Tuesday, June 30, 2009

How to spot an investment scam.

In a single day, investment fraud can take away everything you've spent your life building. Couple that with the knowledge that scam artists are most active when times are very good, and when times a tough. You don't need me to tell you that times are tough these days, and scam artists are streaming out of the woodwork with new angles every day. Here's the knowledge you need to protect yourself.

6 traits of an investment scam:

1. They're Unsolicited.

Honest investment houses, and the brokers that work for them don't call out of the blue to sell you the next big thing.

2. It looks too good to be true.

If they salesman promises extraordinary rates of return, run! If someone is selling an investment that's up 20%, while its peers are down 30%, something is wrong. For example, a guy calls you up and tells you about a great bank stock that was up in the fall of 2008 (while every bank stock is imploding), it's a scam.

Bernie Madoff's hedge fund/ponzi scheme is another terrific example. By some accounts, that fund was up 15% year after year. The stock market as a whole averages 10% for a much longer time (and was actually down over much of Madoff's stellar returns).

3. The investment is a "penny stock", or microcap..

Both microcap and penny stocks have relatively low numbers of outstanding shares, and are easily manipulated. The classic penny stock scam is by far the "Pump and Dump." In a pump and dump, the scam artist buys hundreds of shares of a penny stock, for example: ACME Widgets Inc, then calls or emails hundreds of people (unsolicited) telling them that ACME Widgets Inc is going to make it big real soon, and they ought to get in on the ground floor before it's too late.

This becomes a self fulfilling prophecy as more and more people buy the stock and drive the price up. Once the price hits what the scam artist feels is the high point, he dumps the stock leaving everyone else holding the bag.

4. The person contacting you is overly pessimistic.

This is the opposite of the "pump and dump". Where the scam artist in the pump and dump is overly optimistic and tries to talk you into buying, this one is trying to get you to sell. This scam is commonly called a "short and abort" because it preys on investors fears to drive the price down so the scam artist can "short" the stock for a profit. This type of scam also tends to focus on penny stocks, though not always.

5. There really isn't an investment.

As silly as it sounds, scam artists do make a living tricking people into investing in stocks or real estate that simply does not exist. Do your research and verify that any potential investment actually exists - take nothing for granted.

6. The broker is not a broker.

A companion scam to the non-existent investment is the illegitimate broker. I think this one works because of all the others listed above. Most people pride themselves on being savvy investors, and know to look out for penny stock scams and the like. But this scam is all about the artist and his charisma. He's selling a real investment, but what people are buying is the salesman. By the time they realize they don't actually own the investment, the scam artist is long gone.

What you can do.

Always check a potential broker out at www.NASDR.com or www.SEC.gov. If they're legit, they'll have a record of it.

If you suspect a scam, check out www.fraud.org or www.fraudbureau.com. If you know you were scammed, you can file a fraud claim.

Get to know the sec and learn how investments work.

Finally, take a tip from Warren Buffet - only invest in what you understand.

Thursday, June 25, 2009

How to rate a stock.

I don't care how many stocks you have in your portfolio, you need to have a plan. You need to take the emotional reaction out of the decision making process of buying and selling stocks. One of the best ways to do this is to rank, or rate each stock you hold on a scale of 1 to 4.

Here's the scale that Jim Cramer,of Mad Money fame, recommends:

1. Buy more now.

2. Buy more if the price dips x%.

3. Sell if price goes up x %

4. Sell NOW.

Do this every week, to avoid being surprised by any sudden events. By doing so, you not only become aware of the general condition of each holding but you put a plan of action in place to avoid having to make a spur of the moment decision when emotions run high.

It's also a lot harder to forget what you're holding and made a mistake by neglecting a poorly performing stock and having that drag your overall portfolio down.

To really supercharge this tip, use it with stops and limit orders, that way you can put your portfolio on auto piliot each week!

Monday, June 22, 2009

How to buy low and sell high - for real!

The number one reason people don't buy low and sell high is emotion.

Emotions cloud our thinking, and make us do things we wouldn't think of doing otherwise. Think of the fall of 2008 into spring 2009 when the market was shedding hundred of points on a daily basis. I know many people who got out of the market altogether because they panicked.

That's why the best thing you can do as an investor is to remove yourself from the moment. Create an action plan for your investments ahead of time and that way you simply become the executor of the plan when conditions demand that action.

The obvious trick to buying low and selling high is knowing which is which. Too many people try to time the market and guess incorrectly - they let their emotions get the better of them.

So, how do you take the emotion out of it, and ensure you don't try market timing?

Know your orders.

The basic tools that allow you to buy and sell stocks without being present in the moment or even at the moment of execution are the Stop Order and Limit Order.

Market orders are real time trades, that are executed at the time they are received, but Stop Orders and Limit Orders are executed only when market conditions reach a trigger threshold.

Stop Order.

A stop order is a market order that is executed once the share price has dropped below a specified threshold set by the seller.

Here's an example:

You have 100 shares of stock in ACME Widgets Inc. and have decided that good times at ACME are about to end. You've decided to sell all shares, but don't want to miss out on any further gains the stock  may make before it starts to drop. It's trading at $57 per share, and you decide that you'd be happy if you sold your shares at $55 per share. Using a market order, you'd have to sit around and watch the stock price all day and hope to sell at the right time.

Alternatively, you could use a stop order and set the execution price at $55, then go fishing (or whatever else you feel like!). If the stock price drops below $55 while the order is in action (usually a day or 60 days), your shares are sold and you reap the reward.

Limit Order.

Now let's suppose that you don't own any shares of ACME Widgets Inc., but you would like to. You think a fair price is $48 and would like to buy 100 shares if the price ever hit that target. Here's where a limit order comes into play. You would issue a limit order for 100 shares of  ACME Widgets Inc. with a target price of $48. If the share price drops to $48 or lower, your order would be executed.


Both stop orders and limit orders are incredibly useful investing tools, but they don't eliminate all risk. For example, you still have to have your valuations right, and there will be plenty of times when the price will overshoot your targets - in both directions! But the key here is that these tools can help you greatly reduce your losses and even maximize your returns.

Happy investing.