Thursday, June 29, 2006

Fear of Loss

Fear of trading tends to occur after a string of losses. You must be driven to succeed, and consistently taking action by following your method is critical. Find out how to get on track and be ready to consistently pull the trigger on new trades I notice that many traders continue to experience the issue of executing their trading ideas consistently, especially after a losing streak. Fear of trading after a string of losses is experienced by most traders at one time or another. The reality is that human beings tend to do things that either maximize pleasure or minimize pain. And not pulling the trigger on trades becomes a way for traders to minimize pain, as mentally the thought is that we are not causing ourselves any more damage if we do not trade. The problem is that we then remain stuck in a state of fear until we can TRUST our method again and start taking trades. This is why its so critical to have a trading plan that is tested and then be able to stick with it.

Heres a game plan for getting yourself back on track:

1) Define Your Trading Plan - If you already have a plan, reexamine it. Are you following your rules for entry, exit and money management? Does your plan still have an edge in the current market conditions?

2) If In Doubt, Get Out - Who says you have to trade every day? If you are not pulling the trigger on your trades, it is because you lack confidence in yourself or your plan. Try taking a step back for a short while, where you consciously decide not to trade real dollars, but that you will work on paper trading your buy and sell signals. Sure, its not the same as trading real dollars, but this step allows you to work on executing your trading plan. I have found systematic trading to be much easier than discretionary trading, because it helps take my ego out of the equation. I focus instead on the execution of buy and sell signals, as opposed to my ego wanting to be proved right. Paper trading will allow you to get refocused on execution of your ideas.

3) Measure Your Results - Too often traders may have a good plan but then lose sight of measuring their results on a regular basis. What this leads to is that 90% of your trades may be done properly, but it is those 5-10% of your trades that eat you up with big losses. If you monitor your results closely, you should start to develop a Success Profile which defines what your best trades look like. Once a trade doesnt fit this Success Profile anymore, you should look to exit (whether at a profit or a loss) as your edge no longer exists.

Good day and good trading.

Wednesday, June 28, 2006

Annual Reports

Easy Reading: The A,B,C's of Understanding Annual Reports

In my investing seminars, I make it a point to ask my audience for a show of hands to find out if they actually read the financial statements sent to them by the companies in which they invest. The answer is invariably, about 3-5% of the attendees.

That is an abysmal percentage, yet completely understandable. Just the thought of reading and comprehending the small print, convoluted charts and the seemingly-endless gobbledygook of the legalese contained in the pages of 10-Ks and annual reports can put a glaze over the eyes of even the most avid of investors.

However, the rapidly-changing, instant-information, highly-competitive age that we live in today necessitates that astute investors gain a thorough understanding of their investments. And financial reports - although historical in nature - are very important barometers for gauging just how well - or poorly - your companies are performing today, as well as good indicators of future performance. Consequently, you should learn to read them for one very good reason: to become a better and more profitable investor.

In the pages of these reports, you will find numerous tidbits that will give you a wealth of information about your companys most recent, current, and future strategies, actions and results. And armed with that information, you can make much better investing decisions, which will hopefully, translate into increased portfolio returns.

In this missive, I hope to convince you of two critical points: The importance of staying on top of the financial health of the companies in which you invest, and how easy it is to do that. Now, you are surprised, but I promise you, once you get the hang of knowing just where to look and which parts are important, you will be breezing through the thickest of financial reports in less than an hour. So, where do you start?

Very simply, at the beginning - with the 10-K - the summary of a firms performance that the Securities and Exchange Commission (SEC) requires every public company to submit 60-90 days after the end of its fiscal year.

The 10-K incorporates the data from that nice, shiny-paged, colorful annual report that most investors receive from the companies in which they hold stock. If your companies dont mail them to you, you can easily access them at no charge either through the companies own web sites (generally, in the Investor Relations section) or through the SEC at

Before you start your exploration, you need to know that the financial statements for just one year wont give you a very complete picture of the companys status. For a thorough review, you really do need to compare at least 2-3 years worth of data. So, pull up a 10-K, relax and lets go investigating.

The easiest way to tackle a seemingly-complex task is to break it down into manageable tasks. Fortunately, the 10-K is already divided into 4 primary sections:

Part I includes Business; Properties; Legal Proceedings; and Submission of Matters to a Vote of Security Holders. This section will provide details on the companys revenues, marketing plans, major products, competition, and risk factors. If you compare it from year-to-year, you will be amazed at just how much you can learn about the changes in the firms strategies, product lines and where it stands among its competitors and its marketplace.

You will also want to keep a keen eye on the firms legal proceedings. In todays world, it is not unusual for a business to be involved in lawsuits. What you need to know is how much the proceedings could potentially cost or earn them, and if that amount will have a material effect on the company. If a business doesnt or cant answer those questions, you may want to reconsider your investment.

Part II includes Market for Registrants Common Equity and Related Stockholder Matters; Selected Financial Data; Managements Discussion and Analysis of Financial Condition and Results of Operation; Financial Statements and Supplementary Data; Changes in and disagreements with Accountants on Accounting and Financial Disclosure; Controls and Procedures; and Other Information.

The most important part of this section is managements discussion of the most recent reporting period, as compared to prior years. Here, the company will give detail of the major events affecting its operations, such as divestitures and acquisitions, which, when compared to previous years reports, will give you a good sense of the firms ongoing growth strategies. Any restatements of financial statements will also be noted here, and you want to make sure that will not create an ongoing problem for the business, nor is it a regular occurrence.

Next, you get to the heart of the report - the financial performance summary of the company and the events that affected it - good or bad. This will include an analysis of income and expenses, margins, changes in debt, liquidity, capital, leases, taxes, pension plans, accounting changes, related-party transactions, and executive compensation. Here, you will want to watch for out-of-the ordinary changes that may have a major impact on the companys bottom line. Are expenses, as a percentage of revenues out-of-line? Are margins steady, and growing? If the company has taken on large quantities of debt, is it funding growth of sales and earnings, or is it just creating more interest payments?

Pay special attention to the pension section to make sure the company is on top of its funding and hasnt squandered the pension monies of its retirees. If it falls behind, one day it will have to play catch-up. Related-party transactions can also be of importance, to ascertain if a companys shifting money among subsidiaries is on the up-and-up or suspicious. You may also find out if the firm is making unwarranted and unethical loans to upper management or directors.

Lastly, executive compensation needs to be reasonable. You will have to consult the companys Proxy statement for complete details, but its a worthwhile task. Just ask yourself, is the executives pay (including options) in line with the revenues and earnings the company is producing?

Part III includes Directors and Executive Officers of Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; Certain Relationships and Related Transactions; and Principal Accountant Fees and Services. Take a good look at your companys directors and officers. Is there a revolving door at the firm? If so, it could mean tumult in the management suite or board room and may create havoc in the companys finances. Or has the companys management been around too long - fat and happy - without the drive and ambition to continue making the company successful?

It is always interesting to see the level of and changes in management and beneficial owners shares. Are they buying or selling? How many shares do they still own? Is management putting its money where its mouth is? Beware of companies whose key management members do not invest in its shares, or those who are aggressively selling shares while making glowing statements about the companys future.

Next, does the company change auditors frequently? This is a potential red flag, and could possibly portend doom and gloom for the financial health of the business. Note that this information may not be complete in Part III; you may be referred to the companys proxy statement or an exhibit accompanying the 10-K.

Part IV includes Exhibits, Financial Statement Schedules; and Reports on Form 8-K. In this section, you will find detailed financial statements. Please read them and compare them, year-over-year. Look to see how the individual accounts have changed. On the income statement, pay attention to changes in operating income, including cost of sales, and increases or decreases in selling & administrative and operating expenses, as a percentage of sales. Can the company easily cover its interest expenses? Is income growing because of increased sales, lowered expenses (including taxes), or both?

On the balance sheet, review the changes in inventories, accounts receivables and payables, which will give you a good read of the companys efficiency. Again, run a keen eye over the firms debt levels. Is short-term debt growing too quickly and staying in place too long? Do goodwill and intangibles look reasonable?

The cash flow statement has one primary purpose - to show you where the company received cash and how it spent it. The most important line is Cash Flow from Operations. This is the cash that a company takes in from its day-to-day business. If it is an amusement park, the cash is from ticket, merchandise and food sales. Is this number positive; is it trending positive, from year-to-year? Its great if a firm is making money from real estate sales or investments, too, but the bulk of its cash should be derived from the business operations.

Although a companys 10-K is much more comprehensive than space allows me to review here, I believe these pointers will considerably aid you in your search for good investments.

And I hope that this information will encourage you to become regular readers of your companies financial statements. This process will give you greater insight into their current strategies as well as future possibilities. Once you have read a handful of these reports, you will begin to have a much better understanding of what makes a good company good and a bad company bad.

Good day and good investing.

Tuesday, June 27, 2006

Books on Trading

When I first came into trading, I asked my mentor to recommend some books to me so that I could get on the fast track to trading well. He recommended several to me, most of which were psychological books. I remember being baffled about why he recommended these books. I was thinking, why doesnt he just recommend a book to me that tells me when to enter trades and when to exit them?

