Saturday, April 30, 2016

Trading Personality


“If you get nothing else out of reading this book than the one following principle, it will still have been a very worthwhile endeavor: Successful traders find a methodology that fits their personality.” 

Jack Schwager, author of Market Wizards

“Traders must find a methodology that fits their own beliefs and talents. A sound methodology that is very successful for one trader can be a poor fit and a losing strategy for another trader."

Colm O’Shea


If you are a new trader, it may be a difficult task for you to choose your trading style, but it is absolutely a necessary step for your long term success as a trader. By choosing the trading style that best suits your personality, you will have a better chance of being a profitable trader. In this section, we shall look at the various trading styles and see whether you can find one style that suits you most.

According to Jack Schwager, author of Market Wizards, successful traders usually match one of the four types of trading with their personality type.

Scalping

Scalping is a very rapid trading style. Scalpers often make trades within just a few seconds of each other, and often in opposite directions (i.e. they are long one minute, but short the next). Scalping is best suited to active traders that can make immediate decisions and act on those decisions without hesitation. It is one of the most cognitive demanding forms of trading. Successful scalpers rely on intuition developed through years of experience along with a defined set of rules that are part of their overall system. This may be out of reach for traders who are just starting out. In addition, new traders who have more active personalities tend to overtrade their accounts. Even experienced active traders can fall into the overtrading trap as well. 

Day Trading

If you are one of those who get worried because of overnight positions then maybe day trading is for you. Like scalping, day trading also have no overnight positions, but it is the milder form of scalping. Day traders may take two or three trades a day and then liquidate all trading positions before the close of the day. A day trader does not subject his or her capital to overnight risk that can adversely affect a portfolio. 

While day trading requires skill, knowledge and discipline, it does not require the precision and high winning percentages to become profitable like scalping. They can usually locate trading opportunities that offer a minimum 1 to 2 risk to reward ratio. By only taking trades with a 1 to 2 risk to reward ratio, day traders only need to win 32% of the time to breakeven. Overtime, as the active personality skills develop, they may incorporate scalping as a natural next step.

By developing a solid day trading plan, active traders will have both a winning strategy that they can stick with because it matches their personality style which needs activity and variety. 

Swing Trading 

Swing trading strategy would ideally fit the analytical person as he aims to profit from both trend following moves and the subsequent corrections. Active personalities may find swing trading uncomfortable as they incline to make quick decisions, they cannot stick to a swing trading plan that may take weeks to unfold. They may feel restless and even begin to question the trade. As a result, they will find themselves taking profits or exiting a trade too early. Swing trading generally requires a larger stop loss than day trading, so the ability to keep calm when a trade is against you is a necessity.


Position Trading

Position trading is the longest term trading of all, and often has trades that last from weeks to months or even years. Therefore, position trading is only suitable for the most patient and least excitable traders. Position trading targets are often several thousand pips (for example, forex), so if your heart starts beating fast when a trade is 25 pips profit, position trading is probably not suitable for you. Position trading also requires the ability to ignore popular opinion because a single position trade will often hold through both bull and bear markets. For example, a long position trade may need to be held through an entire year when the general public is convinced that the economy is in a recession. If you are easily swayed by other people, then position trading is going to be difficult for you.


Being Faithful to your Trading Style

Choosing a trading style requires the flexibility to know when a trading style is not working for you, but also requires the consistency to stick with the right trading style even when it is not performing optimally. One of the biggest mistakes that new traders often make is to change trading styles (and trading systems) at the first sign of trouble. Constantly changing your trading style or trading system is a sure way to catch every losing streak. So often we hear that traders have to change their personality to fit trading. To some extent this can be done. However, if the changes are too far from a person’s core personality, failure is more likely. Personality should drive the choice of trading strategy rather not the other way round. Once you are comfortable with a particular trading style, remain faithful to it, and it will reward you for your loyalty in the long run.

Saturday, April 23, 2016

Investors Vs Traders

Many people are lured into the world of trading because of the promise of “Quick Returns”! Yes, you can make money real fast, but you can lose your money real quick too!

