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If I were to ask you a question

If I were to ask you a question: How happy are you? To answer this question, you will start to look around your friends and neighbours what they have in order to judge how happy you are with what you have. This is known as "anchoring" which means we like to make decisions based on some reference points. To illustrate this concept further, there was an experiment done by a famous behavioural economist, Dan Aeriel based on an actual ad from the Economist.

There were three offers in the ad: an Internet-only subscription for $59, a print-only subscription for $125, and a combined print and Internet subscription, also for $125. When Dan gave these options to a group of students, 16% chose the internet-only subscription, none took the print-only subscription, and 84% opted for the combined subscription. Sounds reasonable ? But in his second round of experiment, he took out option 2 since no one selected it and offer the Internet-only and combined subscription options to another group of students. The results? 68% of students selected the Internet-only option and only 32% chose the combined offer.

What is wrong here? Nothing wrong, its just marketing gimmicks to take advantage of peoples emotional weakness that often use the wrong things for comparisons. The above example showed that when given the price of print-only subscription is the same as the combined subscription, the latter looks like a great deal!

In stocks, we like to compare the historical prices when we make decisions. For example, we did not buy a stock at RM5 because we originally looked into it and did not buy at RM3. Buying at RM5 will make you regret more as you were making the comparisons.

With investment, we have to be rational and objective. We should try to put the past prices behind and focus on the current value and future prospects of the stock that we are buying. If we keep thinking about the lows that weve missed in March this year, we may be ended missing the whole boat altogether.

Happy investing,

Pauline Yong
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How to value a mining company

By Paul van Eeden

I received an interesting question about company valuations from one of my newsletter subscribers that I thought I would address as a Commentary. It is a multi-part question that will take more than one Commentary to address; this week is part one: Valuing Mining Stocks.

Mining is a finite business. Mineral deposits contain a certain amount of ore and when that ore is mined out the deposit is depleted, no matter what you do or wish.

That is in stark contrast to say, an auto parts manufacturer, who can adapt to new demands and specification changes and (hopefully) stay in business for many decades. When you value an auto parts company, you can compare the companys price to earnings, price to cash flow, operating margin and net profit margin (among other things) to the companys peers to assess whether the stock in question is relatively cheap, or relatively expensive. You can also get a sense of whether the stock is cheap or expensive in an absolute sense by looking at the book value per share and comparing things like the profit margin and dividend rate to prevailing interest rates. But, embedded in all this (except book value per share) is the implicit assumption that the earnings and cash flow are for all intents and purposes infinite. When you are dealing with a business that can be reasonably expected to continue in a similar fashion for many decades, earnings per share, cash flow per share, dividend rate, etc. are meaningful. That is not the case with mining.

Take a hypothetical mining company that has only one mine as an example. Let us assume that mine is going to produce for another five years before the ore will be depleted. Now, let us say that the companys price to earnings ratio is ten. A hypothetical auto parts manufacturer also has a price to earnings ratio of ten. Based on just this one metric, we cannot differentiate between the two stocks. Let us also assume that the prevailing ten-year interest rate is five percent.

This means that you can invest your money in a ten-year bond and earn five percent per year while taking relatively little risk (other than the risk of interest rates rising, which could negatively impact all the investments under consideration and is therefore not considered).

The auto parts manufacturer has a price to earnings ratio of ten. That means for every dollars worth of stock you buy, you expect to earn ten cents, or ten percent, in earnings. It does not really matter for our purposes whether those earnings are retained by the company or paid out as a dividend since, either way, the earnings accrue to the benefit of shareholders. Furthermore, you can reasonably assume that the auto parts manufacturer is going to be in business for several more decades and, because you have done lots of due diligence, you can also assume that the future earnings are likely to be the same as the current earnings. So, if you buy the auto parts stock, you will earn ten percent per year as opposed to five percent on your bonds. The auto parts stock is probably riskier than a bond; however, if you can make twice as much money it might be tempting.

