolio should also diversify among different asset classes, meaning allocating a certain percentage to bonds, commodities, real estate, alternative assets and so on.
Mutual Funds
Owning a mutual fund that invests in 100 companies doesnt necessarily mean that you are at optimum diversification either. Many mutual funds are sector specific, so owning a telecom or healthcare mutual fund means you are diversified within that industry, but because of the high correlation between movements in stocks prices within an industry, you are not diversified to the extent you could be by investing across various industries and sectors. Balanced funds offer better risk protection than a sector-specific mutual fund because they own 100 or more stocks across the entire market.
Many mutual fund holders also suffer from being over-diversified. Some funds, especially the larger ones, have so many assets (i.e. cash to invest) that they have to hold literally hundreds of stocks and consequently, so are you. In some cases this makes it nearly impossible for the fund to outperform indexes - the whole reason you invested in the fund and are paying the fund manager a management fee.
Conclusion
Diversification is like ice cream: its good, but only in reasonable quantities.
The common consensus is that a well-balanced portfolio with approximately 20 stocks diversifies away the maximum amount of market risk. Owning additional stocks takes away the potential of big gainers significantly impacting your bottom line, as is the case with large mutual funds investing in hundreds of stocks. According to Warren Buffett: wide diversification is only required when investors do not understand what they are doing. In other words, if you diversify too much, you might not lose much, but you wont gain much either.
BarChart Technical Analysis NITE-LYNX $STAU
http://www.barchart.com/technicals/stocks/STAU
Why Analyze Securities?
Security Analysis - Does it Matter?
Designed for companies with financial reporting problems, economic distress, or in bankruptcy to make the limited information they have publicly available. The Limited Information category also includes companies that may not be troubled, but are unwilling to provide disclosure pursuant to to OTC Pink Basic Disclosure Guidelines. Companies in this category have limited financial information not older than six months available on the OTC Disclosure
How To Evaluate A Companys Balance Sheet
For stock investors, the balance sheet is an important consideration for investing in a company because it is a reflection of what the company owns and owes. The strength of a companys balance sheet can be evaluated by three broad categories of investment-quality measurements:working capital adequacy, asset performance and capitalization structure.
Tutorial: Financial Statement AnalysisIn this article, well look at four evaluative perspectives on a companys asset performance: (1) the cash conversion cycle, (2) the fixed asset turnover ratio, (3) the return on assets ratio and (4) the impact of intangible assets.
The Cash Conversion Cycle (CCC)
The cash conversion cycle is a key indicator of the adequacy of a companys working capital position. In addition, the CCC is equally important as the measurement of a companys ability to efficiently manage two of its most important assets - accounts receivable and inventory.
Calculated in days, the CCC reflects the time required to collect on sales and the time it takes to turn over inventory. The shorter this cycle is, the better. Cash is king, and smart managers know that fast-moving working capital is more profitable than tying up unproductive working capital in assets.
CCC = DIO DSO – DPO
DIO - Days Inventory Outstanding
DSO - Days Sales Outstanding
DPO - Days Payable Outstanding
There is no single optimal metric for the CCC, which is also referred to as a companys operating cycle. As a rule, a companys cash conversion cycle will be influenced heavily by the type of product or service it provides and industry characteristics.
Investors looking for investment quality in this area of a companys balance sheet need to track the CCC over an extended period of time (for example, five to 10 years), and compare its performance to that of competitors. Consistency and/or decreases in the operating cycle are positive signals. Conversely, erratic collection times and/or an increase in inventory on hand are generally not positive investment-quality indicators. (To read more on CCC, see Understanding the Cash Conversion Cycle and Using The Cash Conversion Cycle.)
The Fixed Asset Turnover Ratio
Property, plant and equipment (PP
Business Acumen
One of the most obvious, but less tangible, rewards of fundamental analysis is the development of a thorough understanding of the business. After such painstaking research and analysis, an investor will be familiar with the key revenue and profit drivers behind a company.
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http://www.barchart.com/technicals/stocks/EFIR
All corporate actions, including: symbol changes, venue changes (new to the OTC), OTC Tier changes, Caveat Emptor status changes, Splits, Dividends, and Deletes are available within the Corporate Actions section.
9 Tips For Safeguarding Your Accounts
Wisely managing your investments includes taking advantage of all possible protections. While you may already be aware of the Federal Deposit Insurance Corporation (FDIC) insurance for your bank-deposited funds, there are other ways to divide up your funds, lower your potential risk of loss and guarantee your moneys safety. Read on for some ways to keep your money safe that you may want to consider in a bear market. (For background reading, see Are Your Bank Deposits Insured?)
No. 1: Use a brokerage account to invest in brokered CDs.
By opening an account with a brokerage firm you can invest in brokered CDs. These are typically CDs with large denominations, which are issued by banks to brokerage firms for their customers investments. Brokers pool investors funds to purchase the CDs, enabling investors to get a share in larger CDs (with potentially higher interest rates) than what they would be able to access by investing on their own. Brokered CDs also allow investors to buy multiple CDs issued by different banks and qualify for FDIC coverage for each CD held.
Before investing in brokered CDs be sure that:
• You understand the terms and features of each CD you invest in
• The bank offering the CD is an FDIC-insured bank
• You dont invest in a CD offered by a bank where you already hold accounts (because you may inadvertently exceed the FDIC insured limit)
• You get documentation of your ownership (or partial ownership) of the CD from your broker (i.e. a copy of the CDs title) to ensure that you qualify as a depositor for the FDIC coverage. (To learn more, read Are Your Bank Deposits Insured?)
No. 2: Bank with a credit union that carries private excess share insurance.
Some credit unions that are members of the National Credit Union Association (NCUA) carry excess share insurance to provide members with additional coverage for their deposit accounts. (To read more about credit unions, see Tired Of Banks? Try A Credit Union and Choose To Beat The Bank.)
No. 3: Open an account with a DIF- or SIF-insured bank.
