Thursday, August 26, 2010

Why Is There A Lack Of Interest In The Market?

THE FTSE Bursa Malaysia KL Composite Index (FBM KLCI) finally touched 1400-level again. Despite high index level, the overall daily traded volume remained low at about 700 million-800 million. We believe, except for certain fund managers and day traders, not many retail investors were excited about the market. In this article, we will look into the reasons why investors are not investing at the moment.

We believe one of the main reasons is that many investors are still quite worried about the global economic recovery. Given that a lot of newspaper articles, media as well as some investment gurus have been saying that the global economy still has the possibility to have “double dips” or slip into recession again. Nevertheless, at this point in time, we believe nobody will know for sure whether the economy will enter into recession.

However, we notice that the current high FBM KLCI level was mainly driven by high stock prices of some key blue-chip stocks or fund favourite stocks. Investors need to understand that even though the FBM KLCI is surging to reach the recent 2008 peak of 1500-level again, there are still plenty of stocks selling at very cheap valuation.

A lot of second- and third-liners are still selling at 2008-09 low but with good values, i.e. price/earnings ratio of about six times, dividend yield of above 5% as well as selling below the owners’ costs (or selling below net tangible asset).

Despite the cheap valuation for lower liner stocks, not many investors are aware of their values. For those who may be aware of the values, not many are willing to inject fresh money into the stock market. One of the main reasons is many may still be holding poor quality stocks and these stocks are selling at 2008-09 low.

Given that they are not willing to cut their losses and worried about losing more money in the stock market, they prefer to stay sidelined while waiting for their existing poor quality stocks to recover one day.

In behavioral finance, we name this phenomenon as “snake-bite” effect.

Unfortunately, in most instances, the moment the prices of these poor quality stocks start to recover, this may indicate the end of the recent market rally because most fund managers, company owners and experienced traders will take the opportunity to liquidate their holdings to these retail investors.

Apart from the above reasons, some investors are quite worried over corporate governance issues in some Malaysian listed companies.

Incidents, like some companies being abandoned by their key owners, companies defaulting on their loan repayments, increasing number of companies being classified under Practice Note 17 and later failed to regularise their companies, are affecting the overall market sentiment. As a result, retail investors are quite careful in investing in new companies lately.

Except for Malaysia and a few other countries in the emerging market, the stock market performance of most overseas markets was weak since April this year.

Retail investors were quite concerned over the financial crisis in some European countries, the weak euro currency, weak US economic indicators as well as asset bubble in China. As a result, the retail participation in these markets, including Malaysia, was quite low. Hence, the current low buying interest from our retail investors is in line with the overall global market phenomenon. The buying interest will only come back when the global stock market starts to show signs of recovery again.

Another reason why investors are not buying stocks is that most retail investors have invested quite a big sum of money in unit trust funds. Even though they still have some savings to invest directly in the market, they prefer to keep those excess savings in fixed deposits rather than to buy stocks directly.

This phenomenon also happens in most developed countries where investors prefer to put money in unit trust funds rather than investing in the stock market. As a result, the fund size managed by unit trust companies grows faster every year.

Hence, we notice that the stock prices for fund managers’ favourite stocks or stocks covered by research analysts are surging to new high whereas the performance of the neglected firms remain low.

Unless investors are holding those fund favourite stocks, they will complain that they have not benefited from the recent market rally.

As mentioned earlier, we still have a lot of second or third liner stocks with strong fundamentals that are selling at cheap valuations. Investors are encouraged to do their own research to discover those companies.

Monday, August 23, 2010

Jesse Livermore: Lessons From A Legendary Trader

Born in 1877, Jesse Livermore is one of the greatest traders that few people know about. While a book on his life written by Edwin Lefèvre, "Reminiscences of a Stock Operator" (1923), is highly regarded as a must-read for all traders, it deserves more than a passing recommendation. Livermore, who is the author of "How to Trade in Stocks"(1940), was one of the greatest traders of all time. At his peak in 1929, Jesse Livermore was worth $100 million, which in today's dollars roughly equates to $1.5-13 billion, depending on the index used.

