Friday, March 30, 2007

Forward Test: Redtone

Ben told me that Seng from Fusion Investor asked about Redtone from TA perspective.
So I decided to dedicate a whole post to it and label it Forward Testing.
Let's see if the market acts like the way I predict it or not. Remember, we make a prediction, but let the market decide. Should the market decide our prediction is wrong, as a TA practitioner, we must concede defeat and accept that the market is always right. You cannot win against 100 people pushing you down, no matter how strong you are.

First we look at the weekly chart - overview.
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We see bloodshed happenned in 2006. We see that in 2007, it tried to recover but so far to no avail. Volume remained thin throughout with the exception of 2007 where the long green candle marks the jump in price supported with volume. However, we also see a blue line drawn by me, marked as resistance. The blue line, resistance, was not successfully taken, and price falters with volume.

Next we take a closer look - still the weekly chart - zoom.
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We note, EMA 50 (pink line) is still above EMA 20 (orange line). This is bearish.
We also note that the last candle rests slightly above EMA 20 weekly chart. This we note as Key support. Further assault on this support would be unthinkable.

Let's now look at Daily Chart - overview
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We note that the last candles are now resting on near previous highs in November 2006, December 2006 and January 2007. Previous resistance now has become a support. This would jive with the statement above from Weekly chart that the stock is now at the Key Support. Further assault on its Key Support, would be fatal.

Let's now look at Daily Chart - zoom
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This one is interesting.
First, we have long green candle with high volume.
Next candle is a shooting star with high volume.
Following is the bearish engulfing. Though volume is not as high, we must take this as a confirmation that the previous candle is a shooting star indeed.
Follows is another assault - red candle.
Following day, counter opened lower, intraday wise, reached the EMA 50(pink line) but it managed to close slightly above the previous day's closing. This is the Piercing Pattern. Piercing patterns are bullish reversal patterns.
However, the following day, while the counter opened higher, it closed lower. This cannot be regarded as a confirmation to the Piercing Pattern. While it close above the previous day's closing, the open high, close low is always a negative signal. If the bullish sentiment exist, why would a stock open higher to close lower?

This was proven true with the two red candle days. However EMA 50 held.
The following is a green candle that forms a Harami pattern.
However, the following Red Candle does not confirm it, and forms a Dark Cloud Cover.
However this is also not confirmed with the following Green Candle.
And this is followed by a Red Candle.
This is what was described in Steve Nison's books that a reversal does not necessarily happen with Harami, Dark Cloud Cover, Piercing Pattern, Bullish/Bearish Engulfing. It could merely move in sideways.

Thereafter, a sudden breakout occurred. Long Green Candle.
But proved to be a false breakout with the appearance of a Dark Cloud Cover.
The next two candle showed that the counter tried to recover but this is all in vain.

Resistance is futile. Marked with Blue Vertical Line, the Bearish Engulfing on a High Volume marks a whole new beginning to a downtrend of the stock.
Further assaults were made on EMA 20 support (Orange Line) and now the EMA 50 support (pink line).

While the assaults are with low volume, it does not mean that the downtrend is not real. From my personal observations, a rally with low volume is unsustainable. But a downtrend with low volume is very real. Volume could not be used in the same manner to analyse the uptrend and the downtrend. A counter with low volume downtrend, slowly drifts into the death of the stock. OK, I was being dramatic. It drifts and it drifts, until distribution is over.

The charts look bearish. The general condition of the chart is bearish. Yes, while I use a total 14 indicators, they were all removed from the chart, save the EMAs :P. But, price volume action is the originator of all indicators.
So, general condition is bearish, Redtone is now at its key support point. Any confirmed break on this support, would confirm that we re now looking at the beginning phase of another distribution.

Standard Boring Disclaimer
The above is the personal view of the author based on Technical Analysis. The author disclaims all responsibility whatsoever on the course of action that may be taken.
Also, take note that the author is merely an accountant by profession, previously an investor and now a trader. He is not licensed to give any stock advisory services.

