Stock Market A-Z

A is for ADRs

American Depositary Receipts are instruments that allow U.S. - based investors to buy shares in foreign (non - U.S.) corporations in U.S. Dollars and in a form that is tradable on U.S. exchanges in the same way as domestic stocks. For the U.S. - based investor the advantage of ADRs is the convenience of not having to deal with the additional complexities of foreign stock exchanges and the varied share registration requirements of foreign jurisdictions. Companies based in other countries are motivated to have their shares listed in the U.S. in this way because it deepens their investor base in a capital market that is the deepest and most sophisticated in the world. Most typically foreign corporations making use of this facility issue so-called sponsored ADRs. One designated depositary institution holds the underlying stock in the country of origin and issues the negotiable securities called American Depositary Receipts that represent ownership of the underlying foreign securities. Three New York banking institutions dominate this market; Bank of New York Mellon, Citibank and JPMorgan Chase. Note that investment in ADRs still involves exchange rate risk as the U.S. Dollar share price of the ADR will always be based on the price of the underlying shares translated into U.S. Dollars at prevailing exchange rates. Well-known foreign companies traded as ADRs include BP Plc (stock symbol BP) and GlaxoSmithKline (GSK) of the UK; Bayer (BAY) and Deutsche Bank (DB) of Germany; Novartis (NVS) and Credit Suisse (CS) of Switzerland; Sony (SNE) and Toyota Motor (TM) of Japan; Nokia (NOK) of Finland; and Grupo Televisa (TV) and Coca-Cola FEMSA (KOF) of Mexico. Chapter 6 of our book has much more information and background detail.

B is for Buttonwood Tree

The Buttonwood Agreement was signed on May 17, 1792 under a large sycamore tree, or a buttonwood in the vernacular of the time, that stood in front of 68 Wall Street in New York. The twenty-four brokers who signed the agreement agreed that they would only trade securities with each other, would abide by a fixed commission rate, and would not participate in auctions. This stock exchange was not the United States’ first – the Philadelphia Stock Exchange dates from 1790. However, it was this New York exchange that drafted its constitution as the New York Stock & Exchange Board on March 8, 1817, was renamed as the New York Stock Exchange in 1863, and became the most important and influential stock exchange in the US and indeed the world. (See Chapter 1 in our book).

C is for Central Fund of Canada

Calgary, Alberta based Central Fund of Canada, (with symbol CEF on the American Stock Exchange), is a closed-end investment management company set up in 1961 to hold gold and silver bullion passively on a secure basis. At least 90% of CEF's assets are maintained in gold and silver at all times. An investment in Central Fund of Canada provides share ownership in this gold and silver bullion, the value of which, together with some cash holdings and other assets, was at August 31, 2007 just under $950 Million (U.S. Dollars). As at that date the split in precious metals holdings was 52% of net assets in gold and 46% of net assets in silver. As it has no actual commercial business operations as such, the value of the stock is entirely driven by prevailing precious metals prices – gold and silver. Therefore it is a great stock to use as a proxy for trading precious metals without the cost and inconvenience of the trader actually holding or delivering the physical metal itself. There are now gold and silver-linked exchange traded funds (ETFs) that provide similar trading/investing opportunities, but these have the downside of relatively short track records and it may be that not all of their advantages and disadvantages as trading and investing vehicles have yet fully emerged in varied market environments. CEF is a kind of older, more mature cousin to the hot gold sector ETFs of today. In Chapter 6 of our book when we look at “price pegging” CEF is one of two stocks that we provide as a particularly successful example of the use we have made of the technique. The other is the stock of biotechnology company Genentech (DNA).

