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FREEDOM FOR ALL
Stock Trading Series – Basic Course
STOCK SAVVY
STRATEGIES
S T O C K T R A D I N G S E R I E S – B A S I C C O U R S E
Stock Savvy Strategies
Copyright by Deslyn O’Dell
Freedom for All, Inc. P.O. Box 6543
Spring Hill, FL 34610
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Stock Savvy Strategies – Basic Course
Copyright © 2008 – 2014 by Deslyn O’Dell, Freedom for All, Inc.
All rights reserved.
“Investor’s Business Daily,” “IBD,” and “IBD 100” are registered trademarks of Investor’s Business Daily, Inc. “Standard & Poor’s 500” and “S&P 500” are registered trademarks of The McGraw-Hill Companies, Inc. “Nasdaq” is a registered trademark of The Nasdaq Stock Market, Inc. “The New York Stock Exchange” and “NYSE” are registered trademarks of the New York Stock Exchange, Inc. “The Wall Street Journal” and “Barron’s” are registered trademarks of Dow Jones & Company, Inc. “The Dow” and “Dow Jones Industrial Average” are service marks of Dow Jones & Company, Inc. “ClearStation” and www.clearstation.com are service marks, trademarks, or registered trademarks of ClearStation, Inc. “TopTenREVIEWS” is a trademark of TopTenREVIEWS, Inc. “MetaStock” is a registered trademark of Equis International.
All other trademarks, service marks, or registered trademarks referred to in this publication are the property of their respective owners. Other names, designs, titles, words, logos, or phrases in this publication may constitute trademarks, service marks, or trade names of other entities which may be registered in certain jurisdictions.
BigCharts.com web site Copyright © 2008-2014 MarketWatch, Inc. biz.yahoo.com web site Copyright © 2008-2014 Yahoo! Morningstar.com web site Copyright © 2008-2014 Morningstar, Inc. Investors.com web site Copyright © 2000-2014 Investor’s Business Daily, Inc. InvestorWords.com web site Copyright © 1997-2014 InvestorGuide.com, Inc. MetaStock.com web site Copyright © 2008-2014 Equis International
No part of this publication may be reproduced, translated, or transmitted in any form or by any means, graphic, electronic, or mechanical, including photocopying, taping, or by any information storage retrieval system, without the written permission from the copyright holder.
The Stock Savvy Strategies – Basic Course Workbook and other material are information services for investors and traders are not a recommendation to buy or sell securities, nor an offer to buy or sell securities. The principals, employees of, as well as those who provide contracted services for Freedom for All, Inc. are neither stockbrokers nor investment advisors, and are not acting in any way to influence the purchase of any security.
This publication is designed to provide accurate and authoritative information regarding the subject matter covered. It is sold with the understanding that neither the author, copyright holder, nor the publisher is engaged in providing securities trading advice, legal, accounting, or other professional services. If trading, investment or legal advice or other expert assistance is required, the services of a competent and appropriately licensed person should be sought. The information provided is obtained from sources deemed to be reliable, but is not guaranteed as to its accuracy or completeness. Trading in securities may not be suitable for all individuals and involves volatility and risk. Consult your broker or other professional to determine your suitability.
Printed in the United States of America.
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Table of Contents
About This Manual ................................................................... vi The Psychology of Trading ....................................................... 1
Chapter 1 Review ........................................................................... 4
Chapter Notes ................................................................................. 4
The Market ............................................................................... 5
Market Mood ................................................................................... 5
Market Trend .................................................................................. 6
Market Basics ................................................................................. 7
Market Hours ............................................................................................. 7
Exchanges ................................................................................................ 7
Markets: Sectors, Industries, Stocks........................................................ 8
Stock’s Life Cycle ......................................................................... 10
Stock’s Quarterly Cycle................................................................. 11
Chapter 2 Review ......................................................................... 13
Chapter Notes ............................................................................... 13
Trading System ....................................................................... 15
Fundamentals ............................................................................... 15
Fundamental Criteria for Stock Selection ............................................... 16
Creating a Watch List .............................................................................. 20
Technicals – Charts and Indicators ............................................... 20
Charting Basics ....................................................................................... 21
Technical Indicators ................................................................................ 24
Chapter 3 Review ......................................................................... 33
Chapter Notes ............................................................................... 33
Selecting a Broker and Trading ............................................... 35
Broker Errors ................................................................................ 37
Trading Terminology ..................................................................... 38
Alerts............................................................................................. 40
Trailing Stop Loss – Protecting Your Profit ................................... 41
Chapter 4 Review ......................................................................... 44
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Chapter Notes ............................................................................... 44
Using Checklists ..................................................................... 45
Stocks Going UP – Buy Stocks Long ........................................ 45
BUY Long Checklist ................................................................................ 46
SELL Long Checklist ............................................................................... 48
Stocks Going DOWN – Sell Stocks Short ................................. 49
SELL Short Checklist .............................................................................. 50
BUY Short Checklist................................................................................ 53
Chapter 5 Review .......................................................................... 55
Chapter Notes ............................................................................... 55
Money Management ............................................................... 57
Quality NOT Quantity of Your Trades ............................................ 57
How much do I buy? ...................................................................... 58
Red Zone Rules ............................................................................. 59
Red Zone Rules Example ....................................................................... 59
Strategies for Using Margin ........................................................... 60
Wrong Way to Use Margin ...................................................................... 61
Correct Way to Use Margin ..................................................................... 61
Lock in Profit – Buy Again with More Leverage ...................................... 62
Tricks of the Trade ......................................................................... 63
Sell Before Earnings ............................................................................... 63
MA Crossover Bow-Tie ........................................................................... 65
MAPB – Moving Average Pull Back ........................................................ 66
How the Media Can Affect a Stock ......................................................... 67
Chapter 6 Review .......................................................................... 68
Chapter Notes ............................................................................... 68
The Trading Process – Putting it All Together .......................... 69
Step 1 – Select Broker and Open Account .................................... 70
Step 2 – Set Up BigCharts ............................................................ 71
Step 3 – Filter IBD Stocks and Create Watch List ......................... 77
Step 4 – Review Charts/Indicators and Select Stock to Trade ...... 78
Step 5 – Check Earnings ............................................................... 79
Step 6 – Decide on Trade Entry .................................................... 80
Step 7 – Enter Trade and Set Trailing Stop Loss .......................... 81
Step 8 – Exit Trade with Profit ....................................................... 83
Critical Keys to Trading Success ................................................... 85
Profit Formula ................................................................................ 85
How to Rate Your Success ............................................................ 86
What to Do with Your New Wealth ................................................ 86
Challenge ...................................................................................... 86
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Chapter 7 Review ......................................................................... 87
Chapter Notes ............................................................................... 87
Resources .............................................................................. 89
Web Sites ..................................................................................... 89
Checklists ..................................................................................... 97
Fundamental Criteria Checklist ............................................................... 97
BUY Long and SELL Long Checklists .................................................... 98
SELL Short and BUY Short Checklists ................................................... 98
Flowcharts .................................................................................... 99
The Trading Process ............................................................................... 99
Trade Entry Decisions ........................................................................... 100
Trade Exit Decisions ............................................................................. 101
IBD Tables and Practice Charts .................................................. 102
Recommended Reading ............................................................. 106
Glossary ............................................................................... 109
Reader Comments ................................................................ 117
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About This Manual
This manual teaches an objective, simple system for trading stocks and follows this philosophy.
If you give a person a fish, you feed them for a day. If you teach a
person to fish, you feed them for a lifetime.
The objectives of this manual are:
1. To make you an Independent Thinker.
2. To provide you with a “System” for buying and selling stocks.
3. To help you reach your financial goals.
4. To keep your 401k from turning into a 101k.
This manual is organized into the following chapters. At the end of each chapter, you will find the chapter review and space to write notes.
Chapter 1 – The Psychology of Trading
Chapter 2 – The Market
Chapter 3 – Trading System
Chapter 4 – Selecting a Broker and Trading
Chapter 5 – Using Checklists
Chapter 6 – Money Management
Chapter 7 – The Trading Process: Putting It All Together
Following Chapter 7, you will find helpful Resources and a Glossary of Terms.
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The Psychology of Trading
Two emotions – FEAR and GREED – make the market run.
o be a successful trader, you need to have a system – a simple, objective system that makes life easy and solves the problem of your retirement. A trading system gives you a method or plan for trading your money. This means you can plan your work and then work your plan. Once you have your plan, you must take action.
An objective trading system is based on strategies that help you determine when to buy and when to sell, so you can minimize losses and maximize gains. Hoping and wishing are not strategies that will help you achieve the right frame of mind or be a successful trader.
Let’s define the difference between stock Investors and stock Traders.
Investors are people who make their decisions based on Fundamentals – company performance (details about Fundamentals in Chapter 3, Trading System).
Traders are people who make their decisions based on Technicals – what the market thinks about the stock (details about Technicals discussed in Chapter 3, Trading System).
Trading involves observation. Remember the five Ws? The five Ws ask Who, What, When, Where, and Why. You need to be observant and watch what is going on. In trading, you are reactive, not proactive, which means you look at the data and make an objective finding instead of anticipating what may happen. This system involves 90 percent objective criteria and 10 percent subjective criteria. The subjective part is based on your individual preferences and does not make a difference in a significant way.
Before you move on, complete the following goal-setting exercise. What annual percent return do you expect to get on your trading that you can realistically achieve? Without using a number that is “pie in the sky,” write it down – right here.
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_______ % Return
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Let’s debunk some myths about the Stock Market that you may have heard or that you may believe yourself.
Myth Number One – There is some “Holy Grail.”
This refers to software or trading platforms that promise guaranteed money-making results. These companies only supply the information or data on which to base a trading decision. Nobody can make the decision but you. You still have to take the information, use your trading system, and press the button to make money.
Myth Number Two – I can buy a “Black Box.”
You see the “Black Box” advertised on TV all the time. Some expensive package or complicated data that you do not understand that will make you money. Basically, all it does is speed up the calculations of the data or make it faster in providing the information. You still have to actually trade.
Myth Number Three – My stocks always go down.
The reason your stocks go down is you have the wrong criteria for buying them. You need the proper criteria for selecting stocks that will go up.
The two critical emotions that make the market run are FEAR and GREED. These emotions are fundamental to the psychology of trading.
Fear is the emotion that prevents you from entering a trade. You can also experience fear of losing money, as well as fear of making money.
Greed is the emotion that keeps you in a trade when you should get out. Remember that pigs get fat and hogs get slaughtered. Don’t be a greedy hog.
Fear and Greed affect nearly every aspect of what happens in the market. Getting control of these two emotions will make the difference between being a hundred-aire and a multi-millionaire. With an objective method of choosing stocks, you will not be induced into following someone’s “hot tip” or getting up in the morning to trade and just not “feeling” right about it.
The following principles help underscore the right mental attitude you need to implement the objective trading system explained in the upcoming chapters. Use these principles when you are picking a stock, playing or trading a stock, and playing or trading stocks to win.
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Picking a Stock Playing a Stock Playing to Win
Always have a good reason. No reason, no play!
Plan the trade and trade the plan.
Play to win!
Don’t play maybes. When in doubt, stay out!
Don’t chase a stock – wait for it to come to you.
Be open.
Most tips don’t pan out. Always use stops (Trailing Stop Loss).
You don’t need to win on every trade.
Trends are your friends. Lock in profits religiously. No one ever went broke taking profits.
No one makes money every day.
Go for the easy money. Think in terms of risk vs. reward.
Greed = Death. Hogs get slaughtered!
It’s a marathon, not a sprint.
Don’t catch falling knives. Swing for the singles, not the fences – often you will hit home runs anyway.
Be flexible. Don’t fight the market! Don’t fight the trend!
Take small losses. On a bad day, take a walk.
Don’t marry stocks. Control your inner knucklehead.
Don’t panic buy or sell. Use sound money management.
You don’t have to trade every day.
You are responsible for everything you do, both in trading and in life. There are no victims, only volunteers!
Make trading fun.
Remember to give something back.
Have a life outside trading.
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Chapter 1 Review
You need a system to be a successful trader.
Investors make decisions using Fundamentals – Traders make decisions using Technicals.
Write down your trading goal – the annual percent return you think you can achieve.
Do not believe the myths about the stock market, use a trading system with objective criteria.
Control FEAR and GREED – the two emotions that make the market run.
Internalize the principles for Picking a Stock, Playing a Stock, and Playing to Win.
