Money for the Long Run: Learn About Online Trading

When you're starting out in your career, it's smart to invest in your employer's 401(k) plan or a mutual fund.

Another option is to dabble in the stock market. Stephen Rapp, 23, of Avon, a recent graduate of Roberts Wesleyan College who works for Rochester Broadway Theatre League, has decided to take that gamble. And rather than doing business with a local financial firm, he's relying on E*Trade, an online discount brokerage firm, to make his trades at a significant cost savings.

The price of cutting costs

Online discount brokerage firms, such as E*Trade or Ameritrade, allow you to conduct business on the Web or over the phone using a toll-free number. You'll pay less in commission fees for trades than you would if you used a standard brokerage firm.

For example, Rapp pays a flat rate of $9.99 to make five to 49 trades per month. He'd pay a $50 minimum commission fee if he used a full-service firm to make such trades, says Antonio Porretta, 30, of Irondequoit, a financial adviser with Brighton Securities.

Low commissions are what attracted Rapp to E*Trade. While he's saving on fees, however, he doesn't have one-on-one contact with a personal financial adviser, which could cost him in the long run.

"A lot of people outside of our business think, 'You must hate service vehicles like E*Trade, because they're taking business' from us. But that's not necessarily the case," Porretta says. The financial adviser says his focus is more than just trades; he cares about creating client relationships.

"The No. 1 reason investors fail is emotion versus a rational decision. An adviser takes emotion out of the equation," he says.

While discount firms provide a lot of historical information about individual stocks, they won't guide you in making investment decisions. And although Rapp does a lot of research before ordering a trade, he admits to making some blunders.

"There are some stocks that I take a dive on, but I have to look at it as part of the learning process," he says.

Another tricky element of online trading is timing. Stock prices can shift while orders are being routed and change before transactions are final.

Is online trading for you?

Researchers have long studied investors' trading habits, and it seems that women do better using online firms than men.

"The assessment is that the men suffer from significantly more overconfidence than the women, provoking them to trade much more, burning up more in trading costs," says Dan Burnside, a certified financial planner and lecturer at the William E. Simon Graduate School of Business Administration at the University of Rochester.

Burnside adds that, in general, online investors tend to buy too few stocks, when experts say that diversification - buying a range of stocks, bonds and mutual funds and participating in a 401(k) plan - is the key to successful investing.

Remember, you can afford to take some risks and make mistakes when you're young, but, in the long run, your goal should be a portfolio packed with all kinds of investments.

Types of Trading

Day Trading, Swing Trading, Position Trading, Online Trading

There are several types of trading styles that persons seeking to profit from short term trades in the market may wish to use. Here is a brief description of the most widely used short term trading styles.

Day Trading

Day traders buy and sell stocks throughout the day in the hope that the price of the stocks will fluctuate in value during the day, allowing them to earn quick profits. A day trader will hold a stock anywhere from a few seconds to a few hours, but will always sell all of those stocks before the close of each day. The day trader will therefore not own any positions at the close of any day, and there is overnight risk. The objective of day trading is to quickly get in and out of any particular stock for a profit anywhere from a few cents to several points per share on an intra-day basis.
Day trading can be further subdivided into a number of styles, including:

Scalpers: This style of day trading involves the rapid and repeated buying and selling of a large volume of stocks within seconds or minutes. The objective is to earn a small per share profit on each transaction while minimizing the risk.
Momentum Traders: This style of day trading involves identifying and trading stocks that are in a moving pattern during the day, in an attempt to buy such stocks at bottoms and sell at tops.

Swing Traders

The principal difference between day trading and swing trading is that swing traders will normally have a slightly longer time horizon than day traders for holding a position in a stock. As is the case with day traders, swing traders also attempt to predict the short term fluctuation in a stock's price. However, swing traders are willing to hold stocks for more than one day, if necessary, to give the stock price some time to move or to capture additional momentum in the stock's price. Swing traders will generally hold on to their stock positions anywhere from a few hours to several days.

Swing trading has the capability of providing higher returns than day trading. However, unlike day traders who liquidate their positions at the end of each day, swing traders assume overnight risk. There are some significant risks in carrying positions overnight. For example news events and earnings warnings announced after the closing bell can result in large, unexpected and possibly adverse changes to a stock's price.

