Friday, March 30, 2007

Technology Sector Investing

Much as in life, simplicity matters in the technology world. You have to realize that tech companies usually take large gambles on new technology. If the company is a start-up, their big gamble will determine whether they go on to become the next IBM or just another failed business statistic.

Knowing the right questions to ask about a tech company’s product is essential to understanding if it will be the next iPod or Betamax. To determine whether a tech company will succeed, you first have to know the answer to these six questions:

1. Do you understand the technology? If you don’t understand the technology, how are you supposed to know whether it’s good? Like Warren Buffet said, you need to invest only in that which you understand. Research and dig deep if you have to. But in the end, you should have a solid grasp on what the technology is, how it works, and what benefits it provides.

2. Is the new technology easy to make? This is important because it tells you whether the time has come for the technology at hand. If the technology is using some experimental atomic-sized manufacturing process, it’s likely the manufacturer won’t have a good yield. When that happens, costs rise and margins are squeezed. As an investor, low margins should be a red flag because if a price war happens (which is common in the technology world), the company with the lowest margins loses. So make sure that the company can easily produce the technology before you investigate further.

3. Is the new technology scaleable? If the technology can be ramped up for many years in the future, then the manufacturer saves money on development. A good example is Intel’s (INTC) NetBurst architecture used in older Pentium 4 CPUs. This architecture lasted more than six years.

4. Is the new technology cheap? If not, can the manufacturing cost come down quickly? If the technology isn’t cheap, not many people will be able to buy the first generation. Granted, most leading-edge products are just like that. So what you need to know is how quickly a manufacturer can lower the cost of making the product. LCD panels are a good example of a technology that wasn’t initially cheap, but is (relatively) today. Note that mass adoptions usually occur when the new technology is priced similarly to the old technology.

5. Does the new technology have a distinct advantage over competitors? Making money from a company that is releasing another product into a saturated market is difficult. But if the company has some unique positioning or new feature, you then stand a chance to profit. For instance, Nintendo (NTDOY.PK) had stiff competition in the video game console wars. But their latest system – Wii - drastically changed the way video games are played, making them unique among the competition. Now they are outselling their competitors by a nearly 2-to-1 margin.

6. Is the new technology easy to adopt? Just because a technology is superior doesn’t mean that other companies want to use it. If adopting the new technology incurs lost productivity, a high initial cost, and needs a large learning curve, you can be sure that most companies will stick to what they know and love. Sony (SNE) is a perfect example. They have a superior gaming system in PlayStation 3, but programming is expensive and programmers suffer lost productivity as they learn how to program the new chip. So what are video game producers doing? They’re dropping support for the system.

In the tech world, there are hundreds of products that have succeeded and failed. The success or failure of these products has often gone on to determine the company’s future and share price in a significant way. But the most profitable companies made sure to build a technology that was easy to make, scaleable, had a distinct advantage over its competitors, and a manufacturing cost that went down significantly over time.

If you make sure to invest in a company that does all of these things, you’ll increase your chances of making money from tech companies.

Click the Technology Sector Investing title link above to read more about this profitable industry.

Thursday, March 29, 2007

Successful Trading Behaviors

Winners share certain beliefs and behaviors. Read on for specific actions that you can take to increase your odds of success in trading and investing.

1. My trading objectives are perfectly clear, and I truly believe I will achieve these goals. If you have the belief that you will win, you increase your chances of trading to win. In order to have this level of conviction, you must have a thoroughly-tested plan. You also must have a clear vision of how you will proceed with your plan to reach your goal. The more detailed you can visualize your goals being achieved, the more you will strengthen your internal belief and confidence that you will reach your goals.

2. I have created a plan to achieve my trading goals. I'm sure you've heard the saying "I didn't plan to fail; I failed to plan." Without a plan, your results will tend to be mixed and uninspiring. Commit to writing down your trading plan, and make sure you can answer the questions found in a recent TrendWatch on creating your trading plan.

3. I prepare my plan before the trading day starts. If you don't have a plan of action once the trading bell rings, you are moving from the proactive mentality into a reactive approach. I contend that the more reactive you become, the more you will get in late to market moves and dramatically diminish your reward-to-risk ratio. I prepare after the close for the next day's trading, seeking to stay proactive and a step ahead of the rest of the crowd. (continued below)

4. I regularly monitor my trading results to measure my progress toward my goals. Trading results tend to follow a zig-zag approach similar to how a plane is guided to its destination. At periodic steps along the way, if a pilot is off course, they will set a new course towards the target. This is called course correction. Once you have defined your trading target, your periodic evaluation should lead you to assess what is taking you off course and encourage you to make the necessary corrections to get you back on target.

5. I quickly discard negative emotions that can hurt my trading results. When you lose, you want to learn from the experience, then put it behind you. You cannot afford to dwell on a loss once the trade is complete. You have to have total focus on the new moment and forget about the past, save for the time you allocate to evaluating past trades (which should be done outside market hours).

6. I am focused on the market during the trading day, and not easily distracted by non-market activities during trading hours. This can be a tough one for many traders who have many responsibilities. If this is the case, define the time you will be focused on the market and make arrangements not to be interrupted For more information on this topic of successful trading behaviors, click the title header link above.

Good day and good trading!

Wednesday, March 28, 2007

The Best Conversations With Top Traders

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.

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.

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.

Click the "The Best Conversations With Top Traders" title link above to order this excellent book.

Good day and good trading!

Tuesday, March 27, 2007

Trading Gaps

Today, I'm going to talk about gaps and how to trade them. Gaps can be very significant, or simple readjustments of closing and opening of prices from one day to the next because of supply demand and liquidity issues. Trading gaps can be very profitable also.

Types of Gaps

Continuation gaps occur during powerful trends. In a bull trend, the stock is moving upwards strongly and then gaps up. In a bear trend, the stock gaps down while already in a powerful down trend. These trends are confirmed when you see volume spike by 50 percent or more on the gap up.

Breakaway gaps

These occur when a stock is in a base and then gaps up or down as it begins a new powerful trend. The longer the base, the longer the new trends tend to last. These trends can last anywhere from weeks to years. Usually the volume on the day of the gap is much higher than usual and often times, it persists for several days. These gaps represent a mass change in the sentiment on the stock.

Common Gaps

Most gaps are common gaps. Common gaps are short-lived and the prices reverts to close the gaps relatively quickly, usually within the next few days after the gap. Volume tends to remain average during common gaps. There is really nothing extraordinary or powerful about common gaps. Usually, they are not tradable.

Exhaustion Gaps

Exhaustion gaps are so named because they occur at the end of trends. The difference between exhaustion gaps and continuation gaps is that exhaustion gaps are typically not accompanied by the higher highs that you see in continuation gaps. You can confirm an exhaustion gap when you see prices reverse in the opposite direction of the gap thus closing the gap. Once you see prices return back to their orginal levels before the gap, it's time to exit the position. (continued below)

How to Profit

The most effective way to profit using options on gaps is to buy or sell short on breakaway gaps. These are the most effective setups because they have the most potential to trend powerfully (enough to double the value of your options). An effective risk control method is to set a stop right at the price of the stock before gape. IF the stocks gapped down 40% on a bear trade, this is obviously not going to work, but if the gap is smaller (like 3-4%) this may be an effective place to set a stop for your position. The best setups occur after a long base or trading range has been in place for a multi month, or mult-year period. If you are trading a continuation or breakaway gape, it is imperative that the stock continue to make higher highs in a bull trade and lower low's in a bear trade. Otherwise, what looked like a continuation or breakaway gap may actually be an exhaustion gap.

