Tuesday, October 31, 2006

Information Overload

Do you ever feel overwhelmed by the sheer amount of information you have to process in your work day, or to be more specific, in the information you must process to determine your investment and trading decisions? As the pace of change continues to accelerate, and as market volatility perceptibly increases over time, I personally feel an internal nagging that I'm missing something. I'm not quite sure what it is, but I'm afraid I'm missing it - whatever "it" is. In my job guiding fellow investors and traders, I suppose for me it's the fear of missing the next big move in the markets. But I know that this fear is omnipresent, and decisions must be made with less than perfect information. My goal here today is to suggest some strategies to get back to the basic priorities that can help convert data into knowledge, while proactively cutting away the chaff that we cling to which really is just clouding our vision and focus.

It seems that the core problem is an increasing supply of information coming at us, without a defined set of filters to sort out the hidden nuggets of wisdom from the majority of data that serves to muddy up our thinking. The explosion of the Internet has put more data at our fingertips in a day than prior generations could access in a lifetime. But we must define the quality of the information we receive and not be consumed by the quantity.

Here are several core ideas for Proactive Strategies:

1) Preparation before entering a market in motion is critical. By doing your homework and creating a focus list of 5-7 names you will trade at a maximum (why do you think phone numbers are capped at seven digits?), you can come in to each trading day with a plan. While news may change during the trading day, I personally seek to let the market or stock reaction to news tell the tale of whether I should enter, hold or exit a position. By trading what you see in a stock's price action, this is the reality of whether buyers or sellers are winning the war, regardless of extraneous news. The last thing I want to do is come in unprepared and then be reacting to various news headlines without an understanding of the underlying structure of a stock or market.

2) What filters are effective at tightening your focus on the best or worst stocks? I have to give credit to Bill O'Neil at Investors Business Daily for two of the best filters: relative strength and volume filters. Relative strength gets the trader focused on the top longs and shorts to then apply other filters like volume to further narrow the focus on the most attractive situations. IBD shows you the top stocks according to their Relative Strength system, and this excellent paper also shows stocks breaking out on higher-than-average volume. In a database of roughly 2000 stocks I follow, if I focus on the top 1% of stocks for potential buys, that immediately narrows my buy list to 20 stocks. Further examination typically culls that list to less than 10 stocks.

3) Look past the traditional sources of market analysis to get a more focused view of outperformers and underperformers. For example, if I looked for every stochastics crossover each day, I would be faced with hundreds of stocks to sort through in my database. But if I instead search for stocks which are staying overbought over 80% or staying oversold under 20%, I get a more focused list of select situations where these stocks are trending longer and stronger, up or down, than most traders would expect.

4) Get organized. It's a fact that the more clutter you have around your workspace, the more stress you will feel from projects that are literally calling for your attention. This is called "subliminal screaming" and it will not help your trading focus. Get your open projects filed in order you will address them outside of the defined hours you will trade.

5) Boil down your indicators to truly value-added methods. If you're looking at both stochastics and the Relative Strength Index (RSI), you're really looking at the same overbought and oversold methods twice and should seek to eliminate one of the overlapping techniques. In contrast, volume indicators can add value to a traditional price-based indicator, since it offers a new piece of information to most price-following methods.

I suppose I could go on with other ideas to help you manage information overload, but then I'd be overloading you with too much information, right?! The bottom line is you should seek to boil down your indicators and sources of information to those that help you perform in a simple and effective fashion.

Good day and good trading!

Risk Reward

Think you know about risk and reward? Most traders use the target price and the stop price as their model of risk and reward, and leave it at that. However, they may be missing an important risk/reward concept. Read on to add a new weapon to your trading arsenal.

The concept of a risk/reward ratio is pretty straight-forward; for any given trade, you're targeting a certain amount of gain, while setting a stop-loss limit if the trade goes the other direction instead. This is a critical concept for any trader to grasp, as the idea is to establish the potential loss to see if it justifies the potential gain. Of course in all cases, you want your reward to be at least a little better than your risk, so you set your targets and stops accordingly. A good rule of thumb is to seek a return of three times as much as the amount risked, making the reward/risk ratio 3 to 1. But it's equally common to see reward/ratios of anywhere between 2 to 1 and 4 to 1. Let's go through a real example.

Say we're buying XYZ shares at $36.00. We think XYZ will move to $46.80 for a 30% gain, and we're willing to risk a 10% loss in the attempt to get that 30% gain. A 10% loss on $36.00 (initial investment) means shares would fall to $32.40 before we threw in the towel and closed out the position. Our potential reward is 30%, but we're risking a 10% loss. What's the reward to risk ratio? Well, 30% divided by 10% equals a 3 to 1 reward/risk ratio.

So as long as your rewards are bigger than your risks, over time (and enough trades) you'll make money, right? Wrong. Unfortunately, too many traders automatically set up a 3 to 1 ratio when setting price targets and stop losses on any of their trades. But they're forgetting something very important. Just because your profit target is three times as big as your risk doesn't mean you'll ever actually hit that target. You also have to factor in the likelihood of a successful trade. Let's take a look at why.

Let's stick with the assumption that our optimal reward/risk ratio is 3 to 1. Let's also assume you've developed a trading system (or you're able to pick stocks) that produces one winning trade in every four trades. So, your win/loss ratio is 1 in 4 (25%), while your reward/risk ratio is 3 to 1. Do you think you'll make money with that system? Nope - for every trade that gains 30%, you have three more trades that lose 10%. The rewards were three times as big as the risk, but it didn't create any real profit! The best you could hope for is to break even.

So how does one measure the real reward-to-risk ratio? You have to factor in the odds of a winning trade into the potential gains or losses. Again, we'll illustrate it with an example. Say you've found a stock you think will move 20% higher, and you're willing to risk 10% to enter that trade. You're target is 20% above your entry price, and your stop loss is 10% under your entry price. With a reward/risk ratio of 2 to 1, this trade doesn't necessarily seem all that great. But, what if the trading system had a success rate of three winners for every four trades? You'd have a 75% chance of making 20%, while only a 25% chance of losing 10%. With that particular trade, your real reward-to-risk ratio would be about 6 to 1.

The point is, don't fall into the trap of setting targets and stops based on a predetermined risk/reward ratio. Big rewards and small losses are pointless if the system is a net loser. Rather, focus on the actual risks and rewards of a total methodology. This will also force you to determine just how successful your trading system or stock picking really is, which is something you should know anyway.

Good day and good trading!

Monday, October 30, 2006

Low Risk High Reward Trading Software

We use and trial a lot of the top trading software on the markets. Click the Low Risk High Reward Trading Software header link above to learn more about what we have currently ranked as the number one trading software.

Today I'm writing about what we use and consider to be one of the best trading software systems on the market. Its called MTPredictor.

There's a lot of trading strategies, trading signal services, and trading software on the market these days to help traders trade successfully. Different markets, seasons, events, trends, and ranges require different trading strategies to be successful in the long term. It's a lot to analyze and manage manually. Different strategies have different risk/reward characteristics. Professional traders know the first rule of trading and use it . . . assess risk first then reward second before taking any position in any market with real money. Doing it automatically saves time effort and reduces a whole lotta stress.

Tired of analyzing and managing yourself to death over trades? Solution: Trading software that automatically identifies low risk high reward trades and provides built in money management for correct position sizing based on the size of equity and the trading account so as not to over leverage the account into oblivion. The solution is the MTPredictor Trading Software.

MTPredictor automatically assess low risk high reward trade setups and has built in automatic money management through correct position sizing based on the trading account equity size.

Identifying high reward low risk trades is key to trading success in the long term. Avoiding high risk low reward trades is a must to keep risk as low as possible and have potential reward as high as possible. Getting stuck in losing trades wastes time as well as money. Time is more valuable than money unless you plan to live forever. Getting stop-lossed out all the time doesn't work either. Its all about at least having two winning trades that provide profits that are at least double to one small stop-loss trade to stay in the trading game for the long term. Easier said than done in todays highly volitile markets. With MTPredictor Trading Software, its all automatic to identify, and manage low risk high reward trades.

We use MTPredictor the most of all our trading software systems because it provides the lowest risk highest reward trades we've experienced. We have experienced reward risk ratios of over 5:1 and sometimes over 10:1. That's huge reward for risk, and is what the MTPredictor Trading Software is all about.

As a user and distributor of the MTPredictor we invite you to trial it free for 30 days. Experience complete trade low risk high reward trade identification, and trade management with MTPPredictor then tell us what you think.

Click the Low Risk High Reward Trading Software header link above to check out and trial the software. I2S users receive a 10% discount off the regular price.

Check out the MTPredictor Trading Software Free Forum at http://www.mtptrader.com. Access Real-Time low risk high reward trades submitted by MTPredictor Users and the MTPredictor Developers.

Good day and good low risk high reward trading.

The World's Greatest Trader

Jesse Livermore - The World's Greatest Trader

In the early part of the 20th century, Jesse Livermore was the most successful (and most feared) stock trader on Wall Street. He called the stock market crash of 1907 and once made $3 million in a single day. In 1929, Livermore went short several stocks and made $100 million. He was blamed for the stock market crash that year, and solidified his nickname, "The Boy Plunger." Livermore was also a successful commodities trader.

