A question that I often get asked, especially when discussing my investment strategies is why I use stop trades. In case you are not aware, a stop is a price at which you will exit a position. There are many different ways to use them but in general I like to use them in a very clear manner. What do I mean? For example, on most long and short tech stocks that I enter, I use a 20% stop loss limit and a 20% stop gains limit.

That does not mean that I will never lose more than 20% on a trade though. Some events such as earnings can move stocks significantly and a stock could lose or gain 10-20% in an instant. When that happens, there is no way to limit the loss. For example, if I have a trade that stands at -17% and the stock that I am long loses 10%, I will be unable to limit my loss to 20%…

If The Loss Is Not Limited To The Stop Loss, What’s The Point?

The primary objective here is not to limit the loss to a certain amount but rather to gain some extra discipline while trading. Imagine yourself entering into a casino to play Black Jack or roulette or almost any other game. Look around you, you will see many people winning that come into the casino and start winning money. How do they react? It comes very easy to “get caught in the game”. What do I mean?

Losers think that they’ll be able to win back their losses so they put in a bit more. Winners feel like they have the momentum and the luck and they will be able to come home with lots more money. It becomes so easy to be overly optimistic and that can often lead to bad results.

I’d be curious to know how many of those end up playing long enough to lose everything they won and more. I would think though that players that come into a casino with a more specific plan on how they will play, how much they are willing to put in and when they will get out would generally do much better.

A Few Years Ago.. My First Trade

Some time ago, I did my first trade. Not only did I buy into a company but I actually decided to buy an option, a long term call on Yahoo (YHOO). Believe me, I had no clue what I was doing, I probably was more a gambler than an investor but I believed in the company at that point and wanted to get exposure, options gave me that opportunity.

So I bought a few options and in the following weeks, the value of those options increased rather quickly and even ended up doubling. I was asked by friends (who I was bragging to of course) when I would get out. I had no idea. Initially I though I would with a “decent” profit, whatever that means. At some point, those options had actually doubled in price and it was a successful trade… I never did end up getting out and eventually the option became worthless

I Am So Lucky That Happened!!!

It thought me a valuable lesson. Always have an exit. You might argue for an exceptions when you are investing for longer term (such as your retirement). I would argue that even those should have limits. You can simply put the limits a bit further if these are longer term limits.

Do You Use Stop Losses Or Stop Gains On Your Trades?

If not, how do you determine your exit points?

Last week, we took a look at some of the better dividend payers from all around the world. Many pay considerable dividends and offer good diversification which certainly makes them attractive picks. A few visitors were quick to point out that withholding taxes can have a significant impact on those dividends.

What are withholding taxes? 

When a foreign company decides to pay back its investors through dividends, there is often a part of that amount that is taken by the government where that tax is being paid. For example, foreign investors that decide to a buy a French stock will receive a dividend like any others but the French government (and almost every other government in the world) takes part of that income. Why? There are many reasons but it’s a form of tax on money leaving the country. These are not necessarily easy to track but they are generally between 0% and 30% depending on the country.

An Example

Suppose that an investor receives a dividend of $100 from that French stock.  The investor will end up only receiving $75 as the French government will take a 25% cut. That is one of the most expensive countries to buy stocks in and is certainly worth considering when looking at those attractive dividend yields.

It’s Not All Bad Though

It’s important to remember that you end up paying taxes on US dividends as well. The main difference is the rate (lower in this case but that’s not always the case) so you are simply paying this amount of taxes upfront rather than when filing your taxes.  Another key point is that in almost all cases, there will not be “double taxation”. That means that the dividend that you receive will not be taxed by the US government since you already paid your share to the French government.

Each Country Is Different

It’s important to look carefully at the rules for each country. Some have higher rates, others are lower, for some you don’t get hit by withholding taxes in your non-taxable accounts, etc. I don’t think that these things make a huge difference in most cases and it still makes a lot of sense to add international dividend stocks to almost any portfolio.

Have You Had Any Experience With Withholding Taxes?

One of the questions that I get the most often is how to protect a portfolio. I think that many investors are scared these days. Why? Markets have been more volatile in recent months and it’s scary for everyone involved. Especially those that have less years to make up any potential losses. There are many different reasons why markets have reacted so violently. The first one would be the whole credit crisis that makes it unclear what Europe (and indirectly the world) will look like a few years from now.  That, the uncertainty around banks, real estate prices and more have greatly diminished investor’s confidence.

All of those would be enough to make markets volatile but when you add electronic trading, high frequency traders and hedge funds, it seems to add to the violence of moves. The fact that big movements in the markets then setup new trades from all of these investors seems to make movements even more violent. Are markets too volatile? I personally don’t think so. If markets go up and down 2-3% every day but the end result is not significant, it should not make a big difference to most of us. In the end, most of us are trading with a long term perspective right?

