Wednesday, September 12, 2007

The Credit Crunch and the Stock Investor (You)

The past four weeks have been a doozy. No sooner did the Dow set an all-time record on July 19 above 14,000 than the markets went into a volatile tailspin. The Dow has had several days of 200-300 point moves. Overall the market is down about 6%-7% in the month since July 19.

Whats the best thing to do right now?

First, the background facts:

The tailspin was begun by sub-prime mortgage lending. Many such loans were defaulted. It is fair to say that the mortgage market went into a bubble, and that the bubble is now deflating or collapsing.

The sub-prime mortgage mess began a chain reaction that spread through the credit markets and out into the stock market.

(1) Sub-prime mortgages were bundled into packages (securitized) and sold to hedge funds, banks, and other investors. Hedge funds and financial investors not only purchased these securities, but did so with high leverage: As much as 70% (or more) debt. As mortgagors defaulted on loans, the collateral supporting the mortgage-backed securities collapsed.

(2) Thousands of variable-rate mortgages will reset to higher interest rates over the next few years. As they reset, more owners will default.

(3) The difficulties in mortgages spread to other credit markets. Bank loans to hedge funds were themselves sub-prime, although nobody called them that. Several hedge funds ran into debt crises of their own, and others will follow.

(4) The countrys largest mortgage lender, Countrywide Financial, veered near bankruptcy until it tapped a massive credit line to stay in business. Smaller lenders have failed. Some others will fail, including possibly Countrywide itself.

(5) The problem has spilled over into the stock market via several paths.
(a) Margin calls have gone out. Forced to raise cash, hedge funds and others have been forced to sell stocks.
(b) Many investors have panicked, pulling their money out of the stock market. Financial stocks have been particularly hard hit.
(c) Private equity deals are grinding to a halt, as the money to finance them becomes unavailable. Private buy-outs helped fuel the market run-up earlier in the year. That propulsion is over.

National banks around the world have been injecting massive amounts of money into the financial system to stave off panic and illiquidity. The Fed has done so several times.

On Friday August 17, the Fed surprised by lowering its discount rate (for direct loans to banks) by 0.5% to 5.75%, which is another way of adding money to the economy.

But so far, the Fed has not lowered the Federal Funds rate, the one that impacts most other interest rates and serves as a benchmark for millions of consumer and business loans. The Fed has kept that rate at 5.25% for over a year. Many economists are expecting the Fed to lower the Federal Funds rate to further ease the economy. But the Fed has been reluctant to touch it, as it tries to keep inflation to about 2% or less.

Pundits, economists, and investors are split about the big-picture importance of the credit crunch. (1) Some maintain a not too worried stance, pointing out that the mortgage market is a tiny fraction of GDP, and that even in a worst-case scenario of massive defaults, the economic impact will be smallmuch less than the savings-and-loan crisis of the 1980s. They feel that the markets will work the problems out on their own. (2) Others feel that the crisis is going to get much worse, last much longer, and affect a wide swath of the economy. They say that we dont yet know the depth of the crisis, how many huge sub-prime loans banks have in their portfolios, how tight credit may really get as lenders pull in their horns, nor how the entire economy is going to be affected.

Many stocks of excellent companies, because of the downturn, are at their lowest valuations in years.

Economic fundamentals are fine. The just-ending earnings season showed strong results. Many excellent companies are doing well, growing in a healthy fashion, depend little on debt, and have no weaknesses on their balance sheets.

What does this all mean to the average individual investor? Is it time to be greedy or fearful? Is it time to protect against further losses by selling stocks, or is it time to purchase first-class companies at rock-bottom prices? Are the past few weeks the beginning of a bear market, or just a correction? Will the Fed ride to the rescue with the right moves, or will they screw it up?

For the stock investor, what are the risks right now? Id say these are the top three:

1.The credit problem, already a crisis, may turn into a catastrophe. There are undoubtedly many dangerous loans out there that we dont know about yet, and the credit markets may seize up for many months.

2.The economy will tip into recession. Companies will fall not only in stock price but in actual performance.

3.The Fed will make the wrong moves, or it will wait too long to make the right moves.

Risks usually have counterparts: potential rewards. The top three most likely opportunities:

1.The worst of the credit crunch is already over. The credit machinery of the economy will emerge stronger, as lenders reinstitute old-fashioned sound lending standards, to the long-run benefit of all.

2.The Fed will make the right moves at the right times. The economy will continue growing. There will be no recession.

3.Investors will take advantage of the bargain prices in stocks, accepting inevitable short-term volatility for a while until the market settles down. They will do this believing that in a few months or a year, the market will return the prices of excellent companies to rational levels.

