Browsing articles in "Market"

Why Most People Suck At Investing

Sep 15, 2014   //   by Profitly   //   Market, Profitly, Psychology  //  Comments Off on Why Most People Suck At Investing

Guess what. Most people are HORRIBLE at investing. That’s right, most people do a terrible job of picking out which stocks or sectors will rise and which will fall. You may or may not have heard this before, but it shouldn’t come as a surprise.

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Image via glogster.com

A recent article by Business Insider dove in to just how bad most people really are when it comes to investing.

First and foremost, one big problem is that investors often find themselves buying at highs and selling at lows, especially when volatility picks up and patience is tested. The problem is that so many people keep holding a stock for far too long, thinking it will turn around and move in the direction that they want it to. They then become emotionally invested in it and blind to the reasons that it WON’T move in their direction. If you follow our gurus’ rules and limit your losses, you have less of an attachment to the stock and will be able to make better decisions. You still won’t buy at the very lowest and sell at the very highest, but you buy lower than you sell and still net a profit.

“Amidst difficult financial times, emotional instincts often drive investors to take actions that make no rational sense but make perfect emotional sense,” said BlackRock back in 2012. “Psychological factors such as fear often translate into poor timing of buys and sells.”

Richard Bernstein of Richard Bernstein Advisors considers twenty years of historical data for this in a new research note.

“The performance of the typical investor over this time period is shockingly poor,” wrote Bernstein. “The average investor has underperformed every category except Asian emerging market and Japanese equities. The average investor even underperformed cash (listed here as 3-month t-bills)! The average investor underperformed nearly every asset class. They could have improved performance by simply buying and holding any asset class other than Asian emerging market or Japanese equities. Thus, their underperformance suggests investors’ timing of asset allocation decisions must have been particularly poor, i.e., investors consistently bought assets that were overvalued and sold assets that were undervalued.”

Bernstein’s data is based on the buying and selling activity of mutual fund investors.

“They bought high and sold low,” he added. “When chaos occurred, investors ran away.”

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None of our gurus get 100% of their trades right, but you’ll hear them preach over and over again that the driver of their success is limiting losses. The famous economist John Maynard Keynes once said “Markets can remain irrational longer than you can remain solvent.” It basically means that your investment thesis could be completely right, but the market may not realize that until you’ve been forced out of your position due to massive losses. I don’t think any of us could have said it better ourselves.

For example, Tim could be shorting the crappiest company out there, but if mailers continue to go out at a record pace, the stock could continue to climb considerably higher. That’s why Tim cuts losses quickly and is always prepared to make a trade at a moments notice. Losing $1000 on a trade isn’t a big deal for him, but losing $100,000 on a trade would be. With the small loss, you move on and simply get prepared for the next pattern to present itself.

The 40 Most Important Charts Right Now

Aug 18, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on The 40 Most Important Charts Right Now

Here at Profit.ly, we LOVE charts! There is so much you can learn just from a simple picture. Our guru’s are often predicting a stocks next move based on what they are seeing in certain charts. If you are one of their students, you will know that they often look at charts in their video lessons, webinars, and watch lists. Essentially: CHARTS ARE IMPORTANT! It is hard to even imagine finance and trading without them. That’s why, when I found the following article on Business Insider, I had to share it!

What’s the article, you ask? It’s called “Wall Street’s Brightest Minds Reveal The Most Important Charts In The World.”
Business Insider’s Myles Udland asked dozens of his favorite analysts, economists, strategists, and portfolio managers on Wall Street and around the world to send him their most important charts. The article contains that fascinating composition.
Some themes that arise are continued questions about the housing and credit markets in China, volatility — or the lack thereof — in global markets, and how we can get a sense of what happens when the Fed makes its next move. Here are the charts as well as the person that sent it in: Let us know if you have any that you think we are missing! These guys covered everything from the Fed to Nigeria!

1.Jeff Gundlach, DoubleLine

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2.Emad Mostaque, strategist

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3.Aswath Damodaran, Stern School of Business at NYU

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4.Michael Widmer, Bank of America Merrill Lynch

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5.Joshua M. Brown and Michael Batnick, Ritholtz Wealth Management

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6.Jesse Livermore, Philosophical Economics

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7.Michael McDonough, Bloomberg LP

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8.Tobias Levkovich, Citi Research

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9.Gary Shilling, economist

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10.Jens Nordvig, Nomura

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11.Tim Quinlan, Wells Fargo

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12.Megan Greene, Maverick Intelligence

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13.David Rosenberg, Gluskin Sheff

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14.Jonathan Krinsky, MKM Partners

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15.Sean Darby, Jefferies

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16.Ellen Zentner, Morgan Stanley

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17.Michelle Meyer, Bank of America Merrill Lynch

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18.Todd Colvin, R.J. O’Brien

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19.Lars Christensen, Danske Bank

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20.Steven Englander, Citigroup

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21.Saeed Amen, The Thalesians

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22.Gerard Minack, Minack Advisors

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23.John Stoltzfus, Oppenheimer & Co.

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24.Zach Pandl, Columbia Management

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25.Vladimir Miklashevsky, Danske Bank

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26.Dave Lutz, JonesTrading

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27.Hedy Mansour, Langdon P. Cook Government Securities

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28.Uldis Zelmenis, BTA Insurance Co.