How To Protect Your Portfolio?

One of the most common questions that I get when markets are so volatile is how to protect such a portfolio from big movements. There are no easy or clear answers but here are the main strategies that can be tried. I think it’s important to start off by doing these 2 things:

-Do not worry about short term movements (markets crashing for 1 day and rebounding the next one is not a cause for worry)
-Do not panic (trades and moves made when someone is anxious, upset or scared are almost never good ones)

Here are the main things that you can add into your portfolio. Any movements should be done gradually over time to reduce the volatility of your portfolio. It is almost never a good idea to start selling right away when markets decline. Gradual moves though can improve the performance of your portfolio over time.

7 Ways To Protect Your Portfolio

-Only Invest What You Can Afford To: There is no issue in holding some cash in your portfolio. I personally do not invest anything that I cannot afford to suffer significant (15-20%) losses on.. if you have trouble sleeping because you worry too much, you probably should hold less stocks and more cash.

-Improve your asset allocation: You should not have all of your eggs in equities or in bonds. Ideally, you have a mix between the two. It seems simple but that is probably the most significant

-Do Not Use Leveraged/Inverse Products: Many products are sold as a way to protect your portfolio. Such products are generally build with very short term goals in mind and it’s not what you should be using for longer term strategies.

-Improve Your Diversification: I love technology stocks but holding Google, Apple and Microsoft will provide very little protection in market downturns. It’s important to try to hold companies in different sectors that will help you perform better over time. This also means having more international stocks.

-Hold Alternative Assets: Buying inflation protected bonds, gold or other commodities can help diversify your portfolio. It’s not the first step I would take but as your portfolio becomes bigger, such strategies can certainly make a big difference.

-Pay Attention To Fiscal Impacts: One of the biggest mistakes that investors do when they panic is selling their biggest assets. That may or may not be the best decision. But you should always look at the taxes that will need to be paid. You might have lost $10,000 on a stock and want to sell but if you had made significant profits in previous years, you will be stuck paying capital gains taxes on those.

-Focus On The Right Metrics: I discussed how dividend investors that are using a dividend portfolio to build income should focus on the income that the portfolio generates rather than every day’s profit and losses and that can be true of any portfolio. Keep in mind that market losses means you are able to buy more of those assets which is a good thing. It might not feel that way but if you take the right perspective, you will not feel as much panic.

After a successful year of trading in 2009, last year was a home run in almost every possible way. I do truly believe that the main changes I made last year ended up making a positive difference, especially my decision to stop opening trades later in the year. I know that it was not the most popular decision since those stock picks are among the most read posts but in the end, getting higher returns is the objective.

Last year, I got many questions regarding the stock picks or other technology stocks that I follow. I answered many of them by email, some were comments on the blog, but there was no ideal place really. I ended up creating a new mailing list, dedicated to tech stocks and the trades that I do. If you would like to get more information about the picks, other stocks that I like, or don’t, I highly encourage you to join, it’s free. I will also try to answer some of the questions that I get there since I’m not going to be writing 5 different posts about one trade. The mailing list is sent once every 1 or 2 weeks.

To join the list, simply fill out your name and email here:

Biggest Change For 2012

In the past, I’ve held at most 5 live trades on the stocks that I follow. This year, I will increase that number to 7. Why? There are a few different reasons. First off, it will help me trade more often since chances are greater that 1 of those 7 trades reaches its stop gain or stop loss. Also, it gives me less concentration on a few different names. Each person might have a different view on this but I personally prefer doing a few more picks with less money involved. That means less gains when a trade goes exceptionally well but also less losses when they don’t.

Why Not Add Even More Live Trades?

It’s always a matter of opportunities isn’t it? I track a universe of stocks and try finding opportunities in there. It’s not always easy to find good ones, even with 5. But I do believe that I will be more active on many of the recently turned public stocks such as Groupon (GRPN), Pandora (P), LinkedIn (LNKD) and even Zynga (ZNGA) as well future ones such as Facebook.  That will certainly provide more trading opportunities which is what I’m counting on to be honest. It’s a fairly big change so there is always that possibility that at some points in the year, I will not see good opportunities and prefer not trading for a few days/weeks but I somehow think I’ll find some good ones.

Better At Tracking

I’ve been reliable about posting trades on this blog but not as much in updating the live positions on the right sidebar and the results in the stock picks page. I will make an effort to make it easier for you to track my picks and performance.

What’s The Plan Now?

The plan is to continue to monitor the markets for the next 2 weeks, start preparing myself and then I will be opening a couple of trades in the first week of January. If you have any questions about the tech trades, comments or simply an opinion, feel free to contact me, I’d love to hear from you.