I believe that the second listthe list of opportunitiesis more likely to occur than the first list, although that is certainly not a slam dunk. Reasons:

Investors are likely to recognize that the credit crisis is ultimately limited in size, and that overall the economy is in good shape.

The low valuations on many excellent companies will prove compelling and prevail over the fear that the credit crisis will ruin the economy.

By its injections of money into the economy and by its rate-lowering action, the Fed has signaled recognition of the importance of maintaining real liquidity in the economy and the markets.

The credit crunch is already reversing, what with the Feds action Friday, the shuttering of some hedge funds with the worst difficulties, the reinstitution by banks of more traditional and conservative lending standards, and so on.

Heres what we are likely to see over the next six months:

More revelations of serious credit problems in various areas.

More hedge funds will collapse. Some banks and financial institutions will be revealed to have more exposure to worthless credit assets than previously thought. The stocks of these companies will fare poorly.

Commercial and consumer lending standards will become tighter. Cash-rich companies (who have no need for credit) will benefit in comparison to companies which need debt to operate.

Investor sentiment will yo-yo as different revelations come to light. Therefore, the stock market will remain very volatile for a while longer. Up and down days of 200+ points on the Dow will be fairly common.

The Fed may or may not lower the Federal Funds rate. They will continue to take other actions to insure liquidity in the economy.

Investors will be all over the map on whether this is a time to be fearful or greedy, but on balance, the tilt will be towards seeing this as a buying opportunity. As a result, the stock market will be higher in six months than it is now, perhaps back to its July 19 level if not higher.

Action steps:

1.To the extent you have cash to invest, look for excellent companies with strong balance sheets.

2.If you use sell stops, either set them wider than normal, or dont set them at all, putting your faith instead in the foregoing analysis. The wider sell-stops will allow room for volatility.

3.Because the conclusions above are not slam dunks, limit your stock investments to or 2/3 of your available stock money. Neither be fully invested nor flee the market.

Dave Van Knapp is the author of Sensible Stock Investing: How to Pick, Value, and Manage Stocks. Click on this link to go directly to the book's page on . Or click on this link to learn more about the book and its sytematic approach to investing specifically designed for individual investors:

Always Use Protection! Sell-Stops for Safe Investing

For most individuals, whether to sell a stock is the hardest decision in stock investing.

It sounds simple at first: Sell your losers and let your winners run. Sure, obviously. But how do you know which stocks are your future long-term winners and losers? More to the point, how do you tell the differenceright nowbetween a stock that is only on a short-term losing streak as opposed to one which is destined to be a long term loser?

Clearly, its easy to list your winners and losers as of right now. But thats not what this particular decision is about. This is about future eventsunknowable by definition. Even if your stock is falling in price, you dont want prematurely to decide that you made a mistake buying it or that its prospects have reversed from bright to dim. It may not be a loser at all. It just may have hit a bad patch. Your original positive outlook on the company and its stock may be correct, and the optimum decision may be to give the stock more time to reach its profitable destination. A stock in a short-term stall can become a long-term winner.

On the other hand, we all know Rule #1 of investing: Dont lose. So you cant wait forever to make your decision when a stocks price keeps falling.

Every Sensible Stock Investor wants to take a strategicnot whimsicalapproach to making sell decisions. You want to contain losses and sidestep risks.

The trailing sell-stop order is a very effective tool for sticking to a strategic approach. Lets make sure we understand what this order is. Then well talk about how to use them.

A trailing sell-stop orderwhich is a standard type of order with all brokerageshas these characteristics:

It is a sell order with a condition attached. You attach it. When the condition is satisfied, the order to sell is executedwhether you are at work, in the bathroom, on vacation, or wherever.

The condition is the ''stop'' price. That is the price you pre-select to trigger the sell order. If the stocks price falls to or through that point, the sell order is executed. You pre-select the trigger price when you are thinking objectively and strategically, not in the heat of a fast-moving stock price.

It is a trailing order. Over time, as the price of your stock moves up, you reset the trigger price a little highersay once per week. That way, the stop price trails along behind the stocks actual price, protecting you on the downside while not limiting your upside.

It is a standing order. That means it just sits there until (1) it is executed, (2) it expires, (3) you change it, or (4) you remove it.

Of course if the stocks price is going down, you leave the existing stop price alone. The whole idea is that it is there to protect you against losses. It does not take long to review and reset all the stop prices in a small portfoliomaybe a minute per stock online.

So trailing sell-stops are used to limit losses from your purchase price or to lock in the gains of your stocks as they advance. A trailing stop order gets you out if the stock suddenly starts to tumble. It works like a ratchet, letting your stock price move up but not down past the trigger price you have selected.