The enormity of his success becomes even more staggering when considering that he traded on his own, using his own funds, his own system, and not trading anyone else's capital in conjunction. There is no question that times have changed since Mr. Livermore traded stocks and commodities. Markets were thinly traded, compared to today, and the moves volatile. Jesse speaks of sliding major stocks multiple points with the purchase or sale of 1,000 shares. And yet, despite the difference in the markets, such automation increased liquidity, technology, regulation and a host of other factors that still drive the markets today.

The Test of Time
Given that this trader's rules still apply, and the price patterns he looked for are still very relevant today, we will look at a summary of the patterns Jesse traded, as well his timing indicators and trading rules. (For more classic and lesser-known investing titles to add to your collection, check out Investing Books It Pays To Read.)

Price Patterns
Jesse did not have the convenience of modern-day charts to graph his price patterns. Instead, the patterns were simply prices that he kept track of in a ledger. He only liked trading in stocks that were moving in a trend, and avoided ranging markets. When prices approached a pivotal point, he waited to see how they reacted.

For instance, if a stock made a $50 low, bounced up to $60 and was now heading back down to $50, Jesse's rules stipulated waiting until the pivotal point was in play in order to trade. If that same stock moved to $48, he would enter a trade on the short side. If it bounced up off the $50 level, he would enter long at $52, closely watching the $60 level, which is also a "pivotal point." A rise above $60 would trigger an addition to the position (pyramiding) at $63, for example. Failure to penetrate or hold above $60 would result in a liquidation of the long positions. The $2 buffer on the breakout in this example is not exact; the buffer will differ based on stock price and volatility. We want a buffer between actual breakout and entry that allows us to get into the move early, but will result in fewer false breakouts.

While Jesse did not trade ranges, he did trade breakouts from ranging markets. He used a similar strategy as above, entering on a new high or low but using a buffer to reduce the likelihood of false breakouts. (Find more profitable entry and exit locations with this standard indicator; read Measure Volatility With Average True Range.)

Price patterns, combined with volume analysis, were also used to determine if the trade would be kept open. Some of the criteria Jesse used to determine if he was in the right position were:
  • Increased volume on breakout.
  • The first few days after the break prices should move in the breakout direction
  • A normal reaction occurs where prices retrace somewhat against the trend, but volume is lower on retracements than it was in the trending direction.
  • As the normal reaction ends, volume increases once again in the direction of the trend.

Deviations from these patterns were warning signals and, if confirmed by price movements back through pivotal points, indicated that exited or unrealized profits should be taken. (For more read our Greatest Investors Tutorial.)

Timing the Market
Any trader knows that being right a little too early or a little too late can be as detrimental as simply being wrong. Timing is crucial in the financial markets, and nothing provides better timing than price itself. The pivotal points mentioned above occur in individual stocks and market indexes, as well. Let price confirm the trade before entering large positions.

Jesse Livermore believed no matter how much we "feel" that we know what is happening, we need to wait for the market to confirm our thesis. And only when it does do we make our trades - and we must do so promptly. (From picking the right type of stock to setting stop-losses, learn how to trade wisely in Day Trading Strategies For Beginners.)

Trading Rules
The trading rules that follow are simple, and have been included in many trading plans by many traders since they were created nearly a century ago. They are still valid today, and were created under Jesse's truism: "There is nothing new in Wall Street. There can't be, because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."

  • Trade with the trend. Buy in a bull market, short in a bear market.
  • Don't trade when there aren't clear opportunities.
  • Trade using the pivotal points. (Learn how to spot the pivot point from which a new movement will emerge; read Find A Trend With The Partial Retrace.)
  • Wait for the market to confirm opinion before entering. Patience leads to "the big money."
  • Let profits run. Close trades that show a loss (good trades generally show profit right away).
  • Trade with a stop, and know it before you enter.
  • Exit trades where the prospect of further profits is remote (trend is over or waning).
  • Trade the leading stocks in each sector; trade the strongest stocks in a bull market, or the weakest stocks in a bear market.
  • Don't average down a losing position.
  • Don't meet a margin call; close the position instead.
  • Don't follow too many stocks.