Position Trading

Position trading is similar to swing trading, but with a longer time horizon. Position traders hold stocks for a time period anywhere from one day to several weeks or months. These traders seek to identify stocks where the technical trends suggest a possible large movement in price is likely to occur, but which may not be fully played out for several weeks or months.

Online Trading

Online trading is not really properly described as a trading style. Rather, online trading is simply a term that refers to the medium used to enter and execute trades. Online traders, which can include long term investors, as well as day, swing and position traders, use either an Internet connection or a direct access online trading platform to access and execute trades with Web based brokers.

Stockmarkets: What to look for?

"Fools rush in where angels fear to tread," said Alexander Pope, the well-known eighteenth century English poet and writer. Well, we are certain that he was not referring to the stock markets when he said that, but the current market situation in India is not too different! With stock markets at unprecedented highs, much above what is warranted by fundamentals, it is only the 'fools' who would rush in to buy any stock at these levels. The 'fool' that we are referring to in this case implies the participant who is willing to pick up any kind of stock at such levels, giving least consideration to the inherent strength of the company and its future growth prospects and believing that 'the stock', like some other stocks will definitely give him bumper returns!

Now, we are not saying that one should totally avoid the stock markets at this juncture. What we are saying is that investors need to practice caution and more of it now than ever before. With valuations looking fairly stretched, there is every reason to be cautious. Just look at the factors driving the markets up - liquidity is sloshing around like never before, FIIs are pumping in hundreds of millions of dollars into the markets, even though stocks have run ahead of fundamentals (at last count, net FII investment in CY05 to date has crossed US$ 5 bn). Virtually all the indices, including mid and large-cap indices, have hit all-time highs. But none of this seems to be justified by fundamentals.

Now take a look at some factors that we need to be concerned about - like stocks, unfortunately, oil prices are also at record highs. The US property market 'bubble' could top out anytime, reducing the spending power of the debt-ridden US consumer, by far the strongest force driving the growth of the global economy on the demand side, the slow job growth and wage growth in the US economy relative to the increase in productivity, China's overheated economy due for a slowdown, risk of terrorist strikes, geopolitical issues and so on.

Therefore, given the above factors, if any of the above 'potential party-poopers' do materialize, India will surely be affected in some way or the other, as she becomes increasingly integrated with the global economy. So, what can an investor do in such 'bubbly' and 'frothy' times?

Investors, please consider!

Future growth prospects: For starters, one has to make sure that the company one is investing in has strong growth prospects. In a bull market such as ours at present, even the 'dud stocks' go up along with the real 'gems'. Therefore, in order to separate the wheat from the chaff, doing solid research on the target company is extremely vital. There is no substitute for this! The investor, before 'taking the plunge', must understand the fundamentals of the company, past performance and future growth prospects. Eventually, when markets do cool down and the smoke clears, it is only the 'gems' that will still remain standing!

Management quality: Management is of utmost importance while choosing a company to invest in. For example, in the software industry, which is highly dynamic and competition is on a global scale, the management's ability to think out of the box and come up with innovative solutions to critical business problems will help a company stand out. With the 'global delivery model' pioneered by the likes of Infosys and TCS, the software industry has literally changed the way business is done in the industry and has forced MNC IT majors to do likewise and change their methods to suit the new paradigm shift of global service delivery. With a solid management quality and track record in place, top-tier software majors appear set for strong business growth over the next few years. These are factors one must look for in other companies and sectors as well.

Cyclicality: Another factor that needs to be looked at closely is the cyclicality of the industry. For example, the steel industry is cyclical in nature. When demand soars, steel prices pick up due to lower supply and as capacities are added, demand is satiated and the gap between demand and supply is bridged, prices get back to the lower levels. The major factor that investors need to watch closely is the stage of the cycle. Of course, it is easier said than done, but one can observe broad global factors driving prices, such as a cutback in imports from China, a large increase in steel capacities in India and the trend of global steel prices to gauge the cycle. On the basis of this, one can come to a conclusion as to whether prices will remain strong or not and take a call on companies from this sector.

Valuations: Needless to say, in such a frothy market, where liquidity rather than fundamentals is the main driver of the upward movement in stock prices, valuations take centrestage while choosing a stock. One needs to be careful, particularly if one is considering an investment in mid-cap stocks. Once again, to reiterate the point, we are not saying that there is no stock worth buying in this space, just that caution needs to be the watchword during the process of stock selection. Compare current valuations with earnings growth and see whether the market price justifies the earnings growth, actual and expected. If medium-term earnings growth is already factored into the stock price, quite clearly, the risk-return ratio is skewed towards risk.

