Tendency towards Volatility - Always Think about the Crowd!

Both fundamental and technical analysis can be helpful to investors in deciding when it is a good idea to buy or sell. 

Fundamentals generally change fairly slowly - over a period of quarters or years. 

Technical analysis are used by some as guide to profitable action in the nearer term. 

Prices tend to overshoot both too high and then too low in their attempts to reflect proper reality.

This tendency towards volatility, which seems to have increased in the age of trading at the speed of the internet, can either hurt you or help you.

How it affects us is driven by how well or badly we understand and handle price volatility.

This is a simple realization: that crowd behaviour frequently drives unsustainable and extreme price behaviour at tops and bottoms.

It follows from that observation that extra net returns can be earned by those who constantly watch for the crowd and who think of the market not from their own viewpoints alone but rather in terms of what the crowd is thinking.

Crowd size can be readily observed in trading volume and , with some lag, in net money flows to/from equity mutual funds.

Standing back and discerning where the crowd's often collectively muddled head is will always help you make a better decision.

What drives prices to change?

In the long run, yes, definitely the fundamentals or value.

But between now and that distant tomorrow, the answer is supply and demand. 

And the balance of those forces is not always rationally based.

It is at market-negotiated prices, not values, where we sell (and buy) stocks. 

And markets reflect people, not fundamentals alone!

It is not the news itself that moves prices, but instead the response of investors and traders to that news. 

To the degree that news constitutes a surprise, price will move dramatically.

The extent of changes in opinion can be measured in trading volume.  That tells us the degree of surprise hitting the market and the urgency with which the affected traderss and investors feel they need to take action. 

What studying volume does, in effect , is to reveal

• what the crowd is thinking and
• how big that crowd is. 

Understanding the crowd's collective mind set is crucial to being on the right side of the price action. 

Watching the crowd and the trading volume it creates will add a new dimension to your market and stock analysis.

Why Selling feels Uncomfortable?

Selling requires of us a significant change in our thinking - indeed a complete reversal! 

When we bought that stock, its prospects were wonderful, and it represented value and opportunity.  Now, whether our investment has since done well or not, to sell requires closing down hope and perhaps admitting defeat.  And it is possible that our defeat may have been created by faulty initial thinking, meaning we can place no blame externally since we were actually wrong all along.  Not a realiszation we savour.

Buying involves the opening o f possibilities of great things.  Buying represents open-endedness; continued holding maintains such hope for gain and pleasure (or, when we have a paper loss, hope for recovery and the righting of a temporary wrong).  Selling carries a finality with it because, by definition, it closes the book or ends the game and establishes a final score.  We prefer to have our options open rather than foreclosed, to retain chances for improvement and betterment rather than to know that the verdict is sealed and no chance for change exists.  We have great difficulty coming to closure since it cuts off further possibiiities; it ends hope for any better outcome.  Closure includes such experiences as

• cleaning out great grandmother's attic;
• graduating and leaving school and friends;
• acknowledging a failed marriage by concluding a divorce;
• burying a dear friend or loved one;
• seeing winter come;
• leaving an employer and valued colleagues;
• retiring and therefore wrapping up business. 

Those are heavy and sad passages, so we are predisposed to resist voluntarily creating any closure expereinces that we have power to avoid.  Holding does exactly that.

Holding keeps our options open, while selling clearly brings closure and finality.  (With surprising myopia, we ignore the fact that once we sell a stock we can just as easily repurchase it.  Viewing repurchase as a very real antidote to our revulsion against closure, however, raise visions of again going through that agonising process of reversing our opinion by 180 degrees, which is painful for all the reasons noted above.) 

• So we hold rather than sell because, at the very least, holding postpones coming to closure. 
• Many a bad stock is held (into an uncertain yet not hopeless future) with palpable likelihood of further financial loss because the (presently avoidable) emotional cost of coming to closure is perceived as so heavy. 
• Investors pay in dollar losses to avoid emotional pain from a closure process; often, as losses get worse, they will later need to pay a higher price in both lost dollars and eventual pain by imposing self-punishement over major mistakes. 

The closure aspect of selling is a powerful deterrent, one requiring both strong will and courage to overcome.

