Tuesday, April 22, 2008

Speculating vs Investing-Hua An, Part III

Hua An closed at $ 0.75/share yesterday. Assuming a speculator bought 10,000 shares at $ 0.75/share, his principal is $7,563. Now is the fun part, if he is a speculator, the share price did not move as strong as he wants, he will have to face a choice of keeping it or selling it out at $ 0.75. If he opted to sell out, he will receive $ 7,437, $ 126 loss or 1.7% (inclusive of transaction costs). Despite of last three days favorable market conditions, he is still losing 1.7%? A speculator will have to figure out what the KLSE thinks today after Bank of America missed the estimates big time!

Avoiding pain is a natural instinct for human. Most will avoid taking 1.7% loss. He will switch position. No! this can’t be, I must listen to Warren Buffet. One must take a long view, this is a long-term investment. What the heck you have just said? There you go, a speculator has been converted. From greed, most will hang on to hope, hope things will get better each day, they will monitor price everyday, every hour, some even every minute? But they still have not set their stop loss yet, let’s set it at 10% for argument sake. We have just set up a potential loss of 11.6% or $ 877 to factor in transaction costs.

Soon, HOPE will turn into FEAR. FEAR into DESPAIR. I bet you a speculator will really want to sell at $ 0.60 later despite of the company is a C grade investment candidate but definitely not D or E grade. C grade investment may tie down your money for medium term to long term but may not necessarily losing your principal. From capital allocation point of view, why put your money into C grade while you can find A or B grade?

Most of the average speculator has no plan. Most will not quantify risk-reward. Again, for argument sake, let’s assume a speculator expect price will move to $ 0.8 in three days. That is a potential net gain of $370 or 5%. The risk-reward in this case: $370 if he wins, $126 if he loses.

5% gain vs. 1.7% loss. Do you like the payoff? Have you ever assigned some probability for your payoffs? Let me end my entry by quoting from one of my favorite books Mobs, Messiahs and markets:

“Actually, calling him a speculator is pure flattery. A real speculator has a realistic view of the odds and almost always operates on a simple premise-that the crowd underestimates the odds of discontinuity.

Take the case of the market that goes up every year for 10 straight years. What are the odds that it will go up again? There is no way to know. But mankind is a credulous beast…...And if the market has gone up for 10 years straight, a kind of sentimental momentum tells him it will keep going up. He is loath to accept pure chance as an explanation. He knows there’s a reason for it. Low inflation, record profits, favorable Fed policies: He reads the papers; he knows what’s up.

The real speculator may know no more than the common man. And he has an advantage-he knows the common man. And he knows you don’t win by predicting the future, you win by getting the odds right.”

Good luck, May the Force be With You!

1 comment:

Alan said...

Turtle, I do this kind of trade as well & I've earn some "roti canai" money. Using online trade, we can have lower transaction cost. My bets are mostly on companies I'd like to keep for longer term though.

So, I've missed out on some gains recently because I sold too early!