Author: Gstock Admin

When Is The Time Right For Buying Stocks? A Quick Guide

Is there are right and wrong time to buy stocks? Well, that would depend on your investment strategy. If you are a trader then you may see nothing wrong with buying at a company’s highest share price whereas if you were a value investor you may be more cautious about buying at that same price.

These differing views can occur between different investors on the same stock and at the same price. So which one is correct? The answer is both are correct. The trader could trade out with small short term gains while the investor would be looking at a long term position and may consider the current market cap too high due to the unforeseen rapid increase in stock price.

So when are you supposed to buy shares? Here is a risk analysis of different entry points and also some of my tips on purchasing so that you well educated before you make your decision:

My 5 Rules for Buying Shares

Here are my 5 stock picking rules that I run through before I purchase any stock. These are not all of the factors that I use but they are nevertheless a good starting point:

Purchase on Current Facts Not Future Revenue – A company may have exciting prospects and good future potential but, in my opinion, it would be wrong to invest solely for that reason. Prices fluctuate and you always have to be careful that you are not investing today at a share price that reflects the “potential” value of the company in a few years time. I have seen this type of scenario occur frequently in the mining sector where a company’s price will shoot up to reflect an oil find yet investors forget that there are still further costs and risks associated with extraction and production.

Buy When The Company Is Undervalued – I will usually be watching a few companies at the same and it is important that the company I choose to invest in is the most undervalued of those companies and also undervalued in relation to it’s peers in the same sector. It’s important to wait for a good price and not to buy when the overall market is too bullish.
Beware of Number of Shares in Issue – From my experience, you should always tread carefully with a junior company with a lot of shares in issue. It usually means something has gone wrong recently and they’ve had to issue more shares – this could be due to a number of reasons but all of them are bad. I avoid companies which are going to be short of funds in the near term because another share issue and more dilution will be likely.

Invest in an Experienced Management – Don’t give your money to a senior management team with a lack of experience and poor track record. It’s very important to do some due diligence on the management team and this information can be found on their website, by typing their names into your preferred search engine and also inside your broker research tools.

Do You Understand The Business Model? – I tend to only invest in companies that I can understand. The process in which they generate income and their products / services must be easily understandable and clear. I try not to invest in overly complex companies because it makes following progress much more difficult which presents risks. As Warren Buffet once said “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”.
When NOT To Buy Shares in a Company (Beware of These Risks)

When everyone else is buying – Warren Buffet once said “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. When everyone is talking about a stock to buy, it is usually already too late. If a large number of people have purchase stock in the same company before you the price will already be inflated. Never follow share tips blindly as they often end in disaster. It’s always best to do your own research before making a purchase.

When the market cap is too high – Market capitalisation tells us the price the market values the company at. Beware of high market caps, especially in junior companies as it can be a sign that it has been overbought. A high market cap should always be supported by the value of assets, current revenue and profit among other fundamentals.
When you can’t afford it -This one should be obvious but I’ve lost count of the horror stories I’ve read about people becoming bankrupt from investing in shares. You should only invest with what you can afford to lose, do not pour your whole life savings into the stock market, especially if you are still a beginner, and do not take out loans to buy the “flavour of the month” oil company.

The Risks of Buying at the Top

Should you buy when the share price is at a high? If company A was priced at 10p per share and it was at it’s 52 week high, would you avoid it? The highs and lows of stocks can be a useful indication for entry points but unfortunately they only tell half of the story. The other half is the fundamentals. Perhaps something important happened in the last month which made the share price tumble, making it only worth half of what it was before. For example, if Company A was a copper miner and they had to stop mining at one of their mines due to the price of copper. Here is an example of a graph where a a top has been identified:

Share price performance and highlighted high point in African Eagle Resources

Would you buy at the point highlighted above? There’s a number of reasons why that would probably not have been a good entry point i.e. huge leap in share price on the way to 16p, historical resistance point and poor fundamentals (high market cap and the price shot up due to a farm in deal announcement), high risk and limited reward at that point of the company’s lifecycle and news flow. All of these factors together made any further increases in share price unlikely and unsustainable.

The Risks of Buying at the Bottom

What would you consider to be a low share price? When the price hits a 52 week low? A 1 year low? Or maybe the lowest price is the 5 year low? Different time frames make picking the bottom of a share price very tricky and although buying at any one of those points may give the highest risk to reward, you may also inadvertently find yourself buying a company on it’s way to bankruptcy.

Buying at the bottom is not as easy as it sounds and you should not buy at lows when the company in question is on it last legs (i.e. out of money and ideas). In particular, beware of small companies in trouble as it is likely they will lack the management expertise, experience and funds to get out of trouble.