Chapter Notes
T H E M A R K E T
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The Market
Background and basics of the Stock Market.
harles Dow, an American Journalist and Industrialist, and Edward Jones, a U.S. Statistician, co-founded the Dow Jones Index in 1896, at which time it consisted of only 11 stocks. Charles Dow observed that when certain companies did well, the economy did well. He made a list of these companies and began tracking them. He and Edward
Jones got together and determined that people would pay for this information, so they launched the Wall Street Journal.
The Dow Jones Industrial Average or DJIA is the most widely used indicator of the overall condition of the stock market and is also an economic barometer. It is a price-weighted average of 30 actively traded, well-established company stocks, primarily industrials. The 30 stocks are chosen by the editors of the Wall Street Journal (which is published by Dow Jones & Company), a practice that dates back to the beginning of the century. Today, the Wall Street Journal has become a more political than stock related publication.
Market Mood
First, we want to know which direction the market is headed, not just guess. We can observe the general “mood” or sentiment of the market by looking at the number of stocks that are rising in price – ADVANCERS versus the number of stocks that are falling in price – DECLINERS. The Advancers/Decliners is an objective measure of direction. If the number of Advancers is more than the number of Decliners, then the market mood is considered UP or “Bullish.” If the number of Decliners is more than the number of Advancers, then the market mood is considered DOWN or “Bearish.”
We can also observe the general mood or sentiment of the market by looking at the stocks making New Highs versus the stocks making New Lows. If stocks are constantly making new highs, this is positive sign that the market is going up. We can use New Highs and New Lows as an objective measure of market direction.
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Market Trend
To determine market trends, we follow the direction of the major market indices.
Dow Jones – the oldest and most widely used measure of the overall condition of the stock market.
NASDAQ – the National Association of Securities Dealers Automated Quotation System. This index has the majority of tech or technology stocks that trade on the market.
S&P 500 – Standard & Poor’s 500 Index. An index of 500 of the largest stocks in the marketplace. This is the benchmark for measuring market performance and results. Money managers must beat this index or lose their jobs.
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Trends Are Our Friends
When all three market indices are up (Dow Jones, NASDAQ, S&P 500), the market direction is favorable. The markets are weighted. When you look at the trend of an index, remember to consider its overall weighting in the market.
The trend of the Dow Jones Index is weighted 70 percent, because 90 percent of the stocks in the market follow the trend of the Dow Jones. This means the direction of the Dow Jones carries more weight in determining overall market trends.
The trend of the NASDAQ is weighted 20 percent.
The trend of the S&P 500 is only weighted 10 percent.
For example, if the Dow Jones is trending up and the NASDAQ and S&P 500 are trending down, the overall direction or trend of the market is still up. Remember that together, the NASDAQ and S&P 500 only equal 30 percent. In this situation, however, the market may be showing signs of weakness.
The Market moves in one of three directions: UP, DOWN, or SIDEWAYS. Make sure to follow the appropriate rules when the market is trending UP or DOWN. The market is not trending when it is moving in a SIDEWAYS direction.
Let’s look at a chart of historical data that shows how likely on average the Dow Jones closes UP in any given month.
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Month % of UP Closings
January 64.6%
February 48.9%
March 59.4%
April 54.2%
May 51.0%
June 51.0%
July 61.5%
August 64.6%
September 40.6%
October 54.2%
November 60.4%
December 70.7%
Figure 2-1: Chart of Dow Jones % Up Closings by Month
After looking at this chart, you should be able to tell which months are more favorable for trading stocks in an UP trend. Use this information to objectively determine when to buy with the market direction.
The Market can be compared to an ocean with tides. The tides represent money coming into the market. If a stock is like a boat on the ocean, when the ocean tides are rising all boats are lifted UP. This means that when the big fund managers put money into the market , stocks rise and are lifted up with the resulting up trend in the overall market.
Market Basics
You need to understand some basics to trade stocks in the Market.
Market Hours
The Stock Market is open for trading stocks from Monday through Friday, except holidays.
The Pre-Market trading session starts at 8:00 a.m. Eastern Time and ends at 9:30 a.m. Eastern Time. Limited trading occurs during these hours.
Regular Trading Hours for the Stock Market are from 9:30 a.m. Eastern Time to 4:00 p.m. Eastern Time.
The Post-Market After Hours Trading is open from 4:00 p.m. Eastern Time to 6:30 p.m. Eastern Time. Again, limited trading occurs during these hours.
Exchanges
An exchange is an organization, association or group which provides a marketplace where goods or services are traded or “exchanged.” Exchanges work a lot like auctions. When you agree on a
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price or meet the target price, you exchange your money and get the product. If you do not agree on the price, no exchange takes place.
A grocery exchange, for example, is a marketplace where people trade money or other goods and services for food and other related household items. Some grocery exchanges you may recognize include PUBLIX, WINN DIXIE, or SAFEWAY.
In much the same way that grocery exchanges work, the stock exchanges like NYSE (New York Stock Exchange) and NASDAQ (National Association of Securities Dealers Automated Quotation system) provide a marketplace for trading securities, options, futures, or commodities.
Markets: Sectors, Industries, Stocks
Let’s take a look at the components that make up the Market, so we can understand where an individual stock fits into the hierarchy. Refer to the following figure for an illustration of how these components fit together.
Markets: Sectors, Industries, StocksMarkets - All Stocks & Indexes
Nine OtherMarket Sectors
(Total = 12)
FinancialSector
HealthcareSector
TechnologySector
Each Slice of Market Sector = Industry
Computer Hardware Industry AAPL, DELL, IBMEach Industry Contains Individual Stocks
Figure 2-2: Market: Sectors, Industries, Stocks.
The Market is divided into 12 Sectors by grouping like businesses together. Here is a list of the Market Sectors in alphabetical order.
1. Basic Materials
2. Capital Goods
3. Conglomerates
4. Consumer/Non-Cyclical
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5. Consumer Cyclical
6. Energy
7. Financial
8. Healthcare
9. Services
10. Technology
11. Transportation
12. Utilities
Each Sector of the Market is divided into basic categories of business activity, called Industries. Let’s look at the Industries within the Technology Sector. In this Sector, we find the Computer Hardware Industry, as shown in Figure 2-2. Along with this Industry (or business activity), here are the other Industries that belong in the Technology Sector of the Market.
Communications Equipment
Computer Networks
Computer Peripherals
Computer Services
Computer Storage Devices
Electronic Instruments & Controls
Office Equipment
Scientific & Technical Instruments
Semiconductors
Software & Programming
You may be able to think of some companies that fit these Industry descriptions. If a company participates in multiple business activities or Industries, it is usually considered to be in the Industry in which it receives most of its revenues.
Finally, each Industry is made up of individual company Stocks. For example, let’s refer to Figure 2-2 to see which individual company stocks belong in the Computer Hardware Industry of the Technology Sector. Here are the stocks shown in Figure 2-2, and the rest of the 10 stocks in this Industry (a few of them should be familiar).
Apple Computer Inc (AAPL)
Digital Equipment Corp (DEC)
Dell Computer Corp (DELL)
Digi International (DGII)
Electronics for Imaging (EFII)
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International Business Machines (IBM)
Ingram Micro (IM)
Sun Microsystems Inc Com New (JAVA)
Mercury Computer Systems (MRCY)
Tech Data Corp (TECD)
Notice the list includes the name of the individual company, followed by the company’s Stock Symbol Identifier. This symbol is a system of letters to uniquely identify a stock or mutual fund. Symbols with up to three letters are used for stocks which are listed and trade on an exchange, like the NYSE (New York Stock Exchange).
3 Letters = NYSE For example: MSO and IBM
4 Letters = NASDAQ For example: AAPL and GOOG
Symbols with four letters are used for NASDAQ stocks. The difference in designation for three or four letters in the stock symbol is in the process of changing with the upcoming merging of the current exchanges.
Stock’s Life Cycle
Stocks go through four stages during their life cycle: Embryonic, Growth, Maturity, and Decline. The following figure shows these stages.
Figure 2-3: Stock’s Life Cycle
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The Embryonic stage of a stock’s life cycle occurs as the stock is first listed for trading as an IPO or Initial Public Offering. This stage is usually the first 90 days of the stock’s life. Since the stock can be quite volatile, you will only trade the stock during this stage using an advanced IPO strategy.
You will make all your money with a “Buy Stocks” strategy during the Growth stage of a stock, so this is the stage to focus on. As a general rule, the company is young and attacking the marketplace. In this stage the company is making money, re-investing profits to make more money, and not paying dividends.
Once the company reaches Maturity, it is no longer gaining market share. The Maturity stage is characterized by stability. Mature companies are not reinvesting profits and begin paying dividends. You can trade during this stage with an advanced options strategy – Covered Calls.
Companies in the stage of Decline are no longer competitive. The strategy for this stage is to “Short Stocks.”
The sole purpose of a public company is to make money. You do not care about the company’s product or service, but about its ability to make money. If the company cannot take its product or service and make money, the stock price will reflect it.
Stock’s Quarterly Cycle
Stocks live and die every 90 days when the company releases quarterly earnings. Earnings are the reason that corporations exist, and are often the single most important determinant of a stock’s price. Earnings are important because they give an indication of the company’s expected future dividends and its potential for growth.
Four times a year, each company announces its quarterly earnings. Generally from year to year, these earnings announcements occur in the same months of the year for a particular company, although they may be in different months than other companies. For example, let’s look at the 2007 quarterly earnings announcement dates for Google (GOOG) and Mastercard (MA).
Google (GOOG) announced earnings on the following dates.
1. January 31, 2007
2. April 19, 2007
3. July 19, 2007
4. December 18, 2007
Mastercard (MA) announced earnings on the following dates.
1. February 9, 2007
2. May 2, 2007
3. August 1, 2007
4. October 31, 2007
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You can look up the quarterly earnings announcement dates of any company on a free web site. Here is the link to the web site. For future reference, bookmark the page for looking up earnings announcements: http://biz.yahoo.com/research/earncal/today.html.
biz.yahoo.com/research/earncal/today.html
From the Yahoo Finance web site at biz.yahoo.com, select the “Stocks” item from the Investing Tab. Click on the “Earnings Dates” link under the Company Earnings Feature and you will see the Earnings Calendar for the current date with the list of companies announcing earnings.
Every day companies announce earnings. You can enter any stock symbol in the box and click on the “Get Earnings Date” button to see the next scheduled quarterly earnings date for any company you are interested in. You can also listen to company conference calls by clicking on the “Listen” link. In these conference calls, companies provide guidance about future earnings and business outlook. You can get an idea of which direction the stock may be going from this information or guidance. Even if the guidance is positive, exit your trade before earnings anyway, because the stock price is likely to be volatile and not worth risking your profits.
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Chapter 2 Review
Determine Market Mood or overall direction with objective measures – Advancers/Decliners and New Highs/New Lows.
Use the weighted Dow Jones, NASDAQ, and S&P 500 indices to decide market trend – Up, Down, or Sideways.
Trade during regular Market Hours – 9:30 AM to 4:00 PM Eastern.
Understand the components and hierarchy of the market: Sectors, Industries, and Stocks.
Become familiar with a company’s stock identifier or stock symbol (for example, AAPL).
Look for stocks in the Growth stage of the Life Cycle.
Stocks live and die every 90 days with earnings, so always check earnings announcement dates before trading.
Chapter Notes
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T R A D I N G S Y S T E M
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Trading System
It’s all about the right blend of Fundamental and Technical Data.
ow that you understand the basics, let’s take a look at the Trading System in detail. To be a successful trader, you need both Fundamental and Technical information about the company and the stock to make good trading decisions. First, let’s define what we mean by “Fundamentals” and “Technicals.”
Fundamentals – Analysis of a company’s financial performance and future growth.
Technicals – Analysis using charts and indicators, what the Market thinks of the stock.
Fundamentals
Where do you find the Fundamental information about a company? You can locate company research data in the following sources.
1. Investor’s Business Daily 2. Wall Street Journal 3. Barron’s
You may be familiar with one or more of these sources. Most commonly, people expect to find the right Fundamental information about a company in the Wall Street Journal. While this may have worked years ago, this publication has more political content than stock-related content. You will use the Investor’s Business Daily or IBD as your source of Fundamental data.
The IBD uses a composite ratings system to rank stocks against a set of criteria. You can see for yourself how well IBD’s top-rated stocks, called the IBD 100, perform versus the familiar market benchmark S&P 500. Figure 3-1 shows the return percentages, which is published in each edition of the IBD.
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Figure 3-1: IBD 100 Return Percentage versus the Benchmark S&P 500 Return Percentage
Remember your trading goal that you wrote down in Chapter 1? Now you can see that if you simply take your money and invest it into IBD’s highest rated stocks, you can achieve a return of more than 100 percent. Let’s keep going, though, because your results with this trading system will far exceed the returns of the IBD 100.