Soon after I started trading, I found myself making all sorts of errors. When I was testing, I started getting excited and started to interpret numbers in flawed ways. I began hoping that individual tests would yield positive results. I was convinced that I would come up with a unique, highly complicated system that would be better than everyone elses. Once I started trading, I hoped that my trading would be fast paced, with lots of quick moves and split-second decisions because it would make me feel sophisticated, unique and smart. I also found myself getting bullish when everyone else did and bearish at the same time as everyone else. It was because I was not aware that daily news affected my perception of the markets.

Soon I found out that the errors I was making had less to do with trading and more to do with emotions and my ego. I interpreted numbers in the wrong ways because I wanted to be special, not because it was the appropriate way to interpret the data. I jumped to conclusions in testing because I wanted to look good to my peers and to my superiors, not because the data was conclusive. I got bearish and bullish at the wrong times because I was afraid of missing out on call opportunities when the market reached tops, and I felt like I was missing out on put opportunities at market bottoms. It was the need to be right and my fear of being wrong that drove this erroneous thinking and behavior. I finally learned one of the most important lessons in trading! Trading has more to do with psychology and less to do with technical and fundamental factors. All law-abiding traders have access to the same data. Its what they DO with that data that makes the difference between profit and loss. Today, we will discuss emotional accounting, trading goals, and emotions.

Emotional Accounting

Is it possible that a person would have $1000 cash in one place, and a $1000 in cash in another place and value the two differently? $1000 is a $1000 right? Not for some people. Have you ever heard a friend say this? I just made a lot of money on a gambling trade and I feel like its not even my money. I can just blow it and theres no loss. Or, I just won a ton of money gambling. Heck, it's not even my money. I've got nothing to lose.

I bet you have heard something like this before. Congratulations, you have just encountered new trading knowledge. Namely, you now know what emotional accounting is and how it can affect your trading. Its true that you should treat your retirement money differently from your discretionary income, but when it comes to trading, all cash should be respected, lest you lose your shirt and your cash. Ive heard a story of trader working a system that produced 26 profitable trades in the row, then he bet his whole account on the 27th trade only to give back ALL of his profits and quit the game altogether. Does this surprise you? Dont be too shocked because it happens every day. Its happening this very moment. So remember this: respect your cash! Your cash represents your blood sweat and tears that you worked for. More importantly, recognize your change in emotions when you get overly excited, and be careful with how much you marvel at your own genius. Operate by a money management system rigidly so that you dont fall victim to the bet-the-farm mentality or the may as well lose it all approach to trading. $15,000 is still $15,000, no matter how you made it. If you trade your profits recklessly, you will never get ahead in the game. Stay disciplined and systematic.


Heres another note on emotions. Remember this. It is very common for traders to begin evaluating THEMSELVES because of short-term results in the market. For example, it is common for a trader to get out 3 trades in a row too early then ask himself, Am I much too conservative a trader? Or in many cases, the opposite occurs by a trader who becomes too aggressive. The point is, beware of this. Dont evaluate yourself too often because of short term results. Many times, things just happen because the market makes it happen. You have no control once you enter a trade. The market is in control and you simply have to let go and realize there is an element of luck and of chance in trading. Stick to your system! Everyone knows that setting goals for your life and for trading will reap huge benefits. But is there a drawback to setting trading goals? It depends on how you set them. For example, if you set a goal of a 5000% annual profit target, its likely that you set that goal arbitrarily. Do you believe you can hit that goal? If so, you will likely set plans to achieve the goal. If you dont believe you can hit 5000% annually, then you probably wont make make an actionable plan to do it. The point is, traders should set realistic goals that they believe they can hit. Also, never forget this: the higher your goal is, the more risk you will have to take on to hit that number. That means if you are willing to take the necessary risk to reach 100% annually, you will have to be willing to lose at least 30% annually as well. The additional expected risk is unavoidable so long as you are talking about trading in a law-abiding way.


To conclude, always keep these concepts in mind while trading: Take note of your tendency to account differently for the same amounts of money. Respect all of your trading capital, especially realized profits. Recognize your tendency to get emotional and to over evaluate yourself according to short term fluctuations. Realize that your ego is involved in trading. Keep your ego at bay by being systematic in execution and system development. Only set goals you can see yourself achieving and be aware of the unavoidable risk necessary to reach higher goals.

As my mentor recommended to me, I will recommend to you now. Read more books on trading psychology as the biggest thing that you can control is your mind as you cannot control market. Click the Books on Trading header link above to view all the titles available.

Be disciplined and trade well. Goood Day.

Monday, June 26, 2006

More Option Trading

Some of you will already understand todays concepts, while others may not. In either case, its a lesson worth learning for the first time, or again. For those of you who dont trade options, dont quit reading just yet - I will be wiping away some of the mystery behind option pricing.

As a basic review, an option is simply the right to buy or sell 100 shares of a stock at a predetermined price, within a predetermined amount of time. Of course, if you want to have this right, you must pay for it. This is what investors do when they buy an option - they pay someone else for the right to buy or sell a stock before the option expires. Obviously anyone who buys an option is reasonably confident that the stock will change price as they predicted. If they are correct in their prediction, the option they purchased will increase in value, and they can sell it for a profit (or they can choose to exercise the option). Conversely, the person who sold the option to the buyer thinks the stock will not move as the buyer predicted by the time the option expires.

For example, suppose XYZ company shares are currently trading at $35. If I buy an August 35 call option on XYZ company at a price (or premium) of $5.00, I am buying the right to buy 100 XYZ shares at $35 per share by Augusts expiration day. For this right, I am paying $500 (100 shares x $5.00 premium = $500 ). Obviously I feel that XYZ shares will be at least $5 higher than the current price by the time the call option expires, since I was willing to pay $5 more (per share) than their current value for the option. But I only have a few days to turn a profit before the option expires, so the clock is ticking on my prediction. Suppose that between the day I purchase the call option and the day the option expires, the stock moves from $35 to $45, for a $10 gain. Since I own the right to buy XYZ shares at 35 per share, and shares are at $45 before the option expired, how much is my call option worth? Lets see. If I can buy 100 shares at $35, and sell those 100 shares at $45, I can make a profit of $10 on each of those 100 shares. That makes my call option worth $1000 (100 shares x $10 premium = $1000). Since I originally paid $500 for the option, my net profit of $500 gives me a gain of 100%.

Unfortunately, option pricing in the real world is not nearly as black and white, nor is it that simple. Most option traders know that just because a stock changes price by a certain dollar amount, it doesnt mean that the option does too. The difference between the dollar change in the stock and the dollar change in the option price is known as delta (one of the greeks in option trading). For example, if the delta for an option is 50, this means if the share price of the stock goes up by $1.00, then the premium (or price) of the option will only go up $0.50. Why is knowing the delta of any particular option important? It allows you to set accurate, yet reasonable, price targets for your option trading.

As always, a real-life example will best illustrate this point. Take the Nasdaq 100 Trust (QQQQ) for instance. Yesterday the QQQQs closed at 38.72. One of the closest in the money options for the QQQQ's is the August 36 call, which last traded at a premium of $3.20. The delta for this option is 83.7, meaning for every $1 the QQQQ's move, the option premium will theoretically change by $0.837. If the QQQQ's move higher by $1, then the option premium will move to a theoretical $4.00 (options only trade in nickel or dime increments) for a gain of 25%, or about 80 cents. But what if the QQQQs lose $1.00? Then you will have lost about $0.80 of your $3.20 premium, or about 25%. Not an enviable outcome, but not as bad as losing a whole $1 on your $3.20 investment.

On the other hand, the August 38 QQQQ call last traded at $1.75, and its delta is 65.1. If the QQQQs move up $1.00, then the option price increases to about $2.40, for a 41% gain. Should the QQQQs fall by $1, then the option price falls to $1.10, for a 41% loss. Thats not necessarily good news either, but the upside potential is also much higher than with the August 36 calls.

So now that you know, the question is, are you trying to squeeze blood from a turnip? In other words, are you setting price targets on your option trades that are completely unachievable? If you are thinking the QQQQs are only going to move by $1, then your targeted price change for your QQQQ options need to be appropriately less than $1. In fact, the less in the money the option is (like a strike price of 38), the lower your expected dollar change target needs to be. Of course, on a percentage basis, you get more bang for your buck that way.....but with additional risk. If your option is really deep in the money (like a strike price of 32), you may find that your delta is almost 100. Risk is minimized, but so is the potential percentage gain.

So what determines delta? Primarily the time left until expiration, and how deeply in the money the option is. In other words, how risky an option is will determine the delta value. But the delta calculation isnt even the critical point of todays TrendWatch. The goal today is simply to point out that not all options are created equal, and that you must weigh the risk and reward potential of each one. And more than that, knowing delta data allows you to set reasonable price targets based on what the underlying stock is likely to do. The delta analysis is a logical, organized way to add some precision to your option trading.

For a detailed look at delta analysis and other option pricing models, I recommend Leonard Yates' High High Performance Options Trading, and Sheldon Natenberg's Option Volatility & Pricing. Click the More Option Trading header link above to view these books.

Sunday, June 25, 2006

Option Trading

There are many different things to consider when deciding whether or not to trade options. Even if your familiar with options trading, hopefully a few things in here will be new to you. Here are the most important things you need to know about options.

An option is a derivative, meaning its price is based on an underlying asset. These underlying assets can either be stocks, ETFs or Indexes. Buying an option gives you the right, but not the obligation to purchase the asset at a specific price (called the strike price).