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29.Drew Matus, UBS

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30.Stuart Culverhouse, Exotix Partners

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31.Ruslan Bikbov, Merrill Lynch

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32.George Goncalves, Nomura

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33.David Woo, Bank of America Merrill Lynch

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34.Rick Harrell, Loomis, Sayles & Co.

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35.George Magnus, UBS

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36.Maury Harris, UBS

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37.Boris Rjavinski, UBS

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38.Radoslaw Bodys, PKO BP

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39.Francisco Blacn, Bank of America Merrill Lynch Global Research

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40.Nicholas Spiro, Spiro Sovereign Strategy

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To see the second half of the list, visit Business Insider.

Profiting When The Stock Market Falls

Aug 5, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Profiting When The Stock Market Falls

If you would have simply invested in a Dow Jones Industrial Average, S&P500, or Nasdaq index fund this past week, or even since the start of the year for the Dow, you would have lost money. Yes, you read that correctly, you would have LOST money by investing in index funds that a majority of people believe are safe investments.

On the other hand, if you would have been following our gurus (which a lot of people try to tell you is super risky, you would most likely would have made a great deal of money.

Here’s a comparison of how the Dow, S&P500, Nasdaq are stacking up against our gurus Sykes, InvestorsLive, and Superman. It’s not completely apples to apples since I did the stock market’s return in percentage terms and the guru’s in dollars, but you’ll get the idea:

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This week alone the S&P dropped nearly 3% while Superman closed out a trade for a $150,000+ profit!

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The Dow had its worst week since the week ended January 24 and the S&P saw its largest weekly point decline since May 2012 and its largest percentage drop since June 2012. Ouch. SO why was it such a bad week in the general market? With stocks still near record highs after a strong 2013, any sort of global tension, poor economic report, or market related surprises can quickly cause the market to fall.

Business Insider did a great job summing it up in this post.

UNEMPLOYMENT RATE RISES AND STOCKS SEE WORST WEEK IN TWO YEARS: Here’s What You Need To Know

Stocks slipped for the second straight day, and posted their worst weekly loss since in two years, as the July jobs report came in a bit below expectations and the unemployment rate ticked up to 6.2% from 6.1%. After yesterday’s sharp sell-off, stocks again sank during the morning, but pared some of these losses through the afternoon.

And now, the top stories on Friday:

1.  The S&P 500 finished the week down 2.6%, its worst performance since June 2012. The Dow Jones Industrial Average declined by the same amount, and has now virtually wiped out its 2014 gains. “Whether it’s the Portuguese bank, Argentina or continued unrest in the Middle East, these things are seemingly mattering more to investors now,” Matt McCormick, who helps oversee $11 billion as a fund manager at Cincinnati-based Bahl & Gaynor Inc., told Bloomberg. “All of a sudden, geopolitical things that didn’t matter a few weeks ago are starting to be more relevant concerns, and they’re serving as catalysts to sell. Investors are getting more risk-averse.”

2.  The July jobs report showed the U.S. economy added 209,000 nonfarm payrolls, fewer than the 230,000 that was expected by economists as the unemployment rate rose to 6.2% from 6.1%. Average hours worked were unchanged at 34.5 in July, and wage growth also remained tepid, staying flat over the prior month and growing 2% over the prior year, below expectations for 2.2% growth. Following the report, Dean Maki at Barclays said, “Overall, we view this report as consistent with a return to more moderate job growth in Q3 after the Q2 surge.”

3. The July jobs report also marked the sixth-straight month that the economy added 200,000 or more jobs, marking the first such stretch since 1997. Chris Rupkey, chief economist at Bank of Tokyo Mitsubishi UFJ said, “Quite a milestone today in terms of the number of nonfarm payroll jobs the economy is creating. Six months in a row of big 200K or more monthly numbers. The labor market is strong.”

4. A number of Wall Street economists weighed in on how the report could impact the Federal Reserve’s policy going forward. Dean Maki at Deutsche Bank said, “The slower pace of job growth, the rise in the unemployment rate, and the flat reading on the headline average hourly earnings series all point to slightly less pressure on the Fed to raise rates soon than recent readings might have suggested. Still, we remain comfortable with our view that the Fed will first hike rates in June 2015.” Drew Matus at UBS said following the report that, “Oddly, the slight increase in the unemployment rate was likely welcome news within the Federal Reserve would have pressured their policy outlook.” Overall, the report likely didn’t pressure the Fed’s policy.

5. The Bureau of Economic Analysis released its latest personal income and outlays survey, which contains the personal consumption expenditures index, the Federal Reserve’s preferred measure of inflation. “Core” PCE, which excludes food and energy, rose 1.5% in June against the prior year, but was flat when compared to the prior month. “The acceleration in US income growth in June suggests that in the second half of the year annualized consumption growth will rise from the average of 2.3% of the past two years to close to 3%,” Capital Economics said.