Fundamental Criteria for Stock Selection
Selecting stocks is key to successful trading. As part of your trading system, you need a repeatable, objective process to follow. Use the IBD Research Tables to scan for or select stocks. Here is the list of the six main Fundamental criteria – the first three being the most important. Next to each criterion, you will find a brief explanation. Make sure you are scanning only stocks that are $10 per share and above.
1. Earnings Per Share (EPS) = 90% or higher EPS is critical for determining whether the company is making money, since EPS serves as an indicator of a company’s profitability. This is the number one criteria, because you want the top 10 percent of companies making money. A high EPS rating means a high probability that the stock will go up. Because EPS is so important, this is the first criteria you look at and it has an 80 percent weight factor over the others on the list.
2. Relative Price Strength Rating (RS) = 80% or higher RS is a measure of a stock’s price performance over the last twelve months, compared to all stocks. This is the number two criterion and has a 10 percent weight factor.
3. Sales + Profit Margins + ROE Rating (SMR) = A SMR is a proprietary IBD rating to identify companies with superior Sales Growth, Profit Margins, and Return on Equity (ROE) ratios. An A rating indicates the top 20 percent of companies and an E rating indicates the bottom 20 percent of companies. This criterion has a 5 percent weight factor for your selection of stocks.
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4. Accumulation/Distribution Rating = A for Buying, E for Selling This is also an exclusive IBD rating that tracks the relative degree of institutional buying (accumulation) and selling (distribution) in a particular stock over the last 13 weeks. Stocks are rated on a scale from A+ meaning heavy buying to E meaning heavy selling. This criterion gives you an indication of where the big guys (institutional traders) are moving their money. This criterion has a 5 percent weight factor for your selection of stocks.
5. Volume % Change = +50% and -50% A measure of the relationship between the most recent trading activity to the number of shares traded on an average daily basis over the last 50 trading sessions. A positive percent change indicates stocks going up and a negative percent change indicates stocks going down.
6. Daily Volume = 1 million or more shares Make sure to select a stock that trades at least 1 million shares on a daily basis, so you can avoid a stock that trades too thinly and affects your purchase and sales prices. Stocks trading more than a million shares per day have liquidity, which means that enough shares are trading during normal trading hours that your buy and sell orders will process quickly without extreme fluctuations in price.
Now that you know the six important Fundamental criteria for stock selection, here is how you use them to find good stocks to trade.
Step 1 – Get a copy of the IBD (Investor’s Business Daily) by choosing either of the following.
A. Buy the IBD Monday Special – Weekly Newspaper print edition from your local newsstand or bookstore. The Monday Special is usually available for purchase on Saturday mornings.
B. Order a subscription from Investor’s Business Daily. You can call or order online at www.investors.com. Since you only need to review stocks weekly, you can order the IBD Monday Special – Weekly Newspaper and have it delivered to you.
Step 2 – Locate IBD’s NYSE & NASDAQ Research Tables for stocks that are $10 and above.
You will find the tables in Section B, after the IBD 100. The stocks are grouped by industry in order of performance. Figure 3-2 shows an example of the tables with stocks and criteria you are looking for in the IBD.
Figure 3-2: IBD Table with Fundamental Criteria and Stocks
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Step 3 – Use the 6 Fundamental Criteria to select your stocks.
A. Get out your Fundamental Criteria Checklist (included with this manual), shown in Figure 3-3. You are looking for stocks that meet these 6 criteria.
Figure 3-3: Fundamental Criteria Checklist
B. Start at the beginning of the list of stocks and look for the ones that meet criteria 1 (EPS = 90% or higher).
1) If yes, go on to criteria 2. 2) If no, skip this stock and continue down the list of stocks.
C. If the stock meets criteria 1, check to see if it meets criteria 2 (RS = 80% or higher).
1) If yes, go on to criteria 3. 2) If no, skip this stock and continue down the list of stocks.
D. If the stock meets criteria 1 and 2, check to see if it meets criteria 3 (SMR = A), criteria 4 (Acc/Dist = A for Buying, E for Selling), and criteria 5 (Vol % Chg).
1) If yes, check the following conditions. If the stock meets these 2 conditions, write the stock symbol on a list (this list will become your list of stocks to watch). If not, skip the stock and continue down the list of stocks.
a. Make sure the stock price is more than $10 per share. b. Make sure the daily volume is 1 million or more shares – criteria 6.
2) If no, skip this stock and continue on until you have reviewed the entire list of stocks.
E. If your list has more than 10 or 15 stocks that meet all six criteria, rank the stocks in order, highest ratings first, then remove the stocks with lower overall ratings from the bottom of your list.
Example Procedure for Screening Stocks
Let’s use the 4 stocks listed in Figure 3-2 to go through the procedure of how to screen or filter stocks from the IBD to make your stock selection or watch list.
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1st Stock = AtwoodOcn (stock symbol is ATW)
Does this stock meet the first checklist criteria – EPS = 90% or higher? The answer is YES – its EPS is 99%, so you check to see if it meets criteria 2.
Does this stock meet the second checklist criteria – RS = 80% or higher? The answer is YES – its RS is 91%, so you check to see if it meets criteria 3.
Does this stock meet the third checklist criteria – SMR = A? The answer is YES – its SMR is A, so you check to see if it meets criteria 4.
Does this stock meet the fourth checklist criteria – Acc/Dist = A? The answer is NO – its Acc/Dist is D+, so you skip the stock and continue down the list.
2nd Stock = Quickslver (stock symbol is KWK)
Does this stock meet the first checklist criteria – EPS = 90% or higher? The answer is YES – its EPS is 96%, so you check to see if it meets criteria 2.
Does this stock meet the second checklist criteria – RS = 80% or higher? The answer is YES – its RS is 97%, so you check to see if it meets criteria 3.
Does this stock meet the third checklist criteria – SMR = A? The answer is YES – its SMR is A, so you check to see if it meets criteria 4.
Does this stock meet the fourth checklist criteria – Acc/Dist = A? The answer is YES – its Acc/Dist is A, so you check to see if it meets criteria 5.
Does this stock meet the fifth checklist criteria – Vol % Chg = 50? The answer is YES – its Vol % Chg is +66, so you check the 2 conditions.
Does this stock meet the 1st condition – price more than $10 per share? The answer is YES – its close price is $32.42.
Does this stock meet the 2nd condition or criteria 6 – daily volume is 1 million + shares? The answer is YES – its volume is 3.8 million (3.8m in the Vol 1000 column).
Since this stock meets the 2 conditions, you write the stock symbol, KWK, down on a list that will become your watch list. Now continue down the list.
3rd Stock = RangeRes (stock symbol is RRC)
Does this stock meet the first checklist criteria – EPS = 90% or higher? The answer is YES – its EPS is 98%, so you check to see if it meets criteria 2.
Does this stock meet the second checklist criteria – RS = 80% or higher? The answer is YES – its RS is 98%, so you check to see if it meets criteria 3.
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Does this stock meet the third checklist criteria – SMR = A? The answer is YES – its SMR is A, so you check to see if it meets criteria 4.
Does this stock meet the fourth checklist criteria – Acc/Dist = A? The answer is YES – its Acc/Dist is A, so you check to see if it meets criteria 5.
Does this stock meet the fifth checklist criteria – Vol % Chg = 50? The answer is NO – its Vol % Chg is +3, so you skip the stock and continue down the list.
4th Stock = Rowan (stock symbol RDC)
Does this stock meet the first checklist criteria – EPS = 90% or higher? The answer is YES – its EPS is 98%, so you check to see if it meets criteria 2.
Does this stock meet the second checklist criteria – RS = 80% or higher? The answer is NO – its RS is 76%, so you skip this stock and now you have reached the end of the list of stocks.
Austin’s Weekly Stock Picks
Now you know how, but why do it yourself? Sign up for a weekly email service that will provide your list of filtered stocks automatically. Never screen IBD again, get your latest stock selections from the experts. Here’s how to sign up. Send an email with your contact information to [email protected]. You will receive pricing and ordering information.
Creating a Watch List
A Watch List is a group of stocks or sectors that have been evaluated with a screening or filtering system and meet the base criteria. You just went through the process of using your Fundamental Criteria Checklist to create a list of stocks that will become your Watch List.
Your Watch List does not need to be anything more than a simple list of stock symbols. You can also keep your Watch List online. For instance, Chapter 7 shows the “Chart Favorites” features of the web site, BigCharts.com. This web site is explained in more detail in Chapter 7 and in the Resources section.
You need to update your Watch List every week, because stocks live and die every 90 days with quarterly earnings. You want to make sure your Watch List stocks continue to meet the Fundamental Criteria on the checklist before you trade.
Technicals – Charts and Indicators
Now that you have a list of stocks to watch, you need to know what you are watching for. In this section, you will learn:
How to read a chart like a pro.
How to understand the price bar – OHLC.
How to use Technical Indicators for trend direction.
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Charting Basics
Charts are the main tool you use to understand the price movements of a stock over a given period of time. Although traders may use several different types of charts, we will be focusing on the Daily OHLC Chart, shown in Figure 3-4.
Figure 3-4: Daily OHLC Chart
This example shows a chart for the stock GOOG (Google), with a single price bar representing all of the stock trades that occurred on each day of trading over a period of three months. The chart is basically a graph of these daily price bars plotted over time with the stock price range on the right. This type of chart is called a Daily OHLC Chart because each price bar equals one day of trading and shows the Open, High, Low, and Close prices for that day (OHLC). Figure 3-5 shows how these price bars work.
Daily Price Bar – OHLC
Open
Close
Daily High
Daily Low
Positive or Bullish
Price Bar
Negative or Bearish
Price Bar
Open
Close
Daily High
Daily Low
Middle
Figure 3-5: The Anatomy of the Daily Price Bar – OHLC
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Looking at Figure 3-5, here is how to “read” the daily price bars.
OPEN – The small horizontal bar on the left side shows the opening price of the stock for that day.
CLOSE – The small horizontal bar on the right side shows the closing price of the stock for that day.
HIGH and LOW – The vertical bar in the center shows the range of the stock’s price movement for that day or its intra-day movement. The very top of the vertical bar is the high of the day or the highest price that the stock traded for that day. They very bottom of the vertical bar is the low of the day or the lowest price that the stock traded for that day.
Positive or Bullish Price Bar – The OPEN price of the stock is BELOW and the CLOSE price of the stock is ABOVE the middle of the vertical bar. This means the stock rose during the trading day and closed higher than the open price – upward momentum.
Negative or Bearish Price Bar – The OPEN price of the stock is ABOVE and the CLOSE price of the stock is BELOW the middle of the vertical bar. This means the stock fell during the trading day and closed lower than the open price – downward momentum.
If the OPEN and CLOSE are together (the prices are the same or nearly the same), this is called a “sword.” The OPEN and CLOSE prices become the “handle” of the sword. This type of price bar shows indecision. Although buyers and sellers are undecided, the position of the “handle” indicates a high probability of direction. A handle at the top indicates an upward direction and a handle at the bottom indicates a downward direction.
Besides the OPEN and CLOSE prices, the height of the vertical bar also helps us understand the price movement of the stock. This is called Price Action and is shown in Figure 3-6.
Figure 3-6: Price Action
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The bigger the vertical bar, the more the stock price has moved during the day or the more volatile the day’s trading is. The smaller the vertical bar, the less the stock price has moved during the day or the less volatile.
Now that you have mastered the Daily OHLC Chart, see if you can read the price bars in Figure 3-7 and determine what the stock will likely do next.
Figure 3-7: What Happens Next?
Write down what you think will happen next for each of the price bars in Figure 3-7.
Price Bar 1: _______________________________________________
Price Bar 2: _______________________________________________
Price Bar 3: _______________________________________________
Price Bar 4: _______________________________________________
Now check what you wrote with these answers.
Price Bar 1 – Open price is above the middle and Close price is below the middle. This price bar is negative or bearish and the stock is likely to go down.
Price Bar 2 – Open and Close prices are together. This price bar is called a sword. Because the handle is near the top, the stock is likely to go up.
Price Bar 3 – Open and Close prices are together. This price bar is called a sword. Because the handle is near the bottom, the stock is likely to go down.
Price Bar 4 – Open price is below the middle and Close price is above the middle. This price bar is positive or bullish and the stock is likely to go up. This is the type of price bar you are looking for – it is optimal for trading stocks up.
