Superleverage and Sensible Speculation
Jan 28th, 2005 | By James Boric | Category: Investing Strategies, Options, Penny stocks***James Boric reports from Bloomington, Ind.…
***Mr. Market continues to struggle. Since the beginning of the year, investors have yanked almost $1.5 billion out of the Russell 2000. As a result, our benchmark small-cap index is down 6.1% from its high of 656 on Dec. 31, 2004.
So what are you to do, dear reader?
The answer is twofold…
First, if you are holding onto speculative stocks with little in the way of earnings,no cash, lots of debt and a balance sheet that would scare any decent accountant silly, you may consider getting rid of them now!
According to TrimTabs (which calculates how much money is flowing in and out of the market every day), “Yesterday was the first day in five days that speculative stocks actually rose in the last hour of trading.”
Hmmm…if you are like me, you really don’t want to hold stocks that only rise one out of
every five days!
When the market is struggling for direction, the last thing you want to be doing is holding onto highly speculative stocks. So maybe it’s time to unload them. Just a thought!
The second thing you need to remember in this market is to have patience.
***A year or so ago, I spoke at a conference in New Orleans. As you might have guessed, I spoke about small-cap stocks. I made my big presentation in the morning. And then, as is customary at these conferences, I met with the attendees for cocktails in the evening.
One of the gentlemen I spoke with, while sipping on an alcoholic beverage, was intrigued by the allure of small-cap, aka penny, stocks. So we got to talking. About 15 minutes or so into our conversation, he asked me a question I normally don’t get asked. He said, “James, what is the biggest frustration you find in your line of work?”
My answer…
“I wish I could convince people to have some patience. Anyone who has studied the small-cap market, like I have, knows there is a lot of risk involved. But the longer you are willing to hold stock in good companies, the better your returns will be – and the less risk you will assume.”
In fact, Ibbotson Associates, a research firm based in Chicago, proved my point to a tee. In a classic study comparing large-cap versus small-cap returns, they found that…
“Small stocks again are riskier than large stocks for shorter holding periods, with lower minimum ending values for holding periods of under 13 years. However, for holding periods of 19 years or more, small stocks beat large stocks over 90% of the time. And for holding periods longer than 29 years, small stocks always outperformed large stocks.”
This is HUGE stuff!
If you want to beat the market over the long run, you MUST invest in small-cap stocks. And you must have some patience.
So why don’t people learn this stuff in school? Why don’t young adults learn to invest in small-cap companies when they are investing for the future?
Because we live in a world where the brokers and major stock analysts rule – and the companies they cover, the stocks they recommend and the companies they do business with are all large caps. And we also live in a world where people want returns, and they want them NOW.
Unfortunately, this world doesn’t work like that.
In fact, Carl Waynberg, who follows the OTC Big Board and Pink Sheets markets for his GRIP readers, wrote this yesterday about risk and patience…
“Because short-term risk increases as market cap decreases, an increasing aversion to risk tends to be tougher on small- and micro-cap stocks. And that’s what we’re seeing in the action on the Russell 2000. The small-cap benchmark was showing some signs of strength against big caps a couple weeks ago, but now looks ready to cede the reins of market leadership to its bigger brother. This, too, is bearish for the broader market. Indeed, big caps tend to fare best when they are being outperformed by small caps.
“Since The GRIP is about long-term performance, let’s look a little longer term than a month. Since its inception on Aug. 31, The GRIP Portfolio is up 351%. The S&P 500, Nasdaq and Russell 2000 are up 6.5%, 11.3% and 13.1%, respectively, for the same time period. I understand most of you didn’t become GRIPPERs until the end of December, so it bears repeating that The GRIP is a long-term strategy. Some GRIP picks remains GRIP picks for two years – even longer, as you know. I trust The GRIP’s underlying principles, because I’ve been living by them for years, but you have to ask yourself if you can, too. I think you’ll find there’s empirical evidence to support that old cliche. Patience is a virtue.”
***If Carl didn’t just prove my point, I don’t know what to say. In the last month, every small-cap investor I know has taken a beating. Heck, even a few of Carl’s picks have fallen off a bit. But since Aug. 31, his entire portfolio is up 351%!
