For most working people in Singapore, the difference between the right and wrong choice can amount to more than $200,000.

To some, it might be a bold statement. But I think he has a case as he backed up the claim with figures in this ebook.

The ebook would teach you how to determine the amount of insurance premiums the insurance company and agent are pocketing from you. He found that such costs can range between one to two years’ of premiums. It is hence important to know if you have been ripped off. He deemed that the deduction should not be more than 20%, but first, you must first learn to look at the right numbers to determine it.  The key is to look at the Benefit Illustration and he used a real example in the ebook for the calculation.

He went on to say that a life policy usually takes more than 15 years to break even and the surrender values are “horribly low” prior to the maturity rate. In the event that you can no longer pay the premiums because you have lost your income, you would lose a lot of money if you have to surrender the policy pre-maturely.

The ebook is also dotted with rule of thumbs which are easy and practical for implementation. An example is

You can buy insurance for 5 to 10 years of your income. The cost of this insurance should be within 1% of your income. If you earn $60,000 a year, you can set aside $600 a year for this insurance.

He will share with you how to insure enough and yet not over-commit your salary to insurance. You can save and invest more money which can amount to more retirement funds.

The ebook cost $4 and can help you accumulate $200,000 for retirement potentially. A good enough risk-reward ratio for you?

Buy and download instantly.

I will not be going through DCF’s complex formulas in this post as I only want to address the weaknesses of the method. Investopedia has covered well about the method which you can read about it here. Otherwise, let’s begin.

#1 Predicting Revenue Growth

One of first thing you predict is revenue growth. The question is that even the CEO does not know how much would the company’s revenue grow in the next few years, lest to say an outsider trying to value the company. If you insist, it is more acceptable to predict revenue growth for companies with competitive advantage. You can be more certain a company can continue to grow and capture market share when there are no strong competitors. But there aren’t many companies with competitive advantage and hence, DCF cannot work for most of the companies out there.

#2 Predicting Operating Costs

The company needs to pay out salaries, rentals, raw materials, utilities etc. Are we able to predict how much would these costs change in the next 10 years? Are we even able to predict our utility bills or price of oil 6 months later? I am not confident and I do not know about you. If smart economists can get inflation rate projection wrong, what makes us think that we can predict the rise and fall of companies’ operating costs?

#3 Predicting Capital Expenditure

Let us assume we got it right about our prediction for #1 (revenue growth) and the company indeed made more money but now we have to predict another thing – what would the CEO do with the earnings in the next 10 years? You mean now we have to predict human behaviour? Gosh! How do we know how much would the CEO spend on expansion, buying machinery, etc, and when will he spend it?

#4 Predicting Change in Working Capital

Working capital is the difference between the current assets and current liabilities. “Current” in accounting means less than a year. In other words, the assets are liquid and can be converted/used within the year, and current debts are due within the year too. Since they are so liquid, the items can move in and out of the company easily and frequently. Tracking the movements of these assets and liabilities already takes up a lot of effort. Predicting the changes in current assets/liabilities for the next few years would be even more challenging.

#5 Predicting Risk-free Rate

Interest rate is pretty much controlled by the Fed (and somehow it has a lot of influence on the interest rates in the rest of the world). Although the Fed has been criticised for being lax on monetary policies for many years, it is hard to predict when they would change their mind and stop their money printing press. Yes, there have been speculation of halting QE3 but nothing is certain until it happens. Hence, how do you accurately predict the interest rate in the DCF method?

#6 Predicting Change in Beta

Beta is a term coined by the finance professors to confuse the average Joe. It is one of those numerous sexy terms that professionals use to make them look smart in front of their clients. In simple terms, Beta is a number, which is assigned to a stock based on the correlation of its price with the general market’s movement. It is to measure how volatile the stock price is. A Beta of higher than 1 means it is more volatile than the overall market. But correlation and Beta is not constant for a stock. If you can predict Beta accurately, why don’t you predict the stock price directly?