Trading and investing are two very different ways of profiting from the financial markets.

Benjamin Graham defined investment clearly as: 

"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

Investors

When you are investing, you are looking at a longer time horizon and you expect the assets to generate income for you repetitively. It could be rental yield from properties; interest from bonds or dividends from stocks. The goal of investing is to gradually build wealth overtime. Investors look for values in assets, they focus on the fundamental of assets, they analyze assets using fundamental analysis. Investors are willing to buy and hold an asset, with the understanding that asset prices fluctuate in short term, but over the long run, prices will recover and move in a steady uptrend.

Traders

When you are trading you tend to speculate on an asset, hoping to take advantage of the price difference for short term gains. While most traders speculate on commodities, index futures, forex and stocks for gains on small price movements, others do practice longer term position trades that aim at bigger price differences. It is widely believed that most traders use technical analysis for their trades, however, fundamental analysis is also commonly employed by traders to give them a sense of a macro picture for the assets that they are trading.


There are four types of traders:

Scalp traders – who hold positions in seconds and minutes, with no overnight position.
Day traders – who hold positions within one day.
Swing traders – who hold positions from days to weeks.
Position traders – who hold positions from weeks to months or even years.

I Am Both Investor and Trader

Most traders are also investors, although the reverse is not necessarily true. For example, I enjoy holding long term position in the equity market as most of the stocks that I am holding are dividend stocks that give me fantastic returns annually. At the same time, I also trade in the derivative market to take advantage of certain “obvious trends” such as a double top or double bottom chart patterns. 

Hence, we can say that both types of investing styles can actually complement each other and add value to your overall portfolio.

Whether you consider yourself a trader or an investor, make sure that you learn well how to make good entries and exits. Discipline is very important to trading. Very often we failed because we procrastinate in cutting losses .

Investor or trader – which is better? Whichever fits your personality, risk tolerance and lifestyle. Do not let anyone tell you that you should be one or the other. Examine yourself, and do what lets you sleep well every night.

Saturday, September 26, 2015

W.D. Gann's 12 Tradinng Rules

W.D.Gann published several books in his lifetime. Among which I find “45 Years in Wall Street” most valuable to any trader. He wrote this book at the age of 74 based on his 45 years of trading experience in the stocks and commodities markets. He has his unique ways of analyzing the markets, and he had developed many trading strategies as well. In this blog, I would like to share with the readers his 12 rules about the stock market that he had emphasized throughout his book.

W.D. Gann’s 12 Rules Trading in Stocks
Rule 1. Determining the Trend
“For traders, trend is your friend. Besides drawing trendlines for the individual chart you are trading, it is important to determine the trend of the market index and the industry index that you intend to trade. This is to confirm if the trend of the individual stock is in line with the industry trend as well as the overall market trend.”

The following charts 1a, 1b and 1c shows that the market (KLCI index), the sector index (Finance index) and the individual (Maybank) all exhibited bearish trend during the given period.


Fig 1a




Fig 1b




Fig 1c




Rule 2. Buy at Single, Double and Triple Bottoms

“Buy at single, double or triple bottoms. The fact that prices rebound from the previous low is an indication that this bottom is a support zone. After you have made a trade, do not forget to place a stop to protect your position. Do not overlook the fact that the 4th time the stock reaches the same level, it is not as safe to buy, because it nearly always goes through. Reverse this rule at the top.”


Rule 3. Buy and Sell on Percentages

“Buy or sell on a 50% decline from any high level or a 50% advance from any low level so long as these reactions or rallies are with the main trend. You can use the percentage of the individual stocks as well as the percentage of the market index to determine the resistance levels. The resistance levels are: 3-5%, 10-12%, 20-25%, 33-37%, 45-50%, 62-67%, 72-78%, 85-87%. The most important resistance levels are 50% and 100%.”

See the following examples:

Figure 2 shows that the KLCI achieved a top at 1860, the first low is 3.33% reaction point from the top. Subsequently, the next low is 9.1% from the peak, which is close to the 10% reaction point.

