ONCE UPON A TIME…
… the financial market was the domain of the wealthy and well-connected. The cost of placing a trade was sky high which made it virtually impossible to be an active trader unless you had some seriously deep pockets or a ringside seat on the trading floor in New York or Chicago. Commission costs bordered on highway robbery with charges as high as $50 or $100 simply to place a trade.
Another barrier to the everyday man was information. Or, more specifically, a lack of information. Making sound investing decisions requires quality and timely research. As discussed in October’s newsletter, fundamental and technical analysis are popular methods of analyzing a company to determine if it’s an appropriate investment. Decades ago, getting your hands on fundamental data was expensive and traveled at a snail’s pace. And forget about technical analysis. Back then charts were hand drawn with pencils and a ruler.
Suffice it to say, the deck was massively stacked against the little guy.
That was then, this is now.
We live in a golden age for the individual investor. Technology and competition have driven commission costs ever so close to zero. These days you can find brokers charging a mere $1 (or less) to place a trade. Whereas before you needed tens of thousands of dollars to justify investing, now it’s a viable endeavor even if you’re starting with a couple hundred bucks.
As for connections, well you still need a good one. But now it’s a connection of a different sort. Instead of having an inside man on the trading floor, you simply need a quality internet connection. With wi-fi, you get instant access to global markets so you can trade from anywhere.
Like virtually everything in society, the internet changed the landscape of investing forever. In addition to helping drive down transaction costs and providing access to Wall Street for the public, it also changed the information component. Timely and quality research became instantly available to everyone through easy-to-use trading software. We’ve since seen a veritable explosion in self-directed, do it yourself trading.
Wall Street is now a level playing field in virtually every capacity. The only question is whether you will take the life-changing step of participating. Famed investor Warren Buffett quipped,
The average investor with only average intelligence can consistently outperform the market
There are regular people just like you that are already doing so. The only difference between you and them is they’ve already decided to seek out education and spend time acquiring this new skill.
Isn’t it time you joined them?
I. A Financial Smorgasbord
Once you commit to being a trader, you need to decide which vehicle you’re going to focus on. Fortunately, the stable of offerings on Wall Street has grown considerably over time. And that means you have more choices than ever as to which product you think best fits your investment objectives and risk tolerance. What began as a simple choice between stocks and bonds has grown to include options, futures, and forex. All of these instruments possess different characteristics, and you will eventually come to understand their quirks.
Some traders focus on trading one vehicle only while others tap into the advantages offered by all of them. What matters most is to find what works best for you. There are traders right now using each instrument to generate cash flow and portfolio growth. While there isn’t one “best” asset, many novice investors start with stock trading as it’s the simplest and builds a foundation for moving into the other three vehicles. For the remainder of this month’s newsletter, we will take a brief look at each one.
II. You say Stock; I say Equities
Think of the wealthiest people on the planet. We’re talking people like Bill Gates, Warren Buffet, Mark Zuckerberg, and Jeff Bezos. What they all have in common is they each built businesses that grew to become insanely successful. Gates built Microsoft and Buffet built Berkshire Hathaway. Zuckerberg built Facebook and Bezos built Amazon. The reason they’ve seen their net worth balloon is that they own a boatload of equity in their respective companies.
Wouldn’t it be nice if we could piggyback off of their success by purchasing shares of ownership in these four companies? We can! That’s what stock investing is all about. It enables us to buy shares (or equity) in public companies. If they go on to change the world and acquire mountains of profits, we get a cut. Such a venture isn’t without risk, however. Just ask the competitors to these market share stealing industry leaders. Stock prices can fall delivering losses and pain along the way, so it’s important to learn about risk management and proper stock selection when venturing into this arena.
At the outset, we suggest keeping things simple. First, build a watchlist of companies you’re interested in. Maybe they are companies whose goods or services you use like Wal-Mart and Amazon.com. Or, perhaps it’s companies you think are poised to change the world like Nvidia and Tesla. Regardless of how you start, make sure you focus on trading liquid stocks. Though there are thousands of public companies you can buy or sell, not all of them are actively traded. And that makes them more challenging vehicles to play with. To ensure there is sufficient liquidity limit yourself to stocks that trade at least 500k to 1 million shares a day.
Furthermore, if you’re planning on generating cash flow on your stock holdings, it’s imperative your selections have listed options available. We’ve compiled just such a list over at Tackle Trading known as the Tackle 25 that consists of 25 liquid (and optionable) stocks. If you’re not a fan of reinventing the wheel, then start with the Tackle 25 and add to it if you come across other worthy candidates.
It’s worth noting even if stocks are your weapon of choice, there’s still a lot of variety on how you can use them. Some prefer a more passive approach and view stocks as a buy-and-hold vehicle that delivers considerably higher returns than the bank over time. According to Ibbotson Associates, the S&P 500 has generated a compound annual return of 10% since 1926.
Others look to actively buy and sell stocks multiple times throughout the year, month, or even day. You’ll discover the pros and cons of different durations as you gain experience.
III. Know Your Options
If stock trading is playing checkers, then options trading is playing chess. It’s a more sophisticated game with infinitely more choices. But don’t let the complexity scare you. With it comes the ability to be more creative in how you structure your risk. Not to mention the elevated level of control you have.
