INVESTORS GUIDE
TOP 5 MISTAKES THAT INVESTORS NEED TO AVOID…
1. Emotional trading
Perhaps the single biggest destroyer of a stock market portfolio. Emotions can be manipulated. If you follow your gut, you will buy and sell at all the wrong times. Market makers are counting on people trading with their heart and not their mind.
Solution: Simple. Get a trading system and stick to it. Better yet, write the rules for buying and selling the stock beforehand and share it with a confidant to ensure you adhere to it.
2. Buying stocks on the way down
Investors like to think they are prophets able to foretell how far a stock will move in any direction. Bad earnings come out and maybe the stock drops 10%. "Ah ha! A bottom is formed. I'll buy!" But what about all the other emotional traders that are being manipulated right now? Never try to grab a falling knife - you'll cut yourself. Let the knife fall to the floor and clatter first. Wait for the bottom to be formed and signal that the stock is recovering. This will take time and knowledge. Just because a stock dropped doesn't make it a good deal.
3. No clear rules for cutting losses short.
This can be a problem of rule #1 or it can be that the system is so shoddy that it doesn't have rules for cutting losses short. If a trade goes south - when will you exit gracefully? Will you take a 10% loss? 20%? Does it become a grudge match after that and are you now willing to ride the stock into the ground? Have concrete rules set in play. It could be as simple as "If it goes 7 or 8% below my buy price - I sell no matter what. Sure it may rebound - and I may have to re-buy at a 3% premium - but I will have saved my entire portfolio in the long run." One day you will get a stock that will tank - or you'll be invested during a bust. Get out and wait. Don't lose your fortune like so many others in the dot-com bust.
4. No clear rules for profit taking
The stock goes from $5 to $10. The investor now thinks it could go to $20 so he holds on all the way back down to $5. Too bad! Or he sells too soon. He rides the stock from $5.00 to $5.50 and it goes to $10 without him on board. A good stock system should allow you to ride the profits. It won't find you the exact top of the stock - but should at least help you find a spot to profit-take about 10 - 20% from the absolute top. Riding a $5 stock up to $8 or $9 would be acceptable where taking only 10% profit in this case would not.
5. Day-trading for beginners
I am not a beginner, but I would never day-trade. I know the lure is there for a quick buck - but more often its a quick loss. You can double your investment in a month using other strategies that are far less risky than watching a stock in real-time and trying to guess the second-by-second emotional reactions of people. Its far easier to tell what a stock may do over weeks, months, and a year. But beyond the risk factor - I like to have a life. I screen for exploding growth stocks, I use technical analysis tools to look for a breakout, and I use options to give me 10x - 20x the buying power over a 3 to 6 month period. Then I go out and enjoy life and let the homework pay my way.
TECHNICAL ANALYSIS
What?
• History repeats itself
• Let the market tell you
• Bar Charts
• Use technical tools in combination with fundamental tools to determine direction of trend.
• Use technical tools to spot (even predict) changes in direction of price trends.
• Use technical tools in entry and exit decisions of key importance in timing of actions.
The essence of technical analysis is the use of charts to analyze supply and demand. It is the observation of the battle of the buyers and the sellers. Jack Schwager defines technical analysis as follows:
"Technical analysis is a price forecasting method based on the study of price itself (and sometimes volume and open interest) as opposed to the underlying fundamental (i.e. economic) market factors. Technical analysis is often contrasted with fundamental analysis."
TECHNICAL TOOLS
• Charts
• Support and resistance
• Trendlines and channels
• Reversal patterns
• Continuation patterns
• Gaps
• Percentage retracements
• Volume and open interest
• Moving averages and oscillators
1.Charting
The use of graphs and charts to analyze past price behavior with the hope of forecasting future price movement.
2.1. Support Planes
The support plane is drawn across past lows. The most important support plane is the plane across the life-of-contract lows. In a selective hedging program, the producer will consider lifting the short hedge on an approach to the plane. Unless the fundamental supply-demand balance has changed, the market is not expected to drop down through the support plane
• Support plane drawn across past lows
• Lift short hedges on dip toward the plane
• Most support at life-of-contract low
2.2. Resistance Planes
The futures market has a tough time going where it has not been or has not been recently. The "resistance plane" takes advantage of this. A horizontal plane is drawn across a past high, and the expectation is that the market will falter, unless the fundamental supply-demand balance changes, as it again approaches the plane. Short hedges are placed on a rally toward the plane. The most important resistance plane is the horizontal plane across the life-of-contract high.
