Things To Include In Your Trading Journal or Blog

Following on from yesterday’s post I thought I would comment on some things that I feel are very important to include in any trading journal or diary. The obvious ones are the date when you purchased the stock and the price you paid, but some other ones worth considering include:

·         A summary of the reasons why you purchased the stock. For a fundamental investor I would be looking to detail why you think the company will be able to increase their operations (e.g. one a new mine) , why the underlying commodity may increase in price (e.g. increased investment demand gold) or if there is the potential for the stock to re-rate and become more closely aligned with its peers (e.g. P/E ratios or in ground valuation of gold, etc). For traders I would include information on what technical indicators or metrics led to your decision to buy or sell a particular stock.

·         A detailed list of future expectations based on your research. For the fundamental investor this would include things like the company achieving a certain rate of growth or establishment of new mines or operations and what that would mean for the share price. It is important that this information considers the facts and is not just some fantasy dream that you hope will occur. For the trader this will be solely priced based, but it is also important to note the expected timeframe for each of these items. You could also comment on how much volatility you expect while holding the position as this can have an effect on your frame of mind and ability to hold during down days.

·         Your exit rules. This is probably the hardest thing for a fundamental investor as we usually ignore the short term noise associated with a stocks share price. I would however suggest that the failure of the company to meet a certain objective, the poor performance of management over a period of time or deterioration in the underlying commodity price would be some of the reasons which you could include here. For traders the exit rules can either be price bases (i.e. set your stop loss at a certain pre-determined level) or time based (i.e. if the stock does not start moving in line with my expectations by x date then I will reconsider the position and/or sell).

·         Information on managing the position for trades or investments that go in your favour. For example will you exit 100% of the position in one go or will you scale out of the position over time to ensure you do not sell at the highest nor lowest point. For my investments I plan to scale out of each position because it is simply too risky to take all the money off the table in one go (for positions that are going your way) as there is always the potential for another announcement or the strong buying to continue. This will obviously average out your potential gain/loss but I believe it is an important tool well worth considering.

·         Your thoughts on the riskiness of the position. All of mine investments are typically “high risk”, however I think it is important to detail this in writing as it will remind you of the pitfalls associated with each investment and remind you that even if the price is currently green there are still risks associated with each position. I would also be looking at detailing what risks you foresee in the share price and the company’s operations. This can also be linked in to your exit rules.

I am sure there are many others that I cannot think of off the top of my head so please feel free to comment below and share you thoughts.

Is this a viable lifelong strategy? And A New Definition For Risk

Today someone close to me asked if this is a viable lifelong strategy and it has left me feeling a little bit deflated. Not because I don’t believe that I can make it but more so because it feels like your goal/lifelong dream is being questioned.

Now, I am not under any delusion as to how hard it will be to generate a living from the market, nor how long it will take for the companies I invest in to reach their full potential. I also don’t want to lie and say that if one of my stocks goes up ten times I’ll be a multi-millionaire, because that is simply not the case. To turn this goal into a reality I really need one ten bagger from which I can then enter another couple of stocks with three to four times what I put in my first few (OBJ, MHM & KGL). This is the value of compounding and each successive win means I have more capital to put into my next stock.

Right now the risks are the greatest because I already have three stocks and only room for maybe one or two more. From those five companies one or maybe two will fail but the gains from the others should more than offset those losses. If this occurs then I will have a larger capital base and my future portfolio could probably accommodate up to six stocks, with a bit of cash for short term opportunities and a cash buffer to protect against more than 50% of the portfolio crashing to zero (i.e. ensure I have money to come back in the event of a worst case scenario).

Finally I don’t necessarily classify my portfolio as “high risk” because if you have conducted the research and understand the fundamentals of the company then it should be “known risk”. High risk to me sounds like some useful catchphrase from which people can justify poor investment decisions. Why would anyone invest is something that is “high risk” unless they are gambling. It is a non-sense saying made to satisfy the demands of the ignorant. I apologise if I have used the words “high risk” in relation to my stocks in the past, but it was probably to make sure people understood what I was taking about in a general sense. From now on I will use my new phrase (not sure if it’s been used in investment terminology before or along these lines) but I propose the following definition:

“known risk in relation to a stock (or portfolio of stocks) that are anticipated to generate a high rate of return refers to the ability of an investor to understand the fundamental components of the company, the industry in which they operate and other external factors which may affect their future performance. Taking all these factors into consideration the investor calculates a future share price or market capitalisation that is likely to be five to ten times that of the company’s current value.

If the share price then falls by a considerable margin this is not an unpredicted event, but one of the considerations accepted by the investor when making their investment decision. I.e. The Investor chose to invest based on the likely return, but with knowledge that the return was conditional on a set of targets or objectives.

Known risk should not be used when referring to any investment that involves “hit and hope” exploration, companies with poor management or no/limited future of financial performance or security. These should be classed as poor investment decisions. I.e. there is no risk because they will only ever go one way, down”

Explorer to Producer and Why Your Timing is Important

The other week I replied to a post about a resource stock and its share price. My response was in regard to the life stages of a company as it moves from explorer to producer and the affect this can have on the capital structure. I received some positive feedback on the post so I thought I would share part of it with you again today. It is very simplified but I think it details the overall process well.

As a resource company moves from explorer to producer the share price normally re-rates in a number of ways.

If the company starts out as an explorer the share price will be largely tied to their exploration potential and any discoveries they make. The share price will normally jump in price if they announce good drilling results and a “potential” discovery.

Following this spike in the share price will typically fall. At this stage the stock is basically controlled by traders and after they have traded the run up they will move out of the stock and look for their next target.