6. In addition to the jobs report, two manufacturing indexes came in mixed. Markit’s July PMI came in at 55.8, below expectations for a 56.5 reading and below June’s 56.3.  Following the report, Markit’s chief economist Chris Williamson said, “July data pointed to continued strong growth of production levels and incoming new business across the U.S. manufacturing sector, although the latest survey indicated some loss of momentum since the previous month. Employment growth also moderated during July, and was the weakest in the current 13-month period of workforce expansion.” The Institute for Supply Management’s latest manufacturing report, however, came in better than expected at 57.1 beating expectations for 56.0 and topping June’s 55.3. The prices paid subcomponent of the ISM report also beat expectations, rising to 59.5 from June’s 58.0 and the 58.0 expected by economists.

7. The University of Michigan’s consumer sentiment survey for July slipped to 81.8 from 82.5 in June, though this reading was in-line with expectations. “Overall, today’s report shows consumer sentiment in the same narrow range where it has remained so far this year, but well below readings seen during the housing bubble,” said Barclays’ Dean Maki. “Thus, it remains consistent with continued moderate growth in consumer spending.”

To see the final three headlines, read the article on their website.

 

The Great Search For Yield

Jun 1, 2014   //   by Profitly   //   Market, Profitly, Risks  //  Comments Off on The Great Search For Yield

There has been a great search for yield following the financial crisis. Investors were scared to get back into the stock market but were also hesitant to earn a very low yield on their safer investments such as bonds due to the low interest rates by the Fed.

In 2013, Stocks jumped on the first day of trading in January and didn’t go negative for the ENTIRE YEAR. They went up a historic 30% (still less than I or the other Profitly gurus earn) and finished the year at a new record high.

What drove this? It was mainly investors rebalancing their outrageously lopsided portfolios after five years of the fear I addressed earlier. Flows into equity funds went positive in 2013 while money only trickled into bond funds.

2014 has shown a pause in this movement, however. Bond inflows are ahead of equity inflows year-to-date (reverse of last year). This means that the longer-term move into bonds and out of stocks, is still enormous even though stocks gained ground last year. There has been $1.2 trillion into fixed income funds since 2006 versus a negative $800 billion pulled from stock funds.

However, fund flow data since the beginning of 2013 shows that investors have been rotating from bonds into equities. Equities have had $298 billion in inflows since January 2013, while fixed income has had only $75 billion. But bond flows have picked up this year with inflows of $71 billion vs. $46 billion for equities.

The first chart below is the cumulative flows – stock funds versus bond flows – going back to 2006. You can see a drastic preference for “safety” that is so large, even last year’s enthusiasm barely dents it:

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The second chart shows close-up on this year’s interruption of the Rotation:

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Images and argument via The Reformed Broker.

So, to better understand this movement, let’s define what a bond is. Investopedia has a fantastic definition and example:

“A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.

The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply ‘Treasuries.’

Two features of a bond – credit quality and duration – are the principal determinants of a bond’s interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipals are typically in the three to 10-year range.”

Bonds aren’t the first thing that people tend to think of when they talk about investing. Most people think about stocks, which is what I and the other gurus trade. Perhaps older individuals think more about bonds, since they are viewed as safer and financial advisors often tell people to weight their portfolio more towards bonds as they get older and approach retirement.

But the general public thinks of stocks and the potential for a big return. Stocks are more exciting, so who can blame them! Bonds are also pushed to the side during a bull market (hence the data regarding the great rotation in the beginning of this post). There is also the fact that bonds have some weird jargon that goes with them.

But all it takes is a bear market to make investors run for bonds and the “safe investment.”

So here is just a basic lesson in bonds. First, know that a bond is simply a type of loan taken out by companies. Say you take out a bond in GM. This means that you are lending GM money. In exchange, you will get a “coupon” or interest payment on that bond. These payments come in set intervals. But wait, you can give GM money when you buy their stock, right? The difference is that when you buy GM’s stock, you are buying a portion of equity while when you buy GM bonds, you are buying a portion of debt.

There are a few terms of bonds that you need to familiarize yourself with, as not all bonds are created equal. First is the maturity. This is the date when the principal on the bond will be paid to investors and the company’s bond obligation will end. For example, you can buy a GM bond that matures in 2015, and then in 2015, you get the principal investment back and GM no longer owes you those coupon payments.

The second is Secured vs. Unsecured. Bonds that are unsecured are called debentures; their interest payments and return of principal are guaranteed only by the credit of the issuing company. If the company fails, you may get little of your investment back. A secured bond is one in which specific assets are pledged to bondholders if the company cannot repay the obligation.

A third term is coupon. We addressed this briefly earlier, but it’s the amount of interest paid to bondholders, (normally annually or semiannually).

Fourth is the tax status of the bond. Most corporate bonds are taxable, but some government and especially municipal bonds are exempt from taxes, which essentially increases your return.  But these bonds also typically have lower interest than equivalent taxable bonds, evening it out a bit.

It is also important to point out that bonds are not risk free. There is a credit/default risk, prepayment risk, and interest rate risk. the default risk is that interest and your principal payment will not be made. The prepayment risk is that the given bond issue will be paid off earlier than expected. Why is this bad? Well, the company only has an incentive to repay the obligation early when interest rates have declined substantially…meaning that instead of continuing to hold a high interest investment, investors are left to reinvest funds in a lower interest rate environment. This leads us to interest rate risk. This is the risk that interest rates will change meaningfully from what you expected when you made the investment. If they significantly decline, the you face the possibility of prepayment. If interest rates increase, you will be stuck with an instrument yielding below what you could be making in a similar bond that was just issued later at a higher rate. The longer the maturity on the bond, the greater the risk.

