Credit Option Spreads

Writen by Daniel Beatty

What is a credit spread?

Investopedia.com says “An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.”

OK I know that is very vague, so lets see if I can do better.

It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the stock does not go past the sold strike price at the end of expiration you will receive a full credit winning trade.

For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will increase in price over the next month and you firmly believe that the stock will not go below $50. You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for $.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your account or actually $75 per contract you trade. The risk of the trade or the amount of money per contract you need in your account is $425 per contract. This gives you a return on investment of 17.5% in how ever many days till Feb expiration.

Lets take it out like a real trade - It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or $500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you will lose $2125.

If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed, and exactly how much money you will risk then credit option spread trading is for you. Your profit margins will be between 10 and 20% on each trade - on some of the aggressive credit spreads you can make over 50% - and there are techniques for changing your trade if it becomes a losing trade to help you recover some of the loss and in some cases even make it a winning trade again even though you were wrong on the direction of the movement of the stock.

Daniel Beatty has been trading options for several years and now teaches others how to trade specific strategies for free through his website http://creditoptionspreads.com or Option Spreads.

Crisis of Confidence in the EU

Writen by Peter Grant

The European Union (EU) constitution was dealt a double blow, first by a French “no” vote on 29-May and then by a follow on “no” from the Netherlands on 01-Jun. To add insult to injury, one low level Italian diplomat quickly called for a referendum in Italy to decide if a return to the lira was warranted. Additionally, Prime Minister Tony Blair, who took over leadership of the EU on 01-Jul, indefinitely postponed the British referendum on the EU constitution.

This news along with plenty of speculation about the repercussions dominated the international headlines for much of the month of June. Not surprisingly, all the hubbub about the EU had a direct impact on the FX market. The euro fell to a new seven month low following the French referendum, reaching a low of 1.2371 and the “single currency” has been under pressure ever since. Probes below the 1.2000 level were seen ahead of 30-Jun, suggesting additional near term downside potential toward 1.1756 and beyond.

Since the inception of the euro in 1999 central banks, especially those in Asia and the Middle East were seen diversifying out of dollars into the euro. They were not only looking to scale back their substantial dollar holdings in the face of a declining market, but they also sought the higher returns available in the eurozone. However, returns on eurozone deposits slipped below those in the United States in December and the FED’s string of rate hikes bodes well for those differentials to further widen. Combine the better returns in the US and a generally more favorable dollar outlook with the specter of continued political turmoil within the EU and it seems there is little incentive to hold euros at this point.

Truth be told, the EU was facing some rather significant hurdles long before the double “noes” derailed confidence. Many of these hurdles are associated with expansion. Discontent on the part of established club members with the admission of central European countries in May-04 and general hostilities about the proposed admittance of Turkey played significant roles in the recent referendums. In addition, diverging economic performance, productivity growth, inflation and fiscal performance among member nations are all fodder for further turmoil.

Worthy of particular note is the broad based economic malaise in Italy. Italian consumer product manufacturers are losing their battle with Asia and consequently the trade balance is moving into the red. Unemployment is up, as is the budget deficit. Being part of the euro, and therefore having a relatively high exchange rate, essentially thwarts any effort to compete with Asia on price. Without its own currency, Italy is unable to devalue out of its non-competitive position. Hence, the aforementioned comments by Italian Minister Maroni. Countries such as Portugal and Greece are also in rather dismal economic health. The budget deficit of the former has already reached 7% of GDP.

Many have noted that the EU constitution may be dead, but it’s not buried yet. I’m not so sure that I would agree as approval of all 25 member counties is needed for ratification. The initial thought was that any dissent was likely to come from newer or smaller EU countries and that a little economic arm twisting by the likes of France and the Netherlands might encourage them to reconsider. Unquestionably the long standing skepticism of the Brits was going to be an issue. However, rejection of the constitution by two of the founding members of the EU certainly throws a wrench in the works.

