The Warren Buffett Effect

This is the man that every investor attempts to be.  We all secretly look up to him.  Whether you’re his rival or protege, he is the benchmark to meet.  Yesterday, he released a letter to shareholders of his company Berkshire Hathaway.  He disclosed that he has Stage 1 prostate cancer and will begin treatments in July.  The doctors have stated that they are not concerned about the delay in treatments.  They feel that since it was discovered early, Mr. Warren Buffett should be cancer free very shortly.

Warren Buffett is a completely self made billionaire.  In fact, he is one of the five richest men in the world.  Even with such stature, he still lives in Omaha Nebraska.  Buffett has recently made it his priority to raise money for philanthropy.  He has charged thousands of multi-millionaires to give half of their wealth to charitable causes.

The reason Wall Street looks to this man is his investing acumen.  Warren Buffett has been able to make phenomenal investments through his years.  Most recently, he said the best investment opportunity in the marketplace right now is the housing market.  Since that call, homebuilder Pulte Homes (PHM) has moved from $6.85 a share to $8.50 a share in just a few short months.

While Wall Street looks to Buffett as the benchmark, we often forget that his benchmark is not just his return on investment. Mr. Buffett has been giving millions of dollars every year to charitable causes.  On Wall Street, we believe in making and keeping as much money as possible.  We believe in obtaining as many material objects as possible.  We forget the complete package that Mr. Buffett has been over the past several decades.  The government has a hard enough time getting taxes out of us, much less a noble cause that doesn’t result in a tax deduction.

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Pay Your Taxes, And Mine While You’re At It

Its tax day. What does that mean? Today is the day when we, the super wealthy, have to write big checks to the government to pay our taxes. We hate it and dread it every year. For most individuals, they get money back. Not us.

Ah, but there is always a catch. Tax write-offs are a glorious thing. While working with my accountant, he informed me that since I am officially in business for myself that I can write-off 30% of my income. Through a special retirement fund for self employed individuals, I can write-off $45,000 or 30% of my income each year by moving that money into the retirement account. Then, of course I have all those “charitable donations” to write-off. Long story short, I end up paying 17% in taxes on the year.

Meanwhile, ordinary Americans are not allowed to use the same retirement accounts that I am. You have Roth-IRAs, 401Ks, and other retirement funds to use. Nothing as powerful as mine as far as write-off possibilities go. Yet, my kind will complain to the high heavens that we end up paying taxes; while most people get money back. We completely disregard the fact that we paid little to no taxes throughout the year. If you’re taking a dime of our money, you must be a socialist. Wall Street thinks that because we sit behind a desk making money that we’re entitled to keep every penny. Likewise, we believe that someone pounding nails all day isn’t “smart enough” to use their money wisely. So why not have them pay taxes? It doesn’t matter that they are struggling just to make rent. We want more perks from the “elite” status we feel entitled to.

So while I write this 17% check to Uncle Sam, I know some of my fellow Wall Streeters are writing a check for an even lower percentage complaining about it. Demanding an answer for why someone who “is the reason there is an economy left at all” has to continue to support the “lazy individuals who refuse to get a job.”

Need another reason why this stock trader is fed up with Wall Street?

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Facebook IPO cont

Two years ago, it was more than apparent to any investor that Facebook would be a great investment. Luckily there is a secondary market to trade stock in non public companies. Companies like Facebook have been on that secondary market for years now. Anyone can go there, and with the company’s approval, buy stock.

Oh, there is one tiny catch. In order to buy any Facebook stock, you need a minimum of $2,000,000. That’s no problem, right? Everyone not on Wall Street has that in their sock drawer. Not quite. Basically, that secondary market is there to help make Wall Street richer. Not our clients, but us.

Over the past two years, I have personally sat down with over 10 different investment houses to buy some Facebook stock for myself before it goes public. Each one has demanded that I turn over all the assets I currently have in investments over to them. They would not give any consideration to someone who wasn’t already on their client list.

