Online Stock Trading

Ok, that might not be so; after all, I might be extremely biased. You see, when I sit down to write about the stock market and investment-related matters, very often I encounter many numerous things that I feel passionate about, or that I am at least certainly fond of; things that I would very much like to write about but that I struggle sometimes with bridging those things to this world, to this blog.

For instance, what were those “things besides money for the sake of money alone” that I spoke so feverishly about in my landmark address to you, my growing number of readers? You can’t readily find an answer to that here, on this site about money.

So. the solution was an obvious one. I made another blog. I made a blog where, when I find such things that fall within my many interests, but which fall outside of the strict interests of this blog, I can have a place to put them. What exactly is it that drives me forward? Why even, do I write at all? Where exactly am I going? What are my dreams? Why should you want to go there with me? I can’t easily tell you answers to these and many more things here. Here, I can tell you how to be smart and ultimately prudent about financial matters. Important matters no doubt, but for me, these matters are simply tools to be used in a much larger world.

A world, it turns out, that I have quite a bit to say about. So, I encourage you to investigate and come back often to, Everything Besides. It too, like this blog, has a feed you can subscribe to so you can be alerted of new posts. I waited to announce it, officially, until after I had written at least a few posts. Many more will be coming frequently. I wish you well, and now, I’m off to work. See you soon friends.

I guess I never really thought about it that much to be honest with you. As most of you who have been following along regularly know, I’ve really been enjoying the College Analysts. While reading this article, which could be summed up as chocked full of contrarian opportunities, I found myself salivating profusely. Really. Ask my dog.

So, if finding a stock, beat down and struggling in a choke hold peaks my interest many degrees more than one that is all lime-lit that thunders along from all the back slaps and high fives does, then that might seem to indicate that I am, after all, a bit of a contrarian.

If when describing “value”, the going price of a stock whose assets, earnings, potential for growth and an array of other things holds more of that said value when its price is depressed for either no good reason or at least not a good enough one, then that too might seem to indicate that I am.

If I hold an aversion for stocks doing well (often even for good reason) just because they’re doing well, because the likelihood of, after having done so well, my being able to buy a greater share of assets, earnings, potential for growth and so on is so far reduced, i.e., I’d be buying all hype and speculation about stock price movement and far less company, then that too, would after all, seem to indicate that I am quite contrarian. Mary.

Maybe all this explains why, after so many of my purchases, Motley Fool writes an article about what I just bought. I wonder if I could start charging them. Ok not really. Anyways, I better be off to look for more dogs; and I better control all my drooling before my dog thinks I’m one.

Ideally, every time you buy a stock it would go up in value. Ideally. But, as most and even good investors know, this never happens every time. Instead, you end up buying a stock only to sit and watch it fall right away, and then, sometimes when you decide you’ve had enough, you sell it, only to watch it go right back up again. And then still other times, you take a profit, feeling pretty good about yourself, only to watch it continue its ramp up. Aggravating as hell isn’t it?

I’ve been fortunate thus far to not have had to make a decision precisely like the first yet, in other words, I haven’t had a stock fall so much so as to make me think I really had to get out, but I have certainly seen some stocks I’ve sold go up even more after I booked the profits. It’s moments like these when we’re bound to furrow eyebrows.

Revisit old friends

One thing I like to do to combat the angst is to revisit old friends. Every time I do it, I come out feeling pretty good. Why is that? Because, after all the fist clenching following the witnessing of sold stocks’ gains, I get to see something my sometimes one-sided mind makes me forget. I get reminded of all the ones that fell too. Generally speaking, trying to map out all the “what if?” scenarios is incredibly hard because if I want to start asking “what if?”, I’d have to try to figure out what would have happened had I held on to certain stocks, but, one major problem is that if I had, I would not have been able to buy later stocks had I held on to earlier stocks.

However, I can still make a list of the all the stocks I’ve ever bought and pretend that I bought them at the price I sold them. Then when I’m watching ACH soar (and soar), I can hold that next to all the stocks that have fallen, those that I’ve long since stopped paying attention to, and get a clearer picture as to how I’m doing. I can ask, “Am I consistently selling stocks too soon?”

