Alan's Finance Blog

Why you will absolutely fail in trading if you don’t master this

There are many misconceptions about money management. Most think it means trading with stops, but that is only a small part of it. Below is a short part of the complimentary report I’ve found called “How to Safely Double Your Profits in 2009 Trading ETFs.” This little tip alone could save your trading account.

Why use risk controls?

Every trader/investor must guard himself against drawdowns, which refers to the percentage drop in his account size after one losing trade or consecutive losing trades. For example, imagine that after losing a few trades in a row, your $20,000 account is reduced to $12,000; that would be a drawdown of 8,000/20,000 = 40%. If I were to ask some new traders, “In order to be back up to $20,000, what percentage return do you need to generate?” Many would answer, “Since I lost 40%, I have to make back 40%!” This couldn’t be more wrong! Note that after losing 40%, the trader now starts with a lower base, i.e. to undo the $8,000 loss, the return he needs to generate is 8,000/12,000 = 66.6%! That is why I share free training videos on my website to help dispel some of the myths of trading.

The more severe the drawdown, the harder it becomes to undo the damage, as shown in the numbers below.

Drawdown % %Required to get back to break even
10%                  11.1%
20%                  25%
30%                  42.8%
40%                  66.6%
50%                  100%
60%                  150%
70%                  233.3%
80%                  400%
90%                  900%

That is why all professional money managers only risk 1-2% per trade. It’s because no matter how good your trading system is at some point it is a statistical fact you will have 10 losers in a row. Based on risking only 1-2% per trade this is only a 10-20% drawdown and easily recovered. 99% of the hype trading and investing courses in existence don’t say or do this. They say risk 5-10% per trade. It is wrong and will cause you serious financial pain if you follow their advice.

Many of them also use arbitrary stop loss advice. For example, they say, “Place your stop at $100.10 because that is on the other side of a major support or resistance, trend line, MA, etc.”

This makes your risk based on the size of the stop. That is also wrong because the risk can be too large and it’s not the same risk on each trade.

Others reverse this and say risk only 2% total period and let that determine your stop. This is also wrong and will hurt you because it is important to have the correct technical stop.

The answer is to do both. Use a percentage and technical stop together. It works like this. Let’s say the technical stop is $100.10, but based on your entry price that is a 3% risk. Since your plan calls for a 2% risk you simply lower the number of shares you are trading. This lets you stay within your 2% risk and have the correct technical stop. This is exactly what most professional money mangers do.

Some say that this will lower their profits because of trading fewer shares. So what! Study the numbers above again. You know the old quote, “More risk equals more reward.” Well it’s not always true. Sometimes more risk equals more risk! If you lose your money you have no chance to make a profit. Even losing 50% is disastrous because you would then need to make 100% to get back to even.

Like Warren Buffet says, there are only two rules in investing. Rule #1: Don’t lose money. Rule #2: Don’t forget rule #1.

I’d like to add a third rule. Correct money management and position sizing must be mastered to ensure your long term success.

The good news is that it is easy to have correct money management and position sizing. I just explained how to use a combo of a % stop and a technical stop. If you want more of an explanation please visit the free video area on this website and click on the “Why have risk controls” video.

The system of entries, stops and profits taking is only half of your key to success. The other half is money management. If you get this part wrong you will lose your account every time regardless of how good your system is.

Click here for a newsletter on how to safely average 6% per month trading Exchange-Traded Funds.

http://www.etftrendtrading.com/cmd.php?af=1115334

Thanks, and good luck!

PS- In order to access these powerful FREE videos you must first opt in for the complimentary report.

ETFs Bring the Middle East to You

The Middle East is big news this week with a state-owned company in the tiny emirate of Dubai asking for an extension on debt payments. Markets around the globe are watching intently.

I’m not especially surprised about this …

If you’ve been to Dubai or seen pictures of the shiny new skyscrapers, you know the place has grown like wildfire. With much smaller oil reserves than its neighbors, Dubai has made its mark as a trading center and playground for the wealthy.

Dubai is growing like crazy.

Thanks to exchange traded funds (ETFs), more Americans are investing in Middle Eastern markets. Timing is critical, of course, but you now have several quick and easy ways to trade the region’s growth. Today I’ll tell you about some of them.

6 ETFs to Trade the Middle East

The Middle East is a big, varied region. Some analysts lump North Africa into the mix — so sometimes you’ll see the acronym MENA, which stands for Middle East and North Africa. Others focus specifically on the oil-rich states between the Red Sea and the Indian Ocean.

Here is the full list of ETFs that cover the region, or portions of it.