Fig 2




Figure 3 shows the monthly chart for the S&P 500 achieved a peak prior to the 2008 financial crisis. During the peak of the mortgage subprime crisis, the S&P 500 fell 53% which is close to the 50% important resistance level that Gann discovered. These are important discoveries by Gann as this insight gives us a direction of when is the peak or bottom.


Fig 3




Rule 4. Buy and Sell on 3 Weeks’ Advance or Decline
“Buy on a 3 weeks’ reaction or decline in a bull market when the main trend is up, as this is the average reaction in a strong bull market. In a healthy bull market, it is perfectly normal for the price to undergo correction. If the correction lasts for 3 weeks, that’s a buying opportunity if you want to “buy in dip” in a bull market.

After the market advances or decline 30 days or more, the next time period to watch for tops and bottoms is around 6 to 7 weeks, which will be a buying or selling level, protected, of course, with a stop loss order according to resistance levels.

After a market rallies or declines more than 45 to 49 days, the next time period is around 60 to 65 days (12 to 13 weeks) which is about the greatest average time that a bear market or bull market reacts.”

Figure 4 depicts the weekly chart for KLCI. We can see that during the bull run, the index follows a healthy correction of not more than 6 weeks each time within the given period. However, in 2014 July onwards, the KLCI experienced 23 weeks of downtrend, this is greater than “the 12 to 13 weeks, the greatest average time a bull market reacts,” as stated by Gann.

Fig 4



Rule 5. Markets Move in Sections
“Stock market campaigns move in 3 to 4 sections or waves. Never consider that the market has reached the final top when it makes the first section in a move up, because if it is a real bull market, it will run at least 3 sections an probably 4 before a final high is reached.”

Figure 5 shows the STI chart. It is quite clear that we see that the STI follows this 3-4 waves theory quite well.

Fig 5




Rule 6. Buy or Sell on 5 to 7 Point Moves
“Buy or sell individual stocks on reactions of 5 to 7 points. When a market is strong, reactions will run 5 to 7 points, but will not decline as much as 9 or 10 points. By studying the Industrial Averages you will see how often a rally or reaction runs less than 10 points. However, it is important to watch 10 to 12 points rallies or declines for buying or selling levels on the average.

The next important point to watch is 18 to 21 points up or down from any important top or bottom. Reactions of this kind in the Averages often indicate the end of a move.

When to take profits? Follow the rules and do not take profits until there is a definite indication of a change in trend.”

Figure 6 depicts the price chart of Maybank. We shall use 10 cents to represent 1 point in this example. Maybank achieved RM10.20 as the peak and underwent a bear rally that reached a bottom of RM8.30, which represents RM1.90 or 19 points decline and it’s the end of a move. Subsequently, Maybank rebounded to RM9.25, RM0.95 or 9.5 points, which was below the 10 point move as stated by Gann.

Figure 6




Rule 7. Volume of Sales

“Study the total volume of sales on the New York Stock Exchange in connection with the time periods. Study the volume of sales on individual stocks, as the volume of sales will help in determining when the trend is changing.”

Volume of sales basically gives you a direction whether the current trend is strengthening or weakening. In a typical extreme high year, the volume of sales is high for that particular year as retail investors are attracted into the stock market. Similarly, in an extreme low year, the volume of sales is also high, this is because retail investors are selling down the market in panic.

In a bullish trend, we shall see price rises together with volume rises. If price continues to rise but volume declines, it is an indication that the market has lost momentum and very soon price correction is around the corner.

In a bearish trend, if we see rapid decline in price together with a surge in volume, it is an indication that the selling pressure is gathering momentum, and the bearish trend is expected to persist. However, as prices continue to decline with a lighter volume, we may expect a change of trend in imminent.

Gann also states that the volume of sales has to be studied together not only with the price change but also with the time periods. We shall see in the next section.

Rule 8. Time Periods

“The time factor and time periods are most important in determining a change in trend because ‘time’ can over balance ‘price’ and when time is up, the volume of sales will increase and force prices higher or lower.