I don’t believe that we need to worry about the European Monetary Union (EMU) breaking up any time soon. In other words, the euro will continue to be actively traded on the global spot market. A Reuters poll early in June suggested there is only a 5% chance of an EMU collapse within the next 15 years. However, around the same time the German weekly magazine Stern reported that the failure of the EMU was discussed at a meeting attended by German Finance Minister Hans Eichel and Bundesbank President Axel Weber. Having said that, I don’t think there is any question that there is a greater risk premium attached to the euro than there was a month ago.

In the months ahead, look for continued political wrangling within the EU. Further bad news is likely to be forthcoming, which should help keep the euro under pressure, creating trading opportunities not only against the dollar, but in the cross rates as well.

Peter Grant is VP of Operations for CFS Capital Management (http://www.cfscap.com), an alternative investment firm in Lakewood, Colorado. This article is an excerpt from our monthly newsletter ‘The Alternative’ which can be read online at http://www.cfscap.com/news.htm. Emails may be sent to pgrant@cfscap.com

What are Junk Bonds?

Writen by Mike Singh

In the financial world, those high yield bonds or bonds that are rated below “investment grade” are known as Junk Bonds. Although the risk of such bonds defaulting is higher as compared to other types of securities, they are still preferred by experienced investors, as the returns are typically high as well.

There are two types of risks that come attached to Junk Bonds. These are interest rate risk and credit risk. The first type refers to the rise and fall in value due to changes in the level of interest rates or their structure. The latter indicates the probability of a debtor defaulting in combination with the chances of not receiving principal and interest in arrears after a default.

It is the job of a credit rating agency to analyze and identify the risk with a credit rating such as AAA, AA, A BBB, BB, B, CCC, CC, or C. An additional rating D is used to rate debt already in arrears. Usually, government bonds are placed in the zero-risk category above the credit rating AAA.

All bonds that are rated above BBB are defined as Investment grade bonds. Bonds that are rated below the investment grade are colloquially defined as Junk Bonds. Because of the risk factor that comes with these bonds, these bonds always invite investors by promising higher yields. This makes them attractive investment vehicles for certain categories of financial portfolios and strategies.

Despite the high yield tag, junk bonds often fail to sell well in the market. This is because certain by-laws prohibit many types of provident funds and other investors from investing in bonds that are rated below a particular level. In some cases, the limited market for junk bonds themselves also hinders investment in lower rated securities. As a result, a company with financial problems gets sucked into a vicious cycle where it’s bond rating is further lowered, making it even harder to generate funds.

This vicious cycle is one of the reasons why high profile companies such as Enron and WorldCom, whose bonds were initially rated above investment grade, have collapsed in a heap. Bonds that fall from being certified as having investment grade status to high yield status are termed as “fallen angels”. On the other hand, those bonds whose credit rating levels are on the rise are known as “rising stars”.

Only seasoned investors should try their hands at dealing in junk bonds. A company whose equity has a good value in the market is always a safer alternative investment.

Stocks - Getting Started in the Market

Writen by Joseph Kenny

Hollywood loves the stock market. The chaos of the stock exchange floor, the tension of boiler room day-trading, devious power brokers making back room deals; it all makes for great drama. Then you have the true-to-life stock market stories in the news: insider trading, big money IPOs, the dot com bust. All of it is enough to make you steer clear of the market for good and travel down a safer investment path. But don’t be frightened, history shows that long-term, there’s no better place to put your money to watch it grow. Here are a few tips to get you started.

Stocks 101

Simply put, when you purchase stock in a company, you become part-owner of that company. Along with other shareholders, you all combine as investors in the business, and therefore reap its rewards, or suffer its losses. Stocks are most commonly divided into separate categories depending on the size and type of the company (e.g., mid-cap, small-cap, energy, tech, etc.). While speculation can drive stock prices in the short term, it’s long-term company earnings that determine a stocks gains or losses. Speaking of short term, that’s when stocks are extremely volatile. Over a span of just a few months or years, stocks can climb to astronomic heights or drop to pitiful lows. But, since 1926, the average stock has returned over 10 percent per year. That’s better than any other investment vehicle out there, and that’s why stocks are your best bet for long-term investment.