As I said in the prior Facebook IPO post, this is a great long term investment. Even some of the biggest players on Wall Street are having trouble getting their hands on it before Facebook goes public. Why? Because firms are only selling shares to the biggest fish they have to keep them happy. The big fish pay more in fees over the year. Why would Wall Street help a single mom with two kids scraping by, when we can help a billionaire who pays millions in management fees each year. Seems fair, doesn’t it?

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They Bet Against What They Sell You

While Wall Street is calling you advising that you buy a product, they’re betting against that product. Sounds pretty bad, right? Sorry to inform you, but it’s perfectly legal so long as they disclose it in the fine print.

In the early 2000’s Wall Street was selling mortgage backed securities. That was just our fancy way of saying we bundled mortgages together and resold them. To resell them, we had to have them rated by credit agencies. Mind you we, Wall Street, paid those credit agencies for their services. They obviously had incentive to rate things the way we wanted.

Even though we knew those mortgage backed securities were crap, we were able to get them the highest credit rating possible. By doing so, we could sell them for a higher price with the illusion that they were low risk investments. The kicker is that Wall Street was shorting those mortgage backed securities, banks who owned them, and individuals who owned them. Keep in mind that we are the ones who sold them to those people.

So while we set you up for failure, we were betting against those very products we sold you. As long as we told you that somewhere in the small fine print, it was legal. We did it then. We did it with Greek debt. We’ll do it again so long as we can keep making our wallets fatter.

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The Facebook IPO

Facebook is going to be publicly traded in May.  Whether you agree with it or not, it will be the most oversubscribed IPO since Apple first came public.  What does that mean? It means that if Wall Street prices it out at $40 per share, Facebook’s first trade will be around $80-$85 per share.

Now don’t get me wrong, the numbers and projections make this stock still look cheap at that price in five more years.  Actually, I think this is a once in a generation stock offering.  Finally a stock for the every day person to buy, hold for five to ten years, then sell for a hefty profit.  Don’t forget the Wall Street games though.

First, Goldman Sachs has been selling shares of Facebook to their clients in Europe for about a year now.  Meanwhile, you haven’t been able to buy Facebook at all.  How can they do it?  Because the laws aren’t the same internationally.  Goldman Sachs is using it to grow their client base, and charge more fees, while they take advantage of being bigger and more powerful than you.

Also, what I see happening is a bit of a honeymoon period with Facebook’s IPO.  The stock will soar right away.  After a few days, or even a few weeks, you will see a correction downward in the stock price.  Why?  Wall Street knows that the individual investor wants this stock, and they want it bad.  So they will ride some of the move up before pulling the rug and cashing in their profits.  When that happens, the stock will pull back.  When the stock starts to pull back, people will panic sell.  Wall Street will try to explain that the stock is too expensive on current earnings.  The stock could lose upward of 20-30% during this period.

What Wall Street won’t say, until the stock starts bouncing back up, is that they don’t care about current earnings.  They don’t care about current earnings for most companies.  What they care about are future earnings.  With roughly $6 billion in revenue projected for 2012, and $20 billion in revenue by 2014, the stock will be extremely cheap after the 20-30% pullback.  Wall Street will jump on this as hard as they have jumped on Apple in recent years.

Do not be fooled when Facebook starts pulling back.  Its a great company, solid revenue with a limited monetization model, and phenomenal earnings and growth potential.  Ten years from now, you will kick yourself if you didn’t buy this stock.  Wall Street is going to try to make you think that this stock is just a flash in the pan.  Don’t be fooled.  They’re just looking for yet another way to screw you, and allow themselves a chance to make even more money.

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We Make Money No Matter What Happens

Every day the stock market moves.  Every day professional traders make money.  Your 401k, on the other hand, typically only makes money if the market moves up.  Its easy for the professionals to make money.  We can exploit your fears to make money to the downside, or ride your wave of bliss when the market is doing well.

