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About Profitable Investing Tips

Profitable Investing Tips has been a member since April 20th 2008, and has created 155 posts from scratch.

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How Do You Pick an Investment to Short?

The popular movie, The Big Short, dramatized how hedge fund manager Michael Burry made a profit of $2.69 billion by anticipating the collapse of the US housing market in 2007. Burry created a credit default swap market when he realized that the vast number of high risk subprime loans made the housing market unstable. There is a lot of detail in the movie but the point which interests us here is how do you pick an investment to short? This thought came to mind as we consider and re-consider the aging bull market, the risk of a trade war with China, and the ever-mounting US debt burden.

Predicting Investment Success or Failure

Some investments require unique knowledge to succeed in. And for others you simply need to understand intrinsic value and invest for the long term. Patience is a virtue in this case. Picking an investment to short requires that you recognize when that investment no longer is likely to grow with the economy and the rest of the market or when there are unique factors that will lead to its demise. We wrote about what are the most profitable investments.

The general consensus is that you need to stay in an investment at least five years and probably ten to see the benefits of long term investing. The S&P 500 peaked at 1509 in November of 2007 and bottomed out at 683 in March of 2009. Ideally you would have purchased shares in an ETF that tracks the S&P 500 and done so in March of 2009. But a long term investor would have purchased in 2007 as well. Today the S&P 500 is at 2600 after peaking above 2800 in January of this year. Successful market timing can help but it is difficult to carry off time and time again. The point is that if you had bought the S&P 500 at its high point before the crash and held on you would be up around 80% today. If you had added to your portfolio as the market went down in 2007 and 2008 you would have done even better.

In that article we noted that Kodak which was a great stock for decades became a loser when digital photos came into being and Kodak’s business plan no longer worked. A way to pick an investment to short is to pick the next Kodak. However, the demise of Kodak worked out over a couple of decades and was affected by the company dipping into its cash reserves to buy back stock and prop up the price.

Best Time to Short an Investment

The couple of years preceding the housing market and stock market crashes a decade ago were exuberant. People bought stocks as well as second and third homes with the belief that prices would only go up. Warren Buffett famously said that the best time to buy is when everyone is getting out of the market and the best time to sell is when everyone is getting in. The key for picking investments to short is to calculate intrinsic value. The key to timing the market and making the most profit when shorting an investment is technical analysis. This is the statistically based analysis of market price patterns. Technical traders say that the past predicts the future and that when you can recognize an emerging price pattern you can trade accordingly to make a profit as the pattern plays out. Using statistical analysis to predict a peak in the value of an investment helps you choose when to short an investment and when to buy back at a lower price as the pattern plays out. As a bull market ages it tends to become volatile. That volatility can be an asset when you pick an investment to short.

Are Commodities a Good Investment?

The looming US China trade war has been put “on hold” according to US Treasury Secretary Mnuchin. Trump tweeted that

China has agreed to buy massive amounts of ADDITIONAL Farm/Agricultural Products – would be one of the best things to happen to our farmers in many years!

However, many are skeptical and you can include Profitable Investing Tips among the skeptics. Our eventual question for our readers will be, are commodities a good investment? But, first a little background.

CNBC quotes Moody’s chief economist as saying that the proposed trade agreements are face-saving and lose-lose.

China consented to continue discussing measures under which it would purchase more U.S. products in order to reduce the $335 billion annual trade deficit between the two, but no specific dollar number was put forward. Zandi pointed to this as evidence that neither Washington nor Beijing had a plan, nor did either know what it specifically was they wanted from the ongoing talks.

“When you get right down to it, what exactly are they going to do? Are they going lower the Chinese-U.S. bilateral trade deficit? It’s just not going to happen. They’re kicking it down the road because they really don’t know what they want,” Zandi said.

The two biggest US exporters for years have been Boeing and all of US agriculture. But, will China buy another $200 billion in US Boeing jets when it really wants to develop its own aviation industry? We wrote about this in our article about whether the new Chinese passenger jet would hurt Boeing. And, if Boeing gets a substantial increase in its business with China that will probably come with agreements for technology sharing which would hurt Boeing and US exports in the long run.

Regarding US agricultural exports there is concern about being simply a commodity supplier to China. A couple of years back we wrote to beware the resource curse of boom and bust cycles.

Brazil rode high during its commodity boom and has been licking its wounds ever since. Venezuela bought friends in the Caribbean with discounted oil and now its citizens cannot find milk, diapers or toilet paper in the stores. Beware of the resource curse of boom and bust cycles in commodity dependent economies.