• iShares MSCI Israel Capped Investable Market (EIS)

• iShares MSCI Turkey Investable Market (TUR)

• SPDR S&P Emerging Middle East & Africa (GAF)

• WisdomTree Middle East Dividend Fund (GULF)

• Market Vectors Gulf States Index ETF (MES)

• PowerShares MENA Frontier Countries Portfolio (PMNA)

You’ll notice that the first two funds, EIS and TUR, target single countries. Israel and Turkey are not the biggest countries in the region by any means, but they do have the most developed capital markets. Additional single-country ETFs in the region are expected to be launched next year.

The other ETFs on the above list are based on indexes that cover multiple world markets, sometimes ranging outside the Middle East. The exact mixture of countries varies considerably.

Some ETFs that sound “regional” are really quite concentrated …

The Middle East is a huge, diverse region.

For example, Market Vectors Gulf States Index ETF (MES) has almost half of its portfolio invested in Kuwaiti stocks.

SPDR S&P Emerging Middle East & Africa (GAF) has more than 60 percent in South Africa, with most of its Middle East exposure in Israel.

And PowerShares MENA Frontier Countries Portfolio (PMNA) has about 30 percent in Qatar.

Dubai, in case you’re wondering, is part of the United Arab Emirates (U.A.E.). WisdomTree Middle East Dividend Fund (GULF) has about 17 percent in the U.A.E. while PMNA has around 23 percent.

2 Additional ETFs to Consider …

JETS Dow Jones Islamic Markets (JVS) is a special case. The portfolio isn’t geographically based. Instead, JVS includes international companies that conduct their business in accord with Islamic practices — avoiding alcohol, for instance. Many of the stocks held by JVS are from the U.K., France, Canada, Switzerland, Japan and other markets.

Barclays Asian & Gulf Currency Revaluation ETN (PGD) provides exposure to some of the regional currencies such as the Saudi Arabian riyal and United Arab Emirate dirham. However, it is not a pure play as three Asian currencies are also included.

Should You Buy the Middle East Now?

Undoubtedly, there are risks in the Middle East: Much of the region depends on high oil prices to generate steady income, and no one knows what oil prices will do. Ethnic and political tensions create geopolitical risks. And the area sits astride key trade routes, making it important to far-away powers as they compete for business.

What’s more, most Middle Eastern countries are still classified as “emerging” and “frontier” markets. That means they can represent a tremendous growth opportunity — or a chance for huge losses.

Another point to keep in mind is that all the ETFs, and exchange traded notes (ETNs), I’ve mentioned are fairly new and haven’t attracted huge assets. Volume is usually low, and the bid/ask spreads can be significant. So for now you need to be extremely careful when trading any of these funds. However, if the Middle East prospers, I expect they will do very well over time.

The bottom line is that thanks to the new world of ETFs, investing in the Middle East is now almost as easy as investing in the U.S. And if the Middle East gets through the current turbulence intact, now may be a great time to consider buying one of these ETFs.

Best wishes,

Ron

P.S. I’m now on Twitter. You can follow me at http://www.twitter.com/ron_rowland for frequent updates, personal insights and observations about the world of ETFs.

If you don’t have a Twitter account, sign up today at http://www.twitter.com/signup and then click on the ‘Follow’ button from http://www.twitter.com/ron_rowland to receive updates on either your cell phone or Twitter page.

This Ignored Country is Booming

Emerging markets have been the success story of 2009.

While more developed economies such as the United States and Europe have struggled to recover, countries like Brazil, Russia, India and China are on a roll.

Another emerging economy is also rocketing. Morgan Stanley Capital International has upgraded this market, and it will make the coveted leap to “developed” market status in May of 2010.

It’s Israel. This tiny nation on the Mediterranean Sea might not be the first place that comes to mind when investors think about international diversification, but it should be at the top of the list.

The Tel Aviv 100, a benchmark of Israel’s 100 largest stocks, is up +69% this year.

Israel’s currency, the shekel, has gained ground against the dollar.

Investors may be reluctant about shouldering political and geographic risk. Israel is surrounded by enemies and has been plagued by the constant threat of violence. Yet that has been true since its founding in 1947, and Israel has nevertheless developed into one of the world’s most innovative economies.

Israel’s workforce is among the most educated and is renowned for its entrepreneurial spirit. The country has one of the highest numbers of patents filed in the world and is crawling with start-up companies. The World Bank notes it consistently ranks near the top in per capita research and development spending.

After years of GDP growth at about +5.0%, Israel’s economy — along with the rest of the world — experienced a mild recession last year. Now, it’s rebounding: GDP grew +2.2% in the third quarter of this year and should grow by +2.9% next year, according to a Barclays Capital forecast.