The Deposit Insurance Fund (DIF) is a private company headquartered in Massachusetts that provides insurance on deposit accounts for participating state-chartered savings banks. The Share Insurance Fund (SIF) is also a private fund that insures deposit accounts for Massachusetts-chartered co-operative banks. DIF and SIF member banks guarantee depositors funds above the FDIC limit, regardless of both the FDIC limit and the amount of money held by the depositor. All deposit account types are guaranteed, including savings and checking accounts, CDs, money market and retirement deposit accounts. By providing both FDIC insurance and DIF or SIF insurance, member banks can guarantee that their depositors funds are fully insured. Once you open a deposit account with a DIF or SIF member bank, there are no additional qualification tests to meet or forms to complete. In addition, you do not need to be a Massachusetts residents to do business with a DIF or SIF member bank.
No. 4: Invest in CDs with a CDARS network member institution.
When you invest at least $10,000 in a CD with a Certificate of Deposit Account Registry Service (CDARS) member bank, you can get up to $50 million in FDIC insurance. Thats because a CDARS bank can take your large deposit, divide it up into smaller denominations and invest in multiple CDs across the network of member banks, ensuring that you qualify for FDIC insurance protection with each investment at each member bank. By using a CDARS network member bank, you can secure one interest rate on multiple CD investments and choose the maturities that best suit your investment goals. You pay an annual fee for the service and receive one statement summarizing all of your CD investments. (For related reading, see Are CDs Good Protection For The Bear Market?)
Access to top-notch futures studies at no extra cost. Thinkorswim from TD Ameritrade.
No. 5: Open an MMAX money market account.
The Institutional Deposits Corporation (IDC) offers the Money Market Account Xtra (MMAX) through its network of participating community banks nationwide to depositors looking for additional FDIC insurance. When you open an MMAX Account, your participating IDC bank uses its relationship with other participating IDC network members to guarantee FDIC insurance for your total account balance up to $5 million. You are limited to making six withdrawals from your MMAX account monthly.
No. 6: Research your broker and brokerage firm.
While you are responsible for making and approving decisions related to your investments, its important to know your brokers, and his or her firms, record to avoid becoming a potential victim of fraud. You should check into whether your broker is properly licensed and registered and that he or she has not been the subject of investor complaints or investigation. (To learn more, read Broker Gone Bad? What To Do If You Have A Complaint and Evaluating Your Broker.)
No. 7: Check for SIPC Protection.
Check to make sure your brokerage accounts are protected by the Securities Investor Protection Corporation (SIPC). SIPC guarantees up to $500,000 of your invested funds (up to $100,000 in cash) in the event that your stocks or securities are stolen by a dishonest broker or the firm holding your investments fails and your assets are found missing. (To learn more, read Are My Investments Insured Against Loss?)
No. 8: Know your investment time horizon.
Make sure that money you will need in the short-term is invested in low-risk vehicles such as CDs, T-bills and bonds or bond funds. The closer you are to the time when you will need to access your funds, the less risk you can afford to take that you might lose your principal. (For more insight, read Personalizing Risk Tolerance.)
No. 9: Keep good records of all your investment transactions.
If you are concerned that you may be a victim of fraud or if you are simply concerned that there may be inaccurate information on your investment accounts, you will need copies of your account activity to rectify the error(s), file a complaint or take legal action. (To learn more about personal responsibility in the investing process, read Are You A Good Client?)
Conclusion
Investing is never risk-free, but there are ways to reduce your risk and gain additional insurance coverage for your funds. Take the time to protect your funds and your peace of mind by checking out options available beyond FDIC bank deposit insurance.
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Line charts are also used when open, high and low data points are not available. Sometimes only closing data are available for certain indices, thinly traded stocks and intraday prices.
Investor-focused companies may use either the OTCQX requirements, SEC Reporting or OTC Markets Alternative Reporting Standard to provide transparency to individual investors and the professional investment community. These services increase the flow of information, raise the profile of OTC companies, improve price discovery, and increase trading and liquidity in the OTC market.
The Importance Of Diversification
Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk. Here, we look at why this is true, and how to accomplish diversification in your portfolio. (To learn more, see Diversification: Protecting Portfolios From Mass Destruction.)
Different Types of Risk
Investors confront two main types of risk when investing:
• Undiversifiable - Also known as systematic or market risk, undiversifiable risk is associated with every company. Causes are things like inflation rates, exchange rates, political instability, war and interest rates. This type of risk is not specific to a particular company or industry, and it cannot be eliminated, or reduced, through diversification; it is just a risk that investors must accept.
• Diversifiable - This risk is also known as unsystematic risk, and it is specific to a company, industry, market, economy or country; it can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so that they will not all be affected the same way by market events.
Why You Should Diversify
Lets say you have a portfolio of only airline stocks. If it is publicly announced that airline pilots are going on an indefinite strike, and that all flights are canceled, share prices of airline stocks will drop. Your portfolio will experience a noticeable drop in value. If, however, you counterbalanced the airline industry stocks with a couple of railway stocks, only part of your portfolio would be affected. In fact, there is a good chance that the railway stock prices would climb, as passengers turn to trains as an alternative form of transportation.
But, you could diversify even further because there are many risks that affect both rail and air, because each is involved in transportation. An event that reduces any form of travel hurts both types of companies - statisticians would say that rail and air stocks have a strong correlation. Therefore, to achieve superior diversification, you would want to diversify across the board, not only different types of companies but also different types of industries. The more uncorrelated your stocks are, the better.
Its also important that you diversify among different asset classes. Different assets - such as bonds and stocks - will not react in the same way to adverse events. A combination of asset classes will reduce your portfolios sensitivity to market swings. Generally, the bond and equity markets move in opposite directions, so, if your portfolio is diversified across both areas, unpleasant movements in one will be offset by positive results in another. (To learn more about asset class, see Five Things To Know About Asset Allocation.)
There are additional types of diversification, and many synthetic investment products have been created to accommodate investors risk tolerance levels; however, these products can be very complicated and are not meant to be created by beginner or small investors. For those who have less investment experience, and do not have the financial backing to enter into hedging activities, bonds are the most popular way to diversify against the stock market.