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Technical Indicators
An indicator provides information that calls attention to or helps predict something. Let’s look at a comparison of two types of indicators, one you should be familiar with and the other that works in much the same way.
Figure 3-8: Comparison of Indicators
If you see these indicators, what can you likely conclude or predict will happen with the Weather?
An increase in wind speed
Thunder and lightning
The temperature drops
Usually these weather indicators predict RAIN. To the dismay of many weather forecasters, these indicators are not always accurate or certain. Generally, though, they are useful indicators of the weather.
Technical indicators work in a similar way for predicting what will happen with the direction or trend of stocks. Here are the indicators shown in Figure 3-8 for stocks.
Moving Averages are up
Volume is up
Higher highs and higher lows, reflected in the movement of the price bars
MACD crossover is up
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Usually these technical indicators predict PROFIT. In the same way that weather indicators are not always certain or 100 percent accurate, technical indicators do not always guarantee profit. They are useful as part of your trading system for predicting trends or directions of stock movements.
Let’s look at a Daily OHLC Chart showing the technical indicators in Figure 3-9. In Chapter 7, The Trading Process – Putting it All Together, you will find step-by-step instructions for correctly setting up your own charts like the ones in this manual. Following the chart, you will find a detailed explanation of each of these technical indicators.
Figure 3-9: Daily OHLC Chart with Technical Indicators
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Moving Averages
A Moving Average or MA is the average of the stock’s closing price over a given period of time, specified by a certain number of days. Moving averages show trends in the movement of a stock and are an objective way to know when to buy and sell. The fewer number of days used, the more the moving average line moves up and down. For example, a 15-day moving average will move up and down more than a 200-day moving average. The 200-day moving average will appear much more gradual. Since stocks tend to follow their trends, using Moving Averages as an indicator helps you predict future direction or trend of the stock.
Here are the three Moving Averages you will use in your trading system.
1. 15-Day Moving Average – short-term, daily trends, faster
2. 50-Day Moving Average – intermediate-term, monthly trends, slower
3. 200-Day Moving Average – long-term, yearly trends, slowest
Figure 3-10 shows the Moving Averages on a 9-month daily OHLC chart, so you can see how they relate to one another and help predict the trend of the stock movement.
Figure 3-10: 15-Day, 50-Day, 200-Day Moving Averages
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Moving Average (MA) Crossover
A Moving Average or MA Crossover occurs when the faster 15-Day Moving Average “crosses over” the slower 50-Day Moving Average. The crossovers are strong signals for buying and selling – they indicate the likely direction of the stock.
Figure 3-11 shows a MSFT (Microsoft) daily OHLC chart with MAs and the MACD indicator below the pane with the price bars. The three MA crossovers shown on the chart indicate the direction of the stock. The first crossover indicates a downward direction as the 15-Day MA moves below the 50-Day MA. The second crossover indicates an upward direction as the 15-Day MA moves above the 50-Day MA. The third crossover indicates another downward direction as the 15-Day MA once again moves below the 50-Day MA.
Figure 3-11: Moving Average (MA) Crossovers
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Daily Highs and Lows
When a stock is trending in a particular direction, the daily highs and lows present a pattern. If the trend direction is up, then you will observe a pattern of higher highs and higher lows in the movement of the daily price bars. If the trend direction is down, then you will observe the opposite pattern or lower highs and lower lows in the movement of the daily price bars.
Figure 3-12 shows a pattern of higher highs and higher lows during the months of March and April that indicates the stock is in an uptrend. Remember you are looking for the closing prices of the stock, not the intra-day movement.
Figure 3-12: Higher Highs and Higher Lows as an Indicator
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MACD – Moving Average Convergent and Divergent
MACD is a momentum indicator that is the combination or measurement of two moving averages, a fast one and a slow one (15-Day MA and 50-Day MA, for example). The convergent and divergent angles or “crossovers” indicate a change in direction or trend. The crossovers occur when one moving average “crosses over” the other moving average. These are strong signals for buying and selling – they indicate strength of direction. The wider the divergence, the less chance the stock’s momentum will stop.
Figure 3-13 shows a MSFT (Microsoft) daily OHLC chart with MAs and the MACD indicator below the pane with the price bars. Look at how the three MACD crossovers shown in the chart help predict or indicate a change in the direction of the stock. The first crossover indicates a downward direction, the second crossover indicates an upward direction, and the third crossover indicates another downward direction.
Figure 3-13: MACD Crossovers
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Average Daily Volume
Average Daily Volume is the number of shares traded per day, averaged over a period of time. Volume indicates commitment by institutional investors and helps confirm stock direction. Increasing “buy” volume means money is coming into the stock.
When you set up your charts (see Chapter 7), you will add the Volume+ indicator to your chart view. This indicator shows daily volume bars, color coded for direction (up or down), and a 50-Day Moving Average. See Figure 3-14 for an example of what the volume indicator looks like on a chart.
Figure 3-14: Average Volume on Charts
In this example you will see that the daily volume bars are increasing in height and are closing above the 50-Day MA line. This indicates that the stock is likely moving in an upward direction. By looking at the price bars and the direction of the MAs, you can see that the price of the stock did move up and is confirmed by the increasing volume.
Another method of determining Average Volume is looking it up in the IBD tables, the same tables you use to screen or filter your stocks. Figure 3-15 shows where you can find the average daily volume of a stock in the IBD tables.
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Figure 3-15: Average Volume in IBD
In this example, the average daily volume is 2.6 million shares for the stock “RangeRes” (RRC). You find this number in the column labeled Vol 1000.
The average daily traded volume helps determine the number of shares to buy. Remember to select stocks that trade at least 1 million shares per day on average.
BUY CRITERION = 100 shares per 100,000 average daily volume or 1,000 shares per 1 million daily traded volume.
For example, RRC trades 2.6 million shares daily (on average). The maximum number of RRC shares you would buy is 2,000. Using this maximum number ensures you can easily liquidate your shares when you want to sell and close your trade.
Stocks that trade less than 1 million shares per day on average do not have enough liquidity and the institutional investors/fund managers generally do not move money into these stocks. In other words, you will have a difficult time getting out of your stock trade when you want to sell if the stock does not trade enough shares.
Support and Resistance
Support and Resistance are levels where the buying and selling of stocks are equal. These are powerful indicators to watch, because stocks will “break out” one way or the other at their Support or Resistance levels.
Support is the “floor” level, a price where the stock has reversed its DOWNWARD trend. The price of the stock goes down and hits Support and will not go any lower.
Resistance is the “ceiling” level, a price where the stock has reversed its UPWARD trend. The price of the stock goes up and hits Resistance and will not go any higher.
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Figure 3-16 shows how the stock price moves in a channel between Support and Resistance and tends to bounce off these levels. When the stock price moves in a sideways direction, this is known as Consolidation. The stock is trying to build up the energy to break out of its channel.
Figure 3-16: Support and Resistance
Make sure you are looking at the closing prices of the stock and not the intra-day movement to determine Support and Resistance levels. The intra-day movement of the stock will often break through Support or Resistance.
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Chapter 3 Review
Find Fundamental data in the IBD (Investor’s Business Daily).
Filter or screen stocks in the IBD with your checklist of 6 Fundamental Criteria.
Create a Watch List of the stocks that meet the Fundamental Criteria.
Understand how to read the daily price bars on an OHLC chart.
Use Technical Indicators to predict the direction or trend of stocks.
Follow the Moving Averages to help predict stock trends – 15-Day, 50-Day, 200-Day.
Observe the pattern of daily Highs and Lows to determine the trend.
Use MA and MACD crossovers as strong buying and selling signals.
Pay attention to the Average Daily Volume of a stock as a buy criterion (1,000 shares per 1 million) and as an indicator of money moving into or out of a stock.
Look for “break outs” through Support and Resistance levels.
Chapter Notes
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Selecting a Broker and Trading
Brokers are like bank accounts, they both deal with money.
o trade stocks, you need a broker. A broker is a licensed person or company (brokerage firm) who places trades for buyers and sellers and charges a commission.
Here are the three types of brokers you can choose from.
1. Full-service brokers – In addition to executing trades for clients, these firms also provide research and advice and typically are the most expensive type of brokers.
2. Discount direct brokers – These firms execute buy and sell orders at lower or “discount” commissions and offer minimal services.
3. Online brokers – Brokerage firms which provide trading services to clients over the internet. An online broker may or may not be part of a traditional full-service or discount brokerage.
Regardless of the type of broker you choose, you need to make sure the broker meets certain criteria. Here are the critical criteria your broker must meet before you place any trades.
Paper trading – a virtual trading account, this is a service that allows you to practice trading with play money and perfect your trading system. You can set up your practice or virtual account with any amount of money and then make sure you are comfortable with the mechanics of the broker’s trading process before you use real money.
Round-trip commission fees – $15 to $20 is good rule of thumb for round-trip fees (commission for getting in and getting out of the trade). Make sure you know the fees for both parts of the trade, because some brokers charge different commission for getting in and getting out (buy and sell).
Alerts – notification of a market event like a stock reaching a target price. Brokers may offer different types of alerts – email or pager, for example.
Trailing Stop Loss – this is NOT a stop loss order. Make sure your broker offers this type of order.
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Other things to consider when selecting a broker are the following.
Charges for phone orders to execute trades (not consulting) – if you need to place a trade by phone, make sure you understand the fees you will pay.
Inactive fees or variable fees – some brokers charge clients fees during periods of inactivity or vary their fees based on certain criteria. Paying fees reduces the profit you make on your trading, so be careful to understand what fees your broker charges. All fees affect your bottom line.
Make sure you understand your trading needs, then do your research. You will find a number of helpful web sites to compare brokers, especially online brokers. Here is a web site that provides comparison data, ratings, and reviews for the top 10 rated online brokers – online-stock-trading-review.toptenreviews.com.
Figure 4-1: Comparing Online Brokers at Top 10 Reviews
Let’s take a look at an example of why it is so important to understand broker fees. This example comes from a former student, Joseph, who placed a trade with H&R Block. Reviewing his printed confirmation in Figure 4-2, you can see the impact of the fees charges for his stock trade.
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Figure 4-2: An Expensive Trade
In this case, Joseph placed a phone order to buy 800 shares of a stock and paid the broker nearly $400 in commission and handling fees! These fees did not include the commission or handling for selling the stock – only to buy it.
Broker fees come out of your profit.
Always check the fees BEFORE selecting a broker.
Broker Errors
Brokers deal with money, just like your bank does. Sometimes your bank makes a mistake that needs to be corrected and it’s not fun or easy to fix the error. Brokers, too, make mistakes that need to be corrected. You can follow a simple process to resolve errors made by your broker.
1. Always get a receipt for your transaction.
2. Call your broker to discuss the error.
3. Contact NASD (National Association of Security Dealers) if you cannot get the problem resolved by working directly with your broker.
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Every time you place a trade, you receive an order confirmation. If you trade directly with a broker by phone, make sure you review your order details and write down the order confirmation that he or she gives you. If you trade with an online broker, you receive an online order confirmation that looks something like Figure 4-3. Make sure you print the order confirmation screen or save your order confirmation details, in case your broker makes an error. The order confirmation is the receipt or proof of the trade you placed that you can use to correct any broker errors that may occur. Broker errors are not common, but you need accurate records to validate activity in your account just like you do with the bank.
Figure 4-3: Online Order Confirmation
Trading Terminology
When you work with brokers or online brokerage accounts, you need to use the language of trading. Understanding key terminology is critical to trading success.
Using broker or trading terminology, the two basic types of stock transactions are:
Buy – Long To purchase a stock or open a position you expect to go up.
Sell – Short To open a position or enter a trade that you expect to go down. In this transaction, you are actually borrowing the stock from the broker and do not own it. When you close this position, you buy back the stock and return it to the broker from whom you borrowed it.
How stock is bought and sold.
Ask – this is the price the seller wants for the stock. The seller is asking this much for it.
Bid – this is the highest price the buyer is willing to pay for the stock.
Figure 4-4 shows a detailed online quote for AAPL (Apple Computers) with the Bid Price and the Ask Price. In this case, the Bid Price is 10 cents different than the Ask Price – this is called the spread.
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Figure 4-4: AAPL Detailed Quote Showing Bid Price and Ask Price
Market orders and Limit orders are the two types of orders you need to understand to successfully trade stocks.
Market Order – Whatever the price is, give it to me.
This is a buy or sell order that is executed immediately at current “market” prices. As long as there are willing sellers and buyers, a market order will be filled. A market order is the simplest of the order types. Once the order is placed you have no control over the price at which the transaction is executed. The broker is merely supposed to find the best price available at that time. You may pay a few cents more with a Market order, but your order will be executed or filled.