The downturn in Israel was brief enough to make the Bank of Israel the first major central bank to raise short-term borrowing rates, a sign of strength signaling confidence in the economy. The central bank has held the rate steady the past two months, but could announce another rate hike by the end of the year.

Part of Israel’s success can be attributed to its status as the Silicon Valley of the Middle East. Tech has been the best performing sector in the market this year, gaining more than +55% compared with the S&P’s +23%. About 75% of Israel’s exports are technology products, so it should be a prime beneficiary if this trend continues.

Two funds offer the best broad exposure to Israel: iShares MSCI Israel Capped Investable Market (NYSE: EIS), an exchange-traded fund, and First Israel Fund (AMEX: ISL), a closed-end fund.

Each of these funds offers broad exposure to the Israeli market, with both funds holding many of the same securities.

EIS is a bit top-heavy: Its top five holdings comprise more than 50% of the portfolio. ISL is more balanced: Its top five holdings make up 33% of the holdings. The fund trades at a -7% discount to net asset value, meaning investors get a dollar of assets for 93 cents. Considering that the TA-25 Index is trading at 34 times earnings and the TA-100 Index at 44 times earnings, cost-conscious investors may want to pick up ISL.

Brad Briggs
Staff Writer
StreetAuthority

The Next Sector to Outperform the Market

By: Anthony Haddad

The market rebound, which began in March, has so far increased the value of the S&P 500 by about +55%. Economic indicators are still weak, but the market tends to lead the recovery by several months.

Despite the worry, cyclical stocks — those affected by the economic cycle — are up sharply. Financials are up +146%, industrials are up +74%, consumer discretionary is up +70%, and technology is up +55%. On the other side of the spectrum, defensive stocks — those generally thought to be immune from the underlying economy’s swings — have underperformed. Utilities, for example, are up just +30%. Staples are up +31%. Health care is up +31%.

This is what the beginning of bull markets look like.

In the early stages, high-tech and industrial shares outperform. As the bull gains legs, basic-industry stocks enter the picture. At the peak, energy and metal companies outperform.

In bearish periods, consumer staples and service stocks outperform. On the way down, it’s utilities. Near the bottom, financial and consumer cyclical stocks lead the pack.

During the past three months, the story has been largely the same as it has since March. Financials have beat the S&P by 10.6 points, industrials by 6.5 points, and consumer discretionary by 4.7 points. All other sectors have lagged, although technology hasn’t lagged by much (-0.7 points).

If history means anything and the bull is real, going forward cyclical stocks will continue to outperform the market and defensive stocks will lag. That means you’ll continue to want to hold shares of companies in industrial, consumer discretionary and technology companies.

But in particular I think there’s a real opportunity in technology because of how it has lagged other cyclical sectors since March. Up +54% since March, tech has performed just slightly worse than the S&P (+55%). That’s unusual for this stage of the market cycle, and that could change quickly.

For broad coverage in this sector, an ETF like the Technology SPDR (NYSE: XLK) does the trick.

Anthony Haddad
Staff Writer
StreetAuthority.com

Why ETNs are Riskier Than They Look

by Ron Rowland

Co-editor of Weiss Research’s International ETF Trader

Mike Larson is off today, so he asked me to fill in for him. And one thing that I think Mike and I both agree on is that ETFs, or exchange traded funds, are one of the best things that ever happened for small investors.

You may already know about the advantages they have over conventional mutual funds … liquidity, low costs, transparency, diversification, and more.

What you may not know is that there is a new investment that looks a lot like an ETF but is actually a whole different species. I’m talking about ETNs: exchange traded notes.

On the surface, ETNs share many of the characteristics of ETFs. You can buy and sell them on the stock exchange throughout the day, their performance closely mirrors an index, and they give you access to specialized market niches like commodities and currencies.

However,

There is One Gigantic Difference …
An ETN Is Really a Bond!

That’s why they’re called “notes” rather than “funds.” Yet it usually doesn’t pay interest at a fixed rate, like say a Treasury bond would. Instead your “interest” is the return on a designated index.

Let’s look at an example:

The iPath S&P GSCI Crude Oil ETN (OIL) is very popular right now. It’s designed to track the return of a crude oil price index. This gives you a way to participate in the crude oil market without using more complicated and risky tools like futures.

When you buy the OIL ETN you’re not buying oil. You’re buying a promise from the issuer to pay you some date in the future.

When you buy the OIL ETN, are you actually buying oil? No, you’re not. What you are buying is a promise from the issuer — British banking giant Barclays, the corporate parent of iPath — to pay you a return linked to the performance of the Goldman Sachs Crude Oil Return Index at some date in the future.