How Am I doing?

It turns out, I’m doing pretty well. Using an equal weighting, had I stuck to it with all the stocks I’ve bought, instead of taking some profits, I’d be about flat. Precisely, I’d be up about 3.5%. And that’s with a 68% climb from ACH included. So the next question is, whether, given the stocks I have now, which I would not have been able to buy had I held on to the old, I end up outpacing the general performance of those old, can I feel good about my general decision making. I think so. Greater time will tell with grater clarity.

So, if you ever start feeling in a funk because you look out at a side view mirror and see some things you think you might wish you hadn’t done, don’t forget to check the other one too.

Occasionally, I think of little mantras which help guide my thinking. So, I started writing them down. Eventually, I began to notice just how much influence they began having on my perspective. It turns out they are little versions or even pieces of the abstract side of my comprehensive strategy. They are signposts in a sometimes strange wilderness.

Here are ten of them:

1) Have an iron stomach and nerves of steel

Times can be tough. Investing isn’t all rose-filled sun-draped fields in peaceful Midwestern towns or quaint Old London pubs fixed beside warm cobblestone streets. To the contrary. Investing is a roller coaster ride set in the scene of 28 Days Later. Yes, it can really be that bad. Be tough as hell, and the worse thing that will happen if you have to take a loss, besides taking that loss, is that you can retain some self-respect, that you can get up and try again. Do just that, and you’ll earn my respect too.

2) Be wary of the crowd

This is one of those really bizarre ones. It’s the one that most people keep talking about that most people never do. You must believe in facts. Here’s one: the vast majority of investors under perform the market: and I quote, “Not even the top tenth of [performers] manage to beat the market consistently” (emphasis added). Read the abstract here. Read or download the original study here. Just where is all that money going then? It’s fascinating, but we already know where it goes. Yes, the rich keep getting richer and the others, well…they keep feeding the rich. Read this to see the actual numbers. Absolutely staggering. Start feeding yourself.

3) Learn how to smell a pig

This should be easy right? They stink. Nevertheless, many people buy them. Again, let me quote, “chop stocks alone ‘make up half the 85 million-share volume on the OTC Bulletin Board’” (emphasis added). Unbelievable. Read the Wikipedia article here. Buy reputable companies that are actually making products or selling services, and who have a high likelihood of being able to continue to do either of these long into the future. Anything else should smell like something odd to you.

4) Do at the very least this one math problem

Ok, you’ve done your research, done at least some valuation, taken many things into consideration. You’re ready to buy. What’s the problem? Problem is, most investors (me included) almost always over estimate the likelihood of a stock going up. Then they minimize the likelihood that it could go down. Then, to make matters worse, they forget that it might just sit and stagnate. Sit down and calculate a probability density function. A what? Don’t worry, I’ve made it easy. Download one here. Just fill in the yellow boxes and look at the green one. This will help you become much more conservative (i.e. thoughtful). Using this periodically will help you assess risk more accurately. In other words, it takes into account the possibilities of what a stock can do. All of them. And then it assigns a dollar figure. You don’t have to be precise, you just have to estimate. It’s not a valuation of a security, it’s a valuation of the probabilities of all the possible outcomes involved in buying one.

5) Learn how to take a break

Gracious, go find a beach, a library or a Starbucks. Unwind. Unplug. Go visit your girlfriend, whatever. If you stay so tuned into your stocks, you will go mad. Studies prove this. I swear. I was in one. See here for details.

6) Educate yourself

You don’t have to be an analyst to trade stocks. In other words, you don’t have to know every single kind of trade or how to trade currencies. But you have to get good with at least something. Also, if you do start reading articles, magazines and other informational sources, you’ll start getting a clearer picture of the whole. You’ll start thinking and living investing and like anything else you’ll just eventually start picking up skills. Think drink and talk fitness and you’ll end up by being fit. Then, go see number 5 again.

