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Commodities That Move The Markets

2008-10-17T02:05:00.000-07:00

The daily movements in the world's equity markets are influenced by a multitude of factors ranging from large institutional block trades and program trading to earnings and economic reports. However, one factor that is frequently overlooked is the influence of commodity prices. In fact, fluctuating commodity prices can have a tremendous impact on the earnings of public companies and, by extension, the markets. Read on to learn more about this relationship and why it matters to investors.

Lumber Prices
The average person would probably never ponder the cost of lumber unless he or she was in the process of building a house. However, the pricing of this commodity is closely watched and can affect many companies, such as homebuilders.

However, it's also important to note that many other types of companies pay close attention to lumber prices as well. For example, companies that are looking to expand and build out new locations, such as restaurants, retail chains and even pharmaceutical companies looking to build new manufacturing facilities would naturally be interested in the cost of lumber. After all, even a small tick up in prices can materially affect the cost of a structure.

Random length lumber futures and options trade daily on the Chicago Mercantile Exchange (CME) . Quotes and information may also be published in the Wall Street Journal or Investor's Business Daily and is often noted on major business channels, such as CNBC.

Oil Prices
Many consumers only think about oil prices in the context of how it directly impacts their wallets. In other words, how much they will end up paying at the pump as the result of price fluctuations. However, oil is one of the cornerstones of the North American economy and its price is highly important to companies of all stripes.

The price of oil can affect a variety of companies ranging from retailers to manufacturers of plastics (oil byproducts are a big component in plastic). Just think about how all of the products that are on the shelves at your local Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) are shipped.

By extension, this means that these companies either have to eat the rising cost of fuel or try to pass some of it along to consumers in the form of higher prices. Unfortunately however, if they aren't able to pass along the cost increase, it can have an adverse impact on margins and net income, which can put downward pressure on stock prices and hurt investor returns.

The price of crude can be tracked on the New York Mercantile Exchange (NYMEX).

Cotton Prices
Cotton is used in a wide variety of pruducts. For example, many types of clothes contain large amounts of cotton; therefore, rising prices can have an adverse impact on an apparel retailer's cost of goods sold and declining prices can have a positive impact.

Of course those in the apparel industry aren't the only parties that can be impacted by changing cotton prices. In fact, it's also a key component in things like furniture, coffee filters and a variety of other materials that we all have come to depend on.

As such, companies that sell these items have only a couple of choices when dealing with rising cotton prices. They can raise the price of the product, and/or eat the rising cost. Again either or both of these choices can have an effect on income and by extension stock prices.

Wheat
Wheat is the primary ingredient in many popular cereals and foods. While cereal and other food producers may be able to pass along some of these costs, they may have to absorb some as well. This can impact their margins and, by extension, their profits.

Of course makers of such products aren't the only ones affected. Grocery and convenience stores must purchase the items to keep shelves stocked. Also don't forget about the impact on distributors and any middlemen. Fluctuating wheat prices can have a far-reaching impact on a variety of companies and on consumers.

Corn
Corn in one form or another is used in a variety of products ranging from cereals, building materials, alcohols and even tires.

It's also worth noting that the price of corn is impacted by the demand and production of ethanol, which is an increasingly popular corn based fuel. As the demand for alternative fuels ramps up, corn prices could go even higher. Food manufacturers, retailers, consumers and, by extension, stock prices can be affected by fluctuating corn prices.

Coffee
Rising or declining coffee prices can certainly have an impact on consumers that enjoy drinking it in the morning. It can also have an affect on companies that do a brisk breakfast business, such as diners and fast food chains like McDonalds (NYSE:MCD) or Burger King (NYSE:BKC). Also, companies like Starbucks (NYSE:SBUX), which derives the lion's share of its revenue from coffee or coffee related products, can be dramatically impacted as well.

Gold
The price of gold can have an impact on jewelers as well as on retailers that sell or receive a portion of their sales from jewelry related items. For example, Macy's (NYSE:M) and many of the other well-known mall-based department stores generate a significant amount of revenue from their jewelry departments.

Gold can also be used in medical products, glass making, aerospace and a variety of other businesses. By extension, this means that fluctuations in gold prices can make the markets move.

In addition, because gold is found and valued all over the world, it is considered a universal currency. So, if the outlook for the U.S. equity markets and/or the economy is dim, it's likely that the demand for gold will increase as investors "flock to safety."

If it appears as though the economy is about to perk up, or that corporate earnings are going to be on the rise, investors tend to abandon gold in favor of equities.

Bottom Line
Although there are a variety of factors that can move markets, commodities can have a major influence on businesses, stocks and portfolios. When you're looking to invest in a particular sector or company, take a look at relevant commodity prices and what this might mean for your investments going forward.

by Glenn Curtis,
Glenn Curtis started his career as an equity analyst at Cantone Research, a New Jersey-based regional brokerage firm. He has since worked as an equity analyst and a financial writer at a number of print/web publications and brokerage firms including Registered Representative Magazine, Advanced Trading Magazine, Worldlyinvestor.com, RealMoney.com, TheStreet.com and Prudential Securities. Curtis has also held Series 6,7,24 and 63 securities licenses.

The Importance Of A Profit/Loss Plan

2008-10-16T01:56:00.000-07:00

Who needs a profit/loss plan? Isn't investing only about buying low and selling high? It would be nice to always buy at the bottom and sell at the top, but it is nearly impossible to do so consistently. Furthermore, investors are only human: emotions sway our judgment and it is in our nature to hate losing. Taking a loss on a stock, therefore, is not only detrimental to our pocketbooks, but it also hurts our egos. Time and time again investors take profits by selling an investment that has appreciated, but hold onto declining stocks in the hope of a rebound; oftentimes these investments shrivels to a fraction of their previous worth. So how can an investor avoid this type of outcome? One solution is to learn to be a disciplined investor and to adopt a profit/loss plan. In this article, we'll go over this strategy and show you how to use it to stay in the black.

What Is a Profit/Loss Plan?
This plan is a step that many retail investors (and professionals) often overlook. The profit/loss plan is a set of limits that determines the maximum loss or gain an investor will take on a stock. Containing losses is a very important part of a investing, so the profit/loss plan is crucial to a sound strategy.

We all make stock-picking mistakes and most of us have lost money in the stock market - what sets the great investors apart is their ability to recognize their bad choices and use what they've learned to make up for them later. A profit/loss plan helps you recognize your mistakes by allowing you to separate your emotions from investing. If you aren't too zealous about your gains and you see them purely as a means of increasing your cash flows (rather than your ego), you will have a much easier time letting go of your losses and, therefore, controlling them.

Devising Your Plan
Devising a plan may be more difficult than you'd expect. First, you'll need to set the maximum gain you will accept and the maximum loss you will tolerate for your investments, but these maximums and minimums shouldn't necessarily be the same for every stock. For example, a blue chip stock is more unlikely to rise or fall by 10% within any given year as compared to a small-cap growth stock, which will exhibit more volatility. In other words, you must analyze each stock individually to estimate how much it is likely to move in either direction.

Some investors use technical or fundamental analysis or a combination of both to determine appropriate limits for gains and losses. Another way to devise your limits is by modeling your plan on the performance of a designated benchmark such as an index or even on the past performance of your own portfolio.

Another factor you must consider when devising your profit/loss plan is your risk tolerance, which depends on many factors such as your personality, your time frame and your available capital. Typically, people who are risk averse will have tighter boundaries than those of people who don't mind risk. Risk lovers will try to profit as much as possible from a rising stock, but a more conservative investor may sell the stock early on in its rise to eliminate the risk of losses, which would occur if the stock took a quick downward dive. If you prefer to shy away from risks, a profit/loss plan of 10% each way may not be suitable or even realistic for you. On the other hand, if you are willing to take on the added risks associated with potential profits, then a 10% profit/loss might be more appropriate.

Carrying Out Your Plan
Once you've decided on your numbers, whether conservative or aggressive, you have to put the plan into action with as few hitches as possible. Remember, this plan has a double requirement: you have to sell your stocks (1) if they fall to a certain level and (2) if they rise to a certain level.

Now, brokers will not let you enter two different sell orders for the same security so you need to figure out which one you'd rather enter first. It may be wisest to enter orders that first protect your downside: many wise investors use the stop-loss order, which instructs your broker to buy or sell a stock once it has reached a certain price. The stop loss ensures that you won't get burned on a down market, especially if you aren't able to watch it every second. When you enter in your order with your broker, set the stop price at your maximum loss percentage and then sit and wait. If the price ends up appreciating to your upper boundary, just change the price of your stop loss order, which will then activate the immediate sale of your stock.

Staying Disciplined
Once you have your profit/loss strategy in place, you will have to remember that the whole idea of the plan is to establish strict guidelines for when to sell. Sure, it hurts to see a stock continue to rise once you have sold it, but it is often better to sell on the way up than to wait until you have to dump the stock while the price is collapsing after its peak. Joseph P. Kennedy, Sr. once said, "Only a fool holds out for the top dollar."

Conclusion
Keep in mind that our example figures are generalizations. Devising your plan requires detailed research, analysis, self-assessment and a realistic outlook. Setting a profit limit at 100% (double your money) doesn't make sense if you invest in low-risk companies that grow steadily at 15% per year.

Here are some things to remember:

A stock that declines 50% means you will need to double your money to get back to even. Controlling losses is the key to sound investing.
Making mistakes is human nature. Once you realize this, you will find it easier to move on.
Buying a stock and holding onto it for a very long time doesn't mean you will make money. A buy and hold strategy will work only if you pick the right companies.

The most important part of devising a profit/loss plan is sticking to it!

by Investopedia.com

Getting To Know The Money Market

2008-10-15T01:54:00.000-07:00

Chances are you've heard the term before, but what exactly is the money market? It is the organized exchange on which participants can lend and borrow large sums of money for a period of one year or less. While it is an extremely efficient arena for businesses, governments, banks, and other large institutions to transact funds, the money market also provides an important service to individuals who want to invest smaller amounts while enjoying perhaps the best liquidity and safety found anywhere. Here we look at some of the most popular types of money market instruments and the benefits they offer to the individual investor.

Purposes of the Money Market
Individuals will invest in the money market for much the same reason that a business or government will lend or borrow funds in the money market: sometimes the need for funds does not coincide with having them. For example, if you find you have a certain sum of money that you do not immediately need (to pay down debt, for example), then you may choose to invest those funds temporarily, until you need them to make some other, longer-term investment, or a purchase. If you decide to hold these funds in cash, the opportunity cost that you incur is the interest that you could have received by investing your funds. If you do invest your funds in the money market, you can quickly and easily secure this interest.

The major attributes that will draw an investor to short-term money market instruments are superior safety and liquidity. Money market instruments have maturities that range from one day to one year, but they are most often three months or less. Because these investments are associated with massive and actively-traded secondary markets, you can almost always sell them prior to maturity, albeit at the price of forgoing the interest you would have gained by holding them until maturity.

The secondary money market has no centralized location. The closest thing the money market has to a physical presence is an arbitrary association with the city of New York; although, the money market is accessible from anywhere by telephone. Most individual investors participate in the money market with the assistance (and experience) of their financial advisor, accountant or banking institution.

Types of Money Market Instruments
A large number of financial instruments have been created for the purposes of short-term lending and borrowing. Many of these money market instruments are quite specialized, and they are typically traded only by those with intimate knowledge of the money market, such as banks and large financial institutions. Some examples of these specialized instruments are federal funds, discount window, negotiable certificates of deposit (NCDs), eurodollar time deposits, repurchase agreements, government-sponsored enterprise securities, shares in money market instruments, futures contracts, futures options, and swaps.

Aside from these specialized instruments on the money market are the investment vehicles with which individual investors will be more familiar, such as short-term investment pools (STIPs) and money market mutual funds, Treasury bills, short-term municipal securities, commercial paper, and bankers' acceptances. Here we take a closer look at STIPs, money market mutual funds, and Treasury bills.

Short-Term Investment Pools (STIPs) and Money Market Mutual Funds
Short-term investment pools (STIPs) include money market mutual funds, local government investment pools, and short-term investment funds of bank trust departments. All STIPs are sold as shares in very large pools of money market instruments, which may include any or all of the money market instruments mentioned above. In other words, STIPs are a convenient means of cumulating various money market products into one product, just as an equity or fixed income mutual fund brings together a variety of stocks, bonds, and so forth. STIPs make specialized money market instruments accessible to individual investors without requiring an intimate knowledge of the various instruments contained within the pool. STIPs also alleviate the large minimum investment amounts required to purchase most money market instruments, which generally equal or exceed $100,000.