I prefer not to buy the lows of a long term down trending company and would much rather go with a company at a low but with a clearly defined short term range such as the one shown below:

Final Thoughts

Is there a right time to buy? Well, on the evidence provided in this article I think we can agree that there are several ways we can reduce the risk and maximise reward by choosing our entry points carefully. Remember, you don’t have to time things perfectly in the stock market – you just have to be around the right area and patient enough to hold.

Options on Gold Stocks, The Basics of Option Trading

A significant number of our users have asked us to provide a resource on options trading and related definitions of call options and put options. Here are some basics and we will follow up with further examples of Gold shares and options.

A call option gives its holder the right to purchase an asset for a specified price, called the exercise price, on or before a predetermined expiration date. For example, a November call option on Apple stock with an exercise price of $600 entitles its owner to purchase APPLE stock for a price of $600 per share at any time up to and including its expiration date in November. The holder of the call is not required to exercise the option. Only if the market value of the stock to be purchased exceeds the exercise price will it be profitable for the holder to exercise. When the market price does exceed the exercise price, the option holder may either sell the option or “call away” the asset for the exercise price and obtain a profit. Otherwise the option may be left unexercised.

If it is not exercised before the expiration date of the contract, a call option simply expires and no longer has value. The purchase price of the option is called the premium. It represents the compensation the purchaser of the call must pay for the ability to exercise the option if exercise becomes profitable. Sellers of call options, who are said to write calls receive premium income now as payment against possibility they will be required at some later date to deliver the stock in return for an exercise price lower than the market value of the asset. If the option is left to expire worthless because the exercise price remains above the market price of the asset, the (aside from transaction costs) the writer of the call clears a profit equal to the premium income derived from the sale of the option.

A put option gives the holder the right to sell an asset for a predetermined exercise price on or before an expiration date. A November put on Apple with an exercise price of $600 entitles its owner to sell Apple stock to the put writer at a price of $600 at any time prior to expiration. While profits on call options increase when the stock price increases, profits on put options increase when the stock price falls. A put will only be exercised if the exercise price is greater than the market value of the stock.

An option is described as in the money when its exercise would generate a profit for its holder and out of the money when its exercise would not be profitable. Options are at the money when the exercise price and asset price are equal.

Currency Wars, Gold and How The Stocks React

Back when I started stock trading blog in 2008, the idea that the U.S. dollar could be devalued to such a point that people would begin losing confidence in it, was a wacky fringe idea passed around in gold bug circles and so called “alternative news” sites. I was critical of this concept and thought it was total BS back in 2008.

Fast forward to today. The national debt just crossed above $16.5 trillion and the debt to GDP ratio broke above 100% for the first time since World War II. As of December 2012, the debt to GDP ratio was 103.9%! Back in 2008, the debt to GDP ratio was 74%. In 2008, the national debt had just broke above $10 trillion. In just the last 5 years, the national debt has increased by 53.6%!

Both Parties Keep The Spending Binge Going

I chuckle when I hear someone say that the most recent President is to blame for the national debt. That’s just not true. BOTH parties are to blame for the national debt. Between 1977 and 1980 during the Carter administration, the national debt increased by 42.3%. From 1981 to 1988, Reagan exploded the national debt by a whopping 188.6%, the biggest increase by any President on record. From 1989 to 1992, Bush senior increased the national debt by 55.6%. From 1993 to 2000, Clinton increased the national debt by 35.6%. From 2001 to 2008, Bush junior increased the national debt by a whopping 89%. From 2009 to 2012, President Obama increased the national debt by 53.6%

So much for the incorrect stereotype that one party is better or worse when it comes to increasing the national debt!

Both parties talk a good game when their running for election but as soon as they get into power and the magical checkbook and pen is handed off, they spend like there’s no tomorrow. At this rate, maybe there’s not, at least for the U.S. dollar.

What Was Once Fringe Thinking Has Now Gone Mainstream

I’ve totally evolved in my position on gold since 2008. Take a look at the performance chart below.

gold chart

Since January of 2008, the S&P 500 is up a pathetic 2%. Gold, over that same time span, is up a whopping 100%!
I’m all about the charts folks. Politics and all other personal opinions aside, this is about money and the chart shows that your money would have doubled in gold, since 2008, while in stocks it went absolutely no where. You can’t argue with this chart and everyone knows it.

Is the S&P 500 Going Up, Or Is the U.S. Dollar Going Down?