Unfortunately, even the best analysis of a company and its financial statements cannot guarantee that it wont be a losing investment. Diversification wont prevent a loss, but it can reduce the impact of fraud and bad information on your portfolio.
How Many Stocks You Should Have
Obviously owning five stocks is better than owning one, but there comes a point when adding more stocks to your portfolio ceases to make a difference. There is a debate over how many stocks are needed to reduce risk while maintaining a high return. The most conventional view argues that an investor can achieve optimal diversification with only 15 to 20 stocks spread across various industries. (To learn more about what constitutes a properly diversified stock portfolio, see Over-Diversification Yields Diminishing Returns. To learn about how to determine what kind of asset mix is appropriate for your risk tolerance, see Achieving Optimal Asset Allocation.)
Conclusion
Diversification can help an investor manage risk and reduce the volatility of an assets price movements. Remember though, that no matter how diversified your portfolio is, risk can never be eliminated completely. You can reduce risk associated with individual stocks, but general market risks affect nearly every stock, so it is important to diversify also among different asset classes. The key is to find a medium between risk and return; this ensures that you achieve your financial goals while still getting a good nights rest.
Learn what the ratings mean and the track record of an analyst before jumping off the deep end. Corporate statements and press releases offer good information, but they should be read with a healthy degree of skepticism to separate the facts from the spin.
BarChart Technical Analysis NITE-LYNX $MPPCQ
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Clearing and Settlement – For OTC equity transactions, clearing and settling, the matching of trades and the movement of money and securities, is often handled by third-party firms for the broker-dealers.
When prices move out of the trading range, it signals that either supply or demand has started to get the upper hand.
Getting Into International Investing
Diversification is an essential investing principle. It protects a portfolio from being seriously affected by negative events isolated to only a few stocks. In this article, we take a look at diversification that ventures into an international level, looking at its benefits and the different types of international investments available to the average investor. (To learn more, see The Importance Of Diversification.)
Why International?
Most investors tend to invest in what they know. This isnt necessarily a bad thing as its important to have a good understanding of your investments; however, it becomes detrimental when the blinders are put on and people refrain from learning about other investments. International investing, in particular, is a strategy sometimes overlooked by investors as a means of diversification.
With all the volatility found in stock markets, its difficult enough to pick winning stocks let alone winning economies. This is where diversification through international investing can help. Every year, the economic performance of a country will fluctuate and this undoubtedly affects the stock market. By buying securities in different markets as opposed to purchasing only U.S. stocks and bonds, you can reduce the impact of country or region-specific economic problems. (For more information, see Can You Learn The Stock Market?)
Take a look at the following chart:
Year Japan Nikkei
U.S. S
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Arbitrage is the trading strategy that takes advantage of the price differential between two or more markets for the same underlying asset. Investors and traders profit from the price differential by buying at the cheaper price and selling at the higher price or vice versa. In liquid markets, arbitrage is a short-term strategy because traders quickly recognize the imbalance and correct their prices.
Test Your Money Personality
Like almost everything else in life, your response to money is largely dictated by your personality. But have you given much thought to how you behave in regard to your finances and how that behavior affects your bottom line? Understanding your money personality is the first step and will help you shape your approach to spending, saving and investing. So whats your money personality? Read on to find out.
Whats Your Type?
Money personalities have been analyzed in a variety of ways and many people can identify with aspects of several profiles. They key is to find the profile that most closely matches your behavior. The major profiles are: big spenders, savers, shoppers, debtors and investors.
• Big Spenders
Big spenders love nice cars, new gadgets and brand-name clothing. Big spenders arent bargain shoppers; they are fashionable and they are looking to make a statement. This often means a desire to have the smallest cell phone, the biggest plasma TV and a beautiful home. When it comes to keeping up the Joneses, big spenders are the Joneses. They are comfortable spending money, dont fear debt and often take big risks when investing.
• Savers
Savers are the exact opposite of big spenders. They turn off the lights when leaving the room, close the refrigerator door quickly to keep in the cold, shop only when necessary, and rarely make purchases with credit cards. They generally have no debts and are often viewed as cheapskates. Savers are not concerned about following the latest trends, and they derive more satisfaction from reading the interest on a bank statement than from acquiring something new. Savers are conservative by nature and dont take big risks with their investments .
• Shoppers
Shoppers derive great emotional satisfaction from spending money. They often cant resist spending money, even if its to purchase items they dont need. Shoppers are usually aware of their addiction to spending and are even concerned about the debt that it creates. They look for bargains and are pleased when they get a good deal. Shoppers will often shop to entertain themselves, even if the items they buy go unused.
Shoppers are an eclectic bunch when it comes to investing. Some invest on a regular basis through 401(k) plans and other automatic investments and may even invest a portion of any sudden windfalls such as bonuses or inheritance money, while others view investing as something they will get to later on. (To learn more, read Seven Common Financial Mistakes.)
• Debtors
Debtors arent trying to make a statement with their expenditures, and they dont shop to entertain or cheer themselves up. They simply dont spend much time thinking about their money and therefore dont keep tabs on what they spend and where they spend it. Debtors generally spend more than they earn and are deeply in debt and they dont put much thought into investing. Similarly, they often fail to even take advantage of the company match in their 401(k) plans . (For more, check out Digging Out Of Personal Debt.)
• Investors
Investors are consciously aware of money. They understand their financial situations and try to put their money to work. Regardless of their current financial standing, investors tend to seek a day when passive investments will provide sufficient income to cover all of their bills. Their actions are driven by careful decision making, and their investments reflect the need to take a certain amount of risk in pursuit of their goals. (To learn more about how investors think, read The Successful Investment Journey.)
Advice for Your Personality
Once you recognize yourself in one of these profiles and have put some thought into how you approach money, its time to see what you can do to make the most of what you have. Sometimes making just small changes can yield big results.