#7 Assumptions and more Assumptions

The DCF method hinges on the accuracy of assumptions. And we know that assumptions are often invalidated by reality. DCF users will have to constantly update their model regularly. But soon after they updated the assumptions, there are bound to be new developments to render their assumptions obsolete again. It will never end. Assumptions over and over again.

Practise Conservatism

If you are to use DCF, my advice is to be conservative with your assumptions. But then again, if you are so pessimistic with the assumptions, you will probably not able to find anything worth investing. So what is the value of using DCF? I think we should shift all the books on DCF to the fiction section.

Remember: It is not about how good the method is. The success of your investment hinges on the accuracy of the assumptions you have used in the calculation of DCF, which in my opinion, there are too much room for errors when you have to predict so many things.

This book is one of the favourites for traders. I have heard enough stories about how this book has helped traders make the necessary mental shift to become profitable traders. Instead of believing in what others said, I read the book and judged it for myself. I will not say that it had such a fundamental impact to me but I cannot deny the book did helped me figure out certain things in trading. Not everyone can pick up the same amount of useful ideas from the same book. Different people have different background, experience and objectives, and are triggered by different thoughts. Although I may not have gotten a lot from it, it does not mean you would not. Nonetheless, I enjoyed the book and being able to get a few perspectives from it still makes it a good book. I shall share with you two things that I have learned.

More Knowledge Does Not Prevent Losses

I was guilty about a mistake that Mark pointed out in the book – I lose money because I lack market knowledge. To him, it is not true.

“This means that no matter how much you learn about the market’s behavior, no matter how brilliant an analyst you become, you will never learn enough to anticipate every possible way that the market can make you wrong or cause you to lose money.”

He said that losses are not a result of your reading of the market. No one can learn enough to score 100% wins in all his trades. Hence, it is never about being the super analyst who never make any mistake. This person does not exist.

“Why do you think unsuccessful traders are obsessed with market analysis. They crave the sense of certainty that analysis appears to give them. Although few would admit it, the truth is that the typical trader wants to be right on every single trade. He is desperately trying to create certainty where it just doesn’t exist.”

“The consistency you seek is in your mind, not in the markets. It’s attitudes and beliefs about being wrong, losing money, and the tendency to become reckless, when you’re feeling good, that cause most losses – not technique or market knowledge.”

Hence, do not expect your methods or the market to perform consistently. Do not be disappointed when you are wrong, or become overconfident when you are right. It is about implementing your method consistently regardless of wins and losses. Because wins and losses will stir your feelings and cause you to act irrationally, and result in self-sabotage.

“To be consistent, you have to learn to think about trading in such a way that you’re no longer susceptible to conscious or subconscious mental processes that cause you to obscure, block, or pick and choose information on the basis of what will make you happy, give you what you want, or avoid pain.”

I think the above quote is true – we see what we want to see. We filter information every second and we do that in trading too. We will filter out the information that will cause us pain and select information that gives us pleasure. And doing these seldom lead us to profits.

Why People Love Trading?

I love the way Mark explained why people love trading, and I think to some extent I felt it is true for me.

“Trading is an activity that offers the individual unlimited freedom of creative expression, a freedom of expression that has been denied most of us for most of our lives.”

However, he cautioned that many of us do not have the necessary psychological makeup to survive the market when we have no rules to govern our trading in the boundless market.

“The freedom is great. All of us seem to naturally want it, strive for it, even crave it. But that doesn’t mean that we have the appropriate psychological resources to operate effectively in an environment that has few, if any, boundaries and where the potential to do enormous damage to ourselves exists. Almost everyone needs to make some mental adjustments, regardless of their educational background, intelligence or how successful they’ve been in other endeavors.”

——————————–

These are the two things that were most applicable to my situation. Have you read the book? What were the useful things you have gotten out of the book?