D is for Dividends

Dividends are payments made by a company to its shareholders, usually, but not always on a regularly scheduled basis. Dividends are usually paid in cash but stock dividends can also be paid on occasion. Dividends together with stock price appreciation represent the shareholder’s return on his/her investment. Many years ago the collection of dividends was considered almost the sole reason for investing in stocks. This was turned on its head in recent years and especially during the boom years of the late 1990s. Dividend payments came to be seen as the preserve of old-line economy companies and utilities, useful for income-oriented investors such as the proverbial widows and orphans, but not really for anyone else. Serious investors were more interested in stocks that paid a low dividend or no dividend at all, something that was typical of the fast-growing companies driving the new economy. Money reinvested by a company in its own fast-growing business at a high internal rate of return was more attractive than a cash payout that would be subject to tax and then would require reinvestment. It appeared problematical for investors to be able to find alternative uses for their dividends that could match the heady returns that investments in many companies were perceived to be making – at least on paper. But when boom turned to bust at the turn of the century, dividends made a comeback, as investors perceived that a company’s ability to pay dividends in cold, hard cash certified a company as a serious business enterprise with a mission to reward stockholders in something more than pipe dreams. New legislation easing the tax rate on dividends aided the rehabilitation of the dividend.

E is for ETFs

Exchange Traded Funds (ETFs) are a fast-growing group of instruments that enable investors to invest in or traders to trade in what are essentially index funds, but ones that can be bought and sold just like stocks throughout the trading day. The first ETF to be launched in 1992 was the Standard & Poors Depository Receipts index (SPDRs) or “Spiders” for short. Just like the first index mutual fund aimed at the retail market launched by the Vanguard Group (the 500 Index fund), Spiders tracked the S&P 500 index. Over the last few years, however, the number of ETFs has grown dramatically as well as their associated trading volumes. Today much of the action has moved from the simple tracking of broad market indices such as the S&P 500 or the Wilshire 5000 Total Market index, or the “Diamonds” ETF that tracks the Dow Jones Industrial Average – to much more narrowly-based sector (especially hot sector) ETFs. They have become a tool that is much prized by short-term traders, hedge fund managers etc. Bets can be placed on even very narrow sectors such as cardio devices, for which there is a Healthcare ETF, (stock symbol HHE). Narrowly focused ETFs have such a short history that a comparison of their current price with historical price movements is difficult. In major market corrections, such as that recently experienced, weak track records can lessen their appeal to investors.

F is for Fast Market

We often talk of buyers and sellers of stocks in metaphorical terms. For example, “buyers stayed away in droves” rationalizes a down market. Such expressions erroneously suggest that there can be an uneven number of buyers and sellers and it is this factor that drives stock prices up or down. In reality, the number of buyers and sellers of a stock is always exactly equal, as there can be no sale or purchase without both a buyer and a seller. What is actually at work is a balancing of supply and demand through the mechanism of price. A fast market occurs, however, when owing to significant news relating to the stock in question, an imbalance of trade orders such as many buys and few sells can lead to volatility, trading delays and  an anomaly called backwardation, where for a time the bid price is quoted higher than the ask price.

G is for Gold Mining Stocks

While gold mining stocks are shares in corporations and therefore their individual price movements reflect news that is specific to the individual company, as a group their stock prices generally follow the price of gold. Gold mining companies’ production costs are fixed, so any increase in the gold price flows through to their bottom line, (and equally profits are affected adversely by any fall in the gold price). A rising gold price is a harbinger of inflationary pressures and so the gold price and with it gold mining stocks tend to rise when stocks overall are under pressure and fall when the stock market is up on the day. The same reverse correlation can be seen with energy stocks, (oil and gas exploration, refining and distribution companies), or a major coal mining company such as Peabody Energy (BTU). As a result, even a contrarian ripple trader who follows our principle of buying stocks when both they and the overall market are down on the day, may buy gold or energy stocks that have fallen on an otherwise up day for the market.