Recently, I’ve been spending an increased amount of time studying investing psychology and that is bringing up several questions. Yesterday, I was reading about intuition and how it influences the ways that we act. I started wondering about what role (if any) intuition plays in my trading, especially the long & short technology picks but even in dividend investing.  The reality is that it plays a big role.

“Intuition provides us with beliefs that we cannot necessarily justify” – Wikipedia

Intuition Is A Big Part Of Investing

As much as I think we try to always be rational, to invest based on numbers, on P/E ratios, growth rates, dividend rates, etc. In the end, when I do filtering, the result is never just one stock. There are usually several trade possibilities. What makes me go one way rather than the other? You could probably include several factors:

-My feelings about these stocks/companies
-My past experience trading these names
-Trading momentum
-etc

Intuition Comes Into Play

At some point, we gather all of the numbers, feelings and we end up making a decision. Even deciding not to buy a specific stock is a decision in a way, so yes there is always a decision involved. My question thus becomes: What triggers these decisions? I think intuition plays a big part. I tend to be a strong believer in Google (GOOG) for example and if you showed me two companies that have exactly the same profile, chances are that I would end up picking the one named Google simply because I feel like I will be better off in most cases being long Google.

The Limits Of Intuition

I think we end up getting to know ourselves better over time and knowing when to trust our intuition. Personally, one of the ways I try to improve my analysis is using stop limits. Why? Because when a trade reaches the stop loss point, I force myself out of the trade, to rethink the trade and see if the numbers truly make sense or if I was wrong. In most cases, I do choose to not re-open the trade. The day that you admit to using some intuition, it also opens you up to several possible issues such as being over-optimistic, stubborn, etc. Of course, very few investors to not use intuition at all and those would be trading strictly on technical factors. You can read an interesting piece from one such frame of mind on why intuition is not a good trading tool here.

I Stay Away From Short Term Intuition Plays

Generally, as most of you know, I do stay away from day trading so no I do not trust my intuition on telling where Amazon will end up on Monday. In the same way, I try to stay away from opening new positions just before earnings because it seems like those taking such bets are doing so solely on intuition and luck (except for those that have access to inside information).

What are your thoughts on intuition in trading/investing?

Before getting started today, I’d love to invite you to try our new quiz if you have not done so already, “Do you have what it takes to be a dividend investor?” on TheDividendGuyBlog, it’s meant to be fun, don’t take it too seriously:)

The other day, a reader sent me a video of Buffett explaining how he would fix within a few minutes, the problem of recurring US government deficits and a growing debt. His idea?

“I could end the deficit in 5 minutes” he told CNBC. “You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of congress become ineligible for re-election“.

It’s a terrible, maybe even stupid idea in my opinion. The thought behind it isn’t bad: If we could could give a strong incentive to those members to avoid big deficits, the idea is that they would do everything in their power to keep their job. I do agree that they are generally more worried about their own job than about what is happening to the country so the idea could make sense from an “initial perspective.

Extreme Case Scenarios

The reason the European Union is turning out to be so disfonctional is not because the whole concept is necessarily always flawed. It is however very difficult to make the EU work in unusual circumstances such as a financia/credit/sovereign crises. Such events are unusual but they do happen. It’s not a matter of when or how but rather when they will occur.

Financial Crisis/Crash

You might agree (or not) with the whole bailout that the Obama administration used after arriving to power and the effect that it had on the economy. One thing that you would have to agree with though is that there is no way the US government could have avoided a big deficit in those years. Why? Tough financial times meant less income for individuals and for companies, less capital gains, etc. All of that combined had a dramatic impact on the revenues of the US government. Let’s imagine that the revenues suffered a 5% decline which is certainly possible in difficult economic times.

What To Do Then?

Imagine a government that would face a 5% shortfall in revenues with members of the government losing their jobs on any deficit of 3% or more. Just think about it. They would be stuck with one of two choices:

#1-Stimulating the economy (either through bailouts/subsidies or tax cuts) and ensure the deficit would surpass the 3% cap or
#2-Cut government expenses in order to avoid the defitic breach.

Would you trust the members to do the right thing and say goodbye to their high paying jobs or do you think they would risk putting the economy in even more turmoil in order to save their own jobs? I don’t know about you but I’m not convinced they would only be looking after the interests of the nation.

There Is No Easy Fix

I do have a lot of respect for Buffett but I certianly hope he was joking when he talked about this. The reality is that the issue is not simple enough to be fixed in 5 minutes. I think there are two main things that must be done (also very difficult) in order to fix the system and get our finances back in order:

-Get compromises between the Republicans and Democrats
-Get top politicians to manage with a long term perspective instead of always focusing on the next election.

What are your thoughts? Do you think Buffett was way off on this as I do?