Friday, December 07, 2007

Simple arithmetic

In a stock market bull run it is very easy to make money since prices of stocks seem to go up almost every trading day. However when the market plunges because of external shocks, many retail investors instead of reducing their stock holdings tend to hold onto them or even buy more stocks at cheaper prices to average down their costs of investment. This strategy works well if the overall market rebounds shortly after each heavy fall in prices and if investors have deep pockets and do not trade with margin financing. For example the quick rebounds after the heavy falls in the KLSE on February 27th and on March 5th 2007 caused by the plunge in the Shanghai Stock Exchange.

It also worked for retail investors after the August 17th Asian Stock Markets panic caused by the US mortgage crisis and credit crunch. The rebound started the following Monday as a result of the US Federal Reserve cutting the discount rate the previous Friday.

However in the months of October and November, the Asian stock markets drifted southwards and retail investors in the KLSE who still held onto their stocks or had averaged down during the intermittent falls were not so lucky, this time round; as quite a number of low liner stocks have fallen by 30% percent or more since September with no encouraging signs of activity just yet. Therefore if you had a good hunch or a tip from the Zhouyi that the stock market will fall heavily it would have been better to have cut your losses and run.

Not being sophisticated, I usually do some simple mental arithmetic before deciding to sell down my investments even at a loss during times of uncertainty, or when the Zhouyi gives prior warning of impending crises. (Remember Hexagram 3 Tun / Difficulty in the Beginning?) Somehow, it helps to make the cut loss decisions less painful.

For example, I had bought back a particular stock at 111 sen after it has fallen 20% from its year high. With the Yi’s prior warning, I had sold all the shares at an average price of 100 sen which meant that I have lost 11 sen (111 -100) or 10% per share. And the particular stock in line with the overall market sentiment subsequently fell 30% to 70 sen. (Quite a number of low liners had already fallen more than 50% from their year highs. Pity those who hanged onto those stocks with high margin financing.)

At this point in time, if I buy back the same amount of stock at 70 sen, I would have saved 30 sen per share (100 – 70). The savings of 30 sen can be put into good use – money in the bank, or to buy more of the same stock. If I had sold and bought back say 1,000,000 shares this way, I would have saved 300,000 ringgit (1,000,000 x 30 sen). Nothing to sneeze at, if you are a trader since capital is limited.

On the assumption that I bought back the same amount of stock which was sold earlier and if the share price ever rebounds back to 111 sen, the original cost of investment, I would have made 30 sen per share (111 – 70 = 41 – 11 (the earlier loss) = 30) instead of making nothing, if I have held onto the stock for the past few months.

To me it is simple arithmetic but most traders including the experienced ones cannot do these sums correctly since they are worried that if they cut their losses or take profits, their stocks may go up instead of falling.

Therefore it pays for Yi aficionados cum traders to understand changes and to learn about timing in Yi studies. Without which it could be difficult to work out such simplicity.

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