Market over-balanced – The averages or individual stocks become over-balanced after they have advanced or declined a considerable period of time, and the greater the time period, the greater the correction or reaction. When the time period on a decline exceeds the time period of a previous decline it indicates a change in trend. When the price breaks a greater number of points than the previous decline or reaction, it indicates that the market is over-balanced and a change in trend is taking place.

Reverse this rule in a bear market. When stocks have been declining for a long period of time, the first time that a rally exceeds the time period of a previous rally it is an indication that the trend is changing, at least temporarily. The first time that the price rallies a greater number of points than a previous rally, it indicates that the ‘space’ or price movement is over-balanced and a change in trend has started. The time change is more important than reversal in price. Apply all of the rules to see if a change in trend is due at the time when these reversals take place.

When the market is nearing the end of a long swing or a long downswing and reaches the 3rd or the 4th section, the swings upward will be smaller in price gains and the time period will be less than the precious section. This is an indication that a change in trend is due. In a bear or declining market, when the loss in points becomes less than the previous section and the time is less, it is an indication that the time cycle is running out.”

In layman term, it is important to record down the duration of trends in the market or the individual stocks. For example, during the 2011 US debt ceiling crisis, the US, Malaysia and the Singapore equity markets all experience a bearish trend that lasted for 8 weeks.

In addition, it is important to record down the reaction time period. For example, in a bear trend, record down the duration for each bear rallies, if the current rally is longer than the previous, it indicates inherent bullishness in the trend, especially, when the bear rally is the 3rd or the 4th in a prolong bear trend.

Rule 9. Buy on Higher Tops and Bottoms

“Buy when the market is making higher tops and higher bottoms which shows that the main trend is up. Sell when the market is making lower tops and lower bottoms which indicates the main trend is down. Time periods are always important. Check the time period from previous top to top and from previous bottom to bottom. Also check the time required for the market to move up from extreme low to extreme high and the time required for prices to move down from extreme high to extreme low.”

Rule 10. Change in Trend in Bull Market

“A change in trend often occurs just before or just after holidays.

Bull market ending: When prices on the Industrial Averages or individual stocks break the last low on a 9-point swing chart or break the lst low on the swing on a 3-day chart, it is an indication that the trend is changing, at least temporarily.

Bear market: In a declining market when prices cross the top of the last upswing on a 9-point chart, or cross the top of the last upswing on a 3-day chart, it is the first signal for a change in trend. When prices are at high levels there are usually several swings up and down; then when the market breaks the low of the last swing it indicates a reversal and a change in trend.

At low level prices often narrow down and remain in a narrow trading range for some time, then when they cross the top of the last upswing it is important for a change in trend.

Always check to see if the market is exactly 1,2,3,4 or 5 years from any extreme high or low price. Check back to see if the time period is 15,22,34,42,48 or 49 months from any extreme high or low price, as these are important time periods to watch for a change in trend.”

For the context of KLCI, I notice its a 40 points and 80 points reactions. For example, when the KLCI is advancing and reaching a visible top, then a reaction or price drop more than 40 points per day or 80 point per week, then it is an indication that there is a change of trend from bullish trend to bearish trend. The reverse is true for a bottom.

Rule 11. Safest Buying and Selling Points


“It is always safest to buy stocks after a definite change in trend has established. After a stock makes bottom and has a rally, then follows the secondary reaction and it gets support at a higher bottom. When it starts to advance and crosses the top of the first rally, it is the safest place to buy because the market has already given an indication of uptrend. Stop loss orders can be placed under the secondary bottom.

Safest selling point: After a market has advanced for a long time and made final high and has the first sharp quick decline, then rallies and makes the second lower top, and from this top declines and breaks the low point of the first decline, it is then safer to sell because it has given the signal that the main trend has changed to the down side.

Remember that stocks are never too high to buy as long as the trend is up; and they are never too low to sell as long as the trend is down. But do not overlook the fact that you must always use a stop loss order for your protection. Always go with the trend and against it. Buy stocks in strong position and sell stocks in weak position.”