Why Holding Feels Right - Understanding the Psychology underlying this

Understanding the subtle but strong psychological impediments against selling

At a most obvious level, making profit represents pleasure, while suffering a loss equates to feeling pain.

Let us attempt to understand the deeper layer of forces that dispose us to certain attitudes and behaviours springing from our subconscious pain-avoidance and comfort-seeking tendencies.

When we own a particular stock, inaction (holding) keeps us in or certainly closer to a place of comfort than does taking action to change our circumstances (selling).  Holding onto a friend keeps us close to our past, to memories and feelings we cherish.  Many continue to hold stock in companies whose fortunes peaked years or even decades ago.  Logic alone cannot seem to explain why they resist selling despite obviously dim prospects for recovery or gain. 

• Maybe grandfather worked for the company, or we reside in a town where it supported many families or sponsored the softball team. 
• Perhaps ages ago we made a profit, or at least had a good paper profit for a while in this stock. 
• Or our parents always spoke well of the company or
• confided they had made a decent sum in its shares at one time. 

Thus, nostalgic positive feelings surround it and we find it very difficult to end our association.

Our positive associations with a particular stock create a bonded feeling. 

• We have made a good profit on an overall basis and while the annualised return may be unspectacular, a gain is surely better than a loss and the total dollar or point profit feels pleasant.  So this stock is our friend. 
• Held for a number of years now, it has been virtually adopted as a family member.  Thus, our primary inclination is to not severe such ties by terminating this comfortable relationship. 

Why end this thing, we think at an unconscious and perhaps also at a conscious level.  Living with, rather than without, that stock represents staying in a comfort zone.

Even though the company's fortunes may now have faltered, choosing to sell its stock represents adopting a 180-degree opposite stance.  Issuing that order to liquidate means that we once thought was correct now is no longer so in our minds. 

• This company is no longer under priced, or its prospects or management quality are not what we earlier imagined or expected. 
• Or perhaps we have given up on its price/earnings ratio growing as we had earlier envisioned.

To say sell means that either

• what we once thought was right is no longer so and/or
• that maybe we have already been on the wrong side of the market for some time and are now admitting a change in opinion is warranted. 

Either way, selling represents admitting we now believe what we earlier thought is no longer true.  Most of us have great difficulty acknowledging that we were wrong. 

If you place a very strong value on reputation or esteem in life, the reversal of position inherent in selling is likely to be an especially difficult battle zone for your ego and your comfort.  This can be a special problem for professionals such as doctors, attorneys, and others looked up to.  Reversing a position is made even more difficult if we have publicly or strongly espoused it.  This is a very important reason for keeping our investment holdings secret:  reversing ourselves and selling then at least involves no loss of face with others who knew our prior opinion.

Breakdown of Risk

Actions/risk
that affect only
------One firm-----Few firms---------Many firms---All investments--
                                
Firm-specific=1====2===3==========4=======5===Marketwide


1.  Projects may do better or worse than expected.
2.  Competition may be stronger or weaker than anticipated.
3.  Entire sector may be affected by action.
4.  Exchange rates and political risks affect many stocks.
5.  Interest rates, inflation, and news about economy affect all stocks.

The most prudent practice is never waiting to hear sell advice

A recommendation by an analyst to buy can be presented to every client interested in income.

A sale advice by an analyst applies only to those clients who already own the stock (and to that tiny minority oriented to short selling). 

A sale recommendation has a much smaller business-generating potential.  Reseach analysts are employed and compensated on the basis of the accuracy of judgement and on the amount of business their reports generate.  So analysts have a buy bias too.

Individual brokers face yet another dilemma when making a sale recommendation.  The investor tends to blame poor results more on a sale than on a buy.  That tendency can get brokers into trouble with their clients (and analysts into trouble with a firm's brokers).  Another way for a broker to get into even more trouble is to suggest redeploying the funds in another stock that goes down.

In summary, there are five ways a sale advice can backfire on a broker:

1.  It can offend the client who is emotionally attached to this stock.

2.  Selling can close out a painful transaction (a loss).
3.  The sale can be followed by a price rally, which would have provided greater profit or a reduced loss if the stock had been held.
4.  Funds liberated by the sale might be reinvested unprofitably, making the sale a double troublemaker.
5.  Unless the sale price proves nearly perfect, the broker is resented for generating a commission by suggesting the action.

