What it takes to profit from it. (Part 2)

Warren Buffett, the world’s richest and most successful investor for over 50 years follows two very simple, yet profound rules:

Rule #1: Don’t Lose Money

And

Rule #2: Don’t Forget Rule #1!

His two rules basically imply that it is imperative for everyone not to make any sort of silly investment mistakes that may cause you to take on high risks and lose money unnecessarily. In the case of bad stock selection or the wrong market timing, you can easily to lose up to 20 percent of your investment capital within a few short months. To recover your losses, you need to make returns of at least 25% on your remaining capital which may easily take you two years or longer to achieve. Take a look below:

                             

Loss -20%

RM100,000        ------------>     RM80,000

                             

Gain +25%

RM80,000          ------------>     RM100,000

It takes you over two years to just break-even in this example. After two years, even though you have recouped losses, you have lost precious time. Money is something that comes and goes. Whereas when time is lost, it is lost forever!

These are some of the advises that i discovered and also told about during my early years of investment. Up to today, i still hold these advises strongly in me. Hence, here are some of these toxic investment mistakes which you must avoid at all costs:

#1: You take financial advice from people who sell investment products, not successful investors. The right or wrong advice will have a big impact on both your current and future financial health. Many beginners start off by listening to friends and family members. They get free advice on what works and how to succeed. What they may not realise is that free advice can be very expensive.

#2: You do not have any written financial goals with regards to the number of properties, how much passive income, how much bank borrowing or good debts for property investments, what is your asset allocation model, what investment strategies you want to apply, etc. If you do not have any firm idea, you will not know which direction to head.

#3: Young people (i.e. less than 35 years old) focus the bulk of their time, energy and effort on investments when their investment capital is too little to have any sort of meaningful impact. Instead, they should be focusing on maximising their earning potential as they are at their prime earning age.

#4: You invest your hard earned money in high return investment scams and lose everything. Some people even lose a hundred percent or more in failed business ventures. In my opinion, taking business risks is acceptable. If you do not try, you will never know. As long as you plan to fail cheap and fail fast, it is worth taking a calculated risk.

#5: You buy investment funds and take risks hoping to make average returns of 7-9% per annum. Instead, you can pre-pay your car or housing loans and enjoy a guaranteed savings of 4-6% per annum with absolutely no risks! You should only invest provided there are opportunities where you can make double or even triple the amount you get by saving with minimal risks.

#6: Mistake number five automatically implies that if you are going to have any sort of loans till the day you retire, you cannot invest in investment funds till the day you retire! It is a fact that most Malaysians are expected to have some sort of loan till the day they retire.

#7: To diversify and reduce risks, you buy complex (e.g. structured, capital guaranteed, etc) investment funds that you do not quite understand. Many people even start diversifying when they are still young with their small investment capital. Warren Buffett likened the word ‘diversification’ to “de-worsification’. As long as you know what you are doing, it is not necessary to diversify.

#8: These investments funds have high sales charges of 3-5%. In fact you can buy similar funds with entry costs less than 0.6 percent! After all, is not a dollar saved equal to a dollar earned?

#9: You buy various products from banks and make them rich when it makes greater sense to buy bank shares and make yourself richer!

#10: You are not investing in low risks commercial properties giving high returns of over eight percent per annum with low entry costs. You can actually do so from as little as RM1,000 and enjoy absolutely no property or tenant management problems!

#11: Your first investment property is a landed house giving negative cashflow. This will limit the number of properties you can buy. For beginners, it is advisable to start off with apartments or condominiums as it is easy to achieve zero or positive cashflow every month.

#12: When you get married, you buy a dream home right away! Instead, it makes more sense to buy an investment property and rent a home for the first 10 to 15 years of your married life. As you may not have settled down career-wise and your young family needs changes, renting will give you the flexibility to move as and when the need arises.

#13: You buy a property or a home which you could not financially afford yet. Being young, you think that given time, this property will become affordable as your earnings increases due to promotion, salary increments, etc.

#14: You buy costly high-end residential properties. Instead you could have invested in commercial properties which give the best of both rental returns and capital appreciation. This is applicable if you have a budget of over RM1.5 million for real estate investments.

#15: You buy ‘cheap’ properties when it is a fact of life that ‘cheap things are never good’ and ‘good things are never cheap’! It is always worthwhile to pay a premium and buy the best properties in great locations.