7) Don’t commit your bloody reserves

Ever buy a stock and watch it go down, but still stay convinced that you have a great stock? Then do you ever watch this cycle repeat? Then finally, blood stained boots and all you say, “Damn it. I wish I would have bought it now.” You can, but only if you have more troops. It doesn’t take doing this too many times before you start habitually keeping cash. Then, when the battle goes unconventional, you can send more men to mop.

Construct a solid strategy but use at least some plastic parts

It is vital, in my opinion, to have some kind of strategy, but, if it is of stone, the stock market is not. It is a fluid and moving pool of quicksand; surf rolling up on the beach. If you are too inflexible with a moving target, you will only hit when it comes to you. If you’re too flexible though, you’ll never know what really works. You will become one big second guess. Get the best of both worlds by bending your knees a little. Check your corners and go get the bastard.

9) Evolve into an android

This is not easy, but necessary. What do you have that androids do not? Emotions. Save those for poetry, love letters or even divorce papers. Here, with the stock market, you have to remember that this is business. If business hurts too much, go do charity. Always be rational. Anticipate enough of the outcomes so that you aren’t caught by utter surprise (barring nuclear war or something). Get good enough to know that you knew this could happen. Then, unblinking gaze and all, get back to work.

10) Remember this: The low hanging fruit has already been picked

Just like you should avoid letting depression set in to control your outlook, be at least a little wary of extreme optimism. If you find a stock and begin thinking it’s too good to be true, guess what? Always assume that someone got there first. Remember, it’s not bad to be second, after all a synonym for “got there first” is “bait.”

I like the stock market because it defies our wiring. It trumps learned experience, divorces our inherited instruction set and introduces new paths to old goals. All that from stocks?

When we drink a glass of water, there is a certain and necessary route we’re just going to have to take. We have to take a sip. And then another. And we have to keep doing this until we’re done. Or when we read a book; we start with page one. Then move on to the next. If we set aside a portion of our income for savings, a similar pattern emerges. In other words, there’s a particular linearity to the world around us. (Hold on, I have to take a sip).

That linearity seems most obvious when we conceive time. In fact, I can’t think of anything any more thoroughly linear than that. The world and us in it would be rather different were we, after taking that first sip, at the time we would be ready for the second sip, able to take two instead. Then four the next time and so on. Or instead of reading pages as we are accustomed to, how different it would be to read them in the same fashion, one then two then four. In the current state of things, the only way we could accomplish such strange feats, would be if we could defeat the linearity that stretches them all out. One remarkable thing about investing is the general ability to do precisely this. The linearity that pervades our lives and our thinking now has an out. One dollar, later on, might make you five. (Gulp).

By the time you thoroughly endorse and ultimately adopt this mentality, having learned it from investing, you start seeing that it influences the way you think about all the other linear things around you. You grab the line and bend it. Instead of always eating elephants, you just decide one day to blow them up. Problem solved. You start thinking about how one action now can impact or introduce additional actions later, without needing to have to add those actions later. You think of ways to get the page you just read to read a page later without you having to read that page later, so strange as that might sound. (Ah…)

In the end, besides being the most useful tool I know to expedite otherwise necessary monetary paths, I think this process of thinking can be used to introduce tremendous creativity into a great many things we otherwise thought were strictly linear. I better run, I seem to have run out of water in my glass; sadly though, I merely drank it the old fashioned way.

This is a continuation of this article. In that article, which was simply a beginning examination of what stock price, exclusively, can seem to indicate about price performance, we determined that stock price alone could seem to be used (for the time frame I selected to examine) to achieve a higher yield; higher when compared to the market overall, but only neck and neck with the performance of the major indices. As promised at the time, I’m now coming back to this to assess some of the same things, intra-index. In other words, let’s narrow the scope. Also, a reader, bzak, in response to the last article, suggested some ways we could test some inferences that we need to make before we can use results like these. His implied question was, “What’s the cause of the effect we see?” In other words, if higher priced stocks perform better, what causes that? He offered some excellent suggestions. In a following article, I will begin discussing these too, and will look at ways we can identify and capture those suggestions.