Another strategy to look for is trading the exhaustion gaps. They should be traded in the same manner as the other strategies described above in terms of setting stops. Many exhaustion gaps are accompanied by very strong reversals which can produce significant profits. The most common type of gap is the common gap.

Sell Strategies

What about when to exit? An outstanding sell strategy is to look at the vertical distance that the stock traveled preceding the gap. Stocks often can cover the same distance right after a gap. Use this strategy with continuation gaps and breakaways gaps. In conclusion, gaps offer unique opportunities for traders who can handle the high-risk nature of these trades. Gaps tend to be followed up with much higher levels of volatility. The key here once again is to develop a well-defined, tested, repeatable strategy. Develop yours.

Good day and good trading!

Sunday, March 25, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ Composite's 4.44 point gain on Friday was the result of a modest 0.18% rally. However, the rest of the week was amazingly productive for the index. It gained 83.52 points, or ended 3.52% above the previous week's close. The NASDAQ ended the day at 2456.18. The big move tripped a lot of technical buy signals, but can this bizarre strength actually be sustained?

The commentary for all three indices is pretty similar this week, so we'll be brief with the NASDAQ and focus a little more on the other two charts. However, there are a couple of things we do need to review specific to the composite.

Fist and foremost, the cross above the 50 day line (purple) pushed the index past the last potential tripwire. It wasn't a particularly strong cross of the line though, so we'd prefer to see at least a little more progress before saying the uptrend has been fully renewed.

As far as support goes, the 10 and 20 day lines around 2418 are the levels to watch for any potential downside move. (continued after chart)

NASDAQ Chart - Daily

Click For Large Chart

In the meantime, well just re-insert this weekly chart of the composite as a reminder of the kind of potential pullback we still need to be aware of. We dodged a bullet last week, and may actually end up dodging that bullet altogether. However, just absorb what this chart could mean if the selling got another good start.

NASDAQ Chart - Weekly

Click For Large Chart

S&P 500 Outlook

The S&P 500's close at 1436.10 was the result of only a 1.55 point gain on Friday - a move of only 0.11%. For the week though, we still saw a 49.15 point rally, leaving the index 3.54% higher than where we saw it a week earlier. The technical look pretty bullish as a result.

Take a look at the short-term averages....all of them. It was only a few weeks ago we were lamenting several bearish crossunders. As of Friday, we're on the verge of the 10 day line crossing the 20, and both the 10 and 20 day lines crossing the 100 day average. Along the way, the SPX hurdled all those averages, as well as the 50 day line (purple) - the last remaining potential barrier. While you'll detect a bearish slant elsewhere in this update, those crossovers are all technically bullish.

The possible trump card, though, is the CBOE Volatility Index (VIX). It was falling sharply early in the week, while the market was rallying. However, the move lower has reversed...or at least stopped. We saw the VIX creep higher over the last two days, even though the market drifted higher as well.

From our perspective, now that the VIX has more upside room to travel than it has downside room (look where the Bollinger Band lines are), the threat to the bulls is bigger than the threat to the least in terms of the VIX. However, either way, it's still a little soon to say what's going on there. The VIX could hit the lower band line and just trail it lower - bullish for stocks. We'd really like to see the VIX touch that lower band first so we can see what happens, though we may not get that luxury.

In the meantime, the index stalled late last week, and we have to wonder why. To be safe, the key to any further upside is getting past last week's high of 1438.90. However, only a move under 1410 - where the 10, 20, and 100 day lines are all tangled - would get us thinking bearishly.

S&P 500 Chart - Daily

Click For Large Chart

Dow Jones Industrial Average Outlook

On Friday, the Dow Jones Industrial Average added 20 more points (+016%) to close out at 12,481. That meant a 371 point gain for the blue chip index, leaving the Dow 3.06% above the prior Friday's close; it was the best week the Dow has seen in four years. Nice move, and certainly suggests things are 'all safe' again for the bulls. But, are they really?

You know what's really conspicuously missing from this chart, and the recent bounce specifically? Volume. The buying effort behind the recent bounce hasn't even been average. That's not exactly the best sign that the move higher will have much longevity.

Plus, we're also a little hesitant to jump in blindly simply because a bounce was likely. A week and a half ago, following one of the worst weeks we've seen in years, the Dow was sharply oversold according to the stochastic chart. Now take a look - we're getting into overbought territory. Recent history has shown that to not be a problem, but it's still a concern at this point. After all, a lot of the technical damage taken a month ago is still lingering.

The point is, we're not euphorically optimistic here.

To really get us over the proverbial hump, we'd like to get decisively past the 50 day line (purple). It's currently at 12,473. A couple of closes (consecutively higher closes, mind you) would do the trick. As far as support goes, only a close or two under the 10 and 20 day averages at 12,331 would out us back into the bearish camp.

Dow Jones Industrial Average Chart - Daily

Click For Large Chart

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Friday, March 23, 2007

Trade Your Way To Financial Freedom

I've got to share this book with you. It's an absolute read for any trader. Ground breaking work by the traders trainer . . . Dr. Van Tharp.

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So, You Don’t Have to Spend Your Entire Career Trying to Crack the Code to Profitable Trading.

Van Tharp's bestselling book, Trade Your Way to Financial Freedom has been brought completely up to date to give traders a continued edge in the marketplace.

“…If you intend to trade, you'd better know what's in this book” Ed Seykota, professional trader.

"Van's book gets directly to the heart of what it takes to be a successful trader. It's the best book I've read on trading successfully; not fluff or hype like so many others." Tom Basso, President, Trendstat Capital Management, Inc.

“…The trading public owes Dr. Tharp a debt of gratitude for this insightful masterpiece." Edward Dobson, President, Traders Press, Inc.

Read on to Learn More about the Re-release of Trade Your Way to Financial Freedom.

This highly-anticipated second edition of the bestselling classic delivers Tharp’s proven 14 step model for developing a profitable trading system—as well as his latest methods and techniques for winning in any market.

In one of the brand new chapters, join Tharp as he tracks the progress of 7 traders through 5 market scenario’s. They all differ in beliefs and in the way they make money. See if you match any of their "styles." And see how they manage to profit in the long run no matter how the trade; even when one is short and the other is long in the same market!

Trade Your Way to Financial Freedom includes new information on secular bull and bear markets and macro economics; as well as ways to think about and evaluate trading systems as a set of R multiples (reward to risk). Tharp also elucidates the concepts of expectancy and position sizing—the most important, yet least understood, aspects of profitable trading.

In this performance-directed book, Tharp explains that the Holy Grail in the market is different for each trader—one that can be uncovered quickly and plugged into every trading program with surprisingly little effort. He shows how the interplay of your style, goals, and personality—in combination with a carefully designed and tested system—will ultimately determine your true success.

The New Trade Your Way to Financial Freedom provides key information to help you substantially increase your income:

The psychological biases against good system development.

Ingenious concepts of orderliness that help you accurately predict turning points in the market—and work them to your advantage.

Stock and futures trading models—from Warren Buffett to Perry Kaufman—that examine setups used by the masters.

Position sizing variables, and how to use them to consistently carve out the optimal profits.

Enjoy a free online game to let you practice your new position sizing skills without risk. Tharp also does an all new analysis of 9 trading newsletters using them as sample trading systems to show you if newsletters as a whole represent good systems, if certain trading ideas are better than others, and to give you some information about what you can expect if you follow the recommendations of various newsletters. Tharp will show you the importance of evaluating their performance and results, and how to do it yourself.

Trade Your Way to Financial Freedom promises you a brighter, more lucrative trading future.

