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Saturday, September 5, 2009
Profit From Patience
The recent so-call bull rally has last for almost six months, and while people are predicting that the market will be having a bad day in the month of September as September has always been a bad month for stocks, market continue their wild run after few days of fear. This mini bull rally reminds me of something call profit from patience. For most traders, selling after some percentage of profit and cutting loss is a norm.
The illustration below is to show the comparison both investors A and B, where A will sell his stock once reach 10% while B is holding stocks for some time. Assuming both of them buying stock Z which is yielding 4% a year.
6 months continuous bull run resulting the price go from 1.00 to 3.00
For investor A,
From 1.00 to 1.10 (10%), A realized gain is 10cents
Then stock continue to move up 1.30, and A buy it back and because sentiment is extremely bullish, he will sell at 30% profit. So, once hit 1.70, he sell it again.
A buy again when price drop to 1.60 and sell at RM2.10.
Continue buying when the price hit 1.90 and sell it at 2.80 (40%) because market is bullish, but the price continue to soar to 3.00
i)1.00 -> 1.10, A earns 10cents.
ii)1.30 -> 1.70, A earns 40cents, but top up additional 20 cents from initial capital of 1.00
iii)1.60 -> 2.10, A earns 50cents, extra 10cents cash in hand
iv)1.90 -> 2.80, A earns 90cents, extra 20cents cash in hand
Total net profit A = 10 cents + 20 cents + 90 cents = 1.20 (in actual fact 1.00 for the investment of 1.00)
While investor B have net profit of 2.00, should he realize the gain after 6 months.
People might have been questioning where has the profit of A gone, but let us understand the scenario of both investors using the same initial capital of 1.00. The (i), A earns 10cents, but then again in (ii) A needs to top up additional 20 cents to buy the stocks, but still earn 40 cents. And in case (iii) market pull back a little, and A manage to buy below his sell price, so he earns extra 10 cents. The same goes to case (iv). In this scenario, he really make money in (iii) and (iv) where he has additional cash in hand after buying stock Z. Why this happen is because he is actually chasing stock.....so the profit earned from previous transaction is to be either topped up or buying lower than his previous transaction selling price (if it happens like case (iii) and (iv)). So in the end the real profit is profit from the final transaction + all his cash in hand when he manage to buy lower. While for B, he just put and realized his gain (if market is bullish) in 6 months time and his earnings are a lot more than investor A.
Again, we will have another argument....if market is bearish, A will be at least cutting his loss while B will continue to hold stocks that will be losing its value from time to time. Actually, if we realized, stocks go up and down together. So if A cutting loss at stock Z, and buy Y, Y potentially still bearish and A could still be suffering the same loss as B, in the end, unless A stop playing stocks after the first loss.
What is the point of jumping here and there when market is bearish? You will end up with realized loss, while for those holding the fundamentally strong stocks, only paper loss. However, stock quality is also another consideration, but we will discuss that in the future.
Do you agree??