Picking Stocks

Before you dive head-first into the market, there are a few things you should know about picking stocks. First, the market’s performance as a whole is not necessarily a reflection of its individual stocks. Good stocks can keep growing even in a down market, while bad stocks have the frustrating tendency to drop or remain stagnant in a strong market.

Also, remember that history is not indicative of a stock’s future performance. Even solid stocks can slip from time to time. Remember that stock prices are based on a company’s earnings outlook, not its past performance. If the future looks bright for a company, a $100 dollar stock is probably a good buy. If earnings look less than promising, even a $5 stock can be a waste. Finally, investors determine a stock’s value by measuring a handful of primary criteria, most notably cash flow, earnings, and revenue.

“Diversify”

It’s the rallying cry of all smart investors. When compiling an investment portfolio of stocks, it’s smart to own shares in companies from several different industries. Consider it a “hedge bet”. When one part of the economy experiences a downturn, you’ll have other stocks in your portfolio to put your faith in.

When building your portfolio, the safest bet is to pick from financially strong businesses with earnings growth above the average. Surprisingly, that limits the lot to choose from, as only around 200 stocks today fit that bill. A solid portfolio features somewhere in the ballpark of 20 stocks selected from seven or more industries. A general rule of thumb is to invest in stocks with an above-average rate of growth and reasonable valuations.

Buy and Hold

Day trading is a great way to lose your nest egg, but quick. As we noted before, stocks over the short term are highly volatile. Sure, brokers today are offering cheap trades, but beware. There are a ton of hidden fees and taxes involved with day trading, not to mention the amount of attention required by you to monitor the blow-by-blow proceedings of the market. Our recommendation: buy and hold. A ten percent return over the long term is nothing to sneer at.

Penny Stock Trading

Writen by Peter Emerson

Penny stock aspirants need not worry too much over how they can get started. For the procedure required to be followed in the case of penny stocks is similar to those applicable to other stocks. In other words, you have to open a brokerage account. However, actual trading in the penny stocks is not as simple as in the case of (for example) blue chip shares, because the market intelligence required to make the right investment decision is not easily available. You have to collate this information from different sources using your individual effort.

However, if you have a broker, you job is half done. The broker can provide enough information for you to get initiated into penny stock trading. Further, you can also get insight from your broker into possible market trends in the near, short and long term. In addition, your broker can also advise you on when to buy a penny stock and when to sell that. These brokers know your specific requirement and accordingly give suggestions on investment matters. Moreover, they are always there to help you out with their expert opinion. You broker will charge a specific commission on every transaction that you make using his account. The broker may additionally charge for the advice provided to you.

Alternatively, you can also look up the details on penny stock bids and quotes yourself. These are published in the pink sheets and over-the-counter bulletin board (OTCBB) on a daily basis. In addition, key details on the traded companies can also be obtained from the same sources. Earlier, these details would not be available as the traded companies were not obligated under law to share these details. However, subsequent rules framed by the national association of stock brokers (NASB) require sharing of key details on the listed companies. In addition, some penny stocks are also listed on the NASDAQ and AMEX and hence their price movement can be easily tracked.

Many news letters are also published by brokers to provide information on trading of penny stocks. You can also pore into such new letters to collate the required information besides tips. You can tap this source to collate the required information, without spending too much money. But all said, there is nor sure-fire way to gain success in penny stock trading. You have to tap into informal sources as well to gain sufficient insight into the complexity of the markets. Further, you should also be able to come out with an analytical thinking to make a success of penny stock trading.

Penny Stocks provides detailed information on Penny Stock Investing, Penny Stock Research, Penny Stock Resources, Penny Stock Trading and more. Penny Stocks is affiliated with Wise Stock Trades.

Emotional Involvement

Writen by Al Thomas

I’ll bet with almost anyone that has stocks or mutual funds in his portfolio that he has losers, but he won’t sell them because he “likes them” or some similar excuse. This is the philosophy of a loser.