One thing that often confuses people and business students learn in finance 101 is that yield moves inversely to price. Yield is the figure that shows the return you get on a bond. The simplest version of yield is calculated using the following formula: yield = the coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield.

Investopedia gives a great example of this.

“If you buy a bond with a 10% coupon at its $1,000 par value, the yield is 10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200).”

Sounds simple and you are probably wondering why people get confused, right? Well, this is more complicated in everyday life. When bond investors refer to yield, they are usually referring to yield to maturity (YTM). This is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium).

I’m not going to dive deep into how to calculate YTM, just know that it’s the more accurate way for  you to compare bonds with different maturities and coupons.

In conclusion, think of it this way: the relationship of yield to price can be summarized as when price goes up, yield goes down and vice versa. How can high yields and high prices both be good when they can’t happen at the same time? The answer depends on your point of view. If you are a bond buyer, you want high yields. A buyer wants to pay $800 for the $1,000 bond, which gives the bond a high yield of 12.5%. On the other hand, if you already own a bond, you’ve locked in your interest rate, so you hope the price of the bond goes up and then you can cash out in the future.

Value vs. Growth Stocks

May 16, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Value vs. Growth Stocks

Not all stocks are created equally. There are two distinct groups of stocks that people often talk about: value and growth. So what’s the difference and how can you pick the best ones to trade? Penny stock traders should know the difference even though this isn’t distinctly penny stock research. It can still help you find the best penny stocks to watch.

Well, a growth stock is a company whose earnings are expected to grow at an above-average rate relative to the market. Since they tend to reinvest their earnings into company projects, they do not typically pay dividends. The newer stocks in the tech sector like Twitter would be known as more growth stocks. Something like Google on the other hand wouldn’t be as much of a growth stock since it does pay dividends. Recently there has been a debate on whether Apple is a growth or value stock.

So how do people trade these stocks? Growth investors believe in buying stocks with above-average earnings growth and disregard the current price of the stock. The guiding principle of growth investing is to look for companies that keep reinvesting into themselves to produce new products and technology, in other words, they focus a lot of their capital on research and development.

On the other hand, a value stock has a tendency to trade at a lower price relative to its fundamentals. The fundamentals could be things like earnings or sales. This causes the stock to be considered undervalued by a value investor. The common characteristics of these stocks are: a high dividend yield, low price-to-book ratio and/or low price-to-earnings ratio. A value investor has the belief that the market isn’t always perfectly efficient and that finding companies trading for less than they are worth is a possibility.

Value investors look exclusively for  stocks that are trading at a discount to their usual valuation or what people calculate they should be worth based on things like future earnings projections. It’s important to know the difference between growth and value because they react differently in economic situations. A value stock’s earnings typically fluctuate with the economy and tend to do well when the economy is accelerating out of a recession.

Something else that separates traders looking at value from growth is how they view the market. Growth investors are very forward looking while value investors tend to look at history. People trading growth stocks propose that companies with above average growth rates will generate returns that are also above average. The problem with this strategy arises with the realization of that growth. In order for the price of the stock to rise, the company needs to achieve those growth expectations. Traders looking at value stocks take a lot of time to examine financial statements to estimate the value of the stock to compare it to the current trading price. If the calculated value is a significant amount lower than the current trading price, the investor will buy the stock. The problem arises in getting people to agree on what the calculated value should be.

There are studies that show your returns benefit over time when you buy stocks that are cheap relative to others, aka a value stock. To explain this, think of price to earnings ratios. Suppose stock XYZ typically trades with a P/E ratio of 15 to 25. If you buy XYZ when it is trading at a P/E of 16, and then it goes to 22, you can sell it when the P/E ratio starts to fall back towards the lower end of that increment. This isn’t a risk free investment. If it were, everyone would follow this strategy. Risk becomes involved since you face the possibility that XYZ’s P/E has fallen because the company no longer justified at that level due to various reasons such as business outlook or macroeconomic factors.

Almost all penny stocks are more likely to be growth since hardly any of them will pay dividends. I mean, if a company is worth so little, it’s unlikely they are going to be able to pay out dividends or buy back stock. They’re probably too busy paying their promoters to send money to penny stock traders. Remember that most penny stocks are pump and dump penny stocks.

Taking both of these strategies into account, you might ask why people don’t simply invest in a stock that has a low P/E and a rapid rate of earnings growth. Well, this is because these situations are rare. Any hint of growth attracts investors and increases the stock price. This doesn’t mean that these situations never happen, you just have to do a lot of research and be prepared to act quickly. People make and lose money with each of these strategies, so it is more or less about finding out which is right for you and then adjusting accordingly.

Why The Bull Market Is Great For Penny Stocks

May 7, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Why The Bull Market Is Great For Penny Stocks

A lot of people think that a bull market can hurt penny stocks. They’ll argue that the bull market will cause them to rise too far when Tim wants to short them or that people will look at more typical stocks rather that some of the crappy companies that are what we know as penny stocks. These may be true to an extent, but the pros far outweigh the cons. Let me explain.