So let’s get started

In the previous article, we discovered that stocks over about $25 on average performed better than all stocks, but only mixed when compared to the major indices. This time, we’ll take a similar look at the same measurement within those indices to see whether even more can be said.

We’ll start by looking at the Dow Jones Industrial Average. This index and a graph are never a good marriage. Too few stocks. In this case, trying to assess any correlation between price and yield is difficult because they all have generally high stock prices. The graph below shows the results using a 5-stock, backward oriented smooth. After an initial spike (caused by phenomenal gains from General Motors and Alcoa) the stocks performed within a tight range between about 6 and 8%. Not much to ascertain. You could have picked any of them, only 3 were flat (Intel, Home Depot and IBM), and none fell in value.

The NASDAQ is difficult in a graph because it was highly volatile at almost all price ranges. Ignoring the initial poorest performance of the lowest priced stocks, all price ranges ranged between about 4 and 8%. This graph uses a 200-stock, backward oriented smooth. One interesting thing to note is this: the very cheapest stocks (on the extreme left limit) performed clearly worse than the whole, and the most expensive stocks (on the extreme right limit) performed clearly better than the whole. In fact, once you pass about $35, following from which the previous 200 stocks yielded on average over 8%, the absolute worst you could do on average was over 7% and the best over 9%. This would seem to indicate that indeed, of the stocks over $25 that we looked at from the first article, those in the NASDAQ that were even more expensive than the $25, did best of all. In other words, initially, we could say that stocks over $25 did best, but not better than the indices, but now we can say of those over $25 in total, those that were over $35 and in the NASDAQ did better than the stock market as a whole and better than any index. Now we have a useful subset. In fact, the average yield of the this subset was 8.35%. And I don’t even know the companies’ names.

Now let’s look at the S & P 500. She was the most beautiful beast ever beheld by gridlines on this day. This graph is a 100-stock, backward oriented smooth. Something more clearly interesting happens with her. While the stocks on aggregate, do trend up overall, there is a clear indication that the very cheapest stocks did significantly worse than the most expensive. In fact, once you’re over $58, there’s no holds barred. In fact, just between $58 and $63, there’s a full 1.5% hike, followed by more moderate gains all the way to a spike at the end (smell that? I think Google might be around). After that $63 threshold, you would have, as with the NASDAQ’s sweet spot, both soundly beaten the market as a whole and the major indices.

Here are some next things I’m going to consider. Because we all know that none of us could easily buy “this 200 stock section” or that one of an index, and thus any smaller subset would make literal my repetition of the phrase “on average” (i.e., a gamble), I’m going to begin some density functions (or probability distributions) using some of these subsets. For investors like us who don’t like to gamble, this should certainly be some fun gaming.

As can often be the case in the Blogosphere, bloggers meet other bloggers. Weeks ago, I met the College Analysts because I stepped forward to investigate the possibility of some traffic exchange. After learning that any exchange would be rather inequitable (I would receive far more attention than I could possibly give), we both agreed to box up the prospect for potential future use. We even suggested, should either one of us write something provocative, opening up that box and perhaps sparring a bit. Nothing draws crowds like good sport. In the meantime, I subscribed to their feed and have kept up reading their material, always watchful for something I couldn’t possibly agree with.

So what’s the problem?

The problem is, they don’t do anything wrong. In fact, far from it. It turns out that they’re some of the sharpest “kids” I’ve met (I say “kids” tongue in cheek—we’re likely rather close in age). Truly some talented, quick witted, crystal sharp thinking going on over there. And this is a compliment coming from a guy who runs a blog crammed deep into the recesses of deep thinking of all things.

Again, So what’s the problem?

So the problem is, that while in the course of doing well what they do so well, they managed to stir up a hornet’s nest. They picked on Apple. Wall Street’s momentary darling. But, they didn’t really pick on Apple so much as they analyzed it in a way that no one really liked. Everyone seems to have a vested interest in everyone else’s vested interest; i.e., everyone who’s rooting for Apple doesn’t want there to be a single damned dissenter. The College Analysts valued the stock somewhere (it doesn’t even matter where) below where all those vested interests wanted them to. They would rather have had them value it somewhere between $800 and $1000 I suppose, which is where they hope to have it go.