• Spenders: Shop a Little Less, Save a Little More
If you love to spend, you are going to keep doing it, but you should seek long-term value, not just short-term satisfaction. Before you splurge on something expensive or trendy, ask yourself how much that purchase is going to mean to you in a year. If the answer is not much, skip the purchase. In this way, you can try to limit your spending to things youll actually use.
When you channel your energy into saving, you have another opportunity to think long term. Look for slow and steady gains as opposed to high-risk, quick-win scenarios. If you really want to challenge yourself, consider the merits of scaling back. (Downsize Your Home To Downsize Expenses and The Disposable Society: An Expensive Place To Live.)
• Savers: Use Moderation
Ben Franklin once recommended moderation in all things. For a saver, this is particularly good advice. Dont let all of the fun parts of life pass you by just to save a few pennies.
Tune up your savings efforts too. Pinching pennies is not enough. While minimizing risk is any investors prime goal, minimizing risk while maximizing return is the key to investing success. (For more on how to do this in your portfolio, read Asset Allocation Strategies and Achieving Optimal Asset Allocation.)
• Shoppers: Dont Spend Money You Dont Have
A critical step for shoppers is to take control of their credit cards. Unchecked credit card interest can wreak havoc on your finances , so think before you spend - particularly if you need a credit card to make the purchase. (To learn more, read Take Control Of Your Credit Cards and Understanding Credit Card Interest.)
Try to focus your efforts on saving your money. Learn the philosophy behind successful savings plans and try to incorporate some of those philosophies into your own. If spending is something you use to compensate for other areas of your life that you feel are lacking, think about what these might be and work on changing them.
• Debtors: Start Investing
If you are a debtor, you need to get your finances in order and set up a plan to start investing. You may not be able to do it alone, so getting some help is probably a good idea. Deciding on who will guide your investments is an important choice, so choose any investment professional carefully. (To find out more, see Invest In Spite Of Debt.)
• Investors: Keep Up the Good Work
Congratulations! Financially speaking, you are doing great! Keep doing what you are doing, and continue to educate yourself. (To see if you are on track to achieve post-work bliss, read A Pre-Retirement Checkup.)
Knowledge is Power
While you may not be able to change your personality, you can acknowledge it and address the challenges that it presents. Managing your money involves self awareness; knowing where you stand will allow you to modify your behavior to achieve your desired outcome.
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Group Selection
If the prognosis is for an expanding economy, then certain groups are likely to benefit more than others. An investor can narrow the field to those groups that are best suited to benefit from the current or future economic environment.
To ensure the integrity of quotations, FINRA requires every member to trade at its publicly quoted prices. Integrity of quotes is essential to the normal operation of the OTC market as the failure to honor quotations, also known as “backing away,” can be disruptive to a fair and orderly market.
Dollar-Cost Averaging Pays
Dollar-cost averaging (DCA) is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. This type of systematic investment program is familiar to many investors, as they practice it with their 401(k) and 403(b) retirement plans. When it comes to implementing investment strategies based on dollar-cost averaging, there may be no better investment vehicle than the no-load mutual fund - the structure of these mutual funds almost seems to have been designed with dollar-cost averaging in mind. Here we look at why, helping you use dollar-cost averaging when investing in mutual funds .
Review of Dollar-Cost Averaging
Dollar-cost averaging is carried out simply by investing a fixed dollar amount into your mutual fund (or other investment instrument) at pre-determined intervals. The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per dollar invested due to the higher cost per share. When the markets are down, the situation is reversed and you purchase a greater of number of shares per dollar invested. Its a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you dont have to invest the time and effort to monitor market movements and strategically time your investments.
Why Dollar-Cost Averaging Works Well With Mutual Funds
The expense ratio that mutual fund investors pay to invest in a fund is a fixed percentage of your contribution. That percentage takes the same relative bite out of a $25 investment or regular installment amount as it would out of a $250 or $2,500 lump-sum investment. Compared tostock trades , for example, where a flat commission is charged on each transaction, the value of the fixed-percentage expense ratio is startlingly clear. Consider the following:
Example A
• By making a $25 installment in a mutual fund that charges a 20 basis-point expense ratio, you pay $0.05, which amounts to a 0.2% fee.
• By making a $250 lump-sum investment in the same fund, you pay $0.50, or a 0.2% fee.
Example B
• By making a $25 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10, which amounts to a 40% fee.
• By making a $250 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10.00, which amounts to a 4% fee.
The examples above show that you have to buy more stock in order for the percentage of the commissions to go down. In comparison, the structure of the mutual fund expense ratio makes the investment more accessible: the no-commission trading of the mutual fund coupled with low minimum investment requirements allows almost everyone to afford mutual funds.
Furthermore, many mutual funds waive their required minimums for investors who set up automatic contribution plans (plans that put dollar-cost averaging into action). All this enables low-wage earners and folks with tight budgets to invest $10 or $25 or another nominal amount on a regular basis without worrying about the impact of trading costs. While small contributions may not seem impressive at first glance, they enable investors to get into the habit of saving, and can really add up over the course of a lifetime thanks to the power of compounding.
Of course, dollar-cost averaging with mutual funds isnt a strategy that is limited to use by the less than affluent. If you have a large sum of money and invest it all at once, you face the risk that declining financial markets will take a huge chunk out of your portfolio. Dollar-cost averaging offers the perfect solution to your dilemma. To facilitate a long-term strategy for investing large sums of money, many mutual funds offer investors the ability to make a lump-sum investment in a money market fund, from which predetermined amounts are automatically invested into a designated higher-risk mutual fund at pre-arranged intervals. Its a convenient, cost-efficient solution that mitigates concerns about investing a large sum of money at the wrong time.
A Long-Term Strategy
Regardless of the amount of money that you have to invest, dollar-cost averaging is a long-term strategy. While the financial markets are in a constant state of flux, they tend to move in the same general direction over fairly long periods of time. Bear markets and bull markets can last for months, if not years. Because of these trends, dollar-cost averaging is generally not a particularly valuable short-term strategy.
Consider, for example, an investor making 10 purchases of a mutual funds shares over the course of a month. While it is unlikely that the purchase price of the shares will be identical for each transaction, it is also unlikely that they will differ significantly over such a short time frame.