Wednesday, March 28, 2007

Rewarding the Shareholders

Ever wondered what exactly it means to be a shareholder? What it means when you purchase the scripts of paper (or rather the numbers in the statement)? And why does certain counters are more preferable by many than the other?
You may think its the charisma of the CEO, or maybe the strong management team, or perhaps the strong branding of the company or maybe the stock just have chemistry with you. These are perhaps all important, but to the end, it all boils down to dollars and cents. Rewards.

There are a number of ways a company could reward its shareholders. How? Let's look at it more in depth:
1) Dividends

This is something many loved. There is even groups of people who merely invests just for the dividend. These are normally the more risk adverse investors whose strategy is to keep buying good dividend stock. With good money management, this strategy works.
Basically, the idea is like savings. Every month, instead of saving it in a bank, you purchase a dividend stock. The return per annum is higher than the bank. And you stand to gain for more if there is a capital gain. This strategy works best for working professionals who want a retirement fund.
Another shorter term strategy is to look at historical dividend declaration dates. Anticipate when the next dividend would be declared and purchase the stock. Once dividend is declared, stock price will spike up, normally. Instant gain, low risk.
The theory from textbooks is that your wealth really doesn't change. Once you purchase the stock and receive the dividend, the share price will fall - so you re back to square one. However, in practice, the norm is that the share price will appreciate back to at least where it started.

2) Capital Repayment
This normally comes as a sudden surprise. Everybody loves them.
The idea is the same as dividend play, however, the anticipation would be much more difficult.

3) Bonus Issue
Free shares for every certain number of shares held. Simply great!
One point to note is that once a bonus issue is given, the liquidity of the shares increases. There are more shares now in the market. Hence price may take some time to consolidate prior to recovering to its previous price.
Again, the idea and theory is similar to Dividend Play. Anticipation, however, are difficult.

4) Rights Issue

Frankly, this is not exactly a reward to shareholders. More like a threat, if you ask me.
The idea is this, the company needs cash. Instead of borrowings from the bank, the company declares rights issue. If you hold a certain number of shares, you are eligible to subscribe to a number of shares for a fixed price.
The theory from textbooks is simple - if you exercise your rights issue, your wealth does not change. If you don't you lose out, as share price will fall, but there is no additional shares from rights issue to compensate the drop.
Do take note of the difference between Rights Issue and Bonus Issue.

5) Share Buyback

This is interesting. How does share buyback affect the share price?
Direct impact - as a support to the share price. As the company conducts share buyback exercise, this would serve as an additional support to the share price. Confidence of retailers may also be boosted and may charge in to support alongwith the company. Hence, a falling dagger may be stopped.
Indirect impact - Imagine a pie is to be shared among 8 person. So each gets 1/8 of the pie. Now what happens, if the pie is only to be shared by 5 person? Each gets 1/5 of the pie.
The pie remains the same, but each person gets a larger slice.
Same theory applies to share buyback exercise. What share buyback also achieves, is reducing the number of shares in the company. Since there are less people to share with, there ll be more for everyone, even if the earnings remain the same.

6) By retaining all profits to expand the business

It is often very easy to jump the gun and say that if a company does not declare dividend, it has bad management. However, this may not be the case. A business needs to retain its profits in order to survive, to stay competitive and to expand. Depending on the business model, some industry require heavy reinvestment in order to stay competitive. Failure to do so, would spell disaster for the future of the company.

One notable example is Proton, who has failed to keep its technology up to date. For decades, Proton has dominated the Malaysian car market and they took this for granted. There weren't new models around to replace its old ones. Quality remained an issue after 30 years. Simply a disgrace! This would be a case of bad management. And it has nothing to do with dividend declaration or not. The idea is cash management.
How does the Company manages its cashflow tells us a lot about the company.

Also, in a fast moving industry, such as the IT industry, the company should ensure that there is sufficient cash for Research and Development. Otherwise, its competitive edge, will be lost when its rivals gain key technology which could render the Company's technology obsolete!

In addition, there may be instances where the company would be best to delay or reduce its dividend policy to finance an expansion. This is especially if the expansion would yield a key strategic importance to the company.

All in all, this is in view of the longer term of the Company.

Misuse and Abuse.

