Professional investors make a distinction between portfolio management and trade execution. You might not be a professional, but you can still use the same thought process …

Portfolio management is when you make the decision to buy or sell a particular security. Normally there will be limits on the decision. For example, maybe you only want to buy the shares as long as the price is less than $50. Or perhaps you want to sell all of your shares and be completely out by the end of the month.

Trade execution comes after the portfolio decision. You’ve already decided what you’re going to do; now you want to do it as cost-effectively as possible. Maybe you’re willing to pay $50 a share, but you’d be even happier if you can get in at $49. Good execution helps make this happen.

The importance of execution is directly related to your time horizon. If you’re planning to hold an ETF position for years, a few pennies on the entry and exit may not seem so important. However, those same pennies can add up quickly if you’re moving in and out every week.

With that in mind, here are five suggestions to help improve your ETF trading results …

Trading Tip # 1:
Shop Around for Lower Commissions

Years ago, the only way to get into the stock market was through a broker, who charged dearly for his trouble. Now the story is different. You can bypass the smooth-talking salesman and buy stocks, mutual funds, and (best of all) ETFs online for a very small fee.

If you deal with a full-service broker, he’ll probably try to justify his exorbitant paycheck by telling you his firm really “works” your orders to get the best price. If you’re throwing around millions of dollars at a time, this may be true.

For the rest of us, you probably aren’t getting any better execution than you would at a discount broker. In fact, you may do better at a discount broker that doesn’t have a proprietary trading desk working against you.

Using a discount broker can save you a bundle.

These days it’s not hard to find reputable discount brokerage firms with rates of $8-12 for a typical small trade. And there’s really no reason to pay any more.

Trading Tip # 2:
Get Inside the Spread

If you look at an ETF quote during market hours, you’ll probably see some numbers called “bid” and “ask.” They may be quite different from the “last” trade price.

Bid and ask are the current market prices. The bid is the highest advertised price that you can get if you’re selling right now. The ask is the lowest advertised price you’ll pay if you’re buying right now. The “spread” between these numbers is how market makers earn a profit.

The key word here is “advertised.” Often you can buy for less than the ask, or sell for more than the bid. That’s why it is usually a good idea to try for a price somewhere between the bid and ask.

For instance, if you want to buy an ETF that has a bid/ask of $25.50/$25.80, try placing a limit order at $25.65. Wait a couple of minutes and see if anyone takes the bait. If they do, you just saved yourself fifteen cents a share.

Also keep in mind that the bid and ask aren’t unlimited. They apply only to a certain share quantity. A bid of $25, for instance, may be good only for 100 shares. Sell any more than that and you’ll get a lower price — and it could be a lot lower!

Trading Tip # 3:
Use Limit Orders

Notice that I said in the above example to enter a “limit” order. This is simply an instruction to your broker not to process the trade unless the price is at or better than the limit you define.

If you enter a “market” order, you might not get the best price. What you will get is the best available price at that moment. And it could be substantially higher or lower than you thought you’d get.

I’ve found that it’s almost always better to use a limit order when trading ETFs, even if it means your order isn’t filled right away. The odds are that you’ll get a better price by waiting.

QQQQ is one of the most liquid ETFs.

The only exception is a handful of mega-ETFs like SPDR S&P 500 (SPY) and PowerShares QQQ (QQQQ). These big, actively-traded ETFs normally have very tight spreads and ample liquidity. Small orders are filled instantly at the quoted bid or ask price.

Trading Tip # 4:
Watch the Underlying Market

Several factors define an ETF’s liquidity. One of the most important is the depth of the underlying market. This is the basket of stocks that compose the ETF. Institutional trading desks often try to pick up some quick profits by moving back and forth between ETF shares and baskets of the corresponding index.

If the index is composed of large, actively-traded stocks, the ETF will probably have an efficient market as well. Likewise, when the index consists of low-volume stocks, any ETF designed to reflect it will also reflect the lack of liquidity.

It also helps for the underlying market to be open when you’re trying to trade an ETF. For instance, if you’re trading an international ETF composed of European stocks, you may do better in the morning. That’s because there’s a few hours in the morning when the European and the U.S. exchanges are open. This means more depth and, usually, better prices.

Trading Tip # 5:
Be Aware of the Crowd

On a normal day the stock market tends to have a lot of volume in the first half-hour or so, less action in mid-day, and furious trading just before the close. The same is true of ETFs.

This pattern can work either for you or against you. If you’re trying to move a big quantity of shares, you probably want to take advantage of the depth present in the last hour. If you want to trade against someone who may not have thought ahead, you might find some good prices at lunchtime.

Successful traders get ahead of the crowd.

The point is that you must be aware of your surroundings. Market conditions are constantly changing. Just as you don’t go out in the rain unless you want to get wet, you shouldn’t go into a thin market unless you’re ready to turn it in your favor.

Follow these five trading tips and you’ll be surprised how much your results can improve. Are they magic? No, not at all.

You’ll still have plenty of ups and downs. But good trade execution is still a very important step for more active investors.

Best wishes,

Ron Rowland 
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

What are the questions that educated investors ask in oil and gas?

Last month I gave investors 10 questions they should be asking management teams, or searching for on the company website, in a recent article.  They were basic questions, and you can read them here. After those first 10 are answered, you know how much production a company has, how fast they’re growing, how much cash or debt they have etc.

But if you’re still not sure if you want to invest in the company after all that, or just want to know more…what are the right questions to ask?  What pitfalls or opportunities might an investor uncover?

1. Decline rates are something management teams don’t really hide, but don’t really talk about either.  Every well has declining production until it’s uneconomic.  The new shale gas plays often have 85% decline in production in the first year.  Tight oil plays (Bakken, Lower Shaunavon etc) have 75% initial decline rates. Decline rates are increasing over time now as the industry drills deeper and tighter plays.  Ask management what the initial decline rate is, both company wide, and specifically on their main, big play that they believe will be the growth engine of the company.  Then ask what the decline rate flattens out to—it’s usually 20-30%.

Why is this important? Because many investors, when forecasting growth, use the only public numbers given for a well – the ones in the press release.  Most companies have a production decline graph in their powerpoint, but few actually say what the production levels in the wells in the area flatten out at (and many research reports from analysts don’t either—don’t let The Machine fool you).

2. If the company is operating in a foreign country, what kind of political connections do they have – who from that country is in management or on the board of directors?

3. What is the break even cost, company wide, and in their main play, in terms of price per barrel?  Management should be able to tell you a very good ballpark number.

4. How much does it cost them to bring up a barrel of producing oil?  Costs can range from $8000 per flowing barrel to over $30000.  Obviously, the lower the better, as this will be more profitable.  Then you compare it to what companies are being bought out for.  If a company can produce a barrel of oil for $10,000, and the stocks are being bought or merged at valuations of $70,000 per barrel, that’s a very accretive oil or gas play!  Again, management should be able to answer that question on the phone.

5. What is the recycle ratio, both overall corporately and specifically on their main play that will be the growth engine for the company.  The recycle ratio is a key measure of profitability for an energy company.  It’s a fairly simple calculation, and many companies put it in their quarterly and a few even put it in their powerpoint.  Management will know this number off the top of their head like they know their wife’s name, so don’t be afraid to ask.

The recycle ratio is the profit per barrel (called the “netback”) divided over the cost of finding that barrel–“F&D”—Finding and Development Costs. Both the netback and the F&D costs are in all the quarterlies – usually broken out in simple charts and language in the notes.  The higher the recycle ratio the better.  Anything over 3 is great, 2 is really good and under 2 can still be OK if it’s a big field and lots of wells can be drilled.  Different companies report differently so not all recycle ratios are equal, but it will give you a general idea.

The higher the recycle ratio, the higher the valuation should be.

6. How much of their own infrastructure do they own?  And are they the operator of their plays? Infrastructure includes things like local or regional pipelines, storage facilities, processing facilities.  If they don’t own them, they have to pay charges to use them, and are subject to somebody else’s maintenance and upkeep.  And the market often pays a lot less for a non-operating interest in a play, as the operator gets to call the shots most of the time.

7. Ask management what kind of discount or premium they get for their production, from quoted prices like WTI crude or Brent Crude – and why that is.  For example, heavy oil gets a discount – up to 50% – from the WTI price or Brent crude price that is always quoted in the media.  Maybe their oil or gas has a high sulphur content (which would also give them a tougher time with environmental permits).  A company may say they are producing 10,000 bopd, but if their price is much lower than world price, their future cash flow could be much lower than you think.

8. How much stock does management own, which people on management are the largest shareholders in the group and how much hard cash – not stock options – does management have in the company.

9. If the company is operating in a foreign country, what kind of political connections do they have – who from that country is in management or on the board of directors?

10.  And lastly, ask open ended questions, like – what else is there about your company that you want to tell me? Where do you want to improve the most over the next 2-3 quarters?

The list of questions goes on and on.  I suggest that investors should remember that the answers to these questions are already priced into the stock; it’s highly unlikely you will find any bargains on the stock market from these questions.  But the answers will give you a better understanding of how stocks are valued and why, and give you more confidence in acting on your own intuition about a stock.

By Keith Schaefer
Oil & Gas Investments Bulletin

In fact, we met someone who did it firsthand a few months ago. Over breakfast with Bob Quartermain, the president of Silver Standard Resources (NASDAQ:SSRI), your editor got the first-hand account of the company’s development.

Quartermain, a geologist by training, started at Silver Standard in 1985 when the precious metal bubble had just imploded. He had one goal: acquire silver assets. Silver projects were cheap and plentiful and Silver Standard was buying them.

To make a long story short, this strategy took Silver Standard from a company holding a few dozen “worthless” silver projects to a leading silver mining giant worth more than $1 billion today.

Early investors who spotted this opportunity made 20 to 50 times their original investment or more.

Now it’s looking like it’s happening all over again in another industry no one wants to touch – timber.

I know, I know…timber!…who wants timber? But please, here me out.

The “Insider” Advantage

For obvious reasons, timber is out of favor. Housing starts are still at multi-year lows. Lumber prices are down nearly 70% from their housing bubble peak. And shares of leading timber companies have recently been downgraded by analysts at JP Morgan, Credit Suisse, and other firms (could there be a better buy signal?).

There is, however, one industry insider who may be pulling together another Silver Standard-style success – only in timber. Even if it pays off only half as big though, it’s definitely worth a look.

Last week I was doing some research on a very early stage opportunity for President’s List readers and sat down for lunch with Rick Doman. The Doman name is a big one in the timber industry. Herb Doman, Rick’s father, built Doman Industries from the ground up. Herb started the company in 1953, listed it publicly in 1964, and eventually grew it into a $1 billion timber company.

When Herb left the company in 2001 it was in rough shape. It was weighed down by too much debt and Rick took the reins to lead a restructuring. Rick took the company from the verge of receivership to a $1 billion turnaround success story in about three years.

Rick spotted the housing bubble and realized the great times would not last forever. He knew the mistakes timber companies made in the 90s with debt and other structural mistakes because he witnessed them firsthand at Doman Industries. And when the newly reborn Doman Industries (under its new name Western Forest Products – TSX:WEF) was headed down the same road, Rick got out of there.

Over the next five years he would keep close tabs on the industry though as a consultant. Basically, he charged institutional investors thousands of dollars to tell them not to buy timber.

Frankly, you’d be hard pressed to find someone who knows the industry better. And that’s why your editor became very interested when we found out Rick was getting back into timber. After all, we know the value of the opportunity to accumulate assets no one else wants (who wants timber now?) and we had to get together to learn what he’s doing, why he’s doing it now, and what the real opportunities are out there.

The Real Future of Timber

Now, when you think timber (technically, softwood timber in this case), you think housing. The two industries are practically joined at the hip. Housing construction drives timber demand.

So when housing starts climbed to the rate of 2.2 million per year at the peak of the bubble, lumber prices surged too. Lumber climbed from $250 to $300 per 1,000 board feet at the start of the decade to more than $450.

The great times wouldn’t last forever. Lumber price collapsed when the housing bubble burst. They fell from the $450 peak to less than $150. The downturn forced companies to curtail production and sawmills to shut down as the industry contracted.

As I write, lumber prices are still under $200 and timber is still out of favor. But there’s actually a lot to get excited about.

Here are four reasons why a contrarian could really get excited about timber now (it’s not just housing):

Long-Run Housing Rebound – The housing market is currently working through the bubble era excesses. Prices are down and the government has the industry on life support.

Over the long run the outlook for housing is much different than it is now. It’s all because the fundamental driver of housing demand is population growth.

As a result, U.S. population growth will spark a rebound in housing construction. The boom times may never come again, but there is an equilibrium point the market must get back to. That equilibrium rate is much higher than the current rate. Here’s why.

The Population Reference Bureau expects the population to grow at 0.9% per year through 2050. If we extrapolate the results of recent Texas A&M University study, Housing Market Mirrors Population Growth, which correlates housing and population growth, excluding the recent bubble years, the 0.9% population growth means housing demand will increase 1.12% per year.

That means 1.26 million new homes (105 million currently + 1.12% per year growth) will need to be built each year.

Of course, you have to consider types of housing units, interest rates, and how long the newly constructed houses will last. However, 1.26 million per year estimate is right in line with long-run averages. The current new housing construction rate is 660,000 per year.

Barring an outright depression, housing construction must go up over the long run to meet basic demand from new families and to replace old ones. And the timber demand will rebound right along with it.

A Tight Correlation – Although the timber market is truly global, lumber and U.S. housing are very closely correlated.

For instance, a few hours before Rick and I sat down for lunch, the U.S. government announced plans to extend the $8,000 first-time homebuyer tax credit. That was expected. The market didn’t expect the extension of a $6,500 credit for other non-first-time homebuyers.

The reaction in the lumber trading pits in Chicago was euphoric. Lumber prices surged 5% and went “limit up” – the point at which trading is halted because the price has moved too much in a single day. It’s a very bullish sign.

The Russian Wildcard – Russia accounts for 22% of global wood trade. It is the third largest timber producer in the world behind Canada and the United States.

Russia has repeatedly proven its willingness to leverage natural resources to its political advantage. It has used oil and natural gas and -coming soon – agriculture (follow this link for Agriculture Report), with total disregard for the economic consequences in the country. Timber is about to join that group.

For example, Prime Minister Putin placed a 25% export duty on timber last year and announced it was going up to 80%, with the intention of encouraging foreign investment in Russia’s timber industry. The big increase has been delayed, but the delay is not indefinite.

The impact here is Russian timber became 25% more expensive on the world market with the swipe of a pen. And it’s only going to get more expensive. This creates a situation where timber production has much less competition at current prices.

In addition to all that though, other leading timber producing regions are facing their own set of challenges.

Pine Beetle Devastation – The biggest challenge facing the two largest timber producing regions is the pine beetle. Pine beetles bore through pine tree bark and basically kill the tree. They then move onto the next.