What we professionals love to do is find an extremely volatile stock.  A volatile stock will move quickly and often.  When we find a volatile stock, we use something called a butterfly spread.  Put very simply, we buy put and call options on a single stock with the same expiration date.  Then, so long as the stock moves one way or the other we make money off of it.  

Say we buy a put option for Company X for $50 when it is currently trading at $51.  We also buy a call option on it for $52.50.  If its a volatile stock, Company X should easily bust out either below $50 or above $52.50.  If we’re real lucky, it could do both before our options expire and we make money both ways!  It is extremely simple for Wall Street to do this.

Meanwhile, for an individual investor to be able to use this type of options spread you would need to get approved for level 4 options trading.  How do you do that?  Well, the first qualifier is to have more than $250,000 in your account.  You have that right?  No problem.  Then you have to show your trading prowess, experience, and expertise before you can be approved for level 4 options trading.  Most individuals can’t get approval for this level of trading.

So while we, Wall Street, bar your from using a simple butterfly spread on stocks, we are using it every day to make money off your fears and joys.  So much for a level playing field.  Wouldn’t you agree?

Trading To Another Level

Don’t you hate not knowing where the bottom is on a stock? I don’t. Wall Street doesn’t. Most individual traders think they can just look at a stock quote and the technicals on a stock and have a good idea of where the bottom is. We take the guess work out of it.

Like I said, you look at your stock quote and see the bid and ask price to see which direction the stock is favored to move in. Then you look at the technicals of the stock and figure out if there is resistance or support in one direction or the other. I, and Wall Street, use something called level 2 trading. Most trading firms charge you extra for level 2 trading access. What is level 2 trading? Well, it lays out what orders have been placed on an individual stock. It tells us how many shares are being bought or sold, at what price, and by whom. So I can easily look at a stock and see that there are 50,000 shares with buy orders at say $5.00 and only 1,000 shares with sell orders at $5.03. I can also see that the next sell order after those 1,000 shares have been sold is for 60,000 shares at $5.05 per share.

What does all that mean? It means I know it is much easier to sell 1,000 shares of something before 50,000 shares can be bought. In the scenario above, the stock is most likely to move up to $5.05 and hit at least a momentary point of resistance. Again, it would be easier to buy 50,000 shares of something that it would be to sell 60,000 shares of something.

We take the guess work out of it. We don’t have to look at the technicals and make estimations. We can look at our level 2 trading platforms and place our orders accordingly. Meanwhile, the individual investor doesn’t know what orders have been place, at what price, for how many, or by whom. We take advantage of that knowledge on a daily basis. Yes, all at the cost of you, your retirement, and your children’s education funds. What does Wall Street care though? We’re paid to make money, no matter who we screw…

Leverage Wall Street Uses and Doesn’t Have

In our previous post, we discussed margin. How the pros use it to maximize their returns, and losses. How did all of the banks and investment funds lose their shirts in ’08? The housing bubble burst. That was easy, right? Wrong!

Investment firms lost their shirts because they leveraged themselves to the hilt with the housing market. They had giant sized margin accounts. Most individuals who use margin have an account that is maybe worth three times what they own at the absolute most. That is for an elite trader. Investment firms were giving each other 30x, 40x, even 50x margin accounts that they call leverage. They used those margin account to leverage themselves in some cases upwards of 50x what they actually owned.

So what does that mean? That means for every $50 they were spending on investments in the housing market, they only had $1 in hand. Now obviously when the market collapsed, the couldn’t pay back all that money they owed. That is why all those companies went under.

Today, those investment firms still have margin/leverage accounts worth 15x or 20x what they actually own. It’s absurd! Yet, when they fail you the taxpayer are being forced to bail them out. If you were to default on your margin account, trust me when I say no one will bail you out. You want an unfair advantage Wall Street has over you? They can make 50x the profits your 401k could with the exact same assets because of their leverage. Yet, if they lose its your responsibility to pay them back their losses.