Options contracts are known as derivatives and were the brainchild of three mathematical geniuses in the 1970s: Fisher Black, Myron Scholes, and Robert Merton. What began as a vehicle used solely by institutions and professionals was eventually embraced by the masses. And it’s a beautiful thing because the advantages of using them in your portfolio are myriad. Chief among them is cash flow generation and portfolio protection.
Like stock trading, the popularity of options has exploded, especially over the past decade. From 2000 to 2014, for example, the daily trading volume for options on the S&P 500 Index increased almost ten-fold. With increased trading activity comes increased liquidity and that means it’s easier for everyday traders to buy and sell at fair prices quickly.
At the foundation of the options market lie two types of contracts: calls and puts. They carry very similar specifications with one significant difference. While call options give you the right to buy a stock, put options give you the right to sell a stock. Because both vehicles are available, options traders can make bullish and bearish bets. That is, they can structure trades that profit if the market rises or falls. And believe it or not, you can also build positions that benefit if the market trades sideways.
As long as you have some type of opinion the options market provides a way to build a trade around it.
One way to view the options arena is as an insurance marketplace. It allows traders one and all to acquire protection if desired. It’s kind of like buying insurance on your house to protect you in the event of fire or flood. Only here, you can insure your portfolio to limit the damage suffered during a market crash.
Think of the benefits!
While most of the public cowers in fear when bear markets strike because their 401(k), IRA, or other retirement accounts are losing 30% to 50% of their value, you will have the ability to limit your exposure to around a 10% to 15% loss. This one strategy has the potential to save you tens of thousands of dollars during the next market downturn.
All it takes is a little education.
And then there’s the potential for monthly cash flow. Real estate investors all over the world already understand this concept. They don’t just buy a house and sit on it – they rent it out to generate income. They monetize their assets. Otherwise, there’s a massive lost opportunity.
Well, thanks to the creators of options contracts, it’s now possible to rent out your stocks through a strategy known as the covered call. We’ll unpack this revolutionary idea more in a future newsletter.
IV. Back to the Futures
Another vehicle to sink your teeth into is the futures contract. Were you to venture into the domain of the day trader you’d discover that futures are often their weapon of choice. They’re simple like stock, but carry a ton of leverage. In fact, some view futures trading as glorified stock trading. You’re playing a similar game of buy low, sell high but with the ability to generate much quicker (and larger) profits and losses. Because futures lack all the complexity of the options market, they don’t require near as much intellectual firepower to understand.
Initially, futures contracts were created for commodities like corn, oil, soybeans, gold, and the like. They allowed companies, institutions, and individuals like farmers the ability to hedge their exposure to future price fluctuations in the price of the goods in which they do business. For example, maybe oil prices are trading for $100 today, and Exxon Mobil will have 1 million barrels of oil ready to sell one year from now. Instead of hoping that the price of oil doesn’t drop between now and then, Exxon Mobil could lock-in the sale price of $100 one year from now using a futures contract.
What began as a vehicle to help reduce the volatility and uncertainty for commodity-based entities has grown over time to enable traders to dabble in darn near anything. Some of the more exotic things you can trade futures on these days are volatility, interest rates, and even the weather.
The high leverage typically means these products are reserved for experienced traders with sound risk protocols and the ability for rapid-fire decision making.
V. Money Matters
We conclude this month’s foray into financial vehicles with a look at the biggest market of them all – currencies. Foreign exchange, or Forex for short, is a global market where people gather to trade, well, money. It’s far and away the most liquid market on the planet with daily trading volume north of $5 trillion.
Frequent travelers make forex transactions all the time. Suppose you live in America and are going on vacation to Europe. When you arrive, you’ll convert your dollars (USD) into euros (EUR). To determine how many euros your dollars are worth you look at the forex exchange rate between the two currencies – which is always fluctuating. Maybe in the morning, a single dollar would buy you 1.20 euros. But in the afternoon it buys you 1.22 euros. While minor changes may not matter to the traveler making small conversions, it’s a huge deal to global corporations moving mountains of money from one country to another.
Similar to stocks, options, and futures, the Forex market offers the opportunity to place trades based on how you think currency values will change. If you believe the USD will appreciate in value, then you can buy it. Alternatively, if you feel the USD will depreciate, then you can sell it short. In that sense, it’s virtually identical to stock trading.
Two characteristics that make Forex different than stock, however, are leverage and trading hours. Trading with leverage means you are trading with borrowed money and in the Forex market you can acquire more leverage than anywhere else. On a positive note, that means you can start trading with minimal amounts of money. But, if you’re not careful and you take on too much leverage, a small adverse move in your trade can wipe you out. Highly leveraged positions deliver rapid-fire gains when you’re right, but swift losses when you’re wrong. Because of this, most people playing in the Forex market are day traders which means the duration of their trades is usually a few minutes to a few hours only.
Unlike the U.S. stock market which is only open five days a week from 9:30 am EST to 2:00 pm EST, the Forex market is open 24 hours a day from 5 pm EST on Sunday until 4 pm EST Friday. This provides more flexibility for when you can trade. Those with a regular day job that normally miss out on trading stocks when the market is open can now trade Forex in the evening when they return home from work.
The financial market has numerous on ramps. You can build a trading business with any of the four major vehicles – stock, options, futures, or forex. Which you select is far less critical than the decision to act. The key is to get started! Educating yourself, learning how to invest, is a life-altering decision that will forever change the way you think about money.
We guarantee it.