So with OIL you don’t get any oil, directly or indirectly. All you get is a promise from Barclays Bank that you’ll be repaid when the ETN matures, with no claim on any particular assets. You are now an unsecured creditor of Barclays.

This brings up another question: What guarantee do you have that Barclays Bank will be around to make good on its promise? Answer: none.

If Barclays should fail for any reason — even something completely unrelated to this particular ETN — the promise you bought could go up in smoke. You’ll be just another creditor when the bankruptcy court divides up whatever is left of Barclays.

Now compare this to an ETF …

In the U.S., ETFs are regulated under the Investment Company Act of 1940. They are chartered as separate corporations. The ETF’s board of directors hires a manager to keep things going and you, as an investor, own shares of the corporation.

Before Lehman Brothers went belly up, it launched three ETNs in early 2008. All three have bit the dust.

If the manager of an ETF goes bankrupt, what happens to the assets of the ETF? Nothing. There might be a temporary disruption while the board finds a new manager, but the underlying stocks, bonds or other instruments in the fund will be secure. Not so with an ETN.

Think it can’t happen? It already has!

The now-defunct Lehman Brothers launched three ETNs in early 2008 under the “Opta” brand name. The ticker symbols were EOH, PPE and RAW. Look them up and you’ll find they aren’t around anymore.

When Lehman failed in September, owners of those three ETNs found themselves holding the short end of the stick. Now their money is tied up in one of the most complicated bankruptcy cases ever. It could be years before they get anything back, if ever.

There are other examples, too. Investors in a Bear Stearns-issued ETN narrowly escaped the same fate last year when that embattled company was taken over by JP Morgan Chase.

Even scarier, most of the major ETN issuers are not exactly as stable as the Rock of Gibraltar. Far from it. Going back to our Barclays example, BCS stock has been cut in half in just the last month.

Why? Analysts think Barclays is so shaky the U.K. government may have to nationalize it. The company has taken billions in write-downs on the same kind of toxic derivatives that are bringing down other large banks.

Just this week, Moody’s Investor Services downgraded Barclays debt — which includes all the iPath ETNs — to Aa3 from Aa1. Traders reacted by demanding wider bid-ask spreads on iPath ETNs, which means investors owning those ETNs could take a shellacking.

I’m not just picking on Barclays here. All the banks that issue ETNs are having similar problems. Other top ETN issuers include …

• Deutsche Bank (DB)
• Morgan Stanley (MS)
• Goldman Sachs (GS)
• Swedish Export Credit Corp (FUE)
• HSBC Bank (HBC)

Would you loan your money to any of these companies? That’s exactly what you are doing when you buy their ETNs! Yet most of them are so weak they’ve had to be bailed out by the government and/or the Federal Reserve in the last few months.

Am I Saying You Should
Always Avoid ETNs?

No. I believe that they can provide a way to trade in markets that are hard to access otherwise. What I’m saying is that you need to understand the risk you are taking before you buy.

Sadly, many investors have no idea that they are accepting this kind of credit risk when they buy an ETN. They think it is just a new kind of mutual fund. They don’t know they can lose their money even if their market predictions are totally accurate.

What’s even more infuriating is that the ETN issuers don’t always go out of their way to let people know the difference between ETFs and ETNs. Barclays at least had the good sense to market their ETFs and ETNs under two different names: iShares = ETFs; iPath = ETNs.

Other companies leave it up to you to know what you’re buying. You see “PowerShares” in the name and assume you are buying an ETF. Not so — some ETNs carry the PowerShares name.

Nor is it clear which bank is behind which ETN — sometimes it varies even within the same ETN family. So you have to dig through the prospectus to find out exactly who is getting your money.

Even Morningstar, the very pillar of unbiased fund data, lumps ETFs and ETNs into the same category in their database. Worse, they don’t always include “ETN” in the fund names.

What Should You Do?

I suggest avoiding ETNs completely if there is a very similar ETF available. And if you do buy an ETN, make sure you aren’t exposing too much of your portfolio to any one ETN sponsor — and keep an eye on the issuing companies.

Right now there are roughly 87 ETNs available to U.S. investors. I don’t have enough space to list them all here, but I’m giving you a list below that shows some of the larger ones. Refer to this list — and know what you’re buying.

Best wishes,

Ron

How to Trade China with ETFs

by Ron Rowland

Right now, China is celebrating 60 years of Communist party rule. Most of the party-goers aren’t old enough to remember anything else, of course, but that isn’t stopping the nationwide festivities.

The sheer scale of China is mind-boggling! Just think about it …

• 1.3 billion people — more than 4x the U.S. population …

• 3.7 million square miles …

• And borders that touch 14 other nations!