I think the most valuable knowledge one can gain regarding trading and markets comes from studying market history, and studying the methods of successful traders of the past. Jesse Livermore and Richard Wyckoff are two of the most famous and successful traders of the first half of the 20th century. Many of the most successful traders of today have patterned their trading styles after those of the great traders of the past.

Here are some valuable nuggets I have gleaned from the book, "How to Trade Stocks," by Jesse Livermore, with added material from Richard Smitten. It's published by Traders Press and is available at Amazon.com. Most of the nuggets below are direct quotes from Livermore, himself.

"All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical (technical) formations and patterns recur on a constant basis."

"The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor."

Don't take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don't be an impatient trader.

Livermore's money made in speculation came from "commitments in a stock or commodity showing a profit right from the start." Don't hang on to a losing position for very long.

"It is foolhardy to make a second trade, if your first trade shows you a loss. Never average losses. Let this thought be written indelibly upon your mind."

"Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes."

"When a margin call reaches you, close your account. Never meet a margin call. You are on the wrong side of a market. Why send good money after bad? Keep that good money for another day."

Livermore coined what he called "Pivotal Points" in a market or a stock. Basically, they were: (1) Price levels at which the stock or market reversed course previously--in other words, previous major tops or bottoms; and (2) psychological price levels such as 50 or 100, 200, etc. He would buy a stock or commodity that saw a price breakout above the Pivotal Point, and sell a stock or commodity that saw a price breakout below a Pivotal Point.

"Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend."

A prudent speculator never argues with the tape. Markets are never wrong--opinions often are.

Few people succeed in the market because they have no patience. They have a strong desire to get rich quickly.

"I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans--and human nature never changes."

When you make a trade, "you should have a clear target where to sell if the market moves against you. And you must obey your rules! Never sustain a loss of more than 10% of your capital. Losses are twice as expensive to make up. I always established a stop before making a trade."

"I am fully aware that of the millions of people who speculate in the markets, few people spend full time involved in the art of speculation. Yet, as far as I'm concerned it is a full-time job--perhaps even more than a job. Perhaps it is a vocation, where many are called but few are singled out for success."

"The big money is made by the sittin' and the waitin'--not the thinking. Wait until all the factors are in your favor before making the trade."

An important point I want to make is that Jesse Livermore's trading success came not because of any "inside" information or some huge store of knowledge he had about each and every stock or commodities market he traded. Livermore's trading success was derived from his understanding of human behavior. He realized early on that markets and stocks can and do change--but people and their behaviors do not. Therein lay his formula for trading success. That formula for trading success has not changed since Livermore's hey day in the stock and commodities markets almost a century ago.

A final note: Jesse Livermore may have been called the greatest stock market trader of the 20th century, but I question that notion. Certainly, no one can disagree that his profits were immense and his trading prowess was unmatched. But his life was not in balance. He was a "workaholic" who paid too little attention to his family. Livermore put a gun to his head and pulled the trigger in 1940. He "crashed and burned." You must have balance in your life to achieve lasting success at any endeavor. Trading markets is no exception.

Good day and good trading.

Friday, October 27, 2006

Foreign Exchange Currency Market

The largest financial market in the world is FOREX, the Foreign Exchange currency market. Over $1 Trillion USD in value changes hands every day on this exchange, making it much larger than all the other US financial markets combined.

It's called the market that never sleeps, because from early Monday morning, until late Friday night, the currency market is trading continuously. There are four trading centers set up around the world: Sydney, Tokyo, New York and London. They each take a different part of the trading day. This is one of the major advantages of the financial markets, you do not have to trade during normal business hours. It is possible to trade at any time during the day and make money.

The vast majority of all trading, especially the speculative trading, in the currency markets happens in the majors. These are the most widely traded currencies and consist of the United States Dollar, the British Pound, the Euro, the Swiss Franc, the Australian Dollar and the Canadian Dollar.

When you trade the currency markets, you buy long one currency and sell short another currency against it. The symbols are called "crosses." For example, the EUR.USD cross is the Euro against the US Dollar, with this you would buy Euros and short Dollars. If you were to short the EUR.USD cross, you would be shorting, or betting against, the Euro and expecting the Dollar to rise in relative value.

Most FOREX brokers do not charge a flat commission, but instead widen the Bid/Ask Spread slightly and make their money that way. So instead of having to worry about beating both the spread and the commission charge on each trade, you just have to focus on the spread, which is still usually smaller than either stocks or options.

Leverage and low account minimums are two more great qualities of currency trading. With some FOREX broker accounts you can get up to 200:1 leverage and you can open an account with as little as $250. So with that $250 you can control up to $50,000 worth of currency positions.

Despite its unique advantages, however, FOREX can be just as risky if not more risky than the stock or options markets. With currency you are not buying ownership in a company that has real value as with stocks and you cannot use advanced techniques such as straddles that you can with options trading. When you buy or sell a currency cross you are basically betting on the economic strength of the counties involved. However, FOREX provides a unique trading experience and is at least something that all traders should be aware of.

Click the Foregin Exchange Currency Market header link above to learn more about the worlds largest financial market and how to trade it for high reward and low risk.

Have a good weekend.

Thursday, October 26, 2006

Selling Strategies

It's interesting that so many of us will spend a great deal of time studying the perfect time to buy, yet so little time on when to sell. Ironically though, we may be better served by focusing our efforts on the latter, since the sell side of the transaction actually puts money in our pocket. There is plenty of literature available on the subject of 'when to sell', but today I'd like to highlight some of the most helpful sell rules that you can take and apply immediately.

1) "I never buy at the bottom, and I always sell too soon" - Nathan Rothschild. As difficult as it is, you want to sell stocks when things look like the stock may soar forever. As we all know, all good things do come to an end, and it's far too easy to let a 30% gain turn into a 20% loss because you're trying to squeeze out a 35% gain. You may ultimately leave some profits on the table, but better to leave some profit on the table than none in your pocket.

2) Keep in touch with a company's fundamental data. All of the fundamental research that we do typically comes prior to making the investment, but many times the company's financial statements after you invest in it will clue you in on a pending downturn. If earnings or revenue taper off, you want to be one of the first ones aware of that, prior to a sell-off. (continued below)

3) In Bill O'Neill's Book 'How To Make Money In Stocks', he summarizes good money management (capital protection) with this simple quote, "The whole secret to winning in the stock market is to lose the least amount possible when you're not right." While it's always more enjoyable to dwell on winning trades, it's important that you protect your investment capital. If you allow yourself to take large losses, you have diminished the amount you can put into your next winning trades. This is why it's crucial to use trailing stops, exit rules, and be willing to accept that every trade is not going to be a great trade.

4) For those of you who use technical analysis to generate automated signals, you don't necessarily have to use the opposite of your entry signal as an exit signal. You may find that an entirely different technique than your buy signal gives you better, and more profitable, exits.

Remember, selling is half of the challenge, and you should devote half of your efforts to making sure you're selling at the right time. You will find the results are an efficient, more profitable portfolio.

Good day and good trading.

Children and the Stock Market

When Should Children Learn To Invest?

The concept of children and the stock market seems as logical as mixing nitrogen and glycerin in a blender in your kitchen. Children joining the stock market community? Shouldn’t they be playing Playstation 2 or 3 now? In reality, the combination of children and the stock market and the world’s future is a natural fit. Remember, most of today’s baby boomer investors didn’t have a home computer or video game when they were kids; this generation can save the universe courtesy of Sony and other program creators. There are some keys to introducing your children to the stock market, so let’s get started.

First, it is imperative to start this adventure with a good understanding of stock market basics. You can start by teaching those youngsters that investing is totally different from saving. You might save to buy a new bike, but invest to have the money for college. Next in the process of combining your children and the stock market would be to cover topics such as portfolio diversification, liquidity, and risk reward ratios.

Ready to give your kids the family fortune yet? Let’s hope not! Before the kids actually start picking stocks and investing with real money, it’s best to start with a mock portfolio. There are a variety of ways for kids or anyone else to practice online stock market trading. There are a number of online games for stock and option investing simulation games. Prefer FOREX currency trading for beginners? It’s there too. Or if you enjoy the more traditional method, you can do this all on your own by helping your child construct and track his/her own portfolio of stocks. It’s also wise to encourage your children to invest in companies that they know, such as Disney, Coca Cola, Nike, or Microsoft.

While in the stock market, you can teach your children to track their investments, practice money management techniques, monitor company performance, research each investment, and track trends in the market. Junior probably has a good idea if Sony will impact Microsoft’s profit when the Playstation 3 is launched. This is also a great opportunity to begin teaching the concepts of Japanese Candlesticks stock trading to your children in the stock market. Chances are, they will pick up the principles much quicker than poor old dad!

Once you, and your kids, are ready for the stock market, there are a several investment options you can choose from. The safest course is probably finding a mutual fund. Although this is not the most exciting option, there are kid friendly mutual funds available, and actually some that provide stock market investing education materials as well. All of the principles your kids have learned apply and the bottom line results are real.