Above are all theories and concepts in an ideal world. In real world however, misuse and abuse are rampant.
As you know, most directors are major shareholders in the companies in Msia. The main reason for a large dividend payout is not to benefit shareholders per se, but to ensure their own benefit is secured. It may also be done at the expense of the future of the company, shorttermism rears its ugly head.
Furthermore, there are also companies who misuse the funds of the company to pursue a share buyback program. This is so that they could dispose their large block of shares at a higher price while the company buys them back. In the end, once the share buyback program ends, share price would be unsustainable and fall. The unscrupulous director who was the one that initiated the share buyback program, sold his shares, can now buy back his own shares at a much lower cost.

So let us all be aware of all the aspects that there is. Cheers!

Tuesday, March 27, 2007

Magic of Doji

Very often we hear the scream of "Doji, doji, doji!" as if it is the end of the world. Or it could be the beginning of sunshine. Depends on the prior trend. But how valid is this excitement?
Let us dwell deeper into this mysterious Doji.

Doji is often touted as the reversal signal. If the prior trend is an uptrend, an appearance of doji to many, signals reversals. Correction is about to ensue.

I would define doji in another fashion. A doji to me merely means neither bulls nor bears are in control. You may view it as uncertainty. If there was a prior trend, it indicates that the trend has hit a pause. It may turn into a reversal or a resumption of uptrend. By looking at only the Doji, we will not know what will happen next. Types of Doji, such as, long-legged Doji, Gravestone Doji, Morning Star Doji, may give an additional strength to the Doji but not conclusive.

There are several categories of Doji. Classification is not mainstream but the idea is. Simply said, the idea is not new and have always been there. I merely simply give these doji names :P

1. Useless Doji
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Refer to the chart above. There are so many of them. Is there a meaning to these doji?
Yes, the meaning is these are Useless Doji.

2. Pausing Doji (or commonly known as Failed Doji)
Refer to the chart below. The doji merely create a pause. It does not reverse the previous trend. See how dangerous it is to conclude it is a reversal just based on Doji?
Commonly known also as failed Doji, but personally I dislike the name. It gives a false impression as if a Doji is equivalent to an advance warning of a sure reversal.
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3. Reversal Doji
Refer to the chart above. This doji became a reversal. The end of the era of uptrend.

So, how do we differentiate these doji? How do we know which is which? Useless doji are clear cut. But how are we to differentiate the Pausing Doji or the Reversal Doji?

In candlestick study, we always stress on the importance of confirmation. If it is not confirmed, then it is very risky. A Doji could either be a Reversal Doji or a Pausing Doji.

Another method is to gauge the likelihood of whether the Doji is a Reversal Doji. This can be done via the analysis of the position of the Doji. The idea behind this is to combine Doji with Key Resistance/Support.
Say a stock has been on a downtrend for sometime. A Doji appeared at the Key Support area. This is not conclusive, but it greatly enhances the probability that a reversal may be on the way.

There is also another way of interpreting the Doji, and that is via a combination of other methods. Suggested method is via Indicators. We'll cover more on indicators later.

Till then, I hope that Doji alone would be seen as a mere pause that neither bulls nor bears are in control. Nothing more, nothing less. Unless there are other information.

Monday, March 26, 2007

Why I love the news

Never thought I am such a fan of news, heh?
Read on, let me illustrate with the following news from reputable publishing houses.
Its an observation made which has never cease to amuse me. :)

Dow Average, S&P 500 Advance as Higher Oil Lifts Energy Shares
March 22 (Bloomberg) -- The Dow Jones Industrial Average and Standard & Poor's 500 Index advanced for a fourth day as a surge in oil prices lifted energy companies.

I see, as oil prices go up, stocks will go up. OK. Got it.

Dow: 5-Day Rally, Back In Black
NEW YORK ( -- Stocks inched higher Friday, gaining after unexpected strength in home sales, but worries about rising oil prices limited gains.

OK, if there was no worries that oil prices may go up, stocks would have gained more. OK. Got it.
WAIT a minute... I thought, when oil prices go up, stocks will gain? But how come now oil prices' potential to go up, and stocks are limited from rising? Hey, something's not quite right here...