On the other hand, over the course of a market cycle lasting five or 10 years and including a bull market and a bear market, the price of a given security is likely to change significantly. Dollar-cost averaging will help to ensure that your average cost per share represents both the premiumsof a bull market and the discounts of a bear market, as opposed to just the premiums usually paid by investors in a bull market.
Conclusion: Keep Costs in Mind
While low, percentage-based expense ratios make mutual funds the perfect vehicle for dollar-cost averaging, it pays to exercise caution when it comes to your investments . Some mutual funds charge low-balance fees, sales loads, purchase fees and/or exchanges fees. Be sure to read the disclosure materials prior to investing and make sure you are aware of all expenses associated with your investments.
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To initiate quotations in any OTC Equity security or resume quotations after a four day absence or SEC suspension on either the OTC Link or OTCBB inter-dealer quotation system, a market maker must first obtain and review certain specified information regarding the issuer. The information requirements are specified in the SEC's Rule 15c2-11. The information is supplied to FINRA on Form 211. When approved by FINRA, the member may submit its quotation to OTC Link or the OTCBB, as sufficient reliable current information is available in the marketplace to support the member’s quotation.
Pick Stocks Like Peter Lynch
In the early 1980s, a young portfolio manager named Peter Lynch was becoming one of the most famous investors in the world, and for a very understandable reason – when he took over the Fidelity Magellan mutual fund in May of 1977 (his first job as a portfolio manager), the assets of the fund were $20 million. He proceeded to turn it into the largest mutual fund in the world, outperforming the market by a mind-boggling 13.4% per year annualized!
Lynch accomplished this by using very basic principles, which he was happy to share with just about anyone. Peter Lynch firmly believed that individual investors had inherent advantages over large institutions because the large firms either wouldnt or couldnt invest in smaller-capcompanies that have yet to receive big attention from analysts or mutual funds. Whether youre a registered representative looking to find solid long-term picks for your clients or an individual investor striving to improve your returns, well introduce you how you can implement Lynchs time-tested strategy.
The Lynch Philosophy
Once his stellar track record running the Magellan Fund gained the widespread attention that usually follows great performance, Peter wrote several books outlining his philosophy on investing. They are great reads, but his core thesis can be summed up with three main tenets: only buy what you understand, always do your homework and invest for the long run.
1. Only Buy What You Understand
According to Lynch, our greatest stock research tools are our eyes, ears and common sense. Lynch was proud of the fact that many of his great stock ideas were discovered while walking through the grocery store or chatting casually with friends and family. We all have the ability to do first-hand analysis when we are watching TV, reading the newspaper, or listening to the radio. When were driving down the street or traveling on vacation we can also be sniffing out new investment ideas. After all, consumers represent two-thirds of the gross domestic product of the United States. In other words, most of the stock market is in the business of serving you, the individual consumer - if something attracts you as a consumer, it should also pique your interest as an investment.
2. Always Do Your Homework
First-hand observations and anecdotal evidence are a great start, but all great ideas need to be followed up with smart research. Dont be confused by Peter Lynchs homespun simplicity when it comes to doing diligent research – rigorous research was a cornerstone of his success. When following up on the initial spark of a great idea, Lynch highlights several fundamental values that he expected to be met for any stock worth buying:
• Percentage of Sales: If there is a product or service that initially attracts you to the company, make sure that it comprises a high enough percentage of sales to be meaningful; a great product that only makes up 5% of sales isnt going to have more than a marginal impact on a companys bottom line.
• PEG Ratio: This ratio of valuation to earnings growth rate should be looked at to see how much expectation is built into the stock. You want to seek out companies with strong earnings growth and reasonable valuations - a strong grower with a PEG ratio of two or more has that earnings growth already built into the stock price, leaving little room for error.
• Favor companies with a strong cash position and below-average debt-to-equity ratios. Strong cash flows and prudent management of assets give the company options in all types of market environments.
• 3. Invest for the Long Run
Lynch has said that absent a lot of surprises, stocks are relatively predictable over 10-20 years. As to whether theyre going to be higher or lower in two or three years, you might as well flip a coin to decide. It may seem surprising to hear such words from a Wall Street legend, but it serves to highlight how fully he believed in his philosophies. He kept up his knowledge of the companies he owned, and as long as the story hadnt changed, he didnt sell. Lynch did not try to market time or predict the direction of the overall economy.
In fact, Lynch once conducted a study to determine whether market timing was an effective strategy. According to the results of the study, if an investor had invested $1,000 a year on the absolute high day of the year for 30 years from 1965-1995, that investor would have earned acompounded return of 10.6% for the 30-year period. If another investor also invests $1,000 a year every year for the same period on the lowest day of the year, this investor would earn an 11.7% compounded return over the 30-year period.
Therefore, after 30 years of the worst possible market timing, the first investor only trailed in his returns by 1.1% per year! As a result, Lynch believes that trying to predict the short-term fluctuations of the market just isnt worth the effort. If the company is strong, it will earn more and the stock will appreciate in value. By keeping it simple, Lynch allowed his focus to go to the most important task – finding great companies. (To learn more about value investing , see Warren Buffett: How He Does It and What Is Warren Buffetts Investing Style?)
Lynch coined the term tenbagger to describe a stock that goes up in value ten-fold, or 1000%. These are the stocks that he was looking for when running the Magellan fund. Rule No.1 to finding a tenbagger is not selling the stock when it has gone up 40% or even 100%. Many fund managers these days look to trim or sell their winning stocks while adding to their losing positions. Peter Lynch felt that this amounted to pulling the flowers and watering the weeds. (For more information, read Achieving Better Returns In Your Portfolio.)
Conclusion
Even though he ran the risk of over-diversifying his fund (he owned thousands of stocks at certain times), Peter Lynchs performance and stock-picking ability stands for itself. He became a master at studying his environment and understanding the world both as it is and how it might be in the future. By applying his lessons and our own observations we can learn more about investing while interacting with our world, making the process of investing both more enjoyable and profitable.
