Table of Contents
Since 2012, I started my passion for investing and began trading for stocks, options, CFDs (forex) and automatic trading. I implemented some strategies like value investing, Turtle Trader, options (spread, sell side) and automatic trading via MQL4. Here I wanna share what I learned from the journey of investing.
- Buying stocks is like raising children. Don’t make yourself busy having too many children. Operating too many stocks may cause you error in a hurry. It can make you rich enough if you can handle several good stocks in your whole life.
- It’s a good opportunity to buy stocks in a cheap way when the market is bearish, but you have to know what to buy in advance. So make yourself a favor to do the research before the time comes.
- Media is considered one kind of market makers. They get the news in advance before retail investors get the second-hand information. (Although the media is slower in getting the information than the directors and supervisors, at least they’re faster than public news readers.)
- Don’t judge yourself by the results. Judge by the process.
- Investments are a process of continuous revisions. It’s okay to error. The key is to adjust them.
Motivation and Mantras
- Losers think it’s safe to follow behind others, while winners feel not at ease being followed by too many people.
- Don’t be afraid when we should be greedy more; Don’t be greedy when we should be fearful.
- The market doesn’t care about the past, even the current. It always looks forward into the future.
- The market is always right. Just listen to it. The market determines win or loss after you place the trade.
- The difference of markets is just volatility, rules, and opponents.
- Be happy to trade rather than trade to be happy.
- Professional investors make money by professions and disciplines rather than luck.
- A successful trader is someone who can develop a system and classify things into rules.
- Things considered impossible are usually likely to happen, and it really happens.
- Only until you want to buy or sell the stock of a company will you get to care about its stock price. Value investors should focus on the intrinsic value rather than the explicit stock prices.
- For P/E ratio of companies, E (earnings) is the main root while P (price) just follows it. If earnings don’t grow, the stock price will not surge any further.
- If you want to buy a whole company, it is necessary the company is operated by the manager(s) you can trust.
- If I can not understand the technology of a company and this technology is important for making the investment decision, we don’t invest in this company.
- If it is likely to have a serious personnel problem, we will not invest even though there are huge profits. (e.g., lay off, factory shut down, union business without the rights to strike)
- In buying an enterprise, a company of high quality is more important than cheap price.
- A continuous dividend record of more than twenty years in the past is an important positive factor in assessing the quality of an enterprise.
- Sell stocks when there is a problem in company fundamentals.
- Buy stocks for value rather than for market trends or economic outlook. In the end, it is individual stocks which determine the market, not the market which determines the stocks. Individual stocks can go up in the bear market and go down in the bull market. So, we should buy individual stocks rather than market trends or economic outlook.
- Buy good enterprises with reasonable prices: A good company is defined as having a strong brand, higher-than-average return on equities, light demand for capital investments, high ability to generate cash.
- Sell the investments after the prices reflect its potential value.
- Investors should not only focus on “whether” the current investments are undervalued or not but also “why” is undervalued. It’s important to know why you made this investment and sell when the reasons for supporting you to continue holding the investment no longer exist. Look for investments that have catalysts that directly help realize potential value. Prioritize companies with good management and managers who have personal financial interests in the business. Finally, diversify your holdings.
- Look for undervalued stocks: The price of some stocks is less than the net working capital per share, and the price of some stocks is less than the net cash per share (cash held after excluding all liabilities). The stock price of many stocks is significantly lower than the book value.
- Preparation is the most important. Noah didn’t start to build the ark after rains.
- Hold great companies for long.
- Treating investment like doing business is the smartest.
- Focus on the future productivity of the assets you invested. Think about what a specific asset can produce.
- For the future, qualitative analysis is more important than quantitative analysis.
- Price is what you pay; value is what you get.
- When buying stocks, treat it as part of the business. The mindset and analysis should be similar to buying the entire business. To begin, judge whether you can easily estimate the income range of assets over the next five years or more. If the answer is yes and is within a reasonable price that corresponds to your estimated bottom line, buy the stock or business. However, if you do not have the ability to estimate future income (which is often the case), you can simply move on and continue to look for the next potential target. Never give up on attractive acquisitions just because of the macro or political environment, or the opinions of others. In fact, don’t think about such factors when you make the decision.
- The core value of a business is its sustainable competitive advantage.
- In fact, the best way to evaluate a business is to do research on successful entrepreneurs and ask yourself how they succeeded and why they succeeded.