Well, hold on your horses. There's more :)

U.S. Stocks Rise on Employment, Wage Growth Data; GM Advances
Sept. 1 (Bloomberg) -- U.S. stocks rallied to four-month highs after the government said employers added more jobs and wage increases slowed last month, easing concern that higher interest rates would lead to an economic slump.
Ah, this rationale is simple - more jobs, means economy is good. And economy good, I suppose it means stocks will go up. OK. Got it.

U.S. Stocks Advance, Sending Dow Average to Third-Highest Close
May 5 (Bloomberg) -- U.S. stocks surged, sending the Dow Jones Industrial Average to its third-highest close ever as a smaller-than-forecast increase in the number of jobs last month eased inflation concerns
Ah, logical indeed. Lesser jobs, means economy not so good. Economy not so good, Federal Reserve (US' equivalent of Bank Negara) would not raise interest rate. And that means borrowing costs will not increase. So, stocks go up. OK. Got it.

WAIT a minute! Which is which now? So I know more jobs during good economy and less when bad economy. But good economy = stocks up right? Or bad economy = stocks up? Hmm, or did I even get the jobs as an indicator of the economy correct? :P

The human mind constantly look for reasons as to why things happen the way they do. It is our nature to find the reason. The journalists merely provided the justifications we so seek. Often with much logic in it that we cannot distinguish between what is real and what is not. It is said, "If you re looking for a bull, everything looks like a bull. If you re looking for a bear, everything looks like a bear." The human mind merely recognises the pattern which we so want to seek.

Stay objective. Don't believe everything you've read or heard. Stay objective.

Its not a race...

We often heard of how much one make. Or we often wonder how much does one make? Whether its trading, investment or a job, it makes no difference. Our KPC (keh poh chee) nature wants to know. And after knowing, we re not satisfied. And of all the things we learn from our neighbour, we learn kiasu-ism. Haha, my apologies to Singaporeans but you know its true :P.
We become impatient. We become uncontented. We become competitive. We commit another trading sin.

Trading or investment is not a race. There is no finish line. There is no competition between one individual and another. To me, it does not matter how much one make. Well done, congratulations, I d say. But the money remains the other person's. It would not be mine.
And what if I make less than the other person? Well, what does it matter to the other person? Its my gain, not his. Its my risk, not his.

In the book The Intelligent Investor by Benjamin Graham, the commentator, Jason Zweig said,
"To be an intelligent investor, you must also refuse to judge your financial success by how a bunch of total strangers are doing. You're not one penny poorer if someone in Dubuque or Dallas or Denver beats the S&P500 and you don't. No one's gravestone reads, "HE BEAT THE MARKET"
Good one. I could not refrain from chuckling no matter how many times I ve read this. And no, I don't have a clue where is Dubuque.

Also, it went on to say,
I once interviewed a group of retirees in Boca Raton, one of Florida's wealthiest retirement communities. I asked these people - mostly in their seventies - if they had beaten the market over their investing lives. Some said yes. Some said no; most weren't sure. Then one man said, "Who cares? All I know is, my investment earned enough for me to end up in Boca."

Could there be a more perfect answer? After all, the whole point of investing (or in our case, trading) is not to earn more money than average, but to earn enough to meet your own needs.
The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and behavioural discipline that are likely to get you where you want to go. In the end, what matters isn't crossing the finish line before anybody else but just making sure that you do cross it.

And to be frank, I ve seen people who could make a million in 3 months. And I ve also seen the same person go bust in the next following 3 months. Its a mere risk and reward game. If you re willing to gamble, you could always plunge with all you have plus borrowed money, should you choose to. Few gains in a row, voila, a millionaire is made. Is that simple. But is that your style? You could lose everything and declare bankruptcy the next moment. Is that what you want?

So my friends, let us all take our own pace. Truly, the market is not a race.

Sunday, March 25, 2007

Please give a WARM WELCOME to Vola!!!