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Others might use a combination of long-term and short-term charts. Long-term charts are good for analyzing the large picture to get a broad perspective of the historical price action. Once the general picture is analyzed, a daily chart can be used to zoom in on the last few months.
Minimum Quotation Size Requirements for OTC Equity Securities (FINRA Rule 6433) – FINRA members acting as market makers by submitting quotations into an inter-dealer quotation system must adhere to the minimum size requirements set by FINRA. For example, all quotations with a price less than or equal to $.50 must have a minimum size of 5,000 shares.
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Therefore, there were a lot of bullish buyers of the stock around 18. When the price declined below 18 and fell to around 14, many of these (now unhappy) bulls were probably still holding the stock.
The Benefits Of An Investment Club
Most mutual fund investors would be hard pressed to name more than one or two of the top holdings within their favorite funds. This is because fund investors tend to compare mutual funds on the basis of their performance, without giving much thought to the specific stocks, bonds and other financial instruments held within the fund. By their nature, mutual funds are a passive form of investment: we trust that the mutual fund manager has the expertise to choose the right investments that will provide the best returns in our portfolios.
As individual investors, we rarely have a large enough portfolio to make individual equity or bond selections on our own. As a result, the average retail portfolio is usually insufficiently diversified with individual stock picks, and we mutual fund holders are subjected to undue risk from one or two bad choices forming a large percentage of our total holdings. For these reasons, retail investors who are dissatisfied with the passive approach of mutual funds and want to take a more active role in choosing equities would do well to join an investment club. (Find out more in Benefit From A Winning Investment Club.)
The Benefits of an Investment Club
You can think of an investment club as a small-scale mutual fund where decisions are made by a committee of non-professionals. In fact, an investment club can be established as a legal entity, either as a legal partnership or as a limited liability corporation, making its framework similar in principle to that of a mutual fund. Best of all, an investment club avoids the often burdensome management fees that all mutual funds levy on their unit holders - fees that can have a significant impact on the overall return provided by mutual funds.
But the benefits of an investment club come with a major caveat: the returns (or losses) that the club realizes entirely depend on club members and their abilities to choose the right investments for their pooled funds. When we purchase mutual funds from the major fund companies, we are effectively purchasing the education, experience, skills and discipline of the mutual fund managers entrusted with our money. When we join an investment club, we are attempting to replicate (and improve upon) some of those management attributes, but in a non-professional setting.
A typical investment club will meet on a regular basis (usually every month) to review its existing portfolio and to take suggestions from club members regarding new investment opportunities. The monthly meeting is an open floor, where each club member is able to voice his or her opinion about the suitability of new investments and other concerns regarding the performance of the pooled funds. Unlike any mutual fund, the investment club is a true democracy: here, the collective wisdom of the club members, combined with information theyve gathered through intensive research, serves (in theory) to produce the best investment decisions.
Principles of a Successful Investment Club
The National Association of Investors Corporation (NAIC) is the pre-eminent advocate of collaborative investing. It maintains extensive archives of information for starting and maintaining investment clubs. The NAIC advocates four simple principles which apply as much to making excellent individual investment decisions as they do to making democratic decisions in a club setting:
• Invest regularly.
• Reinvest dividends and capital gains.
• Discover and own leadership growth companies.
• Prudently diversify by company size and industry.
These principles are very much in keeping with a buy-and-hold strategy, characterized by low portfolio turnover rates. The average holding period for equities within NAIC-advocated portfolios is more than six years. The NAICs principles and strategies have enabled it to claim that on average, the long-term performance of NAIC members has generally outperformed market benchmarks. The NAIC boasts a large membership consisting of both individual investors and investment clubs, and it offers services for introducing individuals to clubs in their area. (Learn more about investment clubs in Investment Clubs Pool Assets, Expertise and 4 Tips For Joining An Investment Club.)
Conclusion
You dont need to belong to the National Association of Investors Corporation to see the value in its overarching principles of discipline, diversification, reinvestment and careful selection of top companies. Indeed, you dont even need to belong to an investment club to adopt these principles as part of your individual investment strategy.
But there are clear benefits to the discipline and decision-making typical of investment clubs. By maintaining a strict regimen of regular meetings, investment clubs force individual investors to adopt an active investment style, in which portfolio review is ongoing and investment decisions - whether to buy, sell or hold - are constantly made.
Furthermore, the decision-making power of the investment club resides in its democracy. Each member brings his or her own education, experience and skills to the group, all of which are used to their fullest when evaluating and debating a decision. The power of the mutual fund comes from professional management that may be able to beat average market returns. The power of the investment club comes from the collective talents of numerous individual members.
The firm has the authority to immediately sell any security in your account, without notice to you, to cover any shortfall resulting from a decline in the value of your securities. You may owe a substantial amount of money even after your securities are sold.
In addition, buyers could not be coerced into buying until prices declined below support or below the previous low.
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Financial Statement Manipulation An Ever-Present Problem For Investors
Financial statement manipulation is an ongoing problem in corporate America. Although the Securities and Exchange Commission (SEC) has taken many steps to mitigate this type of corporate malfeasance, the structure of management incentives, the enormous latitude afforded by theGenerally Accepted Accounting Principles (GAAP) and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity. Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warning signs and the tools that are at their disposal in order to mitigate the adverse implications of these problems.
Factors That Contribute to Financial Statement Manipulation
There are three primary reasons why management manipulates financial statements. First, in many cases the compensation of corporate executives is directly tied to the financial performance of the company. As a result, management has a direct incentive to paint a rosy picture of the companys financial condition in order to meet established performance expectations and bolster their personal compensation.
Second, it is relatively easy to manipulate corporate financial statements because the Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude in the accounting provisions that are available to be used by corporate management. For better or worse, these GAAP standards afford a significant amount of flexibility, making it very easy for corporate management to paint a favorable picture of the financial condition of the company.
Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep their client happy. Moreover, auditors typically receive a significant amount of money from the companies that they audit. Therefore, there is implicit pressure to certify the financial statements of the company in order to retain their business.