There are two types of options, Calls and Puts. The value of Call options increase as the value of its underlying asset increases. Traders buy Calls when they think the price of the asset is going to go up. The value of Put options work the opposite way, they increase as the underlying asset decreases.

For Call options, if the price of the underlying asset is below the strike price of the option then it is out of the money, when the price of the asset crosses above the strike price it is called, in the money. This too works the opposite way for Put options. The price of the option has the greatest percentage moves when it crosses from out of the money to in the money but out of the money options also have the most risk.

Options are not issued by companies like stocks are. All options that exist are written or sold by another trader somewhere in the world. So in a way, you are directly betting against that person if you buy an option. They make money if the price goes down and you make money if the price goes up. Of course, if you get into selling options, it works the other way.

All options have an expiration month. The option will expire at the close of trading on the third Friday of that month. If you are still holding the options at that time they will expire and be worthless.

When you trade options you are buying or selling options contracts. Each options contract controls a block of 100 options on 100 units of the underlying asset. So if the price of a call option is $2.00 and you want to buy 4 contracts you will pay $800.00 (2*4*100) and with this you will have the right to purchase 400 shares of the stock.

There are a variety of different trading strategies that options can be used for. The most basic and probably the most common is simply buying Puts and Calls. More strategies include selling options, and using sets of options for calendar spreads, straddles, strangles and butterflies.

There is much more involved with trading options, but these are some of the most basic concepts to help you get started. If you would like to learn more, click the Option Trading header link above to go to the Invest SuperStore DVD's & Books about trading options or watch for future articles about this topic here.

Good monday and good trading.

Saturday, June 24, 2006

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQs close at 2121.47 on Friday was the result of an 8.48 point loss for the week. It was only a 0.40% dip, but still a far cry from the bullishness that was hinted at a couple of times over the last few sessions. Although the underpinnings are still bullish, the fact of the matter is the NASDAQ is being held down pretty well by its short-term moving averages.

The trouble spot is the 20 day moving average line (blue) - the precise turn-back point on Wednesday as well as Friday. It wouldnt be as big of a deal if it were not also the turn-back point on June 2nd. Being unable to get back above the 20 day line then resulted in about a 140 point dip. Thats why we dont want to jump the gun now...the current price chart looks too much like the chart from early June.

On the other hand, there is one key difference between then and now. Then, the 200 day line (green) may have been the key resistance level. It was placed right where the 20 day line was then as well. So, maybe that was the culprit - we just dont know yet. What we do know is that the 20 day line - at 2142 - is the problem now. Until the NASDAQ can make a close above it, we cant get officially bullish.

That said, we are going to be a little inconsistent here and say that the upside gain potential is far greater than any likely downside move. Although not shown on our chart, we saw several internal indications (based on breadth and depth) of a capitulation on the 12th and 13th...the days that resulted in the lowest close of the year (2072.47). We got hints that it was indeed a bottom, in the form of a sharp rally over the next two days. However, we have gone nowhere since then. In other words, the NASDAQ had defied the odds so far, but the bullish potential is still there. If we do manage to break above the 20 day average - and thats a big if - the upside move could be major, and possibly carry the composite back up to this years highs (about 300 points). The potential downside move is only about half that size (or 150 points). A close under last weeks low of 2103.27 would be the signal for such a downside move.

Nasdaq Chart

Click here to view bigger chart.

S&P 500 Outlook

A loss of 7.05 points from last Fridays close left the S&P 500 at 1244.50. The 0.56% dip was slightly bigger than the NASDAQ's, but like the NASDAQ, there was clear resistance at some short-term averages. So, as bullish as the foundation is right now, we cant sink our teeth into the idea of going least not yet.

Last week we mentioned that the S&P 500 had developed a bearish trading range (see dashed lines). At the time, the index was headed higher, but had yet to reach the upper side of that zone. As such, it was possible that stocks could still head higher over the course of the next few days and still not actually break the bigger downtrend. Well, thats basically what happened. The SPX rallied up to 1256.77 on Wednesday, came close to brushing the upper edge of that zone, and then pulled back on Thursday and Friday. Needless to say, the S&P 500 is still technically in a bearish trend. In this case, only a break above that line would get us to think like bulls again. The bullish confirmation would only come in the form of a close above the 200 day moving average line (green), currently at 1261.75.

The problem is, as of right now, it looks like the SPX is rolling over. By that, we just mean that the rate of gain has become non-existent, and we have started to see a lot of closes on the lower ends of the daily bars. To see it occur right after resistance was hit only makes things that much more bearish. So the bearish concern from here is that we stay within this channel, and fall all the way back to the lower edge, currently at 1204 (and sinking).

On the flipside, there are two upside catalysts. The first one is a stochastic buy signal (highlighted). However, we got a stochastic buy signal about three weeks ago, and that one didnt really pan out. The second bullish sign is in the CBOE Volatility Index (VIX). It had developed a support line of its own, but that line was broken at the end of last week. So with the VIX likely headed lower after peaking at 23.81 on the 13th, we have to give a little credit to the bulls. The final test for the VIX will be a close under last weeks low of 14.88. Thats where a support line seems to be in place as of Friday, and only a close under that mark would confirm that the VIX is indeed headed lower.

S&P 500 Chart

Click here to view bigger chart.

Dow Jones Industrial Average Outlook

Even in weakness, the Dow is the bright spot, only losing 0.24% this week. The close at 10,989 on Friday was only 26 points below the prior weeks close. However, the Dow is also plagued with problems similar to those of the SPX and the NASDAQ - specifically, resistance at some key moving averages. On the other hand, the Dow at least managed to break above significant straight-line resistance (dashed).

For a while last week, it looked like the Dow might end up closing above the 10 and 20 day moving average lines (red and blue, respectively), resulting in a short-term buy signal. But, Fridays weakness pulled the index back under the 10 day line. That pullback was prompted by Wednesdays brief encounter with the 100 day line, then at 11,080. We have now seen this line act as resistance as well as support, so we are going to keep watching it closely. In the meantime, Fridays wasnt the most bullish close we have seen.

On the other hand, the Dow broke above a key resistance line as well as moved back above the 200 day average (green). And, this most recent stochastic buy signal has progressed a lot more than the last one did, so maybe this is the one that will get some traction.

Support is at 10,898, while resistance is at 11,142 and 11,203.

DJIA Chart

Click here to view bigger chart.

Have a good week.

Friday, June 23, 2006

Trading Zone

The Zone is a place where every trader wants to be to perform at peak levels. The zone is a place where time is considered to slow down or almost stand still, where you feel acutely more aware of your surroundings, at one with your environment. This transcendent state is often called other things, such as a runner's high for athletes feeling the endorphin surge released during physical exertion.

Mihaly Csikszentmihalyi named this experience (and the title of his book) Flow, and he noted that people who are doing what they love to do tend to have the best odds of getting into this flow. They become totally absorbed in the present moment, with no distractions (can you say this about your trading?). He also called flow a mindset that is intrinsically rewarding. This suggests that we should trade not only for the money, but also because we enjoy it on a deeper, more personal level. Great traders, like those shown in Jack Schwagers Market Wizards series of books, show a love of the trading game itself in addition to the desire to make money.

So how do we get ourselves into this flow state? Csikszentmihalyi defines six important prerequisites to allow entrance into the zone:

1) Confidence - As a trader, you must have confidence in your trading method, and believe that you will succeed if you implement your trading plan. This allows you to place your entries and exits promptly and thoroughly.

2) Focus - A narrow focus on the task at hand is required to get into the zone. Fears about the outcome and regrets about past losses do not exist here.

3) Visualization - A trader pictures what success look like, and gets in the zone through visual processing of data. Verbal cues can take a trader out of the zone.

4) Pleasure - When you enjoy trading, it raises the odds that you will participate fully and maximize your efforts. This increases your chances at achieving mastery which further increases your enjoyment. Those who view trading as work will feel a struggle to find great trades, while those who love trading will feel in harmony with the markets and opportunities appear more easily.

5) Relaxation - Once you get to the zone, you may tense up as you feel in new territory. Fear tends to bring you out of the zone. Stay relaxed to let yourself stay in the zone.

6) Excitement - Some tension can help performance, but too much intensity will create undue stress and hurt performance.

The other element traders need to get into the zone is Preparation. Larry Bird hit key shots under pressure in basketball games because he had practiced so many times in the gym that his shots under pressure felt more automatic to him, which increased his confidence. Traders must spend the time necessary to make trading skills automatic and create winning trading habits. When you are totally focused, you cannot be thinking about technique or strategy. Preparation and practice allow you to develop the skills you need to stay in the zone.

Have a good weekend.

Profitable Stock Investing

7 Critical Steps to Profitable Stock Investing

Investors Business Daily publisher William Oneil Canslim stock investing method stands the test of time. Click the Profitable Stock Investing header link to learn more about Canslim investing. Read more below on simple key analysis to know before buying any stock.

If a business is fundamentally strong (i.e. it actually makes money), has a diversified product line, and is in a solid position in its market, you are 90% of the way to finding a good investment. The remaining 10% is just a matter of looking at a few parameters - no matter what the company does - to determine if its the best stock for your investment dollars.

I will review here seven key metrics that should be reviewed before buying any stock. These indicators should help you get most of the way in understanding a company, its operations, and its underlying business.