It has been difficult to try and make money trading since 2008. It can be done and I’ve built up my blog at GuerillaStockTrading.com showing people the tools I use to do just that. But it’s hard work and the returns are small. It’s sort of disheartening to learn that I could have just put my money into gold in 2008 and today I’d have double the money. No constant trading. No constant brokerage fees. No sitting in front of a computer monitor hours a day. No charting. Just park myself in gold and do nothing and I’d be up 100%.

When I learned about the concept of the petrodollar trade got me thinking. When a currency is devalued, the cost of everything goes up, including stocks. You can study this relationship in real time by considering Iran and how their currency plunged 50% in value due to economic sanctions and their stock market has gone up 30% as a result!

So the question came to my mind to ponder: has the S&P 500 really gone up since the Global Financial Crisis of 2008, or is really the U.S. dollar going down?

This is a difficult concept to chart because currencies are measured relative to each other. Just because the U.S. dollar might be going down because the euro is going up, it doesn’t mean that the U.S. dollar’s absolute value is going down. Trying to find a benchmark for the absolute value of the U.S. dollar is tricky because currencies aren’t measured that way. One method is to consider how a gram of gold buys the same amount of oil today as it did back in the 1950s but it takes many more U.S. dollars to buy oil. You can read more about this method by going here. However, there’s another way to test this thesis.

We can use what is called an inverse formula to test if the S&P 500 is indeed tracking the U.S. dollar. While the absolute value of the U.S. dollar being devalued is masked by the fact that currencies are measured in relative value to each other, we can still plot what are known as perturbations and see if a positive correlation exists between the S&P 500 and the U.S. dollar. We do this by using the inverse variation formula: y = k/x.

If the S&P 500 is indeed being influenced by the U.S. dollar, we would expect to plot the two on a chart and see an inverse relationship between the two. Below is that chart.

gold chart

The chart above should send chills up your spine. It’s an almost perfect mirror image of the other! Since 2008, we see an inverse relationship between the U.S. dollar and the S&P 500. When the U.S. dollar goes up, the S&P 500 goes down and vice versa. It proves that the price action on the S&P 500 is directly connected to the U.S. dollar.
In a Wall Street Journal article entitled Currency War Has Started by Francesco Guerrera, Francesco writes:

Currency wars have been a staple of modern finance ever since the collapse of the Bretton Woods system of fixed exchange rates in the early 1970s. As Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co., says: “Most governments believe that their currencies are too important to be left to the markets.” So policy makers have often tried to manipulate the value of their currencies by intervening in the markets. (Source: http://finance.yahoo.com/news/currency-war-started-034400974.html)

This is incredible! This article was carried over the mainstream Yahoo News service and it comes as courtesy of the Wall Street Journal! Back in 2008, the only places on the Internet where you would find such an article would be on gold bug blogs and other alternative news sites.

The Bretton Woods system of fixed exchanged rates was an agreement for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the IMF could bridge temporary imbalances of payments. The U.S. dollar, in turn, was tied to the price of gold. It was a system developed to prevent the kind of currency wars we are seeing today.

On 15 August 1971, the United States unilaterally terminated convertibility of the U.S. dollar to gold. This brought the Bretton Woods system to an end and ushered in the era of currency wars.

Since 1971 and the end of the gold standard, the U.S. dollar has lost an estimated 90% of its value. We experience this loss in value of the U.S. dollar in terms of how much everything costs, or what is called inflation. See this article for what things cost in 1971 to what they cost today.

What the 1990s Can Teach Us

Critics of my inverse formula applied to the S&P 500 and U.S. dollar as proof the S&P 500 is going up because the dollar is going down will argue that the relationship between the price of stocks and the dollar has always been there and is not something new since 2008. But that would not be true.

If we chart the S&P 500 and the U.S. dollar’s price performance during the 1990s and the huge run up in the stock market, we see that during this time, the inverse relationship between the S&P 500 and the U.S. dollar was absent.

gold chart

In fact, if you look at this chart carefully you’ll notice that for years both the U.S. dollar and stocks went up together. This is the normal relationship where the Federal Reserve has to raise rates to cool off a rip roaring economy and stock market. The increase in interest rates makes the dollar go up in value. That is the normal relationship between the dollar and the S&P 500.

So what has changed since the 90s? The national debt went from $4.9 trillion in 1995 to $16.5 trillion as of January 2013. Assets of the Federal Reserve’s balance sheet went from an operating average of about $700 million at the end of 2007, to $3 trillion as of January 2013. This is the result of massive government intervention to try and jump start the economy via TARP, QE1, QE2, Operation Twist, Dollar Swap, and QE3 over the last 5 years. All this government action has caused the value of the U.S. dollar to drop.

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