Well, the first relevant thing to do is ask the basic question of what is a stock and its significance.

A stock symbolizes ownership of a company. Some view stock as certificates. So the more stocks a person owns of a particular company, the more of the company they own. And the more the company they own, the bigger the influence they have in running the company. This is called equity investment.

The next thing to do is familiarize yourself with financial terms such as ‘price-earnings ratio’, ‘margin’, ‘option’, ‘earnings per share’ and ‘leverage’.

Then, it’s on to knowing where and how to actually buy stocks.

There are two ways to buy stocks:

1. brokerage service
2. online exchanges (e.g. banks)

Exchanges are services that allow investors to access stocks all over the world. Here, they can buy and sell stocks without the need for a broker. Certain banks allow you to set up your own stock portfolio and buy and sell stocks online using the money you have in these banks.

Brokerage services are rendered by brokers. These middlemen do all the work for you. They research the stock market, give advice, and buy and sell stocks according to the wishes of their clients. These brokers earn a commission from the stocks bought or sold.

Once you have chosen how to buy and sell stocks, the next thing to do is to open an account. As stated earlier, exchanges allow you to monitor and control your stock portfolio personally. If you choose to enter the stock trade with a bank, then ask your bank the specifics of setting up your own account.

If you choose to trade stocks via a broker, find a reputable broker and ask them to open and manage an account for you.

After you have successfully set up an account, it’s time to study the stock market and plan your strategy: will you be conservative in investing your money? Or will you be aggressive? Are you in it for the long term? Or are you a day trader?

After you have identified your plan, it’s time to do some research on the stocks offered in the market. Having a broker will significantly make it easier for you as they will do the research and give you advice. But, it is still best to study the market yourself.

Be warned though, the stock market is volatile. Be prepared for a roller-coaster ride.

Over the past few weeks the volatility and downward trend of the share market has caused traders and investors alike to lose very large amounts of money not to mention sleep.

For those traders who were prepared for such an eventuality, they lost very little of either. They would have lost around 5-10% whilst the average trader lost in the vicinity of around 20% if not more.

The average investor was drawn to the last “Bull Run” like moths to a flame. Having unrealistic expectations of easy money plus they are also being influenced by the media hype which is prevalent in a high flying share market.

The “Flavour of the Month” for quite a while has been Margin Loans. They are easy to set up. The paperwork is minimal as is the setting up costs. So you can be up and running in less than a .fortnight.

The average amount borrowed is usually around the $100.000 mark for which the potential trader has to put forward a fifth. In this case $20,000.But you can buy up to the full amount of the loan i.e. $100, 000 worth of stock. This is called leverage.

Now leveraging is a two edged sword, you can make good profits but you can have big losses as well.

The average investor who decides on a margin loan as a “Sure Fire” guaranteed quick way to make money invariably has neither the experience nor the knowledge necessary to cope with a sudden downturn in the stock market when it occurs.

Using the latest downturn in the markets as an example where share prices dropped downwards drastically in the region of at least 20%.Investors who had margin loans of around $100,000 suddenly had a paper loss of $20,000

When this occurred they were placed in the dilemma of either putting in more money (This is called a Margin Call.) or to buy more shares. In a lot of cases being borrowed to the hilt they were unable to do neither.

So their stock had to be sold at a loss which only exacerbates the problem as other traders are in the same boat having to sell their stock also. With a flood of shares hitting the markets all at once this forces share prices down even further. Causing more panic selling.

In some extreme cases investors were left with no share portfolio at all and still owed money on their margin loans. Not a nice position to be in.

So what precautions can the investor or trader employ to make sure that in the case of a downturn in the market, losses can be kept to a minimum?

The first thing to remember that the only security you have is the shares themselves. You have to maintain a margin between the amount you borrowed and the current value of the shares

This is called your” Loan to Valuation Rate” or LVR

If the market falls below your LVR you then have the choice of putting more money in or buying more shares. To bring up your LVR back again. Of course if you cannot do either then your lender will force you to sell all or part of share portfolio.

Having a diversified portfolio which covers several areas is a good idea as it is invariably one area that is hit the worst.

I personally know several traders who had only BHP/RIO in their portfolio who suffered disastrous consequences for not diversifying.

Another option is to start off with a conservative LVR in place.

A worthwhile valuable idea is to have an unused “Line of Credit” option in position. This will give you cash quickly if the need ever arises.

Lastly is of course to have “Stop Losses” (Conditional Orders.) in place to so that you can minimise any losses to 5-10% depending on the percentage you choose. This also has the effect of locking in any profits that you may have made prior to the market downturn.

Also remember the lender also charges interest on average in the 10% area per annum. That plus brokerage has to be taken into consideration as well as capital gains tax. All of which eats into your profit margin.