You cannot become emotionally involved with anything you have bought whether it is stocks, mutual funds, collectibles, real estate, etc. etc. When you see the value of these things heading down it is time to try to salvage some of your money even if you have to take a loss.

I have seen people hang on to a piece of land (or a stock) for years just so they could get out “even”. Believe me “even” is not even. Suppose you paid $20,000 for the land and it took you 8 years to find someone willing to buy it for $20,000. If you could have sold it for $15,000 and put the money in a money market account at 6% for 8 years you would now have more than the original $20,000 ($20,495). When you invest money in anything you cannot afford to have emotional ties to it. You must be willing to sell when the time comes. Most people don’t want to sell for two reasons. They won’t take a loss; however, the main reason is psychological - they don’t want to admit they were wrong. When I was a broker I would watch people trade. Almost none of them were trading to make money although that was what they said. They were trading to find out how much pain they could stand from losing. They were trading for emotional reasons.

The difference between professional traders and a non-professional investor is the ability to divorce themselves from the emotions of the trade. Win, lose or draw the pro knows the risk and is willing to take that loss quickly if it should occur.

Emotional involvement in investing is one of the best ways I know of to lose money. You must be able to look dispassionately at your stocks, bonds and mutual funds and be able to sell them when they turn negative. Negative does not mean go to a loss. It may mean they are no longer making a good return every year with your money and it is time to move to some other stock or fund. You might have a stock that has doubled since you bought it, but that was 2 years ago and it has done nothing since then. Time to sell. Look at your annual ROI (return on investment) of each individual issue to determine if your money is doing better than the overall market or whatever your personal criteria might be.

Many years ago I heard how they caught monkeys. The hunters would drill a hole in a coconut shell just small enough so the monkey could fit his open hand through the hole. It was tied to a tree with a strong cord. Inside there was fruit and sugar. The monkey put his hand in, grasped the goodies, but could not get his closed fist out. He would not even let go when the hunter came to capture him. Unfortunately, there are many investors grasping at losing positions. Isn’t time to let go of some of those stocks you have been holding because you “like” them?

Let go of those emotional ties. You will make more money.

Al Thomas’ book, “If It Doesn’t Go Up, Don’t Buy It!” has helped thousands of people make money and keep their profits with his simple 2-step method. Read the first chapter at http://www.mutualfundmagic.com and discover why he’s the man that Wall Street does not want you to know.

Copyright 2005

al@mutualfundstrategy.com; 1-888-345-7870

Learn to Invest Money in Small Cap Stocks and Make Triple Digit Profits (Part Three)

Writen by J. Shin Kim

Are you tired of earning 5%, 8%, even 15% annual returns from your stock portfolio? Want to earn triple digit gains from your stock picks? Not only is it possible but it’s absolutely probable with a few solid strategies.

In Part Two of this article, I reviewed the importance of having strict buying rules to minimize your risk when investing your money in small and micro cap stocks. Here, in Part Three, I’m going to further expand and modify rule number two.

Rule Number Three: Don’t try to buy at “perfect” prices.

In buying small and micro cap stocks, know that you will almost never buy in at the “perfect” price. If you’ve researched a company thoroughly and are confident that its price will move upward over the short or long term, then do not wait for a “perfect” price. Chances are you will almost never buy in at a perfect price. Small and micro cap stocks almost always have greater volatility than large cap stocks and inevitably will have days of rapid price spikes upward and downward. And it’s impossible to be right all the time about when these spikes will happen.

Furthermore, the law of averages should even out for you over time when buying into small and micro cap stocks. Sometimes the price will dip after you buy into a stock and you may experience immediate regret. Other times the stock’s price will rise upward from the moment you buy in and you would have never been able to buy the stock at a lower price. But if you’ve applied rule number one, even scenario in which the stock dips immediately after you buy in shouldn’t cause you to lose faith in your stock pick, because it does take a strong stomach to invest like this. I’ve had scenarios where a stock lost 10% on the same day I had purchased it, only to rebound by 60% in the next month.