The pine beetle has ravaged forests across North America over the past few years. One of the hardest hit areas is in British Columbia, Canada. The timber industry throughout inland British Columbia has practically ground to a halt. For example, West Fraser Timber (TSX:WFT) closed its last timber mill in northern British Columbia last week. They had to shut it down because there aren’t enough trees. The pine beetle has killed most of them.

It doesn’t stop there; the pine beetle infestation is spreading. It has already spread through the U.S. northwest and has reached as far away as Colorado. The beetles have had the same impact there too. The Colorado State Forest Service recently reported 660,000 acres of lodgepole forests have been destroyed by the pine beetle. That’s more than 40% of Colorado’s forests!

To put the pine beetle infestations into perspective, think of timber like the oil industry. Then picture what would happen if Iran’s oil production was eliminated from the market.

Prices would go up – way up. That’s about what the pine beetle has done so far in the timber industry, but lumber prices haven’t gone up…yet.

Buying Low and Selling High

Needless to say, now is the time to get really interested in timber.

The industry has been decimated by the housing collapse. The sector is completely out of favor and assets are selling for pennies on the dollar.

The timber industry’s future, however, is quite bright for those willing to get past the knee-jerk “housing market is terrible” reaction and look at what’s really going on.

More importantly, all this truly shows there are folks looking to turn the current downturn into an absolute fortune. The markets may be weak and getting weaker, but as investors, we have the opportunity to get on board with the few who are doing it right and go along for the ride. It also shows the best low-risk/very high-reward opportunities will be limited to those of us with a contrarian approach looking where nobody else is.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

If you’re a Dividend Superstars subscriber, you should have closed out that position based on my recommendation in the issue that just went to press. I’m tracking a gain of 32.7 percent. Great!

Now today I want to talk about a couple of the other things I look at on charts … and how they apply to some of the other investments that I’ve mentioned before here in Money and Markets.

Let’s start with …

The Importance of Support and Resistance:
Understanding Investors’ “Lines in the Sand” 

Investors have a tendency to get hung up on certain numbers … quite often round ones. You know, like Dow 10,000.

I’m not a psychologist, so I’m not going to hypothesize on why it happens. But from many years of following the markets, I can tell you that it does happen with alarming regularity.

This is precisely why I pay close attention to clear levels of support and resistance whenever I look at any investment’s chart.

Let me explain with a real-world example …

Here’s a chart from Vanguard’s Inflation-Protected Securities fund (VIPSX), a good stand-in for the TIPS and I-Bond inflation hedges I’ve been regularly suggesting here and in Dividend Superstars …

In my past discussions of this particular fund, I pointed out that the low $12 level seemed very important psychologically to this particular investment. That’s because — as my trendline demonstrates — the fund had repeatedly bumped against this level before the credit crisis began … and again after the market rally started in 2009.

As you can see, once it recently broke through that level, it swiftly moved up another 4 percent. While that move might not sound huge, you have to remember that this is a mutual fund based on government bonds!

Are there fundamental reasons behind the move? Absolutely. Worries over a falling dollar and renewed inflation are obvious catalysts spurring investors to move into these hedging investments.

But that’s the point: These charts reflect the market’s collective thoughts and opinions. When events are enough to push an investment through a level that previously presented resistance … it means a certain critical mass has been achieved … and momentum quite often takes over from there.

Obviously the opposite is also true. When a level has previously held on countless downdrafts — forming a strong area of support — you better look out below the first time that level is seriously broken!

Now I’ll be the first to say that you never know when an important level is going to hold or not. However, simply being aware of critical breaking points — along with the fundamental reasons moving a market or an individual investment — will help you make more educated (and hopefully more profitable) decisions.

Of course, it never hurts to layer on one more relatively simple technical indicator that also measures levels of support and resistance …

Moving Averages: Another
Favorite Technical Analysis Tool

During my last analysis of Colgate in this column, I pointed to trendlines as a way to get a sense of an investment’s general direction.

Well, moving averages take trendlines to the next level because rather than being constructed somewhat arbitrarily (i.e. “pick a couple points that look important to you”), they are computed automatically based on a preset series of data. Specifically, a moving average is a line based on the arithmetic average of the prices it’s drawn against.

What’s the benefit? This way smoothes out all the little movements and creates a line that you can compare them to. Common moving average periods include 200-day, 90-day, and 60-day periods.

I like moving averages as another way to gauge general uptrends and downtrends, and to spot major market reversal points.

Speaking of which, here’s a chart of the S&P 500 with a 60-day moving average thrown in for good measure …

As you can see, the market is well above its moving average, and thus remains in an uptrend. Only a drop below the 1040 level would signal a change in that trend.

And perhaps the best part about technical analysis tools like moving averages is that they are no longer only available to professional investors with thousands of dollars in trading software. In fact, most online chart providers — including free websites like Yahoo Finance — now allow you to overlay these tools to whatever investment you’re viewing.

If you don’t already use these indicators, I encourage you to play around with them … they can give you another interesting way of viewing your investments.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Why do people consistently do things like this? Why do they wait until the last possible moment to move over, even when there were ten signs warning them to do so for the last five miles?

I lump them into two categories:

The first group wants to eke out every last possible foot before they merge, thinking they’re going to time it perfectly. Never mind that it rarely happens and they end up sitting in gridlock with everyone else. It’s not about the end result — it’s about the thrill of going for an extra advantage.

The second — and larger — group is simply not paying attention. Maybe they’re talking on their phones, shaving, or eating burgers. Whatever the reason, they don’t even see the signs in the first place. They’re blindly following the car ahead of them.

None of this is news to you, I’m sure. If you’ve driven on a U.S. highway, you’ve seen these people in action over and over again. But I bring it up today because these very same psychological mistakes can prevent us from successfully building wealth.

Let’s Start with the Proverbial Portfolio Lane Changers …

There’s nothing wrong with trying to actively manage your portfolio. In fact, I think you’re right to stay on top of your finances day in and day out.

However, I don’t think you’re going to get ahead by shifting out of an investment every time it slows down a little bit.

Not only will commissions — and possibly taxes — put a serious drag on your performance, but you face very stiff odds of regularly outperforming, too.

There’s an important difference between taking charge of your finances and making too many micro adjustments.

As a real world example, I’d point to my portfolio in Dividend Superstars. Some of our positions were initiated in the summer and fall of 2007 … right as the market was beginning to crack. And during the March lows, they had fallen substantially (though a lot less than the broad market).

However, their fundamental businesses hadn’t changed. The dividend income was still flowing. There was no reason to abandon ship, in my opinion … so I told my subscribers to continue holding.

Today, the shares have recovered quite nicely. And once you factor in the dividend income, they have really outperformed their benchmarks.

Had we jumped in and out, we would have run the risk of getting whipsawed over and over again.

So my message is this: If you’re already paying attention to the market “signs,” and adjusting accordingly … great! Just don’t overdo it. Major shifts should be undertaken only after much consideration.

Meanwhile, Inertia Can Be Even More Damaging
To Your Ability to Consistently Build Wealth!

I was recently at the Salvation Army to donate some items. As you’d expect, I asked for a donation form so I could write off these donations on my tax return.

That’s a logical thing to do, right? I mean, who wouldn’t take the two minutes to fill out a simple piece of paper for the chance to keep some more of their hard-earned dollars away from Uncle Sam!

Well, the answer is “a lot of people,” apparently.

I say that because as I was filling out my form, another guy next to me grabbed a form and asked me some basic questions about how it worked.

I explained that it was pretty simple. You just wrote down what you were donating and took your copy home with you. An accompanying piece of paper would tell you how much your items were realistically worth for deduction purposes.

He started to write down a word or two … then said something like, “Who am I kidding? This isn’t worth it!” He crumpled up the paper and walked away. And he wasn’t alone. I saw plenty of folks who just dropped stuff off and left.

Sometimes filling out a simple form can yield big financial rewards!

Look, if you’re just giving a couple t-shirts, I understand — it’s not worth the hassle. But I’m talking about people who were giving chairs, tables, and many other big items.

My point is this: Nearly everyone knows that donating to a charity is tax deductible. Yet not everyone will take even one very easy step to ensure that they reap the financial benefit of doing so.

Yet if you want to build and maintain wealth you have to not only think about money matters on a regular basis, but also have the discipline to follow through on your plans!

Consider retirement planning, one of my favorite subjects …

It’s no secret that contributing to a 401(k) plan makes sense for most workers. There are upfront tax advantages. Many companies toss in “free” money in the form of matched contributions. And it’s pretty clear that the traditional retirement anchors such as pensions and Social Security aren’t necessarily going to be there the way they were in prior years.

Yet according to mutual fund behemoth Vanguard, only 60 percent of workers eligible for 401(k) plans chose to participate in 2008.

Sure, you could argue that the other 40 percent had a better use for their money. Or that the recession crunched their finances to the point where contributions weren’t possible.

BUT, Vanguard also found that 84 percent of workers in 401(k) plans with AUTOMATIC enrollment participated.

That 24-percentage-point difference tells me that, for a lot of workers, the sheer “hassle” of filling out a simple form is too much of a burden. They’d rather miss out on all the great advantages of participation than do a couple minutes worth of work. It has nothing to do with their financial situations at all.

Want Prosperity? Just Follow the Rules of the Road!

Since you read Money and Markets, I know you’re already pretty serious about building — and maintaining — your wealth. You’re already very disciplined. And I’m positive that you know a heck of a lot more about financial matters than most other investors out there.

But I also know that we all change lanes a little too frequently, or fail to heed warnings along the road from time to time. So it’s nice to get a gentle reminder that little steps DO pay off down the line. And that it is indeed possible to obsess over your portfolio a little too much.

Remember, all the knowledge in the world doesn’t mean a thing if you don’t use it properly.

So continue to do what you’re doing, and always keep an eye on places in your financial life that you could improve. Here are just four areas off the top of my head:

Taxes: Whether it’s taking the time to fill out a donation form, or enrolling in a tax-sheltered retirement plan, there are plenty of ways to lower your tax bill.

Asset allocation: Periodically revisit your portfolio and make sure you’re happy with how much money you’ve got invested in stocks, bonds, commodities and so on. The percentages should jibe with your age, your risk tolerance, and your overall opinion of where the world economy is heading.

Specific investments: Don’t stick with winners or losers just because. Make sure their stories are still sound … and their purpose in your overall portfolio is still valid.

Your budget: I’ve discussed this in detail before, but it really pays to keep track of what you’re making AND what you’re spending. I think you’ll find that there’s always another way to put a little extra money away for a rainy day. And as many Americans are now discovering, getting thriftier can actually be enjoyable!

Heck, at least think about these things the next time you’re stuck in traffic. Because we all have the tools and potential to build wealth consistently. It just takes a little planning and a lot of patience.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Then it happened, the next great leg down occurred in one of the most vicious bear markets since the 1930’s. The economist’s out there all said the markets are fine and will recover shortly(December 2008). The markets nose dived into March 2008 when Bear Stearns collapsed and was bought by JP Morgan for $2 bucks a share(they later paid $10/share to appease the public).

In March 2008, the market rallied after the Bear Stearns collapse which was not called by any analyst or an economist that I know of. The low on the SPX in March 2008 was 1256 and when the SPX hit 1440 in May the bulk of economist’s and analyst’s everywhere were proclaiming a new growth cycle. Then on May 19th, 2008 the next move down took place in a violent, and fast decline. What happened to the new growth cycle?

As we all know the market has now put in a low in March 2009. This is on the back of a global coordinated stimulus plan by all central banks, a zero percent Fed’s fund rate, and money printing that the world has never seen before. What else could the market do for a few months but rally with that kind of liquidity? However, the analysts, and the economists are back in full force. Upgrades and downgrades are occurring like it was 1999 again(we all remember what happened in 2000). It still amazes me that people are upgrading JPM and the rest of the bank stocks now when these stocks have rallied 300%. Where were the upgrades when theses stocks were in the single digits or when JPM was $15 bucks. Lets not forget Goldman Sachs hit a low of $47 a share in late 2008 as well. However, the upgrades come pouring in when it hit $150 a share. Lets not forget all of these stocks have done huge secondary offerings diluting their shares so they are really above their 2007 highs in real terms. Yet the analysts love them up here and the economists say the world is on the road to recovery.

When the economists and analysts all say things are well in Mayberry it is time to get worried. This is something that much be watched. Why? Because it has called every major top in the market since 2000. I’m just waiting for someone to upgrade Lehman Brothers (that still trades on the pink sheets). Then I will know the top is certainly in.

Nicholas Santiago,
Chief Market Strategist
www.InTheMoneyStocks.com

However, while they each may use wildly different techniques (I spoke with one very wealthy trader who confirmed his chart patterns by looking at planetary movement and moon phases), all of them follow five rules without exception.   Some of them make hundreds of thousands – even millions – of dollars each trading their own account.  These aren’t your typical “always use a hard stop loss” type of rules .  These are actual guidelines successful traders follow religiously.

In fact, I’d bet that deep down you know you should be following these rules as well but you aren’t – yet.  Today is the day you can commit to doing what works for other wealthy traders and get on that same path.

Let’s get started.

1. They plan every single trade.  EVERY SINGLE ONE.
Every trader I’ve talked with that makes money consistently knows the following about every single trade they take before they even begin entering a limit order into their trading platform:

a) the highest price they are willing to pay (if they are going long) or the lowest price at which they are willing to sell (if they are going short)
b) their profit target where they will exit if they are “right”
c) their stop loss where they will exit if they are “wrong”
d) the risk/reward ratio of the trade
e) the exact percentage of their account they are risking

Lots of traders do one or two of these things.  Few do all of them.  In simple terms they know exactly what they want to pay, how much money they anticipate making (or losing) and a very clear idea on the probability of the trade working out.

Although you might think that every great trader uses hard stops that are pre-programmed in, many don’t . However, they are highly disciplined and when their stop loss number comes up they are out.  Most traders don’t have that type of hard-core discipline and so a hard stop loss is still their best option.

2. They stopped trying to pick tops and bottoms years ago
Nearly all of the classes, courses and webinars you’ll find on the Internet talk about using support and resistance of some type to find where a market is turning and how to get in before or while it does.

The funny thing is that only a very few successful traders I have ever talked to trade that way.  Simply put, 95% of the traders out there that make money are buying higher highs and selling lower lows.  They do the exact opposite of nearly everyone out there because they found out long ago that picking tops and bottoms is a sucker’s bet.  One trader described it to me by saying that it’s much easier to just participate in what a market is already doing than trying to guess when that behavior will change.  Flip-flop your strategy to agree with what the market is doing rather than guessing on when it will change its mind, and you’ll be in a much better position to make money trading.

3. They are patient with winners – and ridiculously impatient with losers.
Dennis Gartman is famous for boiling down great trading to one thing: “Do more of what is working and less of what isn’t.”   Sure makes a lot of sense to me.

Most traders have a great deal of patience with their losers but get nervous about locking in gains and sell them to quickly – the exact opposite of what wealthy traders do.  Wealthy traders realize that they may actually have more losing trades than winning trades so they quickly get out when they are wrong.  It is the only way to ensure that they can give their winners the attention they deserve.