1. Institutional activity. Pension funds, mutual funds, hedge funds, insurance companies and corporations that buy and sell huge blocks of shares can create tremendous volatility in prices. To lessen this risk in your investments, try to buy shares in companies where institutions own less than 40% of their shares. You can find this information at, in the Institutional Holders section.

2. Analyst coverage. Another indication of future share volatility is the number of Wall Street analysts covering a stock. Analysts - like the big institutions - have a herd mentality. When one sells, so do the rest, resulting in great numbers of shares changing hands, and usually leading to price declines. Its best to avoid companies with more than 10, or fewer than 2 analysts following them. (You need some analyst interest or you may be waiting a long time for price appreciation, even in the strongest and most undervalued company). You can locate the number of analysts - and which firms they work for - at then select Analyst Opinion.

3. Price-earnings ratio (P/E). The price of one share of a companys stock divided by four quarters of its earnings per share, the P/E ratio is of utmost importance in determining if a companys shares are over or under valued. For the best perspective, go to, then select Ratios and compare the current P/E of the company to its average P/E for the last 3-5 years, to its estimated future P/E and to the average P/E of its industry or sector. One note: If a companys P/E is more than 35, it might be too pricy. You may want to stick with companies that are trading at lower P/Es, particularly if you are fairly new to investing.

4. Cash flow. One of the most important parts of a financial report is its Statement of Cash Flows, which is a summary of how the company made and spent its money. Go to, Financials, then to Cash Flow and select Annual or Quarterly, depending on which period you want to review. Then find Total Cash Flow From Operating Activities, which represents the cash the company took in from its primary business operations. If it sells clothes, its the cash collected from selling clothes.

Its important that this number be positive, or at least trending positive over the course of a year. After all, if the business isnt making money from its primary product - not from investing in real estate or the stock market - then you probably want to pass it by.

5. Debt/equity. This ratio is how much debt per dollar of ownership the business has incurred. Compare the firms historic debt/equity ratios, so you can find out if its debt level over the past few years has been rising too rapidly. Debt isnt bad, as long as it is used as a springboard to grow sales and earnings. Next, contrast the companys ratio with its competitors and its industry so you can further determine if your companys debt position is reasonable. These ratios can also be found at, under the Ratios tab.

6. Growing sales and income. A rule of thumb that has always served me well: Buy shares in companies whose sales and net income are growing at double-digit rates. I cannot emphasize this enough, as, appreciation in stock prices is generally precipitated by growth in earnings (which usually follows expansion of sales). Its certainly possible to buy stock in a company that has no earnings growth (a new business, or a tech company in the late 90s, for example) and still make money on the shares - short-term - but its not a formula for serious, successful long-term investing. This ratio can also be found on, on the Ratios page.

7. Insider activity. Investors will also want to review the buying and selling activities of a companys insiders - its top officers and directors. A sudden rush to sell large quantities of the firms shares may be a good indicator that the business is falling on rough times. Likewise, a large increase in purchases may mean good news is on the way. The website, under the Insider Transactions tab, lists all the recent insider activity at the company, as well as the number of shares remaining after the sale, an extremely important figure.

Remember that no one ratio will determine the validity or potential of your investment. It is of utmost importance that you take a complete look at a companys financial strength and its future prospects, by conducting a thorough analysis over time, usually a 3-5 year track-record.

With these 7 critical factors in hand, it wont be long before you feel very comfortable in analyzing stocks in almost any industry.

Have a good weekend.

Wednesday, June 21, 2006

Trade Planning

Business Planning

When people choose to trade the markets, they always want to rush in and get started straight away. They foolishly think that are going to miss the next big wave. But the market doesnt know when you get in or when you get out. So dont be foolish, take the time to plan.

The entry price to being a trader or investor is fairly low. All you need is enough money to open an account. Your broker doesnt care whether you understand expectancy or objectives. Your broker doesnt care whether you understand that position sizing is the key to meeting your objectives. And your broker certainly doesnt care that you must have your personal psychology in order for any of the other to matter.

Your broker cares about two things:

1. That you have enough money to open an account, and,

2. That you dont lose many times the value of your account so that the broker gets in trouble.

Thats it!

You can easily open an account without knowing the first thing about trading.

Is this true of other professions? Can you become an engineer without understanding calculus? Can you become a doctor without going to medical school? Can you be an attorney without passing the bar? Of course not.

Similarly, could you play golf against a pro the first time you stepped on a golf course? Would you put yourself in a chess tournament against a master player if youd never played before? If so, the worst you could do is lose a few games or your pride.

But what do people lose in the markets? Anything from a few dollars to their life savings; yet there are no rules about who should or shouldnt be in the markets.

Day in, day out, people jump into the markets recklessly: without experience, without training and most definitely, without any type of formal plan. In fact, your broker may not even know the real nuances and fundamentals of safe and profitable trading themselves. And more often than not, people who open a brokerage account will lose money.

If you are serious about being a good trader, then you need to approach the practice of trading with the same level of rigor in which you would approach any high level endeavor. The market does not owe you or anyone great riches. The market does, however, occasionally tease a large number of people with seemingly easy gains (during bubbles and other manias) only to take them away again.

Trading is a business. Its a profession. Its a skill to learn.

Most businesses fail because they fail to plan.

Business planning is the backbone to success. It shows you where you are coming from and helps you to organize your thoughts and your objectives, and come up with a plan to keep you trading successfully and in the markets for the long term.

Therefore Dr. Van Tharp recommends that every trader or investor develops a thorough business plan to guide your trading. And even if you are trading well, he still recommends developing a planning tool. Those who are doing well will just have a little less work to do.

Your business plan should cover all of the following areas:

Your vision.

Your purpose.

Your objectives.

A thorough self-assessment of your strengths and weakness based upon real trading logs that you collect (if you haven’t done so already).

A thorough assessment of the big picture and the fundamentals that might be behind any trend.

A complete understanding of your beliefs about the market.
Procedures for getting empowering beliefs and mental states behind you.

A documentation of your research procedure for developing new systems and determining how to analyze their effectiveness.

Your procedures for developing and maintaining discipline.

Your budget and cash flow systems.

Other necessary systems such as marketing, back office record keeping, etc.

Your worst-case contingency plan.

System 1—which is compatible with the big picture.

System 2—which is also compatible with the big picture.

System 3—which might come into play should the big picture change.

If you have all of those things, then you have a chance of doing well. But your business plan becomes a tool for you to continually use to improve yourself and your trading.

How to Handle Hot Tips:

What happens when someone gives you a tip or idea about the market? Do you get very excited about it and want to act? In some cases, you probably do act. Or, do you become skeptical and suddenly distrust the person giving you the tip? Or do you notice if the tip fits into your game plan? If it fits your plan, you need to do more evaluation according to the criteria that you use in your plan. If it does not fit, then you simply discard it, saying thats not something I know much about.

The only correct response to any hot tip is to integrate it into your game plan for trading to see if it fits and you can evaluate it. An improper response is to go out and buy some closed end Thai mutual fund just because Van Tharp recommended it.

Van Tharp discusses mental rehearsal as one of the ten tasks of trading. The point of mental rehearsal is to determine what could go wrong with your trading plan and determine how to deal with it in your mind. That way, when it does occur under the heat of battle, you are ready to deal with any distractions that might come up. Think of the tip you received as a possible distraction. How did you react?

This tip is a test in several ways. First and foremost it is a test of whether or not you even have a game plan.

Do you have a plan that helps you deal with learning of a new sure-fire cant lose investment you have heard about? If not, then its time you developed one. Just do whatever it takes to develop a thorough business plan to cover your trading or investing.

Having a plan of this nature is so important that Van Tharp ranks it among his top requirements for traders.

Every outcome is preceded by a process. You will not make money trading unless you follow a predetermined plan and continually stick to that plan. Thats why you should pat yourself on the back every day if you can honestly say that you totally followed your rules throughout the day. Every Market Wizard arrives at that stature by taking one trade at a time. The primary difference between that person and the average trader is that the Market Wizard probably continued to follow his plan every single day.

About Van Tharp: Trading coach, and author Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

Click the Trade Planning header link above for more information on Dr. Van Tharp and his training courses for traders and investors.

Tuesday, June 20, 2006

Perfectionist Trading

Perfectionism may help some people succeed in many other careers, but it can be fatal in trading. Ironically, it leads neither to higher performance nor greater happiness. Perfectionism can destroy your enjoyment of trading. Focusing on flaws and mistakes depletes energy. This may escalate to panic-like states prior to making the trade, impairing objective performance. At some point perfectionistic standards get set too high, and life is measured in units of accomplishment. The drive to be perfect becomes self-defeating, as the individual often places the intense pressure on himself, which can become crippling.

Perfectionists share a belief that perfection is required in order to be accepted by others. The reality is that acceptance cannot be gained through performance or other external factors like money or social approval. Instead, self-acceptance is at the root of happiness. The biggest obstacle to overcome that I have faced is fear of failure. If you have a perfectionist mentality when trading, you are really setting yourself up for failure, because it is a given that you will experience losses along the way in trading. You have to think of trading as a probability game You cant be a perfectionist and expect to be a great trader. Your losses (that you hope will return to breakeven) will kill you. If you cannot take a loss when it is small because of the need to be perfect, then the loss will oftentimes grow to a much larger loss, causing further pain for the perfectionist trader.