#1  - Price-Earnings

PE ratio is the most common financial ratio to investors. The numerator is the price of the stocks while the denominator is the earnings of the company. This means that how many times of earnings are you paying for the stocks. For example, if the PE is 10, it means that you are paying 10 years worth of earnings. The lower the PE, the better. Let’s use an example to illustrate this. You saw a house selling for $1m and the owner said it is tenanted. The owner tells you the rental is worth $5k a month. After you have factored all the costs in owning and maintaining the house, your net profit is $2k a month or $24k a year. So the PE ratio for the house will be about 42. It will take 42 years for you to get back the worth of the house through a positive cashflow of $2k per month.

Although PE is a favourite ratio, it is ever changing. Firstly, price can change. No one can predict how high the stock prices can go and although the PE can be high in your opinion, it can continue to go higher beyond your imagination. The other factor that causes PE to change is the significant rise and fall in earnings. A company can be making a lot of money for the past 10 years but because of competition, they may lose market share and suffer a decline in earnings. Hence, PE ratio is at best a view of the company’s and its stock’s historical performance. It does not tell you the future. You would need to assess the quality aspect of the company – Can it sustain it’s earnings? Will the earnings grow?

#2 – Price / Free Cash Flow(FCF)

There is a belief that while it is possible to fake the income statement, it is harder to fake cash flow.  Hence, besides looking at the PE ratio, you can examine the P/FCF Ratio. FCF is calculated based on the values from the cash flow statement, which the statement shows the movement of money in and out of the company. FCF is defined as, Cash Flow from Operations – Capital Expenditures. If the number is positive, it tells us that the company is taking in more money than it is spending. And it often indicates a rise in earnings. PE and P/FCF should tell the same story. You can use either or use both to detect any anomaly/divergence.

#3 – Price Earnings Growth Rate (PEG)

We recognise the deficiency of PE ratio which is plainly historical performance. Is there a better way to look into the future to get a sense if the company is a good buy? The house example assumed the rental does not grow over time. But you and I know that it is not totally true. Rental may go up due to inflation. Likewise, growing companies are likely to increase their earnings in the future. One of the ways to factor this growth is to look at PEG ratio. It is simply PE / Annual Earnings Per Share (EPS) Growth Rate. Yes, it is a mouthful. I will explain the denominator. EPS is simply earnings divided by the number of shares. But we need to look at the growth of earnings. So we have to average out the growth in EPS for the past few years. For example, if the company has been growing at a rate of 10% per year, and its PE is 10, the PEG would be 1. In general, PEG ratio less than 1 is deem as undervalued. However, it is important to understand that we are ASSUMING the company would continue to grow at this rate. No one can forecast earnings accurately. Warren Buffett is smart in this area because he buys into companies with competitive advantage. Only this way, he can be more certain that the earnings will continue to grow, or at least remain the same.

#4 – Price-to-Book or Price-to-Net Asset Value

PB ratio is the second most common ratio. Some people call it price to net asset value (NAV) instead. Net asset is the difference between the value of the TANGIBLE assets the company possessed and the liability the company assumed (intangible assets like goodwill which should be excluded). Let’s revisit the house example. Your house is worth $1m dollars and you owe the bank $500k, so your net asset value of the house is $500k. Hence, the higher the net asset value, the better. If the stock’s PB ratio is less than 1, it means that you are paying less than net asset of the company – think along the lines that you can buy a house below market value.

There is a word of caution when you look at NAV. These numbers are what the companies report and they may overstate or understate the value of assets and liabilities. In fact, not all assets are equal. For example, a piece of real estate is more precious than product inventory. Rising inventory is a sign the company is not making sales and earnings may drop. Hence, rising assets or NAV may not always be a good thing. You have to assess the asset of the company. The worst assets to hold are products with expiry, like agricultural crops etc. Also, during property booms, the assets may go up significantly as the properties are revalued. The NAV may tank if the property market crashes.