Limit Order – I am only willing to pay this much for it.
This is an order to buy at “no more than” or sell at “no less than” a specific price. This gives you some control over the price at which the trade is executed, but may prevent the order from being executed or filled. In other words, you may miss the trade.
Figure 4-5 shows an online stock order form and points out where to select a Market Order and how to enter a Limit Order for a trade.
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Figure 4-5: Entering Market or Limit Orders on an Online Stock Order Form
Alerts
Alerts are critical to your success. If your broker does not offer alerts, find another broker.
Alerts are simply a system of setting criteria (either mechanically or mentally) that notifies or alerts you when the criteria have been met. For example, set an alert to notify you when a stock reaches a certain price or volume. Make sure the alerts offered by your broker are flexible enough for you to select the criteria you want to use.
When you set your alerts, you can choose the notification method that works best for your situation. Generally, you will not be charged a fee for email notifications. If you use a cell phone to receive your notifications, make sure you check with your broker to understand the fees for this service.
Set alerts for the stocks on your Watch List, so you will be notified when the stock reaches a certain price, for example. Alerts free your time for other pursuits, because you do not have to watch your stocks the whole day during market hours and will still be notified for important events.
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Trailing Stop Loss – Protecting Your Profit
ALWAYS use a Trailing Stop Loss NOT a Stop Loss. A Trailing Stop Loss is an order entered with a stop parameter (a percentage or dollar amount) that creates a moving or “trailing” activation price. If the stock price rises, the trailing stop loss price rises proportionately, but if the stock price falls, the trailing stop loss price does not change. This allows you to set a limit on the maximum possible loss without setting a limit on the maximum possible gain. This also keeps Fear and Greed out of your trade because you do not need to pay attention to your trade on an ongoing basis.
So what does that really mean? Here is an example of the difference between using a Stop Loss and a Trailing Stop Loss to illustrate why a Stop Loss will kill your profit and a Trailing Stop Loss will protect profit.
Stop Loss: You buy a stock at $10. The price goes to $11 and you set a STOP LOSS at $11 to keep that $1.00 profit. The price goes to $12, $13, $14, $15, and your Stop Loss is still at $11. Then the stock price takes a dive and goes back to $10.
Stop Loss Result: Your profit = $1.00, but you did not get the additional $4.00 that the stock went up.
Trailing Stop Loss: You buy a stock at $10. The price goes to $11 and you set a $1.00 TRAILING STOP LOSS. The price goes to $12 and your Trailing Stop Loss or TS is now at $11. The prices goes to $13, your TS is now at $12. The price goes to $14, your TS is now at $13. The price goes to $15, your TS is now at $14. Then the stock price takes a dive back to $10.
Trailing Stop Loss Result: Because the Trailing Stop Loss followed the price up, your profit = $4.00. Obviously, this is a much more profitable result than using a Stop Loss.
Find the stock’s average daily percent change. You want to determine how much the stock moves every day on average to set an appropriate Trailing Stop Loss. This way, you can stay in the trade during the up and down swings of the stock’s normal price movement during the day and still protect your profit if the stock moves below this daily range. Figure 4-6 show how to locate a stock’s ATR or Average Trading Range. In the detailed quote, you will find the Change – the dollar amount the stock moved and the Percent Change – this is the ATR you are looking for.
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Figure 4-6: ATR or Average Trading Range for AAPL (Apple Computers)
Set the Trailing Stop Loss to twice the ATR percentage. After you find the ATR percentage, you double it. Here is an example of how to calculate the percentage for your Trailing Stop Loss, based on the ATR for AAPL (Apple Computers) shown in Figure 4-6.
AAPL average daily % change = 1.5% Set Trailing Stop Loss to 3%, which is 1.5% times 2
See Figure 4-7 for an illustration of how to calculate the percentage for your Trailing Stop Loss.
Figure 4-7: Calculating the Percent for a Trailing Stop Loss
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Use a Mechanical (recommended) or Mental Trailing Stop Loss
A mechanical Trailing Stop Loss is one that you actually enter as a trade order with your broker or brokerage firm. This is recommended so you do not have to watch the trade and make the appropriate calculations during the day AND to keep Fear and Greed out of your trades. Figure 4-8 shows the mechanics of how to enter a Trailing Stop Loss Order with an online trading account.
Figure 4-8: Trailing Stop Loss Mechanics in an Online Trading Account
Trailing Stop Loss orders only work during normal market hours between 9:30 AM and 4:00 PM Eastern.
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Chapter 4 Review
Determine your trading needs, do your research, and select a broker.
Choose a broker that offers paper trading, alerts, and Trailing Stop Loss orders.
Make sure you know the broker’s fees BEFORE you open an account – broker fees come out of your profit.
Print or save the order confirmation for each trade – you need accurate records in case of broker errors.
Learn key trading terminology – Long & Short, Ask & Bid, Market vs. Limit Orders.
Set alerts for stocks on your Watch List. Check with your broker so you know about any fees for this service.
ALWAYS use a Trailing Stop Loss to protect your profit.
Chapter Notes
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Using Checklists
ALWAYS use a Checklist, do NOT crash and burn.
ilots use Checklists when they fly to prevent them from making mistakes that would cause them to crash and burn. Successful traders use Checklists when they trade for the same reason.
Stocks Going UP – Buy Stocks Long
When stocks are going up, moving in an upward direction or trend, you enter a trade LONG. To prevent critical trading errors, you use checklists – one for entering the trade “Buy” and one for exiting the trade “Sell.” Here are the BUY and SELL Checklists for stocks going up or Long.
BUY Long and SELL Long Checklists
For your convenience, you will also find all the Checklists from this chapter in the Resources section in the back of this manual.
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BUY Long Checklist
Here is what you check before entering a trade for stocks that are going up with an explanation of each criterion.
Market Trend
You have reviewed the stock chart and determined that the trend or direction of the stock is UP.
Closed above 15 MA
You have reviewed the stock chart and see that the stock closed above its 15-Day Moving Average (MA).
MA Crossover
The Moving Averages or MA on the stock chart shows a crossover in the upward direction. The faster or 15-Day Moving Average has crossed over the slower or 50-Day Moving Average, so now the 15-Day MA is above the 50-Day MA. This is an indication that the stock is likely to go up.
MACD Crossover
The MACD technical indicator on the stock chart shows a crossover in the upward direction. This is a confirming indicator which shows the strength of the stock’s movement. The MACD crossover up is an important indicator to enter the trade. The more indicators going up, the higher the probability that the stock will go up.
Volume Trend (30 Days)
Over the past 30 days, the volume bars have been increasing in size and are above the 50-Day Moving Average line on the stock chart. This is an indicator which helps confirm the direction or trend of a stock, but is not required to enter a trade.
Check Earnings Announcement Date
Since stocks may become volatile on the day that earnings are announced, you do not want to enter a trade on the company’s quarterly earnings announcement dates. Check the earnings calendar at http://biz.yahoo.com/research/earncal/today.html for the stock you intend to trade.
Don’t Buy before 10:00 AM (Eastern)
The first 30 minutes or so of trading is generally volatile and known as amateur hour. Wait until after 10 AM (Eastern) for the novice traders and big institutional program trading before entering a trade. Be sure that your stock still meets the entry criteria after 10 AM before you buy (or sell) it.
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Set Your Trailing Stop Loss
Once you have entered your BUY trade, always set your Trailing Stop Loss to protect your profit. Calculate your Trailing Stop Loss at twice the average daily trading range (ATR) percentage.
Set your “Sell” Alerts
Set an alert to notify you in the event you meet the criteria for exiting your trade – selling the stock. See the “SELL Long Checklist” to review the criteria.
Figure 5-1 is a chart of AAPL (Apple Computers) over a six-month period. The call-outs show four of the BUY Long Checklist criteria for entering a trade. Besides market trend, these are the checklist criteria you are looking for on a stock chart.
Figure 5-1: Stock Chart Checklist Criteria for Buying Long Trades
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SELL Long Checklist
Here is what you check to exit a trade and take profit for stocks going up with an explanation of each criterion.
Market Trend
You have reviewed the stock chart and determined that the trend or direction of the stock is now going DOWN.
Closed below 15 MA
You have reviewed the stock chart and see that the stock closed below its 15-Day Moving Average (MA).
MA Crossover
The Moving Averages or MA on the stock chart shows a crossover in the downward direction. The faster or 15-Day Moving Average has crossed over the slower or 50-Day Moving Average, so now the 15-Day MA is below the 50-Day MA. This is an indication that the stock is likely to go down.
MACD Crossover
The MACD technical indicator on the stock chart shows a crossover in the downward direction. This is a confirming indicator which shows a change in direction of the stock’s movement.
Volume Trend (30 Days)
Over the past 30 days, the volume bars have been decreasing in size and are below the 50-Day Moving Average line on the stock chart. This is an indicator which helps confirm the direction or trend of a stock. To exit a long trade, you may not have a 30-Day trend in the volume, only a recent decline or drop in the volume bars.
Don’t Sell before 10:00 AM (Eastern)
The first 30 minutes or so of trading is generally volatile and known as amateur hour. Wait until after 10 AM (Eastern) for the novice traders and big institutional program trading before exiting your trade.
Set your “Buy” Alerts
Once you sell your stock and take profit (exit your Long trade), set an alert for the next long trade. Use the “BUY Long Checklist” to set the proper criteria for your alert.
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Figure 5-2 is a chart of AAPL (Apple Computers) over a six-month period. The call-outs show four of the SELL Long Checklist criteria for exiting a trade. Besides market trend, these are the checklist criteria you are looking for on a stock chart.
Figure 5-2: Stock Chart Checklist Criteria for Selling Long Trades
Stocks Going DOWN – Sell Stocks Short
When stocks are going down, moving in a downward direction or trend, you enter a trade SHORT. In a short trade, you do not own the stock – you borrow the shares from your broker or brokerage firm when you sell stocks short. When you exit or close the short trade, you buy back the stock and return the shares to your broker or brokerage firm. This happens automatically when you place your order to close your short trade, so you do not have any additional tasks to do.
To prevent critical trading errors, you use checklists – one for entering the trade “Sell” and one for exiting the trade “Buy.” In essence, you do the reverse of buying long. Here are the SELL and BUY Checklists for stocks going down or Short.
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SELL Short and BUY Short Checklists
For your convenience, you will also find all the Checklists from this chapter in the Resources section in the back of this manual.
SELL Short Checklist
Here is what you check before entering a trade for stocks that are going down with an explanation of each criterion.
Market Trend
You have reviewed the stock chart and determined that the trend or direction of the stock is going DOWN.
Closed below 15 MA
You have reviewed the stock chart and see that the stock closed below its 15-Day Moving Average (MA).
MA Crossover
The Moving Averages or MA on the stock chart shows a crossover in the downward direction. The faster or 15-Day Moving Average has crossed over the slower or 50-Day Moving Average, so now the 15-Day MA is below the 50-Day MA. This is an indication that the stock is likely to go down.
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MACD Crossover
The MACD technical indicator on the stock chart shows a crossover in the downward direction. This is a confirming indicator which shows the strength of the stock’s movement and is important signal to enter the trade. The more indicators going down, the higher the probability that the stock will go down.
Volume Trend (30 Days)
Over the past 30 days, the volume bars have been decreasing in size and are below the 50-Day Moving Average line on the stock chart. This is an indicator which helps confirm the direction or trend of a stock, but is not required to enter a trade.
Check Earnings Announcement Date
Since stocks may become volatile on the day that earnings are announced, you do not want to enter a trade on the company’s quarterly earnings announcement dates. Check the earnings calendar at http://biz.yahoo.com/research/earncal/today.html for the stock you intend to trade.
Don’t Sell before 10:00 AM (Eastern)
The first 30 minutes or so of trading is generally volatile and known as amateur hour. Wait until after 10 AM (Eastern) for the novice traders and big institutional program trading before entering a trade. Be sure that your stock still meets the entry criteria after 10 AM before you sell (or buy) it.
Set Your Trailing Stop Loss
Once you have entered your SELL trade, always set your Trailing Stop Loss to protect your profit. Calculate your Trailing Stop Loss at twice the average daily trading range (ATR) percentage.
Set your “Buy” Alerts
Set an alert to notify you in the event you meet the criteria for exiting the trade – buying back the stock. See the “BUY Short Checklist” to review the criteria.
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Figure 5-3 is a chart of HOV (Hovnanian) over a six-month period. The call-outs show four of the SELL Short Checklist criteria for entering a trade. Besides market trend, these are the checklist criteria you are looking for on a stock chart.