They coddle their winners and kick their losers to the curb without a second thought.

4. They trade one market.  ONE
I’ve talked with great traders who can trade futures, forex and stocks at the same time.  They are a gifted tiny minority.

The vast majority of successful traders concentrate on one market and become so comfortable with it that they begin to “know” the behavior of that market just watching price and volume.  Test yourself – if you aren’t able to get rid of all your charts and simply look at price and volume to trade, you’re probably not concentrating enough on one market in order to know it’s moods.  What we’re really talking about here, of course, is not the mood of the market itself but the moods of the market participants!

Focus on trading one market exceptionally well rather than try to trade whatever’s hot – that’s how wealthy traders do it.

5. Their benchmark for success is anything but money
Money changes everything.  It sure does.  We’re all in this to make money.  The trouble is, when traders use the amount of money they make to judge their own success, something happens to them – to all of us, really – that clouds our decision-making ability.

Wealthy traders have realized this and instead focus on other things to determine if they’ve had a successful day. Whether it be how well they were able to execute on their trading plan (see rule #1), or their overall ability to predict short-term movements in the whatever they are trading, they know that if they do those things correctly, the money will follow.

Yes of course the money is important.  Any trader who says otherwise is a fool.  Why else would we put ourselves through this daily ride.  But there is something about making it a secondary focus that allows the best traders to make better decisions.  The growing trading account simply becomes a nice result – a side benefit if you will – of making good decisions and reading the market well.

Tim Bourquin
Co-Founder of TraderInterviews.com

Source: INO.com

This is why many bears — who have actually gotten more visible again during the past few weeks — say it’s time to get out of the market now.

These seasonal stock market statistics are certainly true. And after the strong gains since the July interim low, the market is due for a correction.

So the market may pull back a bit in the short term. But I don’t see it being more than a correction.

In fact, if stocks do go down during the next few weeks, you should probably consider that a buying opportunity.

Here are my arguments for that medium-term bullish view …

During This Phase of the Business Cycle
Fundamentals Do Not Matter …

To begin with, I want to put into perspective the power of bearish arguments based on the state of the economy.

First, during this phase of the business cycle — that is at the end of a recession or the beginning of a new economic uptrend — fundamentals do not matter for the financial markets. That’s because they’re mainly liquidity driven and based on hope, not on facts.

The gloomy state of the economy doesn’t mean a lot to the markets right now.

Moreover, economic data are a mixed bag at best. So the bulls and the bears can pick whatever news underlines their respective arguments. Only later during the cycle do fundamentals have to pick up to replace hope with facts. If they don’t, the bear will return.

Second, the Index of Leading Economic Indicators (LEI) rose four months in a row, finally crossing the zero line in July with a reading of 0.2 percent. This indicator has an excellent track record of calling important turning points in the economy. Right now it’s indicating the end of the recession. So there’s a good and historically valid reason for the above mentioned hope for some kind of a recovery.

Third, the stock market has a shorter time horizon than most of the fundamentally-based bearish arguments. So they’re not important now, but will start to matter later. And I expect the LEI and other time-proven indicators to warn us before this time arrives. Therefore, during the next three or four quarters I cannot see how the economy could collapse again, especially after all the recent massive worldwide stimulus programs.

Fourth, the stock market can ignore fundamental headwinds for a very long time. Fundamentals are long-term drivers of the financial markets. They have no short-to-medium-term predictive value. The very strong momentum of the current stock market rally gives you a clear hint that this rally has the power to ignore a lot of bad news for some time to come.

Plus …

The Market’s Technical Signals
Are Pointing to Strength …

Some medium-term bullish developments have taken place during the past weeks and months. You’ll see in the chart below, a very clear bottoming formation with a technically strong upside breakout.

S&P 500, Volume, Price Momentum Oscillator (PMO) 2008 — 2009

Source: www.decisionpoint.com

Let me explain the specifics in this chart, plus a few other technical indicators that aren’t shown …

First, most major indexes show very solid chart patterns. Take the S&P 500 as an example. You can see a nice bottoming formation, which started to develop in October 2007. The breakout, which happened this July, is a clear medium-term buying signal.

It indicates a medium-term trend change from down to up. The formation is an inverse head and shoulders, one of the most reliable patterns.

Second, coming off of the March 2009 low, momentum indicators (the rate of acceleration of price or volume) shown as PMO in the above chart, reached extremely overbought levels. This is typically a sign of impulse or a kick-off move.

Third, the breakout above the neckline of the bottom formation (950-955 in the S&P 500) was accompanied by very good market breadth (the number of stocks advancing relative to the number declining). This indicates a broad-based uptrend with most stocks and sectors participating.

Fourth, the advance-decline line and the advance-decline volume line both made distinct new highs for the year thus validating the new medium-term uptrend.

Fifth, two important indicators fell in line with the message of a new medium-term up trend: The 200-day moving average (MA200) changed course and started to rise. And the 50-day exponential moving average (EMA50) crossed the 200-day exponential moving average.

Sixth, longer-term sentiment indicators show that this rally is greeted by remarkable skepticism. Bull markets climb the proverbial wall of worry. This wall seems to be in a healthy condition.

What This Means For You …

Look at market drops as buying opportunities.

History shows that financial markets move in prolonged trends and can ignore fundamentals for a long time. And now the technical pictures of stock markets all over the world clearly show medium-term bullish patterns. They indicate a nascent uptrend and are usually followed by further gains.

In hindsight, technical indicators are telling us that a medium-term bull market had started at the March lows. So from now on, bull market rules apply. And the most important rule is: In bull markets, corrections are buying opportunities.

Best wishes,

Claus Vogt
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

I got a lot of positive feedback on the story … including much amazement that this simple approach could have produced such a powerful result during such a tumultuous time for the stock market.

Of course, a few people also chimed in with questions and concerns. Some wondered whether I just chose favorable dates for my case study. More importantly, a couple of the comments suggest to me that my major point about dollar-cost averaging got lost in the shuffle.

So today, I want to look at a “worst-case scenario” with dollar-cost averaging … and clarify a couple other points I was trying to make about the strategy …

A Worst-Case Scenario: A Tech Bubble Investor
Begins Dollar-Cost Averaging in 1999!

I have already shown you how a Great Depression investor would have fared with dollar-cost averaging. And more recently I explained that the strategy would have worked well during the market’s latest swoon.

But what about an absolute worst-case scenario? Well, I can’t think of anything worse than beginning to buy stocks around the new millennium … when prices were exorbitant and investor expectations were sky high.

In fact, as one commentator on my blog put it …

“I feel bad for the 30-somethings that started to pour money into index funds in the mid to late 90s.”

I know a lot of people who fall into that category … and a quick look at a chart of the S&P 500 will explain why the last decade has been tough for them:

As you can see — almost ten years later — the S&P 500 index is still 30.5 percent below where it was when the new millennium started!

So does that blog poster have a point? Yes.

Clearly, a decade of negative returns is one of the worst-case examples we can find for the U.S stock market.

The full data table is too long to display in this column, but you can see it by clicking here.

As before, I assumed our hypothetical investor put $1,000 every month into the S&P 500 starting back on December 31, 1999.

If you look at the data table, you’ll also notice that I highlighted all the times when our imaginary investor purchased stocks at a higher-than-current price. The vast majority fall into that category!

Now, here’s how it would have panned out overall:

Total investment: $117,000.

Total value of the investment ten years later (based on the S&P 500’s recent price of 1020): $103,155.

Return over the ten years: -11.83 percent or about -1.2 percent annually.

Obviously, that isn’t a great result. In fact, you’d be right to assert that even a regular old money market fund would have performed substantially better over the same period.

But here’s the thing …

That Criticism Assumes That You Were NOT Diversified
AND That You Had Perfect Foresight!

Look, it’s easy to sit here today and say that a money market or a bond index fund would have been the better place for all of your money over the last ten years.

But that isn’t how reality works. We never know — with absolute certainty — where a particular market is going next. So we rely on the best indicators and historical data we can find.

Historically speaking, there have only been a few periods in the last century where U.S. stocks have underperformed other asset classes like cash and bonds.

And even if you began investing at the very point when such an anomaly began, you only lost about 1.2 percent a year with dollar-cost averaging!

Meanwhile, nowhere does the law say that you weren’t allowed to put some of your monthly dollar investments into other assets like bonds or even precious metals.

In my opinion, that’s precisely what you should have been doing. And should continue doing today.

Which brings me to my main point about dollar cost averaging — it is a great investment strategy for people looking to build a solid portfolio over time … with minimal timing risk.

I’m certainly NOT using it to prove that investing in any particular asset class is the right way. Only that it helps minimize the risk that you’re getting into a particular investment at the wrong time.

Think about it. Someone looking to put a lump sum into bonds faces the very same challenge as someone putting everything into stocks — namely, that they’re going to get in at an inopportune time.

By allocating a set dollar amount to a broad bond index fund at set intervals, they would effectively limit their risk quite well. It’s a good alternative to the laddering technique I’ve discussed in the past.

Last, A Few Words About Case Studies and Dates …

Whenever we want to look at how a given strategy has performed historically … we have to choose a beginning date and an end date.

Sure, it’s possible to backtest something over every possible period. But to keep things simple, I generally pick out a couple timeframes that cover most major possibilities.

If you look at the example we just did today, you’ll notice how even going back a couple years earlier would have turned the study from a worst-case into a “pretty decent case scenario.”

Ditto on the end date. Based on current prices, we show a loss but …

If the S&P 500 goes to 1,300 next year, our hypothetical dollar-cost averager will go from a 1.2 percent annualized loss to a 1.2 percent GAIN …

And if the broad market simply gets back to its price when the averaging began (1469.25) … our hypothetical investor will be up 27 percent over the period, or 2.7 percent annually.

Again, not a barn-burning return … but still not bad during one of the most volatile decades for U.S. stocks ever.

So by all means, let’s continue to aim for better timing and better results than the averages. As you know, I am all for using more advanced approaches to get outsized returns and lower risk.

But let’s also recognize the power of simple approaches like dollar-cost averaging … for ALL asset classes … and particularly for accounts with long-term investment goals such as retirement.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Always buy undervalued stocks and sell them when they’re overvalued. Or more commonly: “Buy low, sell high.” Of course, if you’ve invested for more than a week, you know this is easier said than done.

Undervalued (cheap) and overvalued (expensive) are such subjective measures when it comes to investing. Most times we end up guessing and most times we end up overpaying.

But today, let me show you one amazingly simple way to always buy stocks that are truly cheap…

Why America’s Most Successful Investors Buy “Low-Density” Stocks

All you have to do in order to invest like Warren Buffett, or any of America’s most successful investors – and rack up easy double-digit gains – is to buy what I call “low-density” stocks.

I define density like this: The value the market assigns to the cash that a company has in the bank.

• A high-density ratio: Means the market overvalues the cash.
• A low-density ratio: Means the market undervalues the cash.

The reason I focus on cash is straightforward: It’s the most tangible, liquid asset – and the easiest to value. After all, $1 is worth $1, so it’s easy to tell when you’re overpaying or getting a discount.

Let me use an example to make this concept crystal clear…

• Company XYZ trades for $1 per share and has $1 per share in cash (total cash divided by shares outstanding).
• To calculate the density ratio, we simply divide the price per share by the cash per share. In this case, the result is 1.

Here’s the thing, though: A one-to-one ratio is uncommon.

Most of the time, you’ll have to pay a premium for a company’s cash. Right now, for example, the density ratios for more than 480 companies in the S&P 500 are higher than 1, meaning you’ll pay more for these shares than they’re worth in cash.

But it’s even rarer to find a stock trading at a density ratio below 1.

Density Ratio Below 1 = Cheap Stock & Massive Gains

A density ratio below 1 means a stock could be worth $10 in cash, yet it trades for $7.50. Or it’s worth $1 and trades for 75 cents, etc.

And rest assured, whenever America’s best investors can buy $1 for 75 cents or less, they do. And you should, too. That’s because these discounts, understandably, don’t last for long.

Just take a look at Cynosure, Inc. (Nasdaq: CYNO). It traded at a density of roughly 0.70 for about a month this year. Once investors woke up to the bargain on offer, shares surged 138% higher.

There’s another low-density stock up for grabs at the moment, too…

Buy This “Low-Density” Stock Today

If you want to put my low-density strategy to work today, consider Trident Microsystems, Inc. (Nasdaq: TRID), which makes specialized semiconductors used in flat panel televisions.

• With zero debt, $2.87 per share in cash, and a market price of $1.90, it trades at a density ratio of 0.66.
• In other words, when you buy Trident, you’re buying $1 for 66 cents.

Incidentally, such a steep discount also makes Trident a prime takeover target. And with $2.21 billion in cash, Broadcom Corp. (Nasdaq: BRCM) could easily afford the $125 million market cap Trident.

But, even if Broadcom doesn’t pounce on the opportunity, history dictates that other investors will.

Based on its low-density ratio, Trident needs to rebound 51% to return to a density ratio of 1.

I recommend you capitalize on this truly cheap stock before it’s too late.

Good investing,

Louis Basenese
Investment U

To be sure, stock prices in many of the markets around the world have come a long way since March. Investors who stood and watched as their portfolios were eviscerated last year have actually recovered at least part of their losses.

But now it’s looking like stock prices in some markets have risen more than was warranted – some of the hottest Asian markets appear to be overvalued – which means that it’s worth looking again at defensive investments that can protect investors from another stock market downturn.

There is no foolproof way of protecting your money against a market downturn. But a mixture of international investments, gold, put options and high-yielding dividend stocks will help you sleep better at night. Just as importantly, those investments will also behave decently even if the market doesn’t crash.

Traditionally, the most frequently used defensive investment has been to keep cash in bank deposits or money market funds. However, with short-term interest rates at zero and inflation still between 2%-3%, keeping funds in cash is a recipe for a slow erosion of its value. What’s more is that inflation is likely to creep up substantially before the U.S. Federal Reserve gets serious about raising interest rates, so that value erosion could become substantial.

Also, if short-term rates and inflation are both running around 5%, the saver still will lose, because he or she will have to pay taxes on the interest received and will get no tax reduction to compensate for the value lost to inflation.

The likelihood that inflation will resurface makes bonds an even worse defensive investment. The income is usually fully taxable and it probably won’t cover the cost of inflation. (Municipal bonds are tax-free, but subject to the currently deep dangers of U.S. state and municipal finance.) Even the nominal principal value of those bonds will decline if interest rates rise.

There are a number of reasons why long-term interest rates may rise. In fact, I can think of three offhand:

• Inflation and a rise in short-term rates could push the whole yield curve upwards.
• Government deficits may become hard to finance, which will force up Treasury bond yields.
• The Chinese and Japanese central banks – and other big holders of Treasury and housing bonds – may get fed up with the low returns and uncertain currency outlook. They could sell their U.S. bonds and replace them with euro, yen or renminbi (yuan) bonds.

