Categories
Investing

Dennis Gartman’s 22 Rules of Trading

Note: These ‘rules’ are for the active trader. Not for the normal person looking to build a retirement nest egg while working a full time job. For most of us – including the financially well-educated – the best strategy is to buy and hold low cost index ETFs.

1. Never, under any circumstance add to a losing position…. ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!

2. Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

3. Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

4. The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is “low.” Nor can we know what price is “high.” Always remember that sugar once fell from $1.25/lb to 2 cent/lb and seemed “cheap” many times along the way.

5. In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many.

6. “Markets can remain illogical longer than you or I can remain solvent,” according to our good friend, Dr. A. Gary Shilling. Illogic often reigns and markets are enormously inefficient despite what the academics believe.

7. Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds… they shall carry us higher than shall lesser ones.

8. Try to trade the first day of a gap, for gaps usually indicate violent new action. We have come to respect “gaps” in our nearly thirty years of watching markets; when they happen (especially in stocks) they are usually very important.

9. Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In “good times,” even errors are profitable; in “bad times” even the most well researched trades go awry. This is the nature of trading; accept it.

10. To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market’s technicals. When we do, then, and only then, can we or should we, trade.

11. Respect “outside reversals” after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more “weekly” and “monthly,” reversals.

12. Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds elegance.

13. Respect and embrace the very normal 50-62% retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen… just as we are about to give up hope that they shall not.

14. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making super-human insights.

15. Establish initial positions on strength in bull markets and on weakness in bear markets. The first “addition” should also be added on strength as the market shows the trend to be working. Henceforth, subsequent additions are to be added on retracements.

16. Bear markets are more violent than are bull markets and so also are their retracements.

17. Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are “right” only 30% of the time, as long as our losses are small and our profits are large.

18. The market is the sum total of the wisdom … and the ignorance…of all of those who deal in it; and we dare not argue with the market’s wisdom. If we learn nothing more than this we’ve learned much indeed.

19. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.

20. The hard trade is the right trade: If it is easy to sell, don’t; and if it is easy to buy, don’t. Do the trade that is hard to do and that which the crowd finds objectionable. Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.

21. There is never one cockroach! This is the “winning” new rule submitted by our friend, Tom Powell.

22. All rules are meant to be broken: The trick is knowing when… and how infrequently this rule may be invoked!

Categories
Wealth

8 Financial Mistakes Made by 20-Somethings

1 Holding too much cash and not investing for years. Time is on your side and the earlier you start compounding returns the less you have to save over the long run.

2 Spending too much of your money to prop up someone else’s education or lifestyle. Friendships and relationships don’t last. Especially ones formed in your twenties. I’ve seen friendships dismantled over a couple hundred dollar loan. It’s good to be generous, but you need to be investing in yourself at this stage of your life.

3 Buying daily takeout food and drinks (yes, including coffee). Waste of money. Plain and simple. A little extra meal planning and you won’t notice the difference…that is except for the extra money in your pocket.

4 Working your ass off for your employer expecting something (other than your paycheque) in return. If you get a promotion and decent pay raise, then great. But many make the mistake of overcommitting to their early employers thinking management will make them whole.

5 Paying thousands of dollars for school, before actually knowing if you’re actually interested in the subject matter and that the education leads to a desired outcome. (Education for education’s sake is for the wealthy, and much of what can be learned in a liberal arts degree can be picked up by reading a few books.)

6 Marrying too early, for the wrong reasons or to the wrong person. Being married to the wrong person is hell. Getting divorced is even worse, and it’s financially devastating.

7 Waiting too long to get married. If you think you will someday want to get married, your 20s is prime time to find a high quality, compatible mate. Added bonus: dual incomes and shared expenses (e.g. housing) makes life more affordable. Of course, divorce is super-expensive so ensure you marry the right person (stable, financially compatible, trustworthy, etc.).

8 Forgetting that you’re in your twenties. This is the decade where you have the freedom and time to do whatever you want. See the world, meet people, invest in your mind and body in multiple ways.