Although the children and the stock market relationship prevents them from owning stocks or opening brokerage accounts, their parents can set up custodial accounts for them under the Uniform Gifts to Minors Act. There are tax ramifications, but you can consult your tax advisor with any questions. Teaching your children to learn how to invest on their own is a valuable first step in their ability to control their financial destiny, as well as a great way for them to spend time with their parents. After you’re finished, maybe you can save the universe together on Playstation 3! And remember this one Dad, you’re probably buying one for Christmas!

Merry Christmas Kids!

Wednesday, October 25, 2006

Trading Games

Trading is a game just like any other game. When you are learning how to play a game you first need to become familiar with all the rules and only then can you start to practice what you have learned to start playing the game. Eventually with practice your skills will improve and you will start to win more. You must be careful to not mix up those steps though. Remember, practice makes permanent not perfect. You want to discipline yourself to practice the right way from the start so you have good trading habits.

Lets start with the rules. What are your rules for trading?

The rules are different for every trader. That is something you have to decide for yourself based on your goals and the amount of risk you are willing to take. It works best if you write these rules down on paper or on your computer, somewhere where you can see them easily and review them often. The first draft doesn't have to be perfect, but this will be your playbook for the game. Always keep yourself accountable to these rules. Here are some questions you will need to ask yourself to start to develop your rules for your system of trading:

When are you going to trade? Are you going to place all your orders after hours and let them execute during the day or are you going to watch the market during trading and place your orders? Types of orders are you going to use? Are you going to place market orders, limit orders, stop orders or a combination of different types depending on the situation? What are the advantages and disadvantages to each and how will you use them for money management? What is your hold time going to be? Day trading? Swing Trading? Short-term trading? Long-term trading? Different time periods have different potential opportunities and risks. What are you going to trade? Just stocks? Perhaps options as well or even futures and currencies. How does volume affect your trades? There are plenty more as well, but you get the idea.

Then you need to use your rules to develop your system. To do this you will need to learn about different indicators and oscillators, how they work and what assets they work best with. You will need software of some kind to test the results of your strategies.

Once you know the rules then you need to practice the game.

Then it is a good idea to do some ?paper trading? with your newly developed system, that is using either one of the stock market trading simulators available on the internet or just keeping track on your own. Get used to applying your strategy to real life and get a feel for how to manage it for several weeks at least.

Once you've done all this, you will be ready to start playing for real.

You probably noticed that the majority of this article was dedicated to the rules section. That is how it is supposed to be. The actual trading is the easy and fun part. Just like most games, playing is the fun part, but many hours of work and dedication go into learning the skills before playing the game. So learn the rules, practice what you've learned and then you'll be ready to win.

Click the Trading Games header link to download a free trading game and to learn more about creating a system of rules to successfully trade the markets.

Good day and good trading.

Millionaire Trading Tactics

Are there specific reasons why millionaires are millionaires? Do they share common characteristics? Should you get financial advice from someone who is broke, or someone who is wealthy? Thomas Stanley wrote several books about the affluent including The Millionaire Mind and The Millionaire Next Door. There are countless ideas from some of these texts that apply to trading. Today we will discuss a few of these ideas as well as using the night before technique to prepare for trading.

Millionaires

One major common characteristic amongst millionaires is the idea of safety of principle. Millionaires believe their CASH is their favorite possession, not their toys or other items. Because of this, millionaires take very good care of their cash by investing wisely and not compulsively. This idea is extremely practical in trading. One major activity that leads to the demise of traders is their desire for action. If the S&P 500 Index increases 10% this year and your portfolio increases 5% after 50 trades, what have those trades done for you other than waste your time and spin your wheels?

So trade like a millionaire, by being extremely selective about your trades. Quell the desire for action and instead focus on trades that are wonderful setups dying to be traded. Another common characteristic amongst millionaires is they are well informed and often usually invest money into financial and business advice. Just the same, traders should invest both time and money into investment newsletters such as The Wall Street Journal and in literature and seminars to increase trading skill and know-how. Like a millionaire, you can slow down and use the method below to execute trades.

Next, we are moving on to an effective, disciplined way to contemplate and act on trading information the night before the market opens. The problem with many traders is their uncertainty. We all know that short-term trading involves a great deal of uncertainty, But many traders are feeble and hesitant while in the trading process itself and during trade selection.

The Night Before

An excellent method of overcoming this is to prepare the night before trading. Here are the specific steps you should take: Many traders narrow it down to around 3 choices when deciding which trade to take. The problem with doing this intraday, is that the psychological pressure and noise that comes from news sources, friends and the trader's own conscience are too distracting. This greatly interferes with the effectiveness of most traders.

So narrow down your trades to the night before. It will only take 15 minutes to look at your 3 charts and to understand the risk and history behind each trade. Get some rest overnight, and you won't even have to think about which one to choose. Instead, you will be subconsciously processing the trade set-ups and the risks involved in each trade in your sleep. By the time morning rolls around, you will have thought further about your trades and will be ready for a strong decision with energy that the morning brings. In conclusion, think and trade like a millionaire and try thinking about your potential trades the night before the market opens and watch your results improve!

Good day and good trading.

Tuesday, October 24, 2006

Bollinger Bands

The Bollinger Bands (B-Bands) technical study was created by John Bollinger, the president of Bollinger Capital Management Inc., based in Manhattan Beach, California. Bollinger is well respected in the futures and equities industries.

Traders generally use B-Bands to determine overbought and oversold zones, to confirm divergences between prices and other technical indicators, and to project price targets. The wider the B-bands on a chart, the greater the market volatility; the narrower the bands, the less market volatility.

B-Bands are lines plotted on a chart at an interval around a moving average. They consist of a moving average and two standard deviations charted as one line above and one line below the moving average. The line above is two standard deviations added to the moving average. The line below is two standard deviations subtracted from the moving average.

Some traders use B-Bands in conjunction with another indicator, such as the Relative Strength Index (RSI). If the market price touches the upper B-band and the RSI does not confirm the upward move (i.e. there is divergence between the indicators), a sell signal is generated. If the indicator confirms the upward move, no sell signal is generated, and in fact, a buy signal may be indicated.

If the price touches the lower B-band and the RSI does not confirm the downward move, a buy signal is generated. If the indicator confirms the downward move, no buy signal is generated, and in fact, a sell signal may be indicated.

Another strategy uses the Bollinger Bands without another indicator. In this approach, a chart top occurring above the upper band followed by a top below the upper band generates a sell signal. Likewise, a chart bottom occurring below the lower band followed by a bottom above the lower band generates a buy signal.

B-Bands also help determine overbought and oversold markets. When prices move closer to the upper band, the market is becoming overbought, and as the prices move closer to the lower band, the market is becoming oversold.

Importantly, the market’s price momentum should also be taken into account. When a market enters an overbought or oversold area, it may become even more so before it reverses. You should always look for evidence of price weakening or strengthening before anticipating a market reversal.

Bollinger Bands can be applied to any type of chart, although this indicator works best with daily and weekly charts. When applied to a weekly chart, the Bands carry more significance for long-term market changes. John Bollinger says periods of less than 10 days do not work well for B-Bands. He says that the optimal period is 20 or 21 days.

Like most computer-generated technical indicators, I use B-Bands as mostly an indicator of overbought and oversold conditions, or for divergence--but not as a specific generator of buy and sell signals for my trading opportunities. It's just one more secondary trading tool, as opposed to my primary trading tools that include chart patterns and trend lines and fundamental analysis.

Good day and good trading.

Stop-Loss

Stop Loss & The Psychology of Investing

Without thinking about your answer, what is the best way to reduce your risk when investing in the stock market? My guess is that you got it right; the best way to reduce your risk is to refrain from investing at all! Ok, now that we’ve pointed out the obvious, let’s take a more realistic view. Every investor has had at least one of those “must have”, “can’t miss” stocks. All too often, those investments end up being the big loser in a trader’s otherwise stellar career. Because of that, it is important that the beginner investing in the stock market makes a plan that includes a stop loss strategy.

It is important to understand the psychology of investing and the stop loss concept; while making those impressive deals in the market, emotions are high and a stop loss strategy is the farthest thing from anyone’s mind. But when the losses start coming, so does the feeling of falling down a well, hopelessly tumbling all the way to the bottom. Remember, that 50% loss started off as an innocent 5% loss. That moment of truth in the well has everyone wishing for a net. A strong stock trading system, such as the candlestick analysis stock market investing technique, and a stop loss strategy is just the net you need when falling down the well of a bad investment.

For this exercise, let’s work with one of several simple stop loss strategies. The technique we will discuss is called the “trailing stop loss” strategy. Simply put, calculate the cost of your investment, set a percentage that you consider a reasonable amount for the stock to turn around, and calculate a trailing stop loss based on that. For example, you bought 100 shares of Stock A at $10 per share and the fee for the transaction was 3%, with a total for the transaction being $1,030. Through candlestick analysis, you determine that 10% is a realistic turning point for this stock; therefore, your trailing stop loss would be $9.27 per share. (Notice that the cost of investing is included in this calculation. Always consider the cost of doing business in any business decision.) If your stock dips below that, you sell and cut your losses. By setting your limit before the transaction, you avoid allowing your greed and fear to control your decision of when to sell. This little stop loss strategy is a simple hedge against big losses, and the best part is that you can protect your gains the same way. As your investment increases from profits, simple recalculate your stop loss.

