Over the years I ve been quite good at buying stocks at or near bottoms by using my favourite market indicators the MACD (Moving Average Convergence/Divergence), the Relative Strength Indicator (RSI) and the full stochastic. They come from different sources of information so when they start to move in the same direction I usually pay attention.
Using indicators can help identify when stocks go on sale, which happens about three times a year, but they re also useful when deciding when to sell to generate cash. Selling right is just as important as buying right, especially if our stocks start to lose money. It s one thing to give profits back to the market, it s another to lose net worth and it s even worse if we made that net worth somewhere else. Selling when the shares are doing so well is not as easy to do as it sounds because we have to be contrarian and not go with the crowd but it is possible.
It s one thing for you as a farmer to lose money farming whether it is your money or the bank s. That wouldn t surprise mostGrainews readers, but if you take profits from your farm and buy stocks and lose money that is as close to a financial catastrophe as it can get. Many cow-calf producers didn t make much money from 2003 to this year. A grain farmer told me that four years out of the last 32 years of farming made 80 per cent of his money. Many things besides stocks can lose a person money. Some decisions are irreversible and once the money is in the ground it is impossible to retrieve it. With stocks, our decisions are reversible so if we are making money we can sell out and keep the cash. If we are losing money we can sell the shares and stop the bleeding. Both might be hard to do but, again, possible.
I m sure some readers say that their stocks are so good that if they do drop in price they will come back up in price so why worry? If that is how you feel then maybe flip the page. Just keep in mind that shares of Bank of Nova Scotia were $54 in October, 2007, and are still below that price. They did drop to $24 and they did go up to $62 but as of early October, the price per share is still a couple bucks below that October, 2007, of $54.
MORE ON MARKET INDICATORS
The signs were there to sell those shares in October and November, 2007. The signs were there to buy those shares at $28 or so on the way up. The signs were there to sell them again at $60 or so earlier this year, but you have to be following the indicators to know that.
A few indicators have been quite good at showing us that stocks could soon go down or up. One indicator is the $SPX:$USB, which is a ratio of the S&P 500 and 30-year U.S. bonds. If you put that indicator on a chart on www.stock-charts.com you will see what I mean. In late July that indicator rolled over and started to drop. In early October the chart is forming lower and lower highs and lower and lower lows. That sort of market can cost us big bucks.
Our readers of StocksTalk are great at sharing information. One reader compared the $SPX:$USB ratio to the exchange traded fund (ETF) of 20-year U.S. bonds. The symbol is TLT. If you put TLT on a chart and compare it to $SPX:$USB you will see that in late July, the TLT started to rise while the $SPX:$USB ratio started to drop. Lately as the U.S. bonds went up many stocks went down. Our gold and silver stocks stayed up for another two weeks and then dropped like a rock out of your stone picker.
I had protected our money with SLW, one of our favourite stocks, by selling calls at strike price $36. We collected $5 so we had downside protection. If we had wanted to buy extreme protection, we could have sold calls on SLW strike $32 when the shares were $40 and collected $8.75 per share. I m not sure you can picture this, but if a stock drops from $40 to $31 all we lose is $1 or so. The folks who did not sell calls lost $9 per share.
Indicators showed stocks were about to drop. All we had to do was believe them and work to preserve our capital. One way is to go to cash when we see trouble ahead. Another way is to sell calls below the price of the day. A third way is to borrow shares and sell short or buy puts.
I ve been looking for a stock that pays a decent dividend, could raise the dividend and would let me sell calls and puts on it. I thought I found it when I bought shares in Just Energy (JE). The company pays a dividend of $1.24 per share per year, and pays the dividend every month and I can sell calls and puts on it.
Turns out the stock is susceptible to the ups and downs in the market. I will make money on the calls and the dividend but I sold the shares as they started to drop. It looks like JE will not be the stock I was looking for.
By the way, since September has ended it might be a good time to say that according to research done by Brooke Thackray September has not been a positive month for stocks from 1950 to 2008. Interestingly enough September was decent in 2009 and 2010 but I think that was one of those aberrations we see from time to time. So if we want to protect our portfolios we might want to learn how to sell covered calls well below the price in July, or buy puts or go to cash. If we are looking for bargains, odds are they will come in September and maybe October; all we have to do is have money and wait.
As of early October I see Microsoft (MSFT) pays a dividend of 80 cents a year, has a good premium on the calls and I could sell puts on the stock. The company has billions of cash, but a lot of that cash is overseas and would be taxed if MSFT brought it home. The company is borrowing long-term money at very low rates of interest and actually increased its dividend by four cents per quarter just lately from 16 cents per share to 20 cents per share. That s up 25 per cent. Many believe that MSFT is part of the group of stocks called dominators which means they are the big leader in their industry. Many dominators raise dividends year after year.
Here is how MSFT stacked up as of early October: Buy 1,000 shares for US$25,000. The dividend is 80 cents a year or 3.2 per cent, which is more than most banks and bonds pay. That s $800 a year or $200 per quarter. I could sell a call for strike price $25 for November and collect $1.27 per share or about $1,200. There would be little capital gain and the shares might get sold. The potential is we could sell calls like this six times a year which would or could bring in $1.27 x 6 = $7.62 + 80-cent dividend for a total of $8.42 which is 33 per cent per year.
More likely I would sell a call at a price above my costs. Again, early in October I could sell a call at strike price $26 and collect 80 cents per share for November and again doing that six times a year would bring in $4.80 + 80-cent dividend is $5.60 per year or 22.4 per cent per year and a chance of $1 or more of capital gain.
As always, if we sell calls the shares could get bought from time to time but then they seem to go on sale several times and odds are we could buy the shares again for less than the price the shares sold for. If they did get sold we might lose the dividend, but as you can see the premium from selling calls can make us more money than the dividend.
Let s look at MSFT for $200,000. At today s price that would buy us 7,500 shares. At 80 cents per share the dividend is $6,000 a year. Add in 60 cents of premium six times a year from selling calls and we have another $3.60 x 7,500 shares for a total of $33,000 a year and all taxed at preferential rates.
I really doubt a quarter section of farmland in most parts of Canada will bring in that money of mostly net income that would be taxed at a preferential rate. Do check my numbers, even if they will be different by the time you read this. Of course there is risk with stocks but don t tell me there isn t risk with cropping.
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