Looks like the DJIA is setting a base for a 400-point move

Just looking ahead...  It looks like the Dow Jones Industrial Average is setting a base to make a potential move.  Sure it may have a little more consolidation in the next day or so, but if everything continues as it has been, we could be around 10,750 in the next 10 trading days.  Call it an early January effect, a Santa Claus rally or what not.  Maybe it will be part of the $10 trillion sitting on the sidelines that I addressed in this earlier post.

At this point I think the risk and reward is leaning toward accumulating positions and increasing holdings.

Disclaimer:  I have a position where I benefit if the Dow Jones Industrial average increases in value.

Exited my Gold Position

In this previous post, I reported that Gold was overbought and that I had a position where I would benefit from a fall in gold prices.

Here is an update on my risk and reward estimate.  I have exited the position since the price has dropped about $6.50 based on GLD and about $65.00 on the spot price.  My initial target was a support of $108 for GLD or about $1,080 for the spot price.  At this time I am not ready to risk about $6.50 in profit to wait for another $3 or $4 to develop.

I expect prices to fluctuate for the next two weeks in the range of $108 and $113.  I would not be a buyer at this time unless it fell below $108.

Forbes article on High-Frequency Trading

Wow. 40 racks of servers overseen by traders backed by two separate power substations and 196,000 pounds of batteries and soon, also a 2,000-kilowatt diesel generator.

In this Forbes magazine (yup, still getting it free), this article talks about the equipment, locations and ideas to make money within milliseconds. Some have a direct fiber-optic connection to exchange computers. Why transmit via the internet?

All this equipment is needed to do "high-frequency" trades. To me, it's a bunch of arbitrage. The systems perform 2,000 trades in one second. It tries to catch 0.1 0r 0.01 cent differences, but catches the difference thousands of times each day.

Now the NYSE is exploring renting out space for similar connections directly to its exchange.

Just don't get it wrong 2,000 times in one second.

Click here to read the article.

What? Limited reward with unlimited risk?

I hope I never get caught in something like this. Here's a piece on "accumulator" contracts. Where you have a one-year contract to purchase a stock every day at a discount. In this example they said you buy a $10 stock for $8 (20 percent discount) every trading day for one year. Sounds great, right? It's a purchase at a 20 percent discount, but if you could sell, it's actually a 25 percent gain!

Here the problem. If the stock goes up five percent, the contract gets cancelled. So you bought a bunch at $8.00 and once it hits $10.50, you no longer can buy at the $8.00 price. On the flip side, if the price drops to less than $8.00, you actually need to buy even more. In some cases, double the amount. Talk about a way to try and support the price of a particular stock.

So the maximum reward is $2.50 and any capital appreciation/dividends beyond $10.50, but the "guaranteed" 25 percent return is gone. The risk is (nearly) unlimited.

Beware, and read the fine print.

Click here to read more details.

Leverage is a double-edge blade: Another story on Risk and Reward

This one is from Forbes Magazine. Still getting it for free. This story is about Louis Reijtenbagh, a Dutch cardiologist and investor who (sounds like) borrowed against everything. Sometimes he borrowed twice, using the same collateral.

Leverage (borrowing) is great when things are going great and it is properly used (on investments vs. lifestyle costs), but it also hurts when things go against you. Beware how you use this tool....

I love the paraphrase by Warren Buffet: "when the tide goes out you get to see who is not adequately covered by collateral..."

Click here for the article.

VW and Porsche saga finally winding down

Here's a nice summary of everything that has happened in the last four years. Click here for the Yahoo! Finance article. Porsche failed in its bid to take over VW (David and Goliath sort of deal) and now is ending up being merged into VW and will likely be one of the VW brands.

With increased Reward comes increased Risk. Market forces will drive them to balance each other out.

Using Variable Ratio/Variable Reward to encourage saving

I just read this interesting piece by Jason Zweig about a bank that is offering prizes (or raffles) just for opening a bank account.

We all know that variable ratio / variable reward is the best way to encourage behaviors. Think of gambling (don't know when you're going to win or how much you're going to win) or even other activities such as golf (don't know when the next good shot will come or how great it will be).

Of course, the rates are a little lower than current market and the differential is how the credit union pays for the "prizes." The article reports the following: "You are sort of betting, but there's no losing."

But in reality, there is losing because of the differential in return and losses to inflation. How you make it up is in the risk/reward ratio. If you contribute the minimum like the reported person who placed only $25 in their CD (Certificate of Deposit) and won $400, the ratio is more justified as compared with someone who opens their CD with $100,000 and wins $400, but misses out in $1,000 for every 1 percent interest rate differential.

Update on Porsche / VW Saga: Porsche loses...

I had previously posted about Porsche's Risk/Reward situation. Click here to read that. Now rumors are going around that instead of Porsche ending up controlling or taking over VW, it is going to be the other way around.