Professionals Short Stocks, While You Lose Money

While the market collapsed in ’08, and fell off a ledge in ’11, the professionals made millions.  How?  By using leverage.  Margin is an extremely powerful tool.  What is margin?  To put it very simply, its like having a giant credit card hooked up to your portfolio.  Out of cash to make a trade?  Don’t worry, you have margin.  Now, margin accounts aren’t for everyone.  Typically, margin accounts have an extremely high interest rate when they are used.  Not only could you lose all of your money, but you could actually end up owing money.

So how do professionals make money while you’re losing every dime in ’08 and ’11?  They use those margin accounts to short stocks.  You buy a stock when you think it will go up, and you short a stock when you think it will go down.  Its that simple.  Under normal circumstances, you can short $1 for every $3 you have.  With a margin account though, you obviously have more funds to use.  That means you can short even more stocks.  As an example, AIG went from a $45 stock and plummeted to sub $3 a share in ’08.  That is an astronomical rate of return.  Meanwhile, most individuals weren’t able to short stocks. Not to mention that 401k’s don’t allow people to short stocks.  So while you were losing everything in ’08, professionals were shorting stocks from $45 a share all the way down to $3 a share.

Now, let’s make the pain even worse.  The professionals used options trading to exponentially increase their gains.  Using that same margin account, which your 401k doesn’t let you have, and the same trading philosophy of buy a stock if its going up and shorting a stock if its going down, it was quite simple.  With options, you buy a call option if the stock is going to head up.  Conversely, you buy a put option if the stock is going to head down.  Only this time instead of paying the full stock price, you only pay a small fee associated with buying a block of 100 shares per option.

So if you would have shorted 100 shares of AIG, although most couldn’t, it would have cost $4,500 to do so.  Then when the stock hit $3 a share, you would have “bought to cover” those 100 shares you sold by shorting the stock for the low price of $300.  You just made yourself a smooth $4,200.  Not bad, right?

Well look at this.  If you would have bought 10 put options on AIG for say a fee of $4.50, at the strike price (stock price) of $45, that would have cost you the same $4,500.  Ah, but the kicker is that you have an option to sell 10 contracts at $45.  Each contract is 100 shares.  So you have the option to sell 1,000 shares at $45, instead of the 100 when you shorted the stock.  Not only that, but you have the option to sell them at $45.  That means that you don’t have to sell them at $45.  So the most you could possibly lose on this trade is the fee ($4,500) that you paid for the options.  I digress.  So now we have these 10 put options (1,000 shares) and you exercise those options at $3 just like you did when you shorted the stock.  How much did you make?  Well, you sold 1,000 shares for $45 each, and you bought them back for $3 each.  That means, using that same $4,500 up front, you would have made $42,000!

Wall Street did that with many different companies.  You could have done the same thing which was even more extreme with Fannie Mae and Freddie Mac.  Wall Street makes you jump through hoops to get margin accounts.  Then they decide whether or not you are worthy of having one.  One small misstep, and they deny you.  So while your contra funds, high growth funds, and dividend funds were losing your money on Fannie Mae, Freddie Mac, AIG, Goldman Sachs, Citigroup, Bear Stearns, and Bank of America, we professionals were banking away fortunes betting against your 401k’s.  The sad thing is, your 401k doesn’t even allow you the option to bet against those companies like we can.  It’s disgusting.

Who I Am

I am exactly what Wall Street hates.  I’m the individual with the knowledge of the extreme advantages professional traders have over you, combined with the credibility.  Why am I writing this?  Its simple.  I’ve been trading for eight years and am tired of hearing about how investment groups keep getting away with screwing the little investor.

I hear on a daily basis about elderly individuals who lost 50% of their retirement during ’08, and are happy because they’ve made back 50% of that money since.  Guess what, that means you’re still down 25%.  Its disgusting that people are taught that the playing field is even when it most decidedly is not.  Through this blog, and various other avenues, I plan on exposing all of the disadvantages you face both while trading stocks and simply managing your 401k.