Financial Notebook - Q&A with CMMB Securities

Q. I heard someone say that a good way to get started in the stock market and measure your feelings about risk is to invest on paper. Something about building a portfolio on paper. How does that work?

Danny, Cascade

A: Building a portfolio on paper or paper trading is a very useful way of testing your risk tolerance. Even experienced traders who are entering a new area for the first time adopt this method in order to better understand the risk dynamics of the investments they are considering. Paper trading is essentially hypothetical investing. For example, let’s say you have $20,000 with which you want to invest equally into two companies on the Trinidad and Tobago Stock Exchange. Instead of actually buying the shares you can be hypothetical and assume you bought the shares on a particular day. Then, from that point on you can track the prices of the two shares over time in order to get an idea of how the prices of these particular shares behave.

You can repeat this exercise for a number of companies which you are considering in order to determine their price movements as well. By doing this you get a good feel for the money you would have made or lost over the time that you would have held these shares. By repeating the process you would then get an even better understanding of the risks you can take and the ones which you cannot afford to expose yourself to. So when you actually start putting “real” money into the market you would do so in an informed manner, knowing full well the value at risk in the market. In short, paper trading allows you to learn the pitfalls of investing in the market without actually losing money in the process. It is a “virtual” way of getting into the market and learning by experience.

Q. How important is timing as far as investing in the stock market is concerned?

Azard, Claxton Bay

A: In most stock markets, timing is of the essence. However it is not so much of an issue on the local stock exchange. In the developed markets the price reaction is extremely high because of a large number of buyers and sellers taking positions in the shares. The price of a share would therefore start increasing or decreasing in line with earnings estimates or “what the street says” long before the actual company earnings are released. If the actual earnings, when released, exceed what the projections were, then the price of the share would experience an increase after the announcement to factor the positive variance from projections. Conversely, if the actual earnings were less than projections then the price of the share would fall or “correct” after the announcement of earnings in order to factor the negative variance from projections.

However, in Trinidad and Tobago the price of a share does not react to earnings’ projections, probably because there is no real forecast or consensus from brokers as to what the earnings of a company would be. While some brokers are beginning the process of projecting company earnings there is no real consensus among them for the market to react to. Therefore buyers and sellers wait till the announcement of actual earnings by the companies to start buying or selling. This results in a phenomenon in the stock market referred to as “post earnings announcement drift.”  This occurs whereby the prices of shares start to rise or fall depending on whether the actual earnings increase or decrease respectively over the corresponding prior year period. This gives ample opportunity for investors to come into the market after the earnings are announced and still make money. Investing in the market then becomes a virtual no-brainer, as one does not need to rely on making accurate forecasts of earnings in order to profit. Such is the behavior of stock prices on the local stock exchange.

Q. Last year one of the measures proposed in the budget was a tax break for credit union deposits up to $10,000. Has this actually been implemented? If so, how does it work?

Richard, Tunapuna

A: While we are not qualified tax advisors the information we have is that this measure has been implemented. According to our sources the tax deduction applies to amounts up to a maximum of $10,000 and was made effective January 1, 2003. Therefore deposits made prior to January 1, 2003 will not qualify for deductions on your tax return. According to tax sources, no new forms have been issued to include a new line item for this new tax deduction i.e. in addition to your existing deductions for mortgages and annuities. However, since the deduction applies for deposits held for a full calendar year, incremental deposits made in this year would only start being claimed in next year’s tax return.  Presumably, the new forms for 2004 would be amended to include this item. However, in order to prove ownership of the deposit a certificate must be issued by the credit union, a copy of which must be submitted to the Board of Inland Revenue when filing your claim next year. For further information please contact a qualified tax advisor.

Questions can be sent to PO Box, 1830, Wrightson Road, Port-of-Spain.
E-mail: cmmbsecurities@mycmmb.com