I follow one hard-and-fast rule: Sell a new purchase before losing 10 percent in it. So as soon as I purchase a stock, I enter a sell-stop order too, usually at 8 percent less than I paid for it.

After a stock gains 10 percent for you, your stop price will have reached what you paid for it, so you will never lose money on that stock. After that hurdle has been cleared, how do you set the stop price? The goal is to give the stock enough room for normal volatility, while at the same time being restrictive enough so as not to let profits escape if the stock starts to go backwards.

There are two main methods to set stop prices. First, you can set the stop price as a percentage below todays price (but never below what you paid once the stop price has reached your purchase price). I use the percentage approach most of the time. My default percentage is 15 percent, although I may change that (up or down) in certain situations.

I might use a looser stop (such as 20 or even 25 percent) for a blue chip company that I really expect to hold for a long time. This would typically be a company that has a fat dividend yield.

I usually use 10 percent if the stock is an ETF (exchange-traded fund). This is because funds are typically less volatile than company stocks, so they dont need as much wiggle room.

And I might use a stop as low as 2 percent or 3 percent for a stock that I have decided to sell. The tight stop price lets me squeeze out any unexpected upside that the stock may have left in it, but it still gets me out with negligible damage if the stock falls at all.

The second way to set the stop price is to examine the stocks chart for the past year or so. You may see that while overall the stock has been rising, some significant leaps and falls are part of its normal behavior. The dips may exceed any reasonable percentage sell-stop that you would normally set. But you dont want to sell the stock on such dips, because you can see that the overall trend has been upward, and you believe that it will be continue to be that way.

In that case, what I usually do is have the charting software (available on most financial websites) draw the stocks moving average line (MA). Try MAs between 50 and 200 days. What you might discover is that although the stock has its ups and downs, it essentially never falls below one of those moving average linesit always seems to bounce off the MA line and head back up. If thats the case, use that MA as the stop price.

This has worked perfectly for me with Chicago Mercantile Holdings (CME). Viewed through a wide-angle lens, the stock has done nothing but go up since it went public a few years ago. But viewed up close, it can be volatile. A couple of times I purchased it, only to have it trigger my stop order before too long. Then I made the observation that the stock never seemed to drop below its 200-day MA. So now I use that for my stop price. As the stock bounces around, the actual percentage of the stop price below the actual price varies. But I dont care. By using that approach, Ive held one block of shares without interruption since February 2006, and it is up 43 percentnearly 50 percent on an annual basis. CME is one of my all-time favorite stocks. The Merc has an exceptional business model, generates cash faster than McDonalds makes burgers, and has rewarded its shareholders handsomely. I am protected to the downside on a fairly volatile stock. Just as with percentage-based stops, I reset the stop price once a week. I just look up the current 200-day MA, and thats my stop price.

If you employ trailing sell-stop orders, you will find from time to time that you are stopped out of a stock that, as things turn out, you would have been better off just hanging on to. But thats OK. Cutting losses and preserving gains are so important to overall success that the risk of getting stopped out is preferable to the risk of taking a large loss. And, if a stop-out proves to be a mistake, you can reverse it. As the situation clarifies, nothing prevents you from repurchasing the stock.

Dave Van Knapp is the author of Sensible Stock Investing: How to Pick, Value, and Manage Stocks.

This guide for individual investors goes into more depth on trailing sell-stops, as well as other aspects of managing a stock portfolio. The book has a perfect 5-star reader rating on

Click here to learn more about the book and the Sensible Stock Investing methodology:

Learn Forex With Forex Training Videos

I came across a brand new forex video course, this one is not like many others since it includes videos, in addition to ebooks. Actually this course includes video tutorials, ebooks, softwares, mentoring from a professional trader, free signals and more. Doesn't that sound good ? I am going to tell you what you will get when you purchase the package.

You will get access to a members area to download the full package. Concerning the forex video courses, there are 28 online videos. You can see a sample on the website. It shows a trade strategy that brings 973 pips in about a week. Of course you don't make this kind of profit every week but this is easy to see how powerful is the strategy.

There are 5 full proven and profitable strategies in this package. Not just one.

You don't only get the video courses. There are much more informations about the strategies and the forex market in downloadable ebooks. You will find tools to help you analyze the market. You will learn the basics, the fundamental analysis, the technical analysis, the trading psychology and the most advanced strategies to pull in big profits in your account.

I have always been convinced that there are traders that know more than others. Of course their day job is forex trading, they do it all day. But there are also people that simply know good systems and make profit every day just following a plan. Their strategies are kept for themselves, the author decided to reveal some of them. And he does it well, and more than revealing his techniques, he and his professional team will mentor you, for free.