Rule 12. Price Gains in Fast Moves

“When markets are very active and advancing or declining very fast they average about 1 point per calendar day. When the movement on averages or individual stocks is 2 points or more per day, it is far above normal and does not last very long. Movements of this kind occur when there are short time periods and a quick corrective reaction or decline in a bull market. When the trend is down in a bear market these quick fast rallies correct the position in a short period of time.”

It says that big price change usually doesn't last very long. For example, KLCI, you may have 40 points increase for one day, but you hardly see 40 points per day for consecutive days, its just not sustainable.


Note: To give you a perspective, the DJIA was trading at 80 - 380 points between 1920 to 1929.


Background

William Delbert Gann, usually referred to as W.D. Gann, attained legendary status as a market operator on Wall Street between 1900 and 1956.

He was born in East Lufkin Texas on June 6, 1878 , which at the time was cotton-growing country. He spent his teenage years working as a cotton warehouse clerk.

In 1902, Gann began trading the stock and commodity markets. In 1908, he moved to New York City and it wasn’t long before he opened his own brokerage firm, W.D. Gann & Co, on 18th and Broadway.

His storied success began early. In the month of October 1909, while being observed by a representative of Ticker Tape Magazine (the Barron’s of the day), Mr. Gann executed 286 trades in various stocks on both the long and short side of the market. He profited on all but 22 of these trades. By the end of this 25-day period, his starting capital had increased by 1000%.


Wednesday, July 15, 2015

Are You A Rational Investor

When you were asked: “Are you a rational investor?” You would probably answer: “Well, yes! I guess. At least I THINK I am rational when making investment decisions.” Not according to Bayes’ Theorem. The definition for rationality according to Bayes’ rule is:  Logical thinking should involve probabilities, hypothesis and statistics to one’s belief. In other words, one should use statistical evidence to quantify his or her belief.

In the classical financial market efficiency theory, it is assumed that investors are rational with perfect information. Rational investors make decisions or judgement using reasoned thinking, based on facts, applying rules. However, in the real world, those described above do exist, but only for the minority. The majority of the market participants are irrational, at least according to the Bayes’ rule. If you look around people around you, you would notice that when faced with investment decisions, they prefer to listen to rumours and tips, rather than spending time doing the research themselves.


This ‘misbehave’ of humankind is actually discovered by the Nobel Prize winner, Professor Kahneman, who started the Behavioural Finance theory with Tversky in the late 70’s.  When conducting statistical research with a group of professional statisticians, they discovered that these experienced statisticians do not apply rules, but their own intuitions when it comes to simple problems given to them.


Likewise, when we need to make investment decisions, we may encounter some mental biases that prevent us from thinking rationally. In the following section, we shall discuss what are those and how we can overcome them.


Overconfidence



This is the most documented of all psychological errors that people tend to be overly optimistic. Most people do not see the need to improve the way they make decisions, as they believe that they are already making excellent decisions. The unwarranted belief that we are correct is a major real-life barrier to critical thinking. Overconfidence often results in investors being fooled by small gains in a few trades, feeling much more in control of a situation than they are. Money managers, advisors and investors are consistently overconfident in their ability to outperform the market, but fail to do so.


Example: After a few small gains, investor A decided to invest a bigger sum on a particular stock. In the end, the stock encountered a major bad news that caused its stock price to plunge. Investor A has over-estimated his knowledge, and under estimated the risk involved by putting all the eggs in one basket. 


Remedy:  At the event of assessing an investment, it is crucial to assess the risk involved. Try to think for the worse case scenario, what is your contingency plan should it happens. Practice diversification of portfolios.



Herd Mentality



The phenomemon of the herd mentality can be useful in many ways. For example, researh shows that although 5% of the animals in a herd know the location of the water source, the entire herd is able to find it. In our dsily lives, we use this instinct to navigate the exit in the cinemas and crowded streets.We have to admit that herding is our human instinct. Herding always make us feel comfortable, and being the odd one out make us feel uneasy. We are programmed to to feel that the consensus view must be the correct one, and this mistaken belief has led to many distastrous decisions.