It is also worth noting that penny-stock houses never recommend a sell unless it is to generate funds to buy something else.  The major reason is that they themselves must buy what investors sell because they, virtually alone, make the market in the stock. 

The most prudent practice is never waiting to hear sell advice.  Assume it will not be heard, and plan to make your personal selling-versus-holding decisions based on your own rules.

Euphemisms

Other words for sell, however, commonly do appear.  Brokerage firms have devised a variety of ways to describte a corporate situation that indicates a sale is the best option. 

• One of them is to write a report covering a corporate finance client, which is labelled a follow-up to the underwriting and carries no opinion or recommendation.  Follow-ups need to be read closely. 
• Even if the official policy is to give no recommendation, the tone of the report needs to be evaluated carefully.  If it is less glowing, suspect that the research analyst is not impressed with this stock and, while constrained from saying so, really thinks it should be sold. 
• Another way, short of uttering the Sell-word, is for the firm to drop analyst coverage of a company altogether.  Such silence is not golden.
• Another diplomatic approach is to give a recommendation other than buy that is kinder and gentler than the Sell-word itself.  The best euphemism for sell, ironically, is its operative opposite: hold.  When an analyst does not want to say buy and is not allowed to say sell, the only option remaining is hold.  Consider hold almost always as a danger sign.  In fact, hold really should generally be interpreted as meaning, do not hold.

Common brokerage euphemisms for sell:

• hold
• accumulate
• long-term buy
• market performer
• market weight
• perform in line
• under perform
• underweight

Another coded way of saying sell is a carefully worded message such as:  The stock is probably a worthwhile long-term holding despite some near-term uncertainties.  That is translated by teh cynic as:  If you hold for quite a while, maybe you will not lose.  All such euphemisms should be taken as signals to cash in.

On the other hand, don't place too much hope on an analyst's postings titled: "Why I like stock XXX a lot?"  Remember the analyst's buy bias and always to do your own homework.

Investors buy stocks in order to sell them at a profit in the future

Investors buy stocks for a number of reasons, many of which are ill-advised. 

From purely an investment perspective, there are only 2 reasons to buy common stocks.

1.  True equities investing consist of identifying those companies with stocks undervalued in terms of future earning power and buying them now because the projected earnings per share (EPS) stream is expected to produce dividends.  So the first objective is dividend income. 

2.  The second objective is capital appreciation.  Growth in price tends to occur over time

• if the fortunes (fundamentals) of the underlying company improve,
• if interest rates do not move sharply higher (squeezing price/earnings ratio [P/Es], and
• if market psychology moves from negative to neutral or positive.

To be successful a transaction requires both buying and selling, since both are required before a transaction's final result is established. 

Many published books dealing with stock market investing in any form focus overwhelmingly on the buying transaction only and neglect the sell side of the equation almost completely. 

Selling may not be exciting, and assuredly it is a narrower topic, but it is absolutely necessary and has its own very interesting twists and curiosities.

Actual reversal to upside price action requires intervention by interested buyers.

Big and persistent buyers must overpower sellers to push stock's price higher

In any speculative market, a snowball that starts going downhill tends to keep going.

Prices swing emotionally from overvaluation to undervaluation. The extent of overshooting on each side is impossible to predict because it is driven by volatile emotions.

So an investor's first job is to become smart enough to realise that the market gyrates and then to get out of the way before the pendulum swings adversely.

While stocks do not always accelerate in decline as an easy telltale signal of having bnttomed, it is universally true that an actual reversal to upside price action requires intervention by interested buyers.

Such buyers must be big and persistent enough first to stop the price decline and then to stabilize the price against any trickle of further selling that results from boredom.

Finally, they must overpower sellers on an ongoing basis to push the stock's price higher.

With literally thousands of stocks available to buy, once a company becomes troubled in the collective opinion of the market, it will take considerable time and probably some notable events for improved prices to hold.

