The Need for Diversification

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Why is it that some people only buy one or two stocks? Others may have 15 stocks but have 50 percent of their investment assets in just one of those 15 stocks. In Wall Street we refer to this type of behavior as concentration. Some firms call it over-concentration. When this happens in a brokerage firm it is always considered dangerous. It is so dangerous, in fact, that if the brokerage firm is using a concentrated stock position as capital, then the market value of the security in question is given a haircut. This means that the full market value of the security is chopped by some fixed percentage in any capital computation. In other words, if you are over-concentrated, you don't get full value. Some of you may have margin accounts. As you know, StocksAtBottom.com advocates cash ownership of stocks. If you own stocks on margin, it is our opinion that you will get sold out on margin. Normally in a margin account you put up 50 percent of the value of the stock you acquire in cash. If equity falls below 35 percent, you get a margin call. Now, brokerage firms love it when clients have 15 or 20 different stocks in a margin account. If there are some bonds in that account, guess what, they love it even more. Why? Because brokerage firms know that stocks represent risky investments. Something can always go wrong in any one situation. Maybe something can go wrong in any two situations. It's tough to see something go wrong in 15 situations. That is the essence of diversification. SPREAD THE RISK AROUND. It makes a lot of sense. Some investors own 50 to 100 stocks. This is because they think they need that many to achieve the investment goals that they set out for themselves. In business school at a master's degree level they teach you that to achieve true diversification you need to own something approaching 14 equity positions. It has been the experience of StocksAtBottom.com that 6 to 10 different equity positions is sufficient to achieve diversification. The one thing we know for sure is that it's not one stock or two stocks. Own one or two and you get killed.

Putting all your eggs in one basket We advise all investors to own several stocks and to own more than one sector. Own more than one type of investment (that means equities, bonds, real estate, cash, you get the picture) or you will have problems. Sectors refer to stocks with broad themes. Examples are: * Energy * Semi-conductors * Housing * Auto * Consumer * Airlines * Personal Computers * Technology in general If you own 10 stocks, but they fall into only 2 sectors then you really have not achieved diversity in your portfolio. You see, when they come to get Ford Motor, usually General Motors is not that far behind. By the way, it's great on the upside to own everything in one sector when that sector is going your way. There's probably not a greater high in the world than when everything you own is going up. On the flip side, when you are overly concentrated in a sector that's heading down, lower and lower every day, there is no worse emotional low. The depression can be almost unbelievable. There's also the issue of owning more than one type of investment. There are equity investments, which are stocks. There are real estate investments, and bond investments. There are also venture capital investments, precious metals, and others such as oil and gas. To a large extent, you achieve diversity in your investment strategies by owning different types of investments, as well as investing in different sectors. Let's go into a few real life examples. We at StocksAtBottom.com believe we have already made the equivalent of a lifetime of investing mistakes, so learn from a few of ours.

Arrow Electronics It was Christmas week in the early 1980's. One of us was sitting at Bear Stearns as a limited partner at the time. We were doing very well as stockbrokers. It was the period of full commissions (no discounting), and clients were doing 10,000 share trades in $50 dollar stocks. Taking home an income of $500,000 to $1,000,000 in a year was no big deal at the time. We were loaded up on Arrow Electronics, a NYSE company in the semi-conductor sector. Business was fantastic, the future was bright, and things could not have been better. Since we were involved on the banking side as well, we had an open line of communication to the company. We knew we had a good thing going. The telephone rang on one of those beautiful days prior to Christmas when New York City is the place to be, Rockefeller Center all lit up with a 50 foot Christmas tree and all. "Hello." A harried response, "There's been a fire at the Tarrytown Hilton Executive Center, a lot of people are dead." "Okay, that's terrible, how does it affect me and by the way, what's for lunch today?" "Buddy, you don't understand," the dead pan voice says. "What don't I understand?" "The entire executive leadership of Arrow Electronics was in that fire." All of them, every one of them had been killed by this monstrous tragedy. It was the worst Christmas imaginable for the wonderful families of this dedicated group of execs. The families never recovered, the company never recovered in terms of the people that were left, and the stock took years to recover. It plummeted from $32 per share to $4 per share in a matter of days. The recovery was slow and hard, it was agony all the way back on this particular stock. Arrow Electronics is an example of putting all your eggs in one basket. It is an example of owning just one stock. SAB does not care how much you know about a company, things can go wrong and do go wrong. You simply cannot own just one company because the risk on the downside is too great. YOU MUST DIVERSIFY IN ORDER TO SPREAD THE RISK.


Copyright 2006 Richard Stoyeck

Buying Stocks on Margin. Good Idea?

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Buying on margin means that you are buying your stocks with borrowed money.If you are buying stocks outright, you pay $5,000 for 100 shares of a stock that costs $50 a share. They are yours. You've paid for them free and clear.But when you buy on margin, you are borrowing the money to purchase the stock. For example, you don't have $5,000 for those 100 shares. A brokerage firm could lend you up to 50% of that in order to purchase the stock. All you need is $2,500 to buy the 100 shares of stock.

Most brokerage firms set a minimum amount of equity at $2,000. This means that you have to put in at least $2,000 for the purchase of stocks.In return for the loan, you pay interest. The brokerage is making money on your loan. They will also hold your stock as the collateral against the loan. If you default, they will take the stock.

One way to think of buying on margin is that it is often comparable to buying a home with a mortgage. You are taking out the loan in the hopes that the value will go up and you will make money. You are in control of twice the amount of shares. All you have to see is the additional profit exceed the interest you have paid the brokerage.

However, there are risks to buying stock on margin. The price of your stock could always go down. By law, the brokerage will not be allowed to let the value of the collateral (the price of your stock) go down below a certain percentage of the loan value. If the stock drops below that set amount, the brokerage will issue a margin call on your stock.

The margin call means that you will have to pay the brokerage the amount of money necessary to bring the brokerage firms risk down to the allowed level. If you don't have the money, your stock will be sold to pay off the loan. If there is any money left, you will be sent it. In most cases, there is little of your original investment remaining after the stock is sold.

Buying on margin is usually not a good idea for the beginner or normal, every day investor. It is something that sophisticated investors even have issues with. The risk can be high. Make sure that you understand all of the possible scenarios that could happen, good and bad.

Winning Stocks Always Leave "Foot Prints"

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SIX STEPS and the IRREFUTABLE LAWS of the MARKET Every Investor and Trader MUST KNOW to Succeed:

Step 1:
A move begins with the sponsors (smart traders) who have insider knowledge as it relates to a particular stock or market. This information will move a market up or down depending on the insiders' information. These buyers are smart, very smart, and recognize trading/investment opportunities very early in the markup cycle.

Step 2:
Days, weeks, or sometimes months after a move has started, there is a brief mention in the electronic media (radio, cable, TV) or on one of the internet chat boards that a market has moved. The public hears for the first time and begins to get interested, but does not buy.

Step 3:
A blurb of information appears in print media. The move also begins getting more exposure on blogs and internet message boards. The public starts paying a little more attention, and will buy a little bit.

Step 4:
Wall Street and LaSalle Street brokers go into full hype mode and hawk the market to their customers. The public begins buying in greater volume.

Step 5:
A full-blown front-page article appears about the particular stock or market in one of the major financial newspapers, magazines, or financial websites. This is often six months after the fact and after a market has shown its greatest appreciation. There is often heavy public buying, even a possible frenzy, as all media, brokers, and so-called "gurus" start to tout the market.

Step 6:
As step 5 gets underway, the sponsors or smart traders begin to move out of the market and take their profits off the table.

The finale: The move ends, the market falls, and investors lose money.

The system is always right! It's the user that fails!

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Why is it that some people are successful in trading the markets while others fail? Is it luck that determines if you're successful in earning big bucks? Is it the system or strategy that a person uses which determines their success? Simply put, I believe the strategy that a person employs will ultimately determine if they are consistent winners in the market.

Every system that exists on the internet will show YOU how to make money using it. Without a doubt, it will make money for you. The question is usually how much money will the system make for you? That's important but a discussion for another day. Anyways...... All the systems out there will show you how theirs has worked base on historical data or activity and then at the bottom of the page there would be a disclaimer clause that states ‘.. Historical data does not determine or guarantee future earnings....’

So why is it that these sites or page include this disclaimer clause?

The disclaimer clause is incorporated because they (the promoters of specific investing systems) know that they can't control one key element that is crucial to success. Human emotions!

Human emotions can easily become the keys to success or the root cause of failure in any business including trading. You can read all the stock investing books you want. You can buy every investing system in existence. However, if you can’t control your emotions, you can’t succeed in the markets. (I.E. LENNY DYkSTRA) Again, this is the reason for the disclaimers because human emotions can destroy even the best of investing systems.

Thus, my belief in forming a strategy that controls or manages these emotions. If human emotions are the biggest pitfalls to investing and you incorporate a strategy that manages that short fall you will ultimately gain a much higher probability of success.

In the market there are two emotions that every trader will experience; GREED and FEAR. When these emotions appear it's not how we eliminate them but rather how we act on them. These emotions force us to ACTION, thus how we act on it will determine the outcome.