Since implementing Dr. Tharp's strategies to my trading style, the results I have experienced are nothing short of miraculous. Quite frankly this is the first and last book you will ever need if you are serious about trading (or investing). Dr. Timothy Wilson, Options Trader.

A Message From Van:

Everything that I said in the first edition of this book reflected my beliefs about the markets and what was necessary for trading success at the time that I wrote the book and I’ve continually said that what I teach reflects the most useful beliefs that I now have about the market and trading success.

Over the years, I occasionally run across beliefs that seem to help people even more than those reflected in the first edition of this book. And after seven years, I’ve adopted many new, more useful beliefs. As a result, even though most of the core concepts have not changed, I still believe that enough things have changed that I can help people even further with a new edition of this book.

I hope that you continue to get as much value from the second edition of this book as the thousands of traders that have enjoyed and prospered from the first.

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I have the original edition – do I really need the new edition?

In my opinion, yes. The 2nd edition is more complete, more understandable, and more current for the realities of the world we now live in. No book can keep up with events on a real time basis, so my goal for this edition was to capture the major changes that have occurred since 1999 and offer improved perspective on how to trade successfully in current and future markets.

I have also incorporated feedback and suggestions from the thousands of people who benefited from the 1st edition. They have been generous with their insights about topics that needed a bit more clarity, concepts that needed more detail, and which sections were especially useful just the way they were.

If you already have the 1st edition – thank you! I am confident that you found it interesting, enlightening, and most importantly, empowering and profitable. The 2nd edition of Trade Your Way To Financial Freedom offers even more information and guidance to help you improve your trading and financial performance. You will benefit tremendously from this updated and improved edition.

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Dr. Van Tharp
Van Tharp's bestselling book, Trade Your Way to Financial Freedom has been brought completely up to date to give traders a continued edge in the marketplace.

Thursday, March 22, 2007

Cruise Control Trading

Why do we use the cruise control while we are driving? Several reasons. It makes our car more efficient. It keeps us from making irresponsible decisions like driving too fast. It keeps us from driving too slow if we have other things on our mind. It makes long trips less tiresome for the driver. Generally, if the conditions are right, it makes the trip a better experience all around. Systemized trading strategies can allow many of the same benefits to your trading account that cruise control allows to your car.

Consistent Results - The best way to get consistent trading results is with a consistent system that looks for specific opportunities. If you plan your entries and exits out completely, your performance will have less variation. Obviously, the conditions of the market will also have an effect on this, but your system will help you stay on track during good periods and bad periods.

Saves Time - You may not have hours every day to look for new trading opportunities. Depending on how you set it up, a good mechanical trading system can tell you in a few minutes whether or not you will have a new trade. Then you can place your order(s) and move on to other things. This is on a day to day basis though, you have to put your time in on the front end researching and defining your system with a good trading plan. Then the actual trades with this system are easy to produce.

Eliminates Fear and Complacency - Fear of losing money is one of the biggest obstacles to traders. Fear can make you miss opportunities and it can make you exit good trades too soon. Feelings of complacency are also a problem. Mechanical systems do not have feelings, they trade by the numbers and have no other concerns.

Controls Greed - Some traders have a tendency to trade more when they are doing well. This will get you into trouble. You will start to take larger and larger risks and this will most likely catch up with you eventually with a big loss. A trading system will keep you trading at a steady pace so you can enjoy the good times without getting too greedy and maintain confidence in the bad times without quitting.

Good day and good trading!

Wednesday, March 21, 2007

Trader Self-Evaluation - Part Two

What are Your Key Beliefs About the Markets? By Van K. Tharp, Ph.D.

Last week I asked you to begin a process of self-evaluation, mentioning that in my work with traders and investors I believe the most significant work that anyone can do to increase market returns is self work. Really understanding yourself and how you think can give you an edge that others in the market don't have.

As part of my Super Trader Program, I give a long questionnaire to each trader to do an evaluation of themselves. Some of the feedback that I get is that taking the test is like doing a Ph.D. program! It's that involved.

I consider that answering the ten questions, the essence of this self-evaluation process, to be a minimum starting point for this type work.

This week we'll continue this process with a second important question to explore. Remember, my advice to my Super Traders is to spend at least an hour on each question—a day is even better. These questions are meant for you to really dig deep and come up with responses from your core belief structure.

Question of the week: What are your key beliefs about the markets?

It is important for you to remember that you can only trade your beliefs about the market. So what are the key beliefs that are guiding you?

To really understand what’s guiding your trading, you should list at least fifty beliefs. However, at least ten is a good starting point.

To help you get started, I’ve listed twelve of my most important beliefs about the market. Some of these are core principles that I teach everyone and some of them are just things that fit me. Also I just came up with these twelve off the top of my head. Like I mentioned, you’ll probably need to discover at least fifty beliefs to thoroughly cover the key principles that guide your trading.

1. Cut your losses short and let your profits run!!!!!!!

2. Risk, as it relates to how much you can lose in a trade, is much more important than risk as it related to how much volatility you can have. Both are related though.

3. You must understand the R-multiple distribution of your trading system and the
average R it produces (expectancy) and the variability of that distribution (i.e., how volatile it is).

4. You must know the objectives you wish to accomplish. What would you like to accomplish and what can you tolerate in terms of drawdowns? In my case, I’d like to make 10% per month in my trading.

5. To achieve your objectives, you must understand and use position sizing to your advantage.

6. Fill your portfolio with a core position that you might adjust weekly or monthly. However, then find efficient stocks and use leverage with those stocks to achieve peak performance. (Again, remember that these are my beliefs and they might not fit you.)

7. When I have a large down day, thoroughly investigate what happened and how I might have caused it or made any mistakes.

8. Keep a trading diary on every trade.

9. Follow the ten tasks of trading.

10. When I cannot be actively trading, remove all speculative positions.

11. Understand the risk reward of each trade before you enter it. For example, your potential reward should be at least three times your potential risk.

12. Keep stops loss levels with my core positions and actively monitor the market for my speculative positions. (Again, this one is my personal preference.)

I want to caution you again that these 12 beliefs are my personal beliefs. Your beliefs might be different. However, certain beliefs are universal for good trading. These include beliefs 1- 4 (knowing your objectives), and 8-11. These are just ideas to get you going.

So be honest with yourself, and start to look at what you truly believe about the markets. You may surprise yourself.

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

Good day and good trading!

Trading Simulation Game
Dr. Van Tharp - International Institute of Trading Mastery
"Secrets of the Masters" Trading Game

Helping others become the best trader or investor they can be has been Tharp's mission since 1982. An Original "Market Wizard", Dr. Tharp offers unique learning strategies, and his trading education techniques for producing great traders that are some of the most effective in the field. Over the years Tharp has helped people overcome problems with system development and trading psychology, and success related issues such as self-sabotage. His trading education programs are of the highest quality and are world-renowned. When you think about the golden rule of trading, it basically describes exits-how you abort losses and ride winners. When you think about Position Sizing, it basically controls how much you risk on any given trade.

Tuesday, March 20, 2007

Valuable Information

William O'neill says to buy high P/E stocks. Buffet and David Dreman say to buy low P/E stocks. Most major broker/dealers suggest that investors get a piece of each sector and then overweight and underweight certain sectors. Buffet suggests avoiding entire sectors (like technology) and would also suggest that it doesn't make sense to buy every sector. Information overload is a challenge in our industry as well as in all other industries. Who do you listen to? Today, I am going to show you how to absorb as much information as possible quickly and to how to avoid bad information. After all, as Michael Douglas says in the movie Wall Street - nothing is more valuable than information. Specifically, I am going to show you how to read effectively and how to avoid bad ideas and stick with strong ones.