H is for Hedge Funds

The name hedge funds derives from the original trading concept that the earliest of these private, closely held investment vehicles adopted – a blend of long and short positions in stocks that meant mitigation of losses from any sharp market movement up or down, thereby hedging their positions. Hedge funds today come in all shapes and sizes and have innumerable investment and trading styles which encompass all kinds of financial instruments, many of them of the most arcane and exotic imaginable. Commodity and financial futures, options and debt instruments are as likely to form part of today’s hedge fund’s trading style as long and short positions in equities. Also the last couple of years have seen a convergence of hedge fund trading with private equity investment, well characterized by Eddie Lampert’s ESL Investment’s recent rolling up and taking private of Kmart and Sears as one retail giant under the Sears name. Basically what makes a hedge fund a hedge fund is its being open to so-called accredited investors only, (originally wealthy individuals, now more likely pension funds, insurance companies and similar kinds of institutional investor). As such they are usually exempt from direct regulatory scrutiny from federal agencies such as the SEC, although there has been debate as to whether this should change. Hedge funds typically use leverage either through borrowing or especially through the use of complex derivative instruments to trade sums many times their assets under management. This can lead to stunningly high rates of return to the hedge funds’ investors, (and juicy performance fees for the fund managers themselves), but also the risk of great losses. In 1998 hedge fund Long Term Capital Management (LTCM) lost $4.6 billion in less than four months and the Federal Reserve felt obliged to organize a bail-out to prevent a feared financial panic and melt-down. Interestingly when hedge fund Amaranth Advisors LLC collapsed in September, 2006 after losing almost $6 billion in a single week through its bets on natural gas futures it disappeared with an almost eerie insouciance on the part of the financial markets. This appeared to signal a worrying development of hubris and under-estimation of risk on the part of market participants and regulators. Indeed the severe credit crunch that hit financial markets and caused extreme price volatility in the summer months of 2007 and then hit markets hard again in late 2007 and early 2008 was clear evidence of a general re-pricing of risk by the market with an accompanying severe credit crunch. (The collapse and bail-out of Bear Stearns organized by the Federal Reserve in March, 2008 held more than a fleeting resemblance to the LTCM episode). Investors in hedge funds have now had to accept that the "marking to market" of hedge funds' assets, especially those of the more complex variety, a practice used by many to value their holdings, has not been a particularly accurate means of measurement where no liquid market existed against which to value them.

I is for Insider Trading

Although many people believe that all “insider trading” is illegal, corporate insiders are in fact allowed to trade in their own company’s stock as long as they follow the rules laid down by the Securities & Exchange Commission (SEC). Corporate insiders are defined as a company’s officers and directors, as well as all beneficial owners of more than ten percent of a class of the company’s stock. Such stockholders are obliged to file with the SEC a statement of ownership, and to report their insider transactions within two days of the date the transactions occurred. While information of corporate insider sales at a company do not necessarily bode ill for the company’s prospects, as the executive selling may be seeking diversification or making estate planning moves, corporate insider purchases suggest that the senior executives making them do feel good about the prospects for their company generally and news of such purchases, (which can be found in the financial press), do reflect positively on a stock as a candidate for investment. What is illegal for such insiders (just as it is for those outside the company who may have access to such information), is trading when in possession of material information that is still not public. In Chapter 5 of our book we mention one kind of insider trading that is pretty much open to large numbers of the general population, but is completely legal! Most people hold jobs at some kind of company, many of which may be publicly traded, and each operating in its own specific industry sector or area of the economy. By the very nature of employees’ day to day contact with what is going on in their company’s industry, they are very well placed to have a wonderful insight into the various merits and demerits of the companies operating in their close business environment, including the company where they are employed. This has nothing to do with the possession and use of material financial insider information, which as mentioned above is illegal. It is simply a reflection of the fact that if you work at a financial services company such as a bank or insurance company, or at a supermarket chain, a pharmaceuticals company, or a manufacturer of household cleaning materials, you will have a better idea than the vast majority of the investing public as to the business trends in your industry, and in your corner of the economy. You will be better placed than most to assess the general performance of your company as well as that of all its major competitors.

J is for June…

…and specifically the third Friday of the month. On this day as well as the third Friday of March, September and December there is a phenomenon known as triple witching. This is when quarterly stock options, stock index options and stock index futures expire. This tends to lead to very high trading volumes as well as high price volatility in the futures, options and underlying cash markets especially during the triple witching hour – the last hour of the trading day. Some market professionals refer to these days as “freaky Friday.”

K is for Kondratieff Wave

Many market theorists point to the cycles and ebb and flow of market movements as having the characteristics of ocean waves. There are the tides, waves and ripples associated with Dow Theory, there is the Elliott wave principle that holds that constant patterns of five waves in the direction of the main trend, followed by three corrective waves in the opposite direction characterize the stock market. Then, for those who like their stock market and economic wave theories to be decades long spanning a whole generation at a time, there is the Kondratieff Wave that originated with the ideas of Russian economist Nikolai Kondratieff. The school of thought that bears his name posits a very long cycle affecting modern capitalist economies - between fifty and sixty years and sometimes called a super-cycle. Ironically Kondratieff himself helped develop the first Five Year Plan of the communist Soviet Union. But his writings were considered critical of certain aspects of the Soviet planned economy and he was sentenced to death by Stalinist officials and executed in 1938 after a period of imprisonment in the Gulag.