Having a mentor for free is the real deal of this package. Imagine all your questions being answered, you will never get stuck and always have a follow up after your purchase.

The creator also offers an additional members with more content. When you will have. New informations, new charts, new strategies, new tools. The package is regularly updated and updates are free ! You are even added to a VIP list and be able to see live examples of trades.

But my favorite bonus is a "one free month of Forex signals". If you already know how to execute a trade this is simply amazing. You know, signals tell you exact entry and exit point of a trade, for a specific pair. You know what pair to trade, when to enter a trade and where you take your profit. Just follow the signals.

This course is really new and I feel not so many people know about it. Anyway this is a perfect package for beginners there is so much information that you can't really go wrong. Plus, the free mentoring, and the free month of forex signals are worth enough the price ($97).

Learn Forex at and find more about the Forex training videos.

Job Search - "Market Timer Needed"

Requirements For The Position

Have you ever wondered what the job requirements would be for the position of "Market Timer?" Assuming such a position existed, would you be qualified for it?

Such requirements would obviously be the same as those needed for anyone to successfully time the markets.

Let's see... what would the ad look like?


Candidates must be able to go against the prevailing opinion.

Candidates must be able to take a bullish position when everyone is bearish, and take a bearish position when everyone is bullish.

Candidates must be independent and self-assured. They don't worry about how they are doing compared with other investors.

Candidates must be able to accept that sometimes their investments will underperform the market, knowing that over time, they will outperform the market.

Candidates must be able to accept that their timing will require them to make frequent trades that may seem like mistakes, and a string of successive small losses won't drive them up the wall.

Candidates must be able to adopt a strategy for the long haul and stick with it, even when at times it is discouraging.

Candidates must be able to able to obey buy and sell signals, which often are issued against the prevailing sentiment.

Candidates must be able to ignore the mass media, which raise emotions and thus increase the risk of not executing a trade. It is often the trade that is hardest to take, that winds up being the most profitable.

Candidates must be decisive and willing to move at a moment's notice, without second-guessing, when a timing system calls for buying or selling.

Candidates must be willing to watch their investments every business day without fail.

What Each And Every One Of Us Face

Okay.... maybe it is not a job that we would see advertised anywhere. But the job requirements tell us a great deal about what each and every one of us face as market timers.

Market timers face a constant psychological battle. Prevailing sentiment, not to mention our next door neighbor, is constantly telling us to cave in and go with the majority. There is comfort in following the majority, at least for awhile.

But timers must walk alone. They can never give in to these pressures because just when the urge is greatest, the next profitable trend is launched. We must be on board. No trade can be missed.

Against The Herd

Yes... sometimes the majority are right, especially during a long trend. But never forget that the majority are wrong at market tops as well as market bottoms, when volume swells and everyone is moving in the same direction with herd-like mentality.

As market timers, we go against the herd. It may be tough at times, but we know that the profits realized over the years are well worth the battle.

Forex: Money Management Principles

Trade With Sufficient Captial

One of the worst blunders that forex traders can make is attempting to trade without sufficient capital.

The trader with limited capital not only will be a worried trader, always looking to minimize losses beyond the point of realistic trading, but he will also frequently be taken out of the trading game before he can realize any sense of success trading the method(s) or patterns.

Exercise Discipline

Discipline is probably one of the most overused words in forex trading education. However, despite the clich, discipline continues to be the most important behaviour one can master to become a profitable trader. Discipline is the ability to plan your work and work your plan.

Its the ability to give your trade the time to develop without hastily taking yourself out of the market simply because you are uncomfortable with risk. Discipline is also the ability to continue to trade the methods and patterns even after youve suffered losses. Do your best to cultivate the degree of discipline required to be a world-class trader.

Employ Risk-to-Reward Ratios

The following shows you possible risk-to reward ratios, and the win ratios required to break even in a trading system.

Risk-to-Reward Ratio (in pips)and Win Ratio Required to Break Even(%)

40/20 (2 to 1) = 67%, 40/40 (1 to1) = 50%, 40/60 (1 to 1.5) = 40%,
40/80 (1 to 2) = 33.5%,
60/20 (3 to 1) = 75%,
60/60 (1 to 1) = 50%,
60 /90 (1 to 1.5) = 40%,
60/120 (1 to 2) = 33.5%

Important Note

Never risk more pips on a trade then you plan to make. It doesnt make sense to risk 100 pips in order to make only 10. Why? See below example.

Profit taking level (pips): 10
Stop used or pips at risk: 100

You win 10 times which makes 100 winning pips. You ONLY lose once and have to give back all profits!!!

This type of trading makes no sense and you will lose on the long term guaranteed!

Toby Smitz - Daily Operations
Forex Trading with free education