Newsletter
May 12, 2007
Risk Tolerance: Knowing Your Limitations
Market & Sector Review
The Oberweis Octagon
Largest Changes In Raw Numbers (21 Days)
This Week's Economic Reports
Risk Tolerance: Knowing Your Limitations
Many novice traders and some more experienced traders have trouble when it comes to accepting risk, even a small risk. They either avoid executing the trade or if they do execute the trade, they find it excruciating to monitor the trade. Good traders know how to tolerate risk. Outcomes from trading are far from definite, but a good trader doesn't mind, he or she understands its just part of the game. Depending on your background and personality, you may have trouble tolerating risk. But don't let it dash your hopes of making profits. You can develop a way to work around a low tolerance for risk.
Taking a risk, to many, translates to fear and makes it hard to concentrate. This fear puts you on edge and tempts you to close out a trade prematurely sole due to the uneasiness created. Risk tolerance has two parts: part one is biological and part two is learned. Some of us are easily agitated, become anxious, and find it difficult to calm down.
If you are easily agitated, try to take precautions to reduce your propensity for over-stimulation. The mind and body go together and there are many ways to reduce your overall level of agitation. Exercise, avoid caffeine, meditate, eat nutritiously and get plenty of rest, and you will stay more relaxed. As for the biological part, that is hard to fight. If you've always been the kind of person who gets anxious easily, you'll have to find a way to work around this aspect of your personality. You may need to adapt your trading style to fit your physiology. There's no one right way to do this. It depends on your preferences. But one issue to consider is the length of time you stay exposed to risk. The longer a trade, the more risk involved. Scalpers, for example, take minimum risk. They get in and get out of the market as fast as possible. Some anxiety-prone people may find this kind of fast-paced trading especially stressful, but others may find it appealing. You don't have to wait very long to see how a trade turns out.
At the other extreme, long term investing can be another option. Some companies have relatively consistent long-term trends. By doing some simple homework, you can identify a few solid companies and use a buy-and-hold strategy. Consider diversified portfolio's such as mutual funds or diversify amongst Exchange Traded Funds in sectors and industry groups that suit your style and thinking. You'll also find it helpful to pre-determine the risk you wish to take by setting a stop, mental or otherwise to help you tolerate risk. You must account for volatility over the course of the trade, it's impossible to completely eliminate all risk. You must find a happy medium between getting stopped out too early and allowing your investment to fall in value to an uncomfortable level.
One of the main reasons people have difficulty taking a risk is that they are afraid of the consequences of a potential loss. They wonder what they would tell their spouse or their parents should they lose. They wonder what they would need to do to make back the lost money. Never trade with money you cannot afford to lose or will not feel comfortable losing. If you can truly believe that losing the money is no big deal, you'll be able to tolerate the risk, even if you have extremely low risk tolerance.
Extremely low risk tolerance can severely hamper trading, but if you take the proper precautions, you can still trade profitably. Find a trading style that suits your personality and only risking money you can afford to lose, you'll feel calm enough to trade freely and profitably.
Market & Sector Review
The Oberweis Octagon
A screening method based upon that utilized by Oberweis Asset Management, Inc. is also used in our on-site watch list. When the new formats are finally ready this will be listed under Growth and Value.
The objective of the Oberweis funds and this screen is to identify companies that have above average long-term growth potential based upon the eight factors known as the "Oberweis Octagon." Since much has been written over the years about the Oberweis approach I've decided to take the information for this newsletter directly from the Oberwieis Funds web site to avoid any confusion and/or misrepresentation of facts.
Rapid Revenue Growth
Extraordinarily rapid growth in revenue. OAM prefers this to be generated from internal growth as opposed to acquisitions of other businesses. At least 30% growth in revenues in the latest quarter for companies in the Micro-Cap and Emerging Growth Funds and at least 20% growth in revenues in the latest quarter for companies in the Mid-Cap Fund.
Rapid Earnings Growth
Extraordinarily rapid growth in pre-tax income. At least 30% growth in pre-tax income in the latest quarter for companies in the Micro-Cap and Emerging Growth Funds and at least 20% growth in pre-tax income in the latest quarter for companies in the Mid-Cap Fund. There should also be rapid growth in earnings per share.
Low Relative Price/Earnings Ratios
There should be a reasonable price/earnings ratio in relation to the company's underlying growth rate. In order to be considered for investment, companies in the Micro-Cap and Emerging Growth Funds must generally have a price/earnings ratio not more than one-half of the company's growth rate, and companies in the Mid-Cap Fund must generally have a price/earnings ratio of not more than the company's growth rate.
Future Growth Potential
Products or services that offer the opportunity for substantial future growth. Such growth generally either stems from products in newer, high growth markets or products with the potential to grow market share within an existing market. In the latter case, such products typically grow market share due to competitive advantages over other market offerings. Examples of such advantages include new technologies, patents and niche market positions with high barriers to competitive entry.
Earnings Acceleration
Favorable recent trends in revenue and earnings growth, ideally showing acceleration.
Low Relative Price/Sales Ratios
Reasonable price-to-sales ratio based on the company's underlying growth prospects and profit margins.
Quality of Earnings
A review of the company's financial statements, with particular attention to footnotes, in order to identify unusual items which may indicate future problems.
Top Quartile Relative Strength
High relative strength in the market, in that the company's stock has outperformed at least 75% of other stocks in the market over the preceding twelve months.
OAM considers these eight factors as guidelines for evaluating the many companies it reviews to identify those companies that have the potential for above-average long-term growth. Such factors and the relative weight given to each will vary with economic and market conditions and the type of company being evaluated. No one factor will justify, and any one factor could rule out, an investment in a particular company.
Although securities of a particular company may be eligible for purchase by more than one Fund, OAM may determine at any particular time to purchase a security for one Fund but not another.
Largest Changes In Raw Numbers (21 Days)
[ Reserved for supporting members, now posted in members area ]
This Week's Economic Reports
Have A Great Week!
Bill
Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.
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