The Stock Market Cash Flow Page 14
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Chapter Summary
Let’s review some of the important points of Chapter Five:
1.Technical analysis helps us get information on the strength of the market.
Prices move based on supply and demand. Stock charts are simply historical records to show investors a picture of the various prices at which a stock was traded during a particular time period. Stock charts can be used to give investors information on anything that has a price: real estate, currencies, stocks, commodities (such as gold and oil), etc.
2.Market makers stand ready to buy and sell shares of a given security.
The fact that market makers stand ready to buy and sell shares provides a degree of liquidity in the markets. Market makers do not care whether they move prices up or down. They simply match buyers with sellers based on supply and demand.
3.Stock charts tell the story of supply and demand, which may or may not correlate with fundamental analysis.
Because supply and demand involves speculation and emotion, investors may buy stocks that do not yet have a proven track record. When buying, they hope that the stock will be more valuable in the future. However, they may also sell off shares of a fundamentally sound company because of their nervousness over a possible selling panic.
4.The financial statement tells the story of the company through fundamental analysis, and the stock chart tells the story to investors through technical analysis.
Investors can use fundamental analysis and technical analysis to make more informed decisions related to how they want to position themselves.
5.An uptrend is created when a chart shows higher swing highs and higher swing lows.
Professional investors use trend to determining what position to take with a stock.
6.A downtrend is created when a chart shows lower swing highs and lower swing lows.
If a stock is in a downtrend, investors will generally take a short position, which means they will profit if the stock price falls. If the price changes direction, investors will execute an exit strategy.
7.A sideways trend is created when a chart shows swing highs and swing lows within a range.
8.Investors want to be in harmony with the trend.
The old adage is that “the trend is your friend.” Many professional investors analyze the broad market trend first and then find individual stocks that are in harmony with the broad market trend.
9.Charts are not a crystal ball. They indicate what is most likely to happen.
Professional technical analysts are like weather forecasters. They’re less prone to speak in absolutes and more prone to speak about likelihoods.
Chapter Six
Pillar 3: Cash Flow
The chapters leading up to this one were designed to help you gain the knowledge and understanding of the tools you’ll need to make smart investing decisions by finding and understanding valuable information about a company and the trends. As you’ve learned: Fundamental analysis gives you valuable information about an entity and technical analysis gives you important insights into the minds and hearts of investors to help you keep your finger on the pulse of supply and demand—and determine what is most likely to happen and when.
With those tools in your toolbox, you are now ready to get into the business of how you can position yourself to increase net worth or cash flow from the stock market.
Turning Information into Profit by Positioning
As you take this next step it can be helpful to think of using the first two pillars of fundamental analysis and technical analysis as the information gathering phase, and the last two pillars of cash flow and risk management as the positioning phase.
The first two pillars of fundamentals and technicals help you to determine your outlook. The last two pillars of cash flow and risk management help you harvest this information and profit by positioning yourself to benefit from what is most likely to occur with certain assets.
This concept of harvesting information to your benefit is profound because it frees you from having to hope that markets always perform well and having to pray that the economy will be kind to you. The ability to use information, whether it’s positive or negative, to one’s benefit can mean freedom from the political policies that are beyond your control, dependency on your company for a job, or dependency in a 401(k) program that by and large requires a long-term growth in the market.
It’s also worth mentioning that in the information-gathering phase you have no control. You’re just an observer. The fundamental and technical details you discover are simply what they are. In the positioning phase, on the other hand, you have total control of how you position your investments to take full advantage of whatever market situation you see. Therefore, you have the responsibility to position yourself as intelligently as possible.
You’ve probably heard this saying before: “When life gives you lemons, make lemonade.” Perhaps the stock-market version of this would be, “When life gives you a bear market, make more money.” That is part of the magic of turning any information—good or bad—into profit.
As we move into the second half of this book, we will be covering some of my favorite topics.
•Examples of positioning to make money in any type of market: up, down, or sideways.
•How to more intelligently set investing goals and determine how capital gains and cash flow fit into your plans.
•How the stock and options market can work together for cash flow and risk management.
•One of Warren Buffett’s favorite strategies…and one you, too, can learn and master.
Because I want to give you some examples from the real world, I will illustrate a few of them with some of my own trades. I think it’s beneficial to see how these trades work in real-life scenarios, not just theory. But it’s important that I do this with a word of warning:
WARNING: When I show you my trades, I am NOT recommending that you should trade the way I do. Also, I am not recommending that you trade the same stocks that I do. Remember, my trades are shared only for the purpose of illustrating real-world examples and to assist in your understanding of specific concepts.