Communist China Turns 60.

Back in the 1970s, the Chinese government figured out that the whole “central planning” thing wasn’t working so well. And communist ideology gave way to a pragmatic mix of state ownership and entrepreneurial capitalism.

It worked … China’s economy is now 70 times bigger than it was in 1978, when the economic liberation began. Depending on how you calculate, China is either the second or third largest economy in the world!

The vast industrial base, concentrated in the coastal regions, is transforming China. Farm workers from the massive interior are drawn by the relative high pay of factories. New cities spring up out of nowhere to house these workers and provide for their needs …

… And now many of the products that were once immediately shipped to the U.S. or Europe are staying at home, snapped up by China’s newly-prosperous middle class.

A middle class in a communist society? Hard to believe, yes, but there really is such a thing in China now. And there’s an entire younger generation that now knows what they’re missing — and they’re working hard to reach the next level.

China’s new middle class is on a shopping spree.

So if long-term rewards are what you’re looking for, China represents an amazing investment opportunity. But how do you play it?

First, recognize that anything China-related is going to be a roller-coaster ride, just as it has been the last few years. Therefore don’t invest unless you’re prepared for the bumps and jerks.

Second, know how much risk you’re taking. Individual Chinese stocks can deliver amazing profits, but they can be hard to trade. That’s why I think exchange traded funds (ETFs) are the best way for most investors to get involved in China’s hot market. And you have several choices — some diversified, some more specialized.

Here’s a quick summary:

Broad-Based China ETFs

U.S. investors can pick from four ETFs that track diversified Chinese stock market indexes:

• iShares FTSE China Index Fund (FCHI)

• iShares FTSE/Xinhua China 25 Index Fund (FXI)

• SPDR S&P China (GXC)

• PowerShares Golden Dragon Halter USX China Portfolio (PGJ)

Each of these ETFs takes a slightly different approach to constructing a China portfolio. FXI holds the 25 largest Hong Kong-listed companies that are available to foreigners. FCHI and GXC are similar but add some mid-cap stocks to the mix. They’re a little more diversified than FXI. All three are capitalization-weighted.

PGJ takes a somewhat different tack. First, it includes only Chinese stocks that have a listing on U.S. exchanges. Second, PGJ uses a tiered-weighting method, which results in the sector mix being a little different from the others.

Specialized China ETFs

If you want to get a little more aggressive, Claymore offers two China ETFs that have a tighter focus:

• Claymore/AlphaShares China Small Cap Index ETF (HAO)

• Claymore/AlphaShares China Real Estate ETF (TAO)

HAO is a good way to get exposure to small, fast-growing Chinese companies. These stocks tend to be less dependent on exports and more related to China’s domestic economy. TAO gives you an opportunity to profit from China’s real estate and construction boom.

China is growing like crazy.

Inverse and Leveraged China ETFs

What if you think that China’s stock market has gone up too far, too fast, and is due for a quick drop? You may still be able to profit with ProShares UltraShort FTSE/Xinhua China 25 (FXP). This is a 2x leveraged inverse ETF. For instance, on a day when the underlying index goes down 2 percent, FXP is calibrated to move twice as much in the other direction — up 4 percent in this example.

On the other hand, if you’re bullish on the Chinese market, there’s the ProShares Ultra FTSE/Xinhua China 25 (XPP). This 2x leveraged “bullish” fund aims to give twice the daily move in the same direction.

The leverage factor for ETFs like these is reset daily, so the 2x math doesn’t always work for periods longer than a day. In other words, FXP and XPP are best used as tools by short-term traders, but if your timing is right you can make big profits from them.

Chinese Currency ETFs

If you want to bet on China’s currency, the renminbi (also called the yuan), you can do it with these two instruments:

• Market Vectors Chinese Renminbi/USD ETN (CNY)

• WisdomTree Dreyfus Chinese Yuan Fund (CYB)

There’s one key difference between the CNY and the CYB: CNY is actually an exchange traded note (ETN), not an ETF. Practically speaking, ETNs work much the same way as ETFs, but they’re actually a form of debt instrument. I wrote about the unique risks of ETNs earlier this year in my Money and Markets column.

Chinese law prevents the funds from directly investing in the renminbi, so they hold currency derivatives known as nondeliverable forwards. These are similar to futures contracts, which reflect a market’s expectations. As a result, these funds might not perfectly track the yuan.

As you can tell, there are plenty of ways to invest in China’s stunning growth story. I’ve only covered a few of them here, and ETF sponsors are planning many more. Do your research first, but don’t overlook China. The opportunity is too big to pass up!

Best wishes,

Ron