Posterous theme by Cory Watilo

The Undertrader


Laying to rest the Myths of Wall Street

Rant: Stock Splits are worthless is a bunch of hooey. $$

So, I was reading this article here: http://www.google.com/gwt/n?u=http://feeds.tuaw.com/click.phdo%3Fi%3Df5a7b925d36d464961f19fcb15f6e2ce and I came across this brilliant piece of journalism, "First, for the uninitiated, a stock split is a zero sum game....If a 4 for 1 stock split takes place, you will wind up 4 shares, instead of 1, but each share will be valued at $50. Did you gain or lose any money? No. It's all on paper....'quick buy Apple and you'll be getting 4 times as much'....The case for this sort of stupidity is well made by Barrons."

So, essentially they are saying stock splits are worthless because they are an even trade.  If you have 1 share for $50 and it splits 2 for 1, you now have 2 shares at $25, or $50 worth.  An even trade, right?  No big deal, right?  Wrong.  Here's why:

First of all, since the stock price is lower, it has the opportunity to be purchased by more people, driving up the price easier than if the stock is out of the reach of most people.  While market makers and funds have 90% of the pull on this these days, it still helps.  The more attractive the price, the easier it is to move.

Secondly, and most importantly, this goes back to the Lesson that the number of SHARES means everything!

Let's talk about Berkshire Hathaway B shares ($Brk-B).  A couple of weeks ago the stock split 50 to 1.  If you owned 10 shares of this stock, you now have 500 shares of the stock.   While your value stayed the same, you now gain $500 for every dollar the stock goes up rather than the $10 you were making before.  Same investment, HUGE difference.  Why people don't see this, I have no idea.

Furthermore, if you put our Lesson about avoiding taxes to use, you can now sell a lot of shares to bank your profit and still have a lot of shares of the stock, whereas you can't do that with 10 shares or 5 shares or even 100 shares. 

Using their example of Apple ($appl), it closed today at roughly $230.  If you had 100 shares of Apple you made $425 today after it's $4.25 gain.  Not bad.  However, if Apple had split yesterday 4 to 1 you would have had 400 shares and would have made 4 times the gain (which, in my opinion at $57.25 (the price if it split 4-1 yesterday) the gain would have been much more than $4.25 a share), but in any event, if it did gain $4.25, the same amount of gain, you would have made $1700 profit rather than $425 profit.  A HUGE difference for the same investment and the same amount of gain.

So, to all of the peeps that believe a stock split is silly or worthless or has no meaning because you end up with the same amount of investment at the end, you couldn't be more wrong if you tried.

Invest in peace...

Google vs Disney...($goog $dis)

A commenter in a chat room today challenged my Google vs Disney post where I said I'd buy Disney over Google.  I just wanted to add to that that as of today for the same amount of 1 share of Google ($goog) you could buy 16 shares of Disney ($DIS).  So, for Google to equal the gains of Disney, Google would have to go up $16 to match a $1 move of Disney stock.  While Google does tend to move a LOT, that's quite a huge leap.  To match a $2 move of Disney stock, Google would have to go up $32, so you see, having more shares of Disney, to me, is less risky and a better investment than risking and hoping on huge jumps from Google.

Invest in peace...

Lesson 9: Limit Orders Only!!! $$

I don't know how many times I've heard stories of people being screwed by Market Orders.  They are a scam.  Do NOT do Market Orders ever!  

I'm sure some of you will ask what a Market Order is.  Think of it this way.  Let's say all the prices at Target were constantly changing and you wanted to buy a T-Shirt.  A Market Order will charge you whatever the price the shirt happens to be when you get to the register.  So, if you picked it up when it was $10 and it's $50 at the register, you pay $50.

A Limit Order is different.  On a Limit Order you say how much you are willing to spend, but not a penny more.  "This shirt is $10, but I'd pay $11 for it."  So, you'd put a Limit Order for $11 and anytime the price falls below $11 you buy.  If it goes above $11, you don't.

Same goes for sales.  If you are willing to take $12 for that shirt, but nothing less, you put a limit order for $12.  Don't set your sales to Market Orders!

For stocks, this is how you trade.  Always lose Limit Orders and put the exact price you are willing to spend/sell at and you'll save yourself a lot of losses that are unnecessary if you had used Market Orders.

Invest in peace...

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Invest in peace...