Of the three main types of STIPs, money market mutual funds are the most accessible to individuals. These funds are offered by brokerage companies and mutual fund firms, which sell shares in these funds to their individual, corporate and institutional investors. Short-term investment funds are operated by bank trust departments for their various trust accounts. Local government investment pools are established by state governments on behalf of their local governments, allowing investors to purchase shares of local government investment funds.

Money market mutual funds are further divided into two categories: taxable funds and tax-exempt funds. Taxable funds place investments in securities such as Treasury bills and commercial papers that pay interest income that is subject to federal taxation once it is paid to the fund purchaser. Tax-exempt funds invest in securities issued by state and local governments that are exempt from federal taxation. These two categories of money market mutual funds provide different patterns of growth, each of which attracts different types of investors.

Treasury Bills (T-Bills)
Treasury bills, commonly known as "T-bills," are short-term securities issued by the U.S. Treasury on a regular basis to refinance earlier T-bill issues reaching maturity, and to help finance federal government deficits. Of all money market instruments, T-bills have the largest total dollar value outstanding--a sum that as of 2004 exceeded $650 billion. In addition to scheduling regular sales of T-Bills, the Treasury also sells instruments called cash management bills on an irregular basis, by re-opening the sales of bills that mature on the same date as an outstanding issue of bills.

When T-bills were initially conceived, they were given three-month maturities exclusively; but bills with six-month and one-year maturities were subsequently added. Three-month and six-month bills sell in the regular weekly auctions, and another bill auction takes place every four weeks for the sale of one-year bills.

T-bills are sold through the commercial book-entry system to large investors and institutions, which then distribute those bills to their own clients, which may include individual investors. An alternative is Treasury Direct, which is run as a non-competitive holding system designed for small investors who plan to hold their securities until maturity. Individual bidders on Treasury Direct have their ownership recorded directly in book-entry accounts at the Department of the Treasury. If an investor purchases T-bills through the Treasury Direct system and wishes to sell them prior to maturity, he or she must transfer them to the commercial book-entry system. The transfer can be arranged only through a depository institution that holds an account at a Federal Reserve Bank; the person making the transfer is required to pay applicable transfer fees.

Conclusion
When an individual investor builds a portfolio of financial instruments and securities, he or she typically allocates a certain percentage of funds towards the safest and most liquid vehicle available: cash. This cash component may sit in his or her investment account in purely liquid funds, just as it would if deposited into a bank savings or checking account. However, investors are much better off placing the cash component of their portfolios into the money market, which offers interest income while still retaining the safety and liquidity of cash. Many money market instruments are available to investors, most simply through well-diversified money market mutual funds. Should investors be willing to go it alone, there are other money market investment opportunities, most notably in purchasing T-bills through Treasury Direct.

by Jason Van Bergen, investopedia.com

4 Steps to Eliminate the Frustration of Using Stop-Losses

2008-10-14T01:50:00.000-07:00

Every trader has had the frustrating experience of placing a stop-loss order too close to the market. It really doesn't matter if the stop was to exit a losing trade or a winning trade, the frustration comes from having the stop get executed and then shortly thereafter the market continues to advance in the direction intended when the trade was initiated.

You either have taken a loss that could have been a gain; or cut a profit short. Of all the issues required to develop my trade approach, I probably have spent more actual time on the issue of improving stop placement than anything else. After giving the issue a lot of thought I decided the issue wasn't whether stops should be; after all trading without stops is an accident waiting to happen. It really is an issue of using stops effectively in order to maximize the probabilities inherent in your trading approach/system.

I took a look into the psychology of the stop-losses and I believe that any trader can improve their use of stops simply be being less aggressive with them. Here are the rules I recommend.

1. First of all, you must accept once and for all that stops are not optional. The surest way to suffer a debilitating drawdown in your equity is to trade without stop protection. This includes mental stops in my opinion.

The purpose of a standing stop-loss order does not have to be solely to exit an existing trade; it needs to be considered as part of a well thought out trading approach that includes the understanding that no trader knows it all. If we are willing to admit to ourselves that we cannot know for certain if any one trade will be a winning trade, then your use of stops is simply an admission of that fact. You, as a serious trader must always have a protective stop working in the market you trade; regardless if you intend that to be an exit order for an open trade you currently have on for today. At the very least, a resting "get me out" stop working against your open trade ensures that if, for whatever reason, you miss something before you exit the trade or enter an overnight stop; you are protected. As most traders know, it is the one time we act with enough over-confidence to assume we don't need a stop this one time (or will place that stop at the end of the day) that our market runs away against us dramatically. Always place a stopï¿½you can always adjust it later as the trade progresses.

2. Next, you must think of stops as profit management tools rather than risk control tools. For the most part, if you have developed a sound enough approach to identifying the marketï¿½s order flow, your trade will work when you are on the right side of the order flow. You could almost say that the initial risk control secured by the first protective stop was immaterial. That stop might as well have never been there. But since you are using solid discipline to protect yourself, once the stop is not needed as a risk control tool as the market goes your way; your stop now becomes a profit management tool. Regardless of your personal trading style or timeframe, you will have the market ï¿½inhaleï¿½ and ï¿½exhaleï¿½ while the price advances toward your initial profit objective. That ebb and flow in price action is normal and expected. The last thing you want to do is place your stop too close to the market to get ï¿½taggedï¿½ during this normal ebb and flow. Rather than roll a protective stop under the market to lock a profit; consider rolling your stop to a breakeven point and wait for the objective to be reached. If you have truly seen the order flow, and you are positioned fairly well to begin with, the probabilities of the market trading your entry price after an advance in your favor drops over time.

After you have a reasonable lead on the market and you are holding a risk-free trade your only need is to watch for something to change. If nothing is changing continue to let the profit run until your objective is reached. If something changes you simply exit the trade with what you have in it at that point. If something changes, and you donï¿½t see that change fast enough to exit with what you have, your breakeven stop will take you out with no damage to your equity. If you had aggressively rolled the stop up behind the market, and been taken out on a normal ebb and flow of price action, you might be tempted to re-enter the trade at a less than optimal time/price relationship; which increases your risk.

3. Use the next highest time frame from your preferred trading time frame to decide where to place a stop. As my trading style evolved over time and through education, I found that my unique style would be considered a ï¿½swingï¿½ trader or a "position" trader (or a little of both). Since I was willing to enter a position and hold it for more than a week or so, the ï¿½random noiseï¿½, or ebb and flow of price action, could easily span several days, even though a day trader might see that as several individual opportunities.

In my case, my initial stop needed to be outside the range of this ebb and flow; which was often the weekly high or low. If the trade was working, and I was in it 3-4 weeks, I might roll my stop to protect the trade but I usually would always make it outside the range for the week. After critically examining the results I found that in most cases you should:
Use the next highest time frame or two from his trading time frame to decide where to place a stop, in most cases the stop will be outside of the normal ebb and flow.

In other words, if you are a day trader using the 60 minute chart for your entry signals, a stop outside the range for the last day or so would work fine. Of course, that needs to be in context with your actual tolerance for risk. If you are looking for 30-50 points on something but a risk-control stop outside the range is 100 points; that wonï¿½t work so well. But in any case, if you are using the next higher time frame to assist you in stop placement you will find you are getting stopped out less often before your trade reaches your profit objective.

4. Benefit from the clear thinking that stop usage brings. I think the a great benefit to always having a stop order working and moving them less aggressively is the peace of mind you have from knowing you are trading in a disciplined manner. Your trade thinking improves when your initial risk is known and protected. Your profit potential improves when you allow the market to behave as it needs to on the way to your objective.

In conclusion, By simply adjusting your use of stops to a less aggressive and more disciplined manner your profit potential is the real main benefit because your losing trades are always going to be there. Using stops less aggressively on your winning trades allows you to hold winners a bit longer. Using stops consistently to begin with limits your equity loss to a more reasonable number until you are holding the winner.

Jason Alan Jankovsky
"The Lion of LaSalle Street"
Jason Alan Jankovsky is a 20 year veteran of leveraged transaction trading. Trading extensively in Futures, Options, and FOREX since 1987, he is self-taught and self-educated. He has authored several trading systems, trained other successful traders, and is often published in industry newsletters. He is the author of "Trading Rules that Work: The 28 essential lessons every trader must master" (Wiley Books, 2006). He hosts a twice daily LIVE internet broadcast on the Global cash FOREX markets providing fundamental and technical insight for traders. Born and raised in Chicago, he is an avid Sailor and Private Pilot.

What Is Market Efficiency?

2008-10-13T01:40:00.000-07:00

When money is put into the stock market, it is done with the aim of generating a return on the capital invested. Many investors try not only to make a profitable return, but also to outperform, or beat, the market.

However, market efficiency - championed in the efficient market hypothesis (EMH) formulated by Eugene Fama in 1970, suggests that at any given time, prices fully reflect all available information on a particular stock and/or market. Thus, according to the EMH, no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.

The Effect of Efficiency: Non-Predictability
The nature of information does not have to be limited to financial news and research alone; indeed, information about political, economic and social events, combined with how investors perceive such information, whether true or rumored, will be reflected in the stock price. According to EMH, as prices respond only to information available in the market, and, because all market participants are privy to the same information, no one will have the ability to out-profit anyone else.

In efficient markets, prices become not predictable but random, so no investment pattern can be discerned. A planned approach to investment, therefore, cannot be successful.

This "random walk" of prices, commonly spoken about in the EMH school of thought, results in the failure of any investment strategy that aims to beat the market consistently. In fact, the EMH suggests that given the transaction costs involved in portfolio management, it would be more profitable for an investor to put his or her money into an index fund.

Anomalies: The Challenge to Efficiency
In the real world of investment, however, there are obvious arguments against the EMH. There are investors who have beaten the market - Warren Buffett, whose investment strategy focuses on undervalued stocks, made millions and set an example for numerous followers. There are portfolio managers who have better track records than others, and there are investment houses with more renowned research analysis than others. So how can performance be random when people are clearly profiting from and beating the market?

Counter arguments to the EMH state that consistent patterns are present. Here are some examples of some of the predictable anomalies thrown in the face of the EMH: the January effect is a pattern that shows higher returns tend to be earned in the first month of the year; "blue Monday on Wall Street" is a saying that discourages buying on Friday afternoon and Monday morning because of the weekend effect, the tendency for prices to be higher on the day before and after the weekend than during the rest of the week.

Studies in behavioral finance, which look into the effects of investor psychology on stock prices, also reveal that there are some predictable patterns in the stock market. Investors tend to buy undervalued stocks and sell overvalued stocks and, in a market of many participants, the result can be anything but efficient.

Paul Krugman, MIT economics professor, suggests that because of the mass mentality of the trendy, short-term shareholder, investors pull in and out of the latest and hottest stocks. This results in stock prices being distorted and the market being inefficient. So prices no longer reflect all available information in the market. Prices are instead being manipulated by profit seekers.

The EMH Response
The EMH does not dismiss the possibility of anomalies in the market that result in the generation of superior profits. In fact, market efficiency does not require prices to be equal to fair value all of the time. Prices may be over- or undervalued only in random occurrences, so they eventually revert back to their mean values. As such, because the deviations from a stock's fair price are in themselves random, investment strategies that result in beating the market cannot be consistent phenomena.

Furthermore, the hypothesis argues that an investor who outperforms the market does so not out of skill but out of luck. EMH followers say this is due to the laws of probability: at any given time in a market with a large number of investors, some will outperform while other will remain average.

How Does a Market Become Efficient?
In order for a market to become efficient, investors must perceive that a market is inefficient and possible to beat. Ironically, investment strategies intended to take advantage of inefficiencies are actually the fuel that keeps a market efficient.

A market has to be large and liquid. Information has to be widely available in terms of accessibility and cost and released to investors at more or less the same time. Transaction costs have to be cheaper than the expected profits of an investment strategy. Investors must also have enough funds to take advantage of inefficiency until, according to the EMH, it disappears again. Most importantly, an investor has to believe that she or he can outperform the market.

Degrees of Efficiency
Accepting the EMH in its purest form may be difficult; however, there are three identified classifications of the EMH, which are aimed at reflecting the degree to which it can be applied to markets.