Example: During the 2000 dotcom bubble, despite the mean price earning ratio for the US technology companies is 156, investors still think the valuation of those dotcom stocks were "reasonable". They believed the majority was correct but infact it was not.


Remedy: It is not wrong to go with the trend. In fact, for trading, it is always good to trade with trends. However, we must know when to follow and when not to follow. To overcome this, we need to have an open mind, be able to see things in different perspectives. When investing, it is always good to ask for different opinions and to gather information form different perspectives. In view of other perspectives, we must be firm to our own beliefs, because when it comes to investing, there is no absolute right or wrong. As long as we focus on the fundamentals, we will be able to resist herd mentality.



Confirmation Bias



Confirmation bias is very common in us. We always have the tendency to select and filter information that fit into our beliefs. We ignore information or news that go against our beliefs.


Example: Miss A was choosing which stock to invest, Malayan Bank or Public Bank. After much consideration, she decided to buy Malayan Bank. After she bought the stock, she read an analyst report that Public Bank was better than Malayan Bank in terms of valuation, Miss A felt discomfort in her mind because this report was against her belief. In order to relief the discomfort, she would tend to disregard the news and went all the way to seek out information that confirms her belief. 


Remedy: Confirmation bias is a kind of "self- deception". To overcome this, we must constantly remind ourselves that when facing problems, we must seek out information from different perspectives. If necessarary, we must be willing to reassess our portfolio accordingly to the new information.


Intuitively, a "rational" or "unbiased" answer will include the consensus of the majority of the population. What is perceived as rational in one person may be considered irrational in another person, just like people from an African tribe wearing leater shoes is seen as "crazy", whereas it is perfectly normal to the rest of the world. A 90% survival rate for breast cancer in the developed countries is considered as normal but become unrealistic in the developing countries. Hence, we must learn how to see things in different angles to make more rational and unbiased decisions. 




 



Monday, June 22, 2015

Decoding The Stock Market

The financial markets are always full of uncertainties. It is generally believed that no one in the world can consistently beat the market as the financial markets are made up of market participants that "move" in groups. The markets only shift the momentum from one direction to the other when the group decides. Not when the individual trader believes the reversal should occur. 

It is believed that for any big movement in price, there must be a fundamental news associated with it, however, the extent of the price swing really depends on how the group think at that moment of the event. In this article, some historical events are highlighted, and we shall look at how the market reacted to each event. 

Date/ Events
Markets
Duration (Beginning of the crisis date to the lowest point)
Change in Index(%
2001  Sept 11
The US Twin Towers Terrorist Attack
S&P 500
KLCI
STI
2 weeks
9 weeks
2 weeks
-9%
-14%
-21%
2003  Feb 24
Asia SARS

STI
KLCI
3 weeks
3 weeks
-8%
-6%
2004  Dec 26
Indonesia Tsunami

JCI
KLCI
STI
No effect
No effect
No effect
-
-
-
2005 Aug 28
US Katrina Hurricane

S&P 500
KLCI
STI
No effect
No effect
No effect
-
-
-
2011 Mar 11
Japan Earthquake/Tsunami

S&P 500
KLCI
STI
4 trading days
1 trading day
5 trading days
-2.3%
-0.7%
-4.3%
2011 Aug 1
US Debt Ceiling (1)

S&P 500
KLCI
STI
8 weeks
8 weeks
8 weeks
-18%
-15%
-21%
2013 Jan 1
US Debt Ceiling (2)
S&P 500
KLCI
STI
No effect
5 weeks
2 weeks
-
-5.8%
-2.4%

Markets are move by news, whether it is micro or macro news. Some news are unheard of such as "Black Swan" incidents, others like asset bubbles kept repeating in the markets. Examples of the historical asset bubbles are: the Japanese asset bubble in the early 1990's; the dot com bubble in the US in 2000; and the 2008 US subprime martgage crisis. These asset bubbles generally impact the financial markets more severely than those ad hoc Black Swan events. For examples: the Nikkei 225 hit 39,000 points before the crash, and until today the index can not be restored. While the US dot com bubble took the Nasdaq 15 years to recover to its 5000 level mark.