The bull market that many say we are currently in brings up some common misconceptions about penny stocks and Tim’s and the other gurus’  strategies.  They don’t only short penny stocks, they find the best penny stocks to buy as well. Just check out how much money people are making through the posts we have on Profitly. Here is how much some of our gurus are up year-to-date:

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Tim is up more than $560k, Super Trades is up more than $630k and InvestorsLive is up more than $270k. That means they have all made more so far this year than most of the people reading this post will make all year. Still think the bull market is bad for our traders? Not at all. Bull markets make it easier than ever to find awesome penny stocks and the best penny stocks today. Most people just don’t understand how penny stocks work.

The gurus do short stocks, as you can see in our weekly roundups, but it should be pointed out that bull markets are great for finding blatant pump and dumps to short. In a bull market, promoters are more likely to find companies that want to take advantage of the larger number of people jumping in to stocks and looking for “great investment opportunities.” That means they are willing to pay the promoters more and the pumps will go higher than if it were a bear market. Then, the higher the stock goes, that more it has to fall and the more money there is to be made from shorting the stock. Investors will be looking for stocks that are marketed as undervalued and have strong growth potential. These are things that promoters often portray in their spam emails, generating a large pool of investors in a short amount of time. Once the promotion stops, there will no longer be a large group of new investors. The strength and hype will quickly disappear and the current investors will realize that the company is not nearly as great as the promoters were making it out to be. This creates a sort of panic, meaning investors will sell as soon as possible. Since there will be far more sellers than buyers, the stock will crash at a rapid pace. This presents more opportunities for you to learn how to trade penny stocks.

As Tim has noted on his blog before, he likes to short into strength. Bull markets create the most strength in some of the worst companies in the world. Another important thing to mention is that Tim and the other Profitly gurus like to buy earnings winners and breakouts. These types of trading plays are far easier to find in a bull market. Companies are more likely to have positive earnings surprises and breakout above key technical levels. Tim has done several videos for trading challenge students on how to spot and buy breakouts. These videos are even more beneficial in a bull market. He also wrote a blog post and did a video of how he made $4,000 in 2 minutes buying a breakout during the bull market.

Supertrades is another guru that has had some amazing trades in the bull market. He focuses a lot on finding momentum plays, and those are all over the place in a bull market.

So before you start thinking that you should wait until a stock market crash to learn how to trade all penny stocks from our gurus, think of the amazing opportunities you’ll be missing out on for penny stocks in 2014. There are new penny stocks to trade every day, and you are going to keep missing out on the next trade until you learn from the best.

CAPE Ratio Pointing to a Downturn?

May 2, 2014   //   by Profitly   //   Market, Profitly, Risks  //  Comments Off on CAPE Ratio Pointing to a Downturn?

With the Dow and the S&P near record highs and people talking about a bubble in the tech and biotech sectors, a lot of people are studying up on different valuations so they can catch the next big trade and trade the best stocks, whether long or short. The Dow’s recent record closing high of 16580 on Tuesday and intraday record of 16631 on April 4 along with the S&P 500’s record closing high of 1890 on April 2 and intraday record high of 1897.28 on April 4 have everyone buzzing about stocks trying to find the best stocks out there.

One of the valuations metrics that people have been looking at lately is something called the “CAPE ratio,” also known as the “P/E 10 Ratio” or “Shiller PE ratio.”

So what exactly is it and how can it help you learn how to trade the best stocks and find the best stocks to invest in? Let’s start with this a great definition by Investopedia:

“It’s a valuation measure, generally applied to broad equity indices, that uses real per-share earnings over a 10-year period. The P/E 10 ratio uses smoothed real earnings to eliminate the fluctuations in net income caused by variations in profit margins over a typical business cycle. The ratio was popularized by Yale University professor Robert Shiller, who won the Nobel Prize in Economic Sciences in 2013. It attracted a great deal of attention after Shiller warned that the frenetic U.S. stock market rally of the late-1990s would turn out to be a bubble. The P/E 10 ratio is also known as the “cyclically adjusted PE (CAPE) ratio” or “Shiller PE ratio.”

The P/E 10 ratio is calculated as follows – take the annual EPS of an equity index such as the S&P 500 for the past 10 years. Adjust these earnings for inflation using the CPI. Take the average of these real EPS figures over the 10-year period. Divide the current level of the S&P 500 by the 10-year average EPS number to get the P/E 10 ratio or CAPE ratio.

A criticism of the P/E 10 ratio is that it is not always accurate in signaling market tops or bottoms. For example, an article in the September 2011 issue of the “American Association of Individual Investors’ Journal” noted that the CAPE ratio for the S&P 500 was 23.35 in July 2011. Comparing this ratio to the long-term CAPE average of 16.41 would suggest that the index was more than 40% overvalued at that point. The article suggested that the CAPE ratio provided an overly bearish view of the market, since conventional valuation measures like the P/E showed the S&P 500 trading at a multiple of 16.17 (based on reported earnings) or 14.84 (based on operating earnings). Although the S&P 500 did plunge 16% during a one-month span from mid-July to mid-August 2011, the index subsequently rose more than 35% from July 2011 to new highs by November 2013.”