How Financial Statements Are Manipulated
There are two general approaches to manipulating financial statements. The first approach is to inflate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.
The second approach to financial statement manipulation requires the exact opposite tactic, which is to deflate current period earnings on the income statement by deflating revenue or by inflating current period expenses. The reason behind this approach may not be as obvious as in the previous example because it may seem counterintuitive to make the financial condition of a company look worse than it actually is. However, there are many reasons to engage in such activity, such as making a company look bad in order to dissuade potential acquirers, pulling all of the bad financial information surrounding the company into one period so that the company will look stronger going forward, pulling all of the bad financial information into the current period when the poor performance can be attributed to the current macroeconomic environment or to postpone good financial information to a future period when it is more likely to be recognized.
According to Dr. Howard Schilit, in his famous book Financial Shenanigans (2002), there are seven primary ways in which corporate management manipulates the financial statements of a company. Lets look at these seven general categories of financial statement manipulation and the typical accounting processes that facilitate the manipulation.
1. Recording Revenue Prematurely or of Questionable Quality
o Recording revenue prior to completing all services
o Recording revenue prior to product shipment
o Recording revenue for products that are not required to be purchased
2. Recording Fictitious Revenue
o Recording revenue for sales that did not take place
o Recording investment income as revenue
o Recording proceeds received through a loan as revenue
3. Increasing Income with One-Time Gains
o Increasing profits by selling assets and recording the proceeds as revenue
o Increasing profits by classifying investment income or gains as revenue
4. Shifting Current Expenses to an Earlier or Later Period
o Amortizing costs too slowly
o Changing accounting standards to foster manipulation
o Capitalizing normal operating costs in order to reduce expenses by moving them from the income statement to the balance sheet
o Failing to write down or write off impaired assets
5. Failing to Record or Improperly Reducing Liabilities
o Failing to record expenses and liabilities when future services remain
o Changing accounting assumptions to foster manipulation
6. Shifting Current Revenue to a Later Period
o Creating a rainy day reserve as a revenue source to bolster future performance
o Holding back revenue
7. Shifting Future Expenses to the Current Period as a Special Charge
o Accelerating expenses into the current period
o Changing accounting standards to foster manipulation, particularly through provisions for depreciation, amortization and depletion
Investors should understand that there are a host of techniques that are at managements disposal. However, what investors also need to understand is that while most of these techniques pertain to the manipulation of the income statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of cash flows . Moreover, even the semantics of the management discussion and analysis section of the financials can be manipulated by softening the action language used by corporate executives from will to might, probably to possibly, and therefore to maybe. Taken collectively, investors should understand these issues and nuances and remain on guard when assessing a companys financial condition.
Financial Manipulation via Corporate Merger or Acquisition
Another form of financial manipulation can be found during the merger or acquisition process. A classic approach to this type of manipulation occurs when management tries to persuade all parties involved in the decision-making process to support a merger or acquisition based primarily on the improvement in the estimated earnings per share of the combined companies. Lets look at the table below in order to understand how this type of manipulation takes place.
Proposed Corporate Acquisition Acquiring Company Target Company Combined Financials
Common Stock Price
$100.00
$40.00
-
Shares Outstanding
100,000
50,000
120,000
Book Value of Equity
$10,000,000
$2,000,000
$12,000,000
Company Earnings
$500,000
$200,000
$700,000
Earnings Per Share $5.00 $4.00 $5.83
Based on the data in the table above, the proposed acquisition of the target company appears to make good financial sense because the earnings per share of the acquiring company will be materially increased from $5 per share to $5.83 per share. However, the earnings per share of the acquiring company will increase by a material amount for only two reasons, and neither reason has any long-term implications.
Following the acquisition, the acquiring company will experience an increase of $200,000 in company earnings due to the addition of the income from the target company. Moreover, given the high market value of the acquiring companys common stock, and the low book value of the target company, the acquiring company will only have to issue an additional 20,000 shares in order to make the $2 million acquisition. Taken collectively, the significant increase in company earnings and the modest increase of 20,000 common shares outstanding will lead to a more attractiveearning per share amount. Unfortunately, a financial decision based primarily on this type of analysis is inappropriate and misleading, because the future financial impact of such an acquisition may be positive, immaterial or even negative.
How to Guard Against Financial Statement Manipulation
There are a host of factors that may affect the quality and accuracy of the data at an investors disposal. As a result, investors must have a working knowledge of financial statement analysis, including a strong command of the use of internal liquidity solvency analysis ratios, externalliquidity marketability analysis ratios, growth and corporate profitability ratios, financial risk ratios and business risk ratios. Investors should also have a strong understanding of how to use market multiple analysis, including the use of price/earnings ratios, price/book value ratios, price/sales ratios and price/cash flow ratios in order to gauge the reasonableness of the financial data .
Finally, investors should keep in mind that the independent auditors responsible for providing the audited financial data may very well have a material conflict of interest that is distorting the true financial picture of the company and that the information provided to them by corporate management may be disingenuous, and therefore should be taken with a grain of salt.
The Bottom Line
The known prevalence and magnitude of the material issues associated with the compilation of corporate financial statements should remind investors to use extreme caution in their use and interpretation. There are many cases of financial manipulation that date back over the centuries, and recent examples such as Enron, Worldcom, Tyco International, Adelphia, Global Crossing, Cendant, Freddie Mac and AIG should remind investors of the potential land mines that they may encounter. Investors should also remember the corporate malfeasance recently conducted by the now defunct auditing firm Arthur Anderson, as well as the disingenuous information provided to the general public by the corporate executives of 360 Networks, Lehman Brothers and General Motors leading up to their bankruptcies. Extreme caution should be used while conducting financial statement analysis.
Finally, given the prevalence and magnitude of the material issues surrounding financial statement manipulation in corporate America, a strong case can be made that most investors should stick to investing in low-cost, diversified, actively-managed mutual funds in order to mitigate the likelihood of investing in companies that suffer from such corporate financial malfeasance. Simply put, financial statement analysis should be left to investment management teams that have the knowledge, background and experience to thoroughly analyze a companys financial picture before making an investment decision. Unfortunately, very few investors have the necessary time, skills and resources to engage in such activity, and therefore the purchase of individual securities by most investors is probably not a wise decision.