L is for the Large Capitalization stocks

Market capitalization is the value of a company’s outstanding shares multiplied by its current share price. Large capitalization stocks are generally safer investments than medium cap or small cap and our low-risk Contrarian Ripple Trading technique focuses primarily on large cap stocks with occasional forays into medium cap territory in the form of “mad money” trades. (See our Chapter 5). There are no hard and fast definitions of what constitutes large, medium and small capitalization stock parameters but the following is a rough guide. Large cap - $5 billion and above; Medium cap - $1 billion - $5 billion; Small cap - $250 million to $1 billion. Companies with a market capitalization below $250 million are generally called micro cap.

M is for Mutual Funds

Mutual funds are collective investment vehicles that pool invested money from a large group of individual investors and make investments on their clients’ behalf in stocks, bonds, money market funds and other securities. Mutual funds are “open-end” investment companies in which additional inflows of investors’ money are simply added to the pool made available for additional investment and which can be redeemed at any time for the net asset value of the shares being redeemed. This differentiates them from closed-end funds that do not take additional money once they have sold a fixed number of shares to the public (just like regular company equities). Also unlike mutual funds they are not redeemable on request by investors. The only exit is sale on the stock market – again just like regular stocks. Mutual funds are regulated under the Investment Company Act of 1940. One of the greatest drivers of mutual fund growth was the development of individual retirement accounts (IRAs) and employer-sponsored defined contribution 401K retirement plans.

N is for Nifty Fifty

The so-called “nifty fifty” was a group of large-capitalization growth stocks that were also dubbed during the 1960s and early 1970s “one-decision stocks” as they were considered the kind of companies that any investor should want to buy and never sell. Characterized by consistent earnings growth and relatively high price/earnings ratios, they also had the advantage of brand appeal in that most people had familiarity with the companies and their products. There was actually no one official nifty fifty stock listing and over the years that the concept was in vogue several publications and brokerage houses drew up their own lists. Most would include stocks such as Procter & Gamble, Coca-Cola, Johnson & Johnson, McDonalds, American Express and Minnesota Mining & Manufacturing (3M) that are still major, successful corporations today. However the fact that names such as Simplicity Patterns, Polaroid, The Joseph Schlitz Brewing Company, Revlon and S.S. Kresge Corp. (later Kmart and now Sears Holdings) were typically also included indicates all too well that even the bluest of blue chips risk being ravaged by new technologies, changing market tastes, competition, lifestyle changes or simple management miscues over a period of time measured in decades. In short, even the best of stocks ultimately are perishable and have a shelf life. It would be interesting to formulate a nifty fifty from today’s major growth stocks and then revisit forty years from now to see which are still as highly regarded. Even though a number of the nifty fifty stocks continue to prosper today, the concept of a nifty fifty group of “one-decision stocks” imploded in the 1973-74 market turndown. The shakeout, which hit these stocks particularly hard, suddenly illustrated all too clearly that nifty fifty companies’ high price/earnings ratios should have been seen, not as a badge of honor, (reflecting the widely-held belief that these were stocks that had value bought at any price), but rather the fact that investors had been paying a hefty premium for these stocks. This left such a sour feeling behind with investors that the term nifty fifty was effectively dropped from usage.

