Picking a Trading Style That is Right For You

When most people think of trading they mostly focus on investing. A slow accrual of wealth over time by holding. This is done by buying and holding stock, investing in mutual funds or ETF and waiting it out. However, this is not the only style of trading out there. So, what do you need to know about different styles?

Time Frame

The first question about your style of trading comes in the form of time frames. You can invest and hold the investment for decades, or, you can trade in a faster pace. Instead of trying to accrue wealth slowly for retirement, you can try enjoying trading profits. They can outperform the buy-and-hold approach, but they also take a lot more effort. Let us delve a bit deeper into different styles of trading.

1. Position Trading

Position trading resembles investing quite a bit. The traders who opt for it will use every analysis tool they have to make decisions. They rely on fundamental analysis to stay in the game. They will follow trends and usually ignore short-term changes. However, while most position traders like to hold their trades for months or even years, some work a bit faster. The main difference between position trading and investments is that an investment is meant to earn money from the fact that the market is on the rise while position traders still plan to use the standard buy low and sell high strategy, but they simply plan it out in longer time periods to maximize their profits.

2. Swing TradingSwing Trading

Swing trading is a very popular style of trading. It combines the best of two worlds. With the use of technical analysis, swing traders will use shorter time frames to profit from market moves. Usually, they will work in terms of weeks or even days. The reason this type of trading is popular is that traders who do not have a lot of time for trading every day can still use it to make a profit. The main idea is to exit a trade when you reach your profit desire, if the trade moved in the wrong direction too much or after the time limit was met.

3. Day Trading

Day trading is a style of trading during which trades are finished during the same day. This means that the trader will both enter the position and exit it on the same trade. With day trading it is not very likely that a single transaction will bring a lot of profit. Instead, day traders will use tick or volume based chart intervals to profit from price fluctuations within a single day. They will follow prices in minutes and rarely hold trades for more than a couple of hours. Unlike investing, day trading is essentially a full-time position. It is a job.

4. Scalp TradingScalp Trading

What do you get when you take day trading to the extreme? Scalp trading. This is the ultimate form of short-term trading. To make a profit, the trader will target the most minuscule price movements and make small gains. However, they will do so frequently and will build a profit every day. As a scalp trader, you will rarely hold a position for more than a minute. However, while the losses are minimal, this style is rather risky. To make a profit you will need a lot of positive trades.

Bonus: High-Frequency Trading

This is a very specific style of trading. To profit from it you will have to use rather complex algorithms. And they are, most of the time, proprietary to certain companies. These algorithms will provide analysis of multiple markets and execute orders themselves based on the conditions they find. When it comes to this style of trading execution speed is everything. For that reason, independent traders cannot really benefit from it.

 

Are stocks safe or can you lose all your money?

Normally Google allows you to see the search terms that has caused someone to end up on your blog. This morning, I saw this question on my Google feed and thought I should answer immediately:

YES! You can lose ALL your money…

Let me explain how this happens…Stock market

When you invest in a stock you are investing in a share of the company with the hope of sharing in the profits of the company after all costs have been paid. There is no guarantee of a profit, or, if there is even a profit, that you will get a share of the profit.

The share of the profits of the company that you receive is called a dividend. The directors of the company decide whether or not to pay a dividend. This decision is normally made each year or sometimes, each quarter. The directors have the option of not paying a dividend and using the profits for something else, such as buying more operating equipment, for example.

If the company continues to reinvest the profits and the company goes bankrupt, liquidators have to decide who is entitled to the assets of the bankrupt company. These assets are sold and the proceeds are distributed between parties who have a stake in the company. Unfortunately, shareholders are paid last, after all debts and other commitments are paid. Most of the time, there are no assets left over to return any money to shareholders. Shareholders would have lost all their money.

In some countries, there is also something called a “reorganization”. This happens when the debtholders (the parties the company has borrowed money from) are not paid. Debtholders have priority over shareholders and can force a company to go into reorganization. When this happens, all the shareholders are “wiped out” from the books and the debtholders end up owning the company. You would have lost all your money from investing in this stock. This is the reason you should always check on how much debt a company has before investing.

Investing in stocks is a good way to build wealth, but it is also fraught with danger. If you are new to the field of investing, it is best to speak to a financial adviser or wet your feet with collective investment products such as ETF’s or Mutual Funds/Unit Trusts.