Dear readers,
This is an exciting moment for Fusion Trader's Blog.
Please give a warm welcome to Vola - the Fundamentalist Expert :)

As a matter of fact, do take note that the latest article - It's the Yen Carry Trade is written by Vola, not me. I could only take credit for the pictures added :P

Vola comes with a massive understanding of Fundamentals Analysis.
We spoke on MSN previously and decided its best that we join forces to make this blog a truly "Fusionised". Actually, we didn't really agreed on that. I have a confession to make, I pestered Vola into agreeing. Haha! Either case, we both felt that we were in a position to teach other and a blog would keep track of the things we shared.

Let's take this as the first step towards a beautiful partnership and a fruitful learning journey.

Let us all, give a WARM WELCOME to Vola. :)

It's The Yen Carry Trade

Forbes has recently hailed “This is the richest year in human history”, as we experience a broad-based increase in all asset classes since the dot-com mania in 2000, and, of course, on the back of a remarkable expansion in the global economy of above 4% growth in the past four years. The boom in assets looked as if going to go on forever not until the news broke out on China shares plunged 8.8% on 27 February and every market in the world went into a tailspin, including the commodities. Well, it wasn’t the China factor that came into play, it was undeniably a catalyst, there were increased risks in the US housing market that prompted a sharp unwinding of yen carry trades, bubbly emerging markets (China, India and Viet Nam, in particular) and growing risk aversion. Things are back to normal now, Dow and Nikkei have rebounded from their lows during the global stocks rout and Asian stocks rallied this week. But it’s good to pay attention to the yen carry trade. We are living at a very interesting and challenging juncture of the time where fundamentals don’t seem to explain everything that goes around in this world.

In fact, the yen carry trade is nothing new for us. It has been with us long enough that it is sort of a part of the financial system promoting cheap credit and revolutionising the entire financial environment which continues to allow more risk taking activities. It was made available by Japan’s ultra-loose monetary policy of 0% interest rate for half a decade which ended last year. Although the period of super-loose financing ended, the Japanese, the hedge funds and the institutional investors continue to take in yen-currency borrowings. The yen has remained the ultimate source of cheap credit fuelling investments in Aussie and Kiwi dollars, US bonds, emerging markets’ stocks and debt, etc; causing the global liquidity glut and inflating asset-price bubble across the world.

The term “yen carry trade” basically refers to the borrowing in yen at very low interest rates to invest in higher-yielding assets that comes at virtually no cost for as long as the Japanese interest rates and currency remain relatively cheap to the targeted carry trade partners. If one of the above rises, the repayment cost of yen-borrowing could increase and yen carry traders would unwind their trades before their return on high-yielding assets being wiped out or their leverage story go bust. No one knows how big is the size of yen carry trade, it is estimated to range from USD20 billion to USD1 trillion. But more worryingly, the unwinding of yen carry trades could or would be self-fulfilling because the expectations of continued weak yen are widely followed by other traders and speculators that adopt “momentum” trading strategy. These “momentum” traders or speculators would just jump on the bandwagon to cover their short positions, tracking closely the behaviour of yen carry traders. Chicago Mercantile Exchange data estimates short positions in yen futures total approximately USD1 trillion. All of this could cause a sharp drop in the yen-funding assets as well as a ripple effect through the global financial system that is more inter-connected than before.

Malaysia should not be spared from this as well. Time after time, we have proven to be very sensitive to any change in the mood of financial optimism among investors. More importantly, the current rally on Bursa has been fuelled by the influx of liquidity from foreign funds. Bursa scored badly in the previous sell-off in global markets. It was the second-hardest hit after China.

As explained earlier, carry trades make sense only if the investor assumes that the yen will remain weak and the central bank of Japan does not raise its rates as much and as fast as the US, the Euro area, UK and other targeted nations like Australia, New Zealand, which are on a tightening bias. But, there were some good news recently i.e. Japan left its key interest rate unchanged at 0.5% this week, the lowest among developed economies, and US ended its tightening bias. Are those strong enough to be a case for defending a weak yen?

