Introduction to the Gemology

TUTORIAL: 20 Investments You Should Know

Gems as an Alternative Investment
Many wealthy investors overlook the disadvantages of gemstone investing because of the potential for exponential gains. Gemstone investing is one of the riskiest kinds of investments; there are many ways to lose invested capital including fraud, political risk, subjective valuations, low liquidity and the potential for stones to be damaged when they are cut. Most of the people who invest in gemstones do so knowing that they're taking a very large risk. However, significant returns can be realized when an investor buys a large, uncut, colored stone, has it cut and then sells the gem for a lot more than he or she paid for the stone and the cost of cutting it.

Traditionally, gemstone investing has happened in the exclusive circles of certain families. A few families in Belgium, Holland, New York, Israel, Africa, Brazil and India have been involved in most of the trade of large stones. Lately, these closed circles have (by necessity) started to open up to outside investors who are willing to part with hundreds of thousands - if not millions - of dollars in exchange for a piece of the action. The main reason why new financiers are being let into gemstone circles is that more stones than ever before are being found and, as a result, buyers and traders need more money to continually finance the purchase of stones.

For those with the means and the connections, gem investments offer a great opportunity for diversification. The price of a gem has more to do with the characteristics of the stone itself, not the market in which that stone trades. Gem investing is also a great way to realize exceptional returns in a flat stock market. Even in the most bearish of markets, uncut gems can still be cut, increasing their worth by as much as hundreds of times their original price. Furthermore, buying one of the rarest materials on earth in a lavish London auction house such as Sotheby's or Christie's, having it cut in Antwerp and then selling it in Dubai is a thrill ride that would excite any tycoon. (For further reading, see Introduction To Diversification.)

The Basics of Gem Investment
If you have a mountain of risk capital and you want to invest prudently in gemstones, there are a few basics that you need to know.

First of all, there are thousands of kinds of valuable stones, but gemstones are usually limited to emeralds, rubies, sapphires and, of course, diamonds. Gemstones are valued according to a number of characteristics and increase in value exponentially if they have a perfect combination of the most desirable characteristics.

In general, the larger a gemstone, the higher its worth - even small increases in size affect the value of a stone.

A stone's grade - which is directly related to the stone's clarity - also works to determine its price tag. Two things contribute to grade: the purity of a stone and its likelihood of cleaving (breaking). Stones with no flaws are almost completely pure and are less likely to cleave during the cutting process.

The color of precious stones has always been important to valuation, but in the last decade, colored stones have experienced tremendous price appreciation. Depth of color and intensity are two of the terms that are frequently used by gemologists to describe gems. Colored diamonds, in particular, have become extremely sought after in North American markets. In fact, large, intensely colored, flawless diamonds are among the most valuable luxury items on earth.

Like precious metals, gemstones are internationally priced in U.S. dollars.(To learn more, see Determining Risk And The Risk Pyramid.)

Gems and Investment Risk
Despite their undisputedly high value, gemstone investments include very high levels of risk, which arise from a number of different factors. Professional gemologists are experts at mitigating many of the risks associated with gemstone investment, but they command very high fees. As we mentioned earlier, some unique risks associated with gemstones include subjective valuations, low liquidity, cleaving and fraud.

Subjective valuation: Experts don't always agree on a gemstone's worth. Anyone who buys a stone should consult with at least a couple of professional gemstone valuators.
Low liquidity: Because gems are rare, infrequently traded and lack a global marketplace, it is often hard to attach a firm value to a stone. Anyone considering such an investment should be willing to hold onto it for a number of years, in case a buyer can't be found.
Cleaving: This is the risk that a stone will break apart when cut and polished, shattering into a number of pieces that are worth exponentially less than the larger, uncut stone. Polished, symmetrical gems are much more valuable than those that are uncut and unpolished, but most gems have a tendency to cleave during the cutting and polishing process, making it a very risky venture.
Fraud: This is the most common risk that investors will face when purchasing gems. Unless you are or are working with a professional appraiser, judging whether or not a stone is real can be very difficult.

Despite the drawbacks, the returns from gemstone investment can be high. Beyond buying a raw stone and selling it as a polished gem, you can also buy a cut and polished stone in a down market, or buy from a seller that is having a hard time selling a valuable stone. These gems can then be either sold when the market warms up, or sold in a different country via auction or dealer. Investors buying gems that they believe to be undervalued generally have a longer-term perspective and may be willing to wait years to turn their investments into cash.
Conclusion
No matter your time horizon or your willingness to bear risk, unless you're dealing under the guidance of a reputable professional, gemstone investing is as close to gambling as you can come without setting foot in a casino. If you are considering investing some of your risk capital in gemstones, be prepared to spend some money on professional assistance, and remember, as always, that high potential returns always come with significant risk.

by Investopedia.com (Contact Author | Biography)

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Introduction to types of trading: fundamental traders

TUTORIAL: Investing 101

Reviewing Different Types of Traders
Before we focus on fundamental trading, let's review all the major styles of equity trading: Scalping - The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread. (You can read about scalping in Introduction to Types of Trading: Scalpers.)
Momentum Trading - Momentum traders look to find stocks that are moving significantly in one direction on high volume and try to jump on board to ride the momentum train to a desired profit. 
Technical Trading - Technical traders are obsessed with charts and graphs, watching lines on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals. 
Fundamental Trading - Fundamentalists trade companies based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions.
Swing Trading - Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit. 

Novice traders might experiment with each of these techniques, but they should ultimately settle on a single niche, matching their investing knowledge and experience with a style to which they feel they can devote further research, education and practice. (You can read about technical trading in Introduction to Types of Trading: Technical Traders.)