Lesson 8: Don't trade when the market is open...$$

Yep, you read that right, I never trade when the market is open.  As a matter of fact, I rarely look at the stock market on weekdays at all.  The way the market fluctuates during the day causes you to make all sorts of awful, snap decisions that usually end up screwing you more than working out.  I refuse to trade on weekdays unless something insanely amazing is occurring.  The best example of when I did trade on a weekday, I woke up at 6am for some ungodly reason and turned on Howard Stern's show to hear he was going to Sirius Satellite radio.  I immediately bought as many shares as I could because I knew there'd be a huge pop to the stock when the people on the west coast woke up and heard this news.  I was right and it was a great day for me.

So, when do I trade?  Well, I look at the market after the close on Friday and I see what I'm up on, what's down and I make myself a list of possible trades I want to make.  I then spend all day Saturday and Sunday just thinking about those ideas.  Do I want to do them?  For example, right now the question is, should I take profit out of my Apple ($AAPL) position?  Instead of deciding immediately, I think about it for a couple of days.  I usually decide to let it run because the iPad is going to shatter records.  That stock is headed up, WAY up.  So I hold it, but the point is, I don't just make that decision while the stock is moving during the day.  I wait until Friday night and give myself 2 full days to think about it and make a good, rational decision.

Sunday nights, usually around 7 or 8 pm is when I put in my orders for open of the market Monday morning.  I just put my orders in, set them to Good Til Cancelled and let them go.  Monday morning I get emails confirming the trades that were made.  No stress.

So, when people tell you it takes a ton of time to be a stock trader and that you have to watch it constantly and that it's a full time job, tell them they're nuts.  I 'work' on my stock trading for about 30 minutes a week, or a whopping 26 hours a YEAR.  And I kill the market.  It's not rocket science.  It's having a solid strategy and sticking to it.

So, wait until the market is closed, take a look at your positions, make yourself a list of possible trades and take your time and think about them before you pull the trigger.

Invest in peace...

Lesson 7: The number of shares you should buy is...

I first learned about trading stocks from my Grandmother, who was pretty good at it, but she taught me what 90% of people do, which is buy 100 shares of everything.  100 shares of this, 100 shares of that.  Unfortunately, this is a down right stupid way to trade stocks.

There are a variety of reasons why this is a terrible strategy, not the least of which being that you only make $100 for every $1 your stock goes up, but the main reason why is you are playing with a variety of factors of risk.

If you have $1000 and you buy 100 shares of an $80 stock and 100 shares of a $20 stock, you have WAY more at risk in stock 1 than you do in stock 2.  What you want to do is decide the amount of money you want to invest in a specific company is and then divide by the share price.

So, if you want to invest $1500 in a stock that is $12.37 you do the math and find out that it's 121 shares you should be buying in that stock.

Now, don't go putting 10% into every stock either.  That will just water down your investments.  You want to put more in the companies that are running (going up) so that you can take the profits out and get more shares for the future.  I have about 40% of my investments currently in Apple ($AAPL) and I'm killing it.  I should have more cash in it, but I like my long-term positions in the other stocks I have and don't want to take a tax hit right now.

In any event, don't buy 100 shares or in blocks of 100, look at the percentage of your investment portfolio you are willing to invest in a company and use that dollar amount to decide how many shares to purchase.

Invest in peace...

Lesson 6: Share price isn't as important as you think...$$

Yesterday we learned why having more shares is the most important part of making profits in trading stocks, (remind me to tell you why people who think stock splits don't mean anything are stupid jackasses later), so today we'll explain why the share price going up isn't important.

Most people think you need to select stocks that go up and up and up and never go down and that's how you become rich.  They absolutely could, but you'd have to select the absolute best stocks at their lowest prices and hold on to them for years and years...insanely difficult.

What's much, much easier is to bounce a stock between two prices.  Disney ($DIS) is a great example here.  Disney tends to bounce between $20ish and 30ish.  A $10 change, which would be a great gain in anyones book.  The problem is the buy and holders just keep moving between these prices and really only gain $10, then lose $10, then gain $10, then lose $10.  It's pretty stupid when you think about it.

Now, the better way to trade the stock is buy it at $20, as many shares as you can, and sell off some of your profit as the stock goes up.  For example, if you have 100 ($2000 investment) shares, you could sell 10 shares at $22, 10 shares at $24, 10 shares at $26, 10 shares at $28 and 10 shares at $30 (I'm being HUGELY general here to make a point, don't do things this structured) and you'd end up with Disney at $30 and you'd have 50 shares of stock and $1300 cash ($1500 in stock.)

Should the stock drop back down to $20, you have $1300 to buy more shares, 65 to be exact, so now you can run 115 shares up that $10 run.