In the above table, it is shown that natural disasters and some ad hoc events have short term impact on the financial markets in US, Malaysia and Singapore as compared to historical asset bubbles (which is not included in the table). In addition, the incidents related to the US impacted the Malaysia and Singapore markets more than other Asian countires' event. We saw the local market reacted more on the US debt ceiling and the terrorist attack incidents. 

Another finding from the above table is that: the market will analyse the relavance of the event to our own country. For example, the United States is Malaysia important trading partner, hence, major incidents from the US will impact the local stock market negatively. The extent of the negative sentiments could last for 2 to 9 weeks and the index fell not more than 15% for the KLCI. 

How about our own local disastrous news? How would that affect our stock market?

In March 2014, MAS encountered a fatal commercial air accident that climed hundreds of casualties. At the event, the MAS shares plummeted. Several months later, in July, another MAS aircraft crashed which claimed more lives, but the MAS shares did not experience the same kind of decline. This shows that when things happened twice, it will not cause much havoc in stock market as people already had the experience, just as the US debt ceiling crisis.

How about oil prices? Yes, Malaysia is affected by the plunging of crude oil prices as we are a net exporter of crude oil. When the crude oil price crashed in September 2014, followed by ringgit depreciation, this is no more an ad hoc incident, but more of a fundamental impact to our economy. However, whether our economy can ride through these hurdles depends on 3 things: the interest rates, the housing prices and the liquidity in the financial systems. Since we know that market moves in groups, and investors confidence will greatly affect the sentiments of the market. In order to restore the market  confidence, we must first take care of the "feelings" of investors/ market participants. In general, I believe investors want to see low interest rates, stable housing prices, and healthy liquidity in our financial system. 


Wednesday, March 4, 2015

GST - An Economics Perspective

Recently I did a sharing on the current hot topic GST (Goods and Services Tax) with a group of pre-University students. I presented my view from 3 perspectives namely: the Government, Consumers and the Producers. It was an interesting discovering for the students and I hope to share with my readers.

GST? Didn't we had it before?
The first confusion that the general public has is that the term GST is not something new to us, we have seen it on our bills when visiting restaurants and paying legal fees. The current GST stands for "Government Services Tax", which is applicable in the service industry and its chargeable to the final consumers. Starting April 1st, it will be replaced by the Goods and Services tax which is charged on every single stage of the provision of goods and services throughout the distribution chain. Under the new system, GST will be charged from the raw materials to the wholeseller,  wholeseller to the retailer, and retailer to the customers. However, as long as you are not the final consumers, meaning you are the business owners, you may claim back your GST on most goods and services. Hence "Government Service Tax" is charged to the final consumers, while the new GST is charged at every stage of provision of goods and services.

Do consumers bear all the tax?
This is an interesting question. From the media and most internet articles we were told that the GST is a consumption tax and its a tax on the consumers alone, and that the producers (business owners) are the middle men, they collect the GST from the customers and later pass on the tax revenue to the government. However from the economics perspective, this is not true.

From the diagram above, we can see that the imposition of a GST will ultimately increase the price while the economic transactions (or output) will reduce. The blue coloured rectangle represents the tax revenue collected by the government. However this tax revenue is not borne by the consumers alone, it is infact shared by both the producers and consumers. The exact tax burden borne is actually depends on the "elasticities" of demand and supply for the goods and services which is another story that I will not cover here.

How would the producers bear the tax, isn't it tax on the spending?
Precisely! Tax on spending! Whether you are a producer or consumer, you are taxed on the GST. The only difference is that producers can claim back their GST paid if they are a GST registered company.  However, some small items like furnitures or A4 papers are not claimable. Hence, cost of doing business will increase ultimately.

Inaddition, there is the "Compliance Cost" that most business owners have to face. Depending on your company's turnover, some may need to submit GST to the authority every month! To cater for this change, companies need to install special softwares and they may even hire more staffs to work on this compliance. Hence, this accounting burden is on the wholesellers and the retailers in general.