Kevin Mzansi

Not putting your eggs in one basket is only the first step…

In the world of Personal Finance, “diversifying your portfolio” forms part of the basics of investing. Diversifying your portfolio is only the first step, however. To effectively manage risk you have to rebalance your portfolio periodically to maintain the diversification benefits. Let me explain why:

There are three main benefits to rebalancing.eggs 1 basket

Let’s suppose that you have decided to diversify your portfolio by dividing it between 5 different sectors: Technology, Industrials, Pharmaceuticals, Banks and Oil.

For your pharmaceutical position, you have picked a highly speculative company that is in the process of conducting clinical trials.  The trials can either be successful and multiply the value of the company or prove dangerous and make your shares worthless. Let’s suppose they are successful and the company quadruples in value. Your pharmaceutical stock now makes up 50% of your portfolio.

The problem is that the pharmaceutical company is still high risk. When you decided on the allocation, you knew that 20% of your portfolio would be at risk if things were to go wrong with the company. Now, 50% of your portfolio is at risk. The overall risk of the portfolio is now much higher. If you rebalance back to the 20% allocation, you will control the overall risk in your portfolio, which is the first benefit of rebalancing.

When you rebalance, you sell positions that have gains and buy positions that have losses to get back to the allocation that you chose. This forces you to sell high and buy low– the essence of making money in the stock market. This is the second benefit of rebalancing.

The third benefit of rebalancing is that it maintains your desired sector exposures. Let’s say you don’t rebalance and your oil company does well. It now comprises 33% of your overall portfolio. A third or your portfolio is now vulnerable to the price of oil dropping, where you only wanted 20% of your portfolio to be at risk. Rebalancing would have kept your risk to the level desired.

Rebalancing does have costs, however. Every time you trade there will be transaction costs and normally taxes that have to be paid on capital gains. To control costs you have to decide on when and how often to rebalance.

In my next post I will talk about two rebalancing methods: “calendar” rebalancing and “percentage-of-portfolio” rebalancing and their benefits and disadvantages.

Kevin Mzansi

Trade often? Beware of those pesky taxes…

We have probably all heard the expression: “investing for the long term”. One of the main reasons why investing for the long term is generally considered better than trading, is because of the costs of realizing a gain and having to pay taxes. One does not really appreciate the full extent of the money lost due to taxes, however. Let me show you the numbers…

In the following example I will illustrate what the tax implications are of trading often. I assume that capital gains taxes are paid at 13.3% – the current South African Capital Gains Tax rate. The calculations are based on the growth of a R1,000 portfolio, growing at 10% for 30 years. I also ignore annual exclusions (the amount of capital gain that is not taken into account in calculations) to make the point clearer.Trade

Let’s assume the investment gains are not taxed, as our base case. This compares well to tax-deffered accounts, like retirement accounts, where you invest with after-tax funds and are not taxed on gains when you retire. We will compare investment gains lost due to taxes with this base case.

Our R1,000 investment will grow to approximately R17,450 over the 30 years, if no taxes are paid.

1st comparison: The investor turns over (sells and replaces) one-fourth of his portfolio every year:
The investment will be worth R15,940 in 30 years time
The investor would lose R1,510 (= 17,450 – 15,940) to taxes over the 30 year term
This represents a loss of 8.7% (= 1,510 / 17,450) of your total possible portfolio if no taxes are paid

2nd comparison: Turn over half of your portfolio every year over 30 years:
The investment will be worth R14,550 in 30 years time
The investor would lose R2,900 (= 17,450 – 14,550) to taxes over the 30 year term
This represents a loss of 16.7% (= 2,900 / 17,450) of your total possible portfolio if no taxes are paid

3rd comparison: Turn all positions once every year for 30 years
The investment will be worth R12,110 in 30 years time
The investor would lose R5,340 (= 17,450 – 12,110) to taxes over the 30 year term
This represents a loss of 30.6% (= 5,340 / 17,450) of your total possible portfolio where no taxes are paid

Yep, that is correct…Your 13.3% per year capital gains tax rate has turned into a 30% loss of your possible investment gains due to taxes. This effect gets even more pronounced as tax rates rise. Here in South Africa, if you trade above a certain number of trades per year, you are classified as a “trader” by the tax authorities. This means that you have to pay tax on capital gains at your normal tax rates. These marginal tax rates can go up to 40%.