You can bounce a stock like this over and over.  You limit your taxes (as we saw in a previous lesson), you amass more and more shares of a good stock without adding any of your own money and you begin to generate more and more profit per move of the stock price by having more shares.

By having one of these 'stable stocks' that don't move so much, you also tend to lower your risk because you know this stock pretty much sits in this pocket of prices.

Start thinking differently.  Think of it like eBay, if you can buy something for $20 over and over and sell it for $30 over and over, wouldn't you do that?  The price doesn't need to keep going up, you just want that steady stream of income.  That's what my strategy gives you.  Push it out over 10 stocks or so and you can make a good living with low risk stocks that don't move much.

Invest in peace...

Lesson 5: How to manage taxes without killing your bank...$$

Ok, so yesterday we learned that shares are most important and today here is a huge reason why.  Let's explain it through example, shall we?

Dumbass has $100 and buys 1 share of a $100 stock.
Undertrader has $100 and buys 10 shares of a $10 stock.

Equal amount invested.

Let's say both stocks double in value to $200.

Dumbass has to sell his entire position to pocket his $100 gain and he is then taxed at (roughly) 30% for a $70 gain.  Not bad.

Undertrader wants that $100 profit, but instead of selling all of his shares, he sells 5 shares at $20, which is $100 and he keeps 5 shares worth $100.

Now, stay with me here, you only pay taxes on your gain.  So, Undertrader sold 5 shares, which is $10 gain each share, or $50 in capital gains and $50 in original investment, so I took my $100 profit, but I'm only taxed on $50 of it.  At 30% (roughly) taxed amount that's only $15 I pay in taxes, so let's see where both traders are sitting.

Dumbass - $170 cash.
Undertrader - $100 in stock and $85 in cash.  I'm $15 ahead and still have my original investment.  

That's the magic of avoiding taxes and keeping your gains.  Like I said, your goal is to amass shares.  If you do this little trick to get cash without getting hammered in gains, you can flip that cash back into the stock when it drops.  So let's say both stocks drop back to where they were.

Dumbass can buy 1 share of his $100 stock again and has $70 cash.
Undertrader can buy 8 more shares of his stock to have 18 shares and $5 cash.

Huge difference.  This is the key to trading stocks and being successful and tomorrow we'll talk about why the share price doesn't need to go up to be successful...

Invest in peace...

Lesson 4: Number of shares owned is...$$

Nothing is more important than number of shares owned.  Not the stock price, not how much the stock moves, not the price you got in, it's the number of shares you own and our goal is to amass as many shares of the stocks we like as we can.  Why is this?  Well, you have to do a little math, but we'll keep it easy.

Let's say Dumb-ass has $100.  He sees stock XYZ is $100 and thinks it's doing great so he buys one share.
Let's say Undertrader has $100 too and he sees a good stock that's currently $5.  He buys 20 shares of stock ZYX.

Dumb-ass has 1 share of his stock.
Undertrader has 20 shares of his stock.

Both stocks go up a dollar the next day.  The exact same amount.  Dumb-ass is now a whopping dollar richer while Undertrader is $20 richer.  They both spent the same amount of money and both of their stocks went up the exact same amount, but Undertrader is up 20% while Dumb-ass is up 1%.  See how important number of shares is?

Now, that's not to say that you should go buy shitty stocks because you can get more shares, but it DOES mean if you like two stocks and one is $60 and one is $30 and they are both below their 50 and 200 day moving averages, I would lean on the side of buying double the shares and getting the $30 stock rather than the $60 stock.

Putting that into real world terms, Google is currently at $563 and Disney is currently at $34ish dollars.  You could buy 16 1/2 shares of Disney for every one share of Google.  Let's say you have $20,000 to invest, that's 588 shares of Disney vs 35 shares of Google.  For every dollar Disney moves you're pocketing $588 profit and for every dollar Google moves you only make $34.  Sure, people say Google moves more, but Google would have to move $17 to match the gains of Disney going up $1.  This for the exact same investment.  I'd rather only have to worry about my stock going up a buck vs going up $17 to make a profit that is meaningful.  Google is a great company, no doubt, but I think you could build an insane amount of Disney shares way, way easier than Google and in the long run, that will be much more profitable.

The other reason we want more shares is tax related, but we'll get into that tomorrow.  Just remember, the more shares you have, the less the stock price needs to move for you to make a profit.  If you have a million shares of ZYX, it only has to move $1 for you to make a million bucks.  Pretty simple when you think of it that way.

Invest in peace...

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