I recently posted the following market overview on Facebook.
I was a very busy financial market dealer in the nineties, trying to earn enough money to raise a family and save for retirement. I have always wanted to take control of my finances, so later in life I wouldn’t have to be dictated to by government policy and preyed upon by financial advisors telling me I needed to down-size, at the same time selling me unsuitable over-priced products.
I really wanted to be sure that my investment savings were going to be enough to guarantee all the plans I had for my family’s needs in the present, future and later for retirement.
I wanted to stop worrying about my future financial security and live in the present.
I was struggling because I didn’t even know where to start planning my financial future. That meant I wasn’t able to work out if my current investment savings and my forecast future investment income were going to be enough to guarantee all my plans for family expenses and eventual retirement.
To make things worse, I felt terrible because with all my education I had not mapped out my future financial plan. I felt even worse still, because I was well aware it would eventually negatively impact on my family’s future, especially my wife. I wouldn’t be able to give my new family the life I promised them and knew in my heart they deserved. I felt frustrated at my current financial status, especially when I compared myself to other family members and my closest friends.
The problem was that the average returns I was getting from my current retail fund, combined with high financial advisor fees, was terrible. Which meant it was stopping me from achieving my financial goals. This would eventually mean I would have to accept a lower quality outcome of life.
That’s when I made a decision to build a bullet proof investment system which would never again have me dependent on a fund manager, financial advisor, or pension, to secure my financial future!
As I examined the sum total of my accumulated knowledge a picture emerged and it now became crystal clear to me how to extract consistent income from the market anywhere, any time. I already had the knowledge base. I now realised if I documented and implemented my investment plan, I could make money for the rest of my life and never have to consider the bulls—it concept of “downsizing in retirement”.
In the process I also realised that you do not have to have a high level of financial knowledge to implement a successful investment strategy. Simplicity equals profitability; complexity is often a cover for advisors to justify high fees. What you need, regardless of your background, is the knowledge to get started, the ability to plan your investment strategy, and the willingness to execute the strategy.
As I buried myself in this project, I reviewed decades of accumulated work and started formulating a logical investment strategy which anyone could implement.
At first my only intention was to start creating a strategy for my own use, but I soon realised it would also be suitable for any private investor wanting to implement their own investment plan.
So I started documenting the strategy into 12 modules of information. But I didn’t stop there.
At the same time I put my neck on the chopping block and put my own money on the line. As expected I started to make money in my own investment accounts without the input from advisors.
I am a person who is not happy with good results. I want fantastic results.
As I implemented my investment process, I was observing what are now obvious mistakes eroding my performance. I could see that improvements were still needed to optimize the investment opportunities before me. The refinements that I made were not foreseeable when I started. With growing experience, I knew exactly what was needed to maximize my annual returns.
I then decided to do a much improved re-write which produced what is now a much more precise investment strategy, developed from real-time experience and real money on the line.
After decades of accumulating financial market knowledge, attending many high level investment symposiums, and documenting my investment process, I had succeeded. I chose to call it “Momentum Investing”. It is a documented process that has been tested, proven, and simple enough for anyone to use.
I was now able to show anyone how to find stock investment opportunities and build a stock portfolio that outperforms the market.
In time I started to let other investors use my Momentum Investing strategy. As a result of all this we were able to achieve the following:
- I have helped many investors for the first time to take control over their stock portfolios.
- I was able to give clients a structured and logical way to analyse financial markets.
- I was able to show people how to outperform a benchmark.
- I also was able to demonstrate how to minimize risk in times of increased market volatility.
- Lastly I was able to teach clients where to look for high yielding ETF that could dramatically increase their annual yield.
After creating Momentum Investing, I was not only able to personally achieve my dream of managing a successful fund without the interference of fund managers and financial advisors, but also it has allowed me to stop worrying about the trajectory of my financial future. I now have complete confidence that I am 100% certain it will deliver my family the future they deserve.