One prominent individual that has been taking a close look at valuation measures, including the CAPE ratio, is Henry Blodget, editor-in-chief of Business Insider. In a recent post, he said “Every valid valuation measure I look at suggests that stocks are at least 40 percent overvalued,” adding that he wouldn’t be surprised if we saw a crash soon. He thinks that just investing in stocks is likely to deliver crummy returns for the next seven years (or so). Not only does that mean that give you more reason to learn from people like the gurus on Profitly that trade rather than invest, it means that the average person in the stock market isn’t going to do very well for the next several years. His points and reasons for coming to this conclusion? He lays out the bullish and bearish cases:

  • Every valid valuation measure I look at suggests that stocks are at least 40% overvalued.
  • Corporate profit margins are at record levels and look like they might finally be rolling over.
  • Lots of sentiment indicators are flashing warning signs (folks are just way too bullish).

And what are the arguments that these concerns are silly and that stocks will keep rising?

  • One of the big bullish arguments seems to be that “there’s no catalyst” for a crash or bear market.
  • Another bullish argument is that the economy’s getting better.
  • Lastly, there’s a general sense that the financial crisis is finally over and that everything finally feels fine.

So which valuation measures suggest the stock market is very overvalued?

  • Cyclically adjusted price-earnings ratio (current P/E is 25X vs. 15X average — higher than any time in the past century with the exception of 1999-2000 and, very briefly, in 1929).
  • Market cap to revenue (current ratio of 1.6 vs. 1.0 average).
  • Market cap to GDP (double the pre-1990s norm).

Here is a recent chart of the CAPE ratio from Bill Hester of the Hussman Funds.

shiller-cape-1

The blue line shows the prediction for 10-year returns. The red line shows the actual returns. If you have heard people say, “CAPE doesn’t work anymore,” you might want to read Bill Hester’s analysis. He looks at all the arguments why CAPE doesn’t work and concludes that it does. (We’ll know for sure in 10 years.)

Second, in case you have been convinced that the “CAPE” ratio no longer works, here’s a look at price-to-revenue.

screen shot 2013-12-24 at 8.58.26 am

This measure is calling for a slightly better long-term return for the S&P 500 — just under 5% — but still a far cry from the long-term average. And far less than the guru’s and their students make in a year. Can you see why looking at charts like this will help you better understand technical patterns and other charts that the gurus look at? You have to know about stuff like this if you want to be a successful trader. Profitly gives you the tools and resources to learn from the best.

Sell In May and Go Away?

Apr 30, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Sell In May and Go Away?

It’s no secret that despite a little bit of a selloff as of late, many stocks are still near their all-time highs. It’s also no secret that it is almost May already. You might be able to see where I am going with this…have you ever heard of “sell in May and go away?” If not, you are sure to hear about it this year. The blog posts and financial commentators are out early with their thoughts on what you should do with your money.

First of all, let’s define this phenomenon in case some of you haven’t heard of it. According to Investopedia, Sell in May and Go Away is:

“A well-known trading adage that warns investors to sell their stock holdings in May to avoid a seasonal decline in equity markets. The “sell in May and go away” strategy is that an investor who sells his or her stock holdings in May and gets back into the equity market in November – thereby avoiding the typically volatile May-October period – would be much better off than an investor who stays in equities throughout the year.

This strategy is based on the historical underperformance of stocks in the six-month period commencing in May and ending in October, compared to the six-month period from November to April. According to the Stock Trader’s Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period.

There are limitations to implementing this strategy in practice, such as the added transaction costs and tax implications of the rotation in and out of equities. Another drawback is that market timing and seasonality strategies do not always work out, and the actual results may be very different from the theoretical ones.

While the exact reasons for this seasonal trading pattern are not known, lower trading volumes due to the summer vacation months and increased investment flows during the winter months are cited as contributory reasons for the discrepancy in performance during the May-October and November-April periods, respectively.”

And since Tim and the other gurus focus a lot on charts and patterns, I wanted to share this great post from another chart strategist, J.C. Parets of allstarcharts.com

In his post titled “Let’s Talk About ‘Sell in May and Go Away,'” Parets says the math behind this makes sense and we should listen to it. He looked back at the Dow Jones Industrial Average to 1950, and the statistics are “simply staggering” in his words. According to Parets, if you had invested $10,000 but only owned stocks between November 1st through April each year, on April 30th of 2013 that $10,000 would have been worth $775,055. But, if you had done the exact opposite and purchased the Dow Industrials every year on May 1 and sold on Halloween, you would have actually lost $687 over the past 63 years. Yes, you would have LOST money over 63 years!

4-22-14-10k-invested-1950-and-avg-perc1

Check out the above graphic. If that doesn’t make you take this market legend seriously, I don’t know what will.

This wasn’t always the case, but it has been since about 1950. Parets shared a one-year seasonal pattern from the Stock Traders Almanac and encouraged his readers to look at the difference between the pre-1950 period and the behavioral patterns since then. Check it out below:

4-22-14-1-yr-seasonal-since-1901

So, in summarizing this charts, mid-term election years bring even worse numbers. And hey, we’re in a mid-term election year! He also points out that this is traditionally the worst year of the 4-year Presidential Cycle. The average return during this upcoming 6-month period on midterm years is -0.43%. And as Tim would say as well, stats don’t lie. Below is the Presidential Cycle Composite chart for the S&P500 going back to 1928:

4-22-14-Presidential-Cycle

Parets says that based on the Presidential Cycle and 6-month cycle, we are entering a period of time where the US Stock market has struggled historically. However, if history is any indication, this could bring one of the best buying opportunities we’ve had in years.