In this recent Reuters article on NYTimes.com Porsche's debt has climbed to more than 10 billion Euros. This Time.com article (from May 2009) reports that Porsche's sales were recently only 9.3 billion Euros. Porsche really leveraged themselves this time and are paying for it, especially in this contracting automobile market.

The price for Porsche is 11.28 billion Euros and the outgoing Porsche CEO may get more than 100 million Euros (for getting Porsche into this mess starting back in 2005).

Porsche took the risk for the reward, and this time it's not paying off. VW was 16 times the size or Porsche.

Ongoing saga at carmaker Porsche

Here's another interesting story about risk and reward.

Starting back in 2005, carmaker Porsche started purchasing shares of VW. It currently owns a majority (>50%) of the company directly by shares. They also controlled additional shares with options. Speculators had been betting that the shares of VW would go down. Once the news got out about how much Porsche owned, there was a squeeze because of the following:

• Porsche shares + Porsche controlled via options + Shares short by speculators was greater than outstanding shares of VW.

I can't find the articles, but it was one of the first times where profits exceeded operating revenue (sales from Porsche cars). Comments at that time were that Porsche had turned into a hedge firm. This was all because of the large VW position.

• Click here for the TimesOnline article in March, 2009 reporting Porsche profits.

Now it appears that risk is starting to catch up to Porsche and they are looking for a bailout via either a merger with VW or loan/investment from a Qatar investment company.

• Click here for the Yahoo! Finance article.

Another risk and reward issue. Porsche received a huge reported reward earlier this year, but now may suffer some risk. We'll have to see how the reporting profits go in the next few quarters.

One response to remove "bonuses" from compensation structure

I think most of us could see this one coming (and it makes sense).

Since the government is going to restrict or eliminate bonuses from companies who have received TARP funds, one company (Citibank) has decided to restructure their compensation so that the bonuses are built in to their base pay. Citibank has received $45 billion from the government so far. It appears the govenment does have a final "veto" of compensation structures before it is implemented.

Here are some of the risks and rewards for Citibank to do this.

• Reward: keep "talented" employees and prevent them from going to other firms where bonuses are not scrutinized (TARP funds already paid off).
• Risk: now if cash flow is tight, the choice won't be whether or not to give the bonuses, but whether or not to keep the employees. If it was a base + bonus structure, the company could opt to cancel bonuses. Now if more is shifted to the base salary, the company will need to play accordingly.

Click here for the full report on Yahoo! Finance

Homes for less than $10,000 on sale in Detroit

Hmmm. Sounds like there's an opportunity and lots of people are taking advantage of this. It reports one person from California has purchased nearly 200 homes.

Click here for the article on CNNMoney.com.

Remember that Real Estate is not a liquid investment. This means, it takes time before you can access or convert it into something that is usable (think sell or borrow against). Compare against a highly liquid asset such as a bank account where you can deposit money into an account and withdraw the same money five (5) minutes later. After you make this purchase, how long will it take for you to "get out" of this investment?

Risk/Reward: Need to weigh the risk of needing liquidity and management issues (dealing with tenants, property management companies, trips to location of property, insurance, tax, liability or legal issues, etc) vs. the reward of potential monthly cash flows from rents and appreciation of the underlying asset.

Banks trying to pay back TARP money. It's all about risk and reward...

...and taking advantage of anomalies in the market. Sort of like arbitrage.

Recent articles report that the banks are now trying to arrange money to pay back TARP fund and the warrants. Here's one of them from Yahoo!/New York Times.

From the government's perspective, they were the lender of last resort during the liquidity crisis. This involves higher risk than usual and they should be (as investors) rewarded. Assuming the economy recovers, their warrants (think of them as long-term options) could be worth a lot more. This would be their reward for taking on the additional risk when no one else was investing in the banks. Being such a large investor in the whole financial system, they could enact changes (legislative, monetary policy, etc) that could benefit the banks and ultimately themselves since they are investors. The government may not mind having the banks pay back their TARP funds (including the warrants) as long as they receive some benefit for their short-term investments.

From the banks perspective, they probably see a promising risk and reward profile to pay off the TARP funds now. They probably are forecasting an increase in stock share prices over the next 10 years and would like to basically invest in themselves (or their own shares via the warratns) and effectively initiate a stock re-purchase program. This would decrease the outstanding common stock and eventually make each share worth more since it represents a larger percentage of ownership.

How Safe are your Assets?

This is from Money Magazine….

A quick and nice table of which accounts are “safe” or insured and which are not. Includes Bank (FDIC insured), Mutual Fund, Broker (Brokerage) accounts, Life Insurance, Annuities, and Long-term-care policies, and Pensions. Scroll to the very bottom of this Money Article