There’s a big difference between education and advice. And this book operates strictly in the realm of education.
Your goal should be to move along the Education Continuum™. Remember that too many people fall victim to the desire to make a quick buck from a stock tip. Unfortunately, their focus is on making a single transaction that could potentially be a winner. It’s unlikely that these people will ever be truly independent. They will always be dependent on others—on people who can give them tips. As your understanding grows, you will begin to know how to make your own trades and take control of your own life.
Investing is for those who take the time to educate themselves, not those who want to gamble their money away. Investing in securities has obvious risks. If I lose money, it’s my own fault. Please remember that same lesson for yourself.
Before you take a position in the market, remember that not all income is created equal.
When most people set their investing goals, they think very little about the fact that different positions would bring about different results. All money is not created equal. For example, in the United States, the government will look at money earned from working at a job much differently than the same amount of money earned from investing. Money earned from a job or as a small business owner is labeled earned income. Money earned in a long-term stock portfolio by buying a stock low and selling high will be labeled as a capital gain. In the United States, as of this writing, earned income can be taxed up to 39 percent. But capital gains can only be taxed up to 15-20 percent. Thus, all money is not equal.
Almost every country taxes the money you earn based upon one or more of three categories: earned
income, portfolio income, and passive income. As you set your financial goals, it’s essential that you use good tax planning and strategize to earn your income in such a way that you receive maximum tax benefit. To learn more about this, I highly recommend Rich Dad Advisor Tom Wheelwright’s book Tax-Free Wealth. I’ve heard Tom say that with the right tax planning and the right positioning, people can make almost any income they earn passive income, with the exception of money that is earned at a job.
For the purposes of this book, however, I want to separate the positions we can take in the stock and options market into three different but very important categories: capital gains, cash flow, and hedges.
If you have been a Rich Dad student, you are probably familiar with Robert and Kim Kiyosaki’s educational board game, CASHFLOW® 101. One of the primary lessons taught in this game is the ability to tell the difference between an opportunity that will produce capital-gain income and an opportunity that will produce cash-flow income.
Positioning with Assets
When I teach classes all over the world, people are always asking me for advice: “Andy, should I buy gold?”
My response to questions like this is usually pretty irritating to those people who simply want to be told what to do: “Well, I can’t give you financial advice, because I’m just your teacher. But I’m curious…what do you want your gold to do?”
“I just want to make money,” they reply.
These folks don’t understand that what I’m really asking them is whether they want to buy gold for capital gain, cash flow, or as a hedge against a falling currency.
A more sophisticated investor would understand that I’m not trying to irritate them. It’s just that depending upon the fundamentals and technicals of the day, gold might be a wonderful hedge against inflation but a very poor cash flow vehicle. So if the person wants to buy gold to become financially independent, then the answer is probably no, because gold is unlikely to provide a monthly passive income that exceeds expenses. Gold is like the proverbial golden egg. It might go up and down in value, but it’s not going to produce new golden eggs.
However, if the person has a large cash position and is worried about losing the value of that cash to inflation, then the answer might be yes… it might make sense for a certain amount of their wealth to be placed in precious metals.
Obviously, most of the people I come in contact with are at the beginning of their investing education. Learning personal fundamental analysis and using a personal financial statement to set goals is a great place to start.
Taking Control
Remember that risk is related to control. One of the frustrating things about buying a stock is that you have no control over how it moves. In our discussion of fundamentals and technicals we saw this very clearly. If you refuse to adjust your position, then once you buy that stock you are at the mercy of how the market moves it.
Long-term investors like those who have 401(k) accounts cannot control whether their account value goes up or down. They just hope it’s bullish, because hope is all they have to hold onto. They are at the mercy of the fundamentals and technicals and lack the skills to improve their position. When life gives these folks a lemon they don’t know how to make lemonade.
On the other hand, when you use information from fundamentals and technicals, you are gathering the details you need to gain some control through positioning. Even though we can never control how a market’s price will move, we can choose how to position ourselves to manage risk to whatever level we’re comfortable with. And you can adjust these positions whenever you want. If you develop a willingness to adjust your position as the information changes, it will bring you a wealth of new opportunities. It doesn’t matter if the economy is bad or if jobs are scarce. It doesn’t matter if the market is moving up, down, or just sputtering sideways. You will always have opportunities to generate reliable income in any market conditions.