So instead of using a specific price point to buy a stock that seriously interests you, use a price range instead. Using hypothetical company YYY as an example, if you absolutely love the future prospects of company YYY, determine a price range that you would be okay with after studying its historical price charts. If you decide that you would be happy buying this stock at a range of $2.90 to $3.10, and the stock is sitting at $3, then go ahead and buy.

I know other financial advisors that will disagree with this advice and declare that if the stock’s technical charts show weakening indices, the wait for a dip in price before deciding to buy. Unless those technical charts are negative in almost every index, I wholeheartedly disagree. Technical indicators are never right 100% of the time, often giving “false” positives and “false” negatives. Furthermore, they are even less accurate with volatile small and micro cap stocks because their inherent volatility makes their technical charts harder to evaluate for optimal buy-in prices. If an “unknown” stock’s story eventually passes through media filters to reach the public masses, its price could spike very rapidly without any technical indications. If you’re solely using technical analysis to decide the optimal buy-in price, you’d be left behind in the dust when this happens. That’s why you should determine a buy-in range, and not an exact price.

Rule Number Four: Invest a smaller portion of your portfolio in riskier small and micro cap stocks.

This is a self-evident rule but I’ll review it anyway, because greed sometimes makes even the most rational of human beings do crazy things. I recommend devoting no more than a maximum of 50% of the total value of your portfolio to small and micro cap stocks. Using a combination of micro and small-cap stock picks and safer large cap stocks can help you easily outperform the S&P 500. But when your small and micro-cap stocks really start to outperform the large cap portion of your portfolio, it is inevitable that the following question will invade your mind:

If my small/micro cap stocks are up 75% and my large cap stocks are only up 15%, why not just shoot for 75% gains in my entire portfolio?

The only reason I recommend against this is because, hopefully, from part I of this article, you gained a sense of how research and time intensive the process is of uncovering great small and micro cap stocks. Frankly it’s not that difficult but it does take LOADS of time. If you build an entire portfolio with stocks like these, unless you have LOADS of time to constantly monitor every one, it’s a much better strategy to just boost your portfolio’s performance every year with great small/micro opportunity stocks while also investing in some less volatile ones that will give you a smoother ride.

© 2006 Global Market Opportunities, Inc.

About the author:

This article may be freely reprinted on another website as long as it is not modified, changed, or altered and as long as the below author byline is included along with the active hyperlink exactly as is.

J. Shin Kim is the founder of Global Market Opportunities. If you’re tired of measly 6%, 7%, and 10% returns from your stock portfolio, learn more about how to identify small and micro cap stocks that consistently and significantly beat the market indices by clicking the following link, Learn to Invest Money and Achieve Financial Freedom. Also subscribe to our free investment advice newsletter by visiting this link.

FOREX Currency Systems - Four Tips to Pick a System that Makes Money

Writen by Stephen Todd

With the many FOREX currency systems available, you can in theory, simply turn your computer on and follow the signals to generate automatic profits.

That’s the theory - but the fact is, there are many FOREX currency systems sold that are obvious scams, and the systems will never work.

This article aims to give you tips on picking systems that can make money, and avoid the scams.

There are two main reasons why most FOREX currency trading systems fail to live up to their Hype:

1. Black Box Systems

These are systems where the logic is not revealed to the buyer - and for a FOREX currency trading system to be used successfully, the trader must have confidence in it.

If you don’t know the logic of the system, you will not have the confidence to follow it when a losing period occurs.

You need to follow a system rigidly to make money - otherwise you may as well not have a system in the first place.

Using a FOREX Currency trading system is all about having the discipline to follow the system - and if you don’t have confidence in the logic, you will never do this.

2. Curve Fitting and Optimization

Another indication of a currency trading system that is a scam, is one that involves curve fitting, or optimization.

These systems give a fantastic performance in back testing - because of the tweaking of the system rules, to make them fit the data, and produce profits.