#16: You purchase commercial properties in areas where the neighbourhood’s purchasing power is low. How well your commercial property does will depend on how well your tenant is able to make profits. A neighbourhood with low purchasing power will not do well compared to a richer neighbourhood.

#17: You purchase a dream retirement home when you are still 30 years away from retirement. As your future lifestyle, likes and dislikes will inevitably change, it is advisable to only think of buying a retirement home when you are only a few years away. For all you know, you may prefer to retire in another country!

#18: Your investments are unable to give decent returns to enable you to outperform your personal inflation rate of 6-10% per annum. Your family’s inflation rate will depend on you, your spouse and your children’s consumption patterns and lifestyle!

#19: You work hard and save to buy one investment property every few years. Whereas savvy investors creatively buy one property a year or even one every few months with little or no money down!!

#20: Your financial goal is to retire debt-free at age 65. On the other hand, smart investors aim to retire at age 45 or earlier by accumulating good debts of at least RM3 million via property investments!

#21: You wrongly focus on hitting a certain net worth instead of generating passive income. For example, when you retire debt-free, you must have RM1.8 million in fixed deposit at two percent per annum, in order to get RM3,000 a month for living expenses. Instead, you can actually get the same passive income by investing RM500,000 in properties!

No matter how hard you work or save, committing any of these 22 toxic investment mistakes will prevent you being Financially Free.

What it takes to profit from it.

I think it's just a human nature that people will always want the easy way out. They want the next best thing in the quickest way possible. There are sayings that goes, "good things comes with a price" or "good things will take time to come". Now, I don't know how to express in words that those sayings are utterly true. People are not willing to spend the effort and time to pursue the challenging (and most of the time spirit breaking) route to success but always want success to be quick. Think about it, one can spend say 3 years in a university to get a job out there. Don't get me wrong but that's also a kind of success! You rough it through university, study hard, late hours on projects, assignments and worse during semester examinations and tests.

Now, for that analogy of roughing through Universities, you worked hard and etc and one probably get a decent paying job (bolding of the word job is on purpose). That's the funny thing about it. People do not mind working their asses off during university for a job but they do not even want to spend 1 year (could be less) in pursuing their success of financial freedom. It's really ironic. I keep hearing people telling me "it's tough, you won't get to see any money for the first 3 years". Well, i was thinking, did anyone see any money during their 3 years in university? Maybe some did and they did odd part time jobs but that's not the point. 3 years is just an example as it depends on how big one's dream and purpose to succeed is. The bigger the dream the more time and effort is required. Bill Gates slept in his office everyday and see where is he now? Everyday thinking of making better softwares from that computer.

Alright, now straight to the point of what some people had asked me about investments. It's interesting that 90% of them are the ones waiting for some kind of "magical" advice and they can win big. To be fair, I was one of that kind at a point of time but thank our heavenly father that i snapped out of it quick. Hence for this post, some asked me what does it take to trade futures or be in the stock market. In my mind, i believe it is not only in the futures market but it ANY financial market. I literally mean ANY because be it from futures market, options market, equities market, properties market, bonds, etf's and so on that these 5 basic "must-have" are a must in anyone. In my own personal opinion, these 5 basics are so simple but yet extremely and utterly hard to achieve. What are they? Here goes:

1) Emotions management

Trust me when i say that i learnt this the hard way and I put it right at the top of the 5 basics. I'll use a trade to enhance my analogy here:

Ok, lets say that one takes a position to go long, and has a stop 10 points away. Market moved downwards and it hit his stop. For the FKLI, 1 point = RM50. So, 10 points is RM500.

So, one may say, "ok, that's the plan i followed. It's ok. i'll try again". So, market went lower, and one bought at a lower price and again placing a stop 10 points lower. Market went further down and hit his stop again. Another 10 points gone. That's already RM1000 in 2 trades.

Later on, there seemed to be a buying opportunity again as it went lower but because your emotions had shaken, confidence shattered. Hence one will say, "crap, let us see how the market goes first since i just lost so much". Who knew, the market rebounded and went up 30 points. That could have covered the the loss and even earned another extra 10 points! Hence, that person will probably be controlled by their emotions and it is two emotions that will always bring a downfall to that person which are fear and greed. Fear because after several losses, they fear of losing more and missed the opportunity and greed when one wants the unachievable by the market and do not accept what the market is doing (or basically think that he is right). Both these emotions will kill an investor/trader as quick as he entered.