1. Strong efficiency - This is the strongest version, which states that all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor an advantage.

2. Semi-strong efficiency - This form of EMH implies that all public information is calculated into a stock's current share price. Neither fundamental nor technical analysis can be used to achieve superior gains.

3. Weak efficiency - This type of EMH claims that all past prices of a stock are reflected in today's stock price. Therefore, technical analysis cannot be used to predict and beat a market.

Conclusion
EMH propagandists will state that profit seekers will, in practice, exploit whatever abnormally exists until it disappears. In instances such as the January effect (a predictable pattern of price movements), large transactions costs will most likely outweigh the benefits of trying to take advantage of such a trend.

In the real world, markets cannot be absolutely efficient or wholly inefficient. It might be reasonable to see markets as essentially a mixture of both, wherein daily decisions and events cannot always be reflected immediately into a market. If all participants were to believe that the market is efficient, no one would seek extraordinary profits, which is the force that keeps the wheels of the market turning.

In the age of information technology (IT), however, markets all over the world are gaining greater efficiency. IT allows for a more effective, faster means to disseminate information, and electronic trading allows for prices to adjust more quickly to news entering the market. However, while the pace at which we receive information and make transactions quickens, IT also restricts the time it takes to verify the information used to make a trade. Thus, IT may inadvertently result in less efficiency if the quality of the information we use no longer allows us to make profit-generating decisions.

by Reem Heakal, investopedia.com

Stop Loss?? I Don't Want To Use It.

2008-10-12T01:37:00.000-07:00

Last week I was reviewing a website which has a trading signal program for those investors who prefer to not being involved in confusing market analysis and I respect them because such services normally will bring them more time to do other important things in their daily life. But the interesting thing was the most of signalers did not actually place a stop loss point on their recommendations. Is that so because they know they are right all the time? Or that's because they did not lose half of their trading account in an unexpected slump of 200 hundred points and a single trade.

However, the answer is most of them have something between -1000 to -5000 pips of open trades on their signal board and they actually trapped in desperately while they could cut the losing trades and ran another one instead. Also I should mention that there are some other types of system trading that called "Hedge Fund" and I don't actually want to argue if they are right or wrong. I am definitely talking to day traders who get into challenge with big bear every day.

Sometimes, I don't understand why a trader could be convinced of not having a Stop Loss while we see almost every month an unexpected uncounted impulse (I would call it Best of the Test for whom with less of the rest) in the market.

There is no specific rule as to where you should place the stop loss, so consider the below mentioned tips as the general rules and ask your mentor to fit reliable Stop loss rules just for you and your trading system(If you have one?).

Many loser traders do place the same stop loss for all the trades they execute without even trying to measure market environment.
Don't be scared of placing a stop loss while it is for your gain and you must know what your profit objective is.
Stop Loss should not be too close to the current price while most of the stop loss enemies have ruined their trading accounts already just by using very close ones.
Stop Loss should not be too far from the point you get into trade while it's better to not placing any Stop Loss rather taking an unreachable, fictional protector.
Try to not to risk more than the points of your profit goal. Pro traders recommend to only take those trades which have at least 2 points of potential profit per 1 pip of potential lose, but I would say it is completely depends on the money management system that you use, as different money management systems has different recommendations for Risk & Reward.
Sometimes a trading system does not work if you risk less than recommended %7 to %10 of your total account balance. It means you trade oversize or you just entered the market when everyone else getting out of the market. In this case this is not your fault as it has a clear message for you "don't trade this way anymore and ask an expert to solve the problem".
If you are convinced enough that you can make up 1 million dollar out of your 10000 dollars account by not using stop losses as you may think you are the one who knows the price will be back on its way to you instead of hitting new highs, well, simply you are wrong.
Remember, there are no sky limits for the price of any of currencies in FOREX market.
If you don't like to place a pre defined Stop Loss on your trades, please ask someone to show you how to follow a wining trade by using "Trailing Stop".
Be sure it is better to have one or two losing trades with 100 points of lose, instead of being desperate with sinking into -1000 pips of dizziness.

How to Define the Best Stop Loss point?

Try these tools to define the most accurate stop loss points easily:

Use 10 pips over/below the first Parabolic SAR spot(dot) appeared over/below the price candles for Short/Long Trades.
Note#1: Remember you just can use 10 pips above the parabolic SAR dots as an Stop Loss point when you have a Short trade and Vice Versa.
Note#2: You realized that the Stop Loss obtained from SAR is too far from the point which you want to enter the market. OK, this means you are about to enter the market very late so better to not do it.
Use 10 pips over/below the day before yesterday's HIGH and LOW and in the case of the market has moved a lot far, use 10 pips over/below the yesterday HIGH and LOW as a Stop Loss point for your Short/Long trades.
Use two Moving Averages of 55 EMA and 144 MA. You may place your stop loss just 10 pips below/above one of those two MAs depending on how do you set up the profit/loss game for your Long/Short trades.
Note#: If you trade on the range market break out be aware of this kind of Stop Loss setting, and it is quite safer to use another way.
Place the Stop Loss 10 pips over/below Bollinger Bands Upper/Lower band for Short/Long trades.
If you use Elliot Waves theory to analyze the market:
# Place the Stop Loss just 10 pips below the lowest point of the Second (2) wave in bullish trend when you LONG on Wave 3.
# places the Stop Loss 10 pips below the lowest point of the 4th Wave when you go for LONG on 5th Wave.
# Place the Stop Loss right above/below the top/low of the previous wave when you go for SHORT/LONG based on A-B-C correctional waves.

Notes:

Aforementioned suggestions are based on 4Hours chart.
Those ways of defining Stop Loss points has worked for me, but It does not necessarily works for you, so ask your mentor or an expert friend to do evaluate the probability of fitting those suggestions to your trading strategy.
10 pips are because sometimes price hit the important support or resistance levels by more than a touch.
Please don't forget, the Stop Loss issue is not actually a game. It is not even an option for you; it is a "MUST" and will save you when you can do nothing, so refresh your mind in this case.
Forward your questions right to my email address s.a.ghafari@iftc.ir , I'll try my best to give you the best answer. Good Lock

by S.A Ghafari

When Fear And Greed Take Over

2008-10-11T01:33:00.000-07:00

There is an old saying on Wall Street that the market is driven by just two emotions: fear and greed.Although this is an oversimplication, it can often be true. Succumbing to these emotions can have a profound and detrimental effect on investors' portfolios and the stock market.

In the investing world, one often hears about the juxtaposition between value investing and growth investing, and although understanding these two strategies is fundamental to building a personal investment strategy, it is as important to understand the influence of fear and greed on the financial markets. There are countless books and various courses devoted to this topic. Here our goal is to demonstrate what happens when an investor gets overwhelmed by one or both of these emotions.

Greed's Influence
So often investors get caught up in greed ("excessive desire"). After all, most of us have a desire to acquire as much wealth as possible in the shortest amount of time.
The Internet boom of the late 1990s is a perfect example. At the time it seemed all an advisor had to do was simply pitch any investment with a ".com" at the end of it, and investors leaped at the opportunity. Buying activity in Internet-related stocks, many just start-ups, reached a fever pitch. Investors got greedy, fueling further greed and leading to securities being grossly overpriced, which created a bubble. It burst in mid-2000 and kept leading indexes depressed through 2001. For more on the dotcom bubble and other market crashes, see Greatest Market Crashes.

This get-rich-quick mentality makes it hard to maintain gains and keep to a strict investment plan over the long term, especially amid such a frenzy, or as the former Federal Reserve chairman, Alan Greenspan, put it, the "irrational exuberance" of the overall market. It's times like these when it is crucial to maintain an even keel and stick to the basic fundamentals of investing, such as maintaining a long-term horizon, dollar-cost averaging and avoiding getting swept up in the latest craze.

A Lesson From "The Oracle Of Omaha"
We would be remiss if we discussed the topic of not getting caught up in the latest craze without mentioning a very successful investor who stuck to his strategy and profited greatly. Warren Buffett showed us just how important and beneficial it is to stick to a plan in times like the dotcom boom. Buffett was once heavily criticized for refusing to invest in high-flying tech stocks. But once the tech bubble burst, his critics were silenced. Buffett stuck with what he was comfortable with: his long-term plan. By avoiding the dominant market emotion of the time - greed - he was able to avoid the losses felt by those hit by the bust.

Fear's Influence
Just as the market can become overwhelmed with greed, the same can happen with fear ("an unpleasant, often strong emotion, of anticipation or awareness of danger"). When stocks suffer large losses for a sustained period, the overall market can become more fearful of sustaining further losses. But being too fearful can be just as costly as being too greedy.

Just as greed dominated the market during the dotcom boom, the same can be said of the prevalence of fear following its bust. In a bid to stem their losses, investors quickly moved out of the equity (stock) markets in search of less risky buys. Money poured into money market securities, stable value funds and principal-protected funds - all low-risk and low-return securities. In fact 2002 saw the largest amount of outflows, about US$40 billion, from the equity markets since 1988, a year after one of the worst stock market crashes in history, and a record $140 billion flowed into the bond market.

This mass exodus out of the stock market shows a complete disregard for a long-term investing plan based on fundamentals. Investors threw their plans out the window because they were scared, overrun by a fear of sustaining further losses. Granted, losing a large portion of your equity portfolio's worth is a tough pill to swallow, but even harder to digest is the thought that the new instruments that initially received the inflows have very little chance of ever rebuilding that wealth.

Just as scrapping your investment plan to hop on the latest get-rich-quick investment can tear a large hole in your portfolio, so too can getting swept up in the prevailing fear of the overall market by switching to low-risk, low-return investments.

The Importance of Comfort Level
All of this talk of fear and greed relates to the volatility inherent in the stock market. When investors lose their comfort level due to losses or market instability, they become vulnerable to these emotions, often resulting in very costly mistakes.

Avoid getting swept up in the dominant market sentiment of the day, which can be driven by a mentality of fear and/or greed, and stick to the basic fundamentals of investing. It is also important to choose a suitable asset allocation mix. For example, if you are an extremely risk averse person, you are likely to be more susceptible to being overrun by the fear dominating the market, and therefore your exposure to equity securities should not be as great as those who can tolerate more risk.
Buffett was once quoted as saying, "Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market."

Easier Said Than Done
Keep in mind this isn't as easy as it sounds. There's a fine line between controlling your emotions and being just plain stubborn. Remember also to re-evaluate your investment strategy and allow yourself to be flexible to a point, and remain rational when making decisions to change your plan of action.

Conclusion
You are the final decision-maker for your portfolio and thus responsible for any gains or losses in your investments. Sticking to sound investment decisions while controlling your emotions, whether it be greed or fear, and not blindly following market sentiment is crucial to successful investing and maintaining your long-term strategy. But beware: never wavering from an investment strategy during times of high emotions in the market can also spell disaster. It's a balancing act that requires you to keep your wits about you.

by Investopedia Staff,
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including more than 1,200 original and objective articles and tutorials on a wide variety of financial topics.

The Only Indicator You Need

2008-10-10T01:23:00.000-07:00

You should try to buy weakness and sell strength. That’s the crowd panicking. The problem is, how do you know they are getting in or getting out?
—Mark Twain, Discussions with Nikola Tesla

Many people are unaware that Samuel Clemens (Mark Twain) was a trader. During his time, traders were referred to as “Speculators” and they had a somewhat unsavory reputation. Speculators were seen as exploiters, making money from other people’s suffering or need.

The worst form of speculator was the carpetbagger who helped rebuild the South with Northern money after the U.S. Civil War. Clemens himself traded in cotton and grains but with little success, according to some biographies of his life.

At the time, the development of futures contracts was in its infancy. The Chicago Board of Trade was only founded in 1848 and probably wouldn’t have survived if futures contracts hadn’t caught the eye of the visionary industrialists and large farmers. Most of the attention that was focused on market opportunities revolved around the Industrial Revolution somehow.

Speculators were often involved in buying land that they hoped to sell to the railroads or lease for the right of way, buying steel to sell to ship builders, and so on. Only occasionally did speculators trade in futures for consumable commodities; it was still a new concept. But even then, during the late 19th century, people saw ahead to the explosive potential in financial markets, and a new class of finance evolved. In today’s world, financial brokers are the gateway between market opportunities and capital—even now when electronic trading typically bypasses the traditional brokerage relationship.