It seems more difficult than it really is. As with all good stock market strategies, emotions should always be left out of investment decisions. Being able to see the need for stop loss strategies is a good indication that an investor realizes that not all investments will be profitable. It is crucial to use stop loss strategies & techniques developed by others who have experienced the same downfalls, add them to your technical analysis, and bring it all together with a strong system. This will improve the success of any investor and prevent “falling down the well”.

Good day and good trading.

Monday, October 23, 2006

Winners & Losers

Most traders typically like to talk about their winners while avoiding any recollection of their losers. Smart traders will be aware of the patterns that occur with losing trades, so as not to hold losing trades any longer than necessary. Read below for tips on managing losses.

If you have been in the market for any length of time, you will have experienced a loss. While experiencing a loss is less than enjoyable, the real danger of a losing trade is the threat it poses to your confidence and your mental approach.

That being said, here are some ground rules to keep in mind:

1. Understand the difference between confidence and unreasonable expectations. You should believe that every trade you place, based on your systematic criteria, is going to be a winner. If you are not confident of that, then don't place the trade. However, realize that over a given length of time, at least some of your trades will work against you. Even a great trading system fails sometimes, so your job is to make sure your system has an overall net positive return. If you are redefining your trading system for every trade in an effort to insure success, that is simply a signal that the system is ineffective.

2. Cut losses. It is critical that you be willing to take small losses before they turn into big losses. I can't tell you the number of times I've heard someone say about a stock "I'm sure it will come back.", only to see the share price continue to deteriorate. Besides doing damage to your account value, riding a loss can be a substantial blow to your confidence. If you are that confident about a stock, then sell it at a small loss and buy it back when you see it begin to turn around.

3. Don't try trade your way out of a loss. (This is an extension of rule number one.). By this I mean don't follow up a loss by placing a trade you wouldn't have normally placed in an effort to make up for the loss. The past can't be changed, so let go of it and approach the next trade in an unbiased manner.

4. Constantly learn. I'm not going to say there is something to be learned with every loss, because sometimes there is not. When there is something to learn though, then you certainly should learn it. More importantly, if what you learn is something that will improve your trading system, take it and apply it to your system. (Notice here that I said to apply it to your system, not just to your next trade.) Your system must have an overall net positive result, but there is nothing wrong with constantly improving your system.

5. Don't let losses paralyze you. It's just part of investing. While a loss may give us reason for caution, take a step back and look at your overall goals and your overall trading approach. If your confidence is injured, then paper trade for a while until you can see that your system has merit and you can invest successfully. It's imperative that you don't simply avoid trading.

Click the Winners & Losers header link above to learn about keeping your losses small and letting your winners run.

Good day and good trading.

Sunday, October 22, 2006

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ's 0.06% gain on Friday was the most tame of all three indices we watch here, as the composite only gained 1.36 points to end the session at 2342.30. That still means a negative close for the week though. The index closed 14.99 points (-0.64%) lower than the previous Friday's close, perhaps finally pointing to the bigger-picture weakness we've been discussing lately.

Although the composite didn't crack this year's high of 2375, Monday's peak of 2368.11 was pretty close. The question is, was it close enough to satisfy any of the would-be sellers who were just waiting for the optimal spot to make an exit? Or, will these folks need to officially see 2375 before they take profits....if they're even interested in taking profits.

While only the coming week can really answer the question, based on the response we saw after Monday, we tend to think the answer is the 'close enough' answer. Things turned bearish pretty harshly on Tuesday, and after we closed the bearish Monday/Tuesday gap, we sank back to the lower end of last week's range, never really looking back.

True, it was an expiration week, so any read we're getting now may be a bit tainted. However, the heart of the problems were already in place before expiration week came. The NASDAQ is still overbought, and the VXN is still strangely low. And, our contention is still that there's a price to be paid.

On the flipside, from here, it's clear the buyers are using the 10 and/or 20 day moving average lines as a buying point. The former is at 2331, while the latter is at 2305. Unless those lines actually breakdown as support, we'll actually have to stay sided with the uptrend, as unlikely as it seems. If 2375 is breached, it could also be a bullish catalyst.

Nasdaq Chart

Nasdaq Chart

S&P 500 Outlook

The S&P 500's close at 1368.60 on Friday was 1.65 points (+0.12%) above Thursday's close. For the week, the large-cap index just gained 3.0 points, or 0.22%. However, the support we've been seeing here is still unwavering.

As it has since July, the SPX has made its way through a generally bullish trading zone, thanks to some help from its 10 day moving average and 20 day moving average. Despite the worries that they wouldn't, all of the SPX's support lines have continued to keep the index drifting higher.

So, as we've been prescribing for weeks, be aware of the potential breakdown from any (actually, all) of those lines. The lowest of them is the 20 day line (blue), currently at 1351, and rising. That also coincides with the long-term support line (dashed) extending back to July. Both of those lines are rising about 2 points per day, so be sure to adjust accordingly.

In the meantime, the VIX is back to the lower Bollinger band, and closed at a multi-month low close of 10.63 on Friday. While we have little doubt that expiration played at least some role in getting the VIX to these dangerous levels, don't forget that this issue was one well before expiration week was here. It's only a question of time before the VIX bounces (sharply) at the expense of stocks. We remain vigilant in our watch.

On a side note, the S&P 500 is now 6% above its 200 day line. Historically speaking, it's a statistical rarity, and yet another bearish concern. The 'reversion to the mean' theory usually kicks in right about here. In fact, there's only one instance in the last two years (December of 2004) when the SPX got significantly greater than 6% above the 200 day moving average. All of them, including the December '04 instance, led to correction of 2% or so, if not greater. The research on this scenario so far is limited, but the concern for the bulls is still obviously merited. We'll keep working on it to bring you the vital stats of the premise later this week.

S&P500 Chart

S&P500 Chart

Dow Jones Industrial Average Outlook

The Dow closed just 9.36 points lower on Friday, for a negligible loss of 0.08%. Ending the week at 12,002.37 meant a 0.35% gain above the prior Friday's close, translating into a gain of 0.35% on a weekly basis.

The duality of the situation applies to the Dow as well. Things are bullish in the sense of upward momentum. But, things are increasingly bearish in the sense of being overbought, and hinting at correcting that condition. We have yet to see either, but we're on the verge of a MACD crossunder as well as a stochastic sell signal. Only a little weakness this coming week would prompt both.

That being said, the 20 day line - no matter what - at 11,848 is still the line in the sand.

Dow Jones Industrial Average Chart

Dow Jones Industrial Average Chart

Good week and good trading.

Friday, October 20, 2006

Bid Ask Spreads

The Bid/Ask Spread is important factor in stock trading. The Bid Price is the current highest price at which someone in the market is willing to buy a stock. The Ask Price is the current lowest price that someone is willing to sell a stock. The difference in these two amounts is called the Bid/Ask Spread.

The Bid/Ask Spread is determined mainly by liquidity. If a stock is highly liquid, meaning there is a large volume of shares being bought and sold, the Bid/Ask Spread will be much lower. A low Bid/Ask Spread is important to traders because that extra cost will eat away at your profits.

For example, on the stock PALM, the Bid Price is $22.70 and the Ask Price is $23.06 so the current Bid/Ask Spread is $0.36. If you were to buy 100 shares and then immediately sell them using market orders (assuming everything stays the same and not factoring in commissions) your loss would be $36 just because of the spread. Remember though that the spread can change throughout the day depending on orders that are coming through.

You can also easily see how volume affects the Bid/Ask Spread by comparing different stocks. The exchange traded fund QQQQ is probably the most liquid asset. The average daily volume for QQQQ is almost 100 million shares, which brings the Bid/Ask Spread down to $0.01 at all times. PALM's average volume is just over 4 million shares a day so it is still very liquid, which makes the Bid/Ask Spread pretty small. Stocks that trade only a few hundred thousand shares or less will start to show spreads much larger then PALM.

It will be comprised of three components, the Short-Term Trends, the Sector Timer and the Economic Outlook. Each one will provide data, systems and research to help you make trades over a variety of different time periods.

The Bid/Ask Spread can cut into your trading profits slightly with stocks. With the PALM example, the stock has to show a gain of about 1% for you even make any money but this isn't a huge problem. Options are where spreads can really start to hurt. With options, the difference between the Bid and the Ask will almost always be at least $0.05. If the option only costs $0.70 then the spread is a fairly large piece of the trade. This is one good use for limit orders, to make sure you get in where you want. But if the market moves too fast a limit order might keep you out of a profitable trade.

Overall, the spread shouldn't be a huge concern for most traders, a good trading system should have no problem overcoming the spread. You should be aware of it though and how it effects your trades.

Click the Bid Ask Spreads header link above to learn more. Have a good weekend.

