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How to recognise a bubble

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I have been increasingly thinking about whether if we are in a bubble state as the stock market has surged sharply over the past month. This made me to do some research on ways to recognize bubble and the following is what I have found on the net .

How Bubbles Grow: 12 Easy Steps

1. A believable concept offers a revolutionary and unlimited path to growth.

2. Surplus of funds and lack of opportunities lead to buying or investing in anything available.

3. An idea is complex and cannot be totally explained or related to an investor.

4. The crowd imitates the leader. All Aboard! Even the gardener has a tip!?

5. Prices fluctuate from traditional level to overvalued level, THEN to all new ground and all time highs.

6. New levels are sanctioned by experts. "We are in a new Paradigm!"

7. Fear of missing the boat takes over. Cloning of the idea occurs as many new overvalued competitors enter the market.

8. Lending practices are eased. Money flows like water to anything or anyone with a new idea.

9. Cult figures emerge for the new paradigm. The media promotes lifestyles, not substance.

10. The Bubble lasts longer than expected. Critics are dismissed. The last suckers are sucked in.

11. Fraud emerges as partly responsible for the bubble as the first cracks show in the bubble.

12. Finally, everyone has a reason why it cannot continue. But nobody dumps, and all hold onto their profits. No new buyers. Market stalls.

How a Bubble Bursts

1. A continued new supply of lower priced offerings occurs from rising prices. New IPO's get bigger and bigger

2. There is a rise in interest costs. The Government declares "Excessive Exuberance" and tightens credit too quickly.

3. Prices collapse and everyone heads for the exits at the same time. With no more buyers, prices hit free fall.

4. Fraud is uncovered in many diverse industries, and in monitoring and auditing agencies. This leads to more selling.

5. Governments intervene and give investors time to get out before the real decline.

Rules to Live By
1. Do not extrapolate the future from the present.

2. Trends continue for a long time (2-5 years) and then suddenly reverse chaotically. Witness the Tech Bubble.

3. Intermittent secondary corrections occur at Fibonacci Levels of 38%, 50% and 62% that result in classic Bull or Bear Traps.

4. Bottom picking begins several different times, trying to restart the Bubble, but to no avail. Massive losses occur to professionals trying to manipulate the markets.

5. Finally everyone recognizes that "Trends go further than you expect, and last longer than expected." Everyone gives up and sells.

6. As the volume of the decline decreases, a slow recovery begins.

Above points taken from 
http://www.solerinvestments.com/Online-Trading/Stock-Market-Crash.htm 


Despite personally worrying over the possibility of a bubble, I am still approximately 80% vested in the market now. Reason being, I believe there's more upside due to  1) lesser uncertainty over bank 2) more economic indicators showing it is recovering 3) Read some article mentioning a lot of cash are sidelined by fund houses meaning more fund will be flowing soon 4) Stock market is usually 3-4 months ahead of the economy.



Melynn Investment Experience

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1. Stock Bought
Ezra (Singapore stock)

2 Reason for making the trades
This trade is mainly of a speculation type and there's no actual reason why I bought this. It is more of a random entry. Thoughts which flow through my mind before making the trade is to try to ride the strong intra day trend and this was derived based on looking at the speed the sell bid is cleared..


3. Holding period
I intend to sell half of my positions within the clearing period(T + 5) and for the rest, I will set a cut loss at 3%. Eventually,  I didn't stick to my original plan and sold them earning a total profit of 7%. Reason for not holding longer is because I am no longer comfortable holding such a larger position as I believe any type of negative news will trigger a massive selldown due to people taking profit from the recent surge.

This decision was made partially also because of  the upcoming release of stress test results for US banks. Personally believe that a wave of bad news might be coming thus I would rather miss a profit than "blowing"(lose my capital) myself..

Points to ponder
- Am I risking too large of a position such that in the event a rare event happened , I wont have enough capital to pay up my  losses. Some rare events might be stock suspension, bankrupt and etc.

I  have risked quite a bit for this trade without considering the worst scenario. This is a point which I need to take note of for my future trades.