The issue with China is that the USA and Europe have exported much of their manufacturing supply chains to China and other nations in Asia. This was initially a good idea because it cut down on production costs. However, the result has been a worsening trade deficit in the USA, loss of jobs, and loss of the skill sets that make manufacturing work. Fixing that situation will take more than getting China to import more jets, corn, soybeans, beef, chicken, and pork products.

Are Commodities a Good Investment?

Fidelity has a good explanation of investing in commodities.

Commodity investing is investing in raw materials that are either consumed directly, such as food, or used as building blocks to create other products. These materials include energy sources like oil and gas, natural resources like timber and agricultural products, or precious metals like gold and platinum.

In the case of US exports to China these commodities would be agricultural. The up side to commodity investment is that helps you diversify your portfolio and there is always the potential for substantial profits. Also, commodities over time tend to hold their value making them a hedge against inflation.
The down side of commodity investment according to Fidelity is this.

Commodity prices can be extremely volatile and the commodities industry can be significantly affected by world events, import controls, worldwide competition, government regulations, and economic conditions, all of which can have an impact on commodity prices. There is a chance your investment could lose value.

If commodities can be a good investment, how do you invest? There are ETFs that track precious metals and there are agricultural companies and related companies that will prosper with increased production and increased exports. Monsanto, CF Industries, Mosaic, John Deere, Agrium, ADM, and ADCO are a few of the larger and more substantial choices.

How Can You Use Options to Protect Your Investment Portfolio?

The stock market has had a long bull run and now is in danger of a major correction. We have written about how to deal with this possibility in our articles about safe investment niches, if you want to buy gold, and how you might switch your investment focus from growth to value. Today, we would like to look at another approach. How can you use options to protect your investment portfolio?

The Use of Options in Investing

Stock options can be useful in getting into an investment, providing a little extra income along the way, and protecting your investment. The tools of options trading are call and put contracts.

Buying Call Options

Call options can provide a cheap entry into a stock position. How do call options work? Our sister site, discusses calls and puts.

A call contract gives the buyer the option to purchase the underlying equity which he will do if the equity price moves in the direction anticipated. A call contract confers an obligation on the seller (writer) of the call option to sell the underlying equity if the buyer executes the contract.

If you the investor expect that a given stock is going to go up in price you may choose to buy a call option on that stock. This option gives you the right to purchase the stock as the contract price, called the strike price, no matter how high the stock price goes. The beauty of the call option is that if the stock price does not go up or even goes down your losses are limited to the price of the options contract. This fact makes call options a valuable tool in a volatile market.

Selling Call Options

If you own a very stable stock it is possible to make extra money by selling call options on that stock. The buyer will believe that the stock price will go up and will pay you a premium to have the right to purchase from you when that happens. If you believe the stock will remain stable and not go up then you can sell call options and make extra money. In the end the option contract will expire, you will still own the stock, and you will make a profit. For more info on this idea, look at the article, how to write a covered call.

Buying Put Options

This gets back to our original question. How can you use options to protect your investment portfolio? Do you think that the bull market has run its course and is in danger of a big correction? Do you also believe that not all stocks will fall and that timing a correction is difficult to do? Then you may wish to protect your gains in one or more stocks by buying puts. A put option gives the buyer the right to sell a stock at the contract or strike price no matter how far the price falls. If the stock does not correct you will have paid a premium for the contract and may consider that to be insurance against potential loss.

What Affects the Current Value of an Investment?

We have written at length about determining intrinsic stock value as a guide to value investing. But, what affects the current value of an investment? How can the current value of an investment vary over time? Along this line of reasoning Bloomberg writes about how stocks today do not seem to reflect the improving economy and earnings.

Neither this year’s impressive corporate earnings results nor the synchronized pickup in global growth nor record levels of stock buybacks by companies has led to impressive gains in stocks.

The performances of the Dow and the S&P suggest the improvement in economic and corporate fundamentals has been accompanied by a de-risking illustrated most vividly by the decline in market price-to-earnings ratios.

The point of the article is that despite better earnings, stocks have leveled off. Regarding what affects the current value of an investment, the author says that positive earnings were already priced into the market, investors are worried about sustainability of profits, and the Federal Reserve backing off its easy money policy is a headwind for rising stock prices.