So, if the choice were between long-term bonds and cash, I would recommend cash.

The traditional investor remedy for inflation is gold and gold-linked investments. I would certainly recommend moderate holdings of these, but would avoid a complete devotion to them. For one thing, the gold price is already high by historical standards, and perhaps a little risky. There must be some chance that the global recession will be deeper and more prolonged and inflation more timid than I project. So, holdings of metallic gold, gold-mining shares and other precious metals such as silver, platinum and palladium should be no more than 20%-25% of your portfolio.

Another good way to hedge against risks in the U.S. stock market is to buy international stocks.

India’s market, in particular, looks slightly overvalued at 20 times earnings. The lowest Price/Earnings (P/E) ratios are in Russia and Venezuela, but with the problems and issues they face, it would be silly to invest in either of those countries today.

Countries like Finland, South Korea and Germany are, perhaps, the most attractive. Their budget deficits are well under control and their economies are showing signs of renewed expansion. It’s well worth thinking about a modest diversification into the markets of nations that have been notably distant from the toxic assets that led to last year’s financial meltdown.

In recent years, inverse exchange-traded funds (ETFs) have become popular hedging mechanisms. These typically take a short position in stock index futures, so their share price rises when the index falls.

There are two problems, however. The obvious problem is that these ETFs are vulnerable to a rise in the index. The less obvious problem is that because the funds must rebalance daily – according to the amount of shares in the fund – they can accumulate “tracking errors,” which means that they end up rising less than the index falls.

Even the Rydex Inverse Standard & Poor’s 500 Strategy Fund (RYURX), which has been running since 1995, is currently only around 10% above its 2000 low, while the Standard & Poor’s 500 Index is more than 30% below its 2000 high.

This problem is much worse for so-called “leveraged inverse funds,” which are supposed to move two or three times as much as their index. These can accumulate tracking errors at an alarming rate – especially with highly volatile indexes in overseas markets. For less volatile indexes, such as the ProShares UltraShort 20+ Treasury Fund (NYSE: TBT), the tracking error is much less.

Nevertheless TBT is only a moderately good hedge against rising interest rates, unless that rise happens quickly.

The best way to hedge against a huge bear market, like that of 2007-2009, is to buy long-dated out-of-the-money put options on the Standard & Poor’s 500 Index (SPX). These are traded on the Chicago Board Options Exchange (CBOE). You can buy these out to December 2011, and those with strike prices of 500 or 600 are currently reasonably priced, at $23 and $38, respectively. To get the value of the actual contract, you multiply by 100. So, for example, $3,800 will buy you an option to sell the SPX at 600 (so 100 units represents $60,000 of stock) in December 2011. Then, if at some point before December 2011, the SPX is trading at 450, you will sell your options, receiving something north of $15,000 for your $3,800 investment.

As with gold, your investment in these options should be limited – perhaps to no more than 5% of your stock portfolio. However, they can have the great advantage of providing investment cash and morale-boosting profits when the market gets hit and is truly depressed.

Finally, you can adjust your stock portfolio itself by buying stocks with strong dividend yields. These will fluctuate with the market, but the dividends they give off will provide you with an additional return, over and above the current measly 2.6% dividend yield of the S&P 500 Index. Moreover, that return will generally rise with inflation (as the company’s sales and earnings rise in dollar terms) so your high income will be much better protected against inflation than you’d be if you were relying on income from bonds.

High dividend stocks, whose dividends are covered by earnings, are typically also low-P/E stocks. Thus, by buying them you are buying at the “value” end of the market where bubble-induced overvaluations are less of a risk. In my view, however, a low-P/E stock that pays a high dividend is greatly preferable to one that doesn’t. That’s because management is giving shareholders a chance to reinvest the money, rather than keeping it to spend on crazy expansion schemes or their own perquisites. There is also less of a chance for the company’s earnings to be fudged through some funny and complicated accounting quirk.

By Martin Hutchinson
Money Morning

My house has been turned upside-down, as she prepares to redecorate several rooms. Fortunately for the household, my input is neither required, nor requested.

Undeterred by the recession, the missus has made Pottery Barn her second home. And look for Williams Sonoma’s (NYSE: WSM) earnings to cruise higher next quarter, thanks to her spending there.

Trouble is, when I return home from work, the items I expect to find in their regular spots are gone, replaced by new stuff.

Yesterday, I found my books lined up in the hallway and was asked to donate the ones I don’t want anymore. However, a good chunk of my library consists of investing books, which I like to consult from time to time.

I’m often asked for recommended investment books, and as I transferred the books from the floor to the new bookshelf (excuse me, escritoire), I revisited some of my favorite titles. Here are the ones that I’ve found most valuable in my career…

Let These Authors Propel You Towards Greater Investment Success

Make some room on the bookshelf – because you’ll want to add these investment books to it if you want to increase your chances of investing success…

• Contrarian Investment Strategies – The Next Generation (David Dreman): My colleague Louis Basenese mentioned this in his investing in small-caps column earlier this week. Like my beloved Yankees, Lou has been knocking the cover off the ball, thanks in part to Dreman, who is considered the father of contrarian investing.

As an analyst, I worked at a strictly contrarian research shop. In fact, I wasn’t even allowed to initiate coverage on a company unless it went against the consensus. I trained with two of the greatest contrarians in recent decades. So believe me when I tell you that Dreman’s book is a must read. It shows you how and why contrarian investing works.

• Understanding Wall Street (Jeffrey Little): This is the first book I ever read about investing. It’s terrific for beginners. Written in an easy-to-understand language, it explains what stocks and bonds actually are. If you’re new to investing, I cannot recommend this book enough.
• The Little Book That Beats the Market (Joel Greenblatt): The author is an extremely successful money manager, who shows investors how to beat average market returns with a value investing approach. You can read this in one afternoon, yet it contains as much valuable information as you’d find in most 500-page tomes.
• Get Rich With Options (Lee Lowell): If you want to know how to make money with options, learn from the guy who did it and retired in his 30s. Mt. Vernon Research’s resident commodities specialist, Lee Lowell, shows investors the most profitable strategies and tools to use. The second edition of the book is due out in September.
• One Up on Wall Street (Peter Lynch): This classic teaches investors how to use what they are already familiar with to make money. Lynch takes a long-term outlook as he guides investors through the analysis process of companies that we interact with every day.
• The New Market Wizards (Jack Schwager): Profiles successful traders such as Stanley Druckenmiller, Linda Bradford Raschke and Blair Hull. I like that the traders open up in these interviews, letting readers in on their processes and hearing about their failures just as much as their successes. Schwager does an excellent job of selecting traders in various markets with different trading styles.
• Reminiscences of a Stock Operator (Edwin LeFevre): No investment book list would be complete without this. Originally published in 1923, it’s the marginally fictionalized biography of legendary speculator Jesse Livermore. It’s believed that Livermore actually wrote the book with LeFevre’s help. Livermore walks the reader through his considerable ups and downs. It’s a fascinating tale and a really insightful look back at market speculation in the early 20th century.
• Technical Analysis of the Financial Markets (John Murphy): While technical analysis can sometimes sound very complex, Murphy does a great job explaining the theories and indicators in a simple language. If you ever look at charts, you need to read Murphy’s book first – it’s the bible of technical analysis.
• The Secret of Shelter Island (Alexander Green): Once you’ve read all the investing books and amassed a fortune, The Oxford Club’s Investment Director will illustrate why money is not the most important thing in life. A compilation of his popular Spiritual Wealth essays, Shelter Island provides inspirational, whimsical and sentimental stories that remind the reader what is truly important.

What are some of your favorites? Leave your comments below – I still have space in the escritoire.

Good investing,

Marc Lichtenfeld
Investment U

Clearly, you wouldn’t get far.

Yet it’s not uncommon to run into investors who are knee deep in option trading, currencies, short selling, or sophisticated arbitrage strategies without mastering – or even understanding – basic investment principles.

Even seasoned hands can benefit from a refresher course from time to time.

So today we’re going to revisit Investing 101 and talk about the six factors that will determine the future value of your investment portfolio, whether it’s worth $10,000 or $10 million.

Six Factors That Determine Your Portfolio’s Future Value

Those six factors are:

• The amount of money you save. To put it bluntly you have to start by maximizing your income, minimizing your outgoing and paying yourself first. Why? Because expenses always rise to meet the income available. As soon as you get a raise or a higher paying job, you’ll find that you need a new car, a bigger house, better furniture and a new set of Callaway irons. But you have to draw the line somewhere. You can’t save a pittance and expect your portfolio to perform miracles each year.

• The length of time your money compounds. The sooner you start investing the better. And the longer you leave it alone the better. If you start too late – or raid your portfolio to redo the kitchen or take the kids to Disney – you’re going to have a lot of catching up to do down the road. The old chestnut is true: Don’t touch your capital. It’s like eating your seed corn.

• Your asset allocation. Studies consistently show that how you divide your portfolio among non-correlated assets – stocks, bonds, real estate investment trusts, precious metals, etc. – determines 90% of your portfolio’s long-term return. (The rest is due to security selection.) If you’re too conservative – or too aggressive to stick with your program – you simply won’t meet your goals.

• Your assets’ annual return. This, of course, is the great unknown. Not even Warren Buffett or Ben Bernanke can say what their portfolio will return each year. But the better your security selection and asset allocation decisions, the higher your annual compounded returns.

• What you pay in expenses. Don’t be oblivious to what all those financial intermediaries are charging you. You can sacrifice far too much in commissions, bid/ask spreads, wrap fees, management expenses and other costs. All things being equal, the lower your expenses the higher your net returns.

• How much you pay in taxes. Too many investors are oblivious to the tax ramifications of their investment moves. When possible, put your high-yielding investments in your tax-deferred accounts and your tax-efficient funds and individual stocks in your non-retirement accounts. (I call this your asset location strategy.) Hold positions 12 months or more to qualify for the lower long-term capital gains tax rate. Offset your capital gains with capital losses if possible.

Only one of these six factors is beyond your control: your assets’ annual compounded return. That means it only makes sense to focus on the other five.

Investing 101: Don’t Worry About The Markets…

So instead of worrying about what the market will do between now and year end – something you can’t possibly know and has nothing to do with what your portfolio will be worth five or 10 years from now – focus on:

• Saving more,
• Leaving it alone longer,
• Getting your asset allocation right,
• Lowering your expenses
• And keeping a close eye on taxes.

Get these big questions right and you’ll find the details will take care of themselves.

Better still, in your golden years, your portfolio will take care of you.

Good investing,

Alexander Green
Investment U

In the last two years, I’ve:

• Gone long the dollar when it was in the tank…
• Shorted oil near its peak…
• Shorted the big move to Treasuries on the heels of the credit crisis…
• And, most recently, shorted gold at $918 an ounce.

At the time of recommendation, each trade was extraordinarily unpopular, prompting some folks to flat out question my sanity. And yet, taking the dissenting opinion made money each time (the jury’s still out on the shorting gold trade.)

How’d I find the wherewithal – and nerve – to do it?

David Dreman – The Father of Contrarian Investing

I’ve been under the tutelage of David Dreman, known as “The Father of Contrarian Investing,” for many years.

Dreman literally wrote the book on contrarian investing. (If you don’t own a copy of his latest work – “Contrarian Investment Strategies: The Next Generation” – get one!)

In the book, he lays out his straightforward, time-tested investment philosophy to consistently outperform the markets: choose cheap investments that other investors hate.

Sounds too simple to be true, I know. But like any trading genius, Dreman’s track record underpins his investment philosophy…

• Since inception in 1988, his flagship large-cap value fund’s average annual return of 9.2% beats both the S&P 500 and Russell 1000 Value index by a full percentage point. His small-cap value fund has performed even better.
• Since inception in 2003, it has trounced the Russell 2000 Index (the benchmark for small-cap investments) and the S&P 500 index by more than seven percentage points.

Investing in Small Caps Predictions Ring True…

Recall, in January I predicted small cap investing would shine this year because they always do coming out of recessions. And this time has been no exception.

• From the March 9 bottom, small-cap stocks are up 50%, compared to 40% for large-caps stocks.
• And using history as our guide, we can expect more of the same ahead – small caps to trump the gains of their larger-cap peers for at least three more years.
• Thus, not capitalizing on this disparity would be foolish.
• Furthermore, the recent rally has increased stock valuations virtually across the board, so finding winning stocks will require increasingly more investment skill.

And that’s where Dreman comes in… No one on earth is better at unearthing small-cap value investments than he has been.

So how does he do it?

• First, he exploits the fact that the U.S. stocks with the lowest 20% of price-to-earnings ratios returned 16.8% per year from 1920 to 2004 – four percentage points better than the market as a whole. He buys nothing but such undervalued stocks.
• That said, he doesn’t just focus on the “cheapness” of a stock to determine its worthiness. “We don’t like dogs,” says Dreman, adding that, “All our stocks are financially strong, have high yields and earnings growth faster than the market.”
• He pays great attention to the stock filtering process, as well. Specifically, Dreman looks for companies with market caps between $300 million and $2.5 billion. Those are then screened based on their respective P/Es.
• Stocks with P/E ratios greater than the market get discarded, immediately (Dreman is innately opposed to paying a premium for growth). And the remaining companies (those with P/E ratios below the industry median) must possess an above average dividend yield, low leverage, low price-to-book and price-to-cash flow ratios, strong management teams and a catalyst that could spur future growth.

The result is typically three to four stocks in each industry group, with only one or two making the final cut.

Collectively, Dreman uses this investment process to construct a portfolio of 95 to 100 stocks from 50 different industry groups, with a 1% weighting to each. Such a small position size means that a single security can’t sour the overall portfolio performance. Which adds another layer of downside protection. (Deep-value stocks are inherently less risky than high-flying, high P/E growth stocks, anyway).

So clearly, Dreman does much more than simply buy small cap companies that investors have discarded, or ones in the midst of tough times. As he puts it, “We look for reasonably strong companies on the whole.”

But to really put his words into perspective, let’s consider a recent purchase…

Dreman Invests In Small-Caps With Aaron’s Inc.

Last year, Dreman added Aaron’s Inc. (NYSE: AAN) – a small-cap company that allows consumers to rent-to-own plasma TVs, household and office furniture and computers, without any credit checks.

Most investors looked at that business model, cringed and sold the company’s stock, causing it to lose 33% in 2007. After all, could you get any riskier than catering to consumers with poor or no credit during a credit crunch?

Dreman, of course, is too smart to fall for that. This guy can sniff out his prey from a mile away. He knew the current credit freeze was about to push previously credit-worthy buyers away from Best Buy and right through Aaron’s front doors. And with the stock trading at a historically low valuation below 11 times earnings, it was a no-brainer.

Sure enough, with an uptick in demand, Aaron’s earnings jumped a solid 19% last year alone.

And the stock defied the market, rallying 39% in 2008 while everything else took a bath. This year, it’s tacked on another 25%, thanks to a 55% jump in earnings in the first quarter.