RHB Research upgrades KNM to outperform

RHB Research upgrades KNM to outperform

Written by RHB Research Institute
Thursday, 21 January 2010 09:19


KUALA LUMPUR: RHB Research Institute has upgraded KNM to outperform from underperform on potential stronger orderbook in FY10-11.

“We have raised our fair value to 91 sen a share (from 65 sen a share previously) which is now based on 13 times FY10 PER (vs 11x FY10 PER previously).

“Given potential upside of 17% to our new fair value, we have upgraded the stock to Outperform (from Underperform previously),” it said on Thursday, Jan 21.

RHB Research said KNM management expects FY10-11 orderbook to rise from RM2.8 billion given stronger demand for process equipment arising from new oil sands investments as well as increase in petrochemical plants and refineries.

Stockwatch

In today's The Edge Financial Daily


RHB Research upgrades KNM to outperform
Thursday, 21 January 2010 RHB Research Institute

RHB Research maintains overweight on motor
Thursday, 21 January 2010 RHB Research Institute

Maybank Research maintain Buy on Tenaga, TP 12.10
Thursday, 21 January 2010 Maybank Investment Research

Maybank Research maintains Hold on Public Bank
Thursday, 21 January 2010 Maybank Investment Research

OSK Research: Tenaga fair value RM9.38
Thursday, 21 January 2010 OSK Investment Research

Selling is often a harder decision than buying

"If you have bought a good quality stock at bargain or reasonable price, you can often hold forever." 

Investing is fun.  For every rule, there is always an exception. 

The main reasons for selling a stock are:

 1.  When the fundamental has deteriorated permanently,  (Sell urgently)

2.  When it is overpriced, whereby the upside gain will be unlikely or very small and the downside loss will be big or certain.

 We shall examine reason No. 2 through the property market.  The property market is also cyclical.  There were periods of booms and dooms. 

If you have a good piece of property that is always 100% tenanted and which gives you good consistent return (let's say 2x or 3x risk free FD rates), would you not hold this property forever?  The answer is probably yes.

Then, when would you sell this property?

 Note that the valuation of property, as with stocks, is both objective and subjective.

Would you sell when someone offered to buy at 500% above your perceived market price?  Probably yes, as this is obviously overpriced.  You could cash out and probably easily re-employ the money to earn better returns in another property (or properties) or other assets. 

Would you sell when someone offered to buy at 50% above your perceived market price? Maybe yes or maybe no.  You can offer your many reasons.  However, all these will be based on the perceived future returns you can hope to get from this property in the future.  This is both objective based on past returns obtained and subjective and speculative on future returns.

However, unlike reason No.1 when you would need to sell urgently to another buyer to prevent sustaining a permanent loss, you need not sell just because someone offered to buy the property at high price. (However, there are also those who "flip properties" for their earnings; they will sell quickly for a quick profit.)  You will not suffer a loss but only a diminished return at worse.  You can take your time to work out the mathematics.  You maybe surprised that you may still achieve a return higher at a time in the near future by rejecting the present immediate gain based on the present high price offered.  Also, you would need to price in the lost opportunity cost when the property is sold at this price, even though it is 50% above the perceived normal market price.  Could you buy a similar quality property with the same sustainable increasing income or return by offering the same price?

Similarly, the same line of thinking can be applied to your selling of shares.  When should you sell your shares?  Yes, definitely when the fundamentals have deteoriorated permanently.  The business has suffered for various reasons and going forward, the earnings will be permanently impaired and deteriorating.  Yes, when the price is very very overpriced.  However, you need not sell your shares in good quality companies that you bought at fair or bargain price.  As long as the fundamentals are strong and the business is adding value, selling now at a higher price may mean losing the return that you could have obtained in the future years from owning this stock and the opportunity cost of reinvesting the cash into another stock of similar quality and returns.  Once again, the importance of sound reasoning and doing the mathematics in making a decision whether to sell or not.

Additional notes: Other reasons for selling a stock (or property) are:

• To raise cash to reinvest into another asset with better return.
• A certain stock (or property sector) may be over-represented in your portfolio due to recent rapid price rises and you need to reduce its weightage to reduce your risk of over-exposure in this single stock (or property sector).