Read Effectively

One of the first challenges to reading is how to fit it into your schedule. Ram Charam said "ask yourself this: are you are at a higher level of performance and skill than you were 5 years ago? Think about it. Why did it take you five years?" I realized the answer to that question quickly- my reading was the primary reason. In the past 5 years, my skill level in many of my areas of life have improved almost entirely because of reading and watching DVD's and listening to tapes/CD's. So that means I should read more right? Absolutely. New information is more than just information. It is a vehicle to a brighter, MORE PROFITABLE future immediately!

So how do I get the most out of it? First of all you have to realize that you can learn about anything, but you can't learn about everything. There's not enough time. Don't kick yourself for not having a P.H.D. in statistics. It's not necessary to have one in order to make money. So here's your first technique: "

Skimming - Your school teacher taught you to finish what you start. But that rule only makes sense with fiction books and as I said, there's not enough time to read all books. So when you go to the library or bookstore, look at the table of contents, introductions, and conclusions of books before you invest 4-8 hours of your life reading a book. I personally am focusing on books that provide statistical and historical data to back up trading strategies, so I toss most trading books aside when I read them. If I was interested in curing lung cancer, I might only read books that include verified/published research from accredited colleges. So skim books before you read them. You don't have to read entire books. There's no reason to read "filler" material. It is of no use to you. "

Take notes - I recommend taking written notes in your word processing software. I have hundreds of pages of notes from books I've read. The key to note taking is this. You MUST paraphrase when taking notes. If you cannot express an idea in different words, that means you don't understand it. Repeating someone's exact words does not mean that you get it. The reason reading changes people so much is that it creates new understanding. New understanding creates new action and new action creates new results. Paraphrasing is a way to almost guarantee new understanding.

Think Effectively

We spoke earlier about how hard it is to decide on who to listen to when reading. Here are some key points to remember when reading.

1. Understand - You need to know exactly what someone is saying before you can disagree with him. Once again, try paraphrasing.

2. Explain yourself - Agreeing with someone without knowing why is ridiculous. Disagreeing with someone without reason is equally preposterous. Interestingly enough, this insight will help you recognize when someone else has disagreed without a reason.

3. How to disagree - Here are several reasons to disagree with someone's ideas. The first reason is LOGIC, that is, the conclusion that someone has drawn is illogical. The second reason is that the person is misinformed. The third reason is that the person's analysis is incomplete. The fourth reason is that the author is uninformed about something. It's likely that if you disagree without one of these reasons, that you may be disagreeing out of spite, ego, or the conclusion is inconvenient to you (which means you disagree even though you have no logical reason to)

4. Know the difference - between a sales pitch and real information. Did you watch the last presidential election? Both candidates had access to the same economic information and one candidate wanted to show that the economy was doing well, while the other said the economy was in bad shape. If you omit the right data, you can get the data to suggest anything. Ask yourself what the author or speaker is trying to achieve. Filter out alterior motives.

That's it for today. In conclusion, remember how important reading can be and do it well. In school, they never really taught us how to read, so throw those old rules out and adopt new ones. If you want to be profitable in trading, then you'll need more than just your instincts. You'll need a constant flow of new information.

Good day and good trading!

Monday, March 19, 2007

The Traders Workspace

Now that we're into 2007, let's take some time to address one of the most common issues in trading - how does a trader setup his or her workspace? The reality is that we could write books on that topic alone. Today, though, we'll just hit the key points you need to think about between now and next year.

Any Structure Is Better Than No Structure

One of the first questions everyone faces in trading is whether or not any kind of workspace/software/analysis tool is need to be a trader. Theoretically, no, all you need is a broker. But in reality, this game is just too hard to be winging it. So, at the very least, there has to be some sort of core process or focal point for your trading activity. I'd estimate that for 99% of us, our core resource is our software and/or our data feed from our brokerage firm. Since we all can (hopefully) agree on that much, I won't belabor that point. However, there are some key components that every piece of software must have. These are...

1) The ability to simultaneously display multiple charts in multiple timeframes. If you can't do that, doing complete analysis can get real old real quick. At a minimum, we're looking at daily and weekly charts at the same time, and even intra-day charts when applicable.

2) A watchlist is essential. There are always more potential good ideas than actual good ideas, but you never know immediately know which ones are which. If you don't have an easy way to track them all, you'll probably miss most of the good ones.

3) A portfolio tracker of your real trades is also essential. Managing your open trades is half of this battle, but if you don't know what's going in, then you can't properly manage your account.

4) Finally, there has to be some sort of consistent way of getting trade signals within your workspace software. If you have to leave your workspace to go look for trade ideas, you're apt to wander aimlessly....and waste time.

Less Is More

That list of 'essentials' seems like a pretty big one, but it's really not. In fact, we've gotten most of our portfolios boiled down to just four screens.....two for charts, one for the watchlist, and one for the actual portfolio of open trades. And all four of them can fit on one computer screen at a time. The only other thing we don't have 'up' all the time is our trade signal scanner, but that's just one click away in most cases.

We use several pieces of software, but one of them key ones we utilize is TradeStation. For an example of our typical workspace, click below for the one we use with our Multi-Cap Growth Portfolio (note that it's a good-sized file, so any dial-up connection users may need to wait a few seconds for it to appear)

See anything interesting about that workspace? A lot of you may have been surprised to see just how simple and minimal it was. Yet, the Multi-Cap Portfolio has been extremely profitable. By the way, our 'buy' signal automatically appears on our weekly chart, eliminating the need to go elsewhere to find them.

Granted, for some of our other services that trade spreads, or where we need to know about the option 'greeks', we may look for a few more details within our workspace......but not a whole lot more. The point is, your software has to be something you can actually utilize, which brings me to the key point........

Over the last few years, trading software has become tremendously powerful. Anything you can even think you'd want, you'll find it. In fact, there are more trading bells and whistles out there than anybody could ever fully explore in a lifetime.

However, I caution you against being enamored with bells and whistles. In my observation, using complex software is almost becoming the focal point of trading, rather than making money. And as such, trading software has almost becoming more meaningful for computer programmers than traders. Tools are great, but never forget that your only goal is to buy low and sell high. If knowing that the "Detrended Price Oscillator is under zero" helps you make more money, then great - use it!. But, nothing really says 'bullish' quite as much as a chart that's moving higher. That's why we try and keep things as simple as possible. Remember, less is more.

Less Typing, More Clicking

Every barrier you put up for yourself just makes it that much more difficult to trade effectively. And, using a keyboard can indeed be a barrier. Even if the only typing you do is typing in a ticker symbol for a chart, then it's still too much. How's that? While the physical motion of typing may only seem minor, it's not. If you have to do it several hundred times a day, you'll eventually stop doing it. The mouse is a much more effective way to navigate through your software, so, use it whenever possible.

Perhaps you're wondering how. In most of the newer trading software, there is a 'linking' option between charts, watchlists, and portfolio positions. That just means when you click on a stock symbol, all of the charts (and maybe even a news or data screen) reloads for that particular symbol. Literally, you can sort through an entire watchlist, look at multiple charts, and even scan news headlines without ever touching the keyboard! What took several minutes (or longer) now just takes a few seconds......which means you'll actually do it. If you have a linking option, and if you have workspace tabs (as you saw on the bottom of our TradeStation workspace), please set them up so you can view everything you want to with little or no typing.

Sound crazy? I don't blame you for thinking it, but I promise you, once you do it, you'll never go back. It's a huge help.