Bottom line, small cap stocks can be some of the most profitable investments in any market. Should this market pull-back continue, consider this another great opportunity to pick up some attractive small caps.

But like Dreman, I recommend you stay away from dogs at any price.

Good investing,

Louis Basenese
Investment U

Martin Denholm, Managing Editor, Smart Profits Report

A Five-Month “Fun Run” For Stocks That Fooled Investors

Over the past five months, world stock markets have put on a historic rally. Since March 9, for example…

• The S&P 500 is up 47%.
• The small-cap Russell 2000 index is up 63%.
• The EAFE international index is up 67%.
• The MSCI Emerging Markets index is up 71%.

But just five months ago, investor sentiment was as black as Halloween night and equity mutual funds were experiencing massive outflows.

How did millions of investors get it so wrong?

The short answer is this: They didn’t know that the economy can’t be reliably forecast and the stock market can’t be consistently timed. They didn’t know that abject pessimism is a long-term investor’s best friend.

And, perhaps most importantly, they didn’t know that it was never likely that we were heading into another Great Depression.

Here’s what is really going on…

The 1930 Depression vs. The 2008/2009 Recession

Read your history and you’ll see that the Great Depression was caused by policy errors: tight money, higher taxes and protectionist legislation.

And while the federal government has done a lot of things wrong since this economic crisis began, it hasn’t been so foolish as to make the same mistakes it did almost 80 years ago.

The Fed has taken short-term interest rates to zero – a powerful tonic. Bernanke is flooding the system with money.

Plus, Uncle Sam is spending money like there’s no tomorrow (too much, in fact). And we haven’t had trade wars with foreign nations.

Bear in mind, economic knowledge in the 1930s was like medical knowledge in the Victorian era. We’ve come a long way since then. No one is going to bleed the economy with leeches.

Yet the gloom-and-doomers, the folks who see the cloud in every silver lining, have never understood this.

Apply The Santayama Philosophy To Your Investing Mentality

Not only have they completely missed out on the stock market’s big gains, but the highest-yielding money market in the nation yields less than 1%. Gold is stuck in neutral. And many with the strength of their convictions are holding double-short funds that have lost most – or nearly all – of their value.

These investors never seem to realize that the media delivers the world through a highly distorted lens.

For example, time and time again, we hear the same news: The economy is in contraction… unemployment claims are increasing by more than 400,000 a month… real estate is spiraling down… consumer spending is anemic… business investment is down… credit is tight. It makes it tough to muster much confidence to buy stocks.

But as I wrote just one week before the market bottomed:

“Irrational exuberance is as dead as Che Guevara. And while true contrarianism is by definition a lonely business, 10 years from now, this market is likely to be viewed as one of the great buying opportunities of our lifetimes. Many investors will disagree, of course. And that’s fine. As George Santayana famously said, ‘Those who cannot learn from history are condemned to repeat it.’”

It hasn’t take 10 years, of course. Or even 10 months. (Although it’s unlikely that we’ll see this bull market reach much higher levels without a few interruptions).

Stick With These Two Core Principles To Boost Your Investment Success

Two of our core principles are…

1. Owning a diversified portfolio of profitable businesses is the best way to protect and enhance long-term wealth.
2. The best time to buy will always be when the majority of investors are despondently selling.

These principles have served us in good stead. That’s why we call them principles.

Good investing,

Alexander Green
Smart Profits Report

But here’s the stark reality: The money Uncle Sam gets from personal taxes, payroll deductions, corporate taxes and various other duties is a little more than half of the money it’s spending. The difference (deficit) has to be made up either by reducing spending, increasing taxes, or both.

It’s an unpleasant reality, but that doesn’t mean we’re helpless against these changes.

Many don’t know why or how much our Gross Domestic Product (GDP) relates to the taxes we all pay. So let’s take a look at how it’s determined and why it’s important. And best of all, how we can even profit from these charges – I mean changes – and make money in the process.

GDP: What is it and Why Should I Care?

Gross Domestic Product – or GDP as it’s most often referred to – is the basic measure of a country’s economic performance.

It’s calculated in a number of ways. One of the most common is the total money spent to purchase the final goods, end products and services produced in one year.

It’s a very big number: In 2008, the International Monetary Fund estimated that the GDP for the entire world was $68.9 trillion. Not too surprisingly, the United States’ share is by far the largest: $14.2 trillion, or about 20.6% of the total.

• It stands to reason that if GDP is rising, economic growth is increasing, unemployment is falling and tax revenue is increasing.
• In the United States, the consumer has historically been responsible for 70% of the nation’s GDP, and that’s what’s sustained our long run of economic growth.
• But now, the consumer’s ATM is tapped out… kaput. He’s now too busy saving and paying down debt (a good thing) to be able to spend money at historical levels.

As a result, GDP – and by extension economic growth – is falling, and unemployment is rising. As a result, federal and state tax revenues are dropping.

So who or what is going to make up the GDP difference? Of course, there’s always the hue and cry of cutting government spending. When was the last time – under any administration – that you actually saw government shrink?

It’s been awhile, but I can assure you that at least at the state and local levels, government is laying off workers and tightening its purse strings. But that won’t be enough: taxes will have to rise to make up the difference.

Our Rising Tax Predicament Was Foreseen in the 19th Century

It’s interesting to note that this scenario was foreseen hundreds of years ago. You see, way back in the 19th century, German economist Adolf Wagner predicted that as societies grew more affluent, taxes would inevitably have to rise. This became known in economic circles as Wagner’s Law.

The reason is simple: A nation’s citizenry ultimately wants more of the things that only its government can easily provide. All those good schools, public order and safety, a strong military, and various public welfare services and Social Security benefits all cost money.

While I’m not a fan of big government, most of these are things the average citizen would have difficulty providing on their own.

Arguments are made all the time that as more social services are provided, there is less incentive for people to work. The reality though, is quite different.

Even when taxes rose sharply – as they did in the early part of the 20th century – from only a couple of percentage points of GDP to the current level (18%), the country still prospered.

Now they will have to rise again, to make up the gap in social service spending. Although there is much ballyhooing about it, the country will still prosper, as most people are quite comfortable from a material standpoint.

So what’s the best way to “play” the inevitable tax increase?

Three Ways To Play The Coming Tax Increase

My answer might surprise you, but I believe there are three sectors that will fill the consumer spending “deficit” and fund an economic recovery: energy, infrastructure and health care.

Both energy and infrastructure will benefit for the next several years from the billions being thrown at the sectors via the stimulus package as well as coming tax increases. We’re just starting to see the first of what will be many large highway, bridge and other infrastructure projects, as well as energy infrastructure undertakings associated with the smart grid.

Regular readers know I follow the first two very closely. Marc Lichtenfeld – an Investment U contributor you’ll be hearing a lot more from in the coming weeks – is an expert on the third. Read about Marc’s ideas on partial profit taking.

• Right now, analysts and most investors are shunning the energy ETFs, many of which are off 25% or more from their highs of last November. Of course, that’s the very reason you should consider taking a position in one.
• Specifically, take iShares Dow Jones U.S. Energy (NYSE: IYE), a fund that seeks to replicate the performance of the Dow Jones Oil and Gas Index. It includes companies in all facets of oil and gas: producers, equipment and distribution.

No one likes higher taxes, but in the coming weeks and months, these three sectors stand to benefit from the coming increase in government spending. We’ll be bringing you more on all three over next few weeks and months.

And remember, there’s always a way to make a profit.

Good investing,

David Fessler
Investment U

For example, one reader wanted to know how options can work with short positions – and referenced doing so on Yamana Gold (NYSE: AUY). We talked about protecting against downside risk with long positions the other day, so let’s look at the other side.

In this case, I’m assuming that you’re short on Yamana and trying to manage the position in order to not take a big loss in case it moves against you.

The way to do this would be to buy out-of-the money call options to protect you against any sharp moves up. This is like insurance. You’ll lose a little bit of money, but your downside will be capped once the option goes in-the-money.

The problem here is that if Yamana trades sideways, you’ll lose on the call option and would have to buy more as each one expires. The way around this would be to buy a LEAP call option, but it will be more expensive and eat away at your potential profits.

Here’s a couple more questions on options that many investors have been asking.

Explaining The Benefits Of Buying Deep-in-the-Money Options

“Please explain the benefits of buying deep-in-the-money options.”

• The buyer stands a lesser chance of benefiting from deep-in-the-money options than the seller, since the underlying shares must rise in order for the buyer to make money.
• On the other hand, the seller can either have Yamana stay at the same price, move up, or move down to make money. Just as long as it’s not by more than his cost. The seller clearly has the better end of this deal.

So what prompts buyers to buy these options? Simple… they’re speculating and only want to risk a little bit of money, as opposed to buying the shares. They’re betting on a strong move up, but will unfortunately lose out 70% to 80% of the time.

That’s why we don’t buy short-term options. Because doing so is basically saying that we can predict where Yamana will be by expiration in a few weeks or months.

Options Investing: What to Do When Your Options Expire

There’s been a number of options investing questions that deal with “what happens next,” after the transaction closes.

“Whenever I read about covered calls strategies, there never seem to be much information of what to do after expiration. For example, if the shares get called away or increase in share price, do we buy the same shares again? And do we still sell deep-in-the-money calls then?”

It depends on your goals.

• For us, when we’re using the deep-in-the-money strategy, the objective IS to get called away every time since we are looking to own the shares at lower levels.
• However, if you’re looking to own the shares and continuously sell calls, then you would buy back the calls the day before expiration, taking advantage of all the premium you have captured from the expiration of time value and volatility.
• Then you would sell another option with either a higher strike and further out. This is called “rolling” your trade.

“If the shares don’t get called away, due to a drop in the share price, do we sell covered calls again, except at a lower strike price in order to get a good premium? Or do we sell out-the-money calls now (but the premium is lower).”

• With the strategy we use, we always try to sell options at the same strike price.
• So if the shares are lower than the strike price and we hold onto them, we’d then sell options at the same strike price and lower our cost even more.
• Our goal is to own the shares for zero or negative cost.

If you want to go out-of-the-money, you’re now engaging in a pure long strategy, which is not the goal of deep-in-the-money investing. The worst case is that the shares fall well below the strike and your cost.

In this case you can either book the loss, or if you’re investing in a very good company, you just hold the shares until they recover. This happens about 20% to 25% of the time.

This is also the reason why you should only invest in companies that you truly do want to own… because sometimes you’ll end up owning them.

Good investing,

Karim Rahemtulla
Investment U

After all, if you know what you’re doing, your chances of success are greatly heightened. And that’s especially true in the sometimes murky world of options.

For example, I often get questions from folks at seminars, asking why I don’t use strategies like butterfly spreads, condor spreads, or iron crosses.

Simple. They’re too complex!

There are many strategies that are much easier to execute than these and are proven to work time after time, so why confuse the issue?

Even if you’re an options aficionado, I believe in keeping it simple. Making a complex trade only defeats the purpose. Just because a trade is complex doesn’t necessarily mean you‘re going to get higher profits or greater win rate consistency.

Over the last couple of weeks I’ve addressed covered call selling, using deep-in-the-money (DITM) options – my favorite way of executing the strategy.

Today, I’m going to focus on Long Term Equity Anticipation Securities (LEAPS) – options that expire anywhere from a year to three years.

The Beauty Of LEAPS

If LEAPS is a new term for you, don’t worry. While it sounds a bit long-winded, it doesn’t involve any fancy or complicated tricks. But because LEAPS are options that expire over a longer period of time, it gives investors a solid method to invest in stocks either from the long side or the short side.

LEAPS offer several advantages over common stocks and you essentially just need to adopt an outlook of less than two years… maybe two-and-a-half years at most. And given that over the past decade, we’ve increasingly become a nation of traders rather than investors, due to immense market volatility, it’s a good strategy for most people.

And since LEAPS expire in a couple of years or less, forget “buy-and-hold” stocks or “legacy” investments. This kind of mentality has pretty much gone by the wayside since we really can’t trust anything we hear from Wall Street anymore. Need I remind you of companies like American InternationalGroup, WorldCom, Global Crossing, Washington Mutual and Enron – all of which have shown us that lying is often an art form in the investment and corporate world?

Cheaper And Better Than Traditional Investing

LEAPS allow you to invest in the same company that you were going to buy shares in… but for a fraction of the cost.

For example, let’s say you want to buy 1,000 shares of Goldcorp (NYSE: GG). At its current price, that’s a hefty outlay of $38,000. And it’s totally unnecessary, since LEAPS allow you to practically replicate the investment over a two-year holding period.

For example, you could control 1,000 shares by buying 10 options contracts (one contract consists of 100 shares of the underlying stock) at the January 2011 $35 strike price for about $9,000. That’s less than 25% of the stock price.

If you’re taking a bullish stance on gold and establish a price target for Goldcorp of $60 or so, here’s how the profit potential breaks down…

• $60 minus $35 (the options strike price, at which you have the right to buy the shares) = $25
• $25 (gross profit) minus $9 (cost) = $16, or $16,000 in net profit.

Two more big benefits…

• If you employed a 25% stop-loss on your shares, you’d actually lose more than if you bought the option and held it for a complete loss.
• By using LEAPS, more than 75% of your money isn’t tied up in the shares – money you can use for other investments.

And that’s just the beginning…

Over the next few columns, I’ll introduce you to several LEAPS options strategies. So stay tuned.

Karim Rahemtulla
Smart Profits Report

For example, I’m used to explosive gains in the biotech world, but I’ve never seen a moonshot quite like this one…

Shares of Vanda Pharmaceuticals (Nasdaq: VNDA) rocketed up by 625% on news that the company’s schizophrenia drug, Fanapt, was FDA-approved. Earlier, the stock had opened at $9.99, having closed at $1.08 per share on Wednesday night – that’s a massive 825% spike.

Even for a biotech veteran like me, a one-day percentage move like this is unprecedented.

When you reel in a big winner, you need to know when to dash off with the money. We recommend investors use trailing stops to help the lock in profits and prevent losses, but there is another strategy you can use when you see one of your holdings take off on you and that is to take partial profits.

Partial Profit Taking Lowers The Inherent Investing Risk

All investing carries inherent risks, even more so when we deal with small-cap stocks and the volatile biotech sector. We want to lower that risk whenever possible. However, that doesn’t mean we avoid risk all together – on the contrary.

It means that any position we enter should have significant upside potential to offset that risk. The more risk… the more profit potential I need to recommend the stock.

Sometimes, good news is already priced into a stock. In the case of Vanda Pharmacueticals, it clearly wasn’t. The reason why VNDA shares were so explosive is because virtually no one expected Fanapt to get the green light.

No doubt some VNDA investors were popping champagne corks, following the small-cap biotech’s liftoff. It’s probably made their year.

Others, however, are still trying to recoup their losses from the stock – even after today’s monumental surge. That’s because two years ago, VNDA was trading around $25.

Many investors who use trailing stops also pull money off the table when they feel a stock has moved up considerably – It could have helped VNDA shareholders two years ago.