The stock market direction throughout the day is generally based  on economic indicators, analyst comments , interest rates and etc (in short it might be random) therefore a trade which has been doing well in the morning might rock in no time for some reason. All these risk is something I need to take note of for my future contra trades .

Risks can be mitigated by i) Tight stop loss ii) Try to ride the profit but sell half of position when the situation is favorable (like 10% profit)

Although I have made a relatively substantial profit for this trade, there are a lot of other factors which I overlooked like

1) Considering the worst scenario
2) Time horizon too short

One most important thing I need to remember is to always differentiate investments and speculation. Never mix them together by holding on to losing trades which are of speculative nature. 

Stock Pick (Google) Summary

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This will be a page where i will be modifying weekly to update several values like stop trail, relative ratios, ATR as discussed in previous post.

Google as of  01/05/2009
Stock Price  : US$393.69
Quantity bought: 17 shares
Price Paid : US$370.69
Total Cost  (inclusive brokerage) : $9596.09
Brokerage Fee : $42.77

1R(Downside) = US$762(? of equity)

Highest Price since I entered the trade : US$403.75
ATR(50 day) : 13.925
Stop Trail : 399.82 - (3* 14.805) = 361.975

Fundamental relative valuation as of 01/05/2009


Stock
Industry
Stock's 5Yr Average*
Price/Earnings
29.6
26.2
67.1
Price/Book
4.4
5.9
10.5
Price/Sales
7.1
5.3
13.6
Price/Cash Flow
19.7
23.5
21.7
Dividend Yield %
---
---
---
Sentiment Gauge

Put/Call Open Interest (3 months)













- Based on the chart, it seems there are lesser interest on put options indicating optimism on stock. Might sell in strength later on.

Short Interest (3 months)














- Steep decrease in short interest thus indicating optimism as well.

Buy/Sell/Hold recommendations by analyst


BUY/SELL/HOLD RATINGS
FOR GOOG
Strong Buy17
Buy3
Hold1
Sell0
Strong Sell0


- Gauge sentiment and potential buying demand. Currently very bullish thus it might be top heavy leading to heavy sell off. Need to take caution in this. 


Common traits of successful investors

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I have came across an interesting an article on the net and decided to share it here. 

The techniques and the characteristics of the most successful investors are diverse, and there's not a guaranteed formula of success. Nonetheless, by following a similar path taken by successful investors, it can help to improve investment returns. Below are some of the key similarities between these successful investing strategies.

Measure your Results and Document your Decisions


As you make buy/sell transactions, document why you are making them. It should be your goal to make the best decision based on currently available information. You cannot predict the future, and you can prove this to yourself by documenting your forecasts. When unforeseen events occur (and they will!), you can go back and review your reasons for making the transaction. This will help you in deciding what you next move should be (buy, sell, or hold).

Remove Emotion from the Investing Decision

The market does not care what you think about a specific stock. In fact, since another party is always on the other end of your stock trade, there is another person that has the opposite view of you about the future prospects of that particular stock. When an investor buys a stock, it is part of human nature to immediately start paying more attention to the current price of the stock. Undeniably it is painful to purchase a stock, and watch it drop 10% over the next few days. Undeniably the investor feels a surge of confidence and pride when a stock happens to rise 10% a few days after the purchase. But these emotional ups and downs can be very detrimental to long term investing success. How can you prepare yourself to not be emotional?  First and foremost, be prepared for the ups and downs that you will likely encounter.  Before your purchase, imagine that the stock price drops right after your purchase. What will your plan of action be? For example, will you sell after a certain percentage decrease, or stick with the stock? Anticipation of possible future events will help you deal with these events when they become a reality.
In addition, if you have documented your reasons for originally making the transaction, you can review these reasons when the unexpected happens. This will help you evaluate your choices going forward.