One thing that remains constant in the process of financial evolution is the concept of inside information. To this day, part of what people view as a trading edge is knowing something ahead of time that is potentially market moving. This is not quite the same thing as a tip. Getting a tip means being advised what to do by someone who allegedly knows something.

Market information or trading edge is more about finding a better way to do something that is already known to work. In the opening quote for this rule, it is apparent that Clemens understood the basic nature of the market and knew it could be exploited; his problem was getting the information required to know whether he was in the right place at the right time. This is where the whole business of analysis and indicators came from—an attempt to quantify market information to exploit what already works. The basics of trading have never really changed.

Remember, some of the biggest fortunes ever made from trading came at a time when the only tools available to traders were their guts, intuition, and knowledge of the crowd. I say this because, as you will have guessed by now, I put only a small part of my trade study into technical analysis. I know many will stop there and form some sort of value judgment.

They might assume that because I don’t use what they have used, and they are making money with it, I must not know what they know; perhaps I don’t know the experts they know, or maybe I just have an axe to grind. They might say I am not qualified to discuss technical analysis because I don’t use technical analysis the way they do. The proof is in the pudding, they would argue.

I say this about big-money traders and historical finance because success without analysis is factual history—not because I feel that analysis has no place in trading. Quite the opposite. Successful technical analysis can be a very important part of lasting trading success but, as discussed in Rule #15, like it or not, it can only go so far. The fact is that using technical analysis is like an unskilled carpenter using power tools. Without the basic knowledge of carpentry, an unskilled carpenter will make a wreck of house building when he is turned loose with better tools than he knows how to use. That brings us to this maxim of “the only indicator you need.”

But first we should clarify the thinking behind most of the indicators currently used. Most indicators and oscillators attempt to quantify the concept of overbought or oversold. The psychology behind this thinking is actually very sound, in my opinion. The idea that the market can get overextended in one direction or the other is not a new idea. It is one of the cornerstones of successful trading. That is one of the concepts that will work for successful traders.

The problem is not that the market can and will get overextended; the difficulty is in calculating when that point is reached. Oscillators and indicators are notorious for being lagging indicators for the simple fact that they are historical and not predictive. In most cases, due to the historical nature of these calculated mathematical concepts, they have often identified a reasonable overbought or oversold area but by the time the signal is verified, the 72-hour/bar rule (from Rule #25) has come into play.

The market you suspected was overextended has already begun correcting the other way, and usually that distance has been a substantial move already. Also, most oscillators and indicators are trend following; they help you get positioned in a trend but will never get you positioned at the turn. In addition, by the time the signal to enter the trend is verified and you execute, the very next correction will likely be right back to your entry price or a bit lower. No real progress in any case.

The newest class of oscillators and indicators attempt to be predictive in nature. Many of them are based on extremely complex computations that can only be done in real time by computers. We call traders who use them the “black box” traders. Again, there is nothing wrong with this kind of approach except that it simply cannot account for the most critical part of trading: What is the crowd thinking?

It is crucial to remember when you are using oscillators or indicators of any kind that they are only mathematical computations. They are all moving averages in various degrees of complexity and performance. They are based on assumptions about the nature of markets and they work under the theory of probabilities. Behind all of these attempts to find a better way to do what is already known to work is the issue of historical versus predictive. If you are willing to accept that indicators, oscillators, and technical analysis are historical and not predictive, you are left with the only indicator you really need: Who is getting in and who is getting out?

That brings us to the study of volume and open interest. In my view, this is the only indicator you really need because this is the only indicator that discloses fairly accurately what the crowd is thinking. Either people are getting into the market or they are leaving the market. Since we already know that most active traders are losing every day, then we know that a change in open interest means people don’t want to play, are convinced they will win, or can’t take the pain any more. If open interest rises we can fairly safely assume that traders are confident to get into the market from both sides. If open interest is dropping we can safely assume the losers can’t take the heat anymore. If all of this is accompanied by higher or lower volume, then we can fairly safely judge the level of fear, panic, or hope that traders are expressing.

Now, to be fair with everyone, correctly reading volume and open interest is not as simple as I make it sound. But the underlying psychology will always be the same. By understanding the relationship between price action, volume, and open interest, you can get a fairly accurate read on what the crowd is thinking. Of course, this is an art form and not science.

Markets can change in character in a heartbeat and your understanding of V/OI may have been completely accurate 20 minutes ago but at this precise moment something has changed. That is the dynamic part of trading and part of what makes V/OI so useful. V/OI is the first indicator developed, and everything after is an attempt to improve upon what V/OI can do with one important difference: V/OI has no time/price relationship.

V/OI is historical from the point of view that it discloses how big the market is or whether that has changed somewhat. V/OI also discloses how thick the market is and whether that, too, is changing. When you combine this information with a price advance or decline, you can discern whether more shorts or longs are opening positions or covering, whether they are executing more often or not, whether they are losing confidence in their positions, and a host of other types of information that make it possible to anticipate (not predict!) what is most likely to happen next.

Once the market closes for the day and this data is compiled and released by the exchanges, you have a fairly accurate picture of the mind of the market when you compare what you see to the price action and other indicators. But because V/OI has no time/price component, you may see clearly that the market is setting up for a price advance or decline but there is no way to know how soon or how fast that change in price will occur.

Although V/OI is the single most important indicator because it discloses the most likely thought process behind how prices got to be where they are, it still cannot predict or expose whether that thought process is ripe for change or whether the change is imminent. That is the whole purpose of all the so-called improved indicators and oscillators: to find the time/price relationship for that imminent change. The V/OI indicator shows you it is there; the others try to say the time is now.

If you personally had to choose between the two indications, “Something in the market has changed” and “Whatever is coming, it will come at 11:00 A.M. tomorrow,” which would you rather have? In the case of the markets, knowing that something has changed is the better choice because only one option is available: a reversal in price. Does it really matter if that reversal happens in the coming 20 minutes or if it will take 20 days, as long as you know that the change will most likely be in only the other direction?

As I have said many times before, I am not trying to oversimplify the issue of timing your trades. My intention is to help you understand that the first and best indicator will always be volume and open interest because it provides a more critical component: the issue of a change to the structure of the market. In most cases, a change to the structure of the market means a price reversal of some kind because the traders who put the price where it is are no longer in the market. The thinking of the crowd has changed. Just knowing that piece of information can give your trading a distinct advantage. You just don’t know precisely when the change will result in a price reversal.

Before we close out this rule I want to sum up a few things. First, the study of V/OI is not a small one. You need to make a consistent effort to understand how V/OI can and does change. It would be impossible in this book to have a discussion about all the different ways you can begin to interpret V/OI in the space we have. I have included titles in the Recommended Reading section that will help you better understand this important market study. Second, you must remember that all the other indicators and oscillators developed in the past 150 years are attempts to better quantify the price/time relationship with V/OI as the foundation to start from. V/OI quantifies the depth and nature of the game as it has been played to date; V/OI tells you a change has happened or is happening. What you do with that data is a reflection of your skill at anticipating what is likely to happen next based on your understanding of the crowd’s needs.

Last, V/OI is never predictive. No indicator or oscillator can be predictive. No form of analysis can predict future price action with any degree of consistency. The important issue is to have the tools you need, and to know how to use them to improve upon what already works.

Samuel Clemens and the traders of his era didn’t have V/OI or any other indicator. If he did, he would have known exactly how to use it and what it means because he understood the basics to begin with. Focus your energy on learning the basics, then understanding V/OI. At that point the rest of your trading stands a good chance of falling into place as a winning approach.

A Brief History Of The Hedge Fund

2008-10-09T01:20:00.000-07:00

Famed hedge fund manager Mario Gabelli wrote in 2002: "Today, if asked to define a hedge fund, I suspect most folks would characterize it as a highly speculative vehicle for unwitting fat cats and careless financial institutions to lose their shirts." This characterization stems from the hedge fund's recent history, which began with the headline-making collapse of Long Term Capital Management in 1998 and continued with the sensational meltdown of the Tiger Funds in March of 2000, followed by the reorganization of the once high-flying Quantum Fund in April of 2000. These high-profile incidents overshadow more than half a century of hedge fund history that began when Alfred Winslow Jones launched the first hedge fund in 1949.

The Father of the Hedge Fund
Alfred Jones was born in Melbourne, Australia in 1901 to American parents. He moved to the United States as a young child, graduated from Harvard in 1923 and became a U.S. diplomat in the early 1930s, working in Berlin, Germany. He earned a PhD in sociology from Columbia University and joined the editorial staff at Fortune magazine in the early 1940s.

It was while writing an article about current investment trends for Fortune in 1948 that Jones was inspired to try his hand at managing money. He raised $100,000 (including $40,000 out of his own pocket) and set forth to try to minimize the risk in holding long-term stock positions by short selling other stocks. This investing innovation is now referred to as the classic long/short equities model. Jones also employed leverage in an effort to enhance returns.

In 1952, Jones altered the structure of his investment vehicle, converting it from a general partnership to a limited partnership and adding a 20% incentive fee as compensation for the managing partner. As the first money manager to combine short selling, the use of leverage, shared risk through a partnership with other investors and a compensation system based on investment performance, Jones earned his place in investing history as the father of the hedge fund.

The Rise of the Industry
When a 1966 article in Fortune magazine highlighted an obscure investment that outperformed every mutual fund on the market by double-digit figures over the past year and by high double-digits over the last five years, the hedge fund industry was born. By 1968, there were some 140 hedge funds in operation.

In an effort to maximize returns, many funds turned away from Jones' strategy, which focused on stock picking coupled with hedging, and chose instead to engage in riskier strategies based on long-term leverage. These tactics led to heavy losses in 1969-70, followed by a number of hedge fund closures during the bear market of 1973-74.

The industry was relatively quiet for more than two decades, until a 1986 article in Institutional Investor touted the double-digit performance of Julian Robertson's Tiger Fund. With a high-flying hedge fund once again capturing the public's attention with its stellar performance, investors flocked to an industry that now offered thousands of funds and an ever-increasing array of exotic strategies, including currency trading and derivatives such as futures and options.

High-profile money managers deserted the traditional mutual fund industry in droves in the early 1990s, seeking fame and fortune as hedge fund managers. Unfortunately, history repeated itself in the late 1990s and into the early 2000s as a number of high-profile hedge funds, including Robertson's, failed in spectacular fashion.

The Hedge Fund Today
With media attention still focused on the recent failure of some hedge funds, there has been an increasing move towards their regulation. In 2004, the Securities and Exchange Commission adopted changes that require hedge fund managers and sponsors to register as investment advisors under the Investment Advisor's Act of 1940. This greatly increases the number of requirements placed on hedge funds, including keeping up-to-date performance records, hiring a compliance officer and creating a code of ethics. All hedge funds that fall under the new SEC rules must be registered by Feb 1, 2006. This is seen as an important move in protecting investors.

Despite troubles in the last few years, the hedge fund industry continues to thrive. The development of the "fund of funds", which is simplistically defined as a mutual fund that invests in multiple hedge funds, provided greater diversification for investors' portfolios and reduced the minimum investment requirement to as low as $25,000. The introduction of the fund of funds not only took some of the risk out of hedge fund investing, but also made the product more accessible to the average investor.

Conclusion
Hedge funds have evolved significantly since 1949. Modern hedge funds offer a variety of strategies, including many that do not involve traditional hedging techniques. The industry has also rapidly grown, with recent estimations pegging its size at $1 trillion - quite the leap from the $100,000 used to start the first fund half a century ago.

With a fascinating past that has twice seen media-fostered publicity push the industry to stratospheric highs and vilify it when it fell from grace, it seems highly probable that the cycle will repeat itself at some point in the future. While it is easy to get sucked in by the hype or repelled by the negative press, it's always advisable to take a step back and conduct some due diligence, just as you would prior to making any investment.
Before you put your hard-earned money at risk, you have to make sure you are choosing the right investment for the right reason. Don't blindly chase performance, and remember that past performance is not an indicator of future performance.

by Jim McWhinney, investopedia.com

Trading Psychology And Discipline

2008-10-08T01:17:00.000-07:00

There are many characteristics and skills required by traders in order for them to be successful in the financial markets. The ability to understand the inner workings of a company, its fundamentals and the ability to determine the direction of the trend are a few of the key traits needed, but none of these is as important as the ability to contain emotions and maintain discipline.