Then you look at the mining stock and notice that it, too, has a price to earnings ratio of ten and, therefore, you can also make ten percent a year if you bought that stock. But you would be wrong. The mining companys mine only has a five-year life ahead of it. So, if it has a price to earnings ratio of ten it means that for every dollar of stock you buy you get ten cents in earnings. But the earnings are only going to last another five years, so your total earnings per dollar of cost will only be fifty cents — - half of what you paid for the stock — - and then the mine is depleted. Thats why comparing a mining stock to other investment opportunities on the basis of price to earnings, price to cash flow, or dividend yield is complete nonsense. It is just as futile to compare mining stocks to each other based on these metrics because mining companies have different mine lives in their operations.

The only reasonable way to evaluate a mining company is to look at the net present value of the potential future cash flow, discounted at an appropriate discount rate. You have to take into account not just the cash flow that the mine(s) is generating, but also sustaining capital costs (including future exploration and development costs) associated with keeping the mine in production. Assuming you can derive a suitable cash flow model for each mine that a company owns you can then calculate the net present value of future cash flow by using an appropriate discount rate to represent the geological, political, social and financial risks. If you sum all the net present values together, add any other assets on the balance sheet and subtract any debt, you will arrive at the net asset value per share. In a rational world you would expect to pay no more for a mining stock than its net asset value per share — - how do you expect to make money if you consistently pay more for stocks than what they are worth? But, in the real world, mining stocks almost always trade for more than the net asset value of their constituent mines, and for a good reason.

Mining stocks also offer leverage to commodity prices. Take a gold mining company as an example. Assume we have a company that mines gold for a total cost of $400 an ounce, and let us pretend the gold price is $500 an ounce. The net present value of the mine would be calculated based on the $100 margin. If the gold price increases by 20% to $600 an ounce the net present value of the mine will double, since the margin would now be $200 an ounce. Thus the value of the company increased five times more than the increase in the gold price. Most people buy mining stocks because of this leverage.

What should be immediately evident is that if you pay more for mining stocks than what they are worth, on the speculation that the price of the underlying commodity will increase, you are merely gambling on the commodity price. Fortunately there is a way to quantify the premium that one should pay for a mining stock to incorporate the leverage it has to the underlying commodity price. There is a formula called the Black-Scholes Model that can be used to calculate the "option" value of a mining stock [Editors note, you can find more information on the Black Scholes model and further links at http://en.wikipedia.org/wiki/Black-Scholes ]. What should be done is to calculate the discounted net present value of the all the companys mines and then add the "option value" of the mines as calculated by the Black Sholes formula to obtain a more realistic asset value per share. By adding the optionality of mining shares to the net present value of the mines themselves we can account for the fact that mining shares trade at a premium to their net asset value because of their leverage to the underlying commodities.

If you calculate the net asset value of a mining stock as described above you will get a result that can be used to compare different mining companies to each other, and mining companies to investments in other sectors. Unfortunately, very few mining analysts employ the Black Sholes model to calculate mining net asset values, so for most people buying mining stocks really comes down to blind speculation on commodity prices.

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Let It Fall Let It Fall Let It Fall!

Last Friday Japan Earthquake was an unexpected event, and this will definitely cause panic selling on the next trading day which is on Monday. Usually for an unexpected event like this our Bursa Malaysia will undergo a period of correction. Ill usually wait for three weeks before Ill go into the market for bargain hunting. Always remember, the stock market will undergo a cycle but on the long run, it will be on an uptrend. So my advice is stay calm, let the market fall for 2-3 weeks, before you go in again. Unless there is another unexpected event happen, things will be different. But for now, that should be my strategy!
Happy investing
Pauline Yong

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Forex Trading Systems The ultimate forex edge an Unbiased Review

As you know, I regularly review automated trading systems for the forex market but I have recently been asked by a website reader to review the ultimate forex edge trading system. Of course, as my website is called "reviewing everything forex" I am also interested in the review of regular trading systems and signal services so I decided to give this a go and review the ultimate forex edge trading system.