The objective should be excellence in trading, not perfection. In addition, you should strive for excellence over a sustained period, as opposed to judging that each trade must be excellent. In trading, the great ones make their share of mistakes, but they are able to keep the impact of those mistakes small, while getting the most out of their best ideas. In order to change long established behavior patterns and personality characteristics, it may be necessary to enlist the support and services of a qualified professional. Long established habits, beliefs and traits never change overnight, but acceptance of a problem is a first step.

Here are a few tips consistent with attempting to become less perfectionistic:

Begin to appreciate the process as well as the outcome - set more achievable goals
Realize that you are worthy no matter whether you win or lose on a given day
Focus on achievement less and on enjoyment more - you may even be surprised with more favorable outcomes

Dont be so critical of your errors - just learn from them
Set one goal and make it process oriented - forget about the outcome. If you achieve that goal to improve your trading via that goal, you win no matter the outcome. Perfectionists often seek to control uncontrollable factors in a trade (like waiting for all the risk to be out and everything to look perfect, the quality of the fill on the exit especially, hoping or willing a better outcome by doubling down on a loser, and many more). When a trader focuses on these uncontrollables, he is more likely to tighten up and not be able to pull the trigger to exit a losing trade or miss out on a new winner that has moved too far.

Based on these perfectionist tendencies, I recommend the following entry strategy for perfectionists. Enter half a position as soon as you see an opportunity that generates at least 3 times the reward for the risk at the current market price, then place the remaining half at your desired perfect entry price. For exits, always place market orders, as the tendency for the perfectionist is to try to get a better exit price with a limit, and then keep missing the exit on the way down.

Heres how this strategy can work as an example: Buy just half of a $10,000 position in a stock as your initial order. If the stock goes down in price, dont buy any more of the stock. If it goes down to your stop price, sell the stock to take your loss. However, if the stock moves up in price from your initial buy point, and it is performing relatively well, you might add another $3,000 to your original $5,000 buy. You would have $8,000 of your $10,000 total position in the stock already committed. If the stock moves up another few percent, you can finish your $10,000 position by buying another $2,000. In this way you average up, not down. You only want to add money if your prior buys are working.

Good day and good trading.

Monday, June 19, 2006

Traders Mind

One of the questions I commonly get is what sort of mindset or mental parameters are needed to truly be a successful trader. While there are literally volumes of books on the mental side of trading alone, the real challenge for most true traders is living in the past. A loss is a tough thing to get over, and the bigger the loss, the tougher it gets. But getting over a loss is not the only problem. As odd as it may be to read or hear, you often have to forget about your big winners as well.

For those of you who follow our sentiment analysis closely, you know that the two main sentiment factors are fear and greed. These also happen to be the two biggest stumbling blocks for individuals, so lets talk about each of them.

Fear does not form in a vacuum. It is a learned response to a particular event or probability. In the case of trading, when you have a trade that goes bad, the regret and frustration can carry over into the next trade. Or worse, the fear of another failure is so consuming, that you dont enter your next trade. Of course, Murphys Law dictates that the trade you dont enter is the one you should have entered, which only compounds fear and frustration.

So how does one learn to fear? Part of the problem is the expectation that every trade you enter should be profitable. If you truly believe that, then here is an important piece of information for you . . . not every trade will be profitable. Thinking each and every trade will be profitable is a way to guarantee disappointment, which will eventually lead to fear paralysis, or a complete abandonment of your trading activity. By setting reasonable expectations, you can limit the amount of fear you learn.

Greed creates the opposite problem. With a couple of consecutive winning trades, many traders feel they have a cushion to become more aggressive. Its true that you do have a cushion, but that shouldnt be permission to change your proven methodology. Beware of the enlarged ego and feeling invincible, this will ultimately lead you to trades that you normally would not have entered. Finding good trades is hard enough, while finding poor trades seems to get much easier after a couple of winners. Never mistake a little luck for genius.

The most effective traders seem to have a short-term memory, which can keep greed and fear in check. They also use systematic criteria rather than their gut, as they are wise enough to know that fear and greed will ultimately lead them down the wrong path. In other words, the best traders only see the trade they are about to enter, or the one they are currently in. The rest are out of sight and out of mind.

When it comes to mental trading, theres no better trading trainer than Dr. Van Tharp. Click the Trader Mind header link above to learn more about Van Tharp and his training techniques.

Also, today is the last day I beleive for the up to 99% off warehouse sale at the Invest SuperStore. Click the following link to view the dvds books courses available.

Good day and good trading.

Saturday, June 17, 2006

Weekly Stock Market Outlook

Nasdaq Outlook

Despite Thursday's rally, the NASDAQ still ended the week slightly in the red. This weeks close at 2129.95 was 5.11 points (-0.24%) lower than last Friday's closing level. And the close under the 10 day line doesnt exactly bode well for the coming week.

Although the latter half of last weeks close was bullish, it was also to be expected. After all, the composite was oversold, and the NASDAQ Volatility Index (VXN) had just eased back from new multi-month highs. Our only goal today is to provide some perspective on the recent bounce, which some have viewed as evidence that we just hit the bottom. Maybe we did, but the charts still show more bearishness than bullishness.

For example, we still closed under the 10 day line on a weekly basis, and the volume has been decisively bearish. In fact, the bearish volume has been growing - see the bottom of the chart. With that in mind, we think theres still some bearishness that needs to play out. Note that we still have room for a little more upside before another significant leg lower. The 20 day line at 2158.73 is they key level to watch, given that it was the resistance line that sent the chart lower a couple of weeks ago. Only a close above that line would get us to a bullish expectation. Otherwise, we are looking for some more weakness...maybe even to the 2000 level.

Nasdaq Chart

Click Here For Bigger Chart

S&P 500 Outlook

The S&P 500 came within a hair of breaking even for the week, closing just 0.75 points (-0.06%) lower than where we closed the prior week. For us, thats close enough to actually call a break-even, so we congratulate the bulls on a nice recovery effort. The SPX ended Fridays session at 1251.55. Thats all well and good, but the large-cap index is still under that key 200 day moving average.

The S&Ps story is the same as the NASDAQs - Thursdays rally was nice, but not really enough to get the bullishness restarted. If anything, it was just a bounce within a bearish trading range. See the dashed lines on the chart below. We saw a similar bounce about three weeks ago, but it didnt break the bearish trend. In fact, the S&P 500 could move as high as 1265 and we would still be in the downtrend. And with the 200 day moving average at 1260 (as is the 20 day line), there are just a lot of barriers that the SPX is going to have to struggle with. The path of least resistance is lower.

Plus, take a look at the CBOE Volatility Index (VIX). We saw a major plunge on Thursday that pulled the VIX all the way down to its 50 day moving average, which set the stage for a major upside reversal. With plenty of room to keep rising from Fridays close of 17.25 to the upper band line at 22.25, that also leaves a lot of room for stocks to fall.

Only a move above 1265 would get us to a bullish stance, and really, we would want to see a close above the 50 and 100 day lines at 1286 to really be confident about being bullish. Our view is that the index will hit a headwind around 1260 and end up falling even under the previous low of 1219.

S&P500 Chart

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DJIA Outlook

No surprises here - the Dows relative strength during the downturn left it as the only index with a legitimate shot at a decent gain this week, which is exactly what happened. The close at 11,015 was 123 points higher (+1.13%) than last Friday's close. Plus, the blue chip index jumped back above its 200 day line. Still, though, the jury is still out.

Like the S&P 500, the 20 day line has been a resistance point lately for the Dow. And specifically, it capped the Dows range on Thursday as well as Friday. With Wednesdays and Thursdays bounce only being on average volume, we cant get too bullish about it. After all, we were well oversold at the time.

Theres also plenty of resistance lines besides the 20 day line (currently at 11,040). The 100 day line and the 50 day line are both slightly above current levels, and should help weigh the index down if the 20 day line cant do the job.

DJIA Chart

Click Here For Bigger Chart

Friday, June 16, 2006

Entry Orders

I see a lot of traders get penny wise and pound foolish when it comes to placing entry orders. Read on below for a powerful example of how it could take you 50 trades of good order entry savings to make up for 1 missed trades profits.

The biggest trades are winners right from the start. I noted that next to a recent list of my recent trades, as the ones that ended up most profitably seemed to get off to a good start and stayed that way.

Historically I have noticed that my best and biggest trades are right very quickly, and they just keep getting more and more profitable from the start. One of the lessons I have learned over the years is that when you study your best and worst trades in search of patterns, you have to also include the trading ideas where you did not get filled. The irony of trading is that the hard trades to enter are the ones you most want to get filled. Competition for sought-after shares makes execution difficult at a desired price. Yet these are the stocks you want to own. If you instead think these leaders have run too far, and start to pick laggards you hope will catch up, you are likely to be left with poor performers. The saying, If you lie down with the dogs, you get up with the fleas is very true here. If you dont fight to get on board the leaders, and instead let the market pick your stocks, you get only the bad ones.

As a result, the most expensive trade is the trade never done. The impact of these undones can be expensive, and failure to execute these trades usually costs more than the squabbling over trying to get in at a specific limit price. If you dont track the undones, you will believe you are doing a good job when you may be leaving a lot of opportunity on the table. The solution is to place market orders when you are concerned about missing out on a breakout situation.

Thought about another way, if you think you are saving 10 cents a trade by placing limit orders, if you miss just one five-point mover because of a limit set too tightly, then it will take 50 trades worth 10 cents of savings to make up for this trade not done.