Trading Psychology
The psychological aspect of trading is extremely important, and the reason for that is fairly simple. A trader is often darting in and out of stocks on short notice, and is forced to make quick decisions. To accomplish this, they need a certain presence of mind. They also, by extension, need discipline, so that they stick with previously established trading plans and know when to book profits and losses. Emotions simply can't get in the way.

Understanding Fear
When a trader's screen is pulsating red (a sign that stocks are down) and bad news comes about a certain stock or the general market, it's not uncommon for the trader to get scared. When this happens, they may overreact and feel compelled to liquidate their holdings and go to cash or to refrain from taking any risks. Now, if they do that they may avoid certain losses - but they also will miss out on the gains.

Traders need to understand what fear is - simply a natural reaction to what they perceive as a threat (in this case perhaps to their profit or money-making potential). Quantifying the fear might help. Or that they may be able to better deal with fear by pondering what they are afraid of, and why they are afraid of it.

Also, by pondering this issue ahead of time and knowing how they may instinctively react to or perceive certain things, a trader can hope to isolate and identify those feelings during a trading session, and then try to focus on moving past the emotion. Of course this may not be easy, and may take practice, but it's necessary to the health of an investor's portfolio.

Greed Is Your Worst Enemy
There's an old saying on Wall Street that "pigs get slaughtered". These little pigs want more and more. This greed in investors causes them to hang on to winning positions too long, trying to get every last tick. This trait can be devastating to returns because the trader is always running the risk of getting whipsawed or blown out of a position.

Greed is not easy to overcome. That's because within many of us there seems to be an instinct to always try to do better, to try to get just a little more. A trader should recognize this instinct if it is present, and develop trade plans based upon rational business decisions, not on what amounts to an emotional whim or potentially harmful instinct.

The Importance Of Trading Rules
To get their heads in the right place before they feel the emotional or psychological crunch, investors can look at creating trading rules ahead of time. Traders can establish limits where they lay out guidelines based on their risk-reward relationship for when they will exit a trade - regardless of emotions. For example, if a stock is trading at $10/share, the trader might choose to get out at $10.25, or at $9.75 to put a stop loss or stop limit in and bail.

Of course, establishing price targets might not be the only rule. For example, the trader might say if certain news, such as specific positive or negative earnings or macroeconomic news, comes out, then he or she will buy (or sell) a security. Also, if it becomes apparent that a large buyer or seller enters the market, the trader might want to get out.

Traders might also consider setting limits on the amount they win or lose in a day. In other words, if they reap an $X profit, they're done for the day, or if they lose $Y they fold up their tent and go home. This works for investors because sometimes it is better to just "go on take the money and run," like the old Steve Miller song suggests even when those two birds in the tree look better than the one in your hand.

Creating A Trading Plan
Traders should try to learn about their area of interest as much as possible. For example, if the trader deals heavily and is interested in telecommunications stocks, it makes sense for him or her to become knowledgeable about that business. Similarly, if he or she trades heavily in energy stocks, it's fairly logical to want to become well versed in that arena.

To do this, start by formulating a plan to educate yourself. If possible, go to trading seminars and attend sell-side conferences. Also, it makes sense to plan out and devote as much time as possible to the research process. That means studying charts, speaking with management (if applicable), reading trade journals or doing other background work (such as macroeconomic analysis or industry analysis) so that when the trading session starts the trader is up to speed. A wealth of knowledge could help the trader overcome fear issues in itself, so it's a handy tool.

In addition, it's important that the trader consider experimenting with new things from time to time. For example, consider using options to mitigate risk, or set stop losses at a different place. One of the best ways a trader can learn is by experimenting - within reason. This experience may also help reduce emotional influences.

Finally, traders should periodically review and assess their performance. This means not only should they review their returns and their individual positions, but also how they prepared for a trading session, how up-to-date they are on the markets and how they're progressing in terms of ongoing education, among other things. This periodic assessment can help the trader correct mistakes, which may help enhance their overall returns. It may also help them to maintain the right mindset and help them to be psychologically prepared to do business.

Bottom Line
It's often important for a trader to be able to read a chart and have the right technology so that their trades get executed, but there is often a psychological component to trading that shouldn't be overlooked. Setting trading rules, building a trading plan, doing research and getting experience are all simple steps that can help a trader overcome these little mind matters.

Courage, Confidence And Discipline

2008-10-07T01:12:00.000-07:00

If many people have made fortunes from the stock market (true also for the commodities and currency markets), and if they have accomplished their fortunes in different times and in different ways, then clearly it is not the methodology that they employed, nor is it the circumstance when they executed their trades that was the common denominator for their achievements. Obviously, circumstance and methodology were critical components of their success, but neither of them was the common denominator.

Execution is the ability to plan a trade and then to trade the plan in such a skillful way that there is a positive outcome. All markets exhibit three powers or forces that need to be harnessed and understood in order for a trader to execute his or her plan properly. Firstly, there is motive which is governed by price. Price is the motivator, is it cheap or expensive? Should I be buying or selling? Then there is pressure, governed by volume. Who else is buying or selling and how strong is the consensus? Finally there is resistance or circumstance governed by time. Time is the circumstance of the trade. “When,” is answered by the question, "Is this the appropriate circumstance?"

Money always chases the twin forces of “safety and yield.” That is, money will very quickly flow towards the safest haven offering the highest yield. This flow will be governed by the “prevailing perception” of the circumstances surrounding the flows of money.

As long as the same perception prevails, we will have a trend and therefore there is a natural tendency to stay with or conform to the prevailing perception. Our tendencies are governed by the phenomenon of a “crowd mind," which is a mind that is made up of the sum total of all the individuals making up the crowd yet which displays its own unique characteristics. By conjoining with the crowd thought we believe we will find safety and yield. Thus it is said that “the trend is our friend.”

To move out of the trend is to recognize changing circumstances that will cause the trend or “prevailing circumstance” to alter its direction. Recognizing this seed of change early enough and positioning ourselves for the change takes courage, confidence and discipline and are indeed the common characteristics of all the traders or investors who have made fortunes in the market.
Thus, “the trend is our friend – until it ends.”

So if success is the ability to recognize the seeds of change early enough and to have the courage, confidence and discipline to act accordingly, it behooves us to assemble these qualities within our own psyche. Our total psyche is a combination of head (rational thought), heart (conviction of feeling) and gut (intuitive confidence born out of experience). Melding these three qualities together takes technique and discipline. Discipline is what is needed to practice these techniques. The good thing is that there are techniques to practice which will accomplish this goal and each one of us can do so at our own pace and according to our own temperament and intensity of desire, i.e., how much do we really want it?

Here is a truism that sticks well in my mind.

“Sow a thought – reap an action,
Sow an action – reap a habit,
Sow a habit – reap a character,
Sow a character – reap a destiny.”

It seems to me that that we need to explore our habits and, if necessary. change them if we wish to achieve the success that is available to us in the markets or, for that matter, in any aspect of our lives. Habits endure since they have been formed since we were born and some say before that, as a result of many lifetimes of accumulation. Whatever the reason, they definitely endure. Hence, we need techniques to help us change our habits and we need the desire to do so. The question is, where do we get this desire?

Desire is built from motivation. Motive is of course the synergy of:
a) having a target
b) a passion to reach that target because of
c) an ideal greater than the target itself and
d) an urgency to arrive at the target.

Picture a table with four legs. Each leg is a symbol of one of the above four qualities. Leg 1 is “passion”. Being all fired up.

Leg 2 is “target,” a clearly defined objective. (Being fired up with no clearly defined objective, one runs the risk of wasting or dissipating one’s energy.) A target focuses energy.

Leg 3 is an ideal greater than the target itself. If the target is money or profit, then the ideal is the reason for acquiring the money or profit. There must be some higher good that makes having the money all the worth while. Finally leg 4 is “Urgency”. There is only NOW. Now is the only time to propel yourself to the target.

The past is history and the future does not exist. Plant the seed now.
So the first technique is to build motivation by defining your target, being truthful enough with yourself to know if you have passion for that target, align yourself with a higher purpose than just money and recognize that now may be the only chance you will ever have to do it.

Once we are motivated we have to adopt a realistic approach to our thinking. We have to find clarity or otherwise be faced with confusion. In our second technique we have 3 objectives:

a) to establish our position or belief system based on research and experience or in other words to determine what we stand for. (If we don’t stand for something, we will fall for anything)
b) align ourselves with the flow of the market
c) manage our emotions.

In this regard I would like to refer you to one of the best sources of techniques for accomplishing theses objectives. Please do yourselves the favor of studying Dr. Richard McCall’s book called The Way of the Warrior Trader. Although Dr. McCall is a trained psychologist, he is also a highly trained Samurai fighter who also teaches Samurai philosophy to traders. What he does so well in his book is to introduce his students to other forces than the intellect for making trading decisions and reaching clarity. Clarity means getting into the zone. Proper posture and breathing techniques and the control of the Ki energy are aspects of all martial arts. In trading, as with martial arts, one needs to bring these factors into account when training oneself to change one’s habits.

The conflict is not with some other person on the other side of the trade who is out to get you but it is with your own habits deeply ingrained within yourself that inevitably will “get” you.

So practicing yoga or martial art techniques to balance one’s energy and shape one’s thought patterns becomes the basis to restructure our habit molds and thereby recondition ourselves for a different outcome. This will occur quickly or slowly depending on the individual. Unfortunately, this column cannot be the forum for all those details. Suffice is it to say that building a strong and balanced posture both physically and mentally, calming the mind through proper exercise and breathing techniques and employing a tool to help the mind keep focused can be very very helpful.

A helpful tool that Dr. McCall uses is the acronym A.C.T.I.O.N.

A - stands for ACCEPT – accept your loss upfront so that you can be free of it. If you know you can only lose 2% of your equity and you have truly accepted that fact before you enter the trade, you will not have to focus on losing during the trade. You will be able to focus on executing your plan or strategy instead. You will not fall victim to the problem of dollar counting.

C - stands for CENTER – center yourself so that your strategy, your energy and your belief system are all in balance. Do this with correct posture and breathing, a single strategy and repetition.

T - stands for TRUST. Trust your strategy. Trust yourself to execute your strategy, which you will be able to do if you have tested it enough to calculate an expectancy ratio. Without completing this step you will never have the confidence that is required to catch big tigers.

I - stands for IMAGINATION or better yet IMAGE-IN-ACTION. Visualization informs the subconscious with new feelings and thoughts which will replace old feelings and thoughts. The subconscious does not differentiate between something done or something visualized, as long as what is visualized is done so with the same intensity as if it was an actual experience. Therefore practice positive visualization, not positive thinking.

O - stands for ONLY. Only focus on managing the trade you are in. Watch the Tiger carefully. If you lose your focus (bad habit) he will get you.

N - stands for NEVER look back. Let old Tigers go away. That is, NEVER dwell on a past loss, it will erode your confidence and rob you of any courage. Have discipline. Just as in fishing when you bait a hook you will sometimes lose some of your bait. Trading is no different and to catch a tiger you will have to use live bait.

So in the end it seems to me that to be successful at trading, especially at finding and catching the big “Tiger-trades,” one has to assemble a total strategy based on defining one’s objectives, researching and understanding a strategy or methodology, putting it to work in a suitable time frame or at the appropriate time and then finally committing resources in a controlled and thoughtfully managed way.

For me it has come down to the development of courage, confidence and discipline on a personal level and the modification of bad habits which ultimately must be replaced with the correct habits for success. This is an ongoing process and one which can take many years. Markets change their dynamics and even if there are patterns that repeat themselves, the circumstances are usually different.

Individuals change too and in the final analysis, success will come from the aligning of one’s individual dynamics with that of the market. This aligning process is never ending. How well we do it will determine our success and define our own special “holy grail."

All I can say is that I have found Tiger Trading a very enriching experience, sometimes even at the expense of making money. Hopefully, though I will endure and become an expert at Catching the Tiger Trade and my wishes are that you will too. Trading Markets has provided a forum for me to express my overall approach for which I am grateful, the objective of which has been a learning experience for me as well. I wish all of you therefore “Happy Trails.” ( In the words of Arlo Guthrie, I don’t wanna die, just wanna ride on my Uni-cy-cle).

Selwyn Gishen

HEDGE FUND INVESTMENT STRATEGIES

2008-10-06T01:09:00.000-07:00

Hedge funds invest in CDOs with three different strategies:
1. Carry trade;
2. Long/short structured credit;
3. Correlation trade.

