After-work Activities: Should you Trade, Invest or Study?

Among the perks of undergraduate living is that you are free to canoodle with spreadsheets.

This spreadsheet attempts to put in absolute dollar terms, the cost of pursuing 3 activities in one's adult life after work hours that doesn't involve liquor, women/men, social activities etc. over 1 year and excludes cost of living.

In this hypothetical case, Mr A Hardy either actively trades with a strict money management strategy, invest for the long haul (i.e. A Long-only investment strategy, but Mr A Hardy believes in careful allocation of funds across portfolios, so he insists on picking his own funds/ stocks/ bonds etc. No shorts or puts or speculative derivatives trading, however) or he can pursue his MSc in Financial Engineering. A course of study which opens doors and earns him the right to climb into a higher tax bracket. (or so he hopes!)

Here's a couple of non-surprising findings.

Trading is ok when one does it for a hobby, but it blows once you do it for a living. Take a look at line (L) of the spreadsheet. By far, investing gives you a much larger share of net wealth, and this is before Cost of Living mind you!

Also note, that these activities are over a 1-year basis. So the negative Net Wealth for Studying Option is amortised over the rest of your remaining life. Furthermore, you make up for that loss by moving into better paying jobs, or earn a higher salary.

Trading, some claim, offers an additional or alternative stream of income. This is true so long as the input less than the output. Consider how much effort,energy and time it takes to maintain one's shareholdings or trading portfolio? If you work in the office, and you work at home, is there space for your family? Is there space for your own interest?

The biggest attraction of getting into trading and investing is the vibrancy of one's after work life. People who are doing stuff with money seem very involved. Its a wee bit like footy lovers. All they seem to do is talk soccer.

It is my personal belief that people who say they trade to become richer are deluded. They trade for the thrill and for the pleasure of seeking something arcane and mystical that has opportunity for wealth. After work traders are modern alchemists.

How NOT to trade equity warrants.

Last year, I made money and lost it again trading warrants. I was up $7000 in May, and in the months following the sub-prime crisis, saw my profits erode to nothing. 

At the start of the year, I had already formed an idea of which sectors were in play. For Singapore in 2007, it was all about the IR industry, the property markets and the financial sector - specifically the banks. 

I was fixated on this sectors and never went around to look at other companies. I was sure that these companies would report good earnings because the economic indicators and numbers looked good. Logically for me the best bet would be to go long on these stocks. 

The earnings report were good. But being right does not guarantee profit. 

(Stock prices are not a function of earnings alone, they're also a function of public perception of risk. People attach risk premiums to the risk-free rate of return and discount future earnings by a larger amount. Stock prices fall, system wide, when people perceive increased risk in the economy. that's why sub-prime crisis is such a bummer.) 

On warrants:

1. As expiry nears, if the warrants weren't in-or-near-the-money already, then there's little chance for the warrants fair value price to move. Let it go if it doesn't fly.

2. Before buying a warrant, draw a timeline, figure out when the company will report earnings. Where possible model for Dividend effect and Earnings effect. As you draw nearer to that date, watch the warrants very carefully. 

3. If warrants go down by 10%, exit position ASAP. Don't average down no matter how far away the date to expiry is.

On Trading:

1. Never trade with money you can't afford to lose.

2. Take small losses early. 

3. Have a trading system. Back Test. Position size. And Keep good records.

4. Write down your Entry and Exit plan and stick to it.

5. Consistency is the key to Profits.

What I did on the 20th anniversary of the Wall Street Crash of 1987

I stayed away from reading any market related news. I read popsugar.com , slashdot.org and boingboing.net instead. Later, I chatted with my girlfriend and had a cup of coffee. I napped for half an hour. Woke up and thought, this isn't too bad. I took the time to reconsider my investment behaviour and reconsider my options.

I stopped trading a few months ago because I blew up my trading account during the sub-prime crisis. The spillover from that event propagated through the financial system and made a couple of my warrants positions finish worthless.

I had bet big on the warrants of Singaporean banks and Capitaland, largest real estate group on the island. Given the fundamentals, I thought they were safe bets. I was wrong.

When the crisis hit, the stocks wouldn't climb to reflect stronger earnings results due to all the negativity in the US market and prices remained depressed. I had committed funds too early in an attempt to average out the losses but by the time the market had bottomed out, I had invested too much money into each bet to make them good candidates for the ride up again.

Looking back I think I began trading in warrants because I was bored. From my lecture notes, I figure I am what Larry Harris, author of 'Trading & Exchanges' describes as a Utilitarian/ Gambler/ Futile Trader.

I'll admit it. I regret placing those bets. I regret them because I compromised on my ideals. That I won't chase the stock. That I won't play the market's game. That I won't be fooled by my schooling.

The more you know, the more you think you have an edge over everybody else in the trading game. The truth is that I am a nobody with little new information and the cost of gathering every little scrap of information just to make a few trades is too expensive for my taste.

Fund managers can trade because they get paid to do it. Brokers trade because they get paid to do it. They need to be on top of the news, they need to be on the lookout for investment opportunities. Its their job.

I don't have to. I have a life. Its Mine. I have only one life and to waste it all scouring the Net for information, prowling the Forums for a sensing on market sentiments - its just too much.

So on the 20th anniversary of the Wall Street Crash of 1987, I'm relinquishing my dreams of becoming an Active Trader and surrendering myself to the way of the Informed Investor.