Have a good weekend.

Wednesday, June 14, 2006

Trader Profiles

I once read in the notes of a champion chess player, that he realized that his competitors often times played the same and he sized up his competition and categorized them. Some players, bears as he called him attacked early in the game and could easily be set up to make overly risky moves. Mice, on the other hand, were overly cautious. It took them too long to set up aggressive positions and the best way to defeat them was attack them aggressively from the beginning.

The point is, traders often fall into categories, and they often make the same mistakes over and over. The first step is to know yourself when trading. Today, we will discus various profiles of traders. I hope to help traders uncover their mistakes and irrational tendencies so that they can continue trading well. We will now look at the various profiles. As you read, decide if you share some of these characteristics.

The News Trader

The news trader often buys right after hes heard some hot news on a stock. He may have heard about the company from a friend or worse yet, the company was featured on the front page of the Wall Street Journal. The news traders decisions are highly colored by press hype and excitement. Often times, the news trader buys right after some hot news and is baffled as the price drops. Few traders are defined by this profile, but most traders are affected by news whether they are willing to admit it or not. Beware of this tendency.

The See Saw Trader

The see saw trader is aptly named because his system changes so often. His expectations, and even strategies are changed by short-term experiences. For example, the see saw trader might enter using an overbought/oversold approach. As he sees the market surge, he cannot wait any longer for oversold conditions, and he buys completely independent of his system. Or, he has decided that he will sell at a 50% gain and then when the stock reaches 20% he fears losing and exits the trade too early. Sure there are times to sell later or earlier than intended, but the see saw trader lets his decision-making become affected by short-term events too often.

The Gambling Trader

The gambling trader is characterized by his tendency to over commit his trading capital to individual trades. Its true that one can earn more by allocating more of the portfolio to each trade, but when losses occur (and they always do) the gambling trader can be wiped out easily. Another trait of the gambling trader is the tendency to over commit to highly correlated investments. For example, the gambling trader might buy 4 gold stocks and take on unnecessary, and inefficient risk. I had a friend who used to work for another firm. In one of his services, he produced 26 profitable trades in a row. The 27th trade was a loss. The problem was the subscribers invested a huge portion of their portfolios into this trade and over 30% of subscribers stopped subscribing to the service. So what really happened? 26 out of 27 is pretty good and perhaps too good because subscribers ended up betting too much on the next trade and because of this over commitment, they lost money and quit the game. This is an excellent example of the gambling trader and how common this trait comes out traders.

Be the Best

The real value of this article is first to show what mistakes we are prone to as traders. The second part is how to deal with these issues. Lets go through them one by one

The News trader. If you are a news trader, develop a quantifiable and repeatable strategy. Dont use news unless its part of your system. Here's an example. GM has been losing market share for more than 10 years and the stocks is at its lowest price in over a decade. But, did you know that in the past 2 months, GM is up over 20%? If you would have listened to all the bad news at GM for the past year, you would have never bought it. However, if you have a system that quantifies negative and positive surprises, then use it. Otherwise, this aspect of your trading is more a distraction than anything else.

The See Saw Trader. The best solution for see saw trader tendencies is to set specific targets and to stick to them. There are so many desires that come to surface when trading including: the desire to be right, the desire to be unique, and the desire to sophisticated to name a few. These are the desires that lead to see-saw behavior in trading. These tendencies often lead traders to change their methods for reason that have nothing to do with trading effectiveness. Traders who lean towards these tendencies too often, should develop rigid systems, preferable with the aid of trading software to tell them exactly when to enter and exit. Also, these same traders should keep a daily journal for trading.

The Gambling Trader. No matter what happens, there will be periods where you have 5 trades in a row that work out and 5 trades in a row that dont. Most traders start allocating larger amounts of their portfolio after 5 successful trades. Most traders are not prepared for 5 losing trades in a row. Since both are inevitable, always allocate an equal percentage of your portfolio into all trades. Optimism is important, but it has to be realistic. Understand that there will be drawdowns and prepare for them. Traders with gambling tendencies should invest in industries that are uncorrelated such as airlines and oil stocks. Each react differently to changes in oil prices.

Be discipline and trade well.

Tuesday, June 13, 2006

Confidence Trading

What is the definition of confidence? I define confidence as positive thoughts, feelings and actions reflecting your self-belief and expectations of your ultimate success. Success is never guaranteed, but self-doubt and negativity can ensure failure. When you believe in yourself, you move away from harmful distractions such as anxiety and fear, and you move toward a more effective performance focus. Today we will take a look at how to make sure you are confident enough to survive the trading game.

Aside from the obvious benefits, confidence also bolsters your internal security during trading slumps and gives you additional fuel to persevere through challenging periods. Self-belief promotes traders to create more ambitious performance targets, allowing for greater accomplishment. Traders who display low confidence tend to worry excessively about mistakes, lose focus on whats driving results, quit trading at the wrong times and get overly worked up about each new trade. Excess confidence can also be dangerous in causing a trader to overcommit capital and be subjected to too much risk when a position goes bad. So your goal should be to promote the internal confidence while still showing the external disciplines to prevent the ego from taking over the consistent execution of a trading method.

Here are seven tips to encourage greater confidence:

1. Frequently visualize a successful trading process. What goes into good trading for you? Make sure you see the preparation required, the focus you have during the trading day, and the continous learning from both winning and losing trades to keep getting more effective.

2. Increase your level of physical fitness, as this will enhance both your trading alertness and give a boost to your self-image simultaneously. Both of these elements make you a more confidence trader.

3. Make a list of your strengths. Review this list regularly to remind yourself of how successful you really are.

4. Eliminate negative thoughts and memories. When they occur, replace them with positive self-statements for example, I create my own luck or I have a good written plan of how I will execute my trades.

5. Have a general strategy going into each trading day. When you prepare the day before, you position yourself to be proactive and gain confidence as you implement your plan. How aware are you of what you are experiencing in your mind, body and soul at any moment? You need to set up a monitoring system at the end of each trading day, to summarize what you executed according to your rules and what you did not. Look for patterns in your behavior, that you can copy if they work for you, or minimize if they are costing you.

6. Create positive body language regardless of the gain or loss on that trading day. The way you act will often influence the way you feel for future trades. The more confident you feel, the more confidence you will show in your trading.

7. Improve on areas of weakness during preparation time and you will create more confidence and belief during the trading day.

Focus on one of these 7 tips at a time, until you can build that area as a habit in your routine - this will service to greatly improve your trading confidence over time!

Good day and good trading.

Seasonal Trading

A Review of Market Models: Seasonal Trading

Sell in May and go away — Old Stock Market Saying.

I have reviewed a little bit two related market models so far. Elliott Wave Theory and Fibonacci Numbers. Today I will look at using seasonal tendencies as a market model.

When I first started trading, seasonal trading of commodities was all the rage. I used that method for several years and later in this article I will share my number one lesson from all of that. But for now, lets look at the basics of seasonal trading.

There are two types of seasonal trading that people advocate:

1. Doing computer back testing of individual commodities (or even stocks and currencies), which looks at all possible scenarios for buy dates and sell dates. For example, if you buy corn on March 3rd and sell it on May 7th, you would have made money the last eight years. You can do this for individual contracts or spreads (where you buy one contract and sell another simultaneously).

2. Review fundamental tendencies of commodities (and stocks) that repeat year in and year out. Then trade according to those tendencies. As an example, knowing the tendency for freezes to affect orange juice crops, only trade the long side during the winter (this particular trade has been complicated by the reverse seasons of large producer Brazil).

Seasonality: Crystal Ball or Lead Anchor?

The second trading system that I ever bought was a Hume report on a seasonal soybean trade. The system claimed that since beans had shown this seasonal move for 9 out of the last 10 years, we could bank on it happening again. It did not. And I lost a bunch of cash on that trade.

There are plenty of resources that will show you printouts of what commodities have made the same move 80 – 100% of the time if you bought them on one date one and sold them many days later. Problem is that these systems do not work. They are almost all based a sample size that is too small to be statistically significant (9 of the last 10 years!).

However, using fundamentally significant tendencies can be very useful in trading. What I learned is that these tendencies can be used as an excellent filter – as a set-up criteria for existing systems. But to be effective, they need good entry and exit criteria.

Now, lets look at our standard list of questions for market models:

Is it theoretically credible? Two answers are needed here. For the style that back tests dates, the way most folks do it is not credible because its based on faulty statistics. This can be useful if the sample size is appropriate. For the use of fundamental seasonal tendencies, it is very credible. People do use more gasoline in the summer and more heating oil in the winter. Crops do have planting and harvest cycles.

Whos it most useful for? Every commodity trader has to be aware of seasonal tendencies. Stock traders will also do well to pay attention to certain patterns in the equities markets, such as the traditional fall off in volume and volatility at the end of the summer.

How fanatic are the fans? Pretty good cheerleaders. Seasonal adherents are adamant about their relationships and data, but they are typically not so boisterous in trying to convert others to their way of thinking.

Is it being used by real-life traders? Most traders that I know keep an eye out for seasonal tendencies, and many use them as trade filters. I dont know anyone using the buy on date A and sell on date B method.

Good day and good trading.

Sunday, June 11, 2006

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ Composite was the weeks biggest loser, falling 84.35 points to close at 2135.06. That's a 3.8% plunge, which is just slightly smaller than the one taken in the week ending May 12th. Oh by the way....the index hit a new low for the year, and is in the red for the year by about 70 points.