A trader once likened this to shooting holes in a barn door, and then drawing circles around every hole - to make each shot look like a bull’s-eye.

Let’s face it, we would all be millionaires, if we had tomorrow’s news today - but we don’t.

Avoid any system that offers unique rules, or many variations for trading different markets.

If the system is based on solid logic - it should work on ANY trending market, and should not be optimized, or curve fitted to an individual market.

You will never see a hypothetical performance that fails!

Most unscrupulous vendors achieve great performance by making the system fit the data - and this causes the system to fail in real time trading.

Here are four tips, to help you separate out the scams, from the good FOREX currency-trading systems:

1. The Rules and Logic are Fully Explained

You will then have confidence in the system when it suffers a string of consecutive losses.

2. Some Evidence of a Real Time Track Record

Has the system has made money in the real world of trading?

This is the acid test of a system. If there is not a real record, look for a hypothetical audit done in real time - many systems do this before launching, and this gives a good indication of how the system will perform.

3. Look for Simple Systems

There is absolutely no correlation between how complicated a system is, and its profit potential. In fact, simple systems tend to work best, and will tend to be more robust in the brutal world of trading.

Most of the top FOREX currencies trading systems are based on simple logic.

4. Avoid any Optimized System

As already mentioned, if the system has sound principles, and then it should work on a broad spectrum of financial instruments - avoid any system that optimizes individual markets.

Not all FOREX currency trading systems fail - but if you want to get one that works, be realistic and do your homework first.

Building Your Own System

Most traders like the concept of FOREX currency trading systems, but like to have some input to customize the system to their specific personality. If the system offers some human input, it is easier to implement the trading system with rigid discipline - which is the key to building consistent profits.

New! A valuable FREE Currency Trader CD containing 9 critical trading reports, tips, strategies and currency trading info. Visit our web site now and grab your CD http://www.tradercurrencies.com

Chapter 11 Bankruptcy - Breathing Ground For Debtors

Writen by Dean Shainin

Signing in for a bankruptcy is the last resort for a person who has borrowed some amount of money and is in no means of paying the debts made. Filing for bankruptcy can cause both mental and emotional burdens to a person and so with the debtor’s credit history.

When one declares bankruptcy, one should get ready for deliberate explanation to a judge or trustee how he get himself into such a situation. The person in one way or another might lose any credit card he has unless he has already paid for it. After declaring economic failure, one can have a hard time re-applying for mortgages, loans, credit cards, life insurance and even some job, so one should get ready to rebuild his credit.

So, before putting yourself to such situation, think thoroughly first, it would be easy to get yourself in such situations but is hard enough to get out of.

There are different types of bankruptcy the two most commonly applied by many are the, Chapter 7, which is the type of bankruptcy which is the person in debt must petition the court to be freed from all debts following the liquidation of virtually all assets. Usually your house can be spared from this type of liquidation.

Another is the Chapter 11 bankruptcy, a type of bankruptcy, which is less severe and allows the person in debt to remain in possession of his assets. A repayment schedule is negotiated with creditors as an alternative to asset liquidation. The company can cancel all the debts made by the person in order for them to make a new start. Now, we will be tackling more about this type of bankruptcy.

More often than not, the Chapter 11 bankruptcy does not have any amount of debt limitation unlike Chapter 13.

Usually this type is most likely applicable to corporations and partnership because they can still go on with their business. A person per se can also dig in to this condition although it will seem too complex and expensive to pursue by an ordinary person.

Chapter 11 is called the reorganization bankruptcy because a person may be allowed to propose a plan of reorganization or repayment so that they can continue with his business while paying for his debt.

This is neither harsh compared to other forms nor methods which will require the debtor to sell all his properties and to repay the credit at any stake. In this process, the debtor is permitted to postpone all payments so that he or she can put himself back to rearrange his or her finances, hoping that the person can recover and build up his business once again.

As soon as the company enters to the conditions of Chapter 11, they can still operate on a day-to-day basis.