Categories
ETFs and Funds Investing Wealth

88% of Canadian Equity Funds Underperform

It’s a stock picker’s market, right? Investment manager earn their keep during down markets, right? Actively managed mutual funds can take advantage of market dispersion and volatility to pick outperforming stocks, right?

Wrong.

Yet again – through up markets, down markets, calm markets and volatile markets – Standard and Poors (S&P) proves that the myth of active investment management is pure bullshit.

S&P periodically releases the SPIVA Scorecard, which compares the performance of active mutual funds against their benchmarks. Whether looking at Canada, US or UK, this report has repeatedly shown that active managers underperform.

The SPIVA report is probably the most accurate of all mutual fund evaluations because of what it doesn’t leave out. The SPIVA Scorecard accounts for mutual fund survivorship bias. This adjustment is critical to understanding the true extent of manager underperformance over time.

Here’s how S&P explains this important adjustment:

Many funds might be liquidated or merged during a period of
study. However, for a market participant making a decision at the beginning of the period, these funds are part of the opportunity set. Unlike other commonly available comparison reports, SPIVA Canada Scorecards remove this survivorship bias.

Standard & Poors SPIVA Canada Scorecard

Facts (from the SPIVA Canada Scorecard- ending June 30, 2020):

  • 88% of Canadian equity funds underperformed their benchmarks over the past year, in line with the 90% that did so over the past decade
  • On an asset-weighted basis, Canadian Equity funds returned a dismal 7.9% below the S&P/TSX Composite over the past year.
  • U.S. Equity funds posted the highest returns over the past year, with a 6.7% gain on an equal-weighted basis and 10.8% on an asset-weighted basis. Both of these metrics fell short of the 12.1% gain of the S&P 500 (CAD), with 84% of funds failing to clear this hurdle over the past year.
  • U.S. equities offered the best returns over the past decade, with the S&P 500 (CAD) gaining 16.9% per year, but active funds were unable to keep up: 95% fell short, by an average of 4.1% per year on an equal-weighted basis.
  • 53% of all funds in the eligible universe 10 years ago have since been liquidated or merged.

The performance tables below compare mutual fund categories (e.g. ‘Canadian Equity’) against their benchmarks (e.g. ‘S&P/TSX Composite’). The first table shows equal weighted returns (average fund return) and the second shows asset weighted returns (average fund returns weighted by size of assets in a fund). As you can see, there is significant underperformance across all time periods and categories.

This is not just an issue with the Canadian mutual funds industry. Here are some facts about the performance of mutual funds sold in the US:

Facts (from the SPIVA US Scorecard- ending June 30, 2020):

  • In 11 out of the 18 categories of domestic equity funds, the majority of funds continued to underperform their benchmarks.
  • 67% of domestic equity funds lagged the S&P Composite 1500® during the one-year period ending June 30, 2020.
  • In 13 out of the 14 fixed income categories, the majority of funds failed to keep up with their benchmarks.
  • Fund liquidation numbers across segments regularly reached into the 60% range over a 15-year horizon.

The equal and asset-weighted performance comparisons for US mutual funds are equally bad and just as significant as fund underperformance in Canada.

Why do most mutual funds underperform?

It’s simple.

1) Mutual funds charge a fee that can be as high as 3% in some cases (most are probably closer to 2%). Just to perform in line with the benchmark a fund manager has to outperform by the fee charged. They are starting from behind.

2) Mutual fund managers are trying to outperform against millions of other professional investors, all with the same public information. By the very nature of the market, there will be people who are wrong and people who are right. It is very difficult to be repeatedly right about something impacted by an infinite number of variables. Hence, the chance about being right about a particular portfolio (relative to a benchmark) at any point in time is about 50/50. Those odds are reduced over longer periods of time (the odds of flipping heads once is 50%, the odds of flipping heads twice in a row is 25%).