Free float: Another factor that needs to be considered is the 'free float' of the stock. As per the BSE, Free-float market capitalization is defined as 'that proportion of total shares issued by the company, which are readily available for trading in the market. It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares, which will not come to the market for trading in the normal course.' The point to note is that, the higher the free float, the greater the stability and lesser the volatility of the shares, as a greater number of shares are traded by a wider audience of investors. It is also reflective of a more true process of price discovery, as a greater number of people get to express their views on the 'fair value' of the stock price, through buying and selling.

Conclusion
It has always been seen in the past that retail investors generally begin to participate at the fag end of any bull market. They buy at the highest prices and sell when the prices have fallen considerably. Thus, in order to ensure that investors do not make such a mistake, considering the points we have listed above is an extremely vital part of the investment decision. Thus, we reiterate that there is no substitute for doing thorough research about the company and sector before taking a decision. Happy and safe investing!

The Top 10 Tips for Successful Investing

1. Start Early - the sooner you invest, the more time your money will have to grow. If you delay, you will almost certainly have to invest much more to achieve a similar result.

THE DIFFERENCE TIME CAN MAKE

If you started investing Rs 5,000 a month on your 40th birthday, in 20 years’ time you would have invested Rs 12 lakhs. Growing at an average of 7% a year, it would be worth Rs 25,52,994 when you reach 60. If you started investing ten years earlier, your Rs 5,000 each month would add up to Rs 18 lakhs over 30 years. Assuming the same average annual growth of 7%, you would have Rs 58,82,545 on your 60th birthday – more than double the amount you would have received if you’d started ten years later! The bottom line - your investments gain most from compounded interest when you have time on your side.

2. Keep some cash aside – it is always a good idea to have some money set aside in case
of emergencies. Enough to cover three months’ living expenses is often a rough guide to how much you need. And make sure you can withdraw it when you need to, without penalties.

WHY YOU MAY NEED YOUR MONEY AT SHORT NOTICE:

• making a major purchase
• taking an unplanned holiday
• for an emergency such as sudden hospitalization

3. Ask yourself how much risk you can take – there is no point having a stock market investment if you are going to lose sleep every time share prices go through a rough patch. It’s vital that you are realistic about your appetite for risk – an Investment Adviser may be able to help you decide how much risk you can tolerate.

"In many ways, the key organ for investing is the stomach, not the brain. What is your stomach going to do when an investment your brain selected declines for a year or two?"

4. Bear in mind that inflation will eat into your savings – returns on risk-free cash investments may sound respectable, but when you subtract the current rate of inflation you may not be so impressed. For significant long-term growth you need to make your money work harder.

INFLATION - THE TICKING TIME BOMB

If you have Rs 10,000 in a savings account earning 3% interest each year, in 20 years time, your savings would be worth Rs 18,061. That’s a return of just over 80%. However, if inflation is
about 7%, Rs 18,061 would only be worth Rs 4,668 in today’s terms!

5. Think carefully about how long you will be investing for – only look at the stock market if you are prepared to put your money away for five or ten years, or perhaps even longer. If you are likely to need your money any sooner, keep it in a lower-risk investment so there is less chance of a fall in value just before you make a withdrawal.

“If you’re going to need money within the near future to put a down payment on a house — the
stock market is not the place to be. You can flip a coin over where the market is headed over the
next year. But if you’re in the market for the long haul — five, ten or twenty years — then time
is on your side and you should stick to your longterm investment plan.”

6. Spread your money across a range of investments – it’s rarely a good idea to have all your eggs in one basket. Depending on your goals and attitude to risk, you will probably want
to spread your money across different types of investment – equities, bonds and cash. You may also want to diversify within each of these categories. An equity fund, for example, will invest your money in a variety of companies but you may want to ensure you have a range of industry sectors too.

ADVANTAGES AND DISADVANTAGES OF THE VARIOUS ASSET CLASSES

CASH – ADVANTAGES
• High security and liquid
• Interest will always be paid
CASH – DISADVANTAGES
• Interest rates vary
• Best rates often have restrictions
• May not beat inflation
BONDS – ADVANTAGES
• Fixed interest paid regularly
BONDS – DISADVANTAGES
• Bond issuer may default on interest payments
• Value of a bond may fluctuate
EQUITIES – ADVANTAGES
• Equities can increase significantly in value
• Can outperform other asset classes over the long term
EQUITIES – DISADVANTAGES
• Equities can also fall significantly in value
• Difficult to predict what will happen in the short term

7. Invest regularly – investing regularly can be a great way to build up a significant lump sum. You will also benefit from what is known as rupee cost averaging. This means that, if you are investing in a mutual fund, over the years, whether the market goes up or down, you will pay the average price for units.