In the end, all of this means I’m now able to look my wife in the eye in the knowledge that as a family we will have a happy and financially secure future and accomplish the things in life that we have always wanted.
One of the least recognised failings of retail investors is their lack of self awareness or understanding of cognitive biases. A cognitive bias refers to a tendency to think and interpret people and/or situations without rationality or good judgement, systematically generating your own “subjective social reality” based on your perception, rather than logic or facts.
The ugly truth is that the errors made through poor choice and badly timed investments can heavily outweigh the perceived benefits of managing one’s own account.
Private investors are seduced by the idea of easy money investing in equity markets, but the reality can be a whole lot different. Investors find their stress levels rising when they have to make buy and sell decisions on their own, in real time, and become overwhelmed with conflicting information. It’s just not easy!
Four cognitive biases
There are four main cognitive biases that can have a dramatic impact on the performance of a stock portfolio; they are anchoring, saliency, herding, and confirmation bias. Investors need to be aware of these four cognitive biases, in order to be able to avoid the damaging effects on the performance of their portfolio.
An example of anchoring could be when a stock starts to lag the market. Investors still hold onto the investment because of its previous performance, waiting for the stock to get back to break-even. Investors may hang on to companies for years, when they should have been selling the laggard stock and redirecting their investment energies to other areas of the market, reinvesting recovered capital.
Anchoring can be also seen when investors listen to financial market media and act on the belief that there is some predictive quality to the information. The most potentially damaging to retail investors in recent times were the Brexit vote and negative media predictions about market outcomes of a Trump presidency. Retail investors who anchored and reacted to these types of stories by staying in cash, missed some of the best growth opportunities of 2016.
Saliency in finance is the tendency for an investor not to take action or ignore the potential for an event, merely due to the fact that this type of event has not occurred recently. If an event has not happened recently, there is a perception held that the likelihood of that event occurring is very small; e.g. sub- prime mortgage and events leading up to the GFC. On the other hand, if an event has occurred recently the reaction of an investor is often over-stated, e.g. staying cash for protracted periods of time after a correction in the market.
Herding behaviour is driven by a concept of social proofing. Social proofing is when people copy each other’s behaviour in an effort to fit in and reflect the correct group behaviour for a given set of circumstances. The so called correct behaviours could be defined by trend setters or guru figures, or people who are perceived to be “in the know”. Herding behaviour can be based on little or inaccurate information. Herding is when you feel the desire to sell a stock just because it is being given a lot of media attention or it could be just a negative opinion expressed by a friend. Investors work with the assumption that others have more information than they do, which influences herding behaviour. As the stock sells off, there is a strong emotional drive to do exactly what others are doing. To just sell because others are selling is not a rational basis for a decision. Investors are better off actively blocking out the “noise”, selecting stocks to buy carefully, and in time selling that stock for the right reasons.
Confirmation Basis is when investors go and look for only that information which supports their preconceived ideas surrounding a stock. Often they will accept all the positive information and ignore all the negative information. If for example they had a concentrated portfolio in financial stocks, often investors overemphasize positive information about the sector and ignore or at least discount negative information about the future expectation of stock performance.
Professional money managers are aware of cognitive biases. Retail investors are generally not. Making money is as much about the quality of decisions driven by cognitive biases as it is about building valuation models.
Take control- Keep on investing and know thyself!
What do futures contracts have to do with anything related to trading Volatility Exchange Traded Notes? The answer is everything. To trade Volatility ETN’s it is useful to have an understanding of where the yield is derived from. This article starts with definitions that will help you understand the concepts of term structure, roll yield and eventually Volatility Exchange Traded Notes.
First a few definitions:
What is a futures contract?
A futures contract is an agreement between two parties to buy or sell a financial instrument at a set price at a specified time in the future. The contracts are standardised and exchange traded. In the following discussion the financial instrument will be the VIX volatility index and the futures contracts are VX futures, which are highly correlated with movements in the VIX index. This article is not about futures but to ensure you know how the yield is generated by Volatility Exchange Traded Notes. It is a necessary discussion.