Taking some money off the table when you’re up is another way to lock in your gains and “sell high.” Unfortunately, many investors don’t.

The Four Purposes of Partial Profit Taking

I’m a big proponent of partial profit taking on a winning position when appropriate. If a small-cap biotech stock is up significantly, locking in some gains serves four purposes:

• Returns Investment Capital: While remaining in the position, I now have capital to put into other opportunities.

• Helps Weather The Downside: If I still believe in the company and the investment, partial profit taking allows me to give the stock more room to fluctuate, as I’m no longer concerned with losing my original investment. It makes it possible to loosen up my trailing stops.

• Participate In Upside: Having secured my original investment, I can now allow my winners to run. That’s where truly large gains happen.

• Removes Emotion from your Decisions: An unemotional investor is a smart investor. Knowing that you’re playing with “the house’s money” can allow you to make decisions based off your risk tolerance and investment horizon, not emotion.

Recently, when I recommended that subscribers take partial profits in a top-performing stock, I received a ton of email asking why… particularly when I expect the stock to go significantly higher.

I emphasized the reasons above – that taking some profits lowers our level of risk, while still allowing us to go for the home run.

I’ll give you another specific example…

In my small-cap healthcare service, Access, we took 65% gains in half our position in SIGA Technologies (Nasdaq: SIGA). That’s allowed us to let the stock run to current levels, which are now 158% above our entry price. It also allowed us to use that money for a number of other winners.

So while VNDA blasted its way higher, remember that it’s a perfect example of how volatile the market can be – and how things don’t always happen the way you expect.

One of the best ways to make sure that volatility doesn’t negatively impact your portfolio is to play with the house’s money whenever possible.

Marc Lichtenfeld
Investment U

I said that the strategy “puts time on your side, and allows you to kick back and relax a lot more in the process.” I went ahead to say that “it’s a great way to deal with the kind of bumpy markets we’re seeing right now.”

And I showed how — even during the throes of the Great Depression — dollar-cost averaging into the Dow could have produced a pretty decent result.

Today, I want to revisit the strategy and show you how it would have worked over the last 12 months, which have proved to be another absolutely brutal time for stock investors. I think you’re going to be very surprised by the result!

But First, a Quick Refresher on
The Strategy of Dollar-Cost Averaging …

The idea with dollar-cost averaging is relatively simple: You buy equal dollar amounts of the same investment on a predetermined schedule.

Please note the italics in that last sentence. Dollar-cost averaging IS NOT buying a fixed number of shares on a regular basis. In fact, it is quite the opposite. Here’s why …

Let’s say you’ve decided to invest $10,000 in XYZ Corp. Rather than deploying the entire amount at one time, you might instead opt to purchase $1,000 of XYZ stock on the first day of each of the next 10 months.

What’s the logic behind this approach? Well, you can expect just about any stock’s price to vary substantially over a ten-month period. So, when the price is higher, your $1,000 will buy fewer shares; when the price dips, your $1,000 will buy more shares.

In other words, buying equal dollar amounts over time allows you to reduce your risk to a stock’s short-term price movements, automatically encouraging you to buy more when prices are lower and less when prices are higher.

It also removes much of the emotion from the investing process. You’ve already committed to buying the stock at regular intervals, regardless of market conditions.

And because you’re doing this automatically, it doesn’t require more than a few minutes of your time (if any at all!).

Okay, But Surely Dollar-Cost Averaging
Wouldn’t Have Worked in the Last Year, Right?

When I wrote that original Money and Markets piece on dollar-cost averaging back on June 17, 2008 … the S&P 500 was sitting at 1,400. Now, it’s more like 1,000. And I don’t have to tell you just how low it went in between.

So clearly someone who started dollar-cost averaging on the day of my column lost out, right?

WRONG.

In fact, as you’ll soon see, an investor who began using dollar-cost averaging in June 2008 has actually come out better than someone who regularly put their funds into a money market account over the same time period!

Let me give you the math behind that bold claim …

Frankly, it really doesn’t make much of a difference whether we pick a daily, weekly, or monthly approach. But for simplicity’s sake, let’s stick with monthly.

We will assume that our hypothetical investor chose to buy a very common index exchange-traded fund such as the S&P 500 SPDR (SPY). As you probably know, that popular ETF attempts to match the broad performance of its namesake U.S. stock index.

And while I could certainly assume that our investor bought on the 17th of every month (the day my original column was published) I’m going to just use the first trading day of each month.

Lest you think I’m trying to avoid including June 2008, I simply pretended that the day of my column counted as the buy date for that month.

I figured our investor would put in $1,000 every time.

So, here’s what the purchases looked like …

A Recent Dollar-Cost Averaging Case Study …
Date	SPY Price	Shares Purchased	$ Invested
06/17/2008	124.62	8.02439	$1,000
07/01/2008	123.5	8.09717	$1,000
08/01/2008	125.41	7.97385	$1,000
09/02/2008	113.6	8.80282	$1,000
10/01/2008	94.83	10.54519	$1,000
11/03/2008	88.23	11.33401	$1,000
12/01/2008	89.1	11.22334	$1,000
01/02/2009	81.78	12.22793	$1,000
02/02/2009	72.99	13.70051	$1,000
03/02/2009	79.07	12.64702	$1,000
04/01/2009	86.93	11.50351	$1,000
05/01/2009	92.01	10.86838	$1,000
06/01/2009	91.95	10.87548	$1,000
07/01/2009	98.81	10.12043	$1,000
08/03/2009	101.2	9.88142	$1,000
TOTALS =		157.82545	$15,000
Today’s Value	101.2	X 157.82545	$15,971.94
Profit =			$971.94

As you can see, our hypothetical investor’s $1,000 bought far more shares of the SPY during the market’s decline and far fewer shares when prices were higher.

The end result of all that buying is that our investor is sitting on 157.82545 shares of SPY today. And based on a recent price of 101.2, that means the total holdings are worth $15,971.94.

Remember, we’re talking about a 15-month period. So that means a total of $15,000 was invested.

End result: Our hypothetical investor is up $971.94, a return of 6.48 percent on the original $15,000 investment.

Yet over the same timeframe, the underlying investment — the S&P 500 index — is DOWN about 28 percent!

Amazing, isn’t it?

Meanwhile, had our investor played it “safe” and just put $1,000 into a money market fund every month … the overall return would have probably been less than 1 percent given current rates.

As you can see, dollar-cost averaging is truly a powerful way to “cut through the market chop” and steer your portfolio through major storms.

But, I want to point a couple things out …

Final Words on Dollar-Cost Averaging,
And Investment Strategies in General …

First, dollar-cost averaging is clearly not right for every investor. It requires a steady stream of investment money and could entail regular brokerage commissions. That makes it ideal for a regular company retirement account such as a 401(k) plan.

But please note that it is the same principle at work when you reinvest dividends. And I’d also say it’s a great way for an investor to gradually invest a large lump sum, such as an inheritance.

Of course, the more important thing to note is that dollar-cost averaging takes guts. How many people — having invested thousands of dollars when the S&P 500 was at 1,300 and 1,400 — would have still been able to put more money in at 700?

In most cases, that is precisely the point at which the majority of investors would switch their investment allocation to something else!

My point? Human nature is perhaps the biggest threat to your wealth.

I don’t care if it’s dollar-cost averaging into an index fund … trading commodities … or buying and selling real estate. As long as you do your homework and pursue a time-tested investment strategy — consistently and without fail — I believe you will come out ahead in the long run.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

While that’s dwarfed by the $9.3 trillion managed by non-ETF mutual funds, exchange-traded funds have an allure that conventional funds seem to lack: In 2008, when the global financial crisis caused markets to nose-dive, investors still poured $176 billion into ETFs. Although the pace of investments have slowed this year, investors have still stashed $35 billion in new cash into ETFs – even as they yanked $49 billion out of conventional mutual funds, according to a recent report by Strategic Insight.

This popularity is understandable: ETFs trade like stocks, but can be used to target torrid markets such as China, or white-hot investing trends such as gold or commodities.

But ETFs have a dark side, too – involving risks that most investors probably weren’t aware of, but that government regulators are now investigating. Investors need to understand those risks, and make their future ETF-related investment choices accordingly.
The government inquiry could bring a lot of those risks to light.

CFTC Hearing: In the Spotlight, On the Hot Seat

In a hearing on Wednesday – in what amounted to a rare regulatory assault on speculators – the U.S. Commodity and Futures Trading Commission (CFTC) heard testimony from people who produce, manufacture and hedge commodities and commodities-based products. Among the targets of interest were several of the gigantic exchange-traded funds that allow investors to place bets on certain specific commodities, as well as on diversified, commodity-based indexes.

The CFTC oversees regulated futures exchanges and has been examining how those exchanges could dampen energy-price volatility, possibly by limiting the number of “futures contracts” that hedge funds, investment banks and other speculators can control. Wednesday’s hearing was the third the CFTC has held.

Commission Chairman Gary Gensler reiterated his view that the CFTC should “seriously consider” speculative position limits for energy futures trading. The agency plans to publish any rule proposals this fall.

But executives with the ETFs that invest heavily in energy commodities on Wednesday told the CFTC that that the funds were not the cause of the wild price gyrations experienced by crude oil and natural gas.

John Hyland, chief investment officer (CIO) for U.S. Commodity Funds LLC – an industry player with $3.9 billion in assets under management as of March 31 – was one of the big ETF players on the hot seat. Hyland is the CIO of both the United States Oil Fund LP (NYSE: USO) and the United States Natural Gas Fund LP (NYSE: UNG) – two ETFs that are among the largest such products in the world.

The executive said that ETFs provide market liquidity by helping buyers and sellers find each other.

“We believe that the significant increases in energy prices last summer were wholly unrelated to the activities of our commodity-tracking funds using the commodity futures market to hedge the exposure to investors that results from their obligation to track the price movement of a commodity,” Hyland said. “In fact, rather than acting as a source of risk, the funds provide investors with a transparent, highly regulated, unleveraged vehicle through which to hedge their pre-existing price risk in commodities.”

The U.S. Oil Fund peaked last February at just over $4 billion, and is now down to $2.4 billion. Oil’s sister fund, U.S. Natural Gas, stands at an even-larger $4.5 billion, and is pending approval from the U.S. Securities and Exchange Commission (SEC) to issue even more shares. The size of the funds points to increasing investor interest in energy-based ETF products – and possibly to the potential for increased volatility in the underlying price of both oil and natural gas.

As of last July, investors who bet on commodities – including the energy complex of instruments – had more than $300 billion directly invested just in index funds designed to track the value of commodity futures, reports the Paris-based International Energy Agency (IEA).
The question at the forefront of the CFTC hearings is whether all this interest is properly placed.

Last year, after oil zoomed upward to establish an all-time-record high in excess of $145 a barrel, a CFTC report attributed the near-vertical price escalation and accompanying volatility on supply-and-demand factors.

Walter Lukken, former U.S. President George W. Bush’s acting-CFTC chairman at that time, later testified to the House Committee on Agriculture that the CFTC “did not find direct evidence that speculation was driving up prices.”

According to The Wall Street Journal, CFTC Commissioner Bart Chilton dissented from the 2008 report, calling the data “deeply flawed,” as well as limited and unreliable.

“We didn’t have all the information we should have and we gave it to Congress anyway, and we spun it,” Chilton is reported to have said at the time.

Enforcement Turf War

U.S. President Barack Obama’s appointment of Gensler as new CFTC chairman began a turnaround at the agency. Addressing speculation in commodities from the CFTC’s perspective intersects with – and perhaps even conflicts with – the power and authority of the SEC squarely in the front yard of ETFs.

ETFs are governed by the SEC and generally come under the rules and regulations of the Investment Company Act of 1940. But, when it comes to commodity-based ETFs, the underlying instrument, or index being tracked, is considered the front yard of the CFTC.

When it comes to commodity-based ETFs, the CFTC and SEC have to work together, something that hasn’t happened in the past.

The problem with so many investors, or speculators, betting on oil and gas – be it directly, or through indexed benchmarks – is that in order for ETF funds to actually track a commodity or index, the funds’ operators must generally trade in the underlying futures markets to take positions that ETF investors are trying to emulate.

The problem with this entire exercise is that if there are finite amounts of a commodity being pursued by increasing amounts of speculative capital, what will happen to prices, and how will the ebb-and-flow of capital influence price volatility?

Investors vs. the Speculators

At the peak of 2008’s commodity grab-fest, the total notional market value of all U.S. commodity futures and options contracts was less than $1 trillion. According to Barron’s, “that’s less than the market value of just five oil companies, and far less than the trillions in speculative funds that could be invested in commodities.”

As interest in commodity investing and hedging and portfolio diversification increases, the lines between speculation and investing may become indistinguishable.

Placing position limits on institutions and traders transacting in the futures markets could go a long way to dampen excessive speculation, no matter how that’s ultimately defined.

But, it won’t solve the problem; in fact, it could increase volatility and boost systemic risk. The reason: ETFs can use complex financial instruments known as derivatives. These can include swaps (swap dealers are exempt from position limits), as well as highly customized exotic instruments – fashioned as private contracts – to mimic any commodity, commodity index, stock or stock index the ETF operator wants to track.

Investors Beware

For investors, the very proliferation of ETFs that makes them attractive to investors – because the explosion of choices makes it easy to play the trend of the day – also makes them highly risky. Not that there is anything wrong with ETFs. They are great – conceptually speaking. But so were mortgage-backed securities before they were sliced and diced into products with nuclear cores that melted down.

It’s one thing for an ETF to track a benchmark or any duly created “index” by actually holding the underlying stocks that make up that index (which isn’t always practical and often isn’t economical). But it’s quite another for the underlying instruments to consist of  derivative contracts.

The problem is with the derivatives. Someone actually takes the other side of these contracts and is expected to make good on them if they are called upon to make delivery on some underlying credit, real asset or cash. But, as we saw with Lehman Brothers Holdings Inc. (OTC: LEHMQ) and American International Group Inc. (NYSE: AIG), even the biggest counterparties with whom contracts are written may not be able to fulfill their paper commitments.

Then there’s the multiplier effect – a “daisy chain” of risk. When a “synthetic” obligation is created, it exposes the contracted party to risk. To mitigate that “paper” – but very real – risk, another derivative is often created to offset the initial contract risk, and then sold to another counterparty.

Wall Street loves ETF products because they have created another separate profit center for the insiders to rape and pillage. The cover is often explained as a healthy arbitrage that keeps the EFT universe of instruments trading near their net asset values. While that’s true, it’s a built in goldmine for the Street, which when it becomes tilted away from them will cost the markets and our faith in them to once again crumble.

It works like this: So-called “authorized participants,” or AP (read that to mean chosen relationships or Wall Street insiders), actually buy or create the underlying tracking portfolios, usually in 50,000-share packets known as “creation units.” The ETF sponsor engages in an “in-kind” swap, accepting the units from the AP in return for an equivalent amount of ETF shares. Finally, the AP, through their relationship outlets, sells the ETF shares to buyers, who bid for them on the exchanges.