Rarely do I get to see so often, stacked up like the dead, so many angry comments from my favorite people like Anonymous, and oh yeah, Anonymous, ridiculing what I thought was a brilliant post. Talk about nit picking. Some of these nameless but obviously angry faces go so far as to mire themselves knee deep in personal attacks. Read this: Nothing gives away someone whose wrong more quickly than that.

After reading these now dozens of angry comments, I realized that I could either join that ugly fray over there or, with far greater reach and room over here, defend those embattled, though quite correct authors, under siege as they are, over here.

All we have to do is ask one question.

Who doesn’t own Apple? Warren Buffett for one. At least not that I am currently aware of (I think we all know that he doesn’t detail many of his purchases until he absolutely has to) and if he ever was in the market for Apple stock you can bet like hell he isn’t right now.

Regardless of whether or not some infinite scrutiny over this earnings projection or that one is absolutely correct (which is ultimately irrelevant because the ones they used are close as hell), we can be certain of one thing: for all the companies that once looked and smelled just like Apple does today (Microsoft, Google, etc), i.e., those that simply exploded, there have been many, many more that simply turned to dust. Dust.

So the College Analysts, by valuing Apple less than Apple-rooters wanted them to, actually pointed this little inconvenient fact out. What’s even worse (or funnier if you’re me), is that if you include any variation of expected return (or value) that incorporates this inconvenient fact in it, the un-popularly low value they provided looks to be many degrees too high even while it’s low.

In the end, I’m rather glad they have the capacity to inconvenience as they do. After all, someone has to have a clear head about these things. Meanwhile, I’ve got some knuckles to go tape. I’ve got allies to go box for.

In response to my article regarding my intention to never take a loss, a very helpful reader, Zlatko, dished up some very tasty food for thought. He brought up the topic of Prospect Theory, a theory I didn’t, at the time, know anything directly about. I replied that I wanted to do some snooping, and afterwards, respond a little more intelligently. You can read those comments here. This entire post is actually my reply, because after doing some of that snooping, I found some very intriguing things.

Here’s some of what I found:

1) Zlatko said, when summing up Prospect Theory, that “a great loss hurts more than an equally great gain helps.” For the sake of precision I’d like to pin down “hurts more” because a phrase like that can be both subjective or objective, depending on how whoever using it means it. It turns out that that subjectivity or lack of it can actually play a very crucial role in an understanding of Prospect Theory. In other words, subjectivity, in the Town of Prospect Theory, is the law of the land. Let’s replace that phrase with “thinks it hurts more.” Now we know it’s subjective. Why is that important? Because, according to this Wikipedia article on the subject, “[Prospect Theory] is a psychologically realistic” theory “that describes decisions between alternatives that involve risk…where the probabilities are known.”

2) This is fascinating, Zlatko. I think most people, including me, have participated in the thought, but never had a name for it. In other words, the concept pervades, but is often unseen.

3) I found a terrific example of the theory’s implications. Given choices between mathematically equivalent alternatives, those that “felt” worse, based on context, were declared “worse” or “more bad” than the ones which “felt” somehow better even though they were actually equal alternatives. You can read the details of the example here.

4) In other words, Prospect Theory is gut checking. It explains how our psychologies lead us to value things sometimes irrationally based on how they seem at first glance.

5) Here’s a counter-point though. Both of these sources seem to suggest that Prospect Theory’s relevance is inherently tied to at least a third-party knowledge of the probabilities involved in the alternatives. By bringing it up in response to my intention to never take a loss, it would seem to indicate that Prospect Theory’s relevance to that intention is also based on my knowledge of the probabilities of taking losses in the stock market. Because however, the stock market is not knowable in this sense, than my decision making, when trying to not take losses, is based on something not entirely included in Prospect Theory’s domain. In other words, the alternatives are not quite so definable. The probabilities are not known, and even though I might be using assumed probabilities, I’m not quite convinced that I’m making completely gut-checked-based decisions. Granted, I might however, still be making irrational ones—though determining this seems to need something at least partially outside of the realm of Prospect Theory.