Figure 5-3: Stock Chart Checklist Criteria for Selling Short Trades
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BUY Short Checklist
Here is what you check to exit a trade and take profit for stocks going down with an explanation of each criterion. Remember when you exit a short trade, you are buying back the stock (sometimes called “buy to cover”).
Market Trend
You have reviewed the stock chart and determined that the trend or direction of the stock is now going UP.
Closed above 15 MA
You have reviewed the stock chart and see that the stock closed above its 15-Day Moving Average (MA).
MA Crossover
The Moving Averages or MA on the stock chart shows a crossover in the upward direction. The faster or 15-Day Moving Average has crossed over the slower or 50-Day Moving Average, so now the 15-Day MA is above the 50-Day MA. This is an indication that the stock is likely to go up.
MACD Crossover
The MACD technical indicator on the stock chart shows a crossover in the upward direction. This is a confirming indicator which shows a change in direction of the stock’s movement.
Volume Trend (30 Days)
Over the past 30 days, the volume bars have been increasing in size and are above the 50-Day Moving Average line on the stock chart. This is an indicator which helps confirm the direction or trend of a stock. To exit a short trade, you may not have a 30-Day trend in the volume, only a recent incline or rise in the volume bars.
Don’t Buy before 10:00 AM (Eastern)
The first 30 minutes or so of trading is generally volatile and known as amateur hour. Wait until after 10 AM (Eastern) for the novice traders and big institutional program trading before closing your trade.
Set your “Sell” Alerts
Once you buy back your stock and take profit (exit your Short trade), set an alert for the next short trade. Use the “SELL Short Checklist” to set the proper criteria for your alert.
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Figure 5-4 is a chart of HOV (Hovnanian) over a six-month period. The call-outs show four of the BUY Short Checklist criteria for exiting a trade. Besides market trend, these are the checklist criteria you are looking for on a stock chart.
Figure 5-4: Stock Chart Checklist Criteria for Buying Short Trades
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Chapter 5 Review
ALWAYS use a Checklist to prevent critical mistakes in your trading.
For stocks going up , follow the criteria on the Long Checklists.
o The BUY Long is for entering the trade.
o The SELL Long is for exiting the trade.
For stocks going down , follow the criteria on the Short Checklists.
o The SELL Short is for entering the trade.
o The BUY Short is for exiting the trade.
Chapter Notes
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Money Management
Trading Motto: Always walk away from a trade with profit. NEVER let a green trade turn red.
oney Management means gaining greater control over the risks to maximize the returns. Since trading involves risk, let’s look at practical ways to minimize losses and to maximize gains.
Warren Buffet’s Money Management Rules:
1. Don’t lose money.
2. Follow Rule Number 1.
You will not win on every trade, but you MUST adhere to the trading motto – ALWAYS walk away from a trade with profit. NEVER let a green trade turn red. This means that when your trade is profitable, you make sure to capture profit and not take a loss. Following the trading motto is critical to your trading success.
Quality NOT Quantity of Your Trades
If you focus on the quality of your trades, you will maximize your profit. Trading is not a contest to see how many trades you can execute in a month. Remember this trading proverb.
Trading Proverb – Person who chases many rabbits goes hungry.
Translation: People who feel they need to control, own, or watch hundreds of stocks (rabbits) will not be able to focus and make profitable trades (go hungry).
You can take one or two stocks and make money by watching for good entries, getting in and taking profit when the trade quits or reaches the sell criteria.
Do not suffer from trading withdrawal. If the stocks on your Watch List do not meet the entry criteria for trading, do not trade them. You do not want to ignore or lower the criteria to make a trade. You need to focus on trades with a high probability of being successful. When in doubt
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about what the market or your stocks are doing, go to cash in your trading account and stop trading.
Trades are like city buses…
Another one will be along in 15 minutes. This means you WAIT for the trade to come to you.
How much do I buy?
This trading system is 90 percent objective and 10 percent subjective. Deciding how much to trade is subjective and up to you to decide. Here are the recommended criteria you can use to determine how to manage your trading fund.
No more than 20 percent of your “Trading Fund” on the initial trade entry.
For example, if your trading fund (or account) is $25,000, you could trade up to $5,000 or 20 percent when you first enter your trade. Make sure, though, that you follow the buy criterion rules – 1,000 shares per 1 million traded. This is especially important for larger trading accounts.
After 3 to 4 days above the 15-Day Moving Average, buy up to 50 percent.
Watch your trade – if the stock price stays above the 15-Day MA, the probability is high that the price will continue to move up. At this point, you can buy more shares – up to 50 percent – of your trading account. Do not exceed the buy criterion rules – 1,000 shares per million traded, so you can easily liquidate or sell the shares when you are ready to close your trade.
Be consistent in the amount you trade.
Trade the same number of shares or dollar amount and increase the shares/amount over time as you build your trading confidence and skill. Here is an example to explain why this is important.
Inconsistent Trading: You decide to trade 100 shares of a stock. The trade goes well and you take $300 profit. You think you’ve got it, so the next trade you decide to trade 500 shares. This trade stops out for a loss of $500. Now your account is down $200 for the two trades ($300 - $500). You did not like that result, so you decide to be cautious and go back to trading 100 shares. This trade goes well and you take $300 profit again. You are ahead $100 in your account now and feeling pretty bold. So you decide to trade 1,000 shares. This time you only take a 50 cent loss, because you are afraid to lose again. Because you traded 1,000 shares, this is still a $500 loss. Now your account is down $400 with 2 positive and 2 negative trades. You can see why this is not a way to maximize profits and minimize losses.
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Consistent Trading: You decide to trade 100 shares of a stock. The trade goes well and you take $300 profit. You think you’ve got it, but you remain consistent in your trading so the next trade you decide to trade 100 shares again. This trade stops out for a loss of $100. Now your account is up $200 for the two trades ($300 - $100). You did not like that trade, but continue to trade 100 shares. This trade goes well and you take $300 profit again. You are ahead $500 in your account now. You decide to trade 100 shares like before. This time you only take a $50 loss. Now your account is up $450 with the same 2 positive and 2 negative trades from the first example. You can see why consistent trading maximizes profits and minimizes losses.
Stick with stocks that are $10.00 per share or higher.
Stocks with prices below $10.00 per share reflect the fact that the company cannot make money. Avoid trading these stocks.
Red Zone Rules
The trading Red Zone is based on the familiar football Red Zone. When a football teams move down the field and gets between the 20-yard line and the goal line, they need to execute critical plays to make a touchdown (get points on the scoreboard). The purpose of the Red Zone and its Rules for trading is to get you into the end zone and get profit into your account. The Red Zone Rules enforce the trading motto – always take profit.
Here are the basic rules of playing in the trading Red Zone.
Enter trade and set Trailing Stop Loss.
Watch initial move of the stock.
If profit pulls back 50 percent, close the trade and take profit.
Never let a green trade turn red – always take profit.
Buy in again if stock still meets criteria.
Red Zone Rules Example
Now that you have reviewed the Red Zone Rules, here is an example of how the Red Zone Rules work. Figure 6-1 is a visual illustration of this example.
You select a stock that meets the criteria for entering a trade. You determined that the appropriate Trailing Stop Loss for this $100 stock is 3 percent. You enter the trade at $100 and then immediately set your Trailing Stop Loss at 3 percent. This means that if the stock goes straight down, your maximum loss is $3.00 per share, because your Trailing Stop Loss will trigger when the stock price gets to $97.00.
In this example, though, the stock price goes up. Between $100 and $103, you are in the Red Zone and watching the initial move to take profit if the stock price turns around and goes down.
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The stock price goes to $102, then starts to go down. When the stock price returns to $101, you close the trade and take a $1.00 per share or 50 percent profit. Here is the simple calculation: $102 - $100 (entry price) = $2.00 x .50 = $1.00 (50 percent profit).
Figure 6-1: Red Zone Rules Example
Once the stock price has reached $103, your Trailing Stop Loss will protect your profit and you will not need to watch the trade so closely. If you take profit in the Red Zone, you can always re-enter the trade if the stock still meets the entry criteria.
The difference between amateurs and professionals – amateurs lose money and professionals make money. The Red Zone Rules help you become a professional.
Strategies for Using Margin
Using Margin is a powerful way to increase or leverage your buying power if used correctly. What is Margin?
Margin – your broker loans you money for shares. Based on a number of factors, some brokers may lend up to four times your trading fund as your buying power.
Let’s say you have a $25,000 trading account. You buy 1,000 shares of a stock at $25 per share (maximum number of shares for your account). The stock goes up $1.00 per share – you make a profit of $1,000. Using the same account with a 4-to-1 Margin, you have $100,000 buying power. You can buy 4,000 shares of that same $25 stock. The stock goes up $1.00 per share – you make a profit of $4,000. This is the power of using Margin.
Margin Call – your Broker wants the money back. If you are using Margin and your trade is going negative, you may get a Margin Call. In this case, you can simply close the trade.
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Remember it’s okay to give up some profit, but do not give up your principal. Always play with their money.
Wrong Way to Use Margin
Using Margin on your initial trade entry is the WRONG WAY to use Margin. For example, your broker authorizes 4-to-1 buying power in your $25,000 account (Margin). This means you have up to $100,000 to trade. You decide to enter a trade using your entire 4-to-1 Margin or $100,000. If the trade goes against you, your losses will be four times worse. Your trade will go negative much faster.
Correct Way to Use Margin
Here is an example of the CORRECT strategy for using Margin. Figure 6-2 illustrates this strategy for safely using Margin in your trading account.
Always use caution when trading with Margin.
Get some trading experience BEFORE you decide to use the following Margin strategy.
You have a $25,000 trading account with 2-to-1 Margin or $50,000 in buying power (this is typical for most accounts). You buy 1,000 shares of a $20 stock. When the stock price moves up equal to the amount of your margin (in this case 2-to-1 Margin or $2.00) AND continues to meet your trading criteria, you buy another 1,000 shares with your Margin.
If the stock price continues to go up, you maximize your profits by using Margin to increase the number of shares you are trading (in this case – double). If the stock price goes down, you have a buffer that you created by waiting to use your Margin and you can close the trade neutral (minus commissions or fees).
Figure 6-2: Example of the Strategy for Using Margin
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Now let’s look at how this strategy works by using a stock chart to show when to enter the initial trade and when to buy more shares on Margin.
Figure 6-3: Using Margin to Increase Profits
Lock in Profit – Buy Again with More Leverage
The real power of trading with margin is to lock in incremental profits and increase your margin. Here is how this works. You enter a trade and wait for the stock price to go up before using margin to buy more shares. After the stock price goes up 20 percent or so, close the trade and lock in the profit. Now you have increased your buying power with margin in your account.
For example, you buy 1,000 shares of a stock at $100 per share. You have a 2-to-1 Margin, so when the stock goes to $102 you buy another 1,000 shares with your Margin. When the stock price reaches $120, which is a 20 percent profit, you close the trade and lock in your $38,000 profit ($20 x 1,000 initial shares + $18 x 1,000 margin shares). Not only do you have $38,000 more in your account, you have an additional $38,000 more in buying power with your increased Margin.
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Figure 6-4: Taking Profit – More Leverage
Tricks of the Trade
These “tricks” are observations about the market and stocks. Understanding and applying them will improve your trading ability as a successful trader.
Sell Before Earnings
You have already learned the importance of checking Earnings Announcement Dates before entering trades. For the very same reasons, you need to know the company Earnings Announcements Dates for the stocks you are trading. Be aware of any upcoming earnings announcement while you are in a trade.
Here are two examples of what can happen to a stock following its Earnings Announcement. Look at the chart and see why you need to sell the stock or close your trade and take profit BEFORE Earnings. Whether the Earnings are good or bad does not matter, you do not risk your profit by staying in the trade.
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Figure 6-5: Sell BEFORE Earnings – CROX (Crocs, Inc.)
Figure 6-6: Sell BEFORE Earnings – AMZN (Amazon)
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MA Crossover Bow-Tie
The MA Crossover Bow-Tie occurs when the moving averages come together at an intersection and then cross. The intersection or “crossover” looks like the knot of a bow-tie, hence its name. Imaginary vertical lines between the moving averages before and after the knot create the edges of the bow-tie.
About 80 percent of the time, the stock price will move about the same distance after the knot as it moved before the knot – in the OPPOSITE direction. The wider the divergence before the knot or crossover, the more powerful the movement after the knot in the opposite direction.
Here is a GOOG stock chart that shows two occurrences of MA crossover bow-ties. Look for the divergence of the moving averages before the knot or crossover and the movement afterward.