Those who have patience do better than those who don’t. Period!
By the way…
*** One more note on patience…
As I was cleaning out my e-mail inbox yesterday, I actually came across a note from that gentleman I spoke to in New Orleans. It turns out he actually took my “patience” advice to heart. Check out his note…
“Hi, James:
“As many people as you meet and deal with, I am sure you will not remember me, BUT I met you in person in New Orleans last year at that seminar. At the reception, we had a bit of conversation (after a few drinks), and one of the things you shared with me was the great opportunities in penny stocks. And that a point of frustration for you was investors wanting very quick profits. That if they would just hold for longer periods of time, they would/could make better returns. And then earlier this year you wrote about the value of holding longer.
“Well, I always want/like quick profits. But I decided to try the longer hold on penny stocks. I chose Navarre Corp. (NAVR:NASDAQ). You recommended it as a buy Nov. 25, 2003 @ $5.35. Then, in January 2004, you changed it to a hold, and finally, in May 2004, you said sell for a 27.8% profit. NOT BAD. “But I said I will try James’ hold-longer thought. I am still holding it at $16.39. A 300%-plus gain!! Just wanted to let you know how right you were and say THANKS, THANKS, THANKS.”
***Finally, here’s a nugget of information you won’t get anywhere else…While most major indexes are getting spanked right now, I have noticed one sector that the major hedge funds and institutions are throwing their money into…GOLD.Since the beginning of the year, over $1.5 billion has flowed into gold funds. I wonder if
that means they are about to take off…again?Stay tuned…
***Irwin, I believe I have said enough today. It’s time for you to wow us with your talk of Superleverage and my favorite four-letter word: risk. Take us home…
Superleverage and Sensible Speculation
Speculating on small-cap stocks is the best thing I can think of. It’s an incredible rush – especially when you can pocket profits of 378%, 336% and 227% courtesy of options guru Steve Sarnoff. But when Steve ratchets it up by talking about how you can speculate on stocks using other people’s money (OPM), the offer is irresistible.
Steve is founder and president of Sarnoff’s Samurai Strategies, as well as editor of Options Hotline – the newsletter which has delivering gravity-defying returns for the past 15 years. Steve pioneered the use of Japanese candlestick charting techniques to accurately predict price movement of stocks and commodities. How good is he at it? If
you had invested $5,000 in each of his recommendations since 1999, you’d be sitting on a cool $1,001,810 profit.
By applying candlestick charting to shed light on stock options opportunities, he has produced breathtaking gains. How about 898% in TRW in 31 days, 209% in Micron in six days or 260% on Starbucks in five days? If this sounds too good to be true, there’s one important thing you need to understand: Steve has spent years mastering candlestick charting…and now, after staying up till the wee hours reading about it, writing about it and applying it, all that hard work is paying off – big time.
Before I continue, I know that many of you are in the dark about candlestick charting. So as your devoted Penny Sleuth, I’m going to take a minute for quick, snapshot explanation…
Candlestick charts were originally developed in Japan over 150 years ago, where traders applied it to determine the price of rice. Today, this ancient technique has been successfully employed for revealing both the price of a stock (or commodity) and market sentiment.
Think of a candlestick with a wick at the top and bottom. The length of the candlestick spans the daily open and close. The wicks show the high and low of the day. Candlesticks with a white body indicate a close that is higher than the open. Candlesticks with a black body signal that the daily close is lower than the open.
By looking at the color of the bar, you can immediately see if the market is bullish or bearish about a stock, instantly deciphering sentiment without specific references to the price. It’s a safe way to make split-second decisions.
There are variations on the candlestick that go by names of plain doji, dragonfly doji and gravestone doji. From my perspective, candlestick charting is a Zen kind of thing.And because Steve is a candlestick Zen master, he is also into the Zen of OPM for making yourself hefty profits.
I was recently given the opportunity to get in touch with Steve, and afterward, my immediate reaction was that my Penny Sleuth readers MUST know about his valuable secrets ASAP.