The opposite can also happen. In a so-called “redemption,” only APs can buy back ETF shares and swap them for the creation units that are the actual underlying instruments.

When the shares of an ETF trade, for any number of reasons, at a discount or premium to their net asset value, or NAV, the APs rush in to “arbitrage” the difference. Buying or selling shares, and swapping them out on the other side to the ETF sponsors, theoretically drives the ETF price closer to NAV. There are billions of dollars to be made – chiefly by insiders, or those connected to insiders – in this exercise, which is why it’s become a business in and of itself. The more ETFs there are, the more locked-in arbitrage opportunities there are for the insiders. It’s brilliant. The problem, not just because I didn’t think of it, is that is skews trading-volume figures, creating a false sense of liquidity – and with that a false sense of safety.

Credit Suisse Group AG (NYSE ADR: CS) now estimates that ETFs account for a quarter of U.S. equity volume.

But now that you understand how this works, here are three obvious – and somewhat scary – questions to ask:

• How much then of the volume we presume to be available on a daily basis in our markets actually consists of ETF-related arbitrage-transaction volume, meaning it isn’t actually providing greater liquidity?
• And does that mean that our financial markets are actually in much worse shape than we realize?
• And, lastly, are the ETFs that retail investors employ to be safer than individual stocks in reality much-riskier instruments?

The questions will be answered – and the reality revealed – when a significant hitch occurs in the stock market’s trading mechanisms, an eventuality you can count upon seeing.

Back to the Future?

The New York Stock Exchange (NYSE: NYX) is already building a 400,000-square-foot fast-trade-hub on the site of an old rock quarry in New Jersey, where it will house the high-frequency-trading computers that are required in order to trade in microseconds (millionths of a second). And the reason – you guessed it – is to give traders a leg up on the arbitrage-type opportunities that the quickly expanding ETF universe continues to create. Regulators, specifically at the SEC, are worried that the glitches that such a rapid-fire-trading marketplace can create will generate systemic risk way beyond anything they can conceive of, let alone calculate.

On a more mundane level, leveraged ETFs and inverse ETFs have finally been fingered as the day-trading vehicles they really are – meaning that they’re inappropriate for the masses who bought them to “hedge” or increase their bets on a controlled basis. They don’t work as they were promoted.

Already, Edward D. Jones & Co. LP, Morgan Stanley Smith Barney (NYSE: MS), and The Charles Schwab Corp. (Nasdaq: SCHW) are steering customers away from these products. The Financial Industry Regulatory Authority (FINRA) has issued warnings and guidance for broker-dealers on determining suitability of these products for clients. And UBS AG (NYSE: UBS) has suspended the sale of leveraged, inverse and inverse-leveraged ETFs.

What may begin as an assault on speculators may very well end up being an assault on speculative instruments. If the end result of that exercise is that ETFs end up being scrutinized from every angle in order to assess their efficacy and the risk they pose to both investors and to the overall markets, we’ll all end up being the better for it.

Right now it’s probably a big revelation that ETFs – a growing favorite of the retail investor – is actually the latest wolf in sheep’s clothing bred by Wall Street.

Also surprising is that speculation isn’t the real problem here.

The problem is that – even after one of the worst financial crises we’ve seen since the Great Depression – Wall Street is still infecting the economy with suspect – and even toxic – instruments that make insiders rich while exposing the rest of the world to their infectious greed.

Let’s hope that the CFTC gets the ball rolling with the currently scheduled hearing, that the SEC follows up with an investigation of its own, and that Congress then steps in to keep this from happening all over again.

By Shah Gilani
Money Morning

P.S. The only 10 stocks worth trading right now

It’s a stock trade that is routed through private liquidity pools before they’re sent to the general market. While the orders are only seen for fractions of a second before they hit the market, it’s still enough time for advanced computerized trading systems to respond and act on them before the public has the opportunity to do the same.

Sounds a bit shady, doesn’t it?

Senator Charles Schumer (D-NY) agrees. He wants to ban these flash orders, which give an unfair advantage to professional traders using high-tech trading systems.

Senator Schumer is doing the right thing. It shouldn’t matter if you’re a $50 million-a-year trader at Goldman Sachs (NYSE: GS) or a grandmother from Dubuque, Iowa; everyone should have the same opportunity to make money in the market.

Unfortunately, the reality is that even with good legislation like this, the playing field will never be level. But don’t despair… there is something you can do about it…

It’s Not What You Know… It’s Who

I’m writing to you today from the downtown San Francisco office of a small hedge fund, which is run by a good friend of mine.

As I took the ferry ride over here from Tiburon (one of the most beautiful places in the country, in my opinion), I reviewed the notes that I’d taken during a conversation with another friend, an investment banker.

We’d discussed some small-cap healthcare names that she thought I should take a look at. In particular, one is starting to attract institutional interest – interest that she believes will continue. I’m doing my due diligence on the company and it may appear as a recommendation in the Xcelerated Profits Report or in my small-cap healthcare service, Access).

As I write, my hedge fund friend and I are talking about various stocks, many of which are flashing away on the bank of five screens on his desk. When I ask him for information about a company, he usually has it in a few keystrokes. And if he can’t find the data, it usually comes to him in minutes, after talking to one of his associates on the phone or by instant messenger.

Having contacts like these gives me an advantage that most people don’t have. This is the way Wall Street operates.

However, I’m not getting any inside information here. No one is calling to tell me that “Blue Horseshoe loves Anacott Steel,” like in the movie “Wall Street.”

The conversations I have entail information like I mentioned above. That someone’s institutional clients are poking around the company. Or a hedge fund manager shares the data from his survey of physicians, indicating that Wall Street is underestimating a company’s market share.

So how can you get a leg up on the competition?

Know Your Sources

Individual investors can do just fine without this kind of information.

That’s if by “fine,” you mean “average.”

And while there’s nothing wrong with average (over the long haul, you’ll make money if your performance is average), if you want to jump into the “above average” category with your stock market returns, you need access to certain little-known information.

For example, Maria Bartiromo knows a lot of people. But when those people tell her things, it’s because they want that information out to the masses. Same thing with any other mainstream media outlet. By then, it’s usually too late to gain any advantage.

In other words, you need to be in stocks early – before the information is in the Wall Street Journal or on CNBC.

So where do you get that kind of information?

Right here!

If you don’t have a son-in-law in the investment business, allow me to fill that role.

Need an uncle who is savvy in the market? You’ve got one in Karim Rahemtulla. Uncle Karim is better at making money in any kind of market than anyone I know.

How about a nephew who knows the inner workings of the trading floor? Lee Lowell is a former floor trader who’s got his finger on the pulse of the options markets.

Whether you rely on our expertise here at the Smart Profits Report or follow our stock and options recommendations in the Xcelerated Profits Report, you can be sure that you’re getting information that is as close to the source and as timely as possible.

Senator Schumer will likely succeed in banning flash orders. But it will be impossible to stop the flow of information and ideas. Knowledgeable people will always have that advantage. Will you be one of them?

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld
Smart Profits Report

One Saturday, years ago, some friends and I went looking for a fun day out and found ourselves at the horse track. Among our group was a track first-timer, hell bent on maximizing his winnings. He laid a big bet on a 20-1 long shot. And when the horse hit the wire dead last, he’d officially been indoctrinated in horse racing and true speculation.

Forget making money, he’d managed only to maximize his loss.

Ever the competitor, he bet on two more races, wagering on big long shots in each. And in about as much time as it took us to park the car, he was wiped out. While the rest of us, only betting $10 or $20 a race, still had hours of fun ahead.

That was seven years ago. And, to date, my friend still hasn’t found the guts to make his horseracing comeback. It’s just another instance where fortunes could have changed, for the better, using position sizing – the most underappreciated decision in investing.

Unfortunately, thousands of investors make the same mistake each and every day.

Here’s how you can avoid treating your investments like random horses and a few rules on how to use position sizing to be sure your money will be around for the long term.

How Position Sizing Works

To illustrate how important position sizing is, let’s look to trading guru and Oxford Club friend, Van K. Tharp. In his book Trade Your Way to Financial Freedom, he develops a trading model and then tests it in five different ways, changing nothing each time but the position-sizing strategy.

Based on an initial investment of $1 million, the worst of the five scenarios returned $32,567 in a year. The best returned $2,109,266 – an incredible difference, based solely on position sizing!

To be fair, Van K. Tharp specializes in short-term trading. So we ought to show how to apply this strategy to our longer-term approach.

Let’s use an extreme example to demonstrate how position sizing relates directly to risk…

• Say an “Average Joe” investor has a starting portfolio of $10,000. And he’s extremely aggressive, putting 50% of his portfolio’s net worth into a single stock. When he sells it (whether for a gain or loss), he again puts half of his portfolio’s worth into his latest stock. And he does this each time, in effect, owning only one stock at a time.
• Now, let’s say his investment strategy performs well, and every position earns 50% that year. Under such premises, after selling all five positions, his portfolio would have swelled to $30,518.
• However, if his strategy had not performed well, and each position fell by 30%, he’d be left with less than $6,000. That’s a high-risk/high-reward approach, for sure.
• Compare that to investor No. 2, who takes a much more conservative approach. He puts 1% of his portfolio into each recommendation. If he encounters precisely the same bad year and each position falls, he’ll still have $9,900 – only taking a nominal loss. However, if he experiences the same success as our first “Joe,” the most he stands to profit is $253 – hardly worth the time of trading.

Position Sizing Strategies & General Rules of Thumb

Of course, a real investor would fall somewhere between the two extremes when following a position sizing strategy.

Here’s a general rule of thumb:

• Limit your investment in any particular stock to 4% of your equity portfolio’s net worth.
• If you want to err on the side of caution, invest less. If your tendency is toward being aggressive, invest more. But not too much more.
• You should also consider the type of stock you’re investing in. For example, you might feel more comfortable having a larger weight in a blue-chip stock.

Over at The White Cap Report, we isolate smaller, speculative companies with breakthrough products. As such, we don’t recommend putting more than 1% in any single stock.

Remember that the stock market, historically speaking, favors the investor. (Conversely, horseracing is rigged in the house’s favor. The track skims enough off the top of each race that it always wins.) Watching your position size will ensure that you’re around long enough to reap the rewards.

Ahead of the tape,

Matthew Weinschenk
Investment U

This simple strategy paid off well for decades.

The cycle was simple. A large-cap company would have one or two bad quarters. Expectations for future quarters would fall. The herd would run away. Once expectations were low enough, the company would be able to beat them. The herd would come piling back in and run up shares. Expectations would rise and the whole cycle started all over again.

It was a near clockwork cycle for most companies and a very profitable one for investors who bought on bad news.

Over the last two years, however, anyone who followed that advice has likely been hammered. Bad news was followed by more bad news which was followed by more bad news. In most cases, the bad news didn’t stop until absolutely terrible news was released.

That’s why in this “new normal” market environment, simply buying on bad news won’t cut it. You have to buy on the right bad news. Because if you can find the right bad news to buy on and position yourself correctly, the next few years will be very prosperous.

A Case of Not-So-Great Expectations

There hasn’t been too much “bad news” to speak of over the past few weeks. Well, the news may have been bad in a few spots, but the market didn’t take it badly.

Like Goldman’s lack of investment banking revenues. The investment banking revenues come from raising money for companies or consulting services and are generally much more consistent than trading revenues.

Then there’s the cost-cutting which has been driving tech stocks. The NASDAQ is up 20% so far this year. Of course, a rational investor would have to wonder what all the excitement is about. Materials and energy costs have dropped considerably since Q2 last year and the tech companies shed jobs just as fast as every other industry.

But as we like to say, great expectations usually lead to great disappointments. In the current market rally, the inverse is happening.

So there’s a lot of bad news and a lot of not-as-bad-as-expected news. We want to find the bad news worth buying on. One of the perfect examples of the bad news worth buying on is in agriculture.

Can It Get Any Worse?

To say agriculture has fallen out of favor is a bit of an understatement. In our 100% Free e-letter, the Prosperity Dispatch, we’ve been over the coming surge in agriculture commodities and agriculture stocks, but the market just doesn’t seem to care.

Agriculture commodities have dropped an average of 20% in the past two months. They’ve been flat since we started looking into the ag (re)boom in the spring, when the terrible harvest came in from the southern hemisphere. Agriculture sector stocks have fallen right alongside them.

Few areas have been hit as hard as fertilizer stocks. As we’ve discussed before, farmers have been unwilling to take on the risks of buying a lot of fertilizer in hopes of recouping the expense in a volatile grain market. Although the reasoning and action behind the farmers’ move makes perfect sense, Wall Street and analysts are valuing fertilizer stocks like farmers will limit fertilizer use forever.

A slew of bad news for fertilizer stocks over the past few months has only compounded the problem.
Potash Corp has consistently scaled back potash production. The price of potash had held up $750 a tonne until Silvinit, a Russian potash producer, and K+S, the German potash producer, both announced deals with India to sell potash for $460 a tonne.

On top of that, the market price for the other two major fertilizer components, phosphates and nitrates, has stayed flat as well. Nitrate and phosphate prices collapsed back to 2005 (pre-agriboom) levels after the bubble burst and haven’t moved much since.

All of this has been viewed, rightly so, as bad news for fertilizer stocks.

The table below shows how analysts’ estimates in the fertilizer sector have plummeted in the past few months:

This is the exact kind of situation we are looking for when looking to buy on the right bad news.  Most of the bad news is out and it’s tough to imagine expectations getting much lower.

In a way, the sector is out of bad news and it would take some absolutely terrible news to send this beaten up sector lower.

Up Next: Not-As-Bad-As-Expected News

It’s times like these that I think of the words from Seth Klarman. The ultra-successful value investor once said, “…most investors tend to project near-term trends—both favorable and adverse—indefinitely into the future.”

That’s exactly what’s happening right now and we can see it in the sharp divergence among performance in different sectors.

Take tech stocks for example. Wall Street is looking at the short-term success of companies’ cost-cutting measures. They’ve been buying up stocks in the sectors as they expect the near-term trend to extend indefinitely into the future. In reality though, cost-cutting measures are usually a one-time, quick fix.

In the case of agriculture stocks, farmers have cut back fertilizer consumption in the face of economic uncertainty. Still though, the outlook is bright and agriculture commodity prices are still, on average, about 50% higher than they were in three years ago. The potential for a big run in agriculture this fall is a very real possibility.

Analysts and investors remain as bearish as ever as they, in typical Wall Street fashion, expect the short-term trend of farmers cutting back on fertilizer usage to extend indefinitely into the future.

When it comes to putting hard earned investment dollars to work I am always looking for the best risk/reward opportunities. In a market like this – almost any market, really – you’re going to find the best risk/reward situations in out of favor sectors. Those are the places you’ll find the bad news worth buying on.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

In my column, I used the example of Yamana Gold (NYSE: AUY), showing you how to reduce your cost when buying stocks – and thereby increasing your upside potential if the shares move higher.