Let's begin our exploration of fundamental trading.

Fundamental Data
Most equity investors are aware of the most common financial data used in fundamental analysis: earnings per share, revenue and cash flow. These quantitative factors can include any figures found on a company's earnings report, cash-flow statement or balance sheet; these factors can also include the results of financial ratios such as return on equity and debt to equity. Fundamental traders may use such quantitative data to identify trading opportunities if, for example, a company issues earnings results that catch the market by surprise.

Two of the most closely watched fundamental factors for traders and investors everywhere are earnings announcements and analyst upgrades and downgrades. Gaining an edge on such information, however, is very difficult since there are literally millions of eyes on Wall Street looking for that very same edge.

Earnings Announcements
The most important situation surrounding earnings announcements is the pre-announcement phase, the time in which a company issues a statement stating whether it will meet, exceed, or fail to meet earnings expectations. A trader will want to trade immediately after such an announcement because a short-term momentum opportunity will likely be available.

Analyst Upgrades and Downgrades
Similarly, analyst upgrades and downgrades may present a short-term trading opportunity, particularly when a prominent analyst unexpectedly downgrades a stock. The price action in this situation can be similar to a rock dropping from a cliff, so the trader must be quick and nimble on his short-selling buttons.

Earnings announcements and analyst ratings are actually closely associated with momentum trading, which keeps alert to unexpected events that cause a stock to trade a large volume of shares and move steadily either up or down.

The fundamental trader is often more concerned with gaining an edge on information about speculative events that the rest of the market may lack. To stay one step ahead of the market, astute traders can often use their knowledge of historical trading patterns that occur during the advent of stock splits, acquisitions, takeovers and reorganizations.

Stock Splits
When a $20 stock splits 2-for-1, the company's market capitalization does not change, but the company now has double the number of shares outstanding, each at a $10 stock price. Many investors believe that, since investors will be more inclined to purchase a $10 stock than they would a $20 stock, a stock split will soon increase the company's market capitalization, (but remember that this fundamentally doesn't change the value of the company).

To trade successfully on stock splits, a trader must, above all, correctly identify the phase at which the stock is currently trading. Indeed, history has proven that a number of specific trading patterns occur before and after a split announcement: price appreciation and therefore short-term buying opportunities will generally occur in the pre-announcement phase and the pre-split run-up; and price depreciation (shorting opportunities) will occur in the post-announcement depression and post-split depression. By identifying these four phases correctly, a split trader can actually trade in and out of the same stock at least four separate times before and after the split, with perhaps many more intra-day or even
hour-by-hour trades.

Acquisitions, Takeovers and Reorganizations
The old adage "buy on rumor, sell on news", applies to trading on acquisitions, takeovers and reorganizations. In these cases, a stock will often experience extreme price increases in the speculation phase leading up to the event and significant declines immediately after the event is announced.

That said, the old investor's adage "sell on news" needs to be qualified significantly for the astute trader. A trader's game is to be one step ahead of the market, so he or she is very unlikely to buy a stock in a speculative phase and hold it all the way to the actual announcement. The trader is concerned about capturing some of the momentum in the speculative phase, and may trade in and out of the same stock several times as the rumor mongers work their magic. He may hold a long position in the morning and short in the afternoon, being ever watchful of charts and Level 2 data for signs of when he or she should change position.

And when the actual announcement is made, he or she will likely have an entirely different trading opportunity: the trader will likely short the stock of an acquiring company immediately after it issues news of its intent to acquire and thereby ending the speculative euphoria leading up to the announcement. Rarely is an acquisition announcement seen positively, so shorting a company that is doing the acquiring is a doubly sound strategy.

By contrast, a corporate reorganization may very well be viewed positively if the market had not been expecting it, and if the stock had already been on a long-term slide due to internal corporate troubles. If a board of directors suddenly ousts an unpopular CEO, for example, a stock may very well exhibit short-term upward movement in celebration of the news.

Trading the stock of a takeover target presents a special case since a takeover offer will have a price per share associated with it. A trader has to be careful to avoid getting stuck holding stock at or near the offer price because the stock will generally not move significantly in the short-term once it finds its narrow range near the target. Particularly in the case of a rumored takeover, the best trading opportunities will be in the speculative phase, the time in which a rumored price per share for the takeover offer will drive actual price movement.

Rumor and speculation are risky trading propositions, especially in the cases of acquisitions, takeovers and reorganizations - such events may spawn extreme stock-price volatility. Because, however, of the potential for rapid price movements, these events also potentially serve as the most lucrative fundamental-trading opportunities available. (You can read about swing trading in Introduction to Types of Trading: Swing Traders.)

Conclusion
Many trading strategists have developed rather sophisticated models of trading opportunities associated with events leading up to and following earnings announcements, analyst upgrades and downgrades, stock splits, acquisitions, takeovers and reorganizations. These charts resemble the charts used in technical analysis, but lack the mathematical sophistication. The charts are simple pattern charts. They display historical patterns of trading behaviors that occur close to these events, and these patterns are used as guides for making a prediction about short-term movement in the present.

If fundamental traders are able to correctly identify the current position of stocks and subsequent price movements that are likely to occur, they stand a very good chance of executing successful trades. Trading on fundamentals may be risky in cases of euphoria and hype, but the astute trader is able to mitigate risk by making history his or her guide to short-term trading profits. In short, do your homework before jumping in.

by Jason Van Bergen (Contact Author | Biography)