Let’s take the example of a person paying a middle class marginal tax rate (35%), who is classified as a trader by the tax authorities and turns over his portfolio once every year:
The investment will be worth R6,610 in 30 years time
The investor would lose R10,840 (= 17,450 – 6,610) to taxes over the 30 year term
This represents a loss of 62% (= 10,840 / 17,450) of your total possible portfolio where no taxes paid.

You read that right: 62% !!!

Over the long term, trading often will cost you a HUGE amount in taxes! This is assuming that you are successful in getting a 10% gain per year consistently – a feat in itself…

It is important consider this illustration when you decide on “getting a quick gain” by trading in-and-out of stocks. I hope this opens your eyes, like it did mine, about the effect that taxes have on gains when you trade often.

Kevin Mzansi

What is better: a market order or a limit order?

One of the first things you will notice when you trade on a stock exchange is the choice between a “market order” or a “limit order”. Let me explain what they are and which is best in which situation…

market order is an order where you buy a certain share or sell a certain share at the prevailing market price. The prevailing market price depends on whether you are buying or selling.
* If you are buying, it will be the lowest price someone is willing to sell her shares for.
* If you are selling, it is the highest price at which a buyer is willing to buy the shares from you.

Let’s say you place and order: Buy 200 shares of Capitec at Market

There is a seller willing to sell 100 shares at R320 and another seller willing to sell 100 shares at R340. Your order will first be filled with the 100 shares at R320 (the lowest price) and then the other 100 shares at R340 (the 2nd lowest price)  

A market order emphasizes immediacy of execution. The trade occurs at the market price when the order is placed. When you place the trade, however, you will not know what the exact trade price will be.

limit order is an order where you specify the maximum you are willing to pay to buy a certain share or the minimum you are willing to receive to sell a certain share. With this type of order you are certain of the worst price at which the trade will occur, but there will be uncertainty as to whether someone is willing to trade at that price.

A limit (sell) order would be something like: Sell 100 shares of BHP at R300.

If a buyer comes along and says that they are willing to buy those 100 shares for R280. The order will not go through, because it is below the minimum price you specified (R300).

Let’s say another buyer comes along with a limit (buy) order: buy 100 shares of BHP at R310.

Since the lowest price you are willing to sell at is R300 and the highest price that the buyer wants to pay is R310, the 100 shares will be sold at R300. The trade will not take place at R310, because the buyer will not pay R310 when he can get the 100 share from you for R300.

With a limit order, the emphasis is on price.

Which is better?

When I was first taught about trading shares, the teacher told us never to use a market order. His reasoning was that the distribution of buyers and sellers could drift from the “real” value of the share.

Let me explain with an example:
Let’s say you are trying to buy a share that trades very rarely. The normal price range is between R5 to R6. You place an order to buy 200 shares at market. A trader notices that there is a seller willing to sell 100 shares at R6. Your order is for 200 shares, though – the rest of the order still has not been met. This trader could conceivably enter an order to sell 100 shares at R100. As you have set a Market order, it will execute at R6 for the first 100 shares and R100 for the other 100 shares. I can assure you that you will not be very happy with this situation.

This is why you should be cautious when setting market orders.

There are situations where market orders are better than limit orders, though.

Here are two situations:
* You own shares of a certain company that has just been announced to be under investigation for accounting fraud. Let’s say you set a minimum price of R20. However, the prevailing price drops to R15, then R10, then R5. There is no buyer that is willing to buy the share from you for R20. You may be left holding worthless shares.
* You are trying to buy shares of a company that has just announced that they have found a cure for cancer. You offer to buy someone’s shares for R10. The problem is that no-one now wants to sell their shares for R10 when the price could be R20, R100 or R500. You will miss out on a good opportunity.

If you need liquidity immediately, a market order may be appropriate. Let’s say you have an emergency that requires immediate cash. If you set a limit order, you will have to wait for a buyer to come along who is willing to buy your stocks from you at the price you set. This may never happen.

The choice between market or limit orders depend on the situation of the trade. It is important to know the advantages and disadvantages of each before deciding on which to place.

Happy Trading!

Kevin Mzansi