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Greetings, Pro-fundity team members -
08-01-03

At the bottom of the Guidepost, a full listing of this weeks picks are shown, in addition to the Charts via the Pick-link.

As a benefit of membership, you have access to all Guideposts (including Archived GP's) and Picks. If you miss a week or two for whatever reason, you will be able to go into the Historical Guidepost link to catch up with both the weekly guidepost and the 30 picks made for the week.

Greetings, fellow Pro-fundity team members

The first three sessions in our Beginning Investing course constitute a discussion of the basics; a) why we should invest in the stock market, b) an introductory primer on what risk means and the importance of risk management, and c) in its most basic terms, “What is a stock?” Hopefully, you’ve had enough time now to answer questions posed at the end of Unit 3 as well as to complete the suggested exercises. Your understanding of coming lessons will be heightened if you do. The very act of writing answers out, either on a PC or with pen & ink, provides a critical link between the material and understanding (or, theory & application). How many times have we heard a new concept and all we can come up with is, “huh?” The smaller the “huh,” the more successful we’ll be as investors/traders. When we get these understandings into our gut, we’ll find uncommon success.

What does it cost?

1. I’ve written about my first experience with supply and demand when I was in the sixth grade, in the late forties. I built a concession stand with an orange crate and sold small bags of popcorn outside the movie theater in the small town of my birth. That was before goodies were sold inside theaters, at least in my town. I learned that if at night’s end I still had bags in my stand, I needed to drop the price another night to get some balance. Demand only occurs when the price is right! I could create demand, just lower the price until that occurs. But the point here is not related to supply/demand, rather to the cost of the venture. I remember one night a teen-ager stopped and asked me if I was making any money. I happily pulled a handful of change out of my pocket to show him the extent of my industry. But he threw me a curve, asking how much of that was profit? I didn’t know what the word “profit” meant!

2. Decades later I fully understand the meaning of profit, which is indeed the bottom line in the failure or success of any venture. “What did it cost” is of profound importance in investing and trading. What are the costs? If there were no expenses in trading, then it would be easy to make a buck. Profit, however, equals revenue (income) less costs (expenses). Whether we see a gain or a loss depends on at least four factors:
   
   • Commissions
     
   • ”Invisible eighth”
     
   • Taxes
     
   • Exchange fees

3. Commissions are the major immediate expense, requiring payout for each market transaction. In the past this paid for broker services which was the only way to execute trades. The internet and on-line investing has minimized the role of the broker, greatly reducing trading commissions. It was not uncommon to pay brokers $50 to $100 to execute a market trade. Today, discount brokers on the net provide the same service for $5 to $25 per trade. However, it remains a real expense we must pay before counting our profits. Yet, we will often hear someone say, “I broke even, except for commissions.” They didn’t break even and it’s delusional for them to say so. And so for us to not fool ourselves, we must add commissions to the purchase price, or subtract them from the selling price at once! To improve our trading success, we need to minimize commission expense so far as possible. Results in the market are measured by how much we make, nothing else.

4. The “invisible eighth” is a factor no one can avoid. This is the difference between the “bid” and “ask” price (the Spread). That is, when we get a quote for current market price on a stock it will always come in two numbers, the bid (what we pay if we’re buying) and the ask (what we pay when we sell). This difference is never less than 1/8 of a point. That means the instant you go long (buy a stock), you are already behind at least $0.125 for each share. It can be much more than an eighth in lightly traded markets.

5. The income tax cost is less well defined, since it depends upon our individual tax bracket and numerous tax-related issues. It is a wise move is to consult your tax accountant as you become a player in the market. Exchange fees are another given, however these fees are reserved for the professional investor/trader. If you answer “Yes” to any of the following questions, you must pay professional exchange fees:
   
   • Are you SEC registered or qualified?
     
   • Are you an investment advisor?
     
   • Are you subscribing for business use?

6. To review why we are here doing what we’re doing, let’s consider the real world with expenses and commissions. If we say that a stock returned 5% in seven days, did we make any money? It depends on how much we invest and how high are the commissions. For instance, consider the different scenarios in the table below. The first column shows the amount invested, then the commission paid, next the amount of stock purchased (the dollars in less commission). We’ve chosen a $3.00 per share stock for the example, with the number of shares purchased in the next column. Next we assume a 5% increase in the stock price which we then sell. The $-OUT column shows the amount out after commissions are paid, with the actual percentage increase next. Finally, we show a break-even stock price and the percent increase in share price to just break even.
   
   
   Fig. 1 Commission/Expense Table

7. This example demonstrates how futile it can be to invest small amounts in the market with high commissions. For the two extremes in the table, $5000 invested with an $8 commission requires only 3/10’s of a percent increase to break even, while $400 with a $60 commission must have a 30% increase. If we are trying to invest with only small amounts of cash it is clear we must be smarter with our money, making a more clever use of what funds we do have.

8. One way to help manage our transactions is with a spreadsheet designed to calculate these important factors. In the Advanced Tools section of the Pro-fundity page is a spreadsheet labeled Personal Investment Planner which you can download for this purpose. The following table outlines the features of the planner:
   
   
   Fig. 2 PIP – An Investment Planning Tool-a

9. Your task is to record the five details of the stock transaction; 1. Ticker symbol, 2. date of the purchase, 3. price per share, 4. commission for the purchase, and 5. the number of shares purchased. Entering this data the spreadsheet will calculate how much money you invested (# shares x price + commission). Additionally, it will calculate the price increase required for you to break even on the purchase. That is, how much of an increase is required to pay for the commission. Data is added only in the green shaded cells, with calculations housed in the white cells.
   
   
   Fig. 3 PIP – An Investment Planning Tool-b

10. Notice in this figure we have recorded the five purchase transactions of four tickers. The third and fourth white columns are an arbitrary strategy, in this case to sell if a target price is reached or if a stop price occurs on the down-side. The percentage for each “sell” can be changed by typing in new values in the green cells. In any event, the data in these two columns are “monitor” data, which you can respond to as you wish. There are no calculations in the spread sheet that require the information. The recorded data shows three of the tickers have been sold. Go to the next table to see the results in a more expanded view of the PIP.
    
    
    Fig. 4 PIP – An Investment Planning Tool-c

11. The first ticker, SCOR, provided a healthy return with a dollar increase of over 10%. The second ticker, AHR, showed in increased sale price ($7.88) over the purchase price ($7.81) yet returned a net negative gain after commissions are taken out for both sides of the transaction. This is how the PIP can help us keep a realistic measure of how we are doing.

12. Trading is like most efficient operations; “Nothing is finished until the paperwork is done.” That is to say there is little glamour in day-to-day trading activities, a lot of work and extreme attention to detail. It is not an easy “drop-a-quarter-in-the-slot” way to make money. There are a lot of expenses and costs, material and emotional.

Follow these steps to exercise your understanding of the PIP trading tool and market operation.