As you may be aware, the yen is the most undervalued currency among the developed economies and more undervalued than the Chinese Renmimbi by some measures. As at end of January, the Economist’s Big Mac Index showed that yen was undervalued by 20% against the USD. Surprisingly, little attention has been paid to it as the world’s largest debtor, the US, is quite comfortable with the easy financing from Japan that has been believed to have, in part, financed the current account deficits in the US, UK and Australia. Economic theory suggests, countries with weak currencies have to offer higher interest rates (risk premium) to attract more money flowing into their countries while countries with strong currencies should only offer lower interest rates as the attractiveness in their currencies are expected to be more than offset the lower rates offered. In the case of the yen, there is not a valid reason for it to continue remain as it is now. The Japanese economy has pulled itself out of the lost decade, back to healthy growth, its consumers are starting to spend more, capital investments are back after a long period of excess capacity overhang, interest rates are on the rise and stock markets are doing well too; a lot of investors are starting to look at Japan. Things are doing well in Japan while the US is facing a slowdown in its consumer spending which has been driven mainly by borrowing against rising home prices, with a possible recession forthcoming if the US housing market deteriorates further. The end of tightening bias reinforces Greenspan’s call for a recession in the latter half of 2007. Historically, real estate slump could pose a more long-lasting effect than the financial markets. In Japan, the real estate slump dragged down its equities market as well, and both lasted for more than a decade. This is not expected to be evidenced in the US unless investors continue to pile up their money in the US aggressively, denying the housing market woes and the rising burden of debt among the consumers.

Another big concern is that the volatility in currencies has increased. The yen does not really have to look at the Japan and other economies to determine its future direction. In turbulent markets, as what we are in currently, the uncertainty in the current environment introduces a lot of volatility to the currencies. Few weeks ago, just a piece of news on the near collapse of the second largest US subprime lender caused our market to plunge by 100 points at the opening, because it induced the unwinding of yen carry trades. It showed that we are very much integrated to the world economy and financial markets. Markets could collapse just because some uncertainty coming out from any major or increasingly influential financial markets in this world, say, China, India, US, UK, HK and Russia. It is not entirely surprising. To gain more perspective, in 1998, the Long Term Capital Management (LTCM), an over-leveraged US hedge fund run by two nobel-prize economists, ran into trouble when its bets turned sour, returns fell by 7% and 10% respectively in May and June that year. Solomon Brothers pulled its fund out of LTCM, and it was not long until the Russian government defaulted on their bonds in August. Panicked investors sold off their Japanese and European bonds hoping to seek shelter in US bonds that have safe-haven appeal. Major players started to get margin call, had to dump their assets to cover their margin calls and the yen carry trade shorts. They all massively tried to cover their shorts exacerbating the yen appreciation. Other macro hedge funds were also affected as the value of these bonds dropped sharply and the global financial markets entered into a turbulent period. The US Federal Reserves then stepped in to bail out the liquidity squeeze in US capital markets. Greenspan then declared the world was facing a global credit crunch and worries about a world recession mounted. The fear is centred more on the ripple effects a disorder financial market could have as the collapse of one company/fund could reverberate to other companies/funds in the markets, sending the debt servicing costs sky-high with debt ratings fall dramatically, in which, very likely would lead to forced liquidation in other companies/funds.

Keep an eye on the yen carry trade.

How to get the MOST out of this site

This site was created for you and me. While I remain the owner of the blog (until Blogger decides otherwise), it is really our site.

What is a forest without the trees,
What is a lake without water,
What is sex without love,
What is a blog without the readers? :)

Here what I could do is to share with you what I have learned.
I hope you would share what you have learned too.
I sincerely believe that we are in the position to teach each other how to become a better trader.
Hence, participation is important.

I will do my best to update everyday. So I do hope that you could visit the site at least once a day too. Its also best that way to avoid too many catching ups to do.
Too much information may not be good. Understanding and comprehension is more important.
Hence, if you visit at least once a day, I think the information would be just nice. :)

Ben from Wisdom Wise Blog also holds a regular chatting session.
Normally I am there :)
Do join in and learn from the master who has been there, done that and got the free t-shirts too. The site address -
However, the chatbox at Wisdom Wise has a limit of 60 posts per hour.
So, if the limit is up, come back over here.
The chatbox here is sort of like a backup.
But remember, while there is no limit in the chatbox here, it is a manual refresh.

I hope we could make the most of this site for you and me! :)

Saturday, March 24, 2007

POLL: Do you wish for tips?