Elliott Wave Trading

What a Trader Really Needs to be Successful - By Robert Prechter

Ever since winning the United States Trading Championship in 1984, subscribers have asked for a list of tips on trading, or even a play-by-play of the approximately 200 short term trades I made while following hourly market data over a four month period. Neither of these would do anyone any good. What successful trading requires is both more and less than most people think. In watching the reports of each new Championship over the past three years, it has been a joy to see what a large percentage of the top winners have been Elliott Wave Theorist subscribers and consultation clients. (In fact, in the latest 'standings' report from the USTC, of the top three profit producers in each of four categories, half are EWT subscribers!) However, while good traders may want the input from EWT, not all EWT subscribers are good traders. Obviously the winners know something the losers don't. What is it? What are th! e guidelines you really need to meet in order to trade the markets successfully?

When I first began trading, I did what many others who start out in the markets do: I developed a list of trading rules. The list was created piecemeal, with each new rule added, usually, following the conclusion of an unsuccessful trade. I continually asked myself, what would I do differently next time to make sure that this mistake would not recur? The resulting list of 'do's' and 'don'ts' ultimately comprised about 16 statements. Approximately six months following the completion of my carved-in-stone list of trading rules, I balled up the paper and threw it in the trash.

What was the problem with my list, a list typical of so many novices who think they are learning something? After several months of attempting to apply the 'rules,' it became clear that I made not merely a mistake here and there in the list, but a fundamental error in compiling the list in the first place. The error was in taking aim at the last trade each time, as if the next trading situation would present a similar problem. By the time 16 rules are created, all situations are covered and the trader is back to square one.

Let me give you an example of the ironies that result from the typical method of generating a list of trading rules. One of the most popular trading maxims is, 'You can't go broke taking a profit.' (The brokers invented that one, of course, which is one reason that new traders always hear of it!) This trading maxim appears to make wonderful sense, but only when viewed in the context of a recent trade with a specific outcome. When you have entered a trade at a good price, watched it go your way for a while, then watched it go against you and turn into a loss, the maxim sounds like a prounouncement of divine wisdom. What you are really saying, however, is that in the context of the last trade, 'I should have sold when I had a small profit.

Now let's see what happens on the next trade. You enter a trade, and after just a few days of watching it go your way, you sell out, only to stare in amazement as it continues to go in the direction you had expected, racking up paper gains of several hundred percent. You ask a more experienced trader what your error was, and he advises you sagely while peering over his glasses, 'Remember this forever: Cut losses short; let profits run.' So you reach for your list of trading rules and write this maxim, which means only, of course, 'I should NOT have sold when I had a small profit.'

So trading rules #2 and #14 are in direct conflict. Is this an isolated incident? What about rule #3, which reads, 'Stay cool; never let emotions rule your trading,' and #8, which reads, 'If a trade is obviously going against you, get out of the way before it turns into a disaster.' Stripped of their fancy attire, #3 says, 'Don't panic during trading,' and #8 says, 'Go ahead and panic!' Such formulations are, in the final analysis, utterly useless.

What I finally desired to create was a description not of each of the trees, but of the forest. After several years of trading, I came up with -- guess what -- another list! But this is not a list of 'trading rules'; it's a list of requirements for successful trading. Most worthwhile truths are simple, and this list contains only five items. (In fact, the last two are actually subsets of the first two.) Whether this list is true or complete is arguable, but in forcing myself to express my conclusions, it has helped me understand the true dimensions of the problem, and thus provided a better way of solving it. Like most rewards life offers, market profits are not as easy to come by as the novice believes. Making money in the market requires a good deal of education, like any craft or business. If you've got the time, the drive, and the right psychological makeup, you can enter that elite realm of the truly professional, or at least successful, trade! r or investor. Here's what you need:

1) A method. I mean an objectively definable method. One that is thought out in its entirety to the extent that if someone asks you how you make your decisions, you can explain it to him, and if he asks you again in six months, he will receive the same answer. This is not to say that a method cannot be altered or improved; it must, however, be developed as a totality before it is implemented. A prerequisite for obtaining a method is acceptance of the fact that perfection is not achievable. People who demand it are wasting their time searching for the Holy Grail, and they will never get beyond this first step of obtaining a method. I chose to use, for my decision making, an approach which was explained in our book, Elliott Wave Principle – Key To Market Behavior. I think the Wave Principle is the best way to understand the framework of a market and where prices are within that framework. There are a hundred other methods, which will work if su! ccessful trading is your only goal. As I have often said, a simple 10-day moving average of the daily advance-decline net, probably the first indicator a stock market technician learns, can be used as a trading tool, if objectively defined rules are created for its use. The bad news is that as difficult and time consuming as this first major requirement can be, it is the easiest one to fulfill.

(Stay tuned for more of Bob Prechter's trading tips in the upcoming issues of the A.M. Trader. You can also read Bob's latest thoughts about the markets right now in his Elliott Wave Theorist.)

Click the Elliott Wave Trading header link above to receive a free Elliott Wave Trading Tutorial and more information on high reward low risk trading with Elliott Wave.

Thursday, October 19, 2006

Stop-Loss Using Candlesticks

Simple Stop Loss Strategies can be easily used with Japanese Candlestick trading.

One of the most often-asked questions we receive is how to use candlestick analysis as part of a simple stop loss strategy.

The fact is, not only is candlestick analysis ideal for pinpointing the exact time the successful trader or investor should enter the trade, but it is equally valuable in stop loss strategies. The proper use of candlestick analysis provides a simple, visual representation of the exact point in time when the reason for buying or shorting no longer exists.

Once you deeply, truly understand candlestick trading tactics, you will soon come to the realization that most of trading is just plain common sense. But, as I believe Mark Twain said, Common sense is not that common.

It amazes me each and every day to see all these brilliant stock annotators and stock analysts attempt to explain what happened in the market that day. As if the market cared one bit about their stock market fundamental and technical analysis. But I guess these guys and gals are just trying to do their job, feeding the all-too-human need of Having to Know Why Something Happened.

Candlestick Traders don’t need to know why something happened. They just look at the candlestick chart patterns and know something happened. In a strong reversal pattern, something happened to totally change the HUMAN EMOTIONS of the HUMAN BEINGS buying or selling that stock or commodity. After all, the candlestick patterns are simply the visual representation of human psychology – of Greed and Fear.

So, when using simple stop loss strategies in their overall stock trading system, the Candlestick Trader does not need to know WHY the stock is now going down after they bought it. The fact is, it IS going down. The psychology has changed.

Simple Stop Loss Strategies Involve Knowing The General Market Direction. The investment psychology of the market, in general, can be easily seen in the Japanese Candlestick signals. Use that stock market information to change the makeup of your portfolio. During iffy periods, having long and short positions will provide better probabilities to make profits, even when the direction of the market is not clear.

Stop Loss Strategies and Techniques using the candlestick method.

Protecting your assets - that is the main objective for putting on stop losses. The stop loss objective is to provide a point where the reason for buying or shorting becomes null and void. Many stock market strategies incorporate stop loss objectives into their trading formulas for closing a trade gone sour. Usually this is done by establishing a percentage loss as the parameter. Here is the first myth to be bashed: The candlestick method completely disregards a preset formula for stopping out.

One of the major investing mistakes is using a prescribed percentage as the stop loss. Your purchase price becomes an important function of where you are to stop out. The stock market investing advice given by some investment advisors recommends three percent as the stop-out level. Others suggest eight percent. But where you buy a trade position now becomes the quantitative element of where you should place your stop.

The most important factor for establishing a stop loss is very basic. What price point would indicate the established trend has been negated? This now becomes a stop loss level established based upon the trend being stalled and/or negated.

As with all of candlestick analysis, this becomes a common sense evaluation. If you have put on a long position based upon a bullish buy signal, where would the price have to back off to confirm that the sellers were still in control?

A signal has significant meaning. Knowing that, the thought process for when to stop out of a trade becomes easy. A buy signal indicates a new trend. What would counter that indication?

Probabilities mean being in that trade has favorable odds for profitability, not any guarantees. Even though a majority of trades will work using the signals, some trades won’t work. Keeping that mindset in focus as well as other candlestick basics, stop loss analysis creates a format for identifying when a trade is not working and getting out of the trade as soon as possible.

Establishing the stop loss point involves using the same common sense approach incorporated throughout the candlestick method and other stock investing concepts.

Studying stock chart patterns will vastly improve your ability to recognize when and where a stop loss should be placed on a trade. Study candlestick chart formations with extensive downtrends. Often a fizzled buy signal can be found. Recognize what the trading candles did after the buy signal and what selling candles negated the buy signal.

Keep in mind that all trades do not work. Learn to move out of those trades and move to other trades immediately.

Click the Stop-Loss Using Candlesticks to learn more about keep your risk and and reward high.

Good day and good trading.

Wednesday, October 18, 2006

Success As A Trader

17 Key Steps That will Ensure Consistent Success as a Trader - Dr. Van Tharp

First, you need to assess your beliefs about trading and about yourself.

Although its difficult to grasp, did you know that nobody actually trades the market? Instead, you always trade your beliefs about the market.

Second, you will need to determine your objectives for trading. System experts know that understanding your objectives thoroughly is half the battle in developing a system but most people have never taken the time to even consider what their objectives might be. Thus, in this workshop you will get to work through questions to help you determine exactly what you want out of your trading system.

Third, you will need to understand the big picture. Whats the market doing overall and how can I measure it for myself?