So if you decide that a Margin Call is the way to go then make sure you are aware of the pitfalls that can trap the unwary investor.

Good trading!

An IPO i.e. Initial Public Offering is offered by a private company to the public. It is the first sale of stock. Generally offered by smaller, younger companies who need funds to establish themselves but at time there are established companies offering IPO’s for new processes or additional cash inputs. Companies usually take the help of investment banks to go public, which in turn “underwrites” the process. Which in reality is nothing is but the authority to investment banks to raise the capital from the public on behalf of the companies that are issuing the securities.

Than there are “Hot IPO’s” are the IPO’s which rises dramatically above the offered price on the very first day itself.  Seasoned investors buy them just to flip them for getting a much higher profit. Generally the stocks are not available at the offered prices to the average investor and if the average investor gets an stock offering than that is generally the one you don’t want. Whereas investing in a brand new stock always has some risk attached with it. You might get lucky and get some money by flipping but you can’t see a profit from it in the long run.

Experts and researchers say that IPO shares generally perform mush worse than shares of seasoned companies in the first three years and in fact have negative returns.  Some experts even say that one-third of the companies go down over 50% to their opening prices and only one-fifth of the companies had really doubled their offering price. This data was achieved from the companies who became public from 1989 to 2000.

We could never ignore the fact that people have made money from IPO’s, for example remember Google. But for starters you should try to get the shares early and as close to the original offering price as possible. It is going to be much better if you have ties with the underwriter, as that could win you allocations. Then sell it early I.e. just before the decline of shares start. As for every winner, there must be some losers who buy the shares at the wrong time.

Finally opportunities do exist in here but it should never be considered as easy money. To be successful in IPO investment you must have a giant degree of skepticism, some strategic planning, a bit of far sightedness and should never be thought of as a short-cut to riches. So go have happy IPO investing period guys.

REIT’s, commodities, large cap, international, emerging markets, convertible bonds, defensive stocks, took severe beatings in 2008. Every company that was considered “too big to fail”, or so conservative that it shouldn’t have failed, did just that. Whoever said “No two bear markets are alike” certainly got that right. Even Warren Buffet’s Berkshire Hathaway stock (Symbol: BRK) experienced a -54% peak-to-trough trading range in since December 2007. There has never more uncertainty among Investors approaching retirement, CFA’s and mathematically minded financial services participants, as the market’s nervous reaction to every “take it to the bank” arbitrage in 2008 became temporarily disconnected.

Author Roger Lowenstein has spent considerable time analyzing those who come to trading by way of the traditional route. In his book, When Genius Failed: The Rise and Fall of Long Term Capital Management1, Lowenstein wrote that “those who are attracted to mathematics and analysis are drawn to fixed income and convertible bond arbitrage because much of what determines their value is readily quantifiable.”

I suspect financial planners and sophisticated investors in general, are a similar breed. The financial planners I know are well educated, mathematically minded, and contemplative. They’re attracted to the certainty of planning, and their vocabularies are peppered with terms like annuity, CAGR, estate planning, efficient frontier, MPT, asset allocation, risk-adjusted return, and diversified portfolio.

On the other hand, those attracted to floor trading, like me are typically emotional, anxious, and highly intuitive. Like hungry street urchins, we rely on quick reflexes and the general belief that it’s more important to be first on a trade than it is to be right. And like any self-respecting trader, we thirst for a little excitement. In fact, we can be described as the liar’s-poker-double-espresso-filled-undiagnosed-ADD-patients-who-trade-triple-beta-ETFs-because–anything-less-than-a-Volatility-Index-level-of-70-is-too-boring orphans of the industry.

Terms that an options floor trader may use on any given day are a bit different than those of a typical financial planner and include skew, kurtosis, theoretical edge, risk reversal, I-Wham (Russell 2000 ETF; Symbol: IWM), implied volatility, assignment, dollar-weighted deltas, and slop.

When I started on the trading floor of the CBOE in 1982, I was 22, and the majority of the traders in those days were from blue collar, Irish families who treated day-trading with the same mentality as a plumber who lays pipe or a carpenter who frames a wall: it was a job.

I spent the majority of my years at the CBOE in the OEX pit, where the practice of hiring MBAs was discouraged – even derided. Why? It was believed that you couldn’t teach a business major anything. And that might have been true: they weren’t pliable enough to mentor. Floor traders needed to have an intuitive sense of risk management and quick reflexes to maneuver around short term market moves. With an eye toward disaster, they frequently owned out-of-the-money puts. Countless arguments erupted between the quants, who understood the mathematical impossibility of a 23 standard deviation move during the Crash of 1987 and the floor traders who had no idea what a standard deviation was, but who did know that they would lose their homes if the market dropped substantially.