Spend Time Doing Research

If you are not able or willing to commit to spending time each week on your investments, then you should not bother with individual stocks. In the case of stocks, halfway understanding what you are doing is much worse than not understanding at all (and therefore buying mutual funds).  You should be able to explain in detail to another person why you have chosen a particular stock for an investment. Try this out on your friends, by verbally explaining your rational. You may be surprised at the ‘irrational’ description that you provide!



Evaluate and Re-Evaluate every Opportunity the Same Way


Regardless of your investing strategy (Value, Growth, Buffett, CANSLIM, etc.), a consistent evaluation of each stock is required. By taking the time to evaluate each company, you allow yourself the opportunity to compare and contrast them. With so much information about a particular stock available for free on the internet you can easily perform this evaluation. The specific metrics that you use (price to earnings, price to sales, debt level, sales growth, etc.) can vary for each investor, but for one investor, the same metrics should be used on all stocks being considered.
Once an investment is made, your work is far from over! You must keep track of the events (earnings reports, mostly) that affect your investment. At least once per quarter, you should review each investment and see if your original reasons for buying are still valid. If they are not, then you should sell the stock.

 Long Term View

Investors should ignore the fluctuations of the market.  Today, it’s quite simple to get quotes, news and other financial information from the internet. While this readily available information is definably helpful, the investor needs to watch out and not get caught up in the day-to-day market fluctuations. The financial press, like the general news media, sometimes over-hype stories, since it is in their interest to grab the readers and viewers attention. The market offers you the opportunity to sell at a particular price. You do not have to take advantage of this offer.
If a company continues to grow in earnings and sales, while debt remains stable or declining, you can ignore the day-to-day, month-to-month, and even year-to-year price gyrations that will be experienced


Nenix's Take on Olam

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Olam, from the trend is showing weaknesses in its strength despite positive trending. Various indicators are pointing towards a weakening trend with correction. However, as my system is based on trend direction, and not prediction, I have to enter a position. However, I wil be monitoring this counter closely as I think this will be the first counter that will hit the exit criteria.

Trend Direction
Although the trend direction is in an upward motion, the crossover seems weak.

Trend Strength
Trend strength also points to weakness in the trend. The +DI is going down signifying that the strength of the uptrend is weakening. The -DI is showing an increasing trend, indicating a selling pressure. However, as both lines are in the region of 20, it can be said that both strengths are weak in nature. 

ATR
ATR has decreased significantly since its low of $0.835, indicating stability in prices.

Momentum
Momentum is currently weakening although generally it is still on an increasing momentum, indicating that the buying interest has waned.

Volume
Volume is in tandem with price direction and this is a characteristic of an increasing trend.

Conclusion
All indicators are pointing to a weak uptrend. However, the decision to enter is due to the fact that it is in an uptrend. Unless I have more screening criteria, I just have to live with it. What I can do is to maybe add more criteria but I feel that it would only make things more subjective, which I do not favor.
If I have to rate this stock, it would be classified as a "weak uptrend stock"
Reproduced with permission from http://nenixdreams.blogspot.com 

Nenix's Take on Kim Eng

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The decision to enter Kim Eng was slightly mixed because i reacted quite slowly when I realised the trend. Basically, the trend was showing positively two weeks ago, but i hesitated because the upside seems limited. Anyway, the analysis is as shown below.

Trend Direction
The 12w trend line crossed over the 26w trend line at a price of $1.47. Although I entered slightly late, I manage to get at $1.50. Although it crossed over, I deliberated in getting into this counter because the upside seems limited. However, this is something that I should not have done because I have allowed personal opinions to influence me

Trend Strength
Trend strength seems to have waned in recent weeks, suggesting that it might go through a corrective phase. However, the +DI and -DI are going in favorable direction, the former going upwards, and the latter going downwards.  If this persist, the trend strength would be able to pick up, moving in a favorable direction.

ATR
ATR is showing a decline which is a sign that prices are stabilizing. This is a common trait among most stocks after the panic selling situation that we face last year. The volatility range is about $0.113 per 14w, which is approximately 7.53% in 14w.