In that it provides no value added, investment fund management is therefore a commodity. An allocation to diversified portfolio of stocks has value, but the overlay of ‘active investment management’ provides no additional value (actually, it subtracts value as shown above). Investors should not pay for something that isn’t delivered. Therefore, investors should not pay active management fees, which are significantly higher than passive fees. This difference in fees could mean the difference between retiring well or retiring broke.

Categories
Investing

Dividend Investing’s Psychological Edge

In theory, the companies that provide the best return are the ones with projects that produce the best ROIC (return on invested capital). Let’s say a retailer (Company X) has discovered a new format of store that generates an ROIC well above what investors could get elsewhere. For this company it would make sense to retain all earnings to reinvest in more stores. It wouldn’t make sense to distribute cash back to investors.

Company X can generate better returns for investors by reinvesting in its own growth prospects. Therefore, Company X stock price should outperform other companies with less favourable growth prospects.

I get the theory and it makes sense. A stock with high growth prospects will tend to have a higher total return than a stock with lower growth prospects. (Of course, not all growth prospects become real so many growth companies eventually fall behind expectations. In fact, there is some research that suggests dividend growers outperform non-dividend stocks over the long run. But for this article, let’s use the simplistic assumption that growth stocks outperform dividend growth stocks.)

The assumption that growth stocks outperform dividend-paying stocks fails to consider investor behaviour and what actually happens at the account level. At the account level, a big segment of investors will perform better by investing in slower growing companies that pay regular and growing dividends.

Stock prices frequently experience corrections and bear markets. Investors have a tendency to ‘buy high, sell low’ – the opposite of what they’re supposed to do – because when stock prices are falling it often feels like the world is crumbling. The news is bad and investors have no idea how much the decline will be. So they see that their holdings are down 10, 20% and they sell. These emotional buy/sell decisions made at the wrong time have a huge negative impact to long-term returns. Indeed, investors tend to drastically underperform the S&P 500.

One of the critical components to becoming a decent investor is to control emotions. We need to fight millions of years of evolution telling us to run when things start to look bad.

My view is that dividend streams help to do that. An investor that holds a portfolio of dividend paying stocks will still receive a stream of cashflow into their account, regardless of stock price performance. I believe these payments are a form of positive reinforcement that rewards good investor behaviour – namely, doing nothing or investing more when stocks are down.

Taking this a step further, many dividend investors view their capital as the price of entry to receive a perpetual and growing dividend stream. You’re trading a lump sum for a stream of income. Investors who look at their portfolios this way will be even less inclined to sell when markets correct, for that would cut their stream of income.

In summary, dividend growth stocks might not produce higher total returns than growth stocks. However, dividend growth investing might because of the positive effects on investor behaviour.

Categories
Investing

Does Gold Outperform Stocks Over the Long Run?

There’s a financial meme out there that suggests gold and silver have outperformed stocks over the past 20 years. The chart looks something like this:

Gold line = gold
Silver line = silver
Blue line = Dow Jones Industrial Average (DJIA)
Red = S&P 500

Looking at this chart, one might come to the conclusion that gold and sliver outperform stocks over the long run. However this conclusion is incorrect.

First of all, the relative performance shown in the chart is very sensitive to start and end dates. For example, if the chart goes back an additional 10 years the outcome completely reverses with stocks outperforming gold and silver:

Alternatively, if I shift the 20 year period to 1959-1979 gold and silver’s out-performance is dramatically amplified.

The point I’m trying to make is that the relative performance of gold and silver is highly dependent on the time period in question. In other words, the performance of precious metals changes with the economic environment. One cannot judge long-run expected returns for gold and silver based on any single period alone.

The next point I want to make is that these memes often make the mistake of comparing gold and silver against the price returns of various stock indices. The charts above use the price returns for the DJIA and S&P 500. Price returns don’t include dividends and therefore provide an incomplete picture of the actual returns from holding stocks.

Below, I’ve re-created the charts and added a black line that represents the total returns provided by large cap stocks (using the Wilshire Large Cap Index back to 1978 and S&P 500 Total Returns Index prior to 1978). While the price return for S&P 500 (red line) was 129% over the 20 year period, the Total Return (black line) was 240%. Gold and silver still dramatically outperformed during this 20 year period.