#5 – Debt-to-Asset or Debt-to-Equity

Sometimes I wondered if I should be looking at Debt-to-Asset (D/A) or Debt-to-Equity (D/E) ratios. After a while, I realised either one of them is fine because both are just trying to measure the debt level of the company. Most importantly, use the same metric to make comparisons. Do not compare a stock’s D/A with another stocks’s D/E! Let’s go back to the example of your $1m house and remember you still owe the bank $500k, what would your D/A and D/E look like? Your D/A will follow the formula, Total Liabilities / Total Assets, which will give you a value of 50% in this case (assuming you only have this house and no other assets or liabilities for the sake of this example). Your D/E, which is defined as Total Liabilities / Net Asset Value, will give you a value of 100%. Hence, for D/A at 50%, it should mean something like this to you: 50% of my house is serviced through debt. And for D/E at 100%, you should read it as: if I sell my house now, I can repay 100% of the debt without having to top up.

As you can see, it is just a matter of preference and there is no difference to which ratio you should use. Most importantly, the value of D/A or D/E is to understand how much debts the company is assuming. The company may be earning record profits but the performance may largely be supported by leverage. You should not be happy to see D/A and D/E rising. Leveraged performance is impressive during the good times. But during bad times, companies run the risk of bankruptcy.

#6 – Current Ratio or Quick Ratio

Long term debts usually take up the majority of the total liabilities. Although the company may have a manageable long-term debt level, it may not have sufficient liquidity to meet short term debts. This is important as cash in the short term is the lifeline of a business. One way to assess this is to look at the Current Ratio or Quick Ratio. Again, it does not really matter which one you are looking at. In investing and in life, nothing is 100% accurate. Close enough is good enough. Current Ratio is simply Current Assets / Current Liabilities. ‘Current’ in accounting means less than 1 year. Current assets are examples like cash and fixed deposits. Current liabilities are loans that are due within one year. Quick Ratio is, Current Assets – Inventory / Current Liabilities, and it is slightly more stringent than Current ratio. Quick ratio is more apt for companies that sell products where inventory can take up a large part of their assets. It does not make a difference to company selling a service.

#7 – Payout Ratio

A company can do two things to their earnings: (1) distribute dividends to shareholders and/or (2) retain earnings for company’s usage. Payout ratio is to measure the percentage of earnings given out as dividends. You will understand how much the company is keeping the earnings and you should ask the management what do they intend to do with the money. Are they expanding the business geographically or production capacity? Are they acquiring other businesses? Or are they just keeping the money without having knowing what to do with it? There is nothing wrong for the company to retain earnings if the management is going to make good use of the money. Otherwise, they should give out a higher percentage of dividends to shareholders. This is a good ratio to question the management and judge if they really care about the shareholders.

#8 – Management Ownership Percentage

This is not a financial ratio per se but it is important to look at. It is unlikely the CEO or Chairman would own more than 50% of a large corporation. Hence, this is  more applicable to small companies. I like to buy into small and profitable companies where their CEO/Chairman is a majority shareholder. This is to ensure his interests are aligned to the shareholders. It is natural humans are selfish to a certain extent and if you have the CEO/Chairman having more stake in the company, you are certain he will look after you (and himself).

Where to find these ratios?

You do not need to calculate all these values yourself! There are websites which have done the service for us. Some are free and some are paid. My advice is try the free ones first and if it is not sufficient, then pay for more information. The following are some of the sites you can consider:

Singapore Stocks

• www.shareinvestor.com
• www.sharesinv.com

U.S. Stocks

• www.finviz.com
• finance.yahoo.com
• www.google.com/finance

There you go. 8 Key Financial Ratios in a nutshell and some websites for your reference. Let me know what other websites provide such fundamental data. Share the good stuffs with us!

• Should you buy a Private Shield Plan or stick to Medishield?
• In fact, are there alternatives to all these? Can I afford to live without them?

I have a Private Shield Plan and I am still fine with it because my premium is still low for my age. However, I do see the premium climbs steeply after a certain age. I will have to balance between the premium cost and the potential benefits I would be getting. Is it worth it eventually? The answer may be no for me in the future. Mr Tan is not trying to persuade you not to get a Private Shield Plan but he laid out the numbers for you to decide. He challenges you to think about the way you want to receive medical treatment in times of need. Is a luxurious private suite necessary? Or a subsidised ward would suffice? There are many questions to ask yourself and no one can tell you what is right or wrong. You have to find out your preferences and get an insurance product that suit you.