8. Choose your funds carefully – you should select investments based on your personal
circumstances and goals. If you are investing in a mutual fund, don’t opt for the flavour of the month, unless you are sure it will be right for you in the future. Don’t assume all funds investing in Indian equities are the same – look at what a fund invests in and check if you are comfortable with its investment style and objectives.

9. Remember that time not timing is the key to successful investing – when planning an investment, it can be tempting to wait for the market to drop. But you run the risk of missing out on the rises that often occur in the early days of an upward trend. In Fidelity’s experience, even the experts cannot “time the market” consistently well. It is better to choose an investment that you feel confident about and take a long-term view, so that you have time to ride out any ups and downs.

10. Review your investments – a portfolio that is right for you at one point in your life may
not be quite so suitable a few years later. Your investments need to adapt to changes in your circumstances, such as getting married, having children or starting a business. It’s also a good idea to check that each of the funds in your portfolio is living up to your expectations. Talking to an Investment Adviser could help you decide whether you need to switch money between funds.

GETTING THE RIGHT MIX

For the greatest long-term growth potential you could invest all your money in equities. But this could be a high-risk strategy as the markets could dip just before you need the money. You may need to think about making changes to your portfolio over time. You could aim for strong growth in the early years, and then, lock in gains you may have made and move into lower-risk investments. As you get closer to needing your money, bonds and cash investments could be your emphasis.

How retail investors lose money

The reason is simple - a retail investor is driven by greed or fear. Never logic.

• Retail investors are always the last to enter a bull run
• "Smart money" enters markets long time back when markets are at its bottoms, there is frustration all around and no one wants to discuss markets
• When markets start booming and indices make new peaks, the retail investor "wakes" up. At this stage, he is still not sure and is a fence sitter.
• Lastly, there is optimism all around. Every one is bullish and talking markets. Stocks which were never traded in a year, suddenly start moving and start reaching "new highs"
• At this time, the retail investor starts buying as he does not want to miss out the "action"
• The retail investor will display a marked preference for "low priced" stocks because these are "cheap". He will stay clear of index stocks as these are "expensive"
• This is also the time when "smart money" starts moving out
• When a correction happens, it is usually quite severe
• The retail investor does one of two things. He either decides to wait (the optimism is still there) or he starts "averaging" his costs. Averaging is nothing but trying to "catch a falling knife"
• At some time or the other, panic sets in. The retail investor will then sell off all holdings as a distress sale.
• Sometimes the retail investor will do nothing but wait for the markets to rise
• When the markets do rise, he will sell off all his holdings at the first available opportunity and thus miss out on the new bull run

Interesting facts you may not be aware of

• About 80% of retail investors in public issues sell their allotments within a week of listing. No one will wait and let their investment appreciate
• In a bull run, the retail investor is usually the first to sell off his holding. This investor seldom waits for the bull run to continue
• Those who have never participated when the rally started will invariably jump in towards the end of the bull run
• Whenever a fall happens, the retail investor is the first to buy as he does not want to "miss this chance" to buy a stock
• Retail investors hate to take a loss. Circumstances eventually force them to take a bigger loss sometime or other
• Lastly, retail investors rely on tips or broker advise and sometimes, company research when buying. This never works because the market has already discounted this news

Conclusion

Follow the trend for profitable investing

Creating a Financial Future - Putting Your Plan Into Action ( Part 1 )

Putting the plan into action is what implementation is all about. It's one thing to have goals, but without concrete steps to achieve them, they remain dreams. The last column discussed measuring the money required for each of these goals. Now it’s time to figure out how we’re going to put that money together.

Of course, the first step is the obvious one. We must have a source of income. This could be a salary, an endowment, or even a loan (although we’d normally advise against that last option). One might consider multiple sources of income. This protects against undue dependence on one source.

Assuming that some income exists, we can begin to make plans for saving. Based upon our analysis, we can determine how much must be saved on a daily, weekly, monthly, or annual basis to reach our goals. We can then consider if it is possible to grow the money fast enough to reach our target date.