In an important disclosure, Parets notes that he has been bearish about US Stocks all year long.

FBN Securities J.C. O’Hara also ran some numbers, and they are in agreement with Parets’. He looked at the past 20 years and created a chart of the returns. He told Business Insider that “The majority of the time the market was unimpressive over those summer months,” and that “the majority of the markets returns were housed in the first model that was long the months into May and the months after September.” Check out his chart below:

cotd-176

The Activist’s Strategy

Apr 2, 2014   //   by Profitly   //   Market, News  //  Comments Off on The Activist’s Strategy

Activist investors have been popping up in the news a lot lately. Not only for targeting massive companies like Apple, but because guys like Larry Fink, the head of Blackrock, are speaking out against them. Learning about all types of investment styles and watching guys like the ones we’ll discuss in this post will help you learn to trade and become more profitable. One saying we love on this blog is “Knowledge is power,” embrace it and learn, learn, learn!

First, let’s make sure everyone knows what an activist investor is. According to Investopedia, and activist investor or shareholder is:

“An individual or group that purchases large numbers of a public company’s shares and/or tries to obtain seats on the company’s board with the goal of effecting a major change in the company. A company can become a target for activist investors if it is mismanaged, has excessive costs, could be run more profitably as a private company or has another problem that the activist investor believes it can fix to make the company more valuable. Private equity firms, hedge funds and wealthy individuals are types of entities that might decide to act as activist investors.”

Now that you know what they do, let’s talk about three of the most notable activist investors.

(All images via businessinsider.com)

CARL ICAHN SPEAKS AT REUTERS SUMMIT.

First we have Carl Icahn. “Uncle Carl” as they call him has attempted to make major changes at Yahoo!, Blockbuster, Time Warner and RJR Nabisco, among other companies. As of late, he has target Apple and eBay. As of this month, he is estimated to have a net worth close to $25 billion, according to Forbes. Yes, that’s billion, not million.

His business philosophy focuses on targeting a business that he believes is badly managed and whose stock price is under-valued. He’ll then secure a large ownership position to gain entrance for a position on the company’s board of directors. Not all activist investors work that way, and we’ll learn more about them later. Wall Street experts say that most of the time he is triumphant, since he is frightening and unyielding. He has been viewed as such a dependable gold mine that investment managers will buy the company’s shares, and whether Icahn is victorious or not, he does leave with vigorous stock price profits.

Carl has had his hand in almost every major story in corporate America over the last year, from battling with Michael Dell, making a killer trade on Netflix, continuing to fight with William Ackman over Herbalife, to lobbying for Apple to repurchase more of its stock. Shares of his publicly-trade Icahn Enterprises have climbed by more than 50% in the last year according to Forbes. Icahn’s investment fund returned 31% in 2013. Icahn’s brand of activist investing is as popular as ever. In August of last year he took to Twitter, setting both the Web and Wall Street on fire by announcing that he had acquired a large stake in Apple.

bill-ackman-says-he-knows-what-will-save-america

Next up we have William Ackman, or Bill Ackman. Even though it doesn’t come close to Uncle Carl’s, Bill’s wealth is nothing to frown upon at $1.5 billion. Ackman is the Founder and CEO of Pershing Square Capital Management. At age 47, it’s unlikely this guy will be going away anytime soon, even if he has had a tough couple of years. Despite one of the biggest rallies in history, his hedge fund’s performance has been anything but impressive, up a measly 9.7% net of fees in 2013, while the market was up roughly 30%. The fund was weighed down last year by one of Ackman’s most recent targets: Herbalife, the nutritional supplements company. Bill has been shorting the stock and continues to believe it is a “pyramid scheme.” Shares of Herbalife were up nearly 140% in 2013, ouch Bill!

dan-loeb-just-gave-a-rare-interview-and-revealed-a-new-position-in-fedex

Finally, we have Daniel Loeb. His net worth falls in between or prior activists at $2.2 Billion. Loeb is the 52-year-old Founder of Third Point, a hedge fund that manages roughly $14 billion according to Forbes. All three of our activists were playing Herbalife as some point. Loeb sided with Carl Icahn and bet on the stock’s rise for a short period of time. He sold at a profit. Another company that has been one of his targets is Yahoo, where he played a large role in a change on the board before getting out of his position with a large profit. Loeb’s flagship hedge fund posted net returns of 25% in 2013, better than Ackman but still trailing the market. In their defense, many hedge funds underperformed last year.

Six Common Trading Myths

Mar 31, 2014   //   by Profitly   //   Market, Profitly  //  Comments Off on Six Common Trading Myths

Ryan Detrick is a Senior Technical Strategist at Schaeffers Investment Research. And although I caution against trusting everyone on financial television, this guy is great. He is a frequent guest on CNBC, Fox Business, and Bloomberg Television. Be sure to follow him on Twitter or StockTwits @RyanDetrick or read his market thoughts at www.schaefferstradingfloor.com.