Time then passes and if we assume that the discovery is good further drilling takes place as the company proceeds to put together a JORC estimate. Obviously it is normally two steps forward, one step back but for the sake of this example and simplicity let’s assume they have discovered something worthwhile. The share price is then likely to jump again once the JORC estimate is finally put together and people will start applying an in ground value to the resource.

The share price then drops back as traders leave it again and longer term holders realise that it takes a significant amount of capital to develop a mine. There is also other risks associated with mining approvals and licences, etc.

Assuming all is well the company will then proceed to the preliminary feasibility stage to run some basic numbers on the project. If we assume this comes back positive then the share price is likely to rise again as the first box towards developing a mine has been ticked.

As per usual it will then drop back as it is dumped by traders again and longer term investors wait for the bankable feasibility study which is required before the formal decision to proceed with the mine can be made.

Once this is released it confirms that a mine can be profitably developed and the share price may run again off this news. However, following this the share price may retrace again because the mine development costs will be high and existing shareholders face the threat of dilution (as the company may issue additional shares to raise funds).

The share price may then run and re-trace every now and then based on the issuing of mining licences, securing of finance and successful capital raisings. During this time the shareholder base is also likely to change with more investors coming on board and positioning themselves for when the company starts producing.

Finally once the mine is in production there will be a re-rate in the share price because they will have finally achieved what they wanted (i.e. a mine that is operating). The real re-rating will however come in 3, 6 or 9 months when the company proves that not only can they run a mine but that they can meet their production targets, revenue and profitability forecast.

Now that is obviously a simplistic breakdown of the process and it may take a resource company many, many attempts at exploration before they are in a position to define a resource. However we can see from the above that the reason why it can run and re-trace so much is because in the early days it is largely traders who push the price up and down. Also as an explorer the company will probably have a market capitalisation of between $20 and $50 million. To develop a mine will cost many times their market capitalisation and as a result new shares will be issued diluting existing holders. Obviously some people will sell in anticipation of this which can also have downward pressure on the price.

I would also like to add that in regard to my investment approach I primarily look for companies that have a good chance of moving into production, low/no debt and preferably a cash in the bank to minimise the potential of a capital raising. In summary if you are a long term investor it is about buying at the right stage of the company’s life to minimise the potential of adverse effects and the burning of time while you wait for the company to move to the status of producer.

An Insight into My Research – Background Analysis

I thought it would be an ideal time to discuss some of my researching methodology and analysis techniques so that you all can get a better idea of how I chose my investments. I will break my investment approach down into a number of separate posts which will be published over the next few weeks. For today I am focusing on the very first step which is the background research I conduct into the company.

Once I have found a company that I am interested in or has what I believe to be good future potential I undertake a significant amount of research into the background of the company. This normally involves reading past ASX announcements, broker reports, news articles and investor presentations. Luckily for me most of the stocks I research have been listed for around 4 to 8 years so it only takes a couple of days to wade through all this information. For both of my current investments (OBJ and MHM) I have read and taken notes on every announcement released since their listing.

I know this may seem extreme, however, it helps me understand where the company has been, where it is now and where it plans on going in the future. For companies that have been listed on the market for a long time or have undergone a significant restructure I normally only read from this point forward. An example is Northern Star Resources (ASX: NST) who acquired Paulsens Gold Mine in 2010. Prior to this the company did nothing of note (in my opinion) so I only spent a small amount of time reading over these earlier announcements. That said if I believe information and a further understanding of the company’s past is required then I commit the time to read it all.

After reading about the company I have normally developed a list of questions and concerns that can affect my investment decision. In particular, my research can help highlight poor management, a failure to meet deadlines or targets or a general chopping and changing of the company’s activities on a regular basis. I will also be better able to understand the company’s future potential from these announcements and what their “vision” is. For example it may highlight that the share price has been depressed for many years due to poor management. However a new senior management team could have been installed six months ago and acquired a project that is moving towards production. This can provide an opportunity as the market may be pricing them at a discount due to the previous management and their old projects.

After I understand the company it is important to do further research into the industry and associated partners. This is particularly evident in the bio-tech space where there is a steep learning curve in regards to understanding the link between large pharmaceutical companies, their smaller partners, the approval processes and timeframe to development. For example with my stock OBJ Limited case we are dealing with three partners, two of which are unknown (due to confidentiality agreements) and as a result links need to be drawn between potential partners to get a clearer picture.

For stocks in the resource sector this analysis can involve looking at nearby mining operations, other similar companies listed on the ASX and other exchanges and considering the future demand of the commodity. This allows for additional analysis and comparisons to be made between companies when I finally proceed to the calculations and forward projections part of my research.

Finally the last part of background research I undertake is into the senior management team and Board of Directors. With Google and Linkedin it is very easy to gain an understanding of what each person has done in the past, the success they have had and any failures along the way. It is important to look for different sources other than what the company tells you because naturally they will only highlight the positives. Now just because a manager may have failed with a project elsewhere does not mean the company is immediately removed from my list of potential stocks. I am more concerned about repeated failures, illegal dealings and anything that indicates that the manager just jumps from one thing to the next with little considerable for shareholders.

As you can see the above does involve a significant amount of time and after starting with some advice from Warren Buffet I am going to conclude with some of my own. Don’t worry about the thought of wasting hours and hours of research only to find out that the company is a dud. It is better to waste 20, 30 or 40 hours of your time than lose all of your money in a poor investment. Sometimes it feels like you have wasted all that time researching a stock only to conclude it is not a good idea to buy, but you should take this as proof that the research is worth doing. In the long run you will be better for it!