In closing, thank you Zlatko. And thank you. When writing about the topics that I do, my ultimate intention is to either a) inspire people to a re-orientation regarding things related to investment that is “deep thinking through and through” or b) to invite people to engage in some intelligent dialogue about those same things. I have no way to adequately gauge the success of the first intention. But, by having readers responding in the way you did, I can at least partly gauge the success of the second. There is no other way. Thank you, Sir.

Have you ever heard the supposition that higher priced stocks tend to perform better than lower priced stocks? Arguments against this supposition will remind us that stock prices ultimately are irrelevant; that, should you have two identical companies, with one whose stock price is half the other’s (i.e. trading at $10 vs. $20), all this means is that the lower priced company simply has twice as many shares. In other words, it’s diluted. Now that we have a dataset, we can set out to examine this.

Is The Theory That Higher Priced Stocks Perform Better A Myth?

For this experiment, I took the stock prices of all the companies in the dataset on September 9th, and October 6th, and used these to find the one month yield for all 7,478 stocks. I then divided those yields into three equal subsets based on their September 9th prices, each containing about 2,493 stocks (labeled groups A, B and C). Group A consisted of all stocks less than $11.97, group B between $11.98 and $25.25 and group C over $25.26.

The Results

For reference, the dataset as a whole yielded 5.90% over the month. It turns out that both groups A and B performed worse than the market as a whole—in other words, you would have been slightly better off literally picking any of the 7,478 stocks at random than by picking any stock at random that you knew was under $25.25 (keep in mind this is only valid for the market conditions as we saw them in the month of September—I’ll be doing this more, using different time periods to see if something similar happens at other times).

What these findings tell us is already apparent: the more expensive stocks must have performed significantly better in order for the average yield of the whole to have been better than the yields of the two less expensive groups. Indeed, group C averaged 7.78%.

What was even more surprising about the two less expensive groups was that the most frequent yield for both groups was actually slightly negative. Here is the graph of all three groups. It is a frequency distribution showing different small yield ranges, and their corresponding frequencies (you may click on it to get a much larger and clearer picture):

Finally, because the most expensive stocks were still chugging along so strongly even at the very limits of the yield range I selected to graph, I decided to construct a second graph that would associate the yields, not as frequencies, but as a relational graph showing the strict trend between price and performance alone. In order for the graph to be even vaguely useful however, I had to smooth it using a 1000 value run. The way to read it then, is as a “leading” graph. At every price point on the x-axis, the yield at that point represents the average yields of the next forward 1000 stock prices. This graph is very interesting too: after $21.00, the yields just keep on getting better, on average, and after about $27 they are sustained even higher still. Here is the graph:

Lastly, let’s look at how the Dow Jones Industrial Average, the NASDAQ Composite, and the S & P 500 did during this time:

So, if anyone tells you that higher priced stocks don’t perform better with certainty, know yourself, that they just may. There could be many reasons for this phenomenon. Likely it is because better performing companies do not dilute their shares, or their share price. Also, even though the more expensive stocks performed better during this time than both the market as a whole, and all the less expensive stocks, they just barely kept nose to nose with the major indices. But here’s a major point, you could have kept nose to nose with the major indices by doing nothing more than selecting stocks by their prices. You wouldn’t even have to know their names. That’s fascinating. Do I recommend doing that? Hell no. After seeing what we have here, I’m interested in doing a similar experiment on stocks, just as above, but by making them subsets of the indices.

Cheers and happy calculating, musing, and of course, always…thinking

As promised here and here, the winner of the Starbucks gift card contest has elected to hijack a blog post.

[Wait! Wait! Please…no…not in the trunk! (muffled sounds follow)]

And thank you for the free coffees ;).