O is for (stock) Options Backdating

The stock options backdating scandal that rocked boards of companies both large and small during 2006 started with a Wall Street Journal article, “The Perfect Payday,” of March 18 of that year that examined stock options grants at six companies. Stock options are awarded to senior company executives and in some companies also to executives lower down in the corporate hierarchy, as part of their overall agreed compensation packages. The award is typically made at an exercise price, (the price at which the option can be exchanged for actual company stock), that is equal to the price of the stock on the day the award is made. Should the stock price subsequently climb, the option will also climb in value, as the option can be exchanged for stock at a predetermined time in the future. Should the stock price drop, then the option eventually expires worthless. The theory behind the granting of stock options is that it helps to align the interests of senior executives with shareholders, who also want the stock price to go up. The Wall Street Journal article pointed out that the companies studied had consistently awarded stock options at times when the stock price had been at particularly low levels and had subsequently rebounded. This was either amazingly coincidental and incredible good fortune for the executives involved, or it suggested that the stock option award dates were being decided on some time afterwards based on the hindsight of what would have been a particularly auspicious time for awards to be made. The options would then simply be backdated to make them appear as if they had been allocated at the award date. The chances that all these lucky breaks for the option grant participants represented pure coincidence was so infinitesimal that the Wall Street Journal concluded that stock option backdating was going on at these companies. Further investigation by the Securities & Exchange Commission (SEC) as well as by the companies that were affected, confirmed this was the case and eventually over 130 companies had to admit that there had been improper backdating of stock options, and in some cases falsification of company records to hide it. The SEC investigation of backdated options also uncovered a different but also troubling practice that came to be known as the granting of “spring loaded” options. In such cases companies awarded stock options to senior executives immediately prior to the release of news that would almost certainly send the stock price up, thereby placing the newly minted options immediately “in the money.”

P is for Private Equity

Private equity firms raise funds for investment purposes from wealthy private individuals and institutional investors. Funds are normally organized as limited partnerships with the private equity firm acting as the general partner (GP) and the investors as limited partners (LP). The “equity” part of the designation “private equity” is an indication that what these firms do is to place risk capital or invest in company ownership. The “private” in “private equity” originally referred to the fact that the funds are raised privately and not through public offerings of securities. However, in the way that private equity funds have operated and developed over the last years as alternative asset investors, the word “private” now serves to incorporate two of their other attributes. One is that they typically invest in private companies that do not have their shares publicly traded on exchanges, or where they do invest in public companies, it is usually in the form of a leveraged buy-out (LBO) in which the public shareholders are bought out and the company is thereby taken private. There is also a third “private” aspect in that privately owned companies do not have the regulatory reporting requirements that public companies do. The aim of a private equity fund manager in making an investment in a portfolio company is to build value over a period of usually three to five years. Often changes in the management team, heavy use of leverage as well as the shedding of non-core assets are among techniques used to raise the profitability and value of portfolio companies. Exit from the investment at a profit is typically achieved either through a sale of the company to a strategic or financial buyer, (the former being a company in the same or a related industry, the latter another private equity fund or another investor whose motivation to buy is financial), or by selling the company to the general public by means of an initial public offering (IPO). LPs who want to cash out of what theoretically are illiquid investments are able to use a vibrant and active Secondaries market in fund partnerships that has grown up in recent years. Private equity firms earn most of their return through retention of carried interest, which is typically 20% of the profits generated by the fund. Private equity funds have benefited greatly from the low interest rate and easy credit environment of recent years. The credit crunch that began in the summer months of 2007 and worsened in early 2008 has raised dramatically the risks and complexity of completion of these firms' deals. This has already resulted in the failure and abandonment of several high-profile transactions. 

Q is for Quick Ratio… (It was either that or quantum physics and we know nothing about quantum physics)

The quick ratio is used in the analysis of a company’s balance sheet to assess how well a company’s short-term debt is covered by its quick assets, which are current assets that can be quickly converted to cash. These are cash balances, near-cash, marketable securities and some accounts receivable – but not inventories, for which cash sales can not be expected to be obtained immediately. This is useful information for a company’s bank lenders and other creditors as it demonstrates how much of the company’s short-term debt and other obligations could be immediately paid off using its most liquid assets in the event that the business had to be wound up immediately. The ratio is also known as the acid test. For an investor in the company it does not hold the same usefulness as in a liquidation the investor as an equity holder would not expect to receive anything. More relevant ratios for investors are therefore those that illustrate the company’s financial condition as a going concern such as those indicating profitability, financial leverage and efficient utilization of assets. However, please see Chapter 2 of our book which describes why it is our belief that you have no need to tie yourself up in knots with ratios and other financial information gleaned from balance sheet and income statement as you ponder the purchase of shares in a major public company.