These strategies enable hedge fund managers to express certain views on credit markets efficiently.

Carry Trade
This is the easiest and riskiest CDO strategy and consists of buying the equity tranche of CDOs. The return generated by the equity tranche depends on the leverage, the maturity and the composition of the basket of credit forming the CDO. Purchasing CDO equity tranches is equal to selling credit protection.

In June 2003, a hedge fund bought Fixed Income Senior Notes for a par value of $5.5 million (hereafter called simply “Notes”) totaling $148 million. These Notes were part of the CDO tranche with the higher claim collateralized by a private placement of high-yield bonds carried out in 1998. The issuance also included another tranche of Senior Notes, characterized by a floating rate for a par value of $34 million.

The Notes subscribed by the hedge fund were due on August 2010 and paid a fixed 6.71% yearly coupon. Technically the issue had defaulted, and the rating of the tranche subscribed by the hedge fund had deteriorated, going from AA3 in 1998 to Baa3 in 2002, turning into a “container” receiving all the capital and interest payments, which were used to pay Senior Notes first, both at a fixed and floating rate, and Subordinated Notes next.

At the time of purchase in June 2003, the par value of the Notes was $4.26 million and the hedge fund bought them for $3.63 million. The Notes were then bought for a price of 85.27 cents, at a substantial discount on the liquidation value of 94.73 cents.

At the time of purchase, the hedge fund had made a conservative assumption according to which 30% of the high-yield bonds would default and the recovery rate would be of 28 %. As a result, the internal rate of return had been fixed at 13.64 %. The investment was expected to be paid back in 3.5–4 years.

At the time of purchase, the underlying portfolio comprised 117 high-yield bonds characterized by an average price of 74.97 cents, including defaulted securities. The initial analysis conducted by the hedge fund also included the expectation that over the short term the default rate of the collateral high-yield bonds would rise, only to decrease again during the residual life of the securities.

Two months after the Notes had been purchased by the hedge fund, $949 786 had been paid out in terms of capital redemptions for the underlying high-yield notes (accounting for more than 25% of the initial original cost incurred by the hedge fund), against an initial estimate of $500 000. Over the same period, $142 808 worth of interest were also paid out. Moreover, the price of the Notes grew significantly with respect to the initial cost incurred by the hedge fund.

The improved performance of the collateral and the higher than expected capital redemptions generated a return on investment of 15.88 %, well above the estimated 13.64 %.

Long/short Structured Credit
This strategy’s objective is to generate absolute returns, regardless of economic and market conditions such as credit spread moves and the general direction of interest rates. The strategy is naturally long credit and benefits from spread tightening. The effect of market spread widening on long positions can be offset by the manager’s ability to short credits that widen more than the general market in a deteriorating environment. The fund employs fundamental credit analysis to determine long and short relative-value positions in different corporate credits. The fund expresses long views through the purchase of CDO equity tranches, and short views through the purchase of single-name Credit Default Swaps.

The long position in CDO equity tranches locks in positive carry. Furthermore, the ability of the hedge fund manager in performing the credit analysis on the companies underlying the CDO generates the trading ideas: a CDO is a basket of credits and the manager can choose inside this basket the credits he wants to be long or short. So the manager can take advantage of opportunities ranging from sector allocation, allocation to single companies and relative-value trading. Finally, the manager can limit the downside from spread widening through the long positions in credit default swaps.

The ideal portfolio built with long positions in CDO equity tranches and with long positions in CDS can have a convexity return profile: an instantaneous equal proportional shift in all spreads, assuming correlation remains constant, should have positive returns irrespective of spread moves. The most difficult challenge for a hedge fund manager implementing this strategy is the
ability to manage the correlation risk among the CDO tranches.

Correlation Trade
CDOs are a recent innovation that enable investors to buy (or sell) limited protection on credit portfolios. The protection attaches (and detaches) once the portfolio realizes certain default losses. The proper compensation for bearing this specialized risk depends not only on the individual portfolio credits, but also on their prospective dynamics, including their prospective interplay. People use the term “correlation” to discuss this interplay, and the term “correlation trading” to capture involvement in these tranched portfolio protection products.

In a correlation trade, credit protection is sold via the purchasing of CDO equity tranches delta-hedged with credit default swaps (CDS). The correlation trade consists of assuming a long position in the equity tranche of a certain CDO and a simultaneous short position in the mezzanine tranche (or a more senior tranche) of the same CDO, in the attempt to take advantage of the spreads among the different tranches of the CDO. This way the hedge fund is long the implied correlation among the CDO tranches.

Note that the implied correlation is primarily a market-based factor, driven by the demand and supply of protection for each individual CDO tranche. This trade has a positive carry, and returns can be generated if the credit spreads in the underlying portfolio move in a parallel way, that is, widen or shrink simultaneously. The correlation trade is exposed to the risk of an unexpected default in the underlying CDO portfolio but, given that in 2005 the prevailing default rate is at historically low levels, many hedge fund managers are comfortable with assuming that risk.
Some investors are reluctant to embrace correlation trading as a model-driven arbitrage strategy.

On 4th May 2005, Tracinda Corp., a company that already owned about 4% of General Motors, offered $870 million to acquire 4.95% of General Motors, and GM shares at the end of the day jumped by 18.1 %. On 5th May 2005, Standard & Poor’s had downgraded the GM bonds (from BBB– to BB) to the status of “junk bond”, maintaining a negative outlook.

This was a surprising capital structure movement, where the riskiest part of the capital, equities, jumped at a time when the less risky part of the capital, bonds, dropped. Many hedge funds were positioned in a correlation trade: they had short positions (buy protection) in CDO senior tranches and long positions (sell protection) in CDO equity tranches, delta-hedging with single-name CDS or iBoxx index. This correlation trade expected implied correlation to increase and had positive carry.

Because of the downgrade of GM, the equity tranche of many CDOs declined sharply while the mezzanine tranche soared because of a “fly to quality” movement. This means that the spreads moved in a non-parallel way. Merrill Lynch estimated that the CDO correlation trades in April lost 12 %, and for some hedge funds this loss was worsened by the use of leverage.

CONCLUSIONS
The important point to note is that these new strategies are relatively untried and untested in periods of market stress, and hence investors could underestimate certain risks, i.e. correlation.

This article is a part of “Investment Strategies of Hedge Funds” ebooks by Filippo Stefanini for closed private educations only. You should nuy his books for the best completely informations.

The Greatest Investors: James D. Slater

2008-10-05T01:07:00.000-07:00

Born:	U.K., in 1929
Affiliations:	Leyland Motor Corporation Slater Walker Securities BioProjects International PLC Galahad Gold PLC
Most Famous For:	The author of an investment column in London's The Sunday Telegraph under the pen name of "The Capitalist," which became a forum for publicizing his personal stock investment methodology. His strategies were one of the first to be made widely available to the investing public in the U.K. Jim Slater is credited with inventing the price-earnings to earnings-growth ratio (PEG) and popularizing its use in America through his book, "The Zulu Principle" (1992).

Personal Profile
Slater began his career as a chartered accountant and then moved into corporate managerial positions from 1953 to 1963 with three different U.K. manufacturing firms, the last of which was the prominent Leyland Motor Corporation. In 1964, he and Peter Walker founded an investment company called Slater Walker Securities. Through this firm, Slater became famous as a major player in the U.K. in aggressive corporate takeovers, building Slater Walker into a significant industrial and financial conglomerate, which, in 1969, evolved into an investment bank.

Unfortunately for Slater, his successful career in investment banking came to an abrupt end with the collapse of Slater Walker Securities during the U.K.'s 1973-74 recession, leaving Slater personally bankrupt.

He fought his way back to solvency through private investing and launched a career as a financial writer. His widely read investment column, "The Capitalist," and an extremely popular investment advisory service called "Company REFS," which provided "really essential financial statistics" on all publicly traded U.K. companies, positioned Slater as an investment guru.

He became known as one of his country's most successful professional investors. A parallel career as an educator of individual investors and as an author of children's books flourished. In 2007, he remained active today as a major investor in a variety of small, growth-oriented companies.

Investment Style
The stock picking strategy that Slater employed developed from the columns he wrote under the pseudonym "Capitalist" in London's Sunday Telegraph, and which subsequently formed the basis for his "Zulu Principle" of investing. Slater's favored type of investment was the small growth company that was undervalued by the market - a so-called hidden gem. At the core of his methodology is his focus on finding small growth stocks before they hit the big time.

The main tool, which Slater invented and popularized to find this type of stock, was his pioneering price-earnings to growth ratio, or PEG. This equation combines growth and value investing. The formula compares a company's price-earnings ratio with its expected, or estimated, earnings per share growth rate.

Slater realized that a P/E ratio didn't mean that a stock was expensive as long as its earnings growth was high. For example, if company's stock was at a relatively high P/E of 30, but its earnings were expected to grow at a rate of 30%, it would have a PEG of 1, which is generally considered a very favorable value relationship. Slater pioneered the use of the PEG ratio, which today is widely used in investment analysis.

Publications

"Investment Made Easy" by Jim Slater(1995)
"The Zulu Principle: Making Extraordinary Profits from Ordinary Shares" by Jim Slater (1992).
"Beyond The Zulu Principle: Extraordinary Profits From Growth Shares" by Jim Slater(2000)
"How To Become A Millionaire" by Jim Slater(2000).
"Make Money While You Sleep" by Jim Slater (2002).

Quotes

"Most leading brokers cannot spare the time and money to research smaller stocks. You are therefore more likely to find a bargain in this relatively under-exploited area of the stock market."

Highlighting what Slater thought was the inherent greater potential for the growth of smaller companies, he said, "I once compared a very large company with an elephant by making the comment that elephants don't gallop."

"You get out of an investment what you put into it, so the first decision you have to make is how much time you are prepared to devote to the initial task of acquiring a basic knowledge of investment.

Investopedia.com

Ten Things to consider before you trade

2008-10-04T01:04:00.000-07:00

If you’re just starting to trade, the sooner you develop
a realistic attitude about the markets, the better off you’ll be.
TRADING Basics - BY ACTIVE TRADER STAFF

Because trading is an entrepreneurial profession that requires you risk money to make money, it pays to adopt a prudent, conservative attitude toward the markets. Here’s some advice for traders who are getting ready to dip their toes in the trading pool — with a focus on capital (and sanity) preservation rather than fast riches.

1. Don’t be in a rush to trade.
The markets will be there tomorrow, next week, next year, and next decade. Don’t worry about missing the move of a lifetime when you’re testing and paper trading on the sidelines. There are always opportunities somewhere — you lose nothing by investing time educating and preparing yourself.

2. Don’t trade without a reason.
When you finally start trading, don’t trade just because you feel you have to, or out of boredom, or impetuousness. Only risk your money when you have evidence a favorable trade opportunity is present and you have a plan for taking advantage of it.

Also, don’t “revenge trade.” If you suffer a sizable loss or string of losses, it can be tempting to try to trade bigger and more frequently to get the money back as soon as possible. Needless to say, this course of action almost inevitably amounts to throwing good money after bad.

3. Don’t use leverage just because it’s there.
There’s no law that says you have to trade on margin, in any market. The more leverage you use, the more you’re increasing your risk. Leverage is a tool that will benefit you only if you know how to wield it, and that takes time.

4. Beware of early success.
A rash of successful trades early in your career would hardly be a rarity. It’s one of the little tricks the markets play on us — we knock off a few good trades early on and we’re convinced we’re brilliant market players.
There is such a thing as beginner’s luck, and it manifests itself in trading, too, so don’t get overconfident. Many traders who lost money early in their careers were thankful — in retrospect — because it gave them a realistic perspective of the challenges and risks of trading.

Even with experience, it’s difficult to fight off the highs and lows that come with winning streaks and losing streaks. Atrader on a hot streak is more likely to unnecessarily increase trade size — just in time for a big losing trade. It’s difficult, but strive to accept both losses and gains with an even temperament.

5. Do your own work, think for yourself.
“The essence of knowledge is experience, and the essence of experience is self reliance.” This quote from T.H. White’s book, The Once and Future King, succinctly describes a large part of what trading proficiency is all about.

We are somewhat programmed in our culture to think that for any problem or need, there’s a product, pill, or service we can purchase that will allow us to achieve our goals. While it may be tempting to rely on someone else’s trade idea, research, recommendation, or system, we have found that the most progress comes when you do your own analysis, form your own hypotheses, and rely on your own decision making.