If, in the end, we find ourselves unable to save adequately for our goals, we must consider that the problem may not be in our plan, but in our income levels. Sometimes it’s simply a matter of recognizing that goals may be unattainable without adjusting income levels. This might involve second jobs, or side businesses, or rather may require stepping back from the current situation entirely, and increasing employability through education or training. Furthermore, it might suggest that new, creative ideas should be considered. Alternatively, it might simply involve selling off unproductive assets. Whatever the case may be, the income level is a crucial part of any financial strategy, and one often overlooked by investment professionals.

Finally, once the income levels and saving decisions have been established, we turn to the final component: the investment strategy. The final strategy may include many different types of investments, and use many different types of methods, but in the end, it should always be focused on the goals.

For example, if the goal is to purchase a house in 1 year, investing in stocks may not be the optimal strategy unless you intend to take a great deal of risk. On the other hand, if you plan to purchase a house when you have earned enough money, but plan to remain flexible regarding the specific time, stocks may be more viable.

This brings us to the consideration of asset types. This is one of the most critical decisions to make. There are at least a dozen different types of assets to choose from. Some of the most popular are:

- Stocks Mutual Funds Real Estate Limited Partnerships
- Art & Collectibles Gold/Commodities Bonds Insurance
- Businesses Derivatives

Of course, this list could go on, but we’ll focus on some of these. First, let’s dispose of the easy ones. Investing in a Business can be a great choice for someone with a solid business plan and sufficient time and capital to make it work. However, many businesses require a full-time commitment, and unless one is able to give up their regular income, it can be a problem. It is possible to start a business part-time, depending on the type, and this may be an option for some. Additionally, one could invest in someone else’s business, but here one must be concerned with issues of honesty, compatibility, and incentive. Finally, investing in a business carries with it liquidity problems, because one cannot always sell a business for what its worth without first locating an ideal buyer. Thus, if you’ve planned to sell at a certain date, in anticipation of reaching a goal, you may have trouble.

Limited Partnerships carry with them unnecessary problems, largely because there is not a great market for these either. Thus, even when they have value, one may not be able to sell them easily. In this way they resemble investing in small businesses, and carry the same risks.

Insurance truly should not be considered an investment, but I include it here because it is so often sold as an investment. In many ways, it can help one plan for tax considerations, but as a pure investment, it is a non-starter.

Art & Collectibles can sometimes increase in value over time, and for those with specialized knowledge in a certain area, it may be a wise speculation. However, much like running a business, it takes time and energy, and has liquidity problems. Still, these can be a small proportion of a portfolio for some investors.

Commodities are bulk holdings of any uniform item for which all have a uniform value. This would include oil, orange juice, coal, silver, or pork bellies. Gold is a commodity with unique qualities because of its long history of use as money and reputation as a dependable store of value. All commodities have fluctuating prices in common, and those who invest in commodities generally have an intimate knowledge of the market for that specific good. Over 90% of people who invest in commodities lose money, while the experts generally make a comfortable living. Investing in commodities can be extremely risky for those who do not have specialized knowledge.

The Benefits of Managed Futures

Modern Portfolio Theory allows investors to estimate both the expected risk and returns, as measured statistically, for their investment portfolios. A portfolio's risk can be reduced and the expected rate of return increased, when assets with dissimilar price movements are combined. Diversification reduces risk only when assets are combined whose prices move inversely, or at different times, in relation to each other.

While the technical underpinnings of the Modern Portfolio Theory are complex, its conclusion is simple and easy to understand: A diversified portfolio, of uncorrelated asset classes, can provide the highest return with the least amount of volatility.

One of the most uncorrelated and independent investments as compared with stocks and bonds is professionally managed futures.

"Portfolios...including judicious investments...in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks alone"
Dr. John Lintner, Harvard University

The term managed futures represents an industry comprised of professional money managers known as commodity trading advisors (CTAs) who manage client assets on a discretionary basis, using global futures and options markets as an investment medium.

Managed futures, by their very nature, are a diversified investment opportunity and they provide direct exposure to international financial and non-finanancial asset sectors. Trading advisors have the ability to trade in over 150 different markets worldwide.

The benefits of managed futures within a well balanced portfolio include:
- opportunity to reduce portfolio volatility risk
- potential for enhanced portfolio returns
- ability to profit in any economic environment
- ease of global diversification