I don't have a million ringgit. I have yet to trade to a million.
However, there have been requests for tips.
And since, I am a service orientated fellow, I shall conduct a poll.
Whoever you are, whether you have posted before or not, please vote.
Please post YES or NO. A simple YES or NO, would suffice.

Do you want tips from me?
Every vote counts.
Let your voice be heard.
Let the voting begin!

P/S: I'll be checking IPs. Only one vote per person. Thank you.

Where is the Value of Intrinsic Value?

This write-up is credited to Blue who requested for it. :)

Before I begin, allow me to do a little background.
There are 3 major schools of investing:
1) Fundamental Analysis
2) Technical Analysis
3) Efficient Market Theory

Fundamentalist has long advocate that any purchase of securities (stock) should be based on its intrinsic value, or the true value of the company.

According to Investopedia, intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.

Note the following:
1) Investopedia says, may or may not be the same as current market value, i.e. share price. Fusion Trader says, it will NOT be the market value. Market moves in accordance to the Supply and Demand. Not based on true value perception.

2) Investopedia says, it is based on the perception of its true value including all aspects of the business, in terms of both tangible and intangible factors.
Fusion Trader says, "Great definition. How are we to value these intangibles?"
Terminology: Tangibles are those with physical form. This would include assets such as Machinery, etc. Intangibles are those with no physical form. This would include assets such as Brandname, etc.
3) Investopedia says, value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.
Fusion Trader says, "Would like to highlight the words - estimate and hopes."

Let's proceed to the many valuation models which could be used to estimate the intrinsic value. The list is not exhaustive.

1) NTA plus
NTA or Net Tangible Assets measures the balance tangible value of the company. Its main use is for safety reasons. It does not measure Intangibles, hence does not fully measure the intrinsic value. The idea is this:
Say, Company A is trading at 2.00 per share.
NTA is 2.50.
Undervalued. Buy.
Logic: Company's NTA is 2.50. And that is without the intangibles! Surely, if the intangibles are accounted for, it would be worth more than 2.50!!! What's more, the share price is only at 2.00!!! What a superb bargain!!!
Problem with Logic: Market is not based on Logic. It is based on Supply and Demand.
Problem with Approach: A self fulfilling prophecy. If all the market players uses this approach to invest in the stock market, it will work. If none uses this approach, it will stay as a "hidden gem" forever.

On another note. Some may think that should this company decides to close its operation, would it be an instant 0.50 profit? You bought it at 2.00 while the the NTA is 2.50.
Logically, the NTA means after liquidating all the assets and repaying all the liabilities, there should be a 2.50 per share sitting around to be distributed to its shareholders. So, if you bought it at 2.00, it wouldn't it be an instant 0.50 profit?

Sadly, I would have to burst your bubble. NTA is not NRV. NRV is the Net Realisable Value.
NTA is based on historical cost. Simply said, it means the cost of which it was acquired.
NRV is based on realisable value. Simply said, it means what you could sell it for.
Notice the difference?

2) Capital Asset Pricing Model (CAPM)
Investopedia says, it is model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
Its formula:

OK, you lost me :P.

3) Modigliani & Miller (M&M)
Investopedia says, it is a financial theory stating that the market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends. Remember, a firm can choose between three methods of financing: issuing shares, borrowing or spending profits (as opposed to dispersing them to shareholders in dividends). The theorem gets much more complicated, but the basic idea is that, under certain assumptions, it makes no difference whether a firm finances itself with debt or equity.
Fusion Trader says, "Can't wait for it to get more complicated" :P

4) Black Scholes Model
For options, many experts, e.g. Alan Voon, the Malaysian Warrants Specialist, uses this model.

says, it is a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. The model assumes that the price of heavily traded assets follow a geometric Brownian motion with constant drift and volatility. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option's strike price and the time to the option's expiry.
Also known as the Black-Scholes-Merton Model.
Fusion Trader says, I have the formula in my ACCA textbooks, but I seriously doubt anyone would be interested into it. The basic idea is good. However, too many subjectivity is involved.
For those who are interested, you can always refer to Mr Alan Voon. I think he wrote an article about this in his site -

If you don't understand what has been transpired so far, I congratulate you.
This is my whole point. I do not see the value of intrinsic value.
While many advocate looking for "hidden gems", I do not advise so.
I understand that my believe in this is radical to many traditional investing views.
It would be a direct contradiction to Benjamin Graham, the father of Fundamental Analysis.