It’s also true that studying the work of others is part of a trader’s education, and that there are many ideas in the public domain that can contribute to a successful trading plan. (If nothing else, learning for yourself will make you an informed consumer of others’ ideas.) But there are no shortcuts. Many experienced traders have said that even a successful trading system will fail if it is not executed properly, and the reality is it’s very difficult to put complete trust in something that is not yours — especially if you don’t fully appreciate its nuances and understand why it works and when its likely to fail. That kind of confidence in a trading idea comes primarily from doing your own work and understanding a concept from the ground up. Trade ideas you understand and make sense to you.

6. If it sounds too good to be true, it probably is.
Whether it’s a trading system, hot tip or indicator, anything that promises big bucks and/or virtually no risk is something to avoid. There are no shortcuts in trading — it’s a challenging business that has made mincemeat of swaths of Ph.D.s and successful professionals from other fields. There’s no such thing as a trading strategy that is correct 95 percent of the time, generates six figures per month, and has no downside risk. Be a skeptic. Get corroboration for any trading idea you’re interested in, including the ones you think of yourself.

7. Focus on trade ideas you can define objectively, research extensively, and test intensively.
Vague trading ideas — e.g., “Buy when the market is oversold and sell when you have a nice profit in hand” — produce uncertain results. The trick is to turn market observations and hypothesis into concrete rules you can test on past price data. For example, what constitutes “oversold”? It could mean anything. An objective rule might be, when a market has made lower lows and lower closing prices on five consecutive days. Whether or not this definition turns out to be a good buy signal is something you have to determine objectively through research and testing.

8. Keep a trade journal and review your performance on a regular basis.
Regardless of their background or approach — investing, short-term trading, technical, quantitative, fundamental — virtually all good traders we’ve talked to agree about the immense benefits of maintaining a log of all your trades and
learning from past experiences.

9. Be patient.
In any case, trading is not as easy as it may first appear. It takes time to master any discipline or profession. Would you expect to become a good musician, doctor, or engineer in a single year?
On top of a natural learning curve, trading also happens to be a profession — unlike music, medicine, or law — in which you can lose money on any given day rather than make it. “Wages” are not guaranteed.
Persevere: Success comes with hard work. Some traders go years without a profit before they finally get on track. Remember, the markets will always be there.

10. Have adequate capitalization/trade within your limits.
Undercapitalization dooms most new businesses, and trading is no exception. Not having enough money to trade renders every other point on this list moot.
Also, when you first trade, do it at an equity level that’s even more conservative than your projected minimum. Start out slow. For example, if you’ve determined you have enough money in your trading account to execute a certain trading
strategy using 500-share trade lots of stocks priced below $30, consider starting out trading 100 or even 50 shares at a time until you’re comfortable with your strategy, execution process, brokerage, and the psychological challenge of risking real money. Then, increase your trade size gradually.

Aiming for the Right Target in Trading by Walter T. Downs

2008-10-03T01:02:00.000-07:00

When trading goes right, it can be a great feeling. When trading goes wrong it can be a nightmare. Fortunes are made in a matter of weeks and lost in a matter of minutes. This pattern repeats itself as each new generation of traders hit the market. They hurl themselves out of the night like insane insects against some sort of karmic bug-light; all thought and all existence extinguished in one final cosmic "zzzzzzt". Obviously, for a trader to be successful he must acknowledge this pattern and then break it. This can be accomplished by asking the right questions and finding the correct answers by rational observation and logical conclusion.
This article will attempt to address one question: "What is the difference between a winning trader and a losing trader?"

What follows are eleven observations and conclusions that I use in my own trading to help keep me on the right track. You can put these ideas into table form, and use them as a template to determine the probability of a trader being successful.

OBSERVATION # 1

The greatest number of losing traders is found in the short-term and intraday ranks. This has less to do with the time frame and more to do with the fact that many of these traders lack proper preparation and a well thought-out game plan. By trading in the time frame most unforgiving of even minute error and most vulnerable to floor manipulation and general costs of trading, losses due to lack of knowledge and lack of preparedness are exponential. These traders are often undercapitalized as well. Winning traders often trade in mid-term to long-term time frames. Often they carry greater initial levels of equity as well.

CONCLUSION:

Trading in mid-term and long-term time frames offers greater probability of success from a statistical point of view. The same can be said for level of capitalization. The greater the initial equity, the greater the probability of survival.

OBSERVATION # 2

Losing traders often use complex systems or methodologies or rely entirely on outside recommendations from gurus or black boxes. Winning traders often use very simple techniques. Invariably they use either a highly modified version of an existing technique or else they have invented their own.

CONCLUSION:

This seems to fit in with the mistaken belief that "complex" is synonymous with "better". Such is not necessarily the case. Logically one could argue that simplistic market approaches tend to be more practical and less prone to false interpretation. In truth, even the terms "simple" or "complex" have no relevance. All that really matters is what makes money and what doesn't. From the observations, we might also conclude that maintaining a major stake in the trading process via our own thoughts and analyses is important to being successful as a trader. This may also explain why a trader who possesses no other qualities than patience and persistence often outperforms those with advanced education, superior intellect or even true genius.

OBSERVATION # 3

Losing traders often rely heavily on computer-generated systems and indicators. They do not take the time to study the mathematical construction of such tools nor do they consider variable usage other than the most popular interpretation. Winning traders often take advantage of the use of computers because of their speed in analyzing large amounts of data and many markets. However, they also tend to be accomplished chartists who are quite happy to sit down with a paper chart, a pencil, protractor and calculator. Very often you will find that they have taken the time to learn the actual mathematical construction of averages and oscillators and can construct them manually if need be. They have taken the time to understand the mechanics of market machinery right down to the last nut and bolt.

CONCLUSION:

If you want to be successful at anything, you need to have a strong understanding of the tools involved. Using a hammer to drive a nut in to a threaded hole might work, but it isn't pretty or practical.

OBSERVATION # 4

Losing traders spend a great deal of time forecasting where the market will be tomorrow. Winning traders spend most of their time thinking about how traders will react to what the market is doing now, and they plan their strategy accordingly.

CONCLUSION:

Success of a trade is much more likely to occur if a trader can predict what type of crowd reaction a particular market event will incur. Being able to respond to irrational buying or selling with a rational and well thought out plan of attack will always increase your probability of success. It can also be concluded that being a successful trader is easier than being a successful analyst since analysts must in effect forecast ultimate outcome and project ultimate profit. If one were to ask a successful trader where he thought a particular market was going to be tomorrow, the most likely response would be a shrug of the shoulders and a simple comment that he would follow the market wherever it wanted to go. By the time we have reached the end of our observations and conclusions, what may have seemed like a rather inane response may be reconsidered as a very prescient view of the market.

OBSERVATION # 5

Losing traders focus on winning trades and high percentages of winners. Winning traders focus on losing trades, solid returns and good risk to reward ratios.

CONCLUSION:

The observation implies that it is much more important to focus on overall risk versus overall profit, rather than "wins" or "losses". The successful trader focuses on possible money gained versus possible money lost, and cares little about the mental highs and lows associated with being "right" or "wrong".

OBSERVATION # 6

Losing traders often fail to acknowledge and control their emotive processes during a trade. Winning traders acknowledge their emotions and then examine the market. If the state of the market has not changed, the emotion is ignored. If the state of the market has changed, the emotion has relevance and the trade is exited.

CONCLUSION:

If a trader enters or exits a trade based purely on emotion then his market approach is neither practical nor rational. Strangely, much damage can also be done if the trader ignores his emotions. In extreme cases this can cause physical illness due to psychological stress. In addition, valuable subconscious trading skills that the trader possesses but has no conscious awareness of may be lost. It is best to acknowledge each emotion as it is experienced and to view the market at these points to see if the original reasons we took the trade are still present. Further proof that this conclusion may have validity can be seen in even highly systematic traders exiting a trade for no apparent reason, and pegging a profitable move almost to the tick. Commonly, this is referred to as being "lucky" or being "in the zone".

OBSERVATION # 7

Losing traders care a great deal about being right. They love the adrenaline and endorphin rushes that trading can produce. They must be in touch with the markets almost twenty-four hours a day. A friend of mine once joked that a new trader won't enter a room unless there is a quote machine in it. Winning traders recognize the emotions but do not let it become a governing factor in the trading process. They may go days without looking at a quote screen. To them, trading is a business. They don't care about being right. They focus on what makes money and what doesn't. They enjoy the intellectual challenge of finding the best odds in the game. If those odds aren't present they don't play.

CONCLUSION:

It is important to stay in synch with the markets, but it is also important to have a life outside of trading. It is a rare individual who can do anything to excess without suffering some form of psychological or physical degradation. Successful traders keep active enough to stay sharp but also realize that it is a business not an addiction.

OBSERVATION # 8

When a losing trader has a bad trade he goes out and buys a new book or system, and then he starts over again from scratch. When winning traders have a bad trade they spend time figuring out what happened and then they adjust their current methodology to account for this possibility next time. They do not switch to new systems or methodologies lightly, and only do so when the market has made it very clear that the old approach is no longer valid. In fact, the best traders often use methodologies that are endemic to basic market structure and will therefore always be a part of the markets they trade. Thus the possibility of the market changing form to the extent that the approach becomes useless, is very small.

CONCLUSION:

The most successful traders have a methodology or system that they use in a very consistent manner. Often, this revolves around one or two techniques and market approaches that have proven profitable for them in the past. Even a bad plan that is used consistently will fair better than jumping from system to system. This observation implies that stylistic foundations of a trader's market approach must be in place before consistent profitability can occur.

OBSERVATION # 9

Losing traders focus on "big-name" traders who made a killing, and they try to emulate the trader's technique. Winning traders monitor new techniques that come on the trading scene, but remain unaffected unless some part of that technique is valuable to them within the framework of their current market approach. They often spend much more time looking at how the market seeks and destroys other traders or how traders destroy themselves. They then trade with the market or against other traders as these situations arise.

CONCLUSION:

Once again, we can note that the individuality of a trader and his comfort level and knowledge regarding his system are far more important than the latest doodad or Market guru.

OBSERVATION #10

Losing traders often fail to include many factors in the overall trading process that affects the probabilities of overall profit. Winning traders understand that winning in the markets means "cash flow". More cash must come in than goes out, and anything that effects this should be considered. Thus a winning trader is just as thrilled with a new way to reduce his data-feed costs or commissions as he is with a new trading system.

CONCLUSION:

ANYTHING that affects bottom line profitability should be considered as a viable area of study to improve performance.

OBSERVATION #11

Losing traders often take themselves quite seriously and seldom find humor in market analysis or the trading environment. Successful traders are often the funniest and most imaginative people you will ever meet. They take joy in trading and are the first to laugh or relate a funny story. They take trading seriously, but they are always the first to laugh at themselves.

CONCLUSION:

Its no wonder that one of the first things psychiatrists test for when treating a patient is whether or not the patient has any sense of humor about his affliction. The more serious the tone of the individual, the more likely that insanity has set in.

SUMMARY OF CONCLUSIONS AND OBSERVATIONS

Both winning and losing traders consider trading a game. However, winning traders take the game not as a diversion but as a vocation which they practice with an intensity and dedication that rivals the work ethic of a professional athlete. Since the athletic metaphor seems appropriate, I will sum up on that note.

If trading were a game like basketball perhaps novice traders would realize more readily that what appears as effortless ease of the professional trader in sinking three-point shots is in fact the product of endless hours spent shooting hoops in deserted back yards and empty playgrounds. As in sports, the governing factors are internal and external. We deal with the market and ourselves. Both are like weapons and they can be used proactively or destructively. Each and every trade should be taken with professional care and planning In order to bring these observations home in an even more compelling form, lets add an element of ultimate risk to life and limb and say that our "sport" is more like target practice with a handgun. While it is certainly important to hit the target, it is more important to make sure the gun isn't pointed directly at ourselves when we pull the trigger.
Minute differences in how we take aim in the markets can have amazing impact on the final outcome. The difference is clear: One method is accurate target practice. The other is Russian Roulette.