The forex ultimate edge website seemed to be just another cheesy marketing website that attempts to bond with the websites visitor by appealing to his likely current situation. The author first describes how he was broke and desperate (as many are likely to be when entering the website) and then he says that he saw the light and started to profit from forex trading. The story of course, has just no back to it, the trader does not mention the actual name of the company that allegedly gave him the chance to trade a 10 million dollar account or any information on any managed account or account he traded before or after this.

As a matter of fact, this is the most important thing. We have this guy telling us he can walk the walk and trade the forex market profitably but where is the proof ? Where are his account statements with all the profits he has been able to make with his trading system ? If anyone was going to learn a trading system from someone they would want him to show his trading statements right away. Why should you be different ? If he is claiming he can do something then he shouldnt have any hard time proving it if it is actually true. Now if it is, Ill be glad to take a look at the new evidence and redo this review to reflect that, but up until now, its just bunch of made up graphs and blablabla anyone can talk.

Being an account manager or selling a trading system is not supposed to be about being able to talk BS but it is supposed to be about being able to convince people through evidence and logic that your system is able to do something good with their money. Of course, up until now, this website is just a bunch of non sense which I would never consider worth buying.

If you would like to learn about automated trading systems and how there is the possibility to trade profitably with automated trading with real profit and draw down expectations please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed this article !
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Expert Advisors The neighborhood full of loose dogs

When I think of the forex automated trading market right now and the way in which it has worked for the past couple of years one analogy always comes to mind. I tend to imagine this expert advisor market as a neighborhood full of loose mean dogs in which you are alone and trying to get across. I think that this perfectly portrays the confusion, misinformation, exploitation of ignorance, unethical behavior and other "properties" of this forex automated trading world.

Why is this market so uncontrolled ? Why is this happening ? For me it is pretty obvious, large sums of money are involved and whenever large sums of money are involved it doesnt take long for the predators of our race to go against their "prey", that is, retail traders who have just begun and are just desperate or wishing to earn financial independence. These people will go to great lengths to deprive everyone of their hard earned money. People will give their money willingly because they dont know any better and they trust the people that lie to them to be honest. The more and more I spend time roaming around this smelly market, the more I realize how people are tricked and how low and dishonest these marketing tactics the use are.

For me there is just one solution to this problem, which is summed up in a single word : regulation. The expert advisor market is in desperate need of some kind of regulation of what can and cannot be sold. People would argue against this since people are free to buy whatever they want and everyone is allowed to sell whatever they want. That is true, but to lie bluntly in order to sell something is an entirely different matter. This EA creators sell you an expert they say can "triple you account every month", "turn x into 100x" and they say this systems have been "battlefield tested", "proved", etc, without any actual conclusive evidence to backup their claims. I did not go to law school but I do consider that tellings lies to sell people things is immoral and should be punishable by law. Specially if it causes these people to lose their money because of their purchase.

My request is simple, have a necessary degree of proof for each claim established so that they are forced to show some realistic, convincing proof of anything they want to claim. It is not that hard, I am just asking for these people to show us the truth, plain and simple. Of course, this will only become true if people gain knowledge and start to demand this in a massive fashion, in no other way will the expert advisor sellers listen. Mainly because most of them cannot backup any of their claims (as you see within my reviews). Sadly, as with the informmercial market, this is likely never going to happen because most people that enter this market are ignorant about this situation and ignorance my friends, turns people into blind men driving.

If you would like to know more about what I have learned about this market, how you can evaluate experts and their proof, build, test and program your own systems and start trading the forex market profitably using automated trading systems please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !
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Herd Mentality

“Although markets do tend toward rational positions in the long run, the market can stay irrational longer than you can stay solvent.” - John Maynard

Today I would like to share with you a mental bias that concerns every investor, which is known as "herd mentality". But before that, lets acknowledge that the phenomenon of the herd mentality can be useful in many ways. For example, research shows that although 5% of the animals in a herd know the location of the water source, the entire herd is able to find it. In our daily lives, we use this instinct to navigate to the exit in cinemas and crowded streets.