Things That Are Nice

While I don't consider any of these items essential, we highly recommend them if it's at all possible for you to have them with your workspace.

1) A technical system builder or system tester. Are you trading on a hunch, or is a particular technical signal a proven winner?

2) The ability sort or scan by technical or fundamental criteria. Can you actually find the viable trade candidates?

3) Real-time data. Actually, real-time data is a two-edged sword. If you're going to see it and then act upon it, then it's great. But, if you're just going to be hypnotized by it and watch the quotes stream by, then it's a liability. In that sense, real-time data can be over-rated. I've known plenty of delayed data (or end of day) traders who have outperformed real-time traders. (continued below)

Things You May Not Really Need

1) Level 2 data. I've always felt that bid sizes and imbalances in the buy/sell balance are reflected in price changes, which makes level 2 data somewhat unnecessary. The exception may be for the scalpers or institutions who are trying to scrape up a few pennies.

2) Expensive software. In general, you get what you pay for, but there are a lot of exceptions to this rule when it comes to trading software. I've seen overpriced, underpowered software, and I've also seen free software that works very well. Be sure to test drive everything you're considering before actually paying for anything. And, don't assume you have to spend a ton of money to use effective software. The only thing your workspace has to do is work for you, which means it could cost little to nothing. That said, don't be afraid to spend a little money to own software that can make you a better trader - it will pay for itself.

Good day and good trading

Saturday, March 17, 2007

Trader Self-Evaluation - Part One

Trader Self-Evaluation - Part One

What are Seven Key Areas that You Need to Work on to Become More Self-Aware? By Van K. Tharp, Ph.D.

In my work with traders and investors I believe the most significant work that anyone can do to increase market returns is self work. Really understanding yourself and how you think can give you an edge that others in the market don't have.

As part of my Super Trader Program, I give a long questionnaire to each trader to do an evaluation of themselves. Some of the feedback that I get is that taking the test is like doing a Ph.D. program! It's that involved.

I consider the ten questions that I give my Super Traders to be the essence of this self-evaluation process — a minimum starting point for this type of work.

This week we'll start this process with just one of the points. My advice to my Super Traders is to spend at least an hour on each question—a day is even better. These questions are meant for you to really dig deep and come up with responses from your core belief structure.

Question of the week: What are seven key psychological areas that you need to work on or are currently working on?

Don’t say “none” because that answer really suggests that you are totally unaware of what is going on with you.

We basically live in a society in which we are programmed to feel separate and alone from everyone else, programmed to follow the rules of the games that others invent for us to play. The net result is most people do the exact opposite of what is necessary for success. As you become aware of this, you’ll also become aware of all your patterns, beliefs, and emotions that you need to work on or clear out to become more successful as a trader.

Here are some examples that might fit some of you:

I really have a fear problem that enters into my trading. I want to make trades but I’m afraid to pull the trigger. And that fear seems to come up in other areas too; I guess I’m really afraid of failure.

I have some internal conflict when it comes to working on myself. On one hand I want to, but on the other hand, I’d rather do other things. Working on myself feels like having a tooth pulled. For some reason, I just don’t want to do it.

I don’t have any discipline. Sometimes I just decide to trade. I make almost random trades or take recommendations that I’ve been given, but just certain select ones appeal to me. And the net result is that those trades never seem to work out. (Note: this is also an incomplete answer. What is the selection process? What happens to those trades? Do you cut losses and let profits run? Are you compelled by some emotion to trade?)

My mother continually criticizes me. My mother gave me everything when I was growing up, and I’m very grateful to her. But she’s always telling me what I do wrong. In fact, it upsets me to be around her. Yet at the same time, I feel that I must support her. I need to find out why her criticism bothers me so much and what I can do about it.

I really don’t like to be alone. When I do all of things that are important to trading success, like psychological work, I have to go inside and search and that really disturbs me. Also when I try to meditate, things come up that cause me to be afraid. (And, of course, if you had this response, I’d want you to at least find out what’s trying to come up that is causing this).

Those five statements are just examples of what might come up for you. But whatever you find, look thoroughly. What’s really going on? What are the emotions you don’t want to feel? What are the hidden beliefs? What is the internal conflict where part of you wants certain things and another part wants something else? Who are these parts and what are they trying to do for you? (The concept of 'parts' is covered extensively in the peak performance home study and 101 workshop).

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

Click the "Trader Self-Evaluation - Part One" header link for more information.

Friday, March 16, 2007

Technical Investing Trading Education

Investors and traders many times say that the price of a stock reflects all the known and unknown information of that stock at a given moment. Technical charting analysis is using price charts of past price history and price movement to try to forecast future price and movement. Technical investing and trading is more an art than a science because we do not yet know what the future will be excatly, but we do invest, speculate, and trade it for potential future reward. Technical analysis is just as important or more so than fundamental analysis. Below we have provided more information on professional investor and trader training from Online Trading Academy our teaching affiliate. OTA provides the finest live and home study training programs for stocks, options, and futures.

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Good day, good investing, and good trading!

Thursday, March 15, 2007

When To Sell

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.

"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.

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)

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.

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.

Tuesday, March 13, 2007

Trading Coaching

We are proud to be an affiliate partner of Dr. Van Tharp. Dr. Tharp in our opinion provides the best training any trader could obtain in the world of trading education. Van Tharp is brillant at developing the trader within each person to be successfull whether buying long or selling short. Click the "Trading Coaching" title link above to learn more about how Dr. Tharp teaches traders to be long term winners in the markets.

Peak Performance Trading Tips

By Van K. Tharp, Ph.D.

In Chapter 12 of the second edition of Trade Your Way to Financial Freedom, talking about how five investors with totally different ideas, including opposite views on what might happen, could all profit from various scenarios. The five such investors included:

1. Mary; a long-term trend follower.
2. Dick; a swing trader.
3. Victor; a value investor
4. Ellen; trading on the idea that there is some order to the universe and the markets
5. Ken; a spreader-Arbitrager

These five people were contrasted with Eric who buys and sells when he gets an urge to do so and Nancy who follows the advice of several newsletters. The reason they can all profit is due to the shared ten common characteristics most good traders have. Last week I gave you five of the ten characteristics, including

o A tested, positive expectancy system that’s proven itself
o A system that fit them and their beliefs
o Totally understanding the concepts they are trading
o Knowing how to determine 1R and
o Being able to evaluate the risk-reward of each trade

Hopefully, you can see how those five qualities would start to generate success. However, I also said there were five equally important (if not more so) qualities and asked you to guess what they are. Let’s see how you did.

The sixth key quality is that they all have a business plan to guide their trading. I’ve been talking about the importance of this plan for years. Most companies have a plan to raise money, but you need such a plan to help you treat your trading like a business. I’ve done a complete teleseminar on this topic and also a prior workshop. You can learn more about these on my website, plus future tips will also be about this topic.

The seventh key quality is that they all use position sizing. They have clear objectives written out, something that most traders/investors do not have. They also understand that position sizing is the key to meeting those objectives, and have worked out a position sizing algorithm to meet those objectives. We’ll be discussing this is subsequent tips.

The eighth key quality is very critical. They all understand that their performances are totally a function of their own personal psychology and they spend a lot of time working on them selves. This area has been my key focus for many years – teaching traders to become efficient, rather than inefficient, decision makers.

The ninth key quality is that they take total responsibility for the results they get. They don’t blame someone else or something else. They don’t justify their results. They don’t feel guilty or shameful about their results. They simply assume that they created them and that they can create better results by eliminating mistakes.