Fourth, your business plan will need to include three strategies that are compatible with the big picture. Although there are thousands of systems out there, there are not many types of strategies. Learn the essence of ten key strategies that you could use, the general picture of how they work and how you can adapt them for yourself.

Fifth, learn what your personal edges might be and how they set you off from the crowd. Having an edge in the markets isnt just a slight advantage; it could be the pivotal difference in your success. So its very important to list your edges in your business plan and be able to capitalize on them.

Sixth, understand the key systems that almost every business must understand and start to think about developing structures for those systems. From marketing to cash flow, to back office and clients, trading is a business and should be regarded as such.

Seventh, develop a worst-case contingency plan. Most people dont even consider this crucial component until its too late, but the key to a successful business plan is to be able to overcome disaster.

The eighth step is to select your trading market based upon two key factors. Whatever you select must take into account the big picture and what is likely to happen in the next five to ten years.

Ninth is strategy preparation. There are several key sub steps that you should take before you think about trading.

Tenth, learn the key steps in strategy development and how to test for each. You will learn about testing exit signals; how to determine what your initial risk will be; and how to select and test your profit taking exits. This is not a substitute for our specific System Development or Mutual Fund/ETF workshops; instead, we will be discussing the key steps that you must take and how to test them.

Eleventh, properly evaluate your system. You need to know how to test and compare your system with any other system. You will need to know whether you have a weak, average, good, excellent, or superb system.

The twelfth step is a simple way to really get to know your system well without a lot of cost.

The lucky thirteenth step is where you will be working on your objectives to actually develop position-sizing models. This step is one of the keys to developing a system that fits you.

Step fourteen do a complete self-assessment. This includes: Knowing your personality type and how it impacts trading. Knowing about the most important attitude that you must have as a trader and understanding your beliefs and values and how to assess yourself.

Step fifteen is the step that will really separate you from other traders and launch you toward top trader status. This includes six to eight things that you can do on a regular basis to really improve yourself.

Step sixteen is to develop a top down approach to discipline. If you combine top-down discipline with regular self-work, you will be amazed at the difference in your trading.

The seventeenth step is putting all of the the other steps into action.

Click the Success As A Trader header link above to learn more on how to be a long term successfull investor, speculator, and trader.

Have a good day.

US Trade Gap Data

U.S. Trade Gap Hits New High? Yawn...

Thursday morning (Oct. 12), the financial headlines reported that the U.S. trade deficit reached a new all-time high. Bad news for the dollar, right? No question. But the greenback barely gave 50 pips to the euro after the news. And then, on Friday morning (Oct. 13) – despite the record trade gap, a rise in weekly U.S. jobless claims, and an unexpected drop in retail sales – the USD came roaring back, gaining almost 100 pips against the EUR toward the close.

If you think that makes no sense, you’re not alone. Last year, every currency analyst who was bearish on the dollar named the rising trade gap as one of the main reasons for the buck's imminent collapse. Instead, 2005 turned out to be one of its best-performing years ever.

Still, month after month, many forex analysts continue to expect from the USD a straightforward reaction to the trade gap figures. And when they don’t get it, they look for other reasons why the dollar is staying supported.

But why reinvent the wheel when the one and only reason for the dollar’s strength this week – forex traders bullish mindset reflected as an Elliott wave pattern – has been staring you in the face from the EURUSD charts?

Elliott Wave analysis of education, training, news, trading signals, fourms, and trading software to learn how to trade with human nature instead of the data, and its repetitive nature which has predictive value.

Click the US Trade Gap Data header link above to learn about human nature and how to trade with it to keep reward high and risk low.

Good day and good trading.

Tuesday, October 17, 2006

Earnings Surprises

Lets talk about earnings expectations and surprises. We will look into data proceeding positive and negative surprises. Many novice investors assume that negative announcements cause stock prices to drop and that positive announcements cause prices to fall. But there is more to it than meets the eye. Not long ago, GM announced another loss for the current quarter yet the company's stock rose on the news. But why? It's because most analysts and market participants were expecting the announcement of a losing quarter but it turns out the loss was not as bad as expected and soon afterwards, GM received an analyst upgrade. So the point is that bad news or good news is not the bottom line when it comes to surprise stock movement.

Traders who speculate on news releases must consider what current expectations are. If a news release is not surprising, then the stock price is likely to stagnate. Therefore expectations set up a virtual hurdle that must be surpassed in order for the stock price to increase. This is what we have seen in Google stock since the IPO. Time after time, the expectations were high for Google earnings, yet the company has surpassed these high hurdles like a pole vaulter. Some analysts specialize in placing speculative trades prior to earnings announcements. Their data suggests that the best earnings trades are proceded by a long-term rise in the stock price followed by choppy, sideways action a week before earnings on moderate volume. They also take into account surges in implied volatility.

A study looked at price movement in stocks 1-3 years after different types of news items. The data suggests that these various news items affect stocks in various ways. This data also suggests that this information is tradable and useable. If you are interested in surprise information, consider doing further research on the subject and if you feel strongly enough about it, then trade accordingly.

Good day and good trading.

Sunday, October 15, 2006

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ's 11.11 point gain on Friday - a gain of 0.47% - left the composite at 2357.29 for the week. That was 2.49% higher than the prior Friday's close, thanks to the weekly gain of 57.30 points. While the bulls are probably happy with the results, we still contend that this recent, and excessive, strength is a likely setup for a bigger correction in the near future. And, the potential trigger is only 17 points away.

How will the market react when and if the composite finally makes it up to this year's high of 2375, hit in April? We can never say for sure, but we do know that the bulls should be aware that we're only 17 points under that mark right now. There's a good chance some major players will be using that line as a make-or-break line, and if traders flinch there, that may be just enough hesitation to start the profit-taking.

Plus, being as stochastically overbought as we are right now, the market remains particularly ripe for a pullback.

That being said, if the composite busts through 2375, don't think it can't just keep going. Stranger things have happened. As Keynes said, The market can stay irrational longer than I can stay solvent. Continue to follow the trend as it is...not for what you think it should be, or will be in the future.

Of course, we have a strong counter-argument to bullishness in our S&P 500 discussion below.

Nasdaq Chart

Nasdaq Chart

S&P 500 Outlook

The S&P 500's close at 1365.20 on Friday was 2.75 points above Thursday's close - a gain of 0.20%. For the week, the SPX continued upward by 16.0 points, or 1.19% above last Friday's closing level. However, being way overbought, and with the VIX back to uncanny lows, we think the S&P 500's rocket-like rise in the last few days has given us a few hints of the uptrend's exhaustion.

We haven't looked at new high and new low data in a while, primarily because it hasn't been all that telling lately. That is, until now. As of last week, we saw new highs for NYSE-listed stocks as well as new lows for NYSE-listed stocks hit those extreme levels associated with tops and bottom. This extreme just happened to be consistent with a top, and is one of the major reasons we expect a pullback in the very near future.

On Friday, we saw 348 NYSE-listed stocks hit a new high. The day before, we saw 12 NYSE-listed stocks hit new lows. Very bullish? Yes indeed. That's the problem though...it may be too bullish. The last time we saw that many new highs was on May 5th - right before the gigantic pullback we suffered through this spring. Each extreme new high day is marked with a green arrow on the SPX's price bars.

The last time we saw that few news lows was August 31st, right before a minor pullback. We also saw tiny new low figures several times earlier this year, most of which came right on front of other minor pullbacks. Each extreme new low day is marked with a red arrow on the SPX's price bars.

To see both the new high and new low readings hit extremes simultaneously hints of a final, blowoff move. To see it occur at the same time the VIX is at almost-bizarre lows just makes a bearish reversal even that much more likely, as we've historically seen on our chart. Each instance of the VIX hitting an unusually sharp low is marked with a blue arrow on the SPX's price bars.

While we're still saying we're due, it's also worth keeping in mind that it could take a few days for any such dip to materialize. This coming week is expiration week, which brings it's on special brand of volatility. But, it's still imperative to keep an eye on al of these measures this week, including the key support and resistance lines we've discussed in earlier editions of this outlook.

S&P500 Chart

S&P500 Chart

Dow Jones Industrial Average Commentary

The Dow Jones Industrial Average gained 13 points on Friday, or 0.11%. However, it was still enough to count as a new all-time high close, at 11,961. Friday's high 12,010 was also a new all-time intra-day high. On a weekly basis, the Dow was 111 point, or 0.94% higher than last week's close. Despite the fact that this blue-chip index isn't quite as vulnerable as the other two indices, it's still teetering on a dangerous edge as well.

We're stochastically overbought (as all the indices are), which is potentially bearish. We're also finding support at the 10 and/or 20 day moving average line, as well as a long-term support line (red, dashed) that extends back to July. That support line is at 11,683 and rising fast, and even though we see a short-term dip in the works, for the Dow, only a slide under that support line would get us bearish in the bigger picture. Just keep some perspective, and keep watching these charts.

Dow Jones Industrial Average Chart

Dow Jones Industrial Average Chart

Friday, October 13, 2006

Exchange Traded Funds - ETF's

An exciting new class of trading vehicles is starting to emerge all over the world equity markets: Exchange Traded Funds (ETFs).