We have to admit that herding is our human instinct. Herding always makes us feel comfortable, and being the odd one out make us feel uneasy. We are programmed to feel that the consensus view must be correct one; and this mistaken belief has led to many disastrous decisions such as the “Four Dragons” and “Four Tigers Era” of the 1990’s where many investors who were initially sceptical ended up buying into the hype under the mistaken belief that not everyone could be wrong. And yet, most people were wrong.

Some researchers theorise that investors follow the crowd and conventional wisdom to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect.

Fear of Regret
People tend to feel sorrow and grief after having made an error of judgment. Investors deciding whether to sell a security are typically emotionally affected by whether the security was bought for more or less than the current price.

For example, most investors avoid selling stocks that are making paper losses in order to avoid the pain and regret of having a bad investment. The mentality is: after all, it’s only a paper loss, as long as I don’t realise the loss, it doesn’t count!

In addition, investors have the mindset of “what if the price goes up after I’ve sold it”; hence they would rather hold on to bad stocks hoping one day it will turn into a star.

However, some professional traders even advocate trend following as their winning trading strategy. They would apply technical analysis to help them in identifying the prevailing trend and trade with the trend. The biggest pitfall of this method is that it ignores fundamental analysis totally.

Herd mentality can be for good or bad. It is not totally wrong to follow the herd, but we must know when to follow and when not to. The challenge is in making an educated guess about when a turning point will occur and developing a trading plan to capitalise on it.

Happy investing,
Pauline Yong
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Experts Views on US Dollar and Gold

The US dollar ended 2010 about where it started; does it resume its downtrend in 2011, or are fears about its demise overblown?

Jim Rogers: No, but further down the road.

Bill Bonner: No opinion. But there is more risk in the dollar than potential reward.

John Williams: There remains high risk of a dollar selling panic unfolding in the year ahead, as the US economy tanks anew, as the Fed continuously expands its easing, and as dollar holders dump the US currency and dollar-denominated paper assets. Such would be a precursor to the inflation problem.

Steve Henningsen: Similar to my thoughts last year, I still believe the dollar is headed down long-term, but it could bounce around over the next year. If sovereign debts become a problem again, like I think they will later this year, then everyone will go running back to "Mother Dollar" once again for one last hug before she lies back down on her sickbed.

Frank Trotter: As the economy waffles and the global investing communitys attention is drawn from one crisis to the next, I expect the US dollar to bounce up and down in the current range. After that, however, my analysis suggests that measured by the key factors of fiscal and monetary policy, combined with a significant trade deficit, the US does not look as good as our major trading partners, and I thus expect the dollar to decline, perhaps significantly, in the intermediate term. Big geopolitical events may accelerate this or create a flight to US dollar quality, so hold on to your hats.

Krassimir Petrov: I think the dollar resumes lower. I expect QE3 and QE4 - a dollar-printing fest that will eventually sink the dollar. Sure, all fiat currencies are in deep trouble and prone to overprinting, but the reserve status of the dollar actually makes it more vulnerable now. Whether the dollar sinks against other currencies is a fools game not worth playing. It is like being in the hospital, where all patients are suffering from cancer, and trying to guess who will feel best at the end of next year, or trying to guess who will succumb first. Thats why it is so much safer to play the dollar against gold.

What to watch in 2011: stay focused on the sovereign debt crisis and bond yields. Spiking yields will trigger the next stage of the crisis.

Gold has risen 10 years in a row, so some are calling it a bubble, yet its roughly $1,000 below its inflation-adjusted high. Whats your outlook for the metal in 2011?

Jim Rogers: It is hardly a "bubble" when very few own it still. Who knows? Overdue for a correction, but who knows?