Ryan recently wrote a guest post for seeitmarket.com (http://www.seeitmarket.com/market-masters-trading-myths-revealed-13562/) about six of the most common trading myths. Not only did he describe the myths, he went on to give hard examples of why they are just that, myths.

For example, have you heard of the saying, “Sell in May?” That has been a popular saying for years, but now May is actually up on average since 1980. Ryan points out that times change and traders must adapt if they want to remain successful. That is why Tim buys and sells stocks, rather than just shorting like he did to make his first million. Being able to adapt to different trading environments will both keep you successful and give you more opportunities. Adapting will help you stay ahead of the game.  Ryan says that “Adapt or die” is one of his favorite trading rules.

Here are the six myths that Ryan debunks.

#1 Light volume is bearish

This is one that has been around for a while and became even more prevalent since the financial crisis. Since at least September 2009 the bears have been saying volume is light, and this is a warning. But here are the facts.  Overall, NYSE volume is indeed lower than historical standards:

NYSE-volume-chart

However, there’s a catch. This volume didn’t just disappear, people adapted to the types of securities available. Have you heard of options and futures?  Traders have moved to those securities as well. Take a look at equity option volume and you’ll see quite the different picture.

equity-option-volume-since-2000

Now what about the fact that stocks are more expensive than five years ago?  Of course volume is lighter now when Apple is $500 versus when Bank of America was around a buck.  You can’t buy 500 shares of Apple the same way people used to buy 500 shares of Bank of America (that’s $250,000 vs. $500)! To gauge this, Ryan looks at all stocks in the S&P 500 Index (SPX) and finds their daily average dollar volume (this is the stock price multiplied by the stock volume). Then, to smooth things out, he takes a 21-day moving average of the results. Below is a chart of what he found.

spx-average-volume-chart

Total-dollar volume is certainly less than during the peak of the financial crisis. But it’s also well above the bull market from 2003 to early 2007. You must ask the question: If total-dollar volume is higher now than the last bull market, how in the world can bears say lower volume is bearish?  Not to mention spikes in volume tend to occur during pullbacks, like when Tim shorts a pump and dump or a company comes out with poor earnings results.

#2 Copper is crashing, which suggests a slowing global economy and a warning for stocks

Many people look to “Dr. Copper” for predictions in major trends in the global economy. So now that copper is breaking down to multi-year lows, Ryan checked to see just how accurate this Doctor is. As it turns out, when copper makes a new 2-year low, the S&P 500 doesn’t tend to do too bad.  Three months later it is about flat, but a year out it jumps 17%. Check out this table:

equities-performance-after-copper-price-low

Here’s a chart as well, and it sure makes it hard to say this is bearish for the S&P 500.

copper-2-year-price-low_equities-chart

#3 Big up days are always bullish

I didn’t even know this one, but there is quite the funny statistic about huge up days (or a rise in prices) in the market….they usually happen in bear markets! Last year, when the S&P 500 had a great year returning roughly 30%, it saw just three days gain more than 1.5%. Compare this with 2008 when the index dropped 38%, and the market saw 43 days gain more than 1.5%.  Slow and steady usually wins the investing race.

historical-stock-market-up-days-above-1.5-percent

#4 The Dow is up five years in a row, and this has to be bearish as we’ve gone ‘too far, too fast’

The 10-year annualized return on the Dow is about 5%. In fact, bull markets don’t end until closer to 15 to 20 year runs and an annualized return of closer to 15%. That would mean we are only about half way through the bull market run!

dow-jones-10-year-return-annualized

Everything isn’t perfect though (as it rarely is), and the 5-year annualized return is getting up near previous peaks. In fact, we are now above the peak in 2007, but well below some other peaks. This can be classified as a potential near-term warning, but not a signal this bull market is dead either.

dow-jones-5-year-historical-return-annualized

#5 This year looks a lot like 1929, so we’re going to crash

You’ve probably heard a lot about this one.  Turns out the chart today looks just like the chart in 1929 before the crash (we wrote about this here: http://blog.profit.ly/2014/02/20/the-scary-chart-being-shown-around-the-internet/). Well, like we said in our blog post, Ryan reiterates that it isn’t quite that simple. Yes, on a daily chart, things look a lot alike, but when you look at the percentage returns, there is a different picture.

dow-jones-current-vs-1929-crash-chart

dow-jones-percent-return-current-vs-1929-period-chart

That same chart that is causing so much fear doesn’t look so similar now, does it?  The rally into the ‘29 peak was a historic blow-off top.  I’m not saying this current one isn’t getting ahead of itself, but the second picture is a more ‘apples to apples’ comparison according to Ryan, and we’d have to agree.

#6 Earnings predict the stock market

This trading myth was picked up by thereformedbroker.com as well. Last year the S&P 500 gained nearly 30% while earnings jumped less than 6%. Earnings gained 6% in 2002 and the index lost 23%.  There was a huge 37% jump in earnings in 2010 while the S&P 500 gained just 12%.  Then there was flat earnings growth in 2009 and a nice jump of 23% on the S&P 500.  I can’t figure out a pattern there, can you?

historical-sp-500-earnings-growth-and-returns

spx-vs-corporate-earnings-historical-performance-chart`

There are many more myths out there, but these are six of the biggest ones, and Ryan does a great job of illustrating why they are myths rather than actually trading tools.

 

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