How to know what you dont know

Want to gauge how much you know about finance and economics - try taking the following multiple choice quizzes - see http://tutor2u.net/quiz/economics/.
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Andrew Sheldon www.sheldonthinks.com

Understanding your opponents

If you want to make money from investing/trading, it is helpful if you understand your competition, that is the people trying to make money off you. You might not identify them as competition, but rest assured you are competing with several vested interest groups in the market, so its worthwhile trying to understand how they think. Consider the following:
1. Taking a position: Small investors can place orders in the market without influencing it to any significant extent. For institutions, the only way they can get sufficient stock is to seek primary placements, or to manipulate the stock price. They will do this by placing stock on the market to create the perception that the price is weakening whilst at the same time buying with smaller volumes. They are more likely to do this on weak trading days as the strategy will be more likely to succeed. The same strategy holds true when they are dumping the stock. They place support under the stock, encouraging smaller investors to place orders in front of them, and they will sell into those orders. It need not mean that the stock will not go higher, its just that they need to be more conservative in their price expectations because of the volume of stock they need to unload.
2. Timing of trades: Institutions need volume so they tend to trade the stocks with higher trading volumes. If the pickings get a little slim in the majors they need to engage in price manipulation to get the volumes they need. The best time for them to enter the market is on opening, and to some extent on closing. Most people make investment decisions in the morning, so this is the best time for institutions to pick up the stock they want.
3. Origin of funds: You need to consider the type of investor holding your stock. If you are holding stock with a significant proportion of foreign investors, then you need to consider that the interests of those investors is different from yours. Foreigners are concerned about forex changes and the factors that influence forex rates. eg. You might hold a copper producer through a period of economic weakness because whilst you might anticipate the copper price to fall, you are expecting your home currency to fall as well, and if you are impressed by higher output, you might be optimistic. But for foreign investors, things are not stable for them. They are not benefiting from a home currency weakness, rather they are exposed to an odd 15% fall in the currency, so given the risks attached with not knowing the future, they will abandon the stock until the home currency consolidates. In these circumstances you are advised to watch your home currency. You might think the stock represents great buying, but it will likely languish until those foreign investors return.
4. Term of investment: You need to decide how long you are going to invest for. For some of you, that might depend on how long your competitors are investing for. Investors invest for anywhere between 3 minutes and 5 years, so its worthwhile considering what your opponents are doing. The critical factor here is the prepensity of investors to sell. To determine that you need to know why they bought. Here are the possibilities:
a. The stock was oversold - so traders have entered the market - expect them to dump the stock within 3 days
b. The stock recently had an issue - expect the pundits who took up the stock for a stag (windfall) profit to dump the stock at the first opportunity. The threat is even greater if an underwriter was forced to take up the stock.
c. The stock has a capital raising due - A stock issue can rise or fall with an issue due. If its a good project, there will be institutional support, but its mostly manipulation, as no one has a vested interest in the short term of the stck, they just want the money. Thats not to say you shouldn't invest, just know when to buy & sell. Dont be too willing to buy into a story that will deliver in 1-2 years - markets have short memories.
5. Distribution of shareholders: Clearly if 40% of the stock is held by management then that is less likely to find its way into the market, and might also discount the possibility of a takeover. Just 10% equity can stop predators from gaining 100% ownership, however 50% for control is more readily achieved. Perhaps the most important shareholders are directors, so take an interest when they are buying stock. Mind you I think directors can manipulate. I dont see anything stopping them from holding their equity whilst at the same time selling short their entire holding. I bet too that this scam is not regulated by governments. They really have no interest in catching executives doing the wrong thing unless it hurts votes.
6. Risk premiums - You need to consider that some investors (particularly in the blue chip stocks where they have a more generous collateral margin allowance) are trading on margin. If there is a rise in interest rates, they need to sweat the impacts in terms of higher interest cost, as well as leveraged exposure to something tha might not rise in the short term. They need to think short term to recoup their interest expense, so you need to think the same way. This is particularly true now that we are in a climate of rising interest rates (inflation). The big factor will be the underwinding of the carry trade as investors adjust their perception of risk. The implication is a higher risk premium attached to the cost of capital.
7. Strategic interest - You need to be aware that some investors have their own strategic interests or context. You might think you have bought into a winning stock, but if its going down on you, maybe you dont have all the facts, or just maybe some major shareholder has determined that they can make more money elsewhere. Maybe they got it wrong. In mining equities, alot of companie end up with non-strategic stakes in small companies by virtue of having backdoor listed assets in the company, or offloaded projects for equity. Expect these investments to be offloaded gradually over time if a significant investor cannot be found for a special sale.