But first a cautionary note that comes directly from Steve himself…
“If anyone tries to sell you something that claims sky-high returns with low risk, zip your pockets. If you are going to have a chance to make high returns, you are going to face high risk. The only certainty in markets is that they’ll fluctuate. Speculators make their fortunes from those changing prices.”
And this is a basic investment philosophy of your Penny Sleuth team. There are no shortcuts to profits. That’s why we follow the investment strategies of the Wall Street legends who had proven this time and again. Warren Buffet, Phil Fischer, Benjamin Graham…and Steve Sarnoff – all of them produced fortunes for themselves and others by
adhering to common-sense investing: research, risk management and patience.
What impressed me about Steve is that he has taken it one step further. He believes that leverage is an important tool for speculators. Leverage involves using OPM to try to make more money than you can with your own funds. Those who utilize financial leverage know that using OPM may augment their rewards when right, but may also
greatly accelerate risk of additional losses when wrong. The key is that if leverage can be applied with an always known and strictly limited risk, it takes on a more sensible aspect.
That’s why Steve is an unwavering believer is something he calls Superleverage.
As Steve tells it, “Superleverage is the art of profiting from changing prices, with limited risk at all times, without ever getting a margin call, being asked for additional funds or having your position liquidated.”
The instruments of Superleverage are exchange-traded put and call options. Buyers of puts and calls are the only ones who possess the full profit power of Superleverage (unlimited profit potential with an always known and strictly limited risk).
Buying puts and buying calls may be the simplest options strategy, but Steve said that he often found the simplest way is the most effective. While more complex “spread” strategies can further limit your risk, they also limit your gain.
According to Steve, the advantages of using Superleverage are “You don’t need to be a financial wizard or have large sums of money to participate. Only as an option buyer do you have all the benefit of using OPM when right, without the concomitant costs and risks when wrong. And your total risk is always known and limited to your cost of taking
a position (making your bet).”
He also wisely counseled on the disadvantages: “The odds are against you. Options are wasting assets. And if the underlying security doesn’t move enough to give you real value before a specified date, your options will expire worthless. That is your risk.”
You’d think a guy like Steve would be sort of fearless. After all, in 2004, of his 34 option recommendations, 30 were winners.
To Steve’s own credit, he admits, “When I’m wrong (and it happens plenty enough), my subscribers can lose 100% of their speculation, but not one cent more. And that’s the important part, because when I’m right, they have an opportunity to multiply their money many times over. But there’s no easy money in markets, and regularly reaping hard-earned rewards is a worthy challenge.”
Well said, Steve. That begs the question of how can you do that?
He weighed in with a great answer…
“Develop what I call your ‘Complete Game Plan for Trading Success.’ Follow the Boy Scout mott ‘Be Prepared.’ The secret to Bill Belichick’s success, as coach of the New England Patriots football club, is his team’s thorough preparation for each game. There should be no surprises. For each trade, you should consider what action you will take if you are right (where to take profits and how much of your position to exit) and what you’ll do if wrong (use stop-loss strategies, or hold on and risk a worthless expiration).”
Steve went on to explain the three cornerstones of a complete game plan: psychology, method and money management.
“Psychology concerns your suitability to speculate. Successful speculators must possess the “Twin Tolerances for Risk.” Financial tolerance is easier to determine. Do the math…annual income, liquid net worth, etc. You should only speculate with risk capital (money you can afford to lose). Psychological tolerance requires you to be able to sleep
at night and not let roller-coaster markets adversely affect your family life. You must look deep inside yourself to determine if you have the nerve and can handle the pressure of speculation.”
He continued…
“The most important factor in successful speculation is sound money management. Trading success is more a function of honing your survival skills than picking winners. Most people have it backwards. They speculate based on hyped-up hopes of fantastic profits. You should speculate based on what you can lose, not what you can gain. Be
prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.”
So now you can see why I was so excited to share Steve’s insights with you. He has mastered the art of integrating world-class candlestick charting with common-sense Wall Street investment principles. And the beauty of it is that he’s made it very easy to use.
Happy investing,
Irwin Greenstein
January 28, 2005
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