This leads to the tenth key quality, understanding that not following their system and business plan rules are a mistake. We’ve discovered that the average mistake can cost people as much as 4R. Furthermore, if you make even one mistake per month, you can turn a profitable system into a disaster. Thus, the key to becoming efficient is to eliminate such mistakes.

If you want more information on any qualities, we can help you. In addition, I’d suggest that you look at Chapter 12 to see how these seven traders approached the sample situations that were given and how they made/lost money.

Next week I’ll talk about what’s involved in evaluating your trading system.

Have a good weekend. This is Van Tharp.

Yes, good day, good 2007 in this year of the boar, and good trading with Van Tharp training.

Sunday, March 11, 2007

Weekly Stock Market Outlook

NASDAQ Outlook

The NASDAQ Composite was the only index to end in the red on Friday, by losing 0.18 points, or 0.01%. That meant a weekly close of 2387.55. But still, for the week the composite regained 19.55 points, or 0.83%. Not bad, but as you'll read below, the other two major indices did considerably better. Were this rebound for real, theoretically the NASDAQ should be leading it. It's not. Therein lies the concern, so we don't think the bulls should get too excited just yet.

On all of our charts this week we backed out to take a longer-term view, just to add some perspective on the last couple of weeks. In looking at the NASDAQ's chart it's clear we haven't undone the damage taken from two weeks ago. Yes we applaud last week, but frankly it was inevitable.... we had plunged 5.85% the week before. Anything will bounce after falling that hard.

As it stands right now the NASDAQ composite failed to even get back above its 10-day moving average line on Thursday and Friday. This will be an absolute minimum hurdle to get over if there's going to be a bounce in the near future. But even then, there's a ton of tangled resistance between 2420 and 2450... where the 100 day, the 20 day, and the 50 day moving average lines are all resting. As far as we're concerned, only a break above 2450 would be a sure sign that the bulls were back in charge.

In the meantime, any move under 2340 is likely to set up another wave of selling.

On our chart, we can see the 200 day moving average line in green. We don't necessarily expect this line to play a support role is 2340 does indeed break as support.

NASDAQ Chart - Daily

Click For Large Chart

S&P 500 Outlook

On Friday the S&P 500 gained only 0.95 points (+ 0.07%) to end this session that 1402.85. That still meant a pretty respectable rebound for the week however, as the index gained 15.7 points, or 1.13%. From a short-term momentum perspective this may seem like a pretty good recovery effort. However, we're hardly out of the woods yet.

The S&P 500 managed to get back above its 10 day moving average line late last week. However it struggled with its 50 day line on Friday. So, there's still some serious work that needs to be done if there rebound is going to be made here. We'd say a move above the 20 day line at 1418 would be a good place to start.

On the flip side, if we see another trade under 1374 where we bottomed on Monday, that may spark round two of a selloff.

On our chart you'll see a small segment of a line around 1270. That's a very long-term support line that actually goes back to the year 2005. Yet, it's on our radar again. Don't forget that the prior 7 months worth of bullishness was a statistical anomaly. We haven't had a correction until now, but the correction we owe the market really could drive the S&P 500 back down to that level... in a worst-case scenario. We don't want to the sound the alarm just yet, because we probably need a few triggers to make it happen (such as the move under 1374). But, don't rule the possibility out.

In the meantime, the VIX remains an enigma. What we do know for the time being is that the VIX stopped falling on Friday, after falling over the previous three days in what was a corrective move of a spike the week earlier. Maybe this is the pivot point, or maybe was just a break. There's an awfully big gap between 11 and 12 that could be calling the VIX lower. Or, we also have to wonder if the recent break above 12.5 is a little more permanent. We just can't say right now. Unfortunately, we may not even be able to say this coming week... option expiration is looming, which can skew the VIX reading. Hopefully we'll be able to provide a little clarity in the MidWeek Update.

S&P 500 Chart - Daily

Click For Large Chart

Dow Jones Industrial Average Outlook

The Dow Jones Industrial Average gained 15 points on Friday (+ 0.12%), and left the blue chip index at 12,276 for the week. And, on a weekly basis, the Dow closed 162 points above the previous Friday's closing level... good for a 1.34% gain. As with the S&P 500, that's respectable, but also a little expected. So far, the Dow Jones industrial average hasn't really tackled any major obstacles.

For the Dow, we can only get back in the bullish camp if the 50 day moving average line at 12,510 is cracked again. So far, the index is struggling with its 10, 20, and under day lines... so there's some pre-work to be done before we even entertain the possibility.

Besides that, there's not really a lot in new to add here... this chart is caught between a rock and our place like the other two are.

Dow Jones Industrial Average Chart - Daily

Click For Large Chart

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Thursday, March 08, 2007

Introduction To Hedge Funds

Today I want to discuss hedge funds, because I was contacted by a hedge fund yesterday to possibly work with them as one of their many traders. I'm looking forward to developing some winning trading strategies with them, and learning about this lesser known part of the financial markets. Excited about the possibility of working and developing with them, I immediately searched Google and up popped this article. After reading it, I've decided to post it here.

If you didn't know, basically Hedge Funds require a minimum $1M investment with long and short positions being taken in the market with some positions using high leverage. Individuals can learn from trading strategies using a lot of money and apply the same strategies using much smaller amounts to lessen risk. The goal of hedge funds is to attempt to create quantum returns with low risk. Not being an expert about hedge funds but wanting to learn as much as possible, I better shut up here and let the real pros explain to us exactly just want a hedge fund really is.

The following hedge fund information is from

Hedge funds are like mutual funds in two respects: (1) they are pooled investment vehicles (i.e. several investors entrust their money to a manager) and (2) they invest in publicly traded securities. But there are important differences between a hedge fund and a mutual fund. These stem from and are best understood in light of the hedge fund's charter: investors give hedge funds the freedom to pursue absolute return strategies.

Mutual Funds Seek Relative Returns

Most mutual funds invest in a predefined style, such as "small cap value", or into a particular sector, such as the Internet sector. To measure performance, the mutual fund's returns are compared to a style-specific index or benchmark. For example, if you buy into a "small cap value" fund, the managers of that fund may try to outperform the S&P Small Cap 600 Index. Less active managers might construct the portfolio by following the index and then applying stock-picking skills to increase (over-weigh) favored stocks and decrease (under-weigh) less appealing stocks.

A mutual fund's goal is to beat the index or "beat the bogey", even if only modestly. If the index is down 10% while the mutual fund is down only 7%, the fund's performance would be called a success. On the passive-active spectrum, on which pure index investing is the passive extreme, mutual funds lie somewhere in the middle as they semi-actively aim to generate returns that are favorable compared to a benchmark.

Hedge Funds Actively Seek Absolute Returns

Hedge funds lie at the active end of the investing spectrum as they seek positive absolute returns, regardless of the performance of an index or sector benchmark. Unlike mutual funds, which are "long-only" (make only buy-sell decisions), a hedge fund engages in more aggressive strategies and positions, such as short selling, trading in derivative instruments like options and using leverage (borrowing) to enhance the risk/reward profile of their bets.

This activeness of hedge funds explains their popularity in bear markets. In a bull market, hedge funds may not perform as well as mutual funds, but in a bear market - taken as a group or asset class - they should do better than mutual funds because they hold short positions and hedges. The absolute return goals of hedge funds vary, but a goal might be stated as something like "6 to 9% annualized return regardless of the market conditions".

Investors, however, need to understand that the hedge-fund promise of pursuing absolute returns means hedge funds are "liberated" with respect to registration, investment positions, liquidity and fee structure. First, hedge funds in general are not registered with the SEC. They have been able to avoid registration by limiting the number of investors and requiring that their investors be accredited, which means they meet an income or net worth standard. Furthermore, hedge funds are prohibited from soliciting or advertising to a general audience, a prohibition that lends to their mystique.

