A lot of traders just dive in.
They may enter the trading world via technical analysis or heavy chart related techniques and they just jump in.
They just jump in trying to find trades right away.
When it can pay to be a bit more patient. Like when you are a teenager and you fall in love. Some cute person tells you they love you and you believe them. It can pay to be a bit more patient and establish some sound principles. Some sound fundamental principles of speculation – FIRST.
And then from these rock-solid foundations, one can then proceed towards developing and implementing a trading philosophy.
One kind of foundational principle is the “Why” and “How” of price movement. These have been discussed in prior blog posts, and will be talked about again in the future.
However, in this blog post I would like to go down a different route and talk about the different types of trades/investments you can place.
Conceptually, there are three different types of trades/investments you can have.
The First Type of trade is that of going purely for capital gain. The reason for the trade is to make a capital gain. So if a trader buys USD/JPY at 100.00 and the price rises to 120.00 and the trader sells out at a profit, that is a capital gain. If a trader buys a stock at $40 and the price rises to $80 and the trader sells out at a profit, that is a capital gain.
Usually these types of trades have zero dividend income / cash flow component.
Most traders are going after this kind of gain. Most traders are chasing capital gains.
The Second Type of trade is that of going purely for dividend income / cash flow. The reason the trade/investment is put on and established, is because the traders hopes to receive what they believe is significant dividend income and a steady stream of it. They are not really concerned with the price appreciating in their favor. Their concern is to get that dividend income / cash flow. If the price stays stable and doesn’t go down while they receive their dividend income the trader is very happy.
As an example, several years ago before Crude Oil prices collapsed, I owned a fair amount of a certain deepwater drilling maker. The stock was trading in the $30’s or $40’s. The primary reason I bought the stock was because of the huge dividend yield – which was around 10% per year. So if I held the stock for a whole year I got a 10% return on the money invested. That is obviously a huge dividend yield, much more than average. The average dividend yield can be around 1.00% – 2.00%. The reason the dividend yield was 10% was because the stock involved much more risk than usual. If oil prices collapsed, the stock could drop a lot and very quickly. I knew that but I got into the stock anyway. I used some global macro analysis and did not expect Crude Oil prices to collapse. So I bought the stock and pocketed a few quarters of dividend income. But then the macro situation changed and I felt I had to get out. I got out around break even and good thing I did, as the stock price dropped below $20, below $10, etc.
Some people buy certain pieces of real estate, not because they are expecting the price of the property to rise, but because they are happy with the rental income that they get. They are happy with this cash flow. Which could be 3% a year, or 5% a year, or 7% a year, or more or less depending on what is going on. If they get price appreciation on the property, that is just a bonus for them.
I gave these example because I want to illustrate the thinking behind this type of trade. A trader places this because they desire to get dividend income / cash flow. That is the primary consideration. They don’t care much for any capital gain. They want that dividend income.
Now we can get to the third type of trade:
The Third Type of trade if you can guess, is a combination of the above two. You find a trade that you like and you place it because of a combination of expecting capital gains and dividend income. The reason is some combination of liking the prospect for capital appreciation and the dividend income it provides.
It could be in the form of a certain currency pair that has a high “carry” yield. For example back in 2004 – 2007, there was a “carry trade” going on in the forex market in the AUD/JPY, EUR/JPY, GBP/JPY. Where the price of those currency pairs rose substantially, and there was also significant carry interest in favor of the long positions. So those placing long trades in those currency pairs received both capital gains and dividend income. As interest rates in Japan were near zero, compared to interest rates in Australia, Eurozone and England which were comparatively very high.
Also, in the aftermath of the 2008 financial crisis, there was an opportunity to buy AUD/USD on the cheap. Interest rates were still very high in Australia compared to the United States. So those who bought AUD/USD in the 0.8000’s saw the price rise to above 1.0000. They received BOTH capital gains and dividends.
In the stock market it manifests itself in a stock that pays out a dividend – say of 2% a year, and also has the prospect for significant price appreciation. For example with The Apple Trade, the stock rose +80% over several years, and it paid a dividend as well. So the trade paid out BOTH capital gains and dividends.
Those are the three primary types of trades.
So next time you place a trade, ask yourself, what type of trade am I placing?
Which is the best type of trade you may ask? Well, it’s going for the capital appreciation type of trade. You obviously want the big paydays in the market. And if you can also find one of those rare situations where you get a big capital appreciation, PLUS, dividend income, then that is even better. As you get to “hear the cash register” ring when that dividend income gets deposited into your account, which always feels good. One of these trades just recently happened to me and I created a complete course for you to help you capture such trades in the future.
It’s called The Apple Trade and it has been completely updated for the year 2017.