Let’s look at just the cash flow section of the table:
Depending on the fundamentals and technicals, you will have some decisions to make. Will you take a long position, a short position or a neutral position? Will you position yourself for a nice capital gain to grow your net worth, or do you want a position that will deliver monthly cash flow? Do you want to be in a position of leverage? If you do, then will you use debt or a contract?
Long and Short Positions
As a general rule, if the fundamentals and technicals suggest that something is going up in value, you want to own it. When investing, owning something—anything—means you are in a long position.
This holds true with anything you buy and take ownership of:
•If you buy some gold you are long gold.
•If you buy some stock you are long the stock.
•If you have U.S. currency in a savings account you are long the dollar.
As the information from fundamentals and technicals change, you may wish to change your position as well. So you would enter a long position by buying a stock, and then exit that long position by selling the stock:
•You enter a long position by buying the gold, and then exit your long position by selling the gold.
•You enter a long position by buying the stock, and then exit your long position by selling the stock.
•You enter your long position on the U.S. dollar by receiving dollars by exchanging something for the dollars like goods or services, and you exit your long position on the dollar when you spend the dollars on something else.
Everybody knows what it’s like to be in a long position. If you have money in the bank you are in a long position on cash. If you have an automobile you have a long position on that automobile.
Taking a short position is less understood and even misunderstood by the average person. When my first stock mentor explained to me how to take a short position and what it meant, I have to admit that I didn’t fully understand it right away. It’s counterintuitive.
Let’s begin by looking at three important facts of taking a short position:
1.You are going to position yourself to make money on something that is falling in value.
2.You are going to sell something that doesn’t belong to you.
3.You are going to change the order of buying and then selling—to doing the exact opposite. In other words, you are going to sell something first and then buy it later. (I don’t know about you, but this made my brain freeze up when I was first introduced to this concept. But there was a large part of me that wanted to understand this. I was interested to see how investors could take such a position and profit from it!)
As stated previously, if we think something is going up in value then we can enter a long position by purchasing the item and then exit that long position by selling the item. So it does make a little bit of sense that if we believe the item going down in value that we should enter a short position by selling the item and then exit the short position by buying the item back.
But how does someone sell something they don’t own? The answer is simple: First borrow from one individual and then sell it to another individual to enter your short position. After the item has fallen in value then you can exit your short position by buying the item back at the new (and hopefully lower) price and return it to its owner.
I want to repeat that, as a teacher, I have the opportunity to teach this concept to thousands and thousands of people. I’d say less than one in a hundred fully understand what entering a short position is all about prior to their first lesson.
To further help you understand, I want to give you a few small examples of short positions. If you have a little trouble getting your head around this, simply review the examples again. Or you can spend some time going through a little more free training I’ve created for you at www.stockmarketcashflow.com where you can watch a free video presentation that breaks down short positions in a way that supplements the detail in this or any book.
Bonus Training!
For many people, watching a video
explanation of shorting helps them better understand this concept.
To watch, go to www.stockmarketcashflow.com
Most U.S. Real Estate Investors Have a Short Position on the U.S. Dollar
Even a basic look at fiscal policy, monetary policy, sovereign fundamentals, and technical analysis on a large scale suggest that the value of the U.S. dollar is likely to decline over the long term. In fact, take a look at the last 30 years and it’s pretty likely you’ll find yourself wishing you had taken a short position on the US dollar. So how can we position ourselves most effectively if this indeed happens?
If you decide to save money, remember that you are in a long position on the U.S. dollar. You’ll acquire your U.S. dollar in exchange for some goods or some services when the dollar’s value is high. If you go shopping today with your dollars, you could buy a lot of great things (and 30 years ago you could have bought even more for the same amount of cash). But if you maintain your long position in the dollar (saving money under the mattress) and the dollar loses value in the future, suddenly you won’t be able to buy as many nice things with the same amount of money. That’s what happens when the dollar loses its value over time.
Let’s suppose you decide to take a short position in the U.S. dollar. Remember, to take a short position we would borrow the money and then exchange it for something that is valuable, such as real estate. One of the advantages of borrowing money in the United States is that often the loan can be acquired at a fixed rate, which means you’ll have the same monthly payment that will never change. As the dollar loses value it takes more dollars to buy valuable things. Food prices will go up because it will take more dollars to buy the valuable food. Clothing prices will go up because it takes many more weak dollars to purchase valuable clothing. The same is true with shelter. If the dollar loses value, then whoever is renting your home needs to give you more of their dollars to compensate you for allowing them to stay in your home. With each year that passes, your monthly loan payment to the bank won’t change as you return the borrowed dollars to the bank. However, those dollars are now worth much less than when you initially borrowed them.