The following is the introduction of the ebook.

Many people in Singapore are worried about paying the medical bills when they get old.

They hear horror stories about how costly it can be, to be treated for cancer or a serious illness.

They look for insurance as a solution, but are not aware that they cannot afford to pay the high premium rate for the elderly or may not be able to get the cover due to pre-existing conditions.

Insurance agents target people when they are young and healthy and encourage them to buy expensive medical insurance, when it is not really needed.

There is actually a practical solution for the elderly in Singapore.

This will be explained in this book.

The ebook only costs S$4 but the information to help you make a good decision is priceless. You can buy it here.

I will say both are right. In fact, you need both to be rich and there are no other ways unless you strike lottery big time. If you and I know that we do not have the destiny to win big from lotteries, we have to work our way through cash flow and capital gains. Let me give you my perspective in this post and I think it will help you frame your thoughts in a useful manner.

Role of Capital Gains

To become rich, you need to have significant capital gains. In order to have large capital gains, you need to have a sizable capital to invest with. Let’s say you invested $100k after the stock market crash in 2008 and you sold your stocks in 2013 and made $100k. Although your percentage gain of 100% is impressive, you are still far away from being a millionaire. How many times will you need to double the money to $1 million? You will need another 2 market crashes which you may only achieve in 10 to 20 years time. But if you have $500k invested in the same period, you would have become a millionaire in 1 market cycle. It is much faster to become rich through capital gains if you know how to invest. 

This is the reason why the rich gets richer. They have sizable capital to invest and grow their money much faster than the average joe. Remember, the growth of wealth is non-linear due to compounding effect.

I think this is simple to understand. But the question is, how do you get a sizeable capital? The answer is not capital gains but cashflow.

Role of Cashflow

Although Dennis got rich because of capital gain, he probably down played the role of cashflow in his wealth building process. When he left his bank job, his income dipped for a few years until he setup his mortgage brokerage firm. The company was making money and Dennis had more than enough money for his expenses. The ‘excess’ money would become savings or investment capital. He had money to invest because of positive cashflow.

In other words, you need positive cashflow to build your capital. Your source of cashflow can be your salary. You need to make sure your expenditure is lower than your salary so that you can have ‘excess’ money to form your capital. If you hardly have enough savings, you need to either reduce your expenditure or increase your income. There are no other ways. Do not leverage your capital excessively to invest as you may not have the financial muscle to hold through the periods your investments are doing badly. You are setting yourself up for financial disaster.

Think of cashflow as a process which you need money to meet your daily needs. You cannot afford to wait for your capital gains to realise in 5 years because you cannot go hungry for so long. Although cashflow is vital, you cannot afford to rely on it solely because you will take a long time to become rich, if ever. Hence, investing for capital gains is still necessary.

Trading and Investing

Most people trade and invest without knowing what they want to achieve. Do they want an income or do they want to grow their money? To me, trading is cashflow and investing is capital gains. I know some people invest for dividends or cashflow but I think that is not the best way to grow wealth. When I invest in stocks, I prefer to hold over a few years. I usually buy when no one wants to, and sell when others are interested to buy. Investments, if done in such a slow and steady way, are quite easy to make money. Sometimes, you can make a few times of your capital. In my opinion, this is the best way to grow rich especially if you have sizable capital.

Trading on the other hand, is good for income. Due to the shorter time frame, you can get cashflow frequently. The amount may not be a lot but it can be enough for you to live and have some extra cash for your investment capital. The frequent but small gains are difficult to make you rich. Some people may mistake trading as a way to get rich quick and I hope by now you understand that is not true. If you have a salaried job and you are happy with it, focus on doing a good job and save up part of your salary to invest. You do not need to trade as you already have an income. Focus on investing to grow your wealth instead, you will become richer than trying to trade. This is because trading is hard and you need to spend a lot of time and effort to figure it out. You have many important things to do in life and you do not want to devote unnecessary energy to trading since it is not going to make a big difference to your wealth. Trading should only be pursued by people who want to make a living from the financial markets.