In hedge funds, liquidity is a key concern for investors. Liquidity provisions vary, but invested funds may be difficult to withdraw "at will". For example, many funds have a lock-out period, which is an initial period of time during which investors cannot remove their money.

Lastly, hedge funds are more expensive even though a portion of the fees are performance-based. Typically, they charge an annual fee equal to 1% of assets managed (sometimes up to 2%), plus they receive a share - usually 20% - of the investment gains. The managers of many funds, however, invest their own money along with the other investors of the fund and, as such, may be said to "eat their own cooking".

Three Broad Categories and Many Strategies

Most hedge funds are entrepreneurial organizations that employ proprietary or well-guarded strategies. The three broad hedge fund categories are based on the types of strategies they use:

1. Arbitrage Strategies (A.K.A., Relative Value)

Arbitrage is the exploitation of an observable price inefficiency and, as such, pure arbitrage is considered riskless. Consider a very simple example. Say Acme stock currently trades at $10 and a single stock futures contract due in six months is priced at $14. The futures contract is a promise to buy or sell the stock at a predetermined price. So by purchasing the stock and simultaneously selling the futures contract, you can, without taking on any risk, lock in a $4 gain before transaction and borrowing costs.

In practice, arbitrage is more complicated, but three trends in investing practices have opened up the possibility of all sorts of arbitrage strategies: the use of (1) derivative instruments, (2) trading software, and (3) various trading exchanges (for example, electronic communication networks and foreign exchanges make it possible to take advantage of "exchange arbitrage", the arbitraging of prices among different exchanges).

Only a few hedge funds are pure arbitrageurs, but when they are, historical studies often prove they are a good source of low-risk reliably-moderate returns. But, because observable price inefficiencies tend to be quite small, pure arbitrage requires large, usually leveraged investments and high turnover. Further, arbitrage is perishable and self-defeating: if a strategy is too successful, it gets duplicated and gradually disappears.

Most so-called arbitrage strategies are better labeled "relative value". These strategies do try to capitalize on price differences, but they are not risk free. For example, convertible arbitrage entails buying a corporate convertible bond, which can be converted into common shares, while simultaneously selling short the common stock of the same company that issued the bond. This strategy tries to exploit the relative prices of the convertible bond and the stock: the arbitrageur of this strategy would think the bond is a little cheap and the stock is a little expensive. The idea is to make money from the bond's yield if the stock goes up but also make money from the short sale if the stock goes down. However, as the convertible bond and the stock can move independently, the arbitrageur can lose on both the bond and the stock, which means the position carries risk.

2. Event-Driven Strategies

Event-driven strategies take advantage of transaction announcements and other one-time events. One example is merger arbitrage, which is used in the event of an acquisition announcement and involves buying the stock of the target company and hedging the purchase by selling short the stock of the acquiring company. Usually at announcement, the purchase price that the acquiring company will pay to buy its target exceeds the current trading price of the target company. The merger arbitrageur bets the acquisition will happen and cause the target company's price to converge (rise) to the purchase price that the acquiring company pays. This also is not pure arbitrage. If the market happens to frown on the deal, the acquisition may unravel and send the stock of the acquirer up (in relief) and the target company's stock down (wiping out the temporary bump) which would cause a loss for the position.

There are various types of event-driven strategies. One other example is "distressed securities", which involves investing in companies that are re-organizing or have been unfairly beaten down. Another interesting type of event-driven fund is the activist fund, which is predatory in nature. This type takes sizeable positions in small, flawed companies and then uses its ownership to force management changes or a restructuring of the balance sheet.

3. Directional or Tactical Strategies

The largest group of hedge funds uses directional or tactical strategies. One example is the macro fund, made famous by George Soros and his Quantum Fund, which dominated the hedge fund universe and newspaper headlines in the 1990s. Macro funds are global, making "top-down" bets on currencies, interest rates, commodities or foreign economies. Because they are for "big picture" investors, macro funds often do not analyze individual companies.

Here are some other examples of directional or tactical strategies:

Long/short strategies combine purchases (long positions) with short sales. For example, a long/short manager might purchase a portfolio of core stocks that occupy the S&P 500 and hedge by selling (shorting) S&P 500 Index futures. If the S&P 500 goes down, the short position will offset the losses in the core portfolio, limiting overall losses.

Market neutral strategies are a specific type of long/short whose goal is to negate the impact and risk of general market movements, trying to isolate the pure returns of individual stocks. This type of strategy is a good example of how hedge funds can aim for positive, absolute returns even in a bear market. For example, a market neutral manager might purchase Lowe's and simultaneously short Home Depot, betting that the former will outperform the latter. The market could go down and both stocks could go down along with the market, but as long as Lowe's outperforms Home Depot, the short sale on Home Depot will produce a net profit for the position.

Dedicated short strategies specialize in the short sale of over-valued securities. Because losses on short-only positions are theoretically unlimited (because the stock can rise indefinitely), these strategies are particularly risky. Some of these dedicated short funds are among the first to foresee corporate collapses - the managers of these funds can be particularly skilled at scrutinizing company fundamentals and financial statements in search of red flags.


You should now have a firm grasp of the differences between mutual and hedge funds and understand the various strategies hedge funds implement to try to achieve absolute returns. Next (in Part Two of this series), we will review the "fund of hedge funds vehicle", highlight the risk/reward features of hedge fund investing, and propose key questions to ask when considering a hedge fund investment.

By David Harper, (Contributing Editor - Investopedia Advisor).

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Wednesday, March 07, 2007

MTPredictor Low Risk High Reward Trading Software

Today I want to stress and discuss trading to win in the long term. That means to keep risk low and reward high. There's one trading software that we like a lot and use. Its the MTPredictor trading software platform. Below is a review of the software by our friends at Active Trader Magazine.

The review below speaks about the chart patterns setups that provide low risk high reward trading. To view the charts in the review and analysis below click the MTPredictor image link below to view the charts, and read more about the features benefits, and avail of the 30 day free trial.

Software review: MTPredictor

Reviewed By DAVID BUKEY - Active Trader Magazine

MTPredictor is an analysis program that uses Elliot Wave theory to find trade setups. Elliot Wave is a complex, subjective approach based on the idea that market trends move in a series of distinct trend and countertrend waves, a technique that has intrigued (and frustrated) traders since Ralph N. Elliot introduced the idea in the 30s.

MTPredictor’s goal is to simplify Elliot Wave’s rules and increase its accuracy. Instead of identifying all Elliot Wave components, MTPredictor attempts to isolate a handful of scenarios with the highest probability of success. The platform can scan thousands of symbols for predefined trade setups, which helps inexperienced traders learn how Elliot Wave works. But MTPredictor can also search for any type of Elliot Wave pattern and lets advanced traders draw patterns manually.

Although MTPredictor automatically identifies trade setups, these signals aren’t strict “black-box” recommendations. The program’s developer, Steve Griffiths, warns that Elliot Wave analysis only works half the time. While MTPredictor can find a potential setup, it’s still up to you to confirm the trade with other tools or ideas.


MTPredictor uses end-of-day (EOD) or delayed intraday data, and it also offers real-time versions via eSignal, TradeStation, and RealTick. These real-time versions are basically add-on tools for eSignal and TradeStation, meaning they only include some of MTPredictor’s features. (MTPredictor offers a stand-alone platform for RealTick data customers.) We reviewed MTPredictor’s real-time version with eSignal and delayed data from Genesis Financial Technologies.