- Companies need to be able to withstand the difficulties: Companies that can withstand adversity and the pressure of prosperity have accumulated enough strength
- Start from analyzing successful businesses.
- Buy best companies at a reasonable price.
- Great investment opportunities come from excellent companies suffered from unusual environment, which can lead to erroneous underestimation of these stocks. Buy them when they need a surgery.
- Upon crisis, cash plus courage is invaluable.
Risks will change depending on the length you hold a specific asset.
If you can hold an asset for many years, you don’t need to care about the short term liquidity. But those who rely on borrowing to invest have no such space.
Recommended Elements to Consider in Selecting Stocks
- The reciprocal of P/E ratio has to be greater than the yield on senior bonds.
- The P/E ratio measured by the average earnings in the past seven years should be no more than 25.
- The stock price is lower than working capital.
Stock Selection Set
- P/E ratio is less than or equal to 9.
- Current ratio is higher than or equal to 150 %.
- For industrial companies, 110% of working capital should be greater than liabilities.
- No loss incurred in the past 5 years.
- Dividends released in the most recent period
- Earnings in the most recent period should be greater than earnings five years ago.
- The stock price should be lower than 120 % of tangible net worth.
- S&P ratings should be greater than B+.
Speculation is different from investing. There are several differences. First, speculation is short-term, like day-trading (buy and sell commodities on the same day or sell first and buy back on the same day) or entering and then exiting the market in an interval of several days, weeks, or even months. It cares about how the price will move in the short-run in order to capture the price difference to profit. Investing cares more about the long-run, like buy-and-hold strategy (choose a stock of high fundamental quality and reasonable price and hold it for several years). The reason for this is that investors value the intrinsic values from the stocks, i.e., the dividends companies distribute to investors from earnings companies generate and the long-term growth potential of companies in terms of its profits, future outlook, competitive advantage compared to its industry peers, financial stability, etc. Second, speculators are price sensitive and investors are not, meaning that speculators keep an eye on the price movement every day. They may suffer from volatile market when they are not able to watch the market in a day. Instead, investors don’t mind if the market opens or not tomorrow because they don’t need to monitor the stock price so often.
General principles of speculation
- Buy at low and sell at high. Long the high prices of strong stocks and short the low prices of weak stocks.
- Do not guess that the price level may be at the lowest or highest level now. You never know if the market will break through another higher level or lower level tomorrow.
- If you want to cut your position, priority is given to the position which is suffering from loss.
- 100% follow your decisions and money management rules.
- Never allow the possibility of a big loss to happen. Stop loss is a must, though painful.
- Ask yourself before entering the market. How much can I earn? How much can I lose? What’s the probability of each case?
- Think in a way that you lose your memory: You shouldn’t care how you ran into the situation. Instead, think about what to do now. Traders who change their habits of trading depending on their confidence and emotions care about their past rather than current reality.
- Trade by signals rather than feelings and intuitions.
- You still have to move forward if you lose money in the market. Accept it and manage the loss.
- Know your edge: In the long run, by your investment philosophy or trading rules, how much can you expect to earn on average for each trade?
Expected value = Probability of Gains * Average Gains – Probability of Loss * Average Loss
- The point is not how frequently you are right (probability of gains and loss). It’s about how large the amount is when you are right (average gains & average loss).
Follow the trend
There are basically two types of speculation strategy, trend-following and mean-reversion. For people who believe in the theory of trend-following, it is about following the trend of the mainstream market. There is no need to predict the future. Just do analysis on the relationship and changes of figures and prices to decide whether to buy or sell. There is no need to study analysis report because the market will react at the moment. Most of the financial institutions have their own algorithms, databases, or special channels to get information. They will be faster than you in receiving information and implementing strategies on the market. Therefore, you just need to learn how to be a market follower. After all, if your trading value is not more than hundreds of millions, you will have no effect on the market. Remember, do not bet on the future direction of the market. If you’re right about the bet, it’s just luck.
- Train your mind to adhere to a strict set of trading rules, and exclude all other market factors, only take action by rules or by your own system. Doing so is expected to remove the emotional judgments caused by individual market decisions.
- Trend followers don’t expect every trade can make a profit.
- The important thing is that trend followers always close their positions until the market is against them. Therefore, you have to bear the painful experience of abandoning some profit. You can not guess whether the lowest or highest level has come or not. So, the strategy is to close the trade in the middle of the trend.
