It was one of the worst pre-July 4th holiday trading sessions in the history of the stock markets. The Dow Jones Industrial Average lost more than 223 points or 2.63% in what was an across the board decline. For a significant portion of the trading day all 30 of the Dow components were in the negative. The technology heavy Nasdaq lost nearly 50 points or 2.67% as well and the broadest measure of the three, the S & p 500 Index was off 26.91 points or 2.91%. A large amount of the selling was attributed to the worse than expected non farm payroll report released this morning.
The employment situation report contains the unemployment rate, nonfarm payrolls and wage information. The report as a whole was mostly in line with the low end of expectations, however payrolls came in at -467,000 well off the largest estimates of -435,000 and a substantial miss from the median consensus estimates of -350,000. The unemployment rate came in slightly better than consensus at 9.5%. Also initial jobless claims were less than forecast, neither of which helped the markets as they continued to focus on the payrolls throughout the day.
This week Citigroup was again in the headlines when it decided to piss people off in several new ways. With the government adding new restrictions on employee bonuses the bank decided to raise salaries, some up to 50%, in order to retain people they consider “key employees”. In a totally unrelated press release Citi said it would be raising rates on the credit cards of up to 15 million customers. Citigroup was among the biggest recipients of federal aid receiving more than $45 billion in TARP funds. Since 2006 their stock has tumbled 95% and over the last six quarters they have lost close to $36 billion.
Another very unpopular company was in the news this week, American International Group or AIG effected a 1 for 20 reverse stock split on Wednesday. The measure was overwhelmingly approved by shareholders, but the stock fell over 22% on the day. Before the split the stock was trading at $1.16 per share on Tuesday, but was down more than 20% early in the morning on Wednesday and closed the day at $18.08 per share. Executives said the move was necessary to prevent the stock from being delisted from the New York Stock Exchange. In a strange coincidence the NYSE erroneously posted a suspension and delisting notice of AIG on the NYSE’s website, the notice was removed once the error was discovered.
Overall the stock markets have turned decidedly negative for the week and it was one of the worst first weeks of July in the history of the markets. For next week market investors will look to earnings as the driving factors for stocks. Alcoa reports its earnings on Tuesday which traditionally begins earnings season. Chevron, 3com, Progressive Corp among others all report their earnings as well. Next week is pretty light on economic data releases the most important ones to watch are jobless claims on Thursday and Consumer Sentiment on Friday.
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[Reprinted with permission of Profit Buddies]
Risk Management is an activity we all engage in; from wearing our seatbelt to homeowners insurance, we’re trying to control some form of risk. But what about the risks associated with investing and trading? In this article we’re going to discuss a few key Risk Management techniques.
As mentioned above, Risk Management is an activity or activities we use to reduce or control some form of risk. In trading or investing, the simplest definition of risk is “losing money”. So what can we do to reduce our risk? There are many articles, studies, books, etc, covering nearly every aspect of Risk Management, but let’s limit our scope to individual investors.
- Never trade with money you need. “Money you need”? Is there such a thing as money we don’t need? Actually, yes… money you need includes money used to pay for essentials (food, clothing, and shelter), to buy gas, pay bills, money to save for emergencies and retirement, whatever you “need” to survive and thrive. Everything else is money you don’t “need”, usually described as “discretionary” or “disposable”. The risk we’re mitigating is not losing the money we “need” for more important purposes.
- Never risk all of your money on one position. As the old proverb states; “never place all of your eggs in one basket”, some very sage advice for a saying that has been around forever. The risk here is pretty simple… if you risk it all and lose; you’re out of the game. Even if you win… and win big… the next time you bet it all and lose, you’re out of the game. As a trader you will at some point hear the phrase; “the longer you stay in the game, the better your chances of winning”, again, some very sage advice.
- Keep your position sizes fairly equal. Doing this ensures that one position in your portfolio doesn’t overpower any other. If you have $100.00 and place 4 bets of $25.00 each, and one of those bets loses 25%, your account will be down a total of only about 6%. If, on the other hand, you have $100.00 and place 3 bets of $20.00 and one bet of $40.00, and the $40.00 bet loses 25%, your account will be down 10%… nearly double the total loss to your account!
- Diversify your positions. As with all investing and trading, diversification is a must. Much like the previous two bullets, diversifying protects us from catastrophic loss of our capital if, for example, some company were to go bankrupt. This subject is so crucial to our financial well-being, I plan on publishing a complete article on this subject in the near future.
- Account Allocation. Account allocation means how to allocate the funds in your account, such as how much to allocate for trading and investing, how much to keep in reserve, how many trades to have open, etc. I’ll try to touch on each of these topics below;
– Allocation. Much like keeping some extra cash for emergencies in a savings account, or not running a checking account balance down to zero, it’s generally a good idea to not invest 100% of your trading funds. These extra funds could allow for unforeseen fees or commissions charged by a broker, minimum account limits, and such.
– Reserve. Reserve is the amount of trading funds kept aside for future investing use. These reserve funds are meant for new position opportunities that may arise, and can also help fund new positions after taking a loss on a previous position.
– Number of Positions. There are two main concepts here; number of positions, and maximum number of positions.
— The number of positions open at any one time is a great way of controlling risk. As market conditions provide higher probabilities of success, more positions could be opened, if market conditions change, fewer open trades reduce your funds at risk.
— Knowing the maximum number of positions you may have open at any one time allows you to properly allocate your trading funds using the above activities. If you don’t know the maximum number of trades you will have open, it will be difficult to determine how much to allocate per trade, how much to keep in reserve, or even how much of your portfolio is at risk at any one time.
- Fixed Fractional Allocation. Although I gave this item a bullet of its own, it’s really another method of Account Allocation. In this approach, a specific percentage of your trading capital is allocated to every new position… say 25%. Using this approach, position allocations grow as your trading funds increase (after winning trades), and position allocations shrink as your trading funds decrease (after losing trades), all while keeping your position allocation at 25% of your trading funds. The intent of this approach is to play more dollars on the way up, yet keep investors/traders “in the game” longer by decreasing risk during losing streaks.
While we’ve covered a lot of information in this article, there is always more to learn about Risk Management; your job is to continue learning, continue earning, and try to apply some of the above concepts in your investing.
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