Momentum
Momentum is on the strong side with little consolidation. Coupling with the possible scenario of trend strength bottoming out, it is likely that the momentum will continue to be on the upside.

Volume
Volume has been consistent and not much analysis can be made out of this.

Conclusion
Although the trend is on the up, the upside seems to be limited. However, the trend strength as represented in the ADX trend signifies that divergence between the +DI and -DI might continue and thus indicating a increasing trend strength. Momentum is still strongly on the upside with minimal contraction.
On the aspect of volatility, it indicates an approximately 7% movement in 14 weeks, which seems acceptable. 
The rationale of entry is due to the trend strength, the sustained momentum and the acceptable volatility.

Reproduced with permission from http://nenixdreams.blogspot.com 

Melynn Investment experience

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1. Stock Bought
i) Tat Hong - 14 lots Long (Listed in Singapore market)
ii) Tat Hong - 28 lots Long

2 Reason for making the trades
My first transaction was made because I believed Tat Hong was still relatively cheap at the point of purchase and also it started to gain momentum. 


I subsequently bought more of Tat Hong and doubled my first purchase. The reason why I doubled is because it is starting to show strength in its trend with good momentum and even though, it may not be as a good bargain as the previous buy in terms of value but still, I believe there will be more upside.

Downside is limited as I have set a trailing stop loss for the above trades to protect my profits or minimize my loss. This will be discussed more later.

3. Holding period
A total of only 18 days. I didn't expect the price to hit my stop loss so soon but I have to stick to my system so have no choice but to sell it. 


4. Selling Point

Set a trailing stop loss whereby it is calculated by deducting (3*ATR) from the stock's high since purchase.

6. How much was the stock sold
In total, I have made a profit of 1347.85 and total commission incurred was like about 10% of the profit. This is the price to pay for holding short term.

Self Assessment
Even though I have made a profit from this trade but still, I think this system wont be sustainable for long term. Reasons being

1. The profit gained from this trade is probably due to luck or merely just pure randomness where the market rallies at the point my purchase , So how many time can I be that lucky? Is my perception of "strong momentum" correct?

2. By following the momentum strategy is like playing the fools game so how sure can I be that I wont be the last to hold on to this?

3. The trading period is just 18 days.. This might be due to my tight stop loss set but assuming this is a losing trade, I will be still incurring the costly commission cost.. Might not be worthwhile on a long term basis

4. The tight stop loss is a double edged sword. On one side it can prevent me from losing more but on another side, this might be just "noise" causing me to get whipsawed.

Points to ponder
How should I align my system to a longer time horizon and at the same time, not seeing my profits getting eroded by holding a stock too long?

Considering the scenario whereby the stock dropped 10% or 20% upon my purchase, should I take the loss or hold it? Instead of just relying on a stop loss defined based on purely technical indicators, I should step back and try to make an objective decision based on

1) Fundamental factors : Can it be over valued ? Can it be caused by short term detoriration of fundamentals (i.e oil and marine sector tend to slump when oil prices are low) . Assuming neither of the mentioned factors are the cause, should I still hold on to it cos a prolonged plunge in stock prices will affect the fundamentals too. 

2) Technical indicators indicating down trend even when fundamentals are intact. Should I still hold on to it by going against the crowd?  If it is a strong down trend, should I sell first and buy back only when its starting to gain momentum since I don't know how low will it go.

The above 2 should be judged based on a longer time horizon.. i.e, I should not judge a stock's 1 week trend or so.. Should use a longer time frame like 6 months..

3) The above needs me to make decision on an objective basis instead of simply following rules thus I will easily be succumbed to greed and fear. For example, I might sell of the stock when it plunged 20%(fear) and sell the stock once it surged10% profit(greed)..

4) Preparing myself mentally for  scenarios like
i ) Stock surge 100%
ii) Stock plunge 50%
iii) How probable the stock price can double?

There are only 3 available choices.. Buy,Sell or hold. This can be answered by going through on a checklist to decide on the action. 


I will try to improve my system based on the above points mentioned and experiment it again.