Figure 6-7: Moving Average Crossover Bow-Tie
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MAPB – Moving Average Pull Back
When a stock’s price bars move away from the moving averages, they will always “pull back” or return to the moving averages. This is called MAPB or Moving Average Pull Back. You can use MAPB as a buying or selling signal.
Here is GOOG stock chart that shows two occurrences of MAPB. Look at what happens to the stock price when it moves away from the moving averages.
Figure 6-8: MAPB – Moving Average Pull Back
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How the Media Can Affect a Stock
The Media impacts a stock’s price by contributing to the emotions of Fear and Greed. In June/July of 2002, Martha Stewart made headlines and the Media went crazy with the story about the insider trading scandal that tarnished her reputation. In this case, Fear and Greed took over.
Here is what happened to Martha’s company stock following this media attention. Figure 6-9 shows the importance of using criteria to keep emotions out of trade criteria. Look at the chart to determine when this stock met the sell criteria.
Figure 6-9: The Media and Martha’s Stock
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Chapter 6 Review
Focus on the Quality NOT the Quantity of your trades.
Do not suffer from trading withdrawal, wait for trades to come to you.
Be consistent in the amount you trade.
Religiously follow the Red Zone Rules to get you into the trading end zone with profit in your account.
Correctly use Margin to increase your leverage and maximize your profits.
Lock in profit – buy again with more leverage.
Sell before Earnings.
Improve your skills with “tricks of the trade” – MA Crossover Bow-ties and MAPB.
Understand how Media can affect stocks.
Chapter Notes
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The Trading Process – Putting
it All Together
What to do – step by step.
ow that you have learned all the principles of your trading system, let’s put it all together in a step-by-step process you can easily follow.
Here are the steps in order, followed by more details.
Step 1. Select Broker and Open Account.
Step 2. Set up BigCharts.
Step 3. Filter IBD Stocks and Create Watch List.
Step 4. Review Stock Charts/Indicators and Select Stock to Trade.
Step 5. Check Earnings.
Step 6. Decide on Trade Entry.
Step 7. Enter Trade and Set Trailing Stop Loss.
Step 8. Exit Trade with Profit.
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Step 1 – Select Broker and Open Account
Determine your requirements for Broker services.
Based on your personal situation, review Broker options and make a selection. (Refer to the web sites in the Resources section for more information about Brokers.)
Complete and submit an online application.
Determine the amount of money you can afford for your trading fund. Follow your Broker’s instructions for transferring or sending the money to fund your trading account.
Make sure you have your Broker’s phone number on speed dial or near your computer while you are trading, in case you experience any problems like a power failure or Internet disruption.
Figure 7-1: Sample Online Account Application
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Step 2 – Set Up BigCharts
Go to BigCharts.com. When the web page displays, click the link “GO DIRECTLY TO BIGCHARTS.COM to bypass the advertisement.
Figure 7-2: Bypass BigCharts Advertisement Page
At the top of the BigCharts home page, enter the symbol DJIA (Dow Jones Industrial Average) in the box.
Click on the “Advanced Chart” Button (the middle of the three chart buttons) to set up the charts you will use in your trading system.
Figure 7-3: Set Up Advanced Charts
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On the Advanced Chart page, change the chart settings with the menu on the left.
The default time frame is set to 1 year. Click the arrow for the pull-down menu and select 6 months for your new time frame.
Figure 7-4: Change Time Frame to 6 Months
Now you need to set up your technical indicators. Click on the “indicators” box in the menu on the left to view the list of indicators you can add.
Figure 7-5: Add Technical Indicators
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The first technical indicators you set up are the Moving Averages. Click the arrow for the pull-down menu and select SMA (2-Line). This gives you 2 Moving Average Lines (SMA means Simple Moving Average).
To set up the 15-Day and 50-Day Moving Averages for your charts, type the numbers 50 and 15 in the box, making sure to separate them with a COMMA and no spaces.
Figure 7-6: Setting Up the 15-Day and 50-Day Moving Averages
In the menu below the Moving Averages, you select the remaining two technical indicators for your charts.
For the Lower Indicator 1, click the arrow for the pull-down menu and select MACD (near the top of the list).
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Figure 7-7: Adding the MACD Technical Indicator
For the Lower Indicator 2, click the arrow for the pull-down menu and select Volume+ (near the top of the list). Make sure you select the Volume indicator with the “+” to get the volume bars and the volume moving average line.
Figure 7-8: Adding the Volume+ Technical Indicator
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Click the “chart style” box in the menu on the left to view chart options.
To set the Price Display option, click the arrow for the pull-down menu and select OHLC. This will display the Open High Low Close (OHLC) price bars on the chart.
To set the Chart Size option, click the arrow for the pull-down menu and select Large. This is only a recommendation for easier viewing. You can select any size that works best for your display or monitor.
Once you have made your BigCharts selections, click the “Draw Chart” button at the top of the menu on the left. Now you can see the chart and indicators you have selected.
Before you save or store the chart settings, check your chart and indicator selections with Figure 7-9.
Figure 7-9: Review of BigChart Set-up Selections
To save your chart selections for future use, click the “Store Chart Settings” link at the bottom of the menu on the left.
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Figure 7-10: Store Chart Settings
Before your chart settings are stored, you will see a pop-window to confirm your choices as your default setting. Click the “OK” button.
Figure 7-11: Store Settings as Default Pop-Up Window
Once your chart settings are saved, click the “OK” button to return to your chart.
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Figure 7-12: Return to Chart Pop-up Window
Step 3 – Filter IBD Stocks and Create Watch List
Using your Fundamental Criteria Checklist, review the stocks in the IBD Tables and make a list of the stocks that meet at least criteria 1 through 3 and 6.
Figure 7-13: Filter Stocks with IBD Criteria
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Create a Watch List from your list of stocks that meet the Fundamental Criteria Checklist. For convenience, you can create your Watch List using BigCharts Chart Favorites.
Review your Watch List weekly.
Figure 7-14: Create a Watch List
Step 4 – Review Charts/Indicators and Select Stock to
Trade
Go through your Watch List and review the stock charts and indicators for each stock, one at a time.
Using your trade entry criteria, select a stock to trade. If more than one stock is ready to trade, select the one that meets the most criteria or the one you feel most comfortable trading.
Figure 7-15 shows a stock chart of AAPL that is ready to trade. Note the stock trend is up, the price bar has closed above the 15-Day Moving Average, the MACD Crossover is up, and the Volume trend is up.
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Figure 7-15: AAPL Stock Ready to Trade
Step 5 – Check Earnings
Go to biz.yahoo.com and locate the Earnings Calendar. (See the Resources section for more information about this web site.)
Enter the symbol for the stock you want to trade in the box and click the “Get Earnings Date” button.
Make sure you note the upcoming Earnings Announcement Date.
Figure 7-16 shows the Earnings Announcement Date for AAPL (example stock selected to trade), which is January 22, 2008, after the market has closed.
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Figure 7-16: AAPL Earnings Date
Step 6 – Decide on Trade Entry
Now that you have reviewed the chart, selected a stock, and checked the earnings, you are ready to enter a trade.
Before the market opens on the next trading day, make sure you have access to your trading account and decide how many shares you plan to trade.
Remember the Rules of Thumb – no more than 20% of your trading fund AND 1,000 shares per 1 million daily shares traded.
You also need to determine the appropriate Trailing Stop Loss to enter once you have placed your trade.
Remember your Trailing Stop Loss should be twice the ATR (Average Trading Range).
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Step 7 – Enter Trade and Set Trailing Stop Loss
After 10 AM (Eastern), enter your trade or Buy Order (Buy for Long, Sell for Short) by completing the information in the boxes on the order screen.
Figure 7-17: Trade Mechanics – Sample Online Buy Order to Enter Trade
Make sure you review your order before you click the button to place your order.
Figure 7-18: Trade Mechanics – Review and Place Buy Order
After you place your order, you should receive an order confirmation of the transaction. Be sure to print this confirmation screen or save the order confirmation.
Check the status of your Buy Order to see that it is filled and you now own the shares in your account.
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Figure 7-19: Trade Mechanics – Buy Confirmation and Order Status
Now enter your Trailing Stop Loss to protect your profit. Make sure you always set a Trailing Stop Loss on every trade. For example, you determined the appropriate percentage for your Trailing Stop Loss is 3 percent.
Figure 7-20: Trailing Stop Loss Mechanics – Entering the Order
Check your Order Status to make sure your Trailing Stop Loss is set for your stock trade. The Trailing Stop Loss when set will automatically execute a market order to sell the stock when it meets your criteria.
Figure 7-21: Trailing Stop Loss Mechanics – Checking Order Status
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Step 8 – Exit Trade with Profit
Each day after market, review the stock’s chart and technical indicators.
When the stock meets the trade exit criteria, decide to sell before the market opens on the next trading day.
Figure 7-22 shows a stock chart of AAPL that is ready to take profit (exit). Note the price bar has closed below the 15-Day Moving Average, the MACD Crossover is down, and the Volume trend is down.
Figure 7-22: AAPL Stock Ready to Take Profit
After 10 AM (Eastern), enter your Sell Order to close your trade by completing the boxes on the order screen (to close a short trade, you enter a Buy Order to buy back the stock).
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Figure 7-23: Trade Mechanics – Sample Online Sell Order to Close Trade
Make sure you review your order before you click the button to place your order.
Figure 7-24: Trade Mechanics – Review and Place Sell Order
After you place your order, you should receive an order confirmation of the transaction. Be sure to print this confirmation screen or save the order confirmation.
Check the status of your Sell Order to see that it is filled and you have the profit from the trade in your account.
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Figure 7-25: Trade Mechanics – Sell Confirmation and Order Status
Critical Keys to Trading Success
Discipline
Consistency
Profit Formula
Here is the formula for calculating the profit on your trade. The trade profit is your Gain.
Compare this example Gain to an annual interest rate of 4 percent on a bank savings account. Remember that the 25 percent Gain is just a single trade. How many profitable trades will you make in one year?
Go back one last time to the goal you wrote down in Chapter 1. Think about what you have learned and how you can put that knowledge to work to dramatically increase the goal you originally set.
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How to Rate Your Success
You can compare trading to playing baseball. Each time you are at bat and hit the ball is like entering a trade and taking profit. Using this analogy, here is how to rate the success of your hits or trades.
Hit a single and get to 1st base = 10 to 25 percent Gain
Hit a double and get to 2nd base = 26 to 50 percent Gain
Hit a triple and get to 3rd base = 51 to 75 percent Gain
Hit a Home Run = 75 to 100 percent Gain
Hit a GRAND SLAM = 100 percent or more Gain
What to Do with Your New Wealth
Figure out how you will spend your profits. Here are some guidelines to consider.
Take a percentage and donate it to charity.
Take a percentage and Blow it – I mean BLOW IT.
Take a percentage and invest it in your education to learn more – the more you learn, the more you earn. Enroll in the Advanced Stock Class.
Take a percentage and re-invest it in your trading account.
Challenge
Based on the results of previous students:
20 percent will do Nothing.
50 percent will make lots of Money.
30 percent will become Multi-millionaires.
The Question is – Where are You Going to Be? Decide right now and take action.
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Chapter 7 Review
Follow the steps in the Trading Process.
Step 1. Select Broker and Open Account.
Step 2. Set up BigCharts.
Step 3. Filter IBD Stocks and Create Watch List.
Step 4. Review Charts/Indicators and Select Stock to Trade.
Step 5. Check Earnings.
Step 6. Decide on Trade Entry.
Step 7. Enter Trade and Set Trailing Stop Loss.
Step 8. Exit Trade with Profit.
Remember the keys to Trading Success are Discipline and Consistency.
Calculate your Profit and Rate your Success like playing baseball.
Decide what to do with your new wealth.
Take the Challenge – Where are YOU going to be?
Chapter Notes
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Resources
In this section, you will find the following helpful trading resources.
Web sites
Checklists
Flowcharts
Practice Charts and IBD Tables
Recommended Reading
Web Sites
Here is a list of recommended, free web sites. Following the list, you will find examples of the pages from these web sites with brief explanations of the information they provide.
morningstar.com – Mutual Funds and ETFs (Exchange Traded Funds).
investorwords.com – online investing glossary.
yahoo.com – earnings information and calendar.
clearstation.etrade.com – sector trends.
investors.com – IBD (Investor’s Business Daily) 100 and Stocks on the Move.
bigcharts.com – charts and indicators (source of all the charts in this manual).
online-stock-trading-review.toptenreviews.com – online broker ratings and reviews.
metastock.com – easy to use, flexible charting software. This company has excellent customer service. Contact Jake Porter at 1-801-270-3133 for more information and an introductory offer.