Conclusion

• The best way for the average joe to become rich is to invest for capital gains
• You need to have sizable investment capital in order to have gains that would make a difference to your net worth
• You need to have positive cashflow to grow your capital
• A positive cashflow is established when your expenditure is less than your income
• To increase the cashflow, you can decrease your expenditure, increase your income, and/or setup more sources of income
• Cashflow alone will take a long time for you to become rich. So you still have to invest for capital gains.
• Trading is cashflow and investing is for capital gains.
• If you have an income, you should invest and not trade.

It is important for consumers to make a balanced decision. Each person has only a limited amount of savings. If you spend too much of your savings on insuring against risks with a low probability of happening, you will not have sufficient savings for other risks.

The biggest risk is insufficient money at retirement. Most people will survive to retirement without a critical illness or big hospital bill. If you over-spend your savings on insurance, you will not have enough savings for your retirement.

When you buy insurance, make sure that you pay the right amount of premium. Do not pay too much. Do not buy insurance that is not really necessary. Choose an adviser who takes care of your interest, rather than one that wants you to spend more (and you know why).

You can buy term insurance (including cover for critical illness) up to age 60 (or earlier) to give a large cover for a modest premium. You can scale down the cover at the older ages, to keep the premium low (e.g. decreasing term insurance or family income benefit).

Most people need insurance when they are young but they only need to cover for a period of say 25 years. After 25 years, they will have sufficient savings to protect them against loss of income due to illness or unemployment. But they need to put their savings in a low cost fund, so that it can grow and give a good rate of return. (Most structured or life insurance savings products take away too much charges and give a poor return).

There is a big argument about the merits of Medishield and Private Shield. There is no doubt that Private Shield covers more than Medishield, but consumers should ask the question – is the justified to incur a higher cost? The lifetime cost for Private Shield Plan A is 2.5 times of Medishield. Why pay 2.5 times of the cost when for most cases, Medishield will be sufficient to cover all the cost (excluding the co-payments). In fact, Private Shield requires you to make bigger co-payment when you are hospitalised.

I want you, as a consumer, to be aware about the choice to be on Medishield. I have presented my reasons. Your insurance agent will present the argument to be on Private Shield. You have to make the final decision.

If you are happy with Private Shield, it is all right. If you decide to convert back to Medishield, you can get cancel your Private Shield and ask the insurance company to put you back on Medishield. I did that.

To recap: You have certain amount of savings to take care of your future financial security. You have to use this savings wisely. You can cover some risks through insurance, but you have to pay the right premium. Do not over-spend on insurance, and leave insufficient money for your retirement needs (as this represent the biggest risk that you have to face).

Originally posted on http://tankinlian.blogspot.sg/2009/09/make-balanced-decision.html

Trade or Invest?

If you want to create an income from the financial markets, then you should trade. If you want to grow your wealth, invest for the long term. You can pursue both objectives too if your capital allows. Either way, you cannot run away from the need to master your emotions. Investing is not a way for you to seek profits when you fail in trading, and vice versa. Trading is a frequent activity and with more trades done, you are likely to have numerous losses. Investing on the other hand, does not require frequent entries and exits, but the market will encourage you to buy when prices are high and sell when prices are low. If you cannot accept these risks and overcome the greed and fear in you, it is unlikely you can fulfill your financial objective/s.

For those who do not wish to stomach these volatility in their wealth, or do not wish to learn to overcome these psychological pains, they should choose investments with low volatility. Products like bonds and endowments, or strategy like Permanent Portfolio would suit them.

If you want to trade profitably, read on.

Finding that Edge

There are many gurus touting their strategies. Strategy is important and we need to find out if it really work. Do not listen to anyone until you test it yourself. And test it with real money because the psychological demands when your money is on the line is different from paper trading. Treat this as research cost. If you treat this as an income generating business, you must be willing to do such testing at a cost. Like any other research programs, you may not be able to find the edge at the very first instance, and you have to test another strategy from scratch. This is not easy for most people to accept.