Bill Bonner:
The smart money is in gold. It will stay in gold until the bull market that began 10 years ago finally reaches its peak. It is extremely unlikely that the top will come in 2011; its probably years in the future. In the meantime, gold is bound to have a losing year or two. Dont worry about it. Buy gold. Be happy.

John Williams: As the US dollar increasingly is debased, and where gold tends to preserve the purchasing power of the dollars invested in it, the upside to gold in the year ahead is open-ended, restricted only by any limits to the massive downside potential for the US dollar. Any intermittent gold price volatility, extreme or otherwise, will be short-lived. There is no bubble - only increasing weakness in the US dollar - with the gold price fundamentally headed much higher in the years ahead.

Steve Henningsen: I believe gold will once again prove the bubble-boys wrong and end the year positive (I have no idea by how much and dont really care). However, I think this year will be more volatile and that Gold Bugs better remain seated on the precious metals express or they might get squished.

Frank Trotter: I still think that with price inflation on the rise and big political events occurring, there may be room to continue to rise. If stock markets take off, then there will be a reduction in appreciation or even a significant decline, but based on the factors I mentioned above, I dont see that as highly likely.

Krassimir Petrov:
Gold still has outstanding fundamentals. I believe that over the course of 2010, the fundamentals have strengthened significantly: (1) "No Exit [Strategy] for Ben" as he unleashed QE2, and will likely unleash QE3, QE4, etc., (2) no more central bank selling of gold, (3) more central banks become buyers of gold, and (4) trial balloons for a global gold-backed currency.

I have no idea how people could even claim that gold is in a bubble - barely 1 out of 100 people have any idea about investing in gold. During the real estate bubble, every second person was involved in it. Maria "Money Honey" Bartiromo has yet to report from the COMEX gold pits; gold fund managers and analysts have yet to obtain rock-star status; and glamorous models are not yet dating the gold guys. Who is the Henry Blodget [co-host of Tech Ticker] of the gold sector, do we have one yet?

Yes, gold will eventually become a bubble, but that feels 5-8 years away.

Whats your best investment advice for 2011?

Jim Rogers: Buy the rmb [renminbi, the Chinese currency].

Bill Bonner: We are in a period much like the period following WWI, in which the great debts and losses of the war had to be reckoned with. It is an era of great risk. The US faces many of the same challenges faced by Germany and England after WWI. Like England, it has huge debts. It is a waning imperial power. And it has the worlds reserve currency. And like Germany, it is attempting to fix its problems by printing more money. This is not a good time to be long either US stocks or US bonds.

John Williams:
As an economist, I look for the US dollar ultimately to lose virtually all of its current purchasing power. Accordingly, for those living in a US dollar-denominated world, it would make sense to move to preserve wealth and assets over the long-term. Physical gold is a primary hedge (as is silver). Holding some stronger currencies outside the US dollar, as well as having some assets outside the United States, also may make sense.

Steve Henningsen: Dramamine (for volatile markets), a stash of cash (for potential investment opportunities), and move some of your assets offshore if you havent already.

Frank Trotter: My advice is first to look at the other side of your balance sheet - the liability and risk equation - before seeking out absolute gains. What are your goals, what resources do you already have to meet those goals, and what events (health, income stream, upheavals) might impact these risks? Place some assets to hedge these risks directly, then look to diversify globally into markets with higher growth potential than we see here at home, and that may balance your global purchasing power risk. Almost like a religion, we have had the phrase, "Stocks are the only legitimate hedge against inflation" beaten into our heads. I say, look at assets that define inflation like commodities and currencies and evaluate where these fit into your risk portfolio.

Krassimir Petrov:
Last year I recommended silver, and I would stick to silver again, despite its phenomenal run. Then it gets tricky. I usually dont recommend diversification, but now I would again recommend a broad portfolio of commodities. Investing during the rest of 2011 should be easy: stay out of real estate, out of bonds, out of fiat currencies, and out of stocks; stay fully invested in commodities, overweight gold and silver.
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