Firms may also negotiate trades over the phone. While the same process and rules apply, the speed with which trades are executed is inherently slower than OTC Link.
What Is Support?
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further.
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Portfolio Management Pays Off In A Tough Market
When you think about investing, you have a very long decision tree - the question of passive or active, long or short, stocks or funds, China or Brazil and on and on. These topics seem to occupy the majority of the media as well as individuals minds. However, these decisions are far down the investing process relative to portfolio management. Portfolio management is basically looking at the big picture. This is the classic forest and trees analogy; many investors spend too much time looking at each tree (stock, fund, bond, etc) and not enough - if any - time looking at the forest (portfolio management).
Prudent portfolio management begins after the client and his or her advisor have reviewed the total picture and completed an investment policy statement (IPS). Embedded in the IPS is the asset allocation strategy of which there are four: integrated, strategic, tactical and insured. Most people recognize how critical asset allocation is, but most investors are unfamiliar with asset allocation rebalancing strategies, of which there are also four: buy-hold, constant-mix, constant proportion and option based. A lack of familiarity with rebalancing strategies helps explain why many confuse the constant-mix rebalancing strategy with buy-hold. Here is a side-by-side comparison of these two most common asset allocation rebalancing strategies.
Buy-Hold Rebalancing
The objective of buy-hold is to buy the initial allocation mix and then hold it indefinitely, without rebalancing regardless of performance. The asset allocation is allowed to vary significantly from the starting allocation as risky assets, such as stocks, increase or decrease. Buy-hold essentially is a do not rebalance strategy and a truly passive strategy. The portfolio becomes more aggressive as stocks rise and you let the profits ride, no matter how high the stock value gets. The portfolio becomes more defensive as stocks fall and you let the bond position become a greater percentage of the account. At some point, the value of the stocks could reach zero, leaving only bonds in the account.
Constant-Mix Investing
The objective of constant-mix is to maintain a ratio of, for example, 60% stocks and 40% bonds , within a specified range by rebalancing. You are forced to buy securities when their prices are falling and sell securities when they are rising relative to each other. Constant-mix strategy takes a contrarian view to maintaining a desired mix of assets, regardless of the amount of wealth you have. You essentially are buying low and selling high as you sell the best performers to buy the worst performers. Constant-mix becomes more aggressive as stocks fall and more defensive as stocks rise.
Returns in Trending Markets
The buy-hold rebalancing strategy outperforms the constant-mix strategy during periods when the stock market is in a long, trending market such as the 1990s. Buy-hold maintains more upside because the equity ratio increases as thestock markets increase. Alternately, constant-mix has less upside because it continues to sell risky assets in an increasing market and less downside protection because it buys stocks as they fall.
Figure 1 shows the return profiles between the two strategies during a long bull and a long bear market. Each portfolio began at a market value of 1,000 and an initial allocation of 60% equities and 40% bonds. From this figure, you can see that buy-hold provided superior upside opportunity as well as downside protection.
Figure 1: Buy-hold vs. constant-mix rebalancing
Copyright ? 2009 Investopedia.com
Returns in Oscillating Markets
However, there are very few periods that can be described as long-trending. More often than not, the markets are described as oscillating. The constant-mix rebalancing strategy outperforms buy-hold during these up and down moves. Constant-mix rebalances during market volatility, buying on the dips as well as selling on the rallies.
Figure 2 shows the return characteristics of a constant-mix and buy-hold rebalancing strategy, each starting with 60% equity and 40% bonds at Point 1. When the stock market drops, we see both portfolios move to Point 2, at which point our constant-mix portfolio sells bonds and buys stocks to maintain the correct ratio. Our buy-hold portfolio does nothing. Now, if the stock market rallies back to initial value, we see that our buy-hold portfolio goes to Point 3, its initial value, but our constant-mix portfolio now moves higher to Point 4, outperforming buy-hold and surpassing its initial value. Alternatively, if the stock market falls again, we see that buy-hold moves to Point 5 and outperforms constant-mix at Point 6.
Figure 2
Copyright ? 2009 Investopedia.com
Conclusion
Most professionals working with retirement clients follow the constant-mix rebalancing strategy. Most of the general investing public has no rebalancing strategy or follows buy-hold out of default rather than a conscious portfolio management strategy. Regardless of the strategy you use, in difficult economic times, you will often hear the mantra stick to the plan, which is preceded by be sure you have good plan. A clearly defined rebalancing strategy is a critical component of portfolio management.
Real-time Level 2 quotes are available for sponsored securities, and all OTCQX securities on OTCMarkets.com. Real-time Level 2 quotes and trades for all other OTC securities are available on OTC Dealer.
Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy.
5 Ways To Protect Your Portfolio From Volatility
Is it possible to gauge the level of anxiety in the investment markets? Certainly, and The Chicago Board of Exchange Volatility Index (VIX) measures it. The VIX reacts in real time - just as a stock does - and measures the level of volatility in the U.S. markets over the next 30 days. When the VIX is at 30, in the next 30 days the market could move as much as 2.5% in either direction, (30% divided by 12 months equals 2.5%). The VIX has hovered around 30 for the latter part of 2011, indicating that the market is still highly volatile.
Although short-term traders may call periods of high volatility great times to make money, the truth is that traders of all skill levels will face challenges in this market. What can you do to protect your portfolio against the wild stock market swings? Though it may not sound exciting to the average active trader, the best defense is to stick with conservative, boring strategies.
Hedge
Think of hedging as an insurance policy. Lets assume that you own Bank of America stock and it is now in a market decline. One way to hedge would be to purchase a put option, with a strike price below where you purchased the stock. You wont lose money on any move below your strike price. Other hedging options include short selling a stock and purchasing put options on index funds, like popular exchange traded fund SPDR S
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