The market is random but over a period of time, the sample size should be large enough to tell you if the strategy gives you an edge. It is akin to the casino operator, who is willing to accept occasional losses but over the long run, her small edge over the gamblers will ensure she will profit more than her losses. Hence, you must be willing to try out a strategy over a period of time, say 6 months to 1 year, to see if that edge exists. You cannot give up after 2 or 3 consecutive losses and denounce the strategy useless without giving it enough time to work itself out.

Losses must be smaller than Profits Cumulatively

A strategy is considered an edge if it has a positive expectancy or in other words, losses must be smaller than profits cumulatively. If you risk $100 to make $50, your strategy must give you at least 67% winning trades in order to be profitable over the long run. If you risk $100 to make $100, your strategy must give you 51% winning trades. If you risk $100 to make $200, your strategy must give you at least 34% winning trades.  Your job is to figure out, based on the risk-reward ratio your strategy prescribes, does the strategy have enough winning trades to prove it gives you an edge.

Evolve and Diversify in Strategies

The bad news is that the market is more complex than the casino. The casino creates a controlled environment which in other words, they set the rules and nothing can happen outside these rules. The financial market is not a controlled environment and uncertainties are rife and anything can happen. This means that while the casino operator’s edge will always be the same, your edge in the financial market may erode and become obsolete one day. In other words, your winning percentage may drop as market conditions change and it is no longer profitable to trade with this strategy. To counter this, you must be constantly finding new strategies while you continue to trade your edge currently. An even better way is to trade a few strategies at the same time. Diversifying in strategies will ensure you still make money even if one of your strategies stop working.

Overcoming your Psychological Barrier

As we mentioned earlier, trading and investing are activities which are emotionally difficult to carry out. Nobody can help you overcome it except yourself. Nobody likes losses. It is detrimental to your pocket, and even more so for your psychology. Once you have found an edge, the rest of the work is on your psychology. You must be able to  focus on following the strategy regardless of the losses (as long as win percentages are maintained in the long run). Trust me, the market will make it very difficult for you to follow your strategy. It will encourage you to doubt your edge by giving you consecutive losses. If you can overcome that, you will make money over the long run.

Most of the things he said were the usual investing psych stuffs. But I do find his investment framework particularly useful. The framework defines 3 parts to a trading strategy

1. investment philosophy
2. trading plan (process)
3. a system of trading

Investment Philosophy

Investment Philosophy is the cornerstone of any strategy and it is unique to individual. It is about understanding your beliefs and trading tendencies. We trade our beliefs in the market and use them to filter the information we observe. For example, Kok Fai’s philosophy is to act after public news. Instead of second guessing or expecting a certain outcome, he prefers to act on news that are confirmed.

Trading Plan

Trading plan is a process to define how you will search, filter, buy, monitor and sell. Your trading plan is developed based on your investment philosophy. For example, he will search and filter for big cap stocks that are going to be added to a stock index. He will wait for the confirmation through public news. No matter what, fund managers who track the index will have to buy too, and in much bigger amount. You should have noted that his philosophy to act after public news drives this trading plan.

A system of trading plans

He said that there are 6 kinds of market conditions:

• Bullish Quiet market
• Bullish Volatile market
• Bearish Quiet market
• Bearish Volatile market
• Sideways Quiet market
• Sideways Volatile market

The trading plan which you have developed may only be applicable in one or a few, but not all of the 6 market conditions. Hence, there is a need to develop more than one trading plan that can perform in other market conditions. But all the trading plans must be a product of your investment philosophy. For example, Kok Fai has another trading plan which is to buy after a major placement to private investors. Those big private investors who have taken a big pie in the stock cannot be disappointed so share price must go up for them to profit. Again, you should note that his additional trading plan is still congruent with his investment philosophy – he will wait for public announcements for such placement.

Do you agree with this framework? What is your investment philosophy?