Companies affected with this type of condition can still trade stocks. Therefore, this is indeed a gratuity for shareholders because they have a chance of maintaining their investments as soon as the company reorganizes itself. Unlike the conditions of Chapter 7 bankruptcy, the company can no longer exist because all their stocks will be liquidated.

However, it will be unnecessary to still buy the stocks of these companies because more often than not the company will only end up in financial loss.

Chapter 11 bankruptcy is almost certainly the most flexible of all the chapters, and the same time the hardest to generalize. Its flexibility makes it generally more expensive to the debtor. The rate of successful Chapter 11 reorganizations is miserably low, estimated at only 10% or less.

Dean Shainin offers online Bankruptcy and debt advice. For more information, articles, news, tools and valuable resources on bankruptcy and debt solutions, visit his site at: Chapter 11 Bankruptcy.

Stock Investing: Why the Individual Often Has an Advantage Over the "Pros"

Writen by David Van Knapp

Famed investor Peter Lynch said, “…the amateur investor has numerous built-in advantages that, if exploited, should result in his or her outperforming the experts, and also the market in general.”

Many people believe that an individual cannot beat the market. They think that they cannot, over long periods of time, generate better returns than the market itself, nor outperform professional money managers who, after all, do this for a living.

But Lynch was right. Many individuals can and do beat the market and the experts. Let’s see why the individual investor actually has certain advantages over the pros.

First, as an individual investor, you run your own shop. Unlike many professional money managers, no boss is telling you to be fully invested. If, during bad market conditions, cash is the best place for your ‘’stock money,” you can keep it in cash and no one will fire you. You can wait for the right price or for other conditions you may require. You can even get out of the market entirely for awhile. You decide what to do with your capital. You are your own fiduciary.

Second, the amount of money you have to invest is small compared to, say, mutual funds. Many mutual funds own unattractive stocks. They do so because they have so much money to invest. So the fund managers go through their first tier of good ideas and on to their second tier, and maybe even into their third. Their fund’s charter may require diversification across a broad range of stocks or investment in illogical sectors. You, on the other hand, can keep your holdings concentrated in your best opportunities.

Third, you can control expenses better. You can buy and sell using the cheapest brokeragethe execution of stock trades, after all, is a commodity service. Why pay $100 or $20 per trade when you can get it done for $10 or $7 or even less? Plus, as your own boss, you don’t have to pay management fees, ”wrap” fees, or marketing expenses, none of which help returns. All of the information you need to invest intelligently is readily available, and it is free. So you don’t have to pay for analysisyou do it yourself.

Fourth, you will (of course) keep your own best interests in mind. Sad to say, at many mutual funds, the primary mission is to attract more investors and grow the fund. Incentives are set that way. Your incentive, in contrast, is to take care of your money. Nobody will ever manage your money better than you will. Nobody cares more, and nobody understands you better.

Fifth, you control taxable events. Until a stock is sold, no taxable event takes place. Capital gains (or losses) are just on paper. Mutual fund shareholders own shares in the fund but not in the individual stocks that the fund owns. Therefore they are at the mercy of sell decisions made by the fund’s managers. A mutual fund can generate taxable gains even though the fund itself declines in value. This happens all the time, when the fund sells some stocks at a profit but does not offset those gains by selling other stocks with losses. So the fund has net profits on its trades even if the total asset value of the fund is lower overall. The net trading profits (by law) are passed through to the fund’s owners. Those unfortunate souls are left with a tax bill even if their investment is worth less than before. By contrast, if you own individual stocks, you are in sole control of selling decisions and the attendant tax consequences.

Finally, you don’t have to worry about ‘’style drift.” For example, the rules for a small-company mutual fund may force the fund’s manager to sell a stock if its market size exceeds a certain limit. That’s what its prospectus promises its investors. But that growth is just what you are looking for! You want your small companies to succeed and become large companies. You don’t want to sell those stocks, you want to keep them as long as they are performing well.

Peter Lynch had it right. He understood that the individual stock owner holds some cards that the professionals only wish they had. If the cards are played right, the individual can surpass both the pros and the market.