Footnote: This is a true story. A rich man was approached by a buyer to sell his property. A few neighbouring lots were sold for $1.6 m the last 2 years. What offer will ensure that you sell your property to me?  Please let me know. The unwilling owner replied, "$5 million". There is a lesson here too.

Buying when the price is right.

When you have a good idea, make sure you bet big.  At other times, don't bother.  Enjoy the things you like, stay inactive if you must.

Just thinking of an analogous situation.  You have been eyeing the house in a neighbourhood.  The house is up for sale, priced at $800,000.  It has been in the market for some time.  The other houses in the neighbourhood had previously been transacted for any price between $600,000 and $800,000.

You have inspected the house and you estimated the fair price for the house based on your assessment to be  $650,000.

Suddenly the economy turned bad.  More houses were up for sale in the neighbourhood.  The prices started to fall.  A house was priced $700,000.  Two months later, another house was in the market for  $730,000.  Then another for $750,000.   The sellers were not keen to lower the prices by much from the quoted price. 

More hardships hit the economy and the community.  No new houses were up for sale, but the buyers literally were not visible.  The prices quoted previously came down, but not by much, except one.  This one house was priced at $600,000 for a quick sale.  The seller was making an urgent sale to obtain cash for various reasons. 

And what did you do?  You waited hoping that the price would drop further.  Perhaps, the seller might sell at $570,000.  You waited for the seller to agree.  You waited. 

Then the news came, the house was sold to another for $600,000.  And how did you feel?  You felt you have missed out on a good deal.  For the next 5 years, the houses in the region never reached this price.  All the houses were priced or transacted around $700,000.

It is difficult, perhaps, close to impossible to buy at the bottom.  There are bargains when the market is on the way down and also on the way up.  The ability to value an asset is important.  As long as the price is below the "intrinsic value" and given an appropriate margin of safety for the risks appropriate for the particular asset, you can buy with conviction. 

Isn't this scenario applicable to buying shares? 

Don't wait for the best price on the way down (Will you ever know when or what will be the lowest price, other than retrospectively?)  or  only pick buy stocks after the prices have swung up from an obvious bottom (Can you predict the short-term volatilties?  The possibilities of the prices swinging up and down over a short period cannot be predicted?  Did you buy when the market swung up from the bottom of March 09, or did you wait thinking that the rally may not be sustainable and the market might go down further?)

Often the shrewd investors wish to buy good quality stocks cheap?  When the prices dropped, some waited hoping for a bigger bargain.  Then the price swung upwards, and that momentary opportunity was lost.  Of course, the consolation is that there will always be another bargain the next time around.

Keeping a proportion of your wealth in cash is always a good thing.  When the opportunities to buy bargains present (and this is always a certainty in the stock market, though perhaps, only about less than 5 times a year), you can then take a big bet.  And here is the point:  Buy when the price is already at a significant bargain to your "fair or intrinsic value".  Once that price is there, buy and buy and buy.  You have all the reasons to buy as you are already buying with a margin of safety to the "intrinsic value."   Of course, if the price dropped further, you can buy more. 

However, be prepared to see the price going further downwards - market prices often overshoot on the way down (and up).  Have conviction in your valuation (assuming you have done the homeworks).  Be patient.  Be very patient.  Be prepared to hold the stock for 2, 3 or 5 years  to realise this objective.  Short term price changes can be volatile and unpredictable.  Provided that you bought only good quality stocks at reasonable or bargain prices, you should, given time and patience, eventually realise a prospective gain.

The importance of only buying good quality stocks cannot be overemphasized.  These are the stocks with good businesses that will over time build value.  These values will eventually be reflected in their share prices.  Even if the prices were to drop below your buying price, given time, the business will generate value pushing the price back to your buying price.

As Benjamin Graham taught, it is not easy to profit consistently by timing the buying. However, one can have high probability of profiting by buying good quality stocks based on price - always buying below the intrinsic value with a margin of safety.

Footnote:

Warren Buffett called the bottom of the market only a few occasions in his long investing career.