However, let me ask you a question,
"Was Warren Buffett, the World's Greatest Investor, the student of Benjamin Graham?"
"Who was more successful, Benjamin Graham or Warren Buffett?"
"Are their approach 100% the same?"

I am neither advising against using Fundamental Analysis, nor am I discrediting it.
To me, Fundamental Analysis is merely an additional tool. It tells us WHY should we buy.
I would rather use another approach - Technical Analysis to tell me WHEN to buy.

PS: Fusion Trader is an accountant, an investor and a trader. His views are formed based on his accounting knowledge, market knowledge and personal experience. His views may or may not be accurate. However, he speaks freely and candidly on his opinions. Feedbacks are always welcomed, irrespective of whether it is positive or negative in nature. Thank you.

Friday, March 23, 2007

Support and Resistance

Definition according to Investopedia
Support is the price level which, historically, a stock has had difficulty falling below. It is thought of as the level at which a lot of buyers tend to enter the stock.
Resistance is the price at which a stock or market can trade, but which it cannot exceed, for a certain period of time.
Breakout is a price movement through an identified level of support or resistance, which is usually followed by heavy volume and increased volatility. Traders will buy the underlying asset when the price breaks above a level of resistance and sell when it breaks below support.
Breakdown is price movement through an identified level of support, which is usually followed by heavy volume and sharp declines. Technical traders will short sell the underlying asset when the price of the security breaks below a support level because it is a clear indication that the bears are in control and that additional selling pressure is likely to follow.

Confusing. Hmm, for once, Investopedia's definition actually is confusing.
Let's see if this critic can do a better job :P

Let's go back to the the definition of Technical Analysis post where I said that market is ultimately about Supply and Demand. What drives this - Supply and Demand? Perception.
The perception that the current price is cheap in relative to its future price - hence a buy.
The perception that the current price is expensive in relative to its future price - hence a sell.

So, based on psychology, my definition would be
Support is where market players think the price is cheap in relative to future price
Resistance is where market players think the price is expensive in relative to future price
Breakout is where previous Resistance level is broken as market players think that price will be higher in the future
Breakdown is where previous Support level is broken as market players think that price will be lower in the future

There are several ways to identify support or resistance.

1) Gaps

Western Technicals uses gap. The Japanese equivalent would be the Rising Window and Falling Window of the candlestick pattern. Hence, it is more of a zonal support and resistance rather than a specific point. Confirmation of breakout required – to test the staying power.

2) Consolidation point

This is where a period of consolidation is used as a zonal support and resistance.
Say a stock went from a downtrend 3.00 and stayed in consolidation in 2.50. After a while it resumed the downtrend to 2.00 before rebounding. The 2.50 zone will be a primary resistance point. The idea is that people who were holding the stock at 2.50 may not have cleared its position. The longer the consolidation period, the higher the strength of support and resistance.

3) Highest/Lowest point
Using the most recent highs or lows as support and resistance. The idea behind this is that when it reaches the recent highs or lows, the general perception is that the stock is expensive or cheap. Hence a good time to sell or buy.

4) Fibonacci levels
The technique of using 23.6%, 31.8%, 50% and 61.8% as a measure of overreactions in price actions. This would be covered under a separate post.

5) Pattern’s Technical Target
The idea is that when a pattern breakout occurs, there is a technical target. Assuming there is a number of pattern technical analysts, then the selling or buying point has been reached. Not a good indicator of support and resistance due to the self-fulfilling nature of Patterns Method.

6) Previous Support becomes a Resistance. Previous Resistance becomes a Support. The idea is simple. Previous support, a lot of buyers went in.
However, a breakdown occurred. Some cut loss. Some have not.
Those who have not, would be content to get out at small gain/loss or breakeven.
Hence the Resistance is formed.

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