The Basis of Intrinsic Value

Value investing is based on intrinsic value assessment and repeated re-assessment. The intrinsic value of any investment is based on future earnings. A strong product line, few competitors in its sector, and R&D that produces new and profitable products are all positives for intrinsic value. A failing economy, high interest rates, and social or political unrest are negative factors. The current stock market rally started as a recovery from the depths of a crash and then continued based on strong earnings. But now, as earnings continue, stock prices are leveling off and have even show evidence of a significant correction. If earnings are still strong then it would seem that societal factors, the prospect of higher interest rates, and political issues are at fault.

Value Instead of Growth

If you have decided to switch your investment focus from growth to value, where do you find and how do you calculate value?

Value stocks are often not ones favored by current market sentiment. Investing novices too often look at what has appreciated recently and assume that the same stock or other investment will continue on its upward course. The history of market bubbles and collapses over the decades is clear proof that this approach does not work. If you are a student of the markets and want to both make a profit and sleep soundly at night, switch your investment focus from growth to value before the market teaches you a painful lesson.

The best profits are often gained when you invest early in a company that has invented or learned how to monetize a new technology. Those investments can also turn around and bite you when someone else enters the market niche with a better approach or simply invents a new technology that replaces the old. If you are looking for a safe investment you will look for products that will predictably remain strong in their markets for years and decades to come. For example, people have been drinking Coca Cola, eating Snickers Bars, and cleaning with Clorox for a long, long time. The current value of investments in Coca Cola and similar companies will be predictable and less likely to lead to losses the negative factors hit the markets.

Do You Use a System for Investing?

Investors are always on the lookout for profitable investment opportunities. And a profitable investment tip may make the difference between a dismal investment portfolio and a stellar one. But, profitable investing tips may require some work before you can put them to use. Do you use a system for investing? You should because that is how you can sort out good tips from bad and pick the best opportunities. Years back we wrote about investing tips.

The best investing tips commonly have to do with how to go about the business of investing. Specific investing tips from your broker, your best friend, investment advisors, or news sources should be investigated by both fundamental analysis and technical analysis before they are acted upon. The problem with second hand investing tips is that they are often yesterday’s news. The market has already acted upon them and driven the stock price up. The best of all investing tips usually come from successful investors and are general in nature. Successful investors like to buy at bargain prices. Successful investors commonly sell stocks and get out of the market when it does not make sense.

Stock investors use fundamental analysis and technical analysis to pick stocks to buy and sell. Long term value investors primarily use fundamental analysis to determine intrinsic stock value and let that be their guide. Short term investors use technical analysis of the market to profit from trends, both up and down. Which system do you use for investing? What are the strong and weak points of each approach?

Value Investing

The first system for investing is to assess the long term value of the investment. There are investors who have used the principles of value investing to become very wealthy. This approach requires patience and the ability to keep your money in an investment for many years. Last year we asked how many years are required to make an investment long term to qualify for true buy and hold investing.

Calculating intrinsic stock value takes into account the long term. If a company shows long term promise its intrinsic value may well exceed its market value and it is a stock to buy and hold. Then, to take advantage of the market you need to hold the stock for a decade or more in order to see the long term benefits of buy and hold investing.

If your system is to calculate intrinsic value you will buy and hold stocks with the promise of a healthy income stream for years to come. You can apply this approach to any given stock tip to pick the winners and ignore the losers.

The down side of long term value investing is that if you need your money for an emergency or an expected expense like a child’s college education you may well end up pulling money out of the investment during a down market and lose money.

Technical Analysis and Short Term Investing

The second system of investing is to use statistical analysis to predict and profit from temporary swing in the market. Short term investment and even day trading both allow you to avoid the problem of having to pull money out of a down investment. This is because you mostly hold cash and only buy and sell when the market presents an opportunity.

There are two things a person may be looking for in a short term investment. One is a place to park their money that is safe and pays better than a bank savings account. The other is a way to profit from the ups and downs of the stock market. The first just has to do with checking out interest rates on T Bills, CD’s, and other short term debt instruments. The second is where technical analysis tools such as Candlestick pattern formations can help a person to trade stocks and make a substantially better profit than the bank offers or even what one can gain from long term investing.

In this case when you are presented with an investing tip you will not look at fundamentals. You will look at market price patterns and buy or sell for the short term in search of profits. The down side of this approach is that no one is perfect at market timing. Thus you will miss out on opportunities and also lose money at times by making poor choices. On the other hand, when you choose correctly you may make the same profit in a couple of days that a long investor will need to wait years for!

In either case, the point is to use a system. Modify your system as needed. And always use your system to avoid falling into the twin traps of greed and fear that torpedo so many investors.

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