The prior week had a glimmer of bullishness, as the NASDAQ was pointed higher (pretty sharply) on the 1st and 2nd of the month. This past week, though, the 200 day line and 20 day line acted as firm resistance, sending the composite back under the 10 day line....and to the lowest close of the year. And as many arguments that could be made for us to be at a bottom, the truth is the odds of a rebound arent as good as you might think.

Why? Take look at the NASDAQ Volatility Index (VXN), for starters. The spike to 27.29 was above the 20 day Bollinger Band, with the close of 24.61 being back under that band line. Thats a classic sign of an upside bounce, and for a while on Friday it look like it might happen. But by the end of Fridays session, it was clear the buyers still wanted no part of it. That's not exactly an encouraging sign for stocks, with the VXN still generally pushing higher. Plus, we are not stochastically oversold yet, so the pump is not quite fully primed.

So, we remain tentatively bearish. Obviously nothing is set in stone, but the selloffs come too easily while the rallies are tough to produce. With no catalyst in sight, the path of least resistance is lower. Stop on this bearish bias come with a close above the 20 day average, currently at 2195.


Click Here For Bigger Chart

S&P 500 Outlook

The S&P 500 gave up 2.79%, losing 35.90 points to close at 1252.30 on Friday. That was the best performance of all three major indices, although only in the sense that it was least worst. The SPX also hit new lows for the year, but year-to-date, its still in the black.....barely.

As each week passes, it seems like more and more technical damage is done. This week, the SPX closed under the 200 day moving average for the first time since October. The resistance at the 100 day line, currently at 1287, was what sent the index lower again on the 5th - the first day of the week. That move under the 200 day average wasnt the only sell signal though. We also have a new MACD crossunder sell signal. This one occurred under the zero level. Those sub-zero sell signals are particularly meaningful because they indicate new short-term weakness within longer-term weakness.

And like the NASDAQs VXN, the S&P 500 Volatility Index (VIX) hasnt really come tumbling down after a rapid move higher over the last few days. In fact, technically, the VIX is trending higher.

When you put all those pieces together, what you get is a bearish scenario. Like the NASDAQ though, keep a short leash on the outlook - things are a little more unpredictable than usual.


Click Here For Bigger Chart

Dow Jones Industrial Average Outlook

The index that had been holding up better than any other finally had a rough week of its own. The Dow Jones Industrials fell by 355.95 points to close at 10,891.92. Thats a 3.16% selloff, yet this blue chip index is still in profitable territory for the year.

The Dow had held up the best of all the indices, but is really pushing its boundaries now. This last week, the 100 day line was toppled as support. That just leaves the 200 day line at 10,874 as support. However, the 200 day line is indeed acting as support - we saw the Dow trade under it on an intra-day basis on Thursday and Friday, but closed above it both days. On the other hand, there's some pretty strong bearish momentum in place now.


Click Here For Bigger Chart

Have a good week and good trading.

Friday, June 09, 2006

Managing Emotions

In order to manage your emotions effectively when trading, you need to create a written plan that you can review regularly to stay focused on your goal of trading success. By writing down your plan, you put yourself in the top 3% of individuals who have written goals and plans, giving you an immediate edge on most traders. Make sure you have answered these questions.

1) How you will enter trades? The key to good entries is putting on trades where there is relatively low risk compared to much higher reward. You also should write down a clear catalyst for the expected stock move.

2) How will you exit trades? You should define an initial stop point for your trade, at the point where the trend is invalidated. You will also need a 'trailing stop technique to protect your profits.

3) What type of orders will you use to enter and exit? When entering, I like to use limit orders, good for the day only, while exits are often market orders. Why? Because limit orders allow me to define my risk and reward clearly on the entry of a trade, while when I need to get out, market orders allows immediate exit compared to the risk of missing my exit with a limit order.

4) How much capital will you need to trade successfully? There are economies of scale as you increase the amount of capital you trade with. Costs related to commissions, quote systems and equipment begin to diminish as the percentage of capital invested goes up.

5) What percentage of your capital will you invest in each trade? The amount of capital I typically use is 10% per trade in my own accounts. I know traders who commit anywhere from 5% of their account per trade to 20% of their account per trade. You goal should be to keep portfolio risk per trade at less than 2% per trade (for example if you invest 20% of your portfolio in a trade, a 10% loss on that position would lead to a 2% loss on your portfolio).

6) How many positions will you focus on at once? I like to concentrate my portfolio in my best ideas, plus I like to stay focused on how each stock is acting. If my portfolio is too big (I'd say more than 7 stocks is too many to focus on), then I will lose focus and invariably miss an exit on a trade that I should have previously exited.

7) What will your Trading Journal look like? In my Trading Journal, I note daily observations, particularly related to my ability to execute my trading plan. I also commit to doing a post-trade analysis every month. I note what I did right and wrong, and seek to learn from mistakes to minimize future errors in similar circumstances, while also looking for winning patterns where I seek to repeat big successes.

8) What is your Position Review process? Have an end-of-day routine to close your day. Review your trades, and assess if you followed your plan. Keep a log of all your trades, and make comments on each position.

9) What is your Preparation process before trading? You need defined time to prepare for the next trading day to build up your trading confidence. I prepare after the close for the next day's trading, which allows me to formulate a plan of action BEFORE I get into the heat of battle. This keeps my trading proactive instead of reactive.

10) What broker will you use? Most traders mistakenly think that commissions are the number one factor they can control. In reality, commissions are a small cost compared to the brokers effectiveness at executing your trade. Your focus should be finding a broker who gets you speedy and fair execution of your orders.

Once you have defined these facets of your trading plan, you are in an excellent position to have a strategy to control your emotions when trading. Make sure to review your plan on a regular basis to create effective trading habits.

Click the Managing Emotions header link above to learn more about being a successfull investor speculator and trader.

Have a good weekend.

Fibonacci Trading

A Review of Market Models: Fibonacci Numbers

This Leo was titanic long before DiCaprio hit the big screen.

Leonardo Fibonacci (or Leonardo de Pisa, as he was known in the hood) was a 12th century Italian mathematician who is credited as the western developer of the number series that now is called by his name.

Fibonacci was solving a biological word problem involving rabbits, but wrote extensively about the number series and the golden ratio that it uncovers.

The Fibonacci sequence is 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765…

Any number divided by the next larger number in the series equals the golden ratio of 0.618 starting with 55 / 89 . (The numbers before that pair get closer to the golden ratio as they get bigger.)

So why the math history lesson?

Fibonacci numbers are some of the most widely used and watched numbers in all of trading.

Fibonacci is less of a complete market model than some of the others that will be described in this series. But it is so pervasive and so many people use it to make decisions that it is treated as a market model by lots of folks.

Fibonacci Retracements & Extensions: Mesmerizing or Mysticism?

For clarity, I must interject that Fibonacci numbers are used within the Elliott Wave Theory. Todays discussion, however, is about a specific and distinct use of Fibonaccis numbers: retracements and extensions.

When a stock, futures contract, currency, etc. has had a defined price move, Fibonacci proponents expect a retracement of the total move to test key levels, specifically 0.382 times the price move, 0.5 times the price move and 0.618 times the price move. The resultant levels are expected to be key testing points where price will be repulsed or will break through.

For strong price movement, adherents also look for extensions of a move to go 1.618, 2.618, etc. beyond the previous high or low.

Now, lets look at our standard list of questions for market models:

Is it theoretically credible? The levels are mathematically sound and they make sense from a market psychology perspective. Many useful market theories are based on predicting (or simply observing) moves followed by retracement followed by extension.

Whos it most useful for? Fibonacci levels are useful for most traders and investors looking to understand the three steps forward, two steps back nature of the markets. Countertrend players can use retracement levels and breakout players can watch extension levels. Theres really a little something for everyone.

How fanatic are the fans? Rabid. Whether or not they are part of the Elliott wave crowd, Fibonacci followers believe that these numbers contain the underlying order of the universe. And they have plenty of occurrences in nature to back them up.

Is it being used by real-life traders? You betcha. Fib retracement levels are followed far and wide (extension levels are less widely followed). Most of the traders that I know use some form of Fibonacci retracement levels in the their analysis, even if its just to see the numbers that numerous other traders are looking at.

I use Fibonacci the most in my chart analysis of any investment instrument. A very simple technical analysis that works very well in keeping losses small and winners big. Fibonacci is a very simple once learned and a very simple and effective approach to trading.

Click the Fibonacci Trading header link above for more information on trading short-term or long-term with Fibonacci.

Good day and good trading.

Wednesday, June 07, 2006

MACD Indicator

Have you ever heard of a little indicator called "MACD"? It stands for Moving Average Convergence Divergence. Today, we will review the book Technical Analysis: Power Tools for Active Investors by Gerald Appel, the inventor of MACD. The book has a very wide range of issues, from broad economic indicators to using treasury yields to time select mutual fund purchases. The inventor of MACD has put together an impressive book full of highly practical trading techniques.