They are typically low cost, index-tracking funds that trade like a stock. These baskets of securities can be bought or sold throughout the market day and offer exposure to leading indexes, sectors and even individual countries throughout the world. Many can even be shorted on a downtick, an advantage that means a lot to short-term traders hoping to capitalize on intraday volatility to the downside.

The American Stock Exchange, for example, a world leader in the development marketing and trading of ETFs, lists more than 120 funds with assets in excess of $150 billion USD.

ETFs have advantages over mutual funds that include:

Portfolio transparency--you can see what they hold

Low turnover rates--leads to more cost effective administration and tax efficiency

No minimum investment level (in most cases)

Continuous intraday pricing

No limits on trading frequency

Optionable

ETFs also have advantages when compared to individual stocks, such as:

Diversification at lower cost

Smoother equity curve and less volatility (not in all cases!)

ETFs are not without their disadvantages, as you would expect. Depending on your investing or trading style, there are issues of liquidity, volatility, size, tax consequences of buying and selling, as well as dividend and capital gains distributions, and administrative costs to consider before jumping on the bandwagon. Do not discount the cost of trading in your calculations!

ETF strategies come in many flavors. To list just a few:

A low cost way to implement a low maintenance asset allocation strategy

To efficiently manage a market timing strategy

To reduce, company-specific risk

As a portfolio hedge

As part of a tax-selling strategy or to improve tax efficiency

As a means to add diversity to an overly focused portfolio

A way to achieve specific sector or index exposure in an efficient manner

To achieve market exposure more efficiently than with mutual funds

To improve the task of portfolio management

To efficiently trade macro opportunities

To efficiently trade the reaction to unexpected news events

To take advantage of short-side trading

ETFs are certainly not the be-all-and-end-all of trading vehicles, but for the informed investor they add a very useful set of tools to your toolbox.

As an example, a new way to participate in the often perilous gold market appeared with the announcement of GLD, the ticker for streetTRACKS Gold Shares, which began trading on the NYSE on Thursday, November 18, 2004. GLD happens to be a tricky way to play a tricky market, since this gold-bullion based Exchange Traded Fund (ETF), tracks the actual commodity, the first US ETF to do so. GLD is sponsored by the World Gold Council and marketed by State Street Global Advisors. Each share will initially represent one tenth of an ounce of gold bullion as priced by the London Bullion Market Association. This will diminish over time, as the fund will pay expenses by selling gold held in the trust as needed. The initial expense ratio is pegged at 0.4% per year. Initial trading in the ETF has been brisk, with over 17 million shares changing hands in the first 2 days of trading.

Barclays Global Investors, the worlds largest provider of ETFs, filed a final version of its registration statement with the SEC for its own gold ETF, which will trade on the AMEX under ticker IAU.

The Dow Jones newswire notes that shareholders gains will be taxed as if they own the underlying gold, which translates into a higher rate. Under current law, gains on the sale of "collectibles," including gold bullion, held for more than one year are taxed at a maximum rate of 28%, rather than the 15% rate applicable to most other long-term capital gains.

GLD and IAU are just one type of ETF available to individual investors. ETFs are growing in popularity and offer a number of advantages to individual investors regardless of style. They can be used in creative ways whether your strategy calls for leisurely asset allocation, position trading, swing trading, intraday trading and scalping, or whether you simply are looking for a more efficient way to capture the returns of specific segments of the world equity markets. With over 120 ETFs offered in the US, you can find ETFs that track broad markets, defined market sectors, individual countries, or narrowly focused industry sectors.

Have a good weekend.

Thursday, October 12, 2006

Stop & Limit Orders

Sometimes you may give your spouse or your child your credit card and they spend hundreds or even thousands more than you expected! Wow, there's nothing you can do about it. The good news is, you can put stop losses and limits on your option positions. This way, your calls and puts don't run away with all of your money. The use of limit orders also sometimes allows you to get a better price than a market order instantly. For example, suppose the bid/ask spread is 3.30/3.50. You put in a limit order at 3.40 and it gets filled immediately and you save yourself 10 cents. It doesn't happen often, but it does sometimes depending on whether or not the market maker is willing to sell at 3.40. To sum up though, the use of stops and limits can have lots of benefits and there are drawbacks as well. Getting educated however, only has benefits.

Stops and Limits Defined

A stop order is an order to buy or sell a stock at the market price once the price reaches or passes through a specified point, called the "stop price." This type of order is generally used by people who own a stock and want to make sure they sell out if the stock price starts to drop. The stop price placed on a sell stop order must be below the current bid price of the security.
Stop orders in volatile issues will not guarantee an execution at or near the stop price. Once triggered, they are competing with other incoming market orders.

Stop orders can be placed for buy orders as well. The stop price specified for a buy order must be above the current asking price. One last note on sell stops. If you use a sell stop for an option, the price that is used is the last trade price. In other words, the actual value of an option can go down significantly without there actually being at trade for the day for this particular option. In this way, a stop loss for an option has its drawbacks because it may offer less protection than it does for a stock that trades millions of shares per day.

A limit order lets you place a price restriction on your transaction. You indicate that you are only willing to buy or sell a stock at a certain price or better. Your order is not filled unless the stock trades at that level. Placing a limit order, however, is not a guarantee that your trade will be executed at your limit price. It does, however, eliminate the risk that your order will be filled at a price worse than you expected.

For example, if you want to buy ABC stock at $50 a share once again, and the market price is 50 bid and 50.20 offer, your order cannot be filled immediately. If somebody comes to sell the stock at $50, then your order will be filled if it is next in line for execution. If more buyers enter the pit and drive up the stock price, your order will not be filled.

Recommendations

We recommend the use of what we call a closing stop. A closing stop is just like other stops but it is not automated and it is based on the ask price as opposed to the last executed price. Let's say we buy an option at 3.00 and we want to set our closing stop at 2.00. We do not execute this order before closing time. Closing time is between 3:45 and 4:00PM Eastern Time. That is why we call this a closing stop- because we only execute it around the time of close. The reason for this is that when you are dealing with options, as in the above example, you might see the ask price as low as 2.50 during the day and then a pop back up to 3.20 for a swing of almost 30%. Intraday volatility is extremely high. If you use normal stops, the chance of getting shaken out (exited) from a trade is very high. We don't want to get shaken out too often because we don't want to trade options excessively because of the bid/ask spread. The difference between a market order and a closing stop is that when a trader uses a closing stop, he has already committed that he will sell once the ask price goes under a certain level. This objectivity is critical in trading because it protects traders from making subjective, and emotional trades.

Next, let's talk about how we use limit orders. Most of the time it makes good sense to enter with a limit order. This guarantees that if we get execution, we will get it at the price we want. Now sell orders on the other hand should be treated differently. Traders have a tendency to hold onto losing trades too long. For this reason, market orders should be used to sell most of the time. Here is an example: suppose you plan to sell your option at $2.00 and you put in a limit order at $2.00 and the current bid price is $1.90. You don't get filled. The market closes and the next morning the stock gaps down and the option is worth $1.00. You decide to hold on for the rest of the day, and the stock goes down another 4% and option at close is worth $0.40! If you had just sold using a market order yesterday, you would have gotten out at 1.90 and saved yourself some significant money. Most of time, depending on technical conditions and liquidity, traders should use market orders to close out their losing positions. On the other hand, the use of limit orders on winning trades is the better way to trade. This way, you prevent yourself from selling your winners too quickly, another common mistake of traders.

So to sum it up, use closing stops with options trades to avoid excessive trading and to protect yourself from daily market noise. When possible, use limit orders to enter and market orders to exit. Be disciplined - and trade well.

Good day and good trading.

Wednesday, October 11, 2006

EURUSD & Elliott Wave

The lull in the euro/dollar market ended when the pair sold off sharply on Friday Oct. 06. Then, early Tuesday morning Oct. 10, when the U.S. forex traders were sound asleep and their European colleagues were still brushing their teeth, the dollar confirmed it meant business by pushing the EURUSD rate another 90 pips down.

According to the forex press, the USD suddenly got stronger as a result of many factors, such as:

Expectation of another increase in U.S. retail sales to be announced this week.

Expectations the U.S. economy might be in better shape than previously thought. (Reuters).

Expectation that North Korea's nuclear bomb test will prompt Japanese investors to buy U.S. Treasuries (Bloomberg).

And finally, expectation that the Fed would not cut interest rates next year. And even if it does, said one analyst, a U.S. slowdown is not a clear-cut signal for selling dollars because it will cause central banks outside the U.S. to stop raising rates.

And to think, just a week ago the expectations for the USD were the complete opposite. Last Monday Oct. 2, for example, one analyst said, after the news of a drop in the U.S. manufacturing, It clearly indicates the U.S. economic growth is slowing down. Longer term, it generates a weaker dollar. (Bloomberg)

In the long-term, maybe, but over the short-term forex traders sudden change of heart towards the USD has cost the EUR some 230 pips over the past 7 days. Ouch.

Click the EURUSD & Elliott Wave header link above to learn about trading the forex market with high reward to low risk trades to profit in the long term. Look for the MTPredictor Elliott Wave Trading Software link midway down the page.