You can plot symbols (stocks, futures, currencies, etc.) in any time frame, depending on your data source. MTPredictor also handles a wide variety of delayed EOD and intraday data from Worden TC2005, CSI Data, Reuters DataLink, and Paritech, among others. The platform can also import data files in MetaStock and text formats.

MTPredictor doesn’t integrate real-time and delayed data, so real-time users must juggle the stand-alone program and a third-party, real-time platform. The real-time versions simply focus on trade setups and risk management, while the main program also scans for trade possibilities and includes advanced Elliot Wave drawing tools. While this isn’t a major complaint, it’s somewhat awkward. However, this arrangement makes it easy to move updated data from an eSignal chart into MTPredictor.

Methodology: As easy as A-B-C

According to traditional Elliot Wave theory, markets trade in combinations of “impulse” waves in the direction of the trend and “corrective” waves against it. The basic pattern is a set of five waves, where waves 1, 3, and 5 are impulse waves and waves 2 and 4 are corrective waves, which often consist of three-leg (A-B-C) subwaves. In an uptrend, for example, the market should rally higher in waves 1, 3, and 5, while giving back some of these gains in waves 2 and 4. (A complete five-wave pattern in one direction is then expected to be followed by a three-wave corrective pattern in the opposite direction.) Elliot Wave followers try to discover where the market is trading within this overall pattern so they can predict the market’s next move. (See “Key Concepts” on p. 80 for more information on Elliott Wave.)

But MTPredictor’s developer Steve Griffiths believes this theory doesn’t always work; even if Elliot Wave patterns appear as expected, where will one wave end and another begin? Instead of trying to identify an entire five-wave pattern, MTPredictor attempts to identify the A-B-C patterns that make up corrective waves 2 and 4 (Figure 1, below). These A-B-C patterns are potentially good trade setups because stronger impulse waves can follow them. Therefore, MTPredictor’s main goal is to confirm the end of any A-B-C pattern.


Layout and charts. Figure 1 shows a typical layout with an A-B-C trade setup on a daily chart of the Russell 2000 tracking stock (IWM) in June. Above the chart, there are shortcuts to MTPredictor’s analytical tools — scanners for pivot points, Elliot Waves, advanced A-B-C patterns, and automatic trade setups. The platform’s navigation and drawing tools appear at the chart’s right side.

You can quickly browse among charts using the black arrows. And after you load a chart, it’s easy to navigate and modify. You can adjust the chart’s X- and Y-axes automatically to view any historical time period, and chart labels can be applied or removed in a couple of steps. You can manually draw Fibonacci retracements, projections, and extensions or apply Fibonacci time analysis (i.e., when current trends might change) to any chart.

Indicators. You can plot a limited set of about 10 indicators and change their parameters (stochastics, on-balance volume, moving-average oscillator, RSI, MACD, Bollinger Bands, CCI, ADX, etc.). MTPredictor also has a proprietary oscillator called the Strong Trend Filter that can highlight potential trend changes. However, you can’t create indicators from scratch.

Trade setups. Figure 1 shows an A-B-C trade setup that MTPredictor found on June 2. Each trade setup has three components: a wave price target (WPT, pink box) that suggests the minor A-B-C wave could end, a reversal bar that helps confirm a possible wave change, and an initial reward-risk ratio of at least 2:1.

MTPredictor calculates WPTs using Fibonacci retracement and extension levels from prior waves. The WPTs’ colored boxes highlight areas where various Fibonacci levels cluster and represent possible market turning points. For example, in Figure 1, IWM closed just below the A-B-C pattern’s typical wave price target (pink), suggesting the market might weaken at that point. On June 2, IWM also formed a reversal day (basically a new high with a lower close), so MTPredictor generated a sell signal.

MTPredictor emphasizes money management — from basing position size on risk tolerance (Figure 1, upper left) to selecting trades with risk-reward ratios of at least 2:1. (Figure 1’s trade example had an initial risk-reward ratio of 3.61:1.)

Scans. MTPredictor’s strongest feature is the trade scanner, which can search thousands of symbols for a wide variety of patterns — trade setups, specific waves within a larger Elliot Wave pattern, and minor scenarios that help confirm reversals such as Dojis, 80/20 bars (weak open, strong close, or vice versa), inside days, volume spikes, and minor pullbacks.

Figure 2 (below) shows the trade scanner’s options. Each of the five waves often break down into minor patterns, which adds to Elliot Wave’s complexity. But MTPredictor can find these patterns in any size — minor, intermediate, or major. The figure’s lower window shows the scan’s results — just five symbols in the S&P 500 had trade setups during this test.

MTPredictor can also draw any element of a trade setup on a chart, which adds flexibility. For example, you could simply highlight reversal bars on a chart, add pivot points (short-term moves upon which wave patterns are based), or plot a wave 2 (or its wave price target). Or you can draw complete Elliot Wave patterns manually that MTPredictor’s algorithms might miss. While identifying these patterns from scratch may be difficult, drawing lines and labeling various waves only takes a few mouse clicks.

Historical scans. MTPredictor can also scan for any previous trade setups and Elliot Wave patterns, not just current ones. Its historical search tool is easy to use, and you can search for these scenarios by clicking back or forward in time. When MTPredictor finds a historical pattern, all “future” price bars disappear, which helps evaluate prior trade setups. Now you can either plot additional price bars or erase them using the “+” and “-“ buttons.

Real-time charts. MTPredictor’s real-time version can find trade setups, calculate initial reward-risk ratios, and size positions on eSignal charts. However, more advanced analysis such as plotting individual Elliot Waves is limited to MTPredictor’s main platform. To use all of MTPredictor’s features, real-time users need both programs open, which seems unnecessary.

Figure 3 (below) shows an A-B-C trade setup on a five-minute chart of the Russell 2000 E-Mini (AB U6) on July 13. This shows how MTPredictor uses Elliot Wave theory to find trade opportunities without depending upon its strict interpretation. For example, the Russell 2000 dropped consistently on July 12 before it rallied the next morning to form a minor A-B-C pattern. The platform generated a sell signal when the market reached a potential end to this corrective wave, and the Russell 2000 reversed direction and traded lower.

MTPredictor helps you manage risk in real-time with the same tools included in its main platform. If you compare Figures 1 and 3, you’ll notice MTPredictor labels the trade’s entry and stop-loss points (including position size) and calculates its reward-risk ratio the same way in both EOD and real-time versions. You can plot these statistics directly on the chart, or MTPredictor can list them in a separate window (Figure 4, below).

Real-time scans. The program uses eSignal’s existing features in clever ways. For example, eSignal’s alert window appears when real-time trade setups emerge, and its Bar Replay feature helps you evaluate historical trade opportunities one bar at a time (similar to MTPredictor’s historical scans). However, eSignal only monitors open charts for trade signals, and you can only open about 20 charts without affecting performance.

Help resources

MTPredictor’s help documents are actually called trading manuals, because the developer focuses more on how MTPredictor interprets Elliot Wave than how to use each feature. But the manual is quite detailed and easy to follow, and the company offers several videos on their Web Site that explain how to operate the platform’s tools.

The company also offers phone and e-mail support, posts daily reports that discuss possible trades, and maintains a forum where new users can ask questions.

Bottom line

MTPredictor simplifies Elliot Wave theory by focusing on a handful of scenarios that don’t always fit traditional interpretations of this approach. But the platform also accommodates Elliot Wave experts who identify patterns from scratch.

While MTPredictor isn’t for everyone, traders who are interested in Elliot Wave analysis won’t have trouble finding potential trades and conducting their own analysis.

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