discount brokers and technical analysis

The stock market can be considered as the place where the financial characteristics of publicly traded companies meet the hopes and fears of potential equity investors.  Fundamental analysis addresses the former issue, technical analysis the latter.

In the US of the Roaring Twenties, technical analysis served both functions.  Depression era reforms that forced companies to release accurate and readily understandable financial statements had not yet been enacted.  So the trading activity of “insiders,” detected by carefully watching price and volume movements, was the best gauge one could get of how firms were actually doing.

Since that’s no longer the case, why do online brokers (Merrill Edge is the only exception I know of) provide such lame information on company fundamentals?

Several reasons, I think:

–brokers earn their revenue from trading, not from investment results.  (For what it’s worth, there’s a strong belief in the professional investment community that there’s an inverse correlation between the amount of trading a portfolio manager does and investment performance.)  So it makes some business sense that they should provide tools that make trades easy to do, with an old-style video game-like interface that makes it seem important and fun.

–a fundamental research effort is a headache.  It’s difficult to create and sustain.   It’s expensive, as well.  Arguably, offering proprietary research also exposes the broker to liability if the recommendations don’t pan out.  The user needs some accounting/economic background to understand what’s being said.  The broker who provides fundamental research has an obligation to consider whether a recommendation is suitable for a given client–opening another can of worms.  And, of course, an emphasis on fundamentals runs the risk of refocusing clients away from frequent trading, to the detriment of profits.

–discount brokers do offer a kind of fundamentals-based product through actively-managed mutual funds and ETFs, as well as through their sponsorship of networks of financial planners for whom they provide back office services.  Offering fundamental research might put brokers into competition with those planners.  And the fundamentally-based fund offerings carry a much higher price tag than DIY trading.


trading (ii)

have a game plan

In the beginning, when you’re feeling your way, a plan will likely be relatively simple.  Still, it should contain at least three elements:

–what you intend to do

–why what you’re doing will enable you to make money, and

–how you are going to measure your performance.

the process

In all likelihood, a trading process will include a healthy dose of technical analysis, which in its saner elements is an effort to read the short-term emotional mood of the market.

Take the case of Tesla (TSLA), where investors seem to alternate between bouts of severe depression and wild enthusiasm.  The plan may consist simply of buying TSLA at, say, $200-, when spirits are flagging, and selling at $250+, when owners are dancing in the streets.

Or it could be that you’ve held Amazon (AMZN) for years.  You observe that the stock is travelling in an upward-sloping channel that’s now bounded on the low side at, say, $750 and on the high side at $850.  You might decide you can trade around a core position by selling some of what you own above $850 and buying below $750.

the source of profits

Ultimately you have to believe that something you do gives you an edge over the average investor. Maybe you are very familiar with the price action of a certain stock because you’ve owned it for a long time.  Maybe your work gives you insight into the publicly traded companies in a given industry or geographical area.  Maybe you think that rising trading volume always precedes rising/falling price and you use screens to identify stocks where this is happening.

measuring performance

There’s a very strong tendency among even professional investors to remember successes vividly but brush losses under the rug.  Because of this, it’s essential to measure how you’re doing, both in absolute terms and relative to the performance of a benchmark index on at least a monthly basis.

This is also the best way to identify your strengths and, more importantly, the mistakes you are prone to.  Everyone has something in this second category.  Simply no longer doing stuff that you always lose money on can give a big boost to performance.  I know this sounds silly, but I can’t think of a single professional I’ve known over the years who hasn’t had to deal with eliminating a chronic bad investment habit.

More on Monday.


so you want to be a day trader

why trading?

As human beings, we’re all very complex.  Sometimes(often, in my case) we do things for reasons we don’t clearly understand.  We can be influenced in ways we’re not fully conscious of by our families, our friends, our neighbors, our heritage   …as well as by daily bombardment by media of all types.

Sounds silly, but:

–Early in my career as an analyst, I remember calling the CFO of an oil and gas exploration firm to ask him, in polite terms, why anyone would buy the tax shelter programs he was selling through investment advisers, since my reading of the prospectuses seemed to show that virtually all the benefits went to the promoter.  His reply was that buyers were not particularly sophisticated financially.  They typically bought the programs as a way to signal to others that they were wealthy enough to have a “tax problem.”

–Some people are attracted to the riskiest stocks simply because they’re risky rather than because they might offer superior returns.  Buying them is in effect a substitute for going on a thrill ride at the amusement park.

In my experience, successful investors and successful traders have one thing in common.  They are clear about their purpose   …which is to make money.  They’re not working to feed their egos, make friends, or enhance their standing in the minds of others, although these positive things might be nice as side effects.  It’s all about making a return.

This is not to say one shouldn’t have scruples.  As an active manager, I avoided tobacco stocks, for example, because I believe this is a morally bankrupt business.

There’s also no way to know whether you can make money buy buying and selling financial instruments–whatever your holding period–unless you try.

Nevertheless, if you are going to be successful, the bottom line must be that you intend to make a profit.


More tomorrow.
























trading: buying in thirds

coming late to the party

I’ve found that the situation arises more often than one might think where I find a stock I think it interesting but where I’m very clearly not the first one at the party.  In other words, the company has potentially attractive long-term prospects but the stock is not cheap enough that I can justify buying a full position right away–and I don’t have a practical feel for how it trades.  My instinct is that the price is a bit too high, but I’m not sure.

how to get involved?

What I’ll typically do is buy a third of the position I ultimately want to have.

I’ll then continue to find out more about the company and watch the stock’s trading carefully (my experience is that people, myself included, never look hard enough if the name is only in a paper portfolio–a kind of portfolio I find psychologically pretty useless, anyway).