• Resistance plane drawn cross past highs
• Place short hedges on rally toward the plane
• Most resistance at life-of-contract high
3. Trend Line Mechanics
The uptrend line is drawn across two lows that are several trading days (preferably 10 or more) apart. The line should not be significantly steeper than the trends that appear via inspection of the price patterns on the chart. The downtrend line is drawn across two highs. The chart below demonstrates both
• Uptrend line drawn across two lows
• Downtrend line drawn across two highs
Corrections
The futures market tends to move in "cycles." Generally, the market reacts -- and perhaps over-reacts -- and then "corrects" over at least part of the preceding price move. The tendency for the market to correct is reliable, and the markets tend to approach 38%, 50% or 62% corrections. Which level might be approximated will depend on the strength of the major move that is developing.
• Market moves in cycles
• Market tends to "correct" the preceding
• Move in price corrections tend to be 38%, 50%, or 62%
Chart Gaps
A gap occurs when the market dips or rallies so fast there is no trade within a price range. Generally, such events occur when a new piece of unexpected information shocks the market. The market typically comes back and tries to "fill" the gap in the following days. If the gap is not "filled" within 5-10 days after the gap is created, the gap can take on a special significance
• Chart gaps occur in fast-moving market.
• Market tries to "fill” chart gaps.
• If the gap is not filled, can take, on a special significance.
Technical Analysis: Double Tops, Bottoms
The top or bottom will occur along resistance and support planes respectively. When the market fails on a rally to a previous life-of contract high, as we expect unless supply-demand fundamentals have changed, a "double top" is developed. A double bottom occurs along he plane at the old life-of-contract low, of course.
• Double top along major resistance plane
• Double bottom along major support plane
• Reliable formations
Technical Analysis: Key Reversals
The reversal requires a new life of contract high (or low), an outside day (trading range exceeds top and bottom of the range for the previous day), and a lower close for a top. A very reliable (70-80%) formation.
• New contract high or low
• An outside day
• A lower close (for a top)
• Very reliable formation
Technical Analysis:
Head and Shoulder Formations
A widely observed formation, we often see head and shoulder tops and bottoms in the grains, oilseeds, and livestock markets. Once completed, the formations give relatively accurate measures of how far the market will move.
• Widely observed
• Provides a projection of how far the market will move
• Very reliable formation
Bear Flag
Ascending wedge or channel -- close below flag projects down the length of the flagpole, a distance AB.
Bull Flag
Descending wedge or channel – close above flag projects up the length of the flagpole -- a distance AB.
Flags are:
1. 70 to 80% or reliable
2. Easy to see.
3. Frequent in occurrence.
4. Confirmed by low volume
while flag is being formed.
5. Formed usually from 5 to
15 days.
Pennants
Pennants are:
1. 60 to 70% reliable.
2. Without basis for projection -- tend to move out the way the market was moving coming into the pennant.
3. Frequently seen in grains, livestock.
Triangles
Descending Triangle. Break out tends to be
to downside.
Ascending triangle. Break out tends to be
to the upside.
Symetrical triangle. Break out tends to be in
the direction when entered the triangle.
Triangles are:
1. Frequent.
2. Longer in time, typically, than flags or pennants.
3. 60 to 70% reliable.
4. Breakout 2/3 across.
OPEN INTEREST & VOLUME
IMPACT ON MARKET ACTION
OI VOL P Implications
U U New buying - strong mkt
U D New selling - bear mkt
D U Short covering - weak mkt, downtrend ending
D D Long liquidation - weak mkt, uptrend ending
U Strong move in mkt, up or down, if price action occurs on high volume
D Weak move in mkt, up or down, if price action is accompanied by low volume.
RSI = 100 x U .
U + D
U = Up average
D = Down average
Values above 75-80 indicate overbought zone
Values below 20-25 indicate oversold zone
Stochastics Value = 100 x last close - 20 day low
20 day high - 20 day low
%K = 3 day moving average of S.V.
%D = 3 day moving average of %K
Values above 75-80 indicate overbought zone
Values below 20-25 indicate oversold zone
Buy/Sell when %K crosses %D (both in zones)
ADX = Average Directional Movement Index
Move above 40 followed by downturn indicates change in trend