So how to overcome it? It's actually quite simple. Plan your trade and trade your plan. Yes. it's that simple. Too simple until it becomes extremely difficult because of emotions that will cloud your judgement

2) Leveraging can make or break a person

Yup, we live in a world of leveraging now. Leveraging here in layman terms means "small capital but earn big money". Hey, sounds good right? In fact, most of what we do now is on leverage. Opening up a business, one will probably get a financial support from the bank. That's a leverage on OPM (Other People's Money). You borrow money from the bank to buy a car or a house, that's leverage too.

In the futures world, the leverage can go up to more than 15x of your capital. For example in the FKLI, 1 point = RM50. Hence if you take a position at 1750 index points, it means 1750 x 50 = RM87500.
That's way too expensive for one to trade right? Hence, futures here goes by contracts and per contract is
only RM5000. So, you're leveraging 17.5x of your contract capital!

Now, not many people realize this but leverage can make or break you. If not handled carefully, it can kill you before you even know what's happening and it also can lift you up so fast that you thought are in heaven already. So, using RM5000, one can trade the FKLI market and lets say you earned 20 points from the FKLI market, that is RM1000 profit which also means it is 20% profit in probably a day or so. That's extremely wonderful as which investment vehicle else can give this kind of profit? However, like i mentioned, leverage can make or break you. If it can make you, it certainly can break you too.What if you lost 20 points? That is a 20% loss in your account of RM5000.

Then, it boils down to emotions again. If you have loss RM1000, emotions will kick in and say "lets earn back that loss by adding more contracts". Instead of one, you now trade two contracts. That's RM10000 and you will be leveraging RM50 x 2 contracts x 1750 index points (using 1750 points as an example). That will give you RM175000 that you're leveraging and not only that if you are down by 20 points that would be RM2000. So, adding from the previous loss of RM1000 + RM2000 = RM3000. RM3000 of RM5000 capital is 60% loss of your capital! That's like more than half of your capital gone!

Hence, leverage at a pace that you are comfortable with. Do not over leverage.

3) Only add positions when you're profiting 

I guess i've already explained this on point 2). If you add positions/contracts when you're on a losing side, you can lose money so fast that you won't even know what happened. Hence, you only can add more positions when you are on a winning side. This is a common downfall for traders/investors because they want to earn as much money as fast as they can!

4) The TREND is your FRIEND

Easy said, easy heard. But why are there many (I was one of them last time) who looses still? People love to think that they are right and they want to "tell" the market what to do but they do not realize is that, that person is just one person and the market is millions of people. So if lets say in a crowd, which one has the louder cry? Is it you or is it the crowd?

So, what can we see from here? In simple words, "let the market lead your decision and not the other way round.". The main thing why this is so hard to follow is human ego (yes, another emotion). Here is how it works:

You do your charting analysis and also fundamentals. You see that it will continue to go long. Hence, you went long. Market dropped and you tell yourself and even some other people that  "don't worry, it will pick up. My trading software strategy is perfect as i've backtested it 10 years behind". The market continued to drop further but because of your ego and what you told yourself and also other people, you will not want to budge from your decision. Market continued to punish you further and further up to the point that you can't bear it any further and you cut your position at a big loss. Then, after that, the market suddenly rebounded and went even higher than your position. That time i guarantee you are going to be so bloody frustrated and you will not even think properly and you will probably blame everything under the sun.

There is a saying, "be humble or be humbled!". When you get egoistic because of wins, that is when the market will punish you big time.

5) Practice makes perfect

I guess this works for anything we do now. The more we practice on something, the better one will become. Like what Bruce Lee said "I will not fear of someone who learns a thousand kicks but will fear someone who learns a kick a thousand times". Hence, that's exactly it. Keep practicing on your plan. Give it time for it to develop.

Yes, some will say they can paper trade and try their plan first but the only problem with this is paper trading does not involve emotions. It's when you use real money into your trades, you will feel that pressure so great that your emotions comes in and take over. Hence that is why emotions management is the first and most important point on this 5 basic points. In futures trading, there is no other way to learn than getting your hands dirty in it. Which means using real money to trade. One can always start small before going in bigger.

As my personal view, one should learn how to earn money from their own local market first before doing overseas markets where the sharks are bigger and the wolves are bigger in overseas market. I always tell myself this, "if you can't win from your own home ground, do you expect to win on your opponents turf? :)