R is for Robert Rhea

The Dow Theory is a theory of stock market cycles based on the editorial writings of Wall Street Journal co-founder Charles H. Dow in the years 1900 – 1902. The Theory was subsequently expanded upon and refined by William Peter Hamilton. But it was left to Robert Rhea to organize and summarize the Theory more fully in his books The Dow Theory of 1932 and The Story of the Averages in 1934. It was in this last that Rhea adopted ocean metaphors to describe the three basic trends of Dow Theory: tides, waves, and ripples. Tides represent primary trends or bull or bear markets. Waves represent secondary “reactions” which we usually call rallies or corrections. Ripples represent the daily fluctuations in the market. We have used Rhea’s “ripple” metaphor in the styling of our own short-term trading technique “Contrarian Ripple Trading,” but to be fair to Rhea he personally felt that short-term ripple fluctuations would not allow successful speculation in the stock market. In line with other Dow theorists he believed that successful stock market speculation lay in correct identification of the primary trends. (See Chapter 3 in our book for more detail).

S is for Short Selling

Selling short is the practice in which instead of buying a stock with the hope of selling it later at a higher price to make a profit, a stock is first sold and then subsequently bought back, hopefully at a lower price than the selling price, thereby generating a profit on the trade. The ability to sell something that a trader does not actually own is based on a service provided by brokers whereby a stock held on behalf of other clients is loaned to the short-seller in order for the short sale to be made. At some point the stock that has been “borrowed” in this way has to be returned, or as the old adage has it, “He who sells what isn’t his’n, must buy it back or go to prison.” Very few people are clever enough to win consistently at the short game, even though bear markets and severe corrections, such as recently experienced, can appear to hold out tantalizing opportunities with the technique. For professional investors it can have a certain value in hedging large long positions and hedge funds have long successfully used short selling as one of their trading and hedging tools. But in Chapter 8 of our book we go into detail as to why for the man/woman in the street, short selling is simply much too risky to form part of any strategy that seeks to be risk-averse such as the one that we espouse through Contrarian Ripple Trading.

T is for ‘Tis the Season…

There are many opinions as to when are the most propitious times during the year to buy or sell stocks. Statistically, September is the month that shows the biggest tendency for stock market declines. October scares some people because some major market crashes have occurred in that month including 1929 and 1987. We hear about “summer rallies,” but find that concept is contradicted by the old adage “Sell in May and go away.” There is a Santa Claus rally, closely followed by a January Effect. But in our view Mark Twain probably summed up the best way to view the timing of stock purchases by month of the year when he wrote: “October. This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February.”

U is for Uptick Rule

A rule instituted by the Securities & Exchange Commission (SEC) following the 1929 market crash, for which short-sellers were (probably unfairly) given much of the blame. The rule was designed to prevent falling stock prices from being further destabilized by short selling. The rule stipulates that you can only sell a stock short when the price trend is moving upwards. As we point out in our Chapter 8, this is just one of many ways in which the dice have been loaded against the short-seller. There was no equivalent rule on the long side that you were only allowed to buy a stock that was going down. After 78 years in force, the SEC repealed the short sale uptick rule on July 6, 2007. We neither confirm nor deny rumors that this action followed a visit made by SEC Chairman Christopher Cox to Ridetheripples.com where he may or may not have noticed our reference to the uptick rule as representing something of an anomaly.

V is for Virgin Atlantic

British recorded music cum airline entrepreneur Sir Richard Branson once quipped “The best way to become a millionaire is to start as a billionaire and then buy an airline.” Uber-investor Warren Buffett himself ruefully summed up his investment in US Airways as follows: “Those who have watched my moves in this investment know that I have compiled a record that is unblemished by success.” On another occasion Buffett famously wrote “If I’d been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough – I owe this to future capitalists – to shoot him down.” See Chapter 8 our book with our own thoughts as to why major airlines are an intrinsically lousy business to invest in – and yet why entrepreneurs and investors are always drawn to it like moths to a flame.