What is the term structure of futures?
VX futures contracts trade and expire at the end of pre-determined months. Each month has a specific code designation. Each expiration month has a different price reflecting differing future price expectations of the underlying financial instrument (VIX). The term structure of futures contracts is the curve that maybe observed when plotting the prices of futures contracts in differing expiry months.
What is the VIX?
The VIX is an index which plots the markets 30 day forward expectation of volatility.
What is the spot price?
The spot price is the current market price of a financial instrument (e.g. the VIX index). This is different from the VX futures contracts where the futures can be bought or sold for cash settlement in the future.
What is an Exchange Traded Note – ETN
An Exchange Traded Note (ETN) is an unsecured security issued by a bank (e.g. Barclays Bank) based on the performance of a financial instrument minus applicable fees with no period coupon payments. ETN’s are traded on major exchanges such as NYSE. Volatility ETN’s are highly correlated to the VIX index.
What is roll yield?
Roll yield is realised at the point of rolling a futures contract forward while the underlying financial instrument or index does not move. Roll yield can be positive or negative and is the profit or loss realised due to backwardation or contango.
How does roll yield work?
At the expiration of a futures contract the near-dated contract is sold and the far-dated contract is bought. This process of closing one contract and opening another is what is known as rolling forward a futures position and is where the word “roll” comes from in the term roll yield. In futures trading it is theoretically possible to realise a profit or loss at the expiration of the contract, even if the underlying financial instrument did not move. The result is negative or positive roll yield.
VX futures trade at prices which are either higher or lower than the spot price (VIX) in contracts that still have time to expiration. As the futures contract gets closer to expiration all contracts converge to the spot price at maturity. Convergence can occur in two ways.
Convergence can be downwards toward a lower spot price resulting in a negative roll yield called contango. Alternately convergence can be upward toward a higher spot price resulting in a positive roll yield called backwardation.
More about positive roll yield
If you trade a long futures contract and the contract price is lower than the spot price you will receive positive roll yield as the futures contract converges upward to meet the spot price (see Backwardation diagram). As a futures trader with a long position you will make money even if the spot price stays still, moves up or even falls slightly as the futures contract converges at expiry, especially as you get closer and closer to expiration. Professional futures traders look for this type of opportunity in backwardated markets with positive roll yield.
More about negative roll yield
If you trade a long future contract and the contract price is higher than the spot price you will receive negative roll yield (see Contango diagram). As a futures trader with a long position you can only make money at expiration if the spot price is greater than the futures price. If the spot price (VIX) remains still or rises only a little bit, the futures trader will make a loss as the futures contract converges downward toward the spot price close to expiration.
So what does all this have to do with trading Volatility ETNs?
You now have a working knowledge of futures contracts, term structure and roll yield, but what has this got to do with anything related to trading Volatility ETNs? The answer is everything. Portfolio managers buy VX futures contracts to hedge risk. When the equity markets fall the VIX rises. VX futures are a primary financial instrument used to hedge portfolios.
Portfolio managers are constantly buying VX futures to hedge risk in a normal term structure. They are experiencing a loss each time they roll forward a contract. This loss is expectable as it is seen as the cost of insurance. Trading volatility ETNs means that in effect we are taking the opposite side of their trade. Their loss is our gain. This discussion was necessary if you are to understand how yield is generated investing in Volatility ETN’s.
In the next blog I will demonstrate exactly how to benefit from the hedging activity of portfolio managers by investing in volatility ETN’s. I will give you exact details how to make money in today’s market and extract yield using ETN’s. The potential to extract extraordinary profits is there for the taking. You only have to understand and apply the concepts.
If you can’t wait for the next blog and want a complete explanation how to trade Volatility ETN’s please attend our live presentation on Wednesday the 1st of March 2017 8:00 PM AEDT (Australia).
Any questions contact firstname.lastname@example.org