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morningstar.com
This web site provides information about different areas of investments. Specifically, you will find Mutual Funds and ratings for ETFs (Exchange Traded Funds). ETFs give you more control over your investments than Mutual Funds do, but only for those who are not trading stocks with the trading system in this manual. From the web site home page, click on the tab labeled “ETFs” for information and ratings on these funds. You can also find research data on other types of funds.
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investorwords.com
To find the definition of over 6,000 investing terms, simply enter a word or phrase in the search box and click the “Search” button. Your results will display in seconds. Besides the definition, this web site provides related terms and links to educational information about investing in the Market.
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biz.yahoo.com/research/earncal/today.html
From the Yahoo Finance web site at biz.yahoo.com, select the “Stocks” item from the Investing Tab. Click on the “Earnings Dates” link under the Company Earnings Feature and you will see the Earnings Calendar for the current date with the list of companies announcing earnings.
Every day companies announce earnings. You can enter any stock symbol in the box and click on the “Get Earnings Date” button to see the next scheduled quarterly earnings date for any company you are interested in. You can also listen to company conference calls by clicking on the “Listen” link. In these conference calls, companies provide guidance about future earnings and business outlook. You can get an idea of which direction the stock may be going from this information or guidance. Even if the guidance is positive, exit your trade before earnings anyway.
To go directly to the Earnings Calendar page, use this link and bookmark the page for looking up earnings announcements: http://biz.yahoo.com/research/earncal/today.html.
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clearstation.etrade.com
On this web site, you will find stocks on the move, screened and sorted each market day. To see the daily trends or changes by sector, click on the “Tag & Bag” menu in the top left corner of the home page, then click on the “Sectors” link. You can sort the information by clicking on the links at the top of each column. To get data on the industries within each sector, click on the sector name. This is an excellent resource for understanding the sectors, industries, and stocks that are going up and going down. Look at the 1 and 5-day % changes to find the stocks moving in the market.
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investors.com
This is the home page of Investor’s Business Daily online edition. You will find IBD’s Stock on the Move section that highlights the stocks being bought heavily by institutional investors. You will also find the IBD 100 – the top 100 rated stocks by IBD that consistently beat the benchmark S&P 500. The IBD 100 is currently a subscription only service that is available to online members or subscribers to the IBD print editions.
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BigCharts.com
BigCharts web site provides easy-to-use, free charts and technical analysis tools. You can also use the favorites feature of this web site to create your own watch list. In Chapter 7, Putting it All Together, you will find detailed, step-by-step instructions for setting up the Advanced Charts to use with the stock trading system explained in this manual.
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online-stock-trading-review.toptenreviews.com
This web site provides ratings and reviews of the top online brokers. You will find comparisons of the fees and commissions, investments offered, trading and investment tools, security, and the type of help or support provided by the most popular online brokers.
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metastock.com
MetaStock provides easy-to-use, flexible analysis software for trading stocks, FOREX, futures, and options. On this web site, you will find more information about this powerful software and you can view a demo of how it works. MetaStock offers a 30-Day free trial of its latest software.
Checklists
Here is the Fundamental Criteria Checklist from Chapter 3, Trading System and the Buy and Sell Checklists presented in Chapter 5, Using Checklists.
Fundamental Criteria Checklist
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BUY Long and SELL Long Checklists
SELL Short and BUY Short Checklists
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Flowcharts
Here are the Trading Process Flowcharts to use with Chapter 7, Putting it All Together.
The Trading Process
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Trade Entry Decisions
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Trade Exit Decisions
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IBD Tables and Practice Charts
Here are sample IBD Tables to practice using your Fundamental Criteria Checklist for selecting stocks to trade. You will also find practice charts for your review.
Explanation of Ratings in IBD Tables
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IBD Research Tables for Practice
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Practice Chart – AAPL
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Practice Chart – VIP
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Recommended Reading
Exchange Traded Funds An Insider’s Guide to Buying the Market Authors: Jim Wiandt and Will McClatchy
Technical Analysis from A to Z Author: Steven B. Achelis
The New Market Wizards Conversations with America’s Top Traders Author: Jack D. Schwager
Encyclopedia of Chart Patterns Author: Thomas N. Bulkowski
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Technical Analysis Power Tools for the Active Investors Author: Gerald Appel
The Millionaire Next Door The Surprising Secrets of America’s Wealthy Authors: Thomas J. Stanley, Ph.D. and William D. Danko, Ph.D.
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Glossary
Here are the definitions of common trading terms. You will also find the definitions of over 5,000 trading terms at www.investorwords.com.
A/D
The ratio of advancers to decliners, which serves as a breadth analysis indicator.
Ask
The price at which a seller will sell stock, also known as the offer. The best ask is the lowest quoted price at which the seller will sell a stock at a particular time.
Ax
A market maker with a large order to fill, who is moving the stock price aggressively.
Bearish
Pessimistic; expecting the market to go down or a stock’s price to fall.
Bid
The price at which a buyer will buy a stock. The best bid is the highest quoted price at which a buyer will buy a stock at a particular time.
Blue sky
A new 52-week high. In blue sky, the stock has no known resistance to hold it back.
Bollinger bands
An indicator used in price charting which uses past data and standard deviations to show support and resistance.
Bounce
A sudden upward movement that follows a downtrend and may or may not signal a larger change in direction.
Breakout
A new high for the day or a stock’s departure from an established range.
Bullish
Optimistic; expecting the market to go up or a stock’s price to rise.
Buy to Cover
To close a short-sale position by purchasing shares to replace the shares borrowed by the account. See sell short.
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Call
An option to buy a stock at a future date a specific price. Compare put.
Dead cat bounce
A bounce that does not signal a change in direction from downtrend to uptrend or rally; instead, a dead cat bounce is merely a brief interruption in a strong downtrend.
Dow Jones Industrial Average (DJIA)
The 30 largest industrial stocks, used as an index.
Down tick
A lowered bid. You cannot sell short on a down tick.
Electronic Communications Network (ECN)
A computerized exchange system that makes market makers’ and other parties’ orders available for execution by third parties.
Ex-date
The day a stock’s share price changes to reflect a stock split and revised number of shares are credited to shareholders’ accounts.
Fading the gap
Going against the initial morning NASDAQ gap or generally playing off an imbalance.
Gap down
A significant price move down from the previous day’s close.
Gap up
As significant price move up from the previous day’s close.
High of the day
The highest price at which a particular stock has been traded on a given day.
Hitting the bid
Using a limit sell order equal to the bid in order to get out of a position quickly.
Home run
An incredible return on one trade, such as 40 percent, 75 percent, or 100 percent. Compare single.
INCA
Level II abbreviation for the Instinet ECN, a favorite hiding place where market makers and other large buyers and sellers trade when they don’t want their identities to be known.
Initial Public Offering (IPO)
The first time a company sells stock to the public.
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Intraday
Inside a single trading day.
ISLD
Level II abbreviation for the Island ECN.
IPO
See Initial Public Offering.
Ka-chingo!
A nice profit on a good trade.
Level I
A basic stock quotation system showing only the current best bid and ask prices and order sizes, along with information on the last executed trade.
Level II
A real-time, streaming stock quotation system showing all market makers’ and ECNs’ posted bid and ask prices and order sizes.
Level III
A NASDAQ order desk for market makers, not available to individual traders.
Limit Order
An order that can execute only at the stated price or better. Check with your broker – some brokers use slightly different names for various order types.
Liquidity
The ability of a stock or other security to be converted into cash quickly and without incurring a loss. The easier the conversion is, the more liquid the stock; if conversion is difficult, the stock is illiquid. Markets often achieve liquidity by having a large number of buyers and sellers.
Listed stocks
Stocks that are traded on an exchange like the NYSE or AMEX, as opposed to over-the-counter stocks.
Lockup expiration
Date on which IPO shares that insiders bought can be sold on the open market.
Lot
A number of shares of the same stock that are traded or held together. Level I quotes show only lots of 100 (round lots), but a lot of any size may be traded (lots that are not multiples of 100 are called odd lots).
Low of the day
The lowest price at which a particular stock has been traded on a given day.
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Margin
The capacity to borrow against the securities in your account. Buying on margin means using the shares you hold long as collateral to borrow money to buy more stock.
Margin call
A broker’s notification to an account holder to sell securities or deposit funds in order to meet a margin requirement. If the account holder takes no action, the broker will liquidate the holdings.
Market Maker (MM)
A firm authorized to buy and sell securities on an exchange at publicly quoted bid and ask prices.
Momentum (momo)
The strength (due to volume) of the buying and selling that’s causing a stock’s price to move. When a price movement has momentum behind it, the movement is more likely to continue in the same direction, at least in the short term.
NASD
National Association of Securities Dealers
NASDAQ
National Association of Securities Dealers Automated Quotation system.
Newbie
A new, inexperienced trader.
NYSE
New York Stock Exchange
Odd lot
A stock holding or order to buy stock in a quantity that is not a multiple of 100. See lot.
Option
A contract giving the owner the right but not the obligation to purchase (call) or sell short (put) a stock at a particular price by a specified date.
Price chart
The main tool used in technical analysis, in which price movement is charted over time on x and y axes.
Pump-and-dump scheme
A stock manipulation in which the stock’s price is made to rise dramatically (“pumped”) by rumor or hype so that the manipulators can sell (“dump”) their shares at the inflated price before it collapses.
Put
An option to sell short a security at a future date at a predetermined price. Compare call.
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Quiet period
A 25-day period after a company’s stock has gone public (after an IPO has started trading), during which neither the company nor its underwriters issue any news on the company.
Resistance
A price level at which a stock has previously reversed its upward course.
Rinse
A sharp spike down for no apparent reason. Market makers are suspected of creating such movements in order to trigger stop orders.
Risk-to-reward ratio
The comparison or relative size of a trade’s anticipated risk to its anticipated reward.
Round lot
A quantity of shares of a stock held or ordered that is a multiple of 100. See lot.
S&P 500
Standard and Poor’s 500 index. An index of 500 of the largest stocks in the marketplace.
Scalp
A quick trade, lasting a few minutes, for a small profit.
Sector
A subset of the market whose component companies are in the same general area of business.
Sell short (“short”)
To sell a security you do not own in order to make money on a downward price movement. Compare take long.
Short squeeze
A sharp move upward, causing short sellers to buy to cover.
Single
A respectable return on one trade, such as 3 percent, 5 percent, or 8 percent. Compare home run.
Size
The number of 100-share blocks available at the bid or ask.
SOES
Small Order Execution System – it gives users the ability to make a NASDAQ market maker take your small order regardless of the size the market maker is advertising. The maximum size allowed varies by security.
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Specialist
A single person responsible for all trades in a single stock. NYSE and AMEX use specialists.
SPOOS
Standard and Poor’s 500 index futures, which is often used as a market indicator.
Spread
The difference between the bid and the ask.
Stop order
A stop-loss order.
Stop limit order
An order to sell a stock at a specific price and no lower than that price if it drops to that price, or to buy to cover a stock sold short at a specific price and no higher than that price if it rises to that price. Once the stop is triggered, the order is executed only if it can be executed at the limit price or better (it becomes a limit order). Check with your broker – some brokers use slightly different names for various order types.
Stop-loss order
An order to sell a stock if it drops to a specified price, or to buy to cover a stock you sold short if it rises to a specified price. Once the stop is triggered, the order is executed immediately at the market price (it becomes a market order). Check with your broker – some brokers use slightly different names for various order types.
Straddle
An options play where both a call and a put are purchased. The call and put have the same strike price, the same expiration month and the same underlying stock or index.
Strangle
An options play where both a call and a put are purchased. The call and put have different strike prices (usually both out of the money), but have the same expiration month and the same underlying stock or index.
Super dot
The electronic order execution system for NYSE stocks.
Support
A price level at which a stock has previously bounces (reversed its downward course).
Take long
To buy a stock. Compare sell short.
Trend
A price movement pattern that is repeated by different stocks and can be relied on to reasonably anticipate the price movements of similar stocks.
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U/D or UD
The ratio between the advancing volume and the declining volume, which serves as a directional strength indicator.
Uptick
A raised bid. An uptick allows a short sale to occur.
Volatility
The degree to which a stock’s price moves up and down. A highly volatile stock experiences large price fluctuations, while a more stable stock does not. A particular stock’s volatility can vary over time according to market and stock-specific conditions.
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Reader Comments
This page reserved for Reader Comments – to be completed for 1st edition.