And they figured – without the aid of a calculator – that their wives would be really, really mad.

Lowenstein cites how Nobel Prize winners Fisher Black, Myron Scholes, and Robert Merton, who created the famous option pricing model known as Black-Scholes, disagreed with the fat tails or steepness of volatility skew that floor traders priced into out-of-the-money put options. To the creators of the Black-Scholes option pricing model, volatility was a constant, log-normal distribution.

“Merton carried the assumption a step further,” Lowenstein says. “He assumed volatility was so constant that prices would trade in continuous time, without any jumps.”

Today’s options traders need a firm grasp on the nuances of volatility skew, kurtosis, dollar-weighted deltas, and Vega. Yes, we have high speed computers that process tens of thousands of theoretical values in hundredths of milliseconds and seven billion stock and option quotes per day sent from exchanges.

But can the emotional and often volatile pit trader offer anything to the structured, well educated financial planner? The answer is yes. The truth is that you don’t need anything other than a simple calculator, the right kind of experience, and often, a little out-of-the-box thinking to achieve a terrific rate of return. After all, it is said that some of the best inspirations come from outside the box.

And who is more outside the box than an options trader?

I was struck by a comment made by CFA Adrian Cronje, who was quoted in the Journal of Financial Planning, January, 2009 issue, as saying, “The good news is that for the first time in many years, investors are now being paid to take risks.”2

Investors are being paid to take risks. Imagine that.

Nowhere is that statement truer than in the current environment of options trading and covered call writing. To be more accurate, investors are getting paid handsomely to take less risk. Recent market volatility has created a once-in-a-generation perfect storm, a history making blizzard favoring the individual investor and featuring:

1.  Unprecedentedly high option volatility levels due to the credit crisis

2.  The inability of investment banks to participate in trading due to their de-leveraging

3.  Clearing firms uniformly reducing risk across all market participant

4.  Continued fear of the downside

Cronje, Adrian, Journal of Financial Planning, “Is Markowitz Wrong?” ;(Jan 2009)

5.  Massive de-leveraging of hedge funds and 130/30 strategies

6.  Generational low interest rates

7.  Pensions and endowments rumored to be selling assets to meet cash obligations rather than rebalancing strategic allocations

Financial Planners and investors may want to brush up on basic option theory especially covered call writing tactics and read the academic white papers on the higher risk adjusted returns covered call writing provides as the nations 76 million baby boomers will be looking to planners and advisors for help in rebuilding their portfolios and simultaneously converting their “buy and hold” portfolios of growth stocks to a vehicle that delivers substantial retirement income.

Retirees are tired of hearing the endless droning from pundits discussing the benefits of greater asset allocation, cutting monthly expenses or promoting the benefits of being a Wal-Mart greeter.

Endnotes:

Lowenstein, Roger, When Genius Failed: The Rise and Fall of Long Term Capital Management (New York: Random House, 2001), 67-68, 76-77.

1. Knowledge

A wise investor would only delve into stock market investment upon being apprised with the necessary and crucial information. It is a must to invest on companies only upon learning everything about it, from its past records, current performance and future plans.

Stock market investment advice should be sought considering the difficulty of locating that right stock that will give big returns. The investor must fully know the fundamental value of the stock he or she will buy.

Invest in a company which belongs to a familiar industry. The stock market investor must have a good understanding of the business in order to realize more the value of the stocks. This will also make the investor less dependent to analysts and advisers.

The sources of information to rely upon must be carefully chosen too. Tips offered in the market should be avoided as much as possible. These are usually given by people with vested interests.

2. Long-term goal

An important consideration in stock market investment is setting a long-term goal. The long-term goal would determine the approaches to be taken and influence the decisions to be made.

The adherence to that goal would ensure regularity in instances of indecision when the stock market gyration comes to play. It would avoid whimsical decisions adversely disturbing the finances. A long-term goal could result to a more stable financial future through steady purchases investments. The key word here is consistency.

3. Calculated Risks

There are risks in any business endeavors. However, this must be calculated to minimize the probability of loss and to increase the expectation of profits. Speculating is not an option.

Never gamble and risk losing big money in the stock market. Investments should not rake in huge losses. It is easy to buy stocks, but money lost would be difficult to gain back. One cannot afford costly mistakes.

The established system in realizing the long-term goal must be strictly followed then. This will reduce the probability of putting too much money just to incur big losses.

5. Discipline

To make the most of the stock market investment, the investor himself must possess the proper determination and discipline to continually persevere in realizing the long-term goals set.

Stock market investment today requires passion and courage to come out as a winner. The stock market gives the opportunities; all that is required of the investor is being prudent.