One of the most useful parts of the books is where Appel discusses MACD and how to apply it. Appel even discusses the times where MACD produces false signals and even includes advice on trying to endure and perhaps even avoid these false signals. Appel suggests that traders should use MACD to find the long term trend such as in a weekly chart and then use this information in conjunction with a shorter-time period like a daily chart. I have tested bullish and bearish convergences between MACD and underlying securities. I have found that it is indeed quite bullish when the indicator outpaces the underlying stock. The great thing about momentum divergences is that they often precede the actual stock movements and therefore work as leading indicators. Naturally, leading indicators are the name of the game. Anyway, Appel goes into detail about the application of MACD and it is highly detailed and worth looking into.

Another interesting point that Appel makes in his book is that when looking at trends, one should not just look at the cycles, but the actual slope of the lines as well as the angles. He believes that this information is highly relevant and highly tradable. We would like to test this further and perhaps give a more definitive opinion after the testing. Of course, we already know that divergences in MACD work quite well and this actually involves the slope of MACD versus the slop of the price line of a stock.

One part of the book that shows Appels versatility is his chapter on various cycles including time, political, and seasonal cycles. Appel suggests once again the that looking at slope and angle of certain trends will assist in predicting its duration. Appel also believes that there are 9 dominant cycles that are important to trading and he discusses how to use them.

One of Appels central points is that using multiple indicators is usually the effective way to get the best bang for the traders buck. The tests that I have conducted suggest that combining indicators often dissipates the effectives of a trading strategy because usually one of the indicators is more effective than the other. I do believe in synergizing certain trading methods though. For example, whenever possible I try to focus on high volume options in addition to the use of certain technical indicators. It is the synergizing of the indicators themselves that I am cautious with. Some combinations work, and some do not.

If you have an interest in mutual funds, take a look at how Appel looks at the NASDAQs relative strength next to NYSE stocks and treasury yields to pick mutual funds. We have already found that comparing the NASDAQs relative strength to the SPX has been highly effective. Overall, the book is highly informative and I have to give it the Big Trends thumbs up. Appel has data to back up his ideas and his logic is very sound.

To purchase the Technical Analysis: Power Tools for Active Investors book by Gerald Appel, click the MACD Indicator header link above for the books description and order form.

Be disciplined - and trade well!

Tuesday, June 06, 2006

Exchange Traded Funds - ETF's

Exchange Traded Funds (ETFs) have been one of the hottest trends in the stock market for the last few years. They have many advantages that both traders and investors should consider.

ETFs are similar to mutual funds, in that you are getting the advantage of diversity by investing in a group of stocks all at one time. However, there are some major differences between these two types of funds. The most important difference is that ETFs trade just like stocks. You can use any broker to buy an exchange traded fund, such as QQQQ, just like you would buy MSFT, INTC or any other stock. This is a major advantage over mutual funds, which are much harder to get in and out of.

ETFs are also not actively managed. Mutual funds usually have a group of people who manage the holdings of the fund and try to provide the best possible returns. ETFs simply track a set group of stocks, usually based on an already established index. Either the major market indexes such as the NASDAQ 100 or other indexes as with the more focused funds like IYF from iShares, which tracks the Dow Jones Financial Sector Index.

Another major advantage to ETFs is that they usually provide a highly liquid asset to trade. According to Yahoo! Finance, which has a large section of their site devoted to information about ETFs, there are 33 funds that have an average daily volume (past three months) greater then 1,000,000 shares. The most heavily traded funds are QQQQ, SPY and IWM. These three funds track the NASDAQ 100, S&P 500 and Russell 2000 indexes, respectively.

The future of ETFs is in the tracking of assets other then stocks. Last year, streetTRACKS released a fund that just holds gold and allows investors to buy gold without the normal hassle of commodity trading. The StreetTRACKS Gold Shares ETF trades under the symbol GLD. Another new fund is Rydexs Euro ETF, the Euro Currency Trust (FXE), which is the first to track a currency. The two newest commodity ETFs are the U.S. Oil Fund ETF (USO) and the iShares Silver Trust (SLV). Still more commodity and currency funds are being planned for release in the future.

Good day and good trading.

Monday, June 05, 2006

Money Management & Position Sizing

Money Management / Position Sizing

Money management is a very confusing term. When we looked it up on the Internet, the only people who used it the way that Van Tharp was using it were the professional gamblers. Money management as defined by other people seems to mean controlling your personal spending, giving money to others for them to manage, risk control, making the maximum gain, plus 1,000 other definitions.

To avoid confusion, Van elected to call money management Position Sizing. Position sizing answers the question of How big of a position should you take for any one trade?

Position sizing is the part of your trading system that tells you how much.

Once a trader has established the discipline to keep their stop loss on every trade, without question the most important area of trading is position sizing. Most people in mainstream Wall Street totally ignore this concept, but Van believes that position sizing and psychology count for more than 90% of total performance (or 100% if every aspect of trading is deemed to be psychological).

Position sizing is the part of your trading system that tells you how many shares or contracts to take per trade. Poor position sizing is the reason behind almost every instance of account blowouts. Preservation of capital is the most important concept for those who want to stay in the trading game for the long haul.

Imagine that you had $100,000 to trade. Many traders (or investors, or gamblers) may just jump right in and decide to invest a substantial amount of this equity ($25,000 maybe?) on one particular stock because they were told about it by a friend, or it sounded like a great buy, or perhaps they decide to buy 10,000 shares of a single stock because the price is only $4.00 a share (equating to $40,000).

They have no pre-planned exit or idea about when they are going to get out of the trade if it happens to go against them and they are subsequently risking a LOT of their initial $100,000 unnecessarily.

To prove this point, we have done many simulated games in which everyone gets the same trades. At the end of the simulation, 100 different people will have 100 different final equities, with the exception of those who go bankrupt. And after 50 trades, we have seen final equities that range from bankrupt to $13 million — yet everyone started with $100,000 and they all got the same trades.

Position sizing and individual psychology were the only two factors involved.

Van says that this just shows how important position sizing is.

So how does it work?

Suppose you have a portfolio of $100,000 and you decide to only risk 1% on a trading idea that you have. You are risking $1,000.

This is the amount RISKED on the trading idea (trade) and should not be confused with the amount that you actually INVESTED in the trading idea (trade).

So thats your limit, you decide to only RISK $1,000 on any given idea (trade). You can risk more as your portfolio gets bigger, but you only risk 1% of your total portfolio on any one idea.

Now suppose you decide to buy a stock that was priced at $23.00 per share and you place a protective stop at 25% away, which means if the price drops to $17.25 you are out of the trade. Your risk per share in dollar terms is $5.75. Since your risk is $5.75, you divide this value into your 1% allocation (which is $1,000) and you are able to purchase 173 shares, rounded down to the nearest share.

Work it out for yourself, so you understand that if you get stopped out of this stock (i.e., the stock drops 25%), you will only lose $1,000 or 1% of your portfolio. No one likes to lose, but if you didnt have the stop and the stock dropped to $10.00 per share, you can see how quickly your capital vanishes.

Another thing to notice is that you will be purchasing about $4000 worth of stock. Work it out for yourself. Multiply 173 shares by the purchase price of $23.00 per share and you will get $3979. It would probably be around $4000 when you add commissions.

Thus, you are purchasing $4000 worth of stock, but you are only risking $1000 or 1% of your portfolio.

And since you are using 4% of your portfolio to buy the stock ($4000), you can buy a total of 25 stocks this way without using any borrowing power or margin, as the stockbrokers call it.

This may not sound as sexy as putting a substantial amount of money in one stock that takes off, but that strategy is a recipe for disaster and very rarely happens. Therefore it is best left on the gambling tables in Las Vegas.

To continue to trade and stay in the markets over the long term, learning position sizing and protecting your initial capital is vital.

Van believes that people who understand position sizing and have a reasonably good system can usually meet their objectives through developing the right position sizing strategy.

Position Sizing—How much is enough?

Start small. So many traders that are trading a new strategy start by risking the full amount that they plan on using for the long term with that strategy. The most frequent reason given is that they dont want to miss out on that big trade or long winning streak that could be just around the corner. The problem is that most traders have a much greater chance of losing than they do of winning while they learn the intricacies of trading the new strategy. Therefore, start small (very small) and minimize the tuition paid to learn the new strategy. Dont worry about transactions costs (such as commissions), just worry about learning to trade the strategy and follow the process. Once you have proven that you can consistently and profitably trade the strategy over a meaningful period of time (months, not days), then you can begin to ramp up your position sizing.

Manage losing streaks. Make sure that your position sizing algorithm helps you to reduce the position size when your account equity is dropping. You need to have objective and systematic ways to avoid the gamblers fallacy. The gamblers fallacy can be paraphrases like this: after a losing streak, the next bet has a better chance to be a winner. If that is your belief, then you will be tempted to increase your position size when you shouldnt.

Dont meet time-based profit goals by increasing your position size. All too often, traders approach the end of the month or the end of the quarter and say, I promised myself that I would make X dollars by the end of this period. The only way I can make my goal is to double (or triple, or worse) my position size. This thought process has led to many huge losses. Stick to your position sizing plan!

We hope this information will help guide you toward a mindset of capital preservation on your journey toward successful trading.

I have talked to many folks who have blown up their accounts. I dont think I have heard one person say that he or she took small loss after small loss until the account went down to zero. Without fail, the story of the blown up account involves inappropriately large position size or huge price moves, and sometimes a combination of the two.

About Van Tharp: Trading coach, and author Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Freedom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors.

Click the Money Management & Position Sizing header link above for more information Dr. Van Tharp and his trader training programs. Good day and good trading.