Walter Downs is a professional trader and market consultant. He is president of CIS Trading Cos., a firm dedicated to the research and development of innovative market techniques
Copyright@ 1999 Walter T. Downs All Rights Reserved. Distribution is allowed with due credit to the author: http://cistrader.com [Note: this site appears defunct as of 4/29/03]

When Trading Journals Don’t Work

2008-10-02T00:08:00.000-07:00

One of the most common pieces of advice trading mentors give to their students is the keeping of a trading journal. By documenting your trading, the common wisdom holds, you can learn what you’re doing right and wrong and speed your learning curve. I happen to be quite a fan of trading journals; indeed, I made journals a mandatory part of the training program at a Chicago-based proprietary trading firm. All too many times, however, I found that the journals did not accomplish their purpose. They became rote exercises that did not get to the heart of either trading problems or solutions. So I thought in this article I’d outline the five most frequent shortcomings with journals and how these can be addressed.

The journal lacks specifics. Many times the journal becomes an outlet for the trader, a way of venting. While there is nothing wrong with venting per se, it is hard to see how *simply* venting in a journal can improve performance. A common entry might state, “I overtraded a slow market and broke all my rules. I know I have to take what the market gives me. Tomorrow I need to trade with more discipline”. All these things may be true, but the entry lacks specifics regarding *why* the trader overtraded; *how* the overtrading will be avoided in tomorrow’s trade; and *what steps* will be taken to return to the discipline. A journal entry that lacks specifics is a statement of good intentions; not a plan. If your journal entry does not include concrete steps that you can follow to address a problem situation, it is unlikely that it will serve as an action guide.
The journal emphasizes problems, not solutions. Traders love to keep journals when they’re losing and then fall off the journaling bandwagon when they’re making money. I would argue that, when you’re making money, that’s the *best* time to keep a journal. Your goal should be to replicate successful trading patterns, not simply analyze problematic ones. The ideal journals isolate what traders do when they’re trading their best, so that these solution patterns can be isolated and mentally rehearsed as part of a learning process. At their worst, journals are like bad parents who chastise their children when they’re doing something wrong, but never offer attention and praise for good behavior. Kids learn to resent such parents, and traders learn to resent problem-focused journaling.
The journal talks too much about the trader and not enough about the markets. Journals are a learning tool, and your ultimate goal is to learn how to trade. By focusing exclusively on your state of mind, what you did or didn’t do in the trade, etc., you lose the opportunity to identify and learn patterns that appear in the market. It’s extremely helpful to review a market day and examine what you could have noticed to alert you to a market move. Perhaps oil made a breakout move preceding a break in the equity indices; perhaps a move in the currency markets could have given you an early read on how the market would respond to Fed news. By retrospectively identifying such trading patterns, you train your mind to look for them the next time they appear.
The journal is reactive, not proactive. This is part of the venting phenomenon: traders will make journal entries after the market day, but rarely use the journal to actively prepare for the coming day’s trade. An ideal journal captures what you’ll be looking for in the coming day in the markets (anticipated setups) and what you’ll be working on in your own trading. Think of your trading as a business and your journal as your business plan for the day. A business plan should reflect your strengths and weaknesses and identify areas of opportunity. A business plan should also detail how you will exploit that opportunity. Learning from past performance is important, but if the learning is not reflected in future plans, it will not be reflected in actual trading outcomes.
The journal lacks metrics. This is perhaps the topic I am most passionate about. I have found that traders can best assess their strengths and weaknesses by keeping detailed records of their trades and by evaluating themselves across a series of performance measures. I cannot tell you how many traders I’ve encountered who don’t have the faintest notion of their average profit per trade; their average win size and loss size; their average holding period per trade; etc. It’s not that the traders don’t care about performance; it’s that they have not drilled down to the trade-by-trade level to see what they’re actually doing in the markets. Many times, traders *think* they’re trading one way, only to find out when they look at the data that they’re not trading that way at all. It’s hard to see how a trader can identify if they’re having problems trading in the morning vs. afternoon; if they’re more often right on the long side than short; or if they are trading large size differently than smaller size if the statistics are not there to be analyzed.

So what’s a trader to do? The first step is to decide whether or not you really *want* to know what you’re doing and how well you’re doing it; whether you want to put in the time and effort to identify the patterns in each trading day—the market’s and your own. To paraphrase U.S. college basketball coach Bobby Knight, many traders want to trade and many want to win, but not many are willing to put in the work it takes to be a winner. While Coach Knight has earned his share of criticism, look at the pure effort he puts into preparation for a coming game. The same intensity of effort can be found in Tour de France leaders Lance Armstrong, Ivan Basso, and Jan Ullrich, as they actively train, plan, and rehearse for each stage of the race. This is the effort required of a winner, and each trader needs to know if he or she has the fire in their belly to sustain such work.

Ultimately, the effort to win is sustained by a desire to know. Excellent traders are always keeping score: they want to know what they’ve done right or wrong, and what’s making and losing them money. They are always working on themselves and their trading. I’ve met far too many “breakeven” traders who, upon inspection, have been losing money consistently. It’s not that they’re lying; they simply don’t want to know the truth. Thus, they avoid it. It is simply too painful to look at the money and opportunities lost. Keeping a journal *should* be painful at times, but it should also bring out the best in you. Without it, you’re likely to be a business without a plan.

by Brett Steenbarger

A Beginner's Guide To Hedging

2008-10-01T00:06:00.000-07:00

Although it sounds like it might be the hobby of your neighbor obsessed with his topiary garden full of tall bushes shaped like giraffes and dinosaurs, hedging is a practice every investor should know about - there is no arguing that portfolio protection is often just as important as portfolio appreciation. Like your neighbor's obsession, however, hedging is talked about more than it is explained, making it seem as though it belongs only to the most esoteric financial realms. Well, even if you are a beginner, you can learn what hedging is, how it works and what hedging techniques investors and companies use to protect themselves.

What Is Hedging?
The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday. For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters.

Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another.

Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another.

Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return tradeoff. A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss. If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge?
Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative.

Let's see how this works with an example. Say you own shares of Cory's Tequila Corporation (Ticker: CTC). Although you believe in this company for the long run, you are a little worried about some short-term losses in the Tequila industry. To protect yourself from a fall in CTC you can buy a put option (a derivative) on the company, which gives you the right to sell CTC at a specific price (strike price). This strategy is known as a married put. If your stock price tumbles below the strike price, these losses will be offset by gains in the put option.

The other classic hedging example involves a company that depends on a certain commodity. Let's say Cory's Tequila Corporation is worried about the volatility in the price of agave, the plant used to make tequila. The company would be in deep trouble if the price of agave were to skyrocket, which would eat into profit margins severely. To protect (hedge) against the uncertainty of agave prices, CTC can enter into a futures contract (or its less regulated cousin, the foreward contract), which allows the company to buy the agave at a specific price at a set date in the future. Now CTC can budget without worrying about the fluctuating commodity.

If the agave skyrockets above that price specified by the futures contract, the hedge will have paid off because CTC will save money by paying the lower price. However, if the price goes down, CTC is still obligated to pay the price in the contract and actually would have been better off not hedging.

Keep in mind that because there are so many different types of options and futures contracts an investor can hedge against nearly anything, whether a stock, commodity price, interest rate and currency - investors can even hedge against the weather.

The Downside
Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses. The cost of the hedge - whether it is the cost of an option or lost profits from being on the wrong side of a futures contract - cannot be avoided. This is the price you have to pay to avoid uncertainty.

We've been comparing hedging versus insurance, but we should emphasize that insurance is far more precise than hedging. With insurance, you are completely compensated for your loss (usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong. Although risk managers are always aiming for the perfect hedge, it is difficult to achieve in practice.

What Hedging Means to You
The majority of investors will never trade a derivative contract in their life. In fact most buy-and-hold investors ignore short-term fluctuation altogether. For these investors there is little point in engaging in hedging because they let their investments grow with the overall market.

So why learn about hedging?

Even if you never hedge for your own portfolio you should understand how it works because many big companies and investment funds will hedge in some form. Oil companies, for example, might hedge against the price of oil while an international mutual fund might hedge against fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend and analyze these investments.

Conclusion
Risk is an essential yet precarious element of investing. Regardless of what kind of investor one aims to be, having a basic knowledge of hedging strategies will lead to better awareness of how investors and companies work to protect themselves. Whether or not you decide to start practicing the intricate uses of derivatives, learning about how hedging works will help advance your understanding the market, which will always help you be a better investor.

by Investopedia Staff,

Gauging The Market's Psychological State

2008-09-30T00:03:00.000-07:00

When volume is high, those traders unlucky enough to be losing money in their positions feel the sharp sting of their losses. In order to alleviate the pain, these traders quickly close their positions (at a loss). As losers exit the market, a trend based on high volume is likely to be short lived. But a trend based on moderate volume can last an extremely long time since small losses can accumulate over time into what may become very large losses. The longest trends are probably driven by markets either going nowhere, changing moderately or even moving both up and down day after day, forming only a gradual trend, which is apparent when viewed in retrospect.

But there's still more to the volume story that pertains to market psychology. I've still got a couple of columns to write in order to cover the theme of market psychology in its entirety - there are many more trading indicators that gauge the market's psychological state. Once again, I must express my appreciation to Dr. Alexander Elder for his work, which renders many of the following concepts and indicators in a clear, concise and understandable way for traders everywhere. For much greater detail on all of the topics mentioned below, you can refer to Dr. Elder's trading book companions: "Trading for a Living: Psychology, Trading Tactics, Money Management" and "Come into My Trading Room: A Complete Guide to Trading".

On-Balance Volume (OBV)
Devised by Joseph Granville, on-balance volume is a running total, which rises or falls every trading day, based on whether prices close higher or lower than on the previous day. OBV is a leading indicator, so it typically rises or falls before that of the actual prices. A new OBV high indicates the power of bulls, the weakness of bears and the likely resultant rise of prices. A new OBV low indicates an opposite pattern: the power of bears, weakness of bulls and a possible decrease in value. When OBV shows a signal differing from that of actual prices, it indicates that volume (emotion of the market) is not consistent with consensus of value (actual prices) - a shift in price, which would alleviate this imbalance, is imminent.

Accumulation/Distribution (A/D)
Accumulation/distribution is also a leading indicator pertaining to volume, but it takes opening and closing prices into account. A positive A/D indicates that prices were higher when they closed than when they opened; a negative A/D indicates the opposite. But the bull or bear winners are only credited with a fraction of each day's volume, depending on the day's range and the distance from opening to closing price. Obviously, a wide range between open and close produces a stronger signal A/D, but the pattern of A/D highs and lows is most important. If a market opens higher and closes lower, thereby causing A/D to turn down, an upward-trending market may be weaker than it initially appears.

The significance of accumulation/distribution lies in its insight into the activities of the distinct groups of professional and amateur traders. Amateurs as a group are more likely to influence the opening price of the market since these amateurs base their first trades on the financial news they have read overnight as well as on the corporate news that was issued by their favorite companies after market close. But as the trading day wears on, the professionals determine the day's ultimate results. If the professionals disagree with the amateurs' bullishness at the open, the professionals will drive prices lower for the close. When the pros are more bullish than amateurs, the pros will drive prices higher all day and into the close. As indicators for future trends, the activities of professionals are generally more important than that of the amateurs.

Open Interest
Shifting from our discussion of volume, we find open interest as the next major indicator of crowd psychology. Open interest applies to the futures market and refers to a reading of future contracts or options expiring at a certain time in the future. Open interest adds the total long and short contracts in the market on a given day, and the absolute value of open interest corresponds to a cumulative long or short position. Open interest only rises or falls when a new contract is created or destroyed - one long and one short seller must enter the market to increase the open interest, and one long and one short seller must close their positions for open interest to fall.

Open interest is only of interest (pun intended) when it deviates from its norm. An absolute value is of no interest (bad pun again intended). Open interest reflects the psychology of the market by way of the market's inherent conflict between bulls and bears. To move the open interest indicator up or down, both bulls and bears must be equally confident that their long or short position is correct (or incorrect). A rising open interest demonstrates that bulls are confident enough to enter into contracts with bears, who are equally confident in their bearishness to enter into the position. One group will inevitably lose, but as long as potential losers (either bulls or bears) enter contracts, the rise or fall in open interest will continue. But there is more to the open interest picture than immediately meets the eye.

A rising open interest points to an increase in the supply of potential losers, propelling the trend forward. Open interest that increases during an uptrend reveals that a certain number of bears believe the market is too high; but, if the uptrend increases, their short positions will be squeezed, and their subsequent buying will propel the market even higher; however, open interