INVESTING & TRADING STUDENT’S GUIDE
Acknowledgements Student’s Guide to Investing and Trading, 1st Edition (2017) Editors: Kevin Lu, Henry Chen Special Thanks to: Alex Barrat
Sharon Yin
Alick Song
Sam Pham
Angela Zhang
Tom Pantle
Jassis Chen
Ethan Ou
Warwick Zhang Software: Adobe Indesign, Adobe Illustrator, Adobe Photoshop, Microsoft Powerpoint © University Network of Investing & Trading 2017
Disclaimer
1. The information in this free guide is provided for the purpose of education and intended to be of a factual and objective nature only. The University Network for Investing and Trading (“UNIT”) makes no recommendations or opinions about any particular financial product or class thereof. 2. UNIT has monitored the quality of the information provided in this guide. However, UNIT does not make any representations or warranty about the accuracy, reliability, currency or completeness of any material contained in this guide. 3. Whilst UNIT has made the effort to ensure the information in this guide was accurate and up-to-date at the time of the publication of this guide, you should exercise your own independent skill, judgement and research before relying on it. This guide is not a substitute for independent professional advice and you should obtain any appropriate professional advice relevant to your particular circumstances. 4. References to other organisations are provided for your convenience. UNIT makes no endorsements of those organisations or any other associated organisation, product or service. 5. In some cases, the information in this guide may incorporate or summarise views, standards or recommendations of third parties or comprise material contributed by third parties (“third party material”). Such third party material is assembled in good faith, but does not necessarily reflect the views of UNIT, or indicate a commitment to a particular course of action. UNIT makes no representations or warranties about the accuracy, reliability, currency or completeness of any third party material. 6. UNIT takes no responsibility for any loss resulting from any action taken or reliance made by you on any information in this guide (including, without limitation, third party material).
Contents Preface
SECTION 1: THE BASICS Why Invest and Trade Unveiling Trading Getting Started
SECTION 2: PROCESS OF TRADING Developing Expectations Idea-Generation - Fundamental Analysis - Technical Analysis - Behavioural Factors Deploying Capital Risk Management Self-reflection
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5 7 9
11 19 21 27 31 33 37 39
SECTION 3: OTHER TYPES OF INVESTMENTS ETFS Fixed Income Commodities Currency Derivatives Property Alternative Investments
SECTION 4: INVESTING, TODAY Student Experiences
Portfolio Strategies Future of Investing and Trading
43 44 45 46 47 48 49
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Utilities
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Section 4: Investing, Today Student Experiences: "Timing is notoriously difficult because you cannot predict the market" "Markets can remain irrational longer than you can stay solvent." 01 | 02
Preface “How do I start?” or “How can I improve?” – The aspiring student when it comes to investing and trading. Whether you’re a first timer or in the makings of a professional, this is the guide to investing and trading for you. Section 1 covers the basics, such as reasons for/against investing and trading, common misconceptions and executing your first trade. Section 2 guides you through the investing and trading process and aid in you in generating strategies to manage your portfolio. Section 3 introduces you to other types of investments you may wish to consider other than stocks including bonds, ETFs, property and others. Section 4 provides insight into past student experiences, the current job market, and the future of investing and trading. We do not, however, guarantee the success of any trades or investments that you may make and recommend seeking professional advice.
Investing: Buying and holding financial instruments for an extended period of time Trading: More frequent buying and selling of financial instruments with the goal of generating superior returns to investing
Section 1: The Basics
03 | 04
Cash vs Equities
20 Years
10 Years
5 Years
Value of $100 Invested in Stocks and Cash
Stocks +10.88% p.a. Cash +2.51% p.a.
Stocks +3.83% p.a. Cash +3.88% p.a.
Stocks +8.28% p.a. Cash +4.67% p.a.
Note: The ASX200 Total Return and BAUBIL Indexes were used as the proxies for Stocks and Cash respectively.
What you have said Survey results from our online poll
Main reasons why students do invest Wealth Generation
58%
Education Purposes
31%
Someone else told them to try
4%
Other
4%
To improve career progression
2%
Main reasons why students don’t invest Don’t know how to
44%
Risk Aversion
23%
Insufficient Capital
22%
Other
5%
Liquidity
5%
Opportunity Cost
2%
If you are not too sure about where to start or particularly worried about losing money, but still want to give investing a shot, we hope this guide will be useful for you!
05 | 06
Unveiling Trading Welcome to the world of finance!
Shares: Units of ownership of a corporation that can be purchased with the expectation of capital gains or dividends Fund Manager: A professional that manages the investment of money on behalf of clients Benchmark: Standard which performance is measured against. If you are trading ASX200 stocks, the ASX200 may be a relevant benchmark etc. Portfolio: Grouping of financial assets such as stocks, bonds and cash Risk aversion: Preference for a lower risk investment than a higher risk investment with a similar expected return
Lets debunk some common myths of trading: 1. “I am going to make a ton of money”
Fund managers do not always generate positive returns. In fact, most fund managers exhibit negative returns during recessions and several academic studies consistently suggest that fund managers are unable to outperform benchmarks over the long term. Overconfidence may cause one to take excessive risks that exceed their risk preferences. Your expectation for returns should be very much in line with the amount of risk you are taking on. See Developing Expectations for more.
2. “I am just going to lose all my money” Stocks carry more risk than cash and so you can expect to generate negative returns every so often. However, overestimating risk can also lead to suboptimal portfolios. You may already be holding stocks in your superannuation account and you may want to consider switching to a very conservative fund if your risk aversion is sufficiently high. You may lose a sizable amount now, but you may be able to expect to recover your losses in your first year as a graduate! That is, your future labour earnings may be used as a hedge against losses in your financial wealth.
EXAMPLE: BULL- BEAR MARKETS
PERFORMANCE
KEY TERMS
BULL MARKET
MARKET TERMS
3. “It’s just gambling” Investing and trading is similar to gambling to some extent as there is an element of chance. However, you may have already realised that stocks are more difficult than pulling a lever on pokies. Historical evidence suggests that market indexes generate positive returns in the long run whereas the expected return in many casino games is negative.
4.”You can only make money in the good times” Some investors prefer to stay out of the stock market in a bear market to avoid potential losses or increased volatility. However, certain stocks can generate positive returns in a bear market as they may thrive when market sentiment is low. Other stocks may be oversold and can be bought at a bargain, heightening returns during the transition back into a bull market. Nonetheless, investors need to be weary that timing the market is difficult and rarely achieved in practice. In the alternative, some investors short sell which enables them to generate positive returns when a stock price declines.
ASX: The Australian Stock Exchange (ASX) is the market which the shares of Australian companies are traded.
Market Index: Aggregate of a group of stocks. The ASX200 is an aggregate of the largest 200 stocks listed on the ASX etc. Bear Market: When share prices are falling and there is widespread pessimism. Bull Market: When share prices are rising and there is widespread optimism. Market Timing: Attempting to predict future market price movements by buying or selling stocks accordingly.
BEAR MARKET
NOTE BULL MARKET
TIME
Historical performance is not a reliable indicator of future performance
07 | 08
Getting Started In this guide, we will mainly be focusing on investing and trading in stocks, and not the other asset types discussed in Section 3. However, most analysis parts of the process can be applied to the other asset types. The process of investing and trading:
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Creating a Brokerage Account To purchase shares, you can either buy them as they are issued or on secondary markets where existing shares are traded. We will be focusing on the latter.
MARKET TERMS Financial Securities: rights to assets generally in the form of shares. Other forms include derivatives and bonds.
BROKERS A broker is an intermediary through which you use to trade shares. Rather than trying to find buyers or sellers yourself, you can buy or sell shares through a broker who will generally charge a commission for their services. Brokers may also offer investment advice at a fee.
Broker: Person or entity that executes trades submitted by an investor
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Short Position: Selling a financial asset, believing that the price will decrease (See Deploying Capital)
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Dividend: Distribution of the earnings of a corporation as determined by its managers
Long position: Buying a financial asset, believing that the price will increase.
STOCK EXCHANGE:
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Capital Gain: Appreciation in the value of an asset
Broker = Middleman
Once you have set up an account with a broker, you are ready to go. If you are unsure where to search for stockbrokers, you may want to consider using the search function provided by the ASX below: http://www.asx.com.au/prices/find-broker.htm CHECKLIST Choose a broker Start a brokerage account
09 | 10
Section 2: Process of Trading
Developing Expectations Summation
1
UNDERSTANDING YOUR INVESTOR PROFILE
Generally, investors can be identified by their appetite for risk, and their time constraints on their trading activity. Understanding your risk tolerance and time constraints guides you to make more efficient trading decisions within your own personal framework, leading to a clearer picture of which asset classes to invest in, and for how long.
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RETURNS - WHAT TO EXPECT
Investors and traders may go into trading expecting to make unrealistic returns, letting their profits run and turning a blind eye to when they should exit the trade.
3
Such wishful thinking often leads to lost opportunities in capturing the 'best' returns, and may even result in investors clinging onto falling stocks.This section aims to clarify what you should expect given certain characteristics of the company.
CREATING A SYSTEMATIC APPROACH
Without a system, investors and traders may tend to sporadically invest in stocks based on when they 'feel like it'. Developing and sustaining a systematic approach to trading is key to consistently performing well in this practice. This disciplined approach generally involves; fostering the habit of recording your trade performance, keeping up to date with economic news, and checking your portfolio regularly. 11 | 12
Developing Expectations Understanding your investor profile
The first question to ask is where do you fall on the risk spectrum. Investors generally fall into three categories depending on their preference for risk: a majority fall under the risk averse label, and the remaining are risk neutral, and risk seeking. Risk averse investors, seek to avoid risk and undertake safer investments, whereas risk seeking investors will undertake increased risk for a chance at a higher return.
PASSIVE TRADING Risk Averse + Time Poor - Buying and holding diversified portfolios or market ETFs
EXAMPLE This differing perspective can be illustrated with a fair gamble scenario. There are two available investments each costing $100: one offers a guaranteed return of 10% (a risk-free investment), while the other gives an 80% chance of making $25, but a 20% chance of losing $50 (a fair gamble). Both investments have an expected return of 10%, but the utility of each differs to every investor. Risk averse investors will choose the riskfree investment whereas risk seeking investors will choose the fair gamble.
OUTSOURCING Risk Seeking + Time Poor - Hiring a fund manager to invest and trade your wealth.
-$0
+$10 +$10
100%
Risk Averse Investor
Which option will you choose? +$25
20%
+$10 80%
Risk Seeking Investor
-$50
RISK SPECTRUM
How far will you dive?
RISK SPECTRUM
TIME SPECTRUM The next consideration is the amount of time available, both in terms of an investment horizon, as well as the amount of time available to dedicate to making investments. Firstly, a time horizon must be chosen. Both short term trading and long term investing have their advantages and disadvantages, with long term trading being more stable, as volatility tends to smooth out over time.
ACTIVE TRADING Risk Averse+ Time Rich
- Regularly trades lower-risk stocks
TIME SPECTRUM
ACTIVE TRADING Risk Seeking + Time Rich
Naturally, to undertake consistent trading, a significant amount of time is required, whether it be research, or making transactions. Â Time poor investors do not have the necessary time to perform extensive market research, and thus tend to hold assets over the long term, while time rich investors can choose to dedicate any amount of time to their portfolio. Everyone has differing amounts of free time, and this should dictate asset holding periods and trading activity.
- Regularly trading higher-risk stocks
HOT TIP
TYPICAL STUDENT'S PROGRESSION:
Invest $5000
The younger you are, the more financial risk you can take as you have more time to recoup the losses than an elderly person. However, using debt to leverage trades is a double edge sword, as is risk. Money management is a largely underrated part of investing a trading, and is key for long term success
Optimistic Scenario: Gains $1000
Pessimistic Scenario: Loses $2000
Fund your next holiday!
Earn it back in weeks as a graduate
13 | 14
Developing Expectations KEY CONCEPTS HEALTH CARE
What is a reasonable target return range? When is it time to close out of your position? It is essential to develop a goal for your investment. While considering your risk preference and time investment will significantly impact your investment decision making, it is still necessary to have a clear target to work to, which will shape how you invest. Your target should be consistent with your resources, and should be reasonable. It may be unlikely that a short-term investment into a low-risk stock would generate significant returns, so it will be unreasonable to expect so. By choosing a reasonable target that is within your means, decision making becomes significantly easier. However, investing is speculative and not all shifts are positive. It is possible for your portfolio to perform poorly and generate a loss. To that end, it is also necessary to decide how much of a loss you are willing to take. While this threshold can vary from stock to stock, knowing a limit is still extremely useful in minimising any potential losses. These limits can be one off or prolonged, and vary in size. Your limit may allow for day-to-day negative movements, but still be small enough to minimise the effect of significant drops in value. See Risk Management for more.
UTILITIES
INDUSTRIALS
LOW RISK
CONSUMER DISCRETIONARY
FINANCIALS
MARKET: ASX500
TELECOMMUNICATIONS
CONSUMER STAPLES
MATERIALS
LOW EXPECTED RETURNS
Beginners need to consider these important questions:
HIGH EXPECTED RETURNS
Returns - What to expect
MARKET TERMS Market Capitalisation: The market value of a firm’s outstanding shares. It is commonly used as an indicator for firm size. Large Caps: Companies with large market capitalisation. By the law of large numbers, it takes more resources to sustain the same growth rate, therefore you should not expect much capital gains going forward. Small Caps: Companies with small market capitalisation.
HIGH RISK
Cyclical: More sensitive to the fluctuations in the business cycle. Blue Chips: Large companies considered to be safe investments. Defensive: Less sensitive to the fluctuations in the business cycle. Growth Stock: A company stock that tends to increase in market capitalisation rather than distributing dividends.
INFORMATION TECHNOLOGY
ENERGY
Value Stocks: A company stock that tends to a have high dividend yield, and is seen to be undervalued relative to the market
NOTE
BASED ON THE LAST5 YEARS OF RESULTS, SUBJECT TO CHANGE IN THE FUTURE
Though we provide a guide as how much return you should expect to see in certain stocks, history has always shown there to be outliers. 15 | 16
Developing Expectations Creating a systematic approach
WRITE IT ALL DOWN! You tend to remember what you want to remember! Keeping in mind the above, it is essential to record everything that you do while investing, not only to keep track of your portfolio, but to constantly remind yourself of your overarching expectations for your investment. Investors can panic and make rushed decisions, overreacting to something as simple as a down day for the market. Writing everything down helps to keep everything in perspective and reduce poor decisions, ensuring your portfolio stays on track to meet your targets. However, just because you have written a plan down does not mean you have to strictly follow it. Use your plan as a guide so you can make choices as rational as possible. If there are significant and relevant changes in the environment that your plan does not cover, then you might need to make some amendments. Thus, you should expect to be keeping a record of everything, every step of the investing and trading process. Using a logbook is a good way to keep track of things. We have provided some suggestions of what columns you may wish to include in your logbook to the right. If you are unsure what your expectations are, hopefully it will be more clear the next time around the investing and trading process!
HABITS TO DEVELOP
KEEPING UP TO DATE WITH THE NEWS
2. MONITORING POTENTIAL LEADS
4. RISK MANAGEMENT
EXCEL SPREADSHEET SETUP
1. DEVELOPING TRADE IDEAS EVERYDAY
3. RECORDING PERSONAL TRADE DATA
5.
Below are a few column suggestions for your logbook template; you do not have to include all of them. The suggestions at the top are the most important, and recommended for setup. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Trade number Entry date Long or short Ticker Size (how many shares) Entry price Brokerage fee Total entry cost (Entry price x Size + Brokerage fee) Exit date Exit price Profit/loss Investment thesis Expectation in optimistic scenario Expectation in pessimistic scenario Contingency plan Evaluation of thesis
CHECKLIST Identified your own risk tolerance Determined amount of time you are willing to put into trading Established your target return range Setup your logbook template 17 | 18
Idea Generation Summation
Fundamental Analysis
KEY CONCEPTS Now that you have the setup out of the way, you can begin to formulate a strategy to generate returns! Put simply, a trade is a bet on a price change. The goal here is to find a stock which you believe is currently mispriced, but will change to its correct price level in the future. Trade ideas can arise through various forms of research, ranging from simply reading your morning newspaper – to the complex back-testing of a combination of technical indicators. Generally, there are three dimensions which shape actionable trade ideas 1) Fundamental analysis 2) Technical indicators 3) Behavioural factors Covering all three dimensions may be overwhelming for beginners, but a basic understanding of each element will help you greatly in developing the analytical skills, the technical deftness, and the psychological fortitude of a trader. Besides the news sources, screening software and applications will aid with narrowing down your stock selection. The process of screening will be discussed in the following sections below.
1
FUNDAMENTAL ANALYSIS (FA)
This form of analysis centres on contextualising the company, enlightening analysis on the company’s market position, financial position, internal and external challenges, a perhaps most importantly, prospective growth. Fundamental analysis encompasses a huge scope of information related to the company, but it generally involves understanding the economic environment surrounding the company, and its financials.
Behavioural Analysis
2
TECHNICALS AN
Here, the focus is on the share price and volume movement of the company on the stock market. The approach aims to identify patterns that may indicate future behaviour.
Technical Analysis
STICK TO YOUR STRENGTHS Find an industry you think you have a good grasp on, and stick to it. Trying to master all industries is an inefficient use of your time. Beginners often worry about missing opportunities, and try to look at as many markets as possible.They often ask advice on scanning software, and ways to sift through entire stock markets under the guidance of a single technical indicator. This often ends up wasting their time as they do not understand the patterns and nuances of a technical indicator in such a specific industry. A better approach would be to narrow your focus on a handful of markets, learning and trading with depth and attention. For instance, if you are passionate about a certain industry, say, the biotech industry, you may already be aware of certain industry trends and players, giving you an advantage when trading those biotech firms. You do not want to be in a situation where you are, analogously, the Jack of all trades, but master of none. It is important to consider all three elements. Fundamental analysis can help you find a ‘good’ company, but without technical and behavioural analysis, you could be at risk of timing your trades incorrectly. Entering and exiting at the wrong times can lose you money regardless of your stock selection.
NALYSIS (TA) Investors use it to help them determine which way a share is trending, and to prepare them to respond to market signals that indicate whether the share is likely to go up in value.
3
BEHAVIOURAL ANALYSIS (BA)
Unlike the other two types of analysis, this form fixates on the consumer sentiment and behavioural biases that underpin the share price of a company, identifying behavioural biases that may have influenced its price movements. Put another way; it is used to determine market over/ under reactions to certain company news.
19 | 20
Idea Generation: Fundamentals Summation
Fundamental Analysis is a broad brush term encapsulating the study of a stock’s intrinsic value based on related economic, financial, and stock specific factors that may affect the future performance of the stock.
FUNDAMENTAL ANALYSIS
There are generally two approaches to investing; top down, and bottom up. Top down analysis starts with the broader economy factors, then narrows down to the industry and stock. Bottom up analysis starts with screening for companies that match certain qualitative and financial metrics outlined by the investor, then focuses on firm specific factors to determine the best prospect stocks.
COUNTRY SELECTION
The emphasis on fundamental analysis should be greater if you are looking to generate returns in the long run. In the short run, there is generally too much noise for the intrinsic value to be realised.
KEY CONCEPTS Private and Public Companies: Not all companies are listed on the stock exchanges. Private companies typically have their ownership split between no more than 50 select investors, allow those investors for more control over the company. Public companies are those listed on the stock exchanges that have their shares available to anyone who may want to purchase them.
COMPETITOR ANALYSIS
MAKING SENSE OF THE ECONOMIC ENVIRONMENT
YOUR SELECTED STOCK (S)
Primary and Secondary Markets: The primary market is where new shares are created and first issued through initial public offerings (IPOs). When a private company is preparing to float on the primary market and ‘go public’, it will enlist the help of an investment bank to underwrite its IPO and guarantee to take on unsold shares at a fixed price. The secondary market is where those shares are then traded publically on stock exchanges without a fixed price.
YOUR PORTFOLIO OF INVESTMENTS
GLOBAL MARKETS
UNIVERSE OF STOCKS
SECTOR/INDUSTRY SELECTION COMPANY ANALYSIS
$
MARKET TERMS MAKING SENSE OF COMPANY SPECIFIC FINANCIALS, AND DATA
$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $
$
$
$
$ $ $ $
Asian markets open up to 8 hours ahead of European and US markets due to the time difference. As stock, bond and currency markets around the world are closely linked, events that occur on the asian markets can effect markets in the Eurozone, UK, or US, and have a bearing on the opening prices when these markets begin trading later in the day. For this reason, investors often look for signals from Asia to determine the likely direction of other markets.
Economic factors: Relevant economic activity that may affect the stock market performance such as interest rates, government policy, and taxes. Intrinsic Value: The true value you ascribe to a company or asset given your underlying perceptions of all facets of the business. Note this guide will not dive into calculating an exact intrinsic value. Equity: There are various forms of equity. Here it translates to a stock or any other security representing an ownership interest. The meaning slightly varies across the contexts of accounting, margin trading, and real estate. Enterprise Value: Measure of a company's total value, including both equity and debt components.
21 | 22
Idea Generation: Fundamentals Making sense of the news
This section aims to illustrate how you can generate trade ideas simply by reading the morning news. Each article can give hints as to where the forces of supply and demand are in action, so key question is to ask yourself is:
Where is the money flowing? Where do investments go to instead? When equity markets fall, and there are huge sell-offs in stocks, the money gained from the sell-off typically is injected into safe-haven such as currencies (JPY) /commodities (Gold) , bonds, and defensive stocks. Defensive stocks are generally stocks that provide a constant dividend and generate stable earnings regardless of the economic conditions (i.e. Utility companies that provide oil and fresh water). This should not be confused with defense stocks; companies that manufacture arms, ammunition and fighter jets. What are the market ramifications? Elections can cause mass withdrawals of capital from a market before the results are even announced. However, this can be an overreaction for which the market will swiftly correct. The 2016 U.S. Presidential election saw futures for the S&P500 and DJIA fall over 4% near midnight of Nov 8th. Yet, within weeks, both indices returned to record highs. Who is most affected? Higher lending rates results in less people borrowing, the systematic effect is felt most strongly amongst debt intensive companies. How does money flow down the supply chain? The last decade has seen a construction boom in China requiring vast quantities of metals from Australia. The corollary became the mining boom in Australia. Popularity of electric cars is rising, spurring global demand for metals like lithium that is a key component of their battery.
THE SMALL STR Politics
Economy
World
General Economic News
Tech
Mar
Markets Slump!
S&P500 tanks a steep loss, U.S Dollar falls after poor projected growth data from the Fed.
Political Instability!
Presidential election causes markets to fluctuate with the possible introduction of new industry regulation and tax policies.
Interest Rate Hikes!
Presidential election causes markets to fluctuate with the possible introduction of new industry regulation and tax policies.
Global Trade
Chinese housing boom ignites construction industry and global materials sectors. Demand for electric cars causes seachange for the global auto industry.
HOT TIP: USE CALENDAR Keep an eye on Bloomberg's economic calendar
Alternative facts:
REET JOURNAL
rkets
Arts
Life
Opinion
Real Estate
Sector and Industry News
Mega Trends!
Social Media, tourism, and Airbnb. Technology consumption, smartphones, and software. Sharing Economies, Kickstarters, and Uber.
Monopoly!
Supported by Rail and Toll Road Logistic Company establishes monopoly over VIC and NSW.
Competitors!
Amazon Prime coming to Australia will trouble for traditional brick and mortar retailers.
Company Specific News Capital Raisings and Trade Halts
SW Media raises $40million and announces offering of new shares at $1.32, a 18.5% discount to last closing price $1.62.
Legal Proceedings
New healthcare drug is legalised in Australia. Employee's launch workplace safety law suit.
Mergers and Acquisition Activity
Tatts attempts to merge with Tabcorp. Facebook acquires Whatsapp for $19B USD.
Major Deal Wins and Expansions
Chief construction company wins government deal to complete metro system.
What are the effects of trends on industries other than it is own? A mega trend will affect more than the immediate companies catering to it. Examples: Exponential rise of social media has incentivised global tourism and posed as significant competition to traditional marketing firms. Hotel chains thought they would benefit from this, but enter Airbnb. Adoption of smartphones, laptops and PCs has driven demand for web platforms. software, and the IPOs of Alibaba, Facebook, and Snapchat. Does this company have competition? Companies without competition but with steady demand are deemed monopolies. These are generally considered safe investments. How does competition affect this industry? Migrating foreign competition can be disruptive to domestic companies, taking market share from incumbent players. How is this to affect the share price? In theory, capital raisings to fund future growth and expansions should be a positive. But in practice, capital raisings of almost any kind and for any debt related reason will more often than not, cause share price dilution. What is the probability of success? Legal proceedings can make or break companies, therefore consider major risks. How is this to affect competitor share prices? Generally, mergers and acqusitions are not beneficial for competitors within the industry. Is this the right move the for the company? Look deeper, a highly debt-leveraged project may be a warning sign.
23 | 24
Idea Generation: Fundamentals Making sense of Financial Information Financial information can be overwhelming for beginners, so here we will provide several key things to look out for. Financials analysis is more to understand if the company is running smoothly and will continue to be operable without being at risk of default, than in predictive of potential growth. Before diving into financial statements, brokers will often have financial summaries which, not only have the raw accounting figures, but also financial ratios and multiples that better contextualises a firm’s performance against other firms. There are three main financial statements that a public company is obliged to release in their annual and interim reports; 1) Income statement 2) Balance sheet 3) Cash flow statement The intricacies of these will be taught in an accounting course, but generally, the key items you should focus on is revenue, net income, cash, debt, and dividends.
SOURCES OF INFORMATION Brokers often have financial summaries so you save time and stress from have to dive into a thick annual report to find them yourself. If however your broker does not supply that information, you may have to find the financial reports on the company website manually.
EXAMPLE: FINANCIAL SUMMARY
Price: $83.76 Market Cap: $144.89 B Shares Outstanding: 1.73 B Enterprise Valuation: $313.91 B Valuation P/E Ratio P/B Ratio PEG Ratio
Market Sector 14.74 17.65 13.41 2.38 1.46 1.43 4.51 1.65 2.86
Company
Profitability Profit margin Operating margin
39.50% 58.14%
UNDERSTANDING THE METRICS Price to Earnings (P/E) Ratio: High P/E means that investors are expecting much growth in the future. Average market P/E ratio is 20-25x. If company P/E > market or sector P/E, it is considered overvalued. Price to Book Value (P/B) Ratio: High P/B translates to riskier investment. A P/B below 1.5 is typically considered safe. Price to Earnings over Growth (PEG Ratio): Should PEG be >1, it is relatively expensive. EBITDA: Earnings before interest, tax, depreciation and amortization. Chiefly used as a measure of profitability.
HOT TIP: SCREENING COMPANY: XYZ Income Dividend Yield Tax Adj Yield
Market Sector 5.0% 4.0% 6.0% 4.0% 2.8% 4.7%
Company
52 Week Previous Close 52 Week High 52 Week Low
83.76 87.74 69.22
Risk Beta Total Debt/Equity Earnings stability
1.09 3.39 79.7%
Management Effectiveness Return on Assets (ROA) Return on Equity (ROE)
1.01% 15.65%
Dividend Yield: How much a company pays out to shareholders, expressed as a % of share price. Beta :A measure of volatility and systematic risk of a stock against the market as a whole. Can be viewed as stock sensitivity to market movements. Debt to Equity Ratio: Used to measure financial leverage. A high debt/equity ratio is red flag. Earnings Stability: Predictability of earnings pattern. ROA (a.k.a ROI): Measure of resourceful profitability. ROE: Measures average return for shareholders.
Say you have found the industry for which you believe you want to invest in, and now you want to pick a stock. Screening is a powerful tool that many help you find your desired stock through filtering out stocks that may not match your fundamentals criteria, saving you time from manually looking through each individual stock within the industry group. Bloomberg and CapIQ are industry standard software applications that professionals use to screen for their companies, but they generally require a hefty subscription fee to access unless your university or college provide free access. Besides your brokerage platform, there are various partially free screening sites online. For the ASX, there is asxiq.com which freely provides both fundamental and technical screening.
KEY ACCOUNTING TERMS Revenue: is the amount that a company has generated through all sales of its goods and services Net Income: is a measure of how much ‘real’ profit a business is making after subtracting expenses, depreciation, amortisation, interest, and tax from its revenues. Cash: is the amount of free flowing funds a company can use to pay of debts, hire new employees, expand, or acquire competition. Debt: is the borrowed money a company is using to fund expansions. Unpaid lenders (Creditors) can seize assets and force bankruptcy if they are not repaid. Dividends: are sums of money paid regularly (typically annually) by a company to its shareholders out of its net income. Yield: usually refers to the measure of the return on investment that is received from the payment of a dividend. 25 | 26
Idea Generation: Technicals Introduction to technical analysis
Technical analysis is the study of market movements, primarily through the use of charts, for the purpose of forecasting future price trends, and simplifying price data. The term ‘market action’ includes the three principal sources of informationa available to technical analysis; price, volume, and open interest (this only applies to futures and options). Technical analysis is used pre-trade – to determine trends and entry price level - and intra-trade – to cut losses and let profits run. But here, we will be focusing on the pre-trade capacities of technical analysis. In pre-trade technical analysis, the aim is to look out for signs of the following two movements: 1) A continuation in the price trend 2) A pivot away from the price trend
NOTE Word of caution, though these indicators are grounded in statistical mathematics, they do not guarantee returns. Beginners often fall into solely using and searching for fancy technical indicators they do not understand, and that are not meant to operate alone. It is important to understand a company’s financials before looking into their technicals. Their success is generally probablistic, and they should not be used as shortcuts to stock selection.
CHARTS: TOP 3
1. Line Chart
The most common and basic type of chart which connects closing prices of a set period
2. Bar Chart
Expands on the line chart with the additions of high, low, open, and close High
Open
Close Low
3. Candlesticks
Similar to bar charts except instead of thin vertical lines showing open close, it uses a coloured box. Open
Close Close
Open
The art of T.A. has a long history, reaching back into the rice market in 17th century Japan. Charles Dow, considered the 'father' of modern T.A., brought the practice to light in the U.S. during 1880s, founding the Wall Street Journal.
USING PATTERNS Patterns can range from simple trend lines to complicated constellations with a certain time frame. The use of one over the other does not always guarantee success.
Trendlines; Support and Resistance Resistance
Suppor t Trendlines are one of the most basic forms of technical tools used to show the direction of share price movement. The chart above illustrates the use of trendlines in identifying support levels for which the share price tends not to fall below, and resistance levels for which the share price tends not to raise above. Think about them as the floor and the ceiling to which the share price bounces between. However, these levels can be broken in events called 'breakouts', where generally, the momentum of the share price is increased leading to greater sell-offs or heightened demand. As such, traders often keep an eye out for breakouts.
Triangles
Ascending Triangle
This triangle is considered a continuation pattern for which is usually found amid a period of uptrend consolidation.
Other patterns
Symmetrical Triangle
Generally regarded as a period of consolidation, a symmetrical triangle breakout coupled with a spike in volume traded indicates increased upside momentum.
KEY TERMS Volume: the amount of shares traded during a given period of time. Liquidity: the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price Volatility: statistical measure of the risk (dispersion of returns) for a given share or market index, either measured by standard deviation or variance between returns. Rally: A rapid increase in the general price level of the market or a stock price
Descending Triangle
The lowering peaks show weakening demand, meaning that at the breakout, traders will short the stock as the downside momentum increases.
There are many technical patterns out there; 'morning star', 'doji', and the 'hanging man', just to name a few. It can be useful to learn a few, but solely focusing on patterns can be overwhelming as they can become more of a distraction than a productive means of trading. 27 | 28
Idea Generation: Technicals Additional technical tools
MOVING AVERAGES Share Price 50 day SMA 100 day SMA 200 day SMA
Moving Averages are one of the main pillars of technical analysis representing the average price over a period of time, wih the aim to smooth out price data. For investors, the 50 day, 100 day, and 200 day simple moving average (SMA) are popular choices. The most basic and oldest being the interaction between the short and long moving averages. When the short moving average crosses down through the long moving average (a.k.a the 'Black Cross') it signals to sell short or close out a position. The opposite is true for when the short moving average crosses up through the long moving average (a.k.a 'Golden Cross'), translating to go long. As such, pay attention to when these cross overs occur to time your entrance.
PRICE BASED INDICATORS
Stochastics
Relative Strength Index (RSI)
Overbought
Overbought
70 50
Oversold
Traders use this oscillating indicator to determine overbought and oversold conditions. It is one of the few 'leading' indicators that generates signals before they appear in pricing behaviour
Momentum
Oversold
30
Similar to Stochastics, RSI is primarily used to identify overbought or oversold conditions. Above 70, the stock is overbought and due for a correction, whilst if it is below 30 it is oversold and due for a bounce. However, during trends, the RSI can stay at those extreme levels for quite a while.
MACD 110 100
0
90 Also referred to as rate of change (ROC), this indicator is used to highlight trend strength by remaining positive during a sustained uptrend, and remaining negative during a sustained downtrend.
Moving Average Convergence Divergence is a momentum indicator that is commonly intepreted by; 1) Crossovers of the two moving averages, 2) Divergences of the share price from the MACD, and 3) Dramatic distancing of MACD lines.
CRITICISMS
USING VOLUME Volume generally reflects market interest. For instance, during a bull market, a rising amount of volume should be observed to indicate rising enthusiasm from buyers. When prices fluctuate on little volume, it is not a strong signal. Yet when a rise or drop occurs on heavy volume, it indicates a fundamental change in the stock price.
Another example of its use would be indicating a reversal after a long price move higher or lower, followed by low price movement, but high volume.
Volume is also key from trading breakouts as low volume indicates a false break, while high volume confirms the breakout. Market depth - also known as the order book, this displays information about the prices at which traders are willing to buy and sell a particular stock. Market depth will reveal the price levels at which there is resistance (lots of sellers), and support (lots of buyers), providing a better picture of supply and demand. Stock that has higher probability of moving up in price level will have lower resistance and higher support as indicated by market depth.
On Balance Volume (OBV)
0m -5m -10m
OBV takes volume information and transforms it into a one line indicator. This measures buying and selling pressure by adding the volume on up days, and subtracting volume on losing days. Ideally volume should confirm trends.
The self-fulfilling prophecy This often used to criticise technical analysis by stating that the use of most patterns has been widely publicised in the last several years, resulting in many traders using and acting on such patterns in concert. However, the truth of the matter is that technical analysis is very subjective, chart patterns are seldom so clear that even experienced technicians always agree on their interpretation. It must be kept in mind that bull and bear markets only occur and are maintained when they are justified by the laws of supply and demand. Can the past be used to predict the future? Simply put, yes, what else is there to use? The only type od data anyyone has to go on is past data. We can only estimate the future by projecting past experiences into that future. Random Walk Theory In a nutshell, this theory states that price movement is random and unpredictable, undermining all forms of analysis. The theory is based on the efficient market hypothesis, which holds that prices fluctuate randomly about their intrinsic value. It also holds that the best market strategy would be a simple “buy and hold” strategy as opposed to any attempt to “beat the market”.
WORLD OF T.A. This short overview of TA and indicators only brushes on the surface of this discipline. In the knowledge base of the Market Technicians Association, there are over 2000 entries. It is important not to be bogged down by this. Professional technical traders constantly backtest combinations of indicators to find the best combination, but its no secret that there is no secret sauce to accurately predicting market movements all the time. 29 | 30
Idea Generation: Behavioural Introduction to Behavioural Analysis
For those who maybe unfamiliar with the market, it can be easy to assume that the market operates rationally. Yet, in practice, it is hard for investors and traders to ignore cognitive and emotional biases when making investment decisions. As such, behavioural analysis posits that markets are driven by sentiment and emotion rahter than rationality. History has shown that these behavioural patterns exist in the forms of overreactions and underreactions. Behavioural analysis is all about picking up on these reactions, as well as being aware of market manipulation. Similar to technical analysis, this topic spans across the pre-trade and intra-trade periods. Here in the pre-trade section we will cover trading around market sentiment, and market manipulation, as well as taking a look at certain behavioural effects an investor may encounter themselves. Here, the analysis uses quantitative signals such as volume to confirm over/under reactions, whilst also using qualitative signals to distinguish temporarily relevant data as opposed to permanently relevant data.
TRADING OVER/UNDER REACTIONS The key to identifying over/under reactions requires is to determine whether the source of the rise or drop in share price is temporary or permanent. Richard Thaler, head asset manager of Fuller & Thaler, provides a neat example: If an oil company had an earnings surprise because the price of oil went up, Fuller & Thaler wouldn't be interested. However, if the company had developed a more efficient process of refining oil, they would have reason to look into the company further. The market may have misread and disregarded the earnings surprise as mere correlation to oil prices, thereby underreacting. Here Fuller & Thaler can take a long position, and wait for the market to correct.
For an example of trading an overreaction: Dr Michael Burry, the principal investor at Scion Capital, was noted in the book 'Big Short' to take a contrarian stance on manufacturing company that had a scandolous board of executives whom embezzled money. At first glance, the corrupt leadership would cause a drop in the share price when they get indicted. However, Dr Burry saw past this, identifying the efficient money making machine underneath the devilish vineer. The market overreacted to the indictment of the company executives with a sharp sell-off, all the while Dr Burry was buying stocks the entire time down. Then, as he foresaw, the price of shares bounced once a new leadership was installed.
KEY IDEAS IN BEHAVIOURAL ANALYSIS Greater fool theory: posits that the price of an object is not determined by its intrinsic value, but rather by irrational expectations of the market. A price can be justified by a rational buyer under the belief that another party is willing to pay an even higher price. This is unfortunately how speculative bubbles are formed. Bubbles will invariably burst, resulting in a sharp sell-off and rapid depreciation of price.
Anchoring effect: human tendency to anchor our thoughts to a reference point even though it may have no logical relevance to the decision at hand. i.e. Diamond Anchor - two month salary/ Company valuation vs Analyst valuation. To avoid anchoring, you must critically assess the information that has been disseminated to you, i.e. whether the person behind certain information had incentive to provide it.
MARKET MANIPULATION From trading forums to company investment publications, to clickbait youtube videos, market manipulation exists across many platforms. Though it is illegal to market manipulate, the practice has proven difficult to regulate.
Investors often like to discuss shares they own or are thinking of buying with like-minded individuals on bulletin boards and investment forums. While these can be a good source of investment ideas, they can also be used by unscrupulous traders who post negative or positive information to inflate or deflate prices. This is especially pertinent with small stocks and crytocurrencies.
As a trader, you will encounter many 'hype - men' and 'down - rampers', that disseminate stock information to benefit their own investment position. You ought to be wary of such content, and quickly identify the motive behind their publication. This often involves checking to see whether they have taken a position on the same stock their content is based on. However, unless it is a reputable forum, such position is difficult to detect. As such, it is recommended that you take such content with a grain of salt, and more importantly, that you conduct your own independent research.
Gambler's fallacy: Also known as the Monte Carlo fallacy, the theory posits that humans are subject to the mistaken belief that, if something happens more frequently than normal during a certain period, it will happen less frequently in the future. Put differently, it is the irrational belief that the eventuation of a random event is less likely to happen following an event or series of events.
LIBOR SCANDAL Manipulation can affect multiple areas of the market in todays globalized financial system. A recent example is the Libor rigging scandal. Libor is a benchmark rate that banks charge each other for short-term loans and is regarded as an important measure of trust between major global banks. The scandal involved traders at 10 firms, which the UK’s Serious Fraud Office alleged had conspired to manipulate the Libor benchmark between 2006 and 2010 in order to keep it artifcially low.
Prospect Theory: assumes that losses and gains are valued differently, and that individuals make decisions based on perceived gains instead of perceived losses. i.e. the lottery, which highlights human irrationality.
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Deploying Capital Place an Order: What price are you willing to transact at?
Market Order A market order is an order through a broker to trade a stock at the best, immediately available price. There are no restrictions on the time frame or price range within which this order must be executed. The primary issue with such an order comes in ‘market slippage’, or ‘bid-ask spread’, where the price of an assets changes, or ‘slips’, from the intended price. These issues will be covered more in depth under transaction costs.
An example order book for UNIT's Shares:
UNIT
University Network for Investing an Last Price
$5.050 Open $5.000
A market BUY order will be executed at $5.06. A market SELL order will be executed at $5.05
Limit Order A limit order is an order to buy or sell a stock at a specified price. Unlike a market order, there may be situations where a limit order is not executed as there are price restrictions to be satisfied during the time window at which the order is active. Thus, a limit order provides the opportunity to execute a trade at a better than market price at the risk of nonexecution.
A limit BUY order for $5.05 will sit on the limit order book at $5.05.
A limit SELL order for $5.06 will sit on the limit order book at $5.06.
BUY
High $5.070
Buyers (Bids) No.
Volume
Price
30
10,000
$5.050
20
15,000
$5.040
250 buyers for 600,000 units
MARKET TERMS
Limit order book: A record of unexecut above Last Price: The price the most recent tra Today’s Change: The difference betwee the previous day. Open: The price the first transaction of t Volume: The number of shares being o No.: The number of buyers or sellers wi
Day Order
nd Trading Today’s Change
+0.050 (+1.00%) Low $5.000
SELL
Volume 1.00M
A limit SELL day order for $5.06 that is not filled by the end of the day will be removed from the limit order book the next day.
Sellers (Offers) Price
Volume
No.
$5.060
5,000
25
$5.070
12,500
20
200 sellers for 400,000 units
ted limit orders for a stock as shown
ansaction was executed at. en the last price and the closing price of
the day was executed at. offered on the limit order book currently. ith a limit order at that certain price.
A day order will automatically expire if it is not fulfilled within the day that the order was made. These types of orders are more typically used by short-term day traders, who leverage large amounts of capital to profit over small price movements. Day orders offer the convenience of being able to place an order at a specified price without the need for a trader to monitor it, and its automatic cancellation prevents a backlog of unexecuted orders.
IOC An immediate or cancel order (IOC) is an order that must be filled immediately and at a specified price. If this can only be satisfied in part, then the remainder of the order will not be filled and expire. IOCs are most often used by active traders and often for very large transactions. IOCs can also be used with the intention to fulfil what portion of the order is possible, and then cancel the remainder. A market BUY IOC for 6,000 shares will result in the purchase of 5,000 shares at $5.06 with the remainder of the order cancelled. 33 | 34
Deploying Capital Transaction Costs and Order Settlement
Order Placement
Order Execution
T+2 Settlement
You place a buy or sell order with your broker
Order is executed and transaction costs are incurred
Your order is settled two days after execution
Brokerage Fees Brokerage fees are an explicit fee charged by your broker to act on your behalf and purchase or sell shares accordingly. Though there is little one can do to avoid brokerage fees, there are a wide variety of services offering different cost structures. For example, some trading platforms may offer a flat fee for every trade up to a cap, after which there may be a percentage fee based on the value of the trade. Whilst seemingly small in the context of a single trade, brokerage fees add up over the course of the hundreds or thousands of trades. Typically, flat brokerage fees range from $10 to $30 per trade. Some brokers offer free brokerage over a promotion period so be sure to shop around.
Bid-ask Spread A bid-ask spread is the difference between the best bid and ask price for a stock. It is an implicit cost incurred for using market orders. For instance, if you place a market BUY order for UNIT (see previous page), then you would be paying an additional $0.01 or 0.2% for each stock than if you had placed a limit BUY order at $5.05 and waited. The bid-ask spread is small for liquid or frequently traded stocks, as UNIT would be, but may be significant for illiquid or unfrequently traded stocks. Implicit transaction costs may also be significant for large trades or stocks lacking volume. If you wanted 6,000 shares of UNIT at the market price, 1,000 shares would be executed at $5.07 or $0.02 higher than if you had placed a limit BUY order at $5.05. This is also known as market slippage and an IOC may be suitable in this scenario.
T+2 Settlement In Australia, you will have two business days from execution to settle your buy order or receive proceeds from your sell order.
Contract for Difference If you have closed your position before T+2, you will be able to effectively engage in a contract for difference (CFD) or margin trading. An example of a CFD using T+2 is provided on the right. On the day of settlement, you would receive $100 in the optimistic scenario and pay $100 in the pessimistic scenario. This enables you to upsize your profit or loss on short term trades and may be useful if you have capital constraints. However, CFDs using T+2 attract additional risk. If UNIT unexpectedly entered into a trading halt before you could close your position, you may have needed to settle your buy order for 5,000 shares. Some brokers explicitly offer CFD services but at additional fees.
Short Selling In Australia, selling a stock that you do not own is prohibited. Therefore, a common way to short stocks is through CFDs whereby you will effectively borrow the stocks from the broker for a certain fee.
CHECKLIST Place your order(s) Fill out Logbook accordingly when orders are executed
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Risk Management Summation
INTRODUCTION In the financial world, risk management is the process of identification, analysis and mitigation of uncertainty in investment decisions. Over the long-term, risk management is essential to the survival of an investor as it helps protect them for unexpected losses in their portfolio. One of the most successful investors of all time, Warren Buffet has two important rules for investing: Rule #1: Don’t lose money Rule #2: Don’t forget rule #1 Now unless you’re Warren Buffet, losses are an inevitable part of trading and the ability to manage such risks will be the difference between making or losing money over the long-run. Before getting into the details, it’s important to know that risk = return and that the higher the return you expect on your investments, the higher the risk is likely to be. Furthermore, risk management can change from individual to individual depending on your risk appetite. For example, if you’re risk seeking, you may be more inclined to invest in growth stocks over value stocks, whilst if you’re risk adverse, your financial tool of choice may be government bonds.
WHAT IS RISK? There are two main types of risk when it comes to investing; systematic and idiosyncratic risk. Systematic risk, also known as “market risk” is un-diversifiable risk inherent to the entire market. Although systematic risk cannot be eliminated, it can be managed and below is a table of some examples of systematic risk that could affect your investments. On the other hand, idiosyncratic risk is the risk which is unique to an individual company or sector. The risk associated with your company can be market wide or involve company decisions made by management as well as the financial structure of the company. For example, if company XYZ has too much debt on it’s books, there is a risk that investors will become concerned and the stock price will fall. Furthermore, industry risk is associated with a particular industry. For example, if you own a company that invests heavily in oil and gas in the energy sector, a fall in oil prices due to an OECD commitment would affect the stock price of your company.
It’s noteworthy that non-systematic risk can be diversified away (discussed next section) by having up to 15 different stocks from uncorrelated sectors so that a decrease in the price of one stock can be offset by an increase in another.
HOW TO MITIGATE RISKS There are five main ways to effectively risk manage your portfolio to prevent and seriously bad losses. The reason why it’s so important to manage risk is that the return required to break even after a loss is always greater than the percentage you have lost due to a decrease in the stock price. This is illustrated in the graph below: LOSS INCURRED 10% 15% 20% 25% 30% 35% 40% 45% 50% 60% 70%
GAIN REQUIRED TO BREAK EVEN 11.1% 17.7% 25% 33.3% 42.9% 53.9% 66.7% 81.8% 100% 150% 233.3%
METHOD 1: DIVERSIFICATION The idea behind investment diversification is to buy asset classes or sectors that are not correlated. That means that if one goes up, the other is probably going down, however such a tactic has become more difficult to achieve recently due to asset classes becoming more and more correlated. The ideal number of stocks to have in a portfolio to eliminate non-systematic risk is 15. However note that although diversification can protect you from serious downside, it also culls the upside.
METHOD 2: STOP LOSS ORDERS You can place a stop loss order with your broker that will automatically sell out all or part of a position if it falls below a certain price point. The key is to set this point low enough so that you don’t exit your position over a minor price pullback, but high enough in order to limit damage to your portfolio. Some Australian brokers such as ‘Commsec’ may only offer stop loss alerts, so check with your personal financial broker.
METHOD 3: HEDGING Although a method for the more advanced trader or business, hedging your position by buying the underlying derivative can be effective in risk management. For example, if you’re trading in the Forex market, you may want to buy the underlying forward contract of the currency pair in case the market turns against you.
METHOD 4: FOLLOW THE TREND Creating trend lines by connecting a series of higher lows on a chart or using a 50 or 200 moving average can help mitigate risk. By being diligent and selling when the price breaks a predetermined support level, you may minimise some loss.
METHOD 5: PORTION SIZING Another method of reducing damage is by limiting your exposure to the riskier assets in your portfolio. For example, a 50% loss on $2000 hurts less than a 50% loss on $20,000, so limit these larger investments for safer value stocks, not small cap stocks. 37 | 38
Self Evaluation Reflecting on your investments and trades
TAKEAWAYS
QUESTIONS TO PONDER
Comparing actual performance and outcomes with expectations that you have written down earlier Self-reflection is an essential part of investment that helps you grow and become better over time. Whether you make or lose money, re-evaluating your initial beliefs about a stock before and after you sell allows you to see what you’ve done right and wrong and to adjust these behaviours for your next investment. Keeping an excel document is essential information about the stock and your profits and losses as well as brokerage fees, keeps you on top of your finances and provides you with realistic expectations about how much you earn. Always conduct due diligence and be intellectually honest with yourself when investing as it’s the worse place to hold any delusions.
CHECKLIST Have I reviewed my Logbook and evaluated my initial beliefs? Did I stick to my trading plan? Am I ready to make my next trade?
OVER - TRADING Over - trading is an issue many traders wrestle with. It generally is defined as taking any trade outside your trading plan, exposing you risk limits that you had not intended to breach. This potentially devastating habit can be prevented, first by having a trading plan, and second, by having separate accounts for trading to limit your net exposure.
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Section 3: Other Asset Classes
The Others Besides shares, there are various other types of investments for which you can trade or use to store your wealth.
ed Fix
Excha nge T rade Fund s
The following section will discuss what these other investments are, and provide several real-world examples of these assets.
cts du ro
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om
Inc
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om
C
s
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OTHER INVESTMENTS
Proper ty
Other Investments ency Curr
a rn te
Al e tiv
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ts
en
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ETFs WHAT IS THIS? An Exchange-Traded Fund (ETF) tracks the performance of an underlying asset or basket of assets and can be traded like stocks. ETFs are typically used in a passive investment strategy.
Examples MARKET ETF ETFs that track the S&P/ASX 200 are considered to be a well-diversified investment that can produce long term returns for a buy and hold strategy. Market ETFs are simple to manage as they can allow you to diversify their portfolio without having to purchase each individual ASX 200 stock and frequently rebalance their portfolio to achieve market weights.
OTHER ETFS ETFs can also track other asset indexes such as international stocks, fixed income products, commodities, real estate, currency and derivatives. These asset classes may be difficult to acquire or attract significant trading costs and thus ETFs may be an attractive means to diversify across different asset classes.
FIXED INCOME WHAT IS THIS? Fixed Income products provide a regular and predictable but low yield stream of income. They are typically used to lower the risk of an investment portfolio and may be more attractive to investors when risk aversion is higher.
Examples BONDS The Australian Government issues AAA investment grade bonds which provide very low risk coupon payments. Like other bonds, they can be sold prior to maturity or when the principal is repaid. The private sector bond market in Australia can be thin and thus investors generally consider oversea bond markets. However, trading foreign bonds will attract risks associated with currency fluctuations.
TERM DEPOSITS Commercial banks offer term deposits which also provide very low risk interest payments and are guaranteed by the government in Australia However, your investment will be locked away for the duration and cannot be “sold� like a bond. Interest payments also tend not to be adjusted for inflation and can expose you to the risk of your investment returns falling below inflation in a low interest rate environment.
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Commodities WHAT IS THIS? Commodities are basic goods that are typically used as inputs in the production of other goods and services. Trading usually occurs through the use of future contracts whereby the price and quantity of the commodity traded is predetermined.
Examples IRON ORE & OIL Iron ore is a demand-sensitive commodity and its price tends to move with the fluctuations in the business cycle. In the last decade, rallies in iron ore price have been sparked by government investment in infrastructure, particularly from China. Contrastingly, oil is a more supply-sensitive commodity as its demand is relatively inelastic with few alternatives available for necessary transportation spending. Rather, oil prices tend to move inversely with global output.
GOLD Gold is viewed as a safe haven asset that has traditionally maintained its value over time. It can be used to hedge against a depreciating currency or rising inflation which reduces the real value of money. Historically, investing in gold can also serve as either as a way to diversify efficiently or to bet against the market as gold prices have historically moved inversely to stock prices.
Currency WHAT IS THIS? Currency is traded on foreign exchange markets and its value tends to move with domestic interest rates. Buying foreign currencies can serve as a hedge against fluctuations in exchange rates when investing in foreign assets.
Examples JAPANESE YEN The Japanese Yen is viewed as a safe haven asset which tends to appreciate when foreign exchange market volatility is high or stock market returns are negative. Its safe haven status has been particularly pronounced during crises. However, the underlying drivers behind the yen are less clear. Some believe it is attributed to Japan’s very low interest rates which encourage investors to borrow from Japan and invest proceeds into higher yielding foreign assets. During crises, these trades are typically unwound, funds flow back into Japan and the Yen is bid up.
CRYTOCURRENCIES Unlike the majority of national currencies, cryptocurrencies are not issued or managed by a central bank. Rather, they are a purely digital currency that take advantage of block chain technology. Cryptocurrencies are a highly speculative investment. Their potential lies in the application of lowering transaction costs, providing anonymity and protection against fraud. However, limitations to its adoption persist and include the threat of cyber attacks, lack of awareness and potential market failures that may arise when the government cannot intervene. 45 | 46
Derivatives WHAT IS THIS? A type of financial contract between two or more parties, the value of a derivative is derived from fluctuations in the price of an underlying asset. Derivatives are used to essentially bet on the future price of an asset, and to insure against risk.
Examples FUTURES Used to fix a price in the future for which contract parties will agree a price that they will exchange their assets. For instance, companies that rely heavily on a product and wish to stabilize their costs may buy futures derivatives to hedge against unexpected rises or falls in the product's price.
OPTIONS As with futures, options fix the price for a future deal but with options the buyer is not obliged to make the transaction. For a small cost, options offer speculators the chance of generating a profit by betting on future changes in the value of an asset, and the size and timing of these changes.
Property WHAT IS THIS? Real estate has historically had a low correlation with stocks and thus can be used as a means to diversify your investment portfolio. Like stocks, real estate can offer capital gains as well as a risky income stream (in the form of rental yield).
Examples PROPERTY Purchasing investment properties can enable you to unlock large amounts of leverage that are generally not available for other asset classes. Leverage is obtained through a mortgage and can efficiently increase expected return from taking on additional risk. However, the illiquidity of the property market may be problematic and costly should you wish to close your position quickly. Property also requires a large amount of upfront capital which may not be available many students.
REIT A Real Estate Investment Trust (REIT) pools its investors funds to buy and sell real estate. REITs are traded on exchanges like stocks and pay out capital gains along with rental income through dividends. Thus, REITs can offer liquid investments into property and take away the hassle of being a landlord. However, this can be at the expense of forgoing leverage through a mortgage and reducing the benefits you get from diversification as REITs tend to be more correlated with the stock market.
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Alternative Investments WHAT IS THIS? Alternative investments include private equity (as opposed shares which are public equity), venture capital, crowdfunding, hedge funds, and certain real assets including precious metals, wine, art, jewelry, sneakers and license plates.
Examples REAL ASSETS Besides property, commodities and land, real assets including luxury and collectable goods are also categories that can hold and generate long-term value. Investors can buy real assets directly or invest with a fund specialising in real assets, such as art investment fund ArtVest Partners. WATER RIGHTS As some food for thought, former principle investor at Scion Capital, Dr Michael Burry has raised many eyebrows, investing in water rights. This is the same investor who foresaw the 2008 GFC 5 years in advance.
VENTURE CAPITAL Investors can directly invest into start-ups, early stage companies, and growth stage companies for a share of their equity. As smaller companies tend to grow faster, the investment returns can be extremely lucrative (i.e. Google, Facebook, and Twitter). However, it ought to be noted that startups are very risky, and often are not operating at profitable levels, taking on more debt to grow faster and keep afloat.
Section 4 Investing, Today
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Student Experiences Name: Kevin Zhang Degree: B. Com/Eco University: UNSW Year: Class of 2018 How did you first get started with trading? I first invested in blue-chip stocks as an alternative to keeping money in the bank. When looking at the historic return of the S&P 200, it looked much more attractive the prevailing cash rate. What was your first trade, how did you come you that idea? My first trade was a long position Qantas, after it recorded a turnaround profit, in comparison to a heavy loss in the previous year. At the time, the oil price was also going down, which was beneficial to cutting costs in the company. However, the success of the trade also came down to luck, as they also continued to increase revenues due to growing tourism later that year. How often would you look at your trading account when you started? When I first started, I would constantly be checking the prices of my portfolio during my free time. In retrospect, it probably caused an unnecessary amount of anxiety when first trading. These days, placing an alert for significant swings in share price or announcements would probably be a better way to manage long-term positions if you are beginning to trade. What sources of information did you use when trading? Mainly a bottom-up approach using company statements and all available public data on the ASX. How did you attempt to time entries and exits, or was it a matter of hitting price levels? At the end of the day, achieving the “perfect” entry and exit comes down to luck more than skill. But there are indicators such as volume that you can look at to help you judge better when to get into or out of a stock. When a trade was not performing the way you expected it would, how did you deal with it? I would often spend weeks trying to understand why it wouldn’t work. As long as you don’t over-expose yourself into a particular stock, a poor trade isn’t as painful in the long-term given you have something to gain from it. Losses are a natural part of the learning experience, and will allow you to re-assess and improve your ability to pick stocks in the future. If there was one recommendation you would make to yourself as you first started trading, what would it be? Markets can remain irrational longer than you can say solvent. More often than not, a seemingly obvious trade won’t go as you expect it, so try develop consistency if possible.
Name: Katherine Guo Degree: B Comm/LLB University: USYD Year: Class of 2019 How did you first get started with trading? I was already interested in trading in high school as my economics tutor was an ex-trader and my parents occasionally did some trading so I opened up a trading account with CommSec in my 2nd year after I spent my first year learning more about finance and trading and keeping up to date with financial news. Partly why I decided to start trading was because it was a great opportunity to put my finance knowledge into practice, learn more about and keep up to date with financial markets. How often would you look at your trading account when you started? What sources of information did you use when trading? When I first started, I would look at my trading account at least a few times a day because I was so nervous about my trade performance (which in hindsight, was more detrimental than helpful). As for sources of information when I first started trading, I tended to rely on financial news (AFR, Bloomberg etc.), databases available via uni like Morningstar and financial statements, analyst reports etc. available through my broker. Bloomberg Terminals is also a very good resource that I would recommend. How did you attempt to time entries and exits, or was it a matter of hitting price levels? Timing is notoriously difficult because you cannot predict the market – however, my view is that markets have bouts of irrationally so when the market seems to clearly be excessively optimistic/pessimistic, I will usually try to exit/enter a position. But, it’s still a mix of hitting price levels for me since I usually just set it at some price level not too far off from the current of market price even when I know I want to enter/exit a position. When a trade was not performing the way you expected it would, how did you deal with it? One of my earlier trades was Origin which I bought not long before oil prices crashed. At the lowest point Origin was trading around 50% of what I had bought it for originally. After doing some research and deciding whether market prices were justified, I ended up deciding to hold onto my position instead of selling off and further invested by buying more shares when Origin was around its lowest point and through its Entitlement Offer. Since then I’ve reduced my position as prices rebounded but I’m still holding some shares as I don’t think it’s currently a sell. It ended up being a much more long-term investment (a bit less than 2 years now) than I was intending but was a great experience which I learnt a lot from. If there was one recommendation you would make to yourself as you first started trading, what would it be? One of the best pieces of advice I’ve heard from a trader was that before you start trading, give a go at trading via a virtual account. This wasn’t something I did and in hindsight, would’ve definitely saved me from a few bad initial trades which I learnt from – it’s better to play with fake money and learn from your mistakes than to do it you real money. It’s important to remain rational when markets aren’t because if you end up panicking with the market and selling off a stock when it crashes instead of evaluating the stock, you can often end up losing out. 51 | 52
Portfolio Strategies When it comes to developing a portfolio, the key term often referred here is 'diversification'. Though the practice of not putting all your eggs in the same basket mitigates risk, it can be customised to your risk tolerance and time constraints. Below are 5 portfolio strategies with unique risk and time constraint profiles:
Income Portfolio
Dividends are the main focus in this portfolio. Companies will be screened and prioritised based on their dividend yield and risk. As the name suggests, the basket of stocks should generate positive cash flow. REITs and blue chips that have high yields are favoured in this portfolio type. REITs specifically return a significant amount of their income to shareholders in exchange for favourable tax statuses.
Defensive Portfolio
This portfolio is constituted of low beta stocks, blue chips, and non-cyclical stocks that are least affected by the tides of the economic cycle. Common sectors involved this type portfolio are the consumer staples, utilties, and the banking sectors. Monopolies are also sought after in this basket of defensive stocks. This prudent portfolio offers dividends, requiring little risk tolerance and time to manage.
Hybrid Portfolio
A hybrid portfolio is constituted of various forms of investments, not limited to shares, stocks, and ETFs. This form of portfolio is the most flexible as investors may choose invest in financial securities and alternative investments across the entire risk spectrum. For instance, investors could take on a small amount of highly speculative trades, and offset that risk with a large amount of capital in bonds, blue chips, or other heding trades
Aggressive Portfolio
Here the portfolio is constituted by high risk - high reward type stocks, that being early growth stage, and high beta stocks. As such the stocks are of companies that generally have a unique good or service that they provide, and that are not common to the household like blue-chips would be. Today, these companies commonly stem from the technology industry, where most innovation generally occurs. To that end, it may be no surprise that risk management is key with this type of portfolio.
Speculative Portfolio
The speculative portfolio holds the highest risk compared to those mentioned above. It generally consists of speculative plays including IPOs, rumoured takeovers, or potential breakthroughs, all of which have an element of opaqueness to their eventuality. More so, there is typically an aspect of leverage involved in these trades for which can multiply the reward, but also multiplies the risk.
The Future The future of investing and trading is an exciting place with developments occuring in; the use of technology to more accurately predict the markets, greater access and popularity of alternative investments, and the current sweeping advent of disruptive Fintech companies. To this end, the selection of securities and permutations of portfolios has never been so large and accessible for all investors and traders.
Algorithmic and High Frequency Trading (HFT)
Computerisation of trading begain in the early 70s, with program trading becoming widely adopted to trade in the S&P500 equity and futures markets. Today, these programs have evolved to become complex mathematical models that can make trading decisions rapidly to exploit arbitrage within the markets. This type of trading is extremely prevalent today, but it tends trade short-time horizons (0.5 seconds). There are ongoing debates regarding the efficacy of practice.
60% of U.S. equity trading was estimated to be HFT at its height in 2009
A.I. and Artificial Neural Networks (ANN)
Developments in the field of big data has led implementations of artifical intelligence, and artificial neural networks in the lucrative practice of trading. These 'systems' are trainable algorithms that operate to take in large swathes of market data, analyse it for patterns and anomalies, then translate them into actionable trade ideas. It may be confronting that you will be trading against these systems, but take comfort in their mixed history of success and failure.
Disruptive Fintech
New ways of distributing and investing money are being brought to light by a blooming industry of Fintech companies. These companies have introduced viable microinvestment services for millenials, key crowdsourcing avenues for start-ups, and even unfettered access to elusive IPOs. Imagine a service where you can invest $10,000 for 5% equity in a college biotech start-up half way across the world. This industry's development is geniunely exciting, opening the world to alternative investments, and increasing the accessibility of capital to those who may need it most.
Cryto-currencies
$3B
USD has been pledged on Kickstarter since its launch in 2009
'Digital money' has received much publicity recently, hailed as the future of money for which cannot be controlled by a particular institution or government (yet). The appeal of a crytocurrency is that it can be used to make direct financial transactions without requiring a bank account, and by extension, the requirement to pay certain bank fees. Transactions are virtually anonymous, and every coin spent is registered on the same invioable digital ledger (blockchain), rendering it less prone to the pressures of inflation and deflation resulting from political and economic changes that affect the conventional currency. 53 | 54
Š University Network of Investing and Trading 2017