- Entering the market upon break-outs may easily incur losses (It’s possible to experience a continuous series of losses caused by fake break-outs). After a trade of loss, you have to tell yourself it’s right to do it at that time.
- You can not ignore the second break-out just because the first break-out caused losses. You must enter the market again.
- Upon break-outs, no matter bull or bear market, there is no way to know how it will develop in the future.
Long is as good as short.
Retail investors usually don’t short the market and don’t get accustomed to it. However, studies show that bear markets are usually steeper than bull markets. If you learn how to short the market and get accustomed to it, you can profit from bear markets and even earn more.
About money management, let the loss stop and let the profit continue. Don’t take profit when you just turn into profit in a position. Instead, increase your position when the market goes in the direction you like.
Protect your capital: Protection -> Consistency -> Excellence
To protect your capital, it is recommended that the loss incurred by a single trade should not exceed 5% of your initial capital (best at 2 ~ 3%). If you have a million, you would like to invest 20% of the capital, and you set the stop loss at 10 ~ 15%, the loss to your initial capital is just 2 ~ 3%. The importance of this principle is that as long as you stay in the market long enough, you will encounter continuous loss. If you got hurt 10% for a continuous series of 5 times, you end up 59% of your initial capital (0.9^5 = 0.59). If you got hurt 20% for a continuous series of 5 times, you end up 33% of your initial capital (0.8^5 = 0.33).
Don’t set the limit of profit and let your loss continue to grow.
Control your hidden beasts (greediness, fear)
- Don’t let your mood go ups and downs with the value of your assets.
- Stick to the plan and keep calm.
- Only consider taking actions when the market condition meets the criterion you set.
- Figure out plans and precautions for tomorrow every day.
The Mistakes You Should Avoid to Make
Below are some valuable points for you to think about when you make decisions. It may help you avoid mistakes people usually make in their investments and achieve better profits.
- Didn’t set stop loss and do it exactly
- Listen to and believe in rumors
- Overreact on herd behavior
- Overreact on positive and negative behaviors
- Take profit in a hurry
- Didn’t accept opinions which are contrary to your beliefs
- Being too confident in your judgment
- Being over-positive or over-pessimist on the investment environment
- Believe in technical analysis too much
- Never give a shit on fundamentals
- Too centralized holdings of stocks without diversification
- Borrow money to invest
- If it’s not possible to reduce the risk, leg go of the fortune you may get.
- Always think about the risks first. What should I do if the price movement is different from my expectation? How to set the stop loss?
- Think well about the condition to exit in advance before entering the market no matter whether the price movement is against me or not in the future.
With respect to options, buy side is totally different from sell side. We can think of the two types as two people with distinctive personalities. Buy side is a person who is sick most of the time because of a lack of volatility. But sometimes they can make a huge profit all of a sudden when the market surges or plunges. They suffer most of the time when they wait for the market to have a big movement. But the market is flat most of the time. Moreover, time value is not on their side as the time value of options they buy continue to decrease as time passes. On the other hand, sell side is a person who is healthy most of the time, but they die all of a sudden if they encounter a serious illness. They are healthy because the market is usually in consolidation. The market doesn’t surge or plunge every day. Instead, the market goes usually in a flat way. When the market is calm, sell side has a high chance of earning money. Only if the market increases (decreases) to a certain level will the sell side of call (put) options start to lose money. Also, time value is on their side since they earn more as the time value of options drops day by day. However, they may incur a loss more than all the profit they earn in the past just once if the market goes in a wrong way dramatically. Remember that selling options has unlimited risks.
- With respect to short-term trading or day-trading, no matter buy-side or sell-side, it is recommended to trade in-the-money options.
- If the time-to-maturity is within seven days, no matter long or short, buyers of options are recommended to trade in-the-money options.
- If the time-to-maturity is more than fifteen days, no matter long or short, buyers of options are recommended to trade out-of-the-money options.
- No matter long or short, sellers of options are recommended to trade at-the-money or out-of-the-money options.
- With respect to buyers of options, it is recommended to set the stop loss no less than 50% of the initial cost. For instance, if you buy a call at 7800 spending 200 points, you should consider exiting the market with a stop loss intention when the premiums decrease to 100 points.
Timings to be on the buy side of Options
- Low implied volatility: an implied volatility of over 30% is too high.
- At the beginning of the contract: low decaying time value
- High level of open interest
Timings to be on the sell side of Options
- High implied volatility
- At the end of the contract: fast decaying time value
- Relatively low level of open interest