W is for Window Dressing

Window dressing is the name given to the widespread practice of institutional investors, and particularly of mutual fund managers, of ensuring that their quarterly reports to investors present an artificially positive aspect. This is done through the quarter end culling of particularly poorly performing stocks, replacing these stocks that would be generally regarded as “losers” with stocks that have been top performers in recent times. The rationale of this practice is to assist in the marketing of the fund to potential new investors by making it appear that the fund manager has been smart enough to invest largely or exclusively in the winners he now lists. As a marketing tactic the practice makes perfect sense while from the point of view of maximizing investment returns it is a counter-productive move as it engages the fund manager in a classic case of “buying high, selling low.” It is so widespread, however, that it has the effect at each quarter end of pushing losing stocks further downwards as funds exit their positions en masse, while adding to the run-up of stocks that have already been on a tear. Naturally once the quarter end has passed, many of the window dressing moves are reversed and so for the contrarian investor/trader each end of quarter offers a great opportunity to buy some already beaten down stocks at an even cheaper price and then watch them recover as the window dressing pressure subsides and reverses.

X is for X

Should you see a stock market ticker symbol that is five letters long and ends with a single letter X, this is an indication that it is a mutual fund. The addition of the single X differentiates it from stocks and bonds and other securities that have ticker symbols. Examples would be Vanguard’s Index 500 Fund, (VFINX) or Fidelity’s Magellan Fund (FMAGX).  Money market fund symbols end in a double XX such as SWMXX – Schwab Money Market Fund.

Y is for the Customers’ Yachts

A fable made famous by Fred Schwed’s book, “Where are the Customers’ Yachts?” published originally in 1940. The story goes that financier J.P.Morgan was showing a client around the docks of the New York Yacht Club and pointed out the impressive looking yachts owned by various Wall Street investment firm titans of the time. His client asked the rather pertinent question “Where are the customers’ yachts?” One wrinkle to this topic is provided by the recent collapse of and bail-out at Bear Stearns. Bear's senior executives have long figured among the best paid on Wall Street, but much of their compensation has been in the form of company stock. When Bear Stearns collapsed in March 2008 and the not insignificant portion of the company's assets that still held value were handed over as an early Christmas present to JPMorgan Chase, (a bank descended from one owned by J.P. himself), hapless stockholders were left with a proposed $2 per share payment in the acquirer's stock, (later raised to $10), compared to the $172 per share that Bear Stearns' stock had traded at just over a year before. Presumably this devastating outcome gave some of Bear Stearns' senior executives no alternative but to put their yachts on the market in order to keep themselves financially afloat. Chairman James Cayne, whose 5.6 million share holding was worth a cool billion dollars at its peak, sold his entire stake for $61 million late March, 2008.

Z is for Zero-Sum Game

A zero-sum game is one where the amount won by those who win exactly equals in aggregate the amount lost by those who lose. All forms of gambling are good examples of zero-sum games. The pot of money that is at stake in all games of chance will be divided up between the winners, the losers and the house. The house theoretically can be counted among the losers in any given instance but gaming is generally a good business to be in because the house typically wins many more times than it loses. The corollary to this is that gamblers typically as a group lose more than they win. But what is happening is effectively a redistribution of the money used to make the bets. The total amount wagered remains unchanged before the wagers are struck and after the game has been concluded. There has been something of an ongoing debate as to whether investing in the stock market is a zero-sum game. Those who say it is point to the fact that there is a winner and loser to every trade. If an investor buys a stock and it goes up, he/she has won and the person who sold the stock has lost in an equal amount. (We are leaving transaction costs out for the sake of simplicity). The winner and loser roles are reversed if it goes down. Those who say that investing in the market is not a zero-sum game point to the fact that as the overall market tends to rise in value over time, therefore most investors are statistically predestined to be winners should they hold their positions over the long haul. Our own thinking is that both arguments have correct elements to them but do not tell the whole story. The second argument ignores the fact that when any seller cashes out a stock position and registers a big profit, the investor who buys the position actually takes a notional loss because theoretically he/she could also have bought it earlier at the lower price. The first argument misses the fact that dividend payments made to investors add to the return on investment with a stream of income in such a way that the “pot” is constantly sweetened, thereby increasing the overall return to the investor beyond the simple capital gain of a purchase and later sale.
Hmmm…complicated stuff. What do you think? Is stock-trading a zero-sum game just like gambling? Or is there a qualitative difference in this form of risk-taking that allows more market participants to emerge as winners than those who find themselves taking losses?

Email us at AidanMartha@ridetheripples.com with your view on this or anything else we have included on this site or in our book. We would be delighted to hear from you.