Today, we’re going to kick things up a notch and explain how you can cleverly take the same covered call strategy and add a twist, by using deep-in-the-money covered calls. When you do so, you can achieve more consistent returns over time, while also protecting your capital.

Simply put, I’m going to focus on mitigating risk…

Getting Deep-In-The-Money… Even When Your Stocks Fall

With a conventional covered call strategy, you buy regular shares of a stock and then sell a call option against them, whose strike price is higher than the current share price. Your aim is that the shares will move higher and will get called away at expiration for a profit.

While this does happen, it doesn’t occur as often as you might think. Plus, it usually only happens during an upward moving market.

However, with the deep-in-the-money (DITM) covered call strategy I’m focusing on today, we’re not expecting the shares to move higher. In fact, we don’t even need the stock to trade higher in order for us to make money. It can actually go lower (sometimes much lower) and we’ll still make money.

Pretty compelling, right?

In short, what we’re seeking is safety. And to get it, we need to employ a strategy that protects us much more often than not.

Deep-In-The-Money Calls: A 75% Win Rate Over 13 Years

So how about a win/loss ratio of 75%? That’s the performance the deep-in-the-money strategy recorded over the past 13 years that I’ve used it. That means we’ve only lost money or broken even 2.5 times out of 10. At all other times, we’ve made money, usually notching up market-beating returns.

Just yesterday, in fact, in my Strategic Income service, we closed out two winning positions – 13% on Wells Fargo (NYSE: WFC) and 33% on Goldcorp (NYSE: GG) – positions we initiated before the market’s collapse.

Here’s how it works, using the Yamana Gold example again. Recall that in last week’s example, we bought Yamana under $9 and sold the $10 (out-of-the-money) calls against our position.

Using Deep-In-The-Money Covered Calls On Yamana

This time, we’re going to buy the same Yamana shares. But instead of selling the $10 calls, we go deep-in-the-money instead.

• Buy 1,000 shares of Yamana at $9.50 – a total outlay of $9,500.

• Sell 10 contracts of the January 2010 $9 calls (AUY-AL). Trading at $1.75 per contract, you receive proceeds of $1,750 (remember that each contract contains 100 shares, so it’s $1.75 multiplied by 100 = $175. Then $175 multiplied by 10 = $1,750).

• Your cost for Yamana shares is now $7.75 ($9.50 minus $1.75) – a full 18% below the current price. This is the crucial number. If Yamana closes above $7.75, you’ll be profitable.

• If Yamana closes above $9 at expiration, you’ll make 16%. You arrive at this number in this way…$9 (strike price) minus $7.75 (cost) = $1.25 (profit).
  $1.25 divided by $7.75 = 16%.

  If the stock moves higher, your returns are capped at 16%, regardless of where it goes.

• Even if Yamana shares stay at today’s level, you’ll still make 16%. So you have an additional chance of profiting from the trade, versus just one with a straight long strategy, which requires the shares to move higher.

Additionally, you reduce your cost of ownership in Yamana to $7.75.

Basically, you’re saying that you’re willing to own Yamana at $7.75 – 18% below current prices. But if you don’t get the shares at that price, then you want to be paid for trying – something that happens nearly 80% of the time.

Key Points to Remember When Using DITM Covered Calls

Here are a few things to remember whenever using deep-in-the-money covered calls:

• You can execute a deep-in-the-money covered call strategy in any trading account.
• If you do end up with the shares, you can sell additional calls against your position to reduce your cost even further. The goal is to own the shares for zero dollars or even a negative cost over time.
• Always make sure you employ position sizing – i.e. never put too much in a single investment.
• At expiration, if the shares are trading above your strike price, they’ll be automatically taken from your account.

That’s all for this issue.

Karim Rahemtulla
Smart Profits Report

They earn their name by being comprised of nothing but low-cost, passively managed index funds – properly diversified – that require nothing but an annual rebalance.

In his latest column, he gushes about how his lazy strategy “keeps beating the S&P 500, as well as popular actively managed funds.”

Here’s my rub: Mr. Farrell doesn’t have a corner on slothful investing.

We’re Going Fishing & Beating the Market, Too!

We’ve got our own version of a lazy portfolio at The Oxford Club. We call it the Gone Fishin’ Portfolio.

And guess what?

It’s outperforming the S&P 500, too. It has ever since we created it six years ago.

It’s trouncing the most popular actively managed funds. That includes the wildly popular Fidelity Magellan, Dodge & Cox Stock, Legg Mason Value, Janus Fund, Baron Growth and American Funds’ Washington Mutual.

It also outperforms all but one of Mr. Farrell’s (overly) self-promoted portfolios and it ties with his top performing one. But I’m not writing today to convince you to adopt our lazy portfolio over one of Mr. Farrell’s. The long-term numbers should always guide your decision there.

Understanding the Secret Behind Slothful Investing

It’s more important you understand the secret behind this type of lazy, slothful investing.

Every mutual fund manager dreams of beating the S&P 500 every year. Yet, less than 5% ever do. In fact, over any given period, you can count on 70% falling short.

Even the Joe DiMaggios of Wall Street eventually succumb to the averages.

Legg Mason’s Bill Miller serves as the most recent example. He beat the market 15 years in a row. Then he fell short… very short. In 2008, his Legg Mason Value Trust Fund (LMVFX) dropped 55%, about 18% more than the market.

• Thus, the first reason laziness works is because it keeps us from fighting a losing battle – trying to predict the handful of actively managed mutual funds that will outperform the market in any given year.
• The second reason laziness pays is because it forces us to use asset allocation – the only Nobel Prize winning investment strategy, responsible for 90% of any investment portfolio’s return.
• And the last reason is that it keeps a lid on our expenses.

Mutual Funds vs. The Gone Fishin’ Portfolio

The average actively managed mutual fund charges a 1.3% annual expense ratio. In comparison, the average expense ratio of the funds in our Gone Fishin’ Portfolio is about 0.30%.

At face value, a 1% difference seems minor. But, trust me. It can make a huge difference.

Just consider…

• Without fees, a $100,000 portfolio earning 10% a year grows to $11.7 million after 50 years.
• Add in a 1% fee and the ending value shrinks by $4.6 million.
• The kicker? Only $794,000 of that difference is actually fees. The rest comes from the lost gains associated with those fees compounding over time.

Obviously, we can’t invest for free. Lazy portfolios and slothful investing, though, get us pretty darn close.

Why Slothful Investing Is So Compelling

Add it all up – better performance, strict asset allocation, lower fees – and the argument in favor of slothful investing is pretty darn compelling.

So much so, institutional money managers are now giving slothful investing a try. A new survey by Greenwich Associates reveals that one in five institutional managers recently sold their actively managed mutual funds in favor of passively managed ones.

Of course, don’t expect Wall Street to recommend you make the same switch. Brokers can’t increase their wealth selling no-commission index funds without excessive management fees.

But that’s what we’re here for – to give you investment advice, devoid of conflicts of interest.

So if you’re frustrated with investing and coming up short, we encourage you to relax… and be lazy!

You’ll beat the market. Even better, you’ll have time for more important things in life like family, friends and fishing.

Good investing,

Louis Basenese
Investment U

I can tell you that the mood out there right now is unremittingly bleak. And when it comes to value investing, that’s cause for celebration. Here’s why…

Analysts will tell you that stocks only reach bargain levels when they are cheap relative to sales, earnings and book value. But here’s how to know when stocks are cheap without looking at a single number:

• It’s when people are apoplectic about their stock portfolios.
• It’s when they are gloomiest about the prospects for the economy.
• It’s when they wish they had never met their stockbroker.

That’s when stocks are truly cheap. So that’s when it pays to buy them…

Sir John Templeton – Value Investing Through Maximum Pessimism

Sir John Templeton, the man who almost single-handedly pioneered global investing – and was one of the world’s great value investors – knew this. When it came to value investing, he swore that the best bargains could only be found “at the point of maximum pessimism.”

These weren’t just words …

In 1980, a Maoist guerilla organization in Peru called the Shining Path took over the country, imposing what it called “a dictatorship of the proletariat.” The country reeled from the violence and brutality. The United States, Canada and the European Union branded the Shining Path a terrorist group and curtailed economic activity.

The Peruvian stock market, understandably, collapsed.

Templeton wanted desperately to buy Peruvian stocks while they were dirt cheap. He knew that things would get better – and so would the performance of the Peruvian market.

Unfortunately, foreigners were not allowed to buy Peruvian shares.

Templeton was undeterred. He formed a Peruvian corporation and used it as a holding company to buy up the nation’s leading companies.

And, sure enough, the Shining Path, at one time a populist group, fell out of favor with Peruvian citizens. Political bonds were restored. Economic activity picked up again. The Peruvian stock market soared.

And, of course, Sir John Templeton made another fortune for his shareholders.

Ignore the Stale Statistics & Stick to Value Investing

Things in the United States right now are not as bad as they were in Peru in 1980; yet everywhere I go I keep hearing the same stale statistics:

• We are in the sixth consecutive quarter recession, making this the longest economic contraction since the Great Depression.
• Unemployment is at a 26-year high – and we’re still losing 500,000 jobs a month.
• Business investment is down.
• Spending – and consumer confidence – is anemic.
• Credit is tight.
• Home prices are still falling.
• Corporate profits are weak.

These things are true, of course. But ask yourself this: Which of these well-known facts are not already factored into stock prices? What here hasn’t already been trumpeted in the media hundreds of times before?

It sounds paradoxical, but rampant pessimism about the economic and investment outlook is the stock market investor’s best friend.

Or as resource analyst Rick Rule likes to say, “You can be a contrarian. Or you can be a victim.”

Know this. Act on it. And buy healthy companies while they’re on sale.

If history is any guide, a year from now you’ll be glad you did.

Good investing,

Alexander Green
Investment U

At the risk of sounding like a conspiracy theorist, I firmly believe that most investors are intentionally kept in the dark about anything that breaks away from the “buy stocks and mutual funds” mantra that makes Wall Street money.

Most mutual fund managers can’t see much further beyond Investing 101, and too many people in general are skeptical of options altogether. The problem is that they have no idea what they’re missing.

The options market was created for professionals, institutional money managers, and those who report to their wealthy, sophisticated constituents instead of the general public. But that doesn’t mean that the average Joe and Jane can’t use it too. They just need to get a few pieces of inside information first.

When George Soros took down the Bank of England to the tune of billions of pounds, he did it by using the leverage that options provided him. Basically, he saw a trend and figured out how to exploit it legally and with a surprisingly small amount of risk.

Sure, if it went against him, he would have lost out big time, but not nearly as much as someone who played the game the usual way. You see, the key to trading options is knowing how to use them to maximize the efficiency of your money. And the first and easiest strategy for doing that is the covered call trade…

Get “Free” Money

In order to execute a covered call trade you need to use both a stock and an option, hence the term “covered.” It means that your trade is covered by the underlying shares that you own.

There is no risk to the broker when you execute it since there is protection of equity by the shares you already own even if it goes against you. And that’s the reason why covered calls can be used by anyone in any type of account, including your retirement account.

When you enter into a conventional covered call trade, you’re essentially pledging to sell your shares at a certain price – known as the strike price – on a certain date, commonly referred to as expiration.

For pledging your shares, a buyer pays you an amount of money called a premium. And it doesn’t matter what the final outcome is; you still get to keep that premium regardless of who ends up with the shares in the end.

Since it’s yours to keep, spend or reinvest, you reduce the basis of your stock. Remember: Anytime you reduce your basis or capital risk, you also reduce your risk.

The One, Two, Threes Of A Covered Call

A typical covered call trade would go something like this:

Step 1: You buy 1,000 shares of Yamana Gold (NYSE: AUY) for $8.40 per share, totaling $8,400, and since you believe that the stock can go to $10 by year’s end, you look at an options chain (a listing of options available) to find out what the market is buying and selling the Yamana $10 options for.

(Note: This market is open to anyone who wishes to buy or sell options)

Step 2: The option is trading for $0.90 on the bid and $0.95 on the offer, so you sell 10 contracts of the Yamana January $10 call options, receiving proceeds of $900.

Now a few things to keep in mind before we go on…

• Just as with stock, you buy at the offer and sell at the bid.

• Options are always priced in increments of $0.01, $0.05 and $0.10 depending on volume traded and selling price. The Yamana options are priced in $0.05 increments and the price reflected is per share x 100 shares.

• Options trade as contracts, and each contract is equivalent to 100 shares of stock. So while the Yamana options are priced at $0.90 by $0.95, the minimum dollar amount that you need to be aware of is for 1 contract or $90 by $95. And it also means for the purpose of covered call trading, that you need to own at least 100 shares of Yamana to execute the trade.

• The strike price of $10 means that the buyer or seller of the option has the right to either buy or sell Yamana at $10 depending on the strategy used. If the option is sold – as in the case of a covered call trade – the seller of the option is obligated to deliver shares of Yamana to the buyer of the option if the shares close at $10 or higher.

The buyer of the option then has the option of taking delivery of the shares or selling the option back into the market.

As Close To A Win-Win Conclusion As You Can Possibly Get

Step 3: With your cost now reduced by 90 cents per share to $7.50 ($8.40 – $0.90), you wait for one of three possible outcomes.

Yamana closes at $10 or higher at expiration in January, in which case your shares will automatically be sold to the buyer of the option at $10 per share.

(In order for the buyer in this case to have made any money, Yamana would have to close at $10.90 ($10 strike price + cost of $0.90 per option) or higher. Anything less, and it wasn’t worth it.)

If it closes at $10 or higher you make 33% on your money ($10 strike minus $7.50 cost = $2.50 profit. $2.50 profit divided by $7.50 cost equals 33%). Or…

Yamana stays at $8.40 come expiration. In that case, as the seller, you still make money because you took in $0.90 per option you sold. Therefore, your return on the trade would be 12% ($8.40 minus $0.90 = $7.50. $0.90 divided by $7.50 = 12%) and you would still retain ownership of the shares since they didn’t close above $10. Or…

Yamana closes below $8.40, in which case you still make money, since your cost was $7.50. The only way you lose money if Yamana closes below $7.50, your adjusted cost and your breakeven point.

Covered Calls: As Simple As That

Basically, just as long as Yamana closes below $10, you retain ownership of those shares. And from there, you can either sell your stock at a time you see fit or keep it to sell even more call options against your position, reducing your cost even more in the process.

And as the owner of the shares, you’re entitled to any dividends paid out to shareholders during your stint as owner.

So let’s summarize:

• A covered call trade requires you to own the shares that you then sell options against.
• The money received from selling the options is yours to keep immediately.
• If the shares close above your strike price, they will be taken away (called away) from your account automatically and the money will be deposited in your account.
• Covered calls can be done in any type of account, including retirement accounts.
• Covered call trading can generate additional income while reducing your risk.

Next week, we’ll explore a variation on covered call trading that can reduce your risk substantially while still providing double-digit returns.

Karim Rahemtulla
Smart Profits Report