Summing Up Jesse Livermore's Strategy
Jesse was highly successful, but also lost his fortune several times. He was always the first to admit when he made a mistake, and when he lost money it came down to two potential culprits:

1. The rules for trading were not fully formulated (not the case for most of his losses).
2. The rules were not followed.

For today's trader, these are still likely the culprits that keep profits at bay. To be profitable, we must actually create a profitable trading system, and then we must adhere to it in actual trading.

Jesse outlined a simple trading system for us: wait for pivotal points before entering a trade. When the points come into play, trade them using a buffer, trading in the direction of the overall market. Let the price dictate our actions and stay with profitable trades, until there is good reason to exit the trade. Losses should be small and trading should be avoided when there are no clear opportunities. When there are trading opportunities, trade stocks that are most likely to move the most. (For more books, check out Ten Books Every Investor Should Read.)

Thursday, August 19, 2010

Malaysia Economic Growth To Stay Strong

The Malaysian economy, which enjoyed a spectacular performance in the first three months of 2010, is expected to ease in the second quarter.

Economists polled by Business Times forecast the economy to grow 7.93 per cent year on year in the second quarter, from 10.1 per cent in the first.

They also project full-year growth to average 6.83 per cent before slipping to 5.47 per cent next year.

Bank Negara Malaysia will announce the latest data today.DBS Bank economist Irvin Seah said that although a moderation of gross domestic product (GDP) growth was expected - as the low base effect dissipates and external demand momentum slows - it would still be "a considerably strong pace of growth", with domestic demand as the key driver.

Private consumption growth may edge slightly higher to 5.3 per cent on the back of a brighter employment outlook.

Seah expects capital investment to bounce back after a sharp inventory destocking of about RM2.4 billion in the previous quarter."We could possibly see investment growth of about 7 per cent (from 5.4 per cent previously) as companies expand their production capacity along with this recovery," he said.

Seah, however, warned that strong domestic demand also implies that import growth will likely outpace the rise in exports and, thus, some drag can be expected from overall net exports.

US investment bank Citi attributed the slowing pace in the second quarter mainly to the services and agriculture sectors.

Within services, growth in electricity production, transport and storage, and tourism has moderated. The weakness in the rubber, crude palm oil and crude oil production sectors has dragged down agriculture and mining output.Economist Kit Wei Zhang said that financial services saw faster household and business loan growth during the second quarter.

Manufacturing growth edged up to 15.6 per cent as both export- and domestic-oriented industries recovered.

"But with production running ahead of exports in recent months, the resulting increase in inventories signals a likely moderation in manufacturing output in coming quarters," Kit said.

He said that construction has also picked up, led by projects under the stimulus packages announced by the government. There was also renewed pick-up in housing construction.

Kit said the narrowing of trade surplus may be partly offset by resilient domestic demand.

"Decline in sales tax has eased significantly, while consumption credit accelerated, although motor vehicle sales moderated slightly.

Economists polled expect GDP growth to ease in the second half of the year to about 5.08 per cent from an average of 9.07 per cent in the first half, due partially to weaker external demand.

Seah said that while manufacturing would once again lead the other key sectors in terms of growth, its pace was slowing.

With the uncertainties surrounding US recovery and the euro zone, and Asia facing slower growth, the pace of expansion in manufacturing would continue to moderate in the quarters ahead, he added.

Kit sees inflation at benign levels."With both output and inflation gap near neutral levels, a more subdued external outlook, and renewed easing by the (US) Federal Reserve (Fed), we maintain our view that Bank Negara Malaysia will stand pat till end-2010 and early 2011," he said.

Kenanga Investment Bank economist Wan Suhaimie Saidi said the slowing pace in the second half of the year was already evident as intra-regional trade showed signs of slowing on weaker export demand.