My intention will be to buy another third on a decline of, say, 5% – 10%, assuming I don;t turn up new information, positive or negative, that overturns my whole thesis.

If I I buy the second third, I’ll wait for a further decline to buy the final portion.

What does this method get me?  I have immediate exposure, in case I’m correct on the stock but too pessimistic on valuation.  At the same time, I still have a chance to lower my average cost by buying the bulk of the position at a lower price.

an example

My California son and I have been talking about the Elon Musk empire for a long time.  Following its weak  4Q14 results, our conversation turned to Tesla (TSLA).  It’s a stock I’ve owned off and on, but my son hasn’t.  (My view, (too) simply put, is that TSLA is a lot like a gold mining issue whose assets consist solely/predominantly in ownership of a reportedly fabulous orebody now under development.  Such stocks typically peak the day the mine opens–when investors have to deal with facts, not dreams.  Before then, the dreams are more important. )

My reading of the TSLA chart–hopefully more useful than parsing nocturnal visions with a dream book–made me think the stock continues to trade in a range between $180 and $260-ish.  I was also willing to believe that TSLA’s 4Q14 failure to sell enough cars was mostly due to bad weather and port difficulties.

Anyway, I decided to buy my first third at $200.  My son said he would wait for $190.

I bought his first third at around $191, where I bought my second third.

I bought his second third at $186? …and another (less than) one-third for myself there. as well.

Then the stock began to move up quickly and we haven’t bought any more.

The result:  my son has a somewhat smaller position, relative to his total portfolio size, with an average cost of $188?.  I have a larger relative position, with a higher relative cost, $194?.  So we both have exposure, and at a lower cost than if we’d bought all at once.

Another point: We’re dealing with a discount broker where our total commission costs are around $20.  Paying for two or three trades instead of one makes little difference.  For a traditional “full service” broker, this probably won’t be the case.





Blackrock’s new trading platform as attack on traditional money managers (l): background

I’m going to write two posts about the internal trade order-matching network that Blackrock intends to have up and running next year.  This one will provide background, some of which I’ve written about before.  Tomorrow’s will deal with how the Blackrock network fits as a strategic weapon in the money manager’s arsenal.

three types of commission

For a conventional money manager, commissions paid for trades–or bid-asked spreads, which amount to the same thing–break out into three types, from most expensive to least:

–research commissions, aka “soft dollar” commissions.  These commissions consist of a payment to a broker for executing and recording a trade plus an amount to compensate for research services.  Ten years ago the research service payment was predominantly in return for information from the broker’s own in-house research.  Today, most brokerage house analysts have been laid off and work in independent research boutiques that their former employers act as middlemen for.

The amount paid per trade will depend on the size and trading habits of a given institutional client, by may amount to, say, $.05 per share.

–commissions for execution.  These are paid strictly in accord with the SEC mandate for registered money managers to obtain “best price” and “best execution” when they trade for clients. They might amount to $.03 per share, of which $.015 might be the broker’s cost and the remainder a profit element.

–trades through electronic crossing networks, aka “dark pools” (for fantasy or vampire fans, I guess).  These have become increasingly popular.  One advantage of such networks is their low cost–maybe $.001 over the expense of executing a trade.  The second is their anonymity–you don’t run the risk that your intentions are not only broadcast to your broker’s proprietary trading desk, as they surely are, but also to all the broker’s best customers as well.

attacks on the conventional model

Blackrock’s new trading platform is the latest one.  That’s tomorrow’s story.

A second attack, blunted for a while by the financial crisis, is coming from Fidelity and concerns soft dollars.

When I entered the industry, conventional money management firms typically had large cadres of in-house research analysts who serviced the firm’s portfolio managers and reported to a research director.  This was expensive.  Also, in many cases the firms didn’t have strong enough general management to ensure the in-house research was any good.

As time went on, firms gradually shrank their in-house research efforts.  Instead, they began to increasingly depend on analysis generated by the brokerage houses they traded with–paid for with higher-than-normal commissions.  This “solved” the management problem.  And it had the added benefit of increasing profits by shifting the cost of research away from salaries paid out of the money manager’s fee income to commission expense paid by the client!

How do you justify this, either to the SEC (assuming the agency weren’t clueless) or to clients?  The standard response was that this was normal industry practice.  How so?  …because that’s what the industry giant, Fidelity, does.  The mantra has been that if Fidelity allocates 15% of its commission volume to pay for research, it’s ok for everyone else to do that, too.

Just before the onset of the financial crisis, however, Fidelity, which has a large in-house research staff, decided to change its practice.  It proposed to the major brokers that it pay them a set cash fee for research each year, say, $8 million.

Brokers balked, for two reasons.  The money was been less than they were getting paid before.  It would have forced an internal reallocation of compensation away from the traders who run the firms to the researchers who were specifically identified with the fee income.

For other money managers–to my mind, the true target of the Fidelity initiative–this was a nightmare.  They could no longer use Fidelity as justification for their soft dollar spending.  In addition, their profits would plunge as they either paid out large portions of their management fee income to newly rehired research analysts or to brokers for their research output.  Smaller managers might be forced to close up shop.

The soft dollar issue hasn’t gone away.  Brokers, however, have “solved” their internal profit allocation problem in the short term by firing most of their veteran researchers during the downturn.  And Fidelity seems to have lost interest for the moment in pushing the issue.  …or at least publicizing it.  It may well be striking cash deals with small research boutiques.

I think Blackrock’s trading platform idea has similar elements of using large market size to damage smaller competitors while at the same time making a profit for itself.