Like in the previous example, extending the history to 30 years flips the script. While the price indices outperform (as they did in the earlier example) the new total returns line dominates. The added compounding effects of dividends becomes increasingly noticeable as time goes on.

The farther back you go, the more impactful the compounding effects of dividends become. The following chart compares 100 years of returns, with the total returns index being the clear winner, while gold, silver and price return stock indices barely register.

Today, we could be in a period in which gold and silver outperforms stocks. This out-performance is highly dependent on the prevailing economics, such as negative real yields and currency depreciation. There are so many factors that nobody really knows for sure.

I personally believe a strategic allocation to gold can help improve portfolio risk-return characteristics. I also believe that we might be in an economic environment in which gold outperforms stocks. However, to extrapolate the out-performance of the last 20 years to argue that precious metals should provide higher expected returns over the long-run is misleading.

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Categories
Investing Wealth

3 Lessons: Don’t Go Broke Investing

In the world of investing, there are tons of mistakes you can make. Many of these mistakes are so costly that people kill themselves over them. So please don’t take the following stories lightly.

The emotional reaction to watching a life’s work evaporate is stunning. Other than losing a loved one, I can think of no greater loss. It’s not the money that affects people. It’s the time, effort and mental anguish that the money represents. It’s the family time you gave up to deliver that project and make your asshole boss happy. It’s the meetings, company retreats, networking, backstabbing, stress and so on.

If you’re lucky, you make these mistakes when you’re young and have little to lose and lots of time to make up for it.

Below are three stories of great financial mistakes various Reddit users made in the markets. The first of which just happened yesterday:

u/optionsnewbie24

I went long on an oil etf Friday afternoon after oil took a huge hit Friday thinking it would recover. I had a 175k position. I’m looking at it today and it’s at 1885 dollars. I’ve lost it all. I’m not sure where to go from here. It was extremely risky and stupid and was my life savings. I’m 28 and make 45k. Most of that was money I saved from inheritance. Not sure where to go from here. I have proof of all the trades. This hurts. I also have a baby on the way and recently married. I was greedy and tried to increase my money and instead lost it all.

u/civgarth

I’m a former derivatives trader with ___. At 28 I found myself in a margin call of 300k. My fiance found me crying on the floor when she came home. We were due to be married in a few months. As a pro, I can’t frontrun and all my trades were shunted behind retail trades. I saw Nortel go from 120+ to 30. (I think though I could be wrong). This was in the year 2000.

Today at 44, with my wife (same lady), we’ve rebuilt our wealth many times over. As long as you learn what got you in your position, and are cognizant about the lesson each time you decide to do something, you will be fine.

Also, look for some help with the gambling. I was trained and paid to do this and still lost everything. It’s a zero sum game.

u/xenocidic

As a relatively new investor, I fell in love with a stock. I thought… Nutritional algae! That’s where it’s all going. (Narrator: It wasn’t.) So I bought. And I bought. And I kept buying, even as it kept going lower and lower. Dollar cost averaging, right? That’s what you do! Buy more…

All I have to show for it is the documents from the firm’s bankruptcy telling me my shares were cancelled and deemed worthless ($TVIA).

I don’t share these stories for amusement. Use them as lessons.

Lesson 1: Placing a massive bet on a single idea – no matter how confident you are – is always a bad idea. Treat each investment as something that could possibly go to zero. It doesn’t matter how much sense your thesis makes, how old the company is or how many people agree with you. Any investment can go to zero under the right circumstances.

Lesson 2: You can believe you’re doing the smart thing (e.g. dollar cost averaging) and still wind up losing money. Dollar cost averaging should be applied at the portfolio level, to ensure you remain fully diversified. It shouldn’t be used as a way reduce your cost base in a single losing position.

Lesson 3: Even pros screw up big time. You’re not a pro supported by a team of researchers and spending 10 hours a day analyzing investments. So stay humble and expect to make mistakes.

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