• On one occasion, the market continued to go down further for 3 years after his call.
• In the recent severe bear market, he called to buy in October 2008. The market continued its downtrend to bottom in March 2009. Those who bought in October 2008 would have to hold on to losses soon after they bought. However, when the market rebounded from the lows of March 2009, and assuming they have held onto their investments to now, they would have made substantial gains to-date.

The 3 key variables in any investing plan

Why You Shouldn't Give Up on Stocks
By Dan Caplinger
January 20, 2010

You'd think that with all the good news investors have gotten lately, all the doomsayers would be laying low. Yet even after the stock market's big rally from last year's lows, some pundits still question whether investing is a hopeless cause.

Keeping your head above water
An article in The Wall Street Journal earlier this week took a close look at the unrealistic expectations that many investors have about the returns they can generate from their portfolios. After a decade during which the broad stock market has laid a big fat goose egg in the return column, a survey showed that investors expect average annual returns of nearly 14% over the next 10 years.

Yet that isn't the most sobering fact about the misconceptions people have about the financial markets. When asked how much they could expect to keep in terms of purchasing power, after accounting for the impact of taxes, investing costs, and inflation, a group of financial advisers estimated a return of between 6% and 9% annually.

Should you hope for returns that are that good? You bet. But should you count on earning them? No way. Fortunately, if you're smart about how you structure your investment plan, you don't have to earn that high a return from your portfolio.

Keep it real
It's easy to understand how people mislead themselves about how much they can earn from investing in stocks. The secret comes down to success stories: We hear the most about winning stocks, while the much larger group of mediocre performers tends to get lost in the shuffle. Take this group of stellar stocks, for instance:

Stock
20-Year Average Annual Return

Dell (Nasdaq: DELL)
32.9%

Oracle (Nasdaq: ORCL)
21.7%

Altria Group (NYSE: MO)
15.4%

United Technologies (NYSE: UTX)
15.2%

Hewlett-Packard (NYSE: HPQ)
14.5%

Source: Yahoo! Finance. As of Jan. 19.

Combine the bull market of the 1990s with the lost decade since 2000, and you'll see that these stocks have greatly outperformed the overall market. Yet when you take away a few percentage points for inflation, a few more for taxes, and another point or so for trading costs, you'll notice that only the best performers manage to stay in double-digit territory.

More importantly, recall that these are the big winners. For every stock like this, there are several like Dow Chemical (NYSE: DOW) and Citigroup (NYSE: C) that have languished with much smaller gains -- and others, such as General Motors, that have contributed substantial losses to the overall picture.

Stay on target
But don't let the sobering reality of the investing world convince you that it's impossible to reach your financial goals. There are three key variables in any investing plan:

• how much you can save,
• how much you earn on your investments, and
• how much you need to spend.

Investors tend to focus almost solely on their portfolios' earning potential and think a lot less about the other keys to financial success.

If you're not making the most of your financial situation to save as much as you can, then you're making a huge mistake with your money. By saving less than you could afford to save, you'll take bigger risks than you need to. Sometimes, those risks will go sour, costing you what would have been an easily attainable financial goal. Just as millions of investors learned too late that their portfolios included more high-risk investments than they really needed, you could be making big bets that you don't need to make in order to have a safe, secure retirement.

You'll get there
What you do need to do, though, is have realistic expectations. If you're more conservative about the return assumptions you make, you'll have to find more savings to reach a certain target value for your portfolio. But you'll also have more options to help you get there, rather than relying on finding tomorrow's top performers at all cost.

If you can do that, then you won't be fooling yourself about your investing. As hard as it is to rein in expectations during a roaring rally, doing so will leave you in a better condition to make rational decisions about your portfolio -- decisions that are likely to lead to exactly the returns you need to reach your goals.

Many people are nervous about 2010's prospects.

http://www.fool.com/retirement/general/2010/01/20/why-you-shouldnt-give-up-on-stocks.aspx

We Are Due for a Pullback!

Stocks have made an epic run but it won't last. "The economy isn't strong enough" to support a new bull market reports The Wall Street Journal. We are overdue for a big pullback.

You have a choice: Stay the course and suffer big losses or go on the offense!

The Four Essentials of Successful Investing

In brief, here are the four rules:

Start early in life to invest.


Invest in common stocks.


Be thrifty.


Pick the right investment.