MTPredictor provides high reward to low risk trades based on Elliott Wave so traders can profit in the long term by keeping losses small and letting winners run by identifying high reward low risk trade setups. The software also has built in money management and position sizing features according to the size of the trading account to properly size the trade so to not over leverage the account and add on more risk. Keeping losses small and letting winners run is the key to successful trading in the forex market and any leveraged market. Once new traders understand this and apply the rules of the system, they will profit in the long term.

As a user of MTPredictor its one of the finest trading systems we use. As a distributor of MTPredictor, we provide a 10% discount to the regular price. Avail of the Free 30 day trial to experience this software. Your trading account will be glad you did.

Good day and good trading.

Fundamental Analysis - Cash Flow

Why cashflow is king.

Sometimes, traditional ways and practices are best. For example, respecting our elders is a good thing. Singing the National Anthem before a ball game is a time honored tradition. And manners will never go out of style.

But some traditions have worn out their welcome.

Like these traditions, the use of earnings as the main fundamental measure of a company has become less and less useful.

Don’t get me wrong – corporate earnings are still the primary reporting measure used by the press and some analysts. But a growing number of fundamental analysts are turning the majority of their attention to my favorite measure of corporate health: cash flow from operations.

Reducing the importance of earnings as a measure of corporate well-being should be the easiest sell in the world – especially after the debacles involving Worldcom, Enron, Global Crossing and others. All of these companies were “cooking the books”, i.e. manipulating their corporate earnings. And all of them gave early warning signs in terms of cash flow problems long before the earnings showed any problems.

Cash flow is not impossible to manipulate. But it is difficult. And the results that we see in cash coming from operations are so useful (as we’ll see next week) that it’s easy to see that cash flow really is king.

The real problem is that earnings are much easier to manipulate under Generally Accepted Accounting Principles (GAAP) than cash flow. And this obsession the public has with earnings makes it easier to hide mistakes or even malfeasance. Worse yet, current mistakes can be hidden for several quarters or even years because of the nuances of accrual accounting. And unfortunately, that can be long enough for a current management team to collect healthy bonuses and have the problems stay hidden until new management teams come into power.

So what’s a trader or investor to do when the world is shouting about earnings per share (EPS) and you have developed a healthy skepticism for this measure? Well, if you want to be a fundamental analyst, you have to dig in! It’s time to pour through the cash flow statements. They’re right there in the quarterly reports along with income statements and balance sheets.

But take care to limit your review to the hardest area to manipulate: Cash flow from operations or Cash flow from operating activities. There will be other areas of the cash flow statement that include investing activities and financing activities.

Good day and good investing.

Tuesday, October 10, 2006

Trader Interviews

It's always interesting to read a book a second time, as you seem to find things that weren't there the first go-around. Perhaps this occurs because the first time you read, you read for content, and the second time for context. Here are some of the things I picked up as I reread The Best Conversations With Top Traders , by Kevin Marder and Marc Dupee.

First, a little background on the book is in order. As the title implies, the book is a series of transcripts of interviews with some of the most successful traders of modern markets. Since these are the people who have amassed enormous profits with their trading activities, we all should be at least a little curious about how they perform their craft.

All of the interviews were open-ended, but there were some common elements that kept coming up in nearly all of the conversations:

1) Above all else, maintain discipline. This usually was the summation of a risk management question. Nearly all of these traders agreed that the number one mistake they saw (especially in new traders) was an unwillingness to let go of a bad trade. The secret to their success was discipline, or as one of the interviewees said, "I would rather have a mediocre strategy and a good money management system than a good strategy and a mediocre money management system."

2) Focus on good trading rather than making money. If you can do the former, the latter will occur naturally. If on the other hand you focus on making money, you'll lose your focus on the good trading that leads to profitability. Ironic, isn't it? In fact, many of the traders regarded trading as a game of sorts. (continued below)

3) You must have a passion for the market. These top traders would have chosen the same profession even without all of the financial rewards. Their passion drove them to persevere, even when most others would have quit. Their love of markets kept them in the game for a long time, and with time comes wisdom and experience. That experience was their edge.

4) You must have humility. Trading is one of the only professions where failure can be expected about half of the time. All of these traders can deal with a bad trade; humility allows them to exit before that bad trade gets worse. Since your ego is a trading pitfall, you must park your ego at the door, and you must have the uncanny ability to not dwell on bad trades.

Marder's and Dupee's The Best Conversations With Top Traders is a good read for the trader who is ready to take their activity to the next level. And, there are plenty more of these helpful ideas like the ones above. You may even want to read it twice, to make sure you get them all.

Good day and good trading.

Sunday, October 08, 2006

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ's ended the week on a bearish note, losing 6.35 points on Friday (-0.28%) to close out at 2299.99. For the week, that still translates into a gain of 41.56 points above last Friday's close...a 1.84% gain. It was once again a case of two steps forward, and then one step back. The bulls are indeed gaining, but they're doing it the hard way. And if the zig-zag pattern we've seen for the last three months continues to play out, we may see a modest pullback to a major support line. As long as it holds, though, it shouldn't be a big deal for the bulls.

Check out the two major trend lines on the chart; the support is green, while the resistance is red. Since July, these rising lines have framed a rather bullish channel. And, until one of those lines breaks, we're not inclined to really get in the way of that uptrend. The lower support line is now at 2238, but will be at 2244 on Monday. Of course, it rises a little more each day, so be sure to make the adjustment if you're following the story on your own charts. By Tuesday, it will be around 2250...which is probably when the issue will be forced. Note that the 20 day average line (blue) is also likely to act as support, at around the same level. Unless we see a breakdown around there, it's possible the trend could continue to stay this bullish - despite the odds.

On the other hand, if all of that support breaks, it would be the first time the bulls had been really threatened since June. A tumble back down to the 100 day line at 2150 would be possible. And, with the market being as vulnerable as it is right now, it's something everyone should be watching.

Why is it vulnerable? Two reasons. The first one is the VXN (again). It's still showing us an amazing amount of confidence and complacency. VXN readings this low usually signal an impending attitude adjustment - in the form of a correction. Of course, we've been due for such a VXN-based correction for weeks now...and it hasn't happened yet. The second reason stocks are vulnerable is the steepness of our bullish trading zone. Overall, the third quarter's rise was a much bigger (faster) rally than usual. The term 'the bigger they are, the harder they fall' applies here too. Once we get a little profit-taking, we expect to start a chain reaction of sorts.

Of course the question remains....when?

Nasdaq Chart

Nasdaq Chart

S&P 500 Outlook

The S&P 500's 0.27% slide on Friday - the result of a 3.64 point dip - left the large cap index at 1349.58. That was 13.75 points higher than the previous week's close, meaning the SPX managed to keep 1.03% of its weekly gain. However, it also needs to be said that Wednesday's heroically bullish move may have encouraged some profit-taking, which in turn could have set up a selling spree in the coming week. Either way, the lack of follow-through on Thursday, paired with Friday's lull, suggests we may slip lower before we head any higher.

The S&P pretty much looks like the NASDAQ, in that it's being guided upward by a fairly narrow set of support and resistance lines (green, and red, respectively). The upper line - at 1354 on Thursday - did indeed manage to send the index lower by Friday, after the SPX had spanned the height of the channel. If the pattern persists, the SPX will meet the support line sometime in the middle of the coming week. It will be at 1328 on Monday, at 1334 on Wednesday, and at 1343 by Friday. Keep an eye on that mark as an early warning of any breakdown.

If it does break, the fall could lead the index all the way back to its 200 day line, at 1285. Of course, there's really no certainty of such a breakdown....we'll have to wait and see.

However, there are two things that make us ready to quickly switch gears if the bearish breakdown actually occurs.

The first is the stochastic 'overbought' condition. However, it's also worth noting that being overbought hasn't been a major problem in the last few weeks. Each time we've gotten overbought, the only result was a pullback from the upper resistance line just back to the lower support line. So, it's a bit of a tainted bearish signal.

The second reason is the low VIX. The market has been content to keep it low...which is bullish as long as they want to keep buying. But, once traders change their minds, the VIX could surge higher, and push stocks lower in a big way on a short period of time....the same vulnerability the NASDAQ has. Look for a break above the VIX's resistance line (dashed) as a red flag....which isn't all that far away.

S&P500 Chart

S&P500 Chart

Dow Jones Industrial Average Outlook

The Dow Jones Industrials were the 'least weak' on Friday, only giving up 0.14%, or losing 16.48 points. On a weekly basis, the Dow found itself in the middle (in terms of performance), as it gained 1.46% (171 points) over the last five sessions. Perhaps more importantly - perhaps not - the week's close at 11,850 was a new high weekly close...the former one was 11,723, from January 14th, 2000. This past week's high of 11,928 was also a new intra-week high. Again, the previous high was hit during the week-ended on January 14th, 2000, when the index reached 11,909. In some regards it's exciting for the bulls, as it could encourage more buying. In other regards, there's some valid concern that it's all excuse the market needed to start selling in a significant way.

Support is at 11,590, while there is no meaningful resistance line. As for the dynamics, the same outlook and problems as the S&P 500 and NASDAQ also apply to the Dow.

Dow Jones Industrial Average Chart

DJIA Chart

Have a great week.