All too often when we begin to see two or even three consecutive losses while trading we begin to express doubts in our ability to trade. When this happens we are entering a state of fear, that is, we fear losing more of our money and thus begin to doubt our current investing system. How do you react? Some bail way before they should and ultimately lose out on future gains. Others don't bail when all signs point towards that being the right decision. Your strategy in controlling your emotions and making an educated decision based on your system will always lead YOU to the correct choice for YOU and your financial plans. Having this strategy will lead you to make decisions based on logic as opposed to fear. Thus, making your decision to bail or hang in there an educated one.

On the flip side, when we begin to see consecutive gains we generally become over confident. We start believing, " WE CAN make a killing doing this!" Many start tweaking the system by putting more money in the market to leverage our earnings or by taking on more overall positions. In many cases this leads to deviating from the system as Greed has taken over our emotions. YOU MUST HAVE A strategy that enables you to overcome Greed. Whether that's a definitive selling points or a definitive amount of cash your willing to wager (IE $2000 per quarter) on the markets. YOU MUST understand yourself and take all possible precautions to dissuade yourself from throwing all of your eggs in one basket. Far, far, far to many people can't control this and as fast as gains appear they disappear even faster.

I personally put a set amount of cash into my E-Trade account for a six month period (I take long positions). I tell myself " I simply don't have any other funds for six months and no matter how good my gains are I don't have any other money to spend." After six months I re-evaluate my positions and move forward.

"The system is only as good as the person using it" is a saying that has been around for awhile and for good reason. IT's TRUE! The discipline to act on our fears and greedy emotions will determine our success in the markets. Thus, creating a strategy on how you will react to these emotions is PARAMOUNT to success. Starting to see a common theme? Your strategy should be on Discipline and how you will react to the highs and lows of investing. You need to understand your personal strengths and weaknesses and plan accordingly. You must have the discipline to follow your plan of action and overcome your greed and say, "I have reached my target. I should take profits now even though it may go higher." Vice versa "I have to take a position even though the market does not seem to be moving in my favor." when fear sits in.

NO matter how good the system, the only sure way to lasting success in the market depends on your strategy of overcoming personal emotions that follow the inevitable highs and lows of investing.

What is this stock market thing?

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Everyday I feel more and more secluded from the people of my generation. The late "y" generation and early "X" generation seem to have very little knowledge of investment methods and very little interest in learning basic techniques to wealth management. I realize it's easy to be pessimistic about finance. We have witnessed a dot com bubble, housing bubble, and world wide credit freeze that almost brought down the world as we know it. I understand this!!!!! But that's the very reason we should jump into the markets now. The world will not stay in the dumps forever. Deals are everywhere you look and if you have the means to spend cash then do so! A good place to start is the stock market. If you don't understand it then today's a great day to begin learning how to build wealth.

Watching the numbers roll by on the bottom of your screen during a news cast might seem like nonsense to you. Those numbers are very important to many people because they make their fortune with stocks. They steadfastly watch the stock markets wanting to see how their investment is doing.

To understand the stock market you first need to understand what stocks are. Stocks are the capital raised by a company when they sell shares. Shares are offered through the stock market and the money taken in from those becomes the company’s stocks.

There are several major stock exchanges in the world where shares are traded. Company’s stocks are increased and decreased each day.

One of these stock markets is the NASDAQ. NASDAQ stands for National Association of Securities Dealers Automated Quotations. The NASDAQ is a United States based stock market. It’s the world’s first electronic based stock market. It also trades more shares each day than any other stock market which means it has the most impact on stocks.

Another large stock market that is United States based is the Dow Jones Industrial Average. You might hear someone say that the Dow is up or down this is what they are referring to. Many stocks are introduced on the Dow.

Many other countries also have a great impact on stocks. In Europe almost each country has their own stock market this includes Portugal, Germany and Lisbon. The people living and working there follow invest in the stock market there and just like in North America the stocks rise and fall.

The people who handle the buying and trading are called stock brokers. Their job is to sell and trade the shares that their clients request. It’s a demanding and rewarding job being involved directly in stocks this way. Stock brokers can make a lucrative income and the ones that study the markets and understand all the ups and downs have a definite advantage.

For the everyday person to get involved in stocks they need to do a bit of research. It might be wise if a large amount of money is involved to talk to a stock broker. Their job is related to stocks and no one is better qualified to assist you.

Stock brokers are paid on commission and therefore their drive is to invest in shares that will ultimately turn a profit. Often a stock broker has extensive knowledge with just a few stocks and he concentrates on those. If you decide to invest in a share that a certain stock broker is very well versed in, it might be prudent to have him or her handle your dealings. They can offer the best advice as to when to buy and when to sell.

There are other avenues available for people interested in stocks and that’s the online stock trading companies. Many of these companies allow anyone to sign up and buy and trade their own shares. This can be a great way for someone to be introduced to the world of stocks and with some research and practice they can make themselves a profit.