Does the economy as a whole benefit from GST?
From the above diagram, the red triangle represent "Deadweight Loss" (DWL) which means there is a loss in economic welfare due to the imposition of the GST or any indirect taxes such as sales tax, import tax and excise duty. This loss in welfare is translated into inefficient allocation of resources and the loss of consumers and producers surplus (benefits).

Is GST progressive or regressive?
Many people say that GST is good because it is progrogressive, meaning the rich pay more taxes, the poor pay less. However, as a percentage of income, this may not be true. Although the high net worth people pay more GST because they can afford more luxury goods, however, their spending on GST accounts only a small fraction of their household income. Whereas the lower income group spend more on GST as a percentage of their income. Hence it is regressive in nature!

If it is bad, why 160 countries in the world impose GST?
The biggest benefit is that it is a good source of revenue for the government. In some EU countries, GST revenue account for 15% - 30% of the total tax revenue. This will definitely elleviate our budget deficit problem. In the past, as an oil producing country, our Petroleum Income Tax revenue accounts for 14% - 30% of our federal tax revenue. Given that the oil price has plunged dramatically, it is the right time to implement the GST to elleviate the burden from the government.

In addition, with the imposition of GST, it is believed we can recover some tax revenue from the "black economy", economic activities that were under-declared previously.

Hence, from the macro level, the imposition of a GST will benefit the whole country because it is definitely a good source of revenue for the government, it can reduce our budget deficit and hopefully with the extra tax revenue, the people can benefit from it, be it in the form of better infrastructures, healthcare systems or educatuon systems.

On the micro level, business owners and consumers are likely to suffer in the short term to medium term as this is a sudden cost to the business community, they will experience a squeez in their profit margin, this will take some time for them to adjust, maybe one to three years time. As for the consumers, the lower income group will feel the pain more as the tax is unavoidable and it will increase their cost of living.


Tuesday, January 6, 2015

Financial Planning Q&A Part 2

Question:

Miss A is 30 years old with an annual income of RM40000. She has been in the work force for 5 years now, and she would like to buy a house for herself. Can she afford a house in KL?

Answer:

In Malaysia, most house purchasing is through financing from banks. Hence, whether Miss A can afford a house depends on whether she can obtain a mortgage loan from the bank. In general, there are various ways for the banks to approve a mortgage loan, one way is the 1/3 rule, which is RM4000/3 to get the monthly affordable instalment of RM1300 for Miss A. 


Based on the table below, if Miss A’s monthly affordable instalment is RM1000, she can afford a RM220000 house. In KL, with rising house prices, Miss A can only afford a house in the subsales market in the suburban region. 


Question:

Like most women, Miss B is a shopaholic. She is 26 years old and she love to shop online. She knew clearly the culprit was her credit cards but she could not control herself and she was in great debt. Suggest ways to help her to change from a shopaholic to a savvy investor.

Answer:

Online shopping indeed brings us convenience, however if we abuse it, it may bring us disasters! Miss B’s problem is twofold. First, she is addicted to shopping; Secondly, she has the wrong attitude towards credit cards.

It is widely believed that addicted to shopping is a form of behavioural problem. The victims believe shopping may bring them happiness, at the same time releases their stress and other problems. However, psychologists think otherwise. The doctors claimed that happiness derived from compulsive shopping can only be short-lived, it does not solve problems at all. A better way is to go out, engage in meaningful activities with friends, work place or even charitable organisations. This way, Miss B will shift her focus onto other people instead of “herself”, and the satisfaction derived from doing charity work is more meaningful.

Next, Miss B should learn how to control her compulsive buying behaviour by drafting a purchase list every time before she buys. This way she is able to differentiate clearly which items are the “needs” and which are the “wants”.  In addition, she should record all her expenses so that she can keep track of her own spending.

Finally, Miss B should understand that credit card is a tool for “payment”, not for “financing”. For a start, she should use cash to make payment instead of credit cards to control her purchases. With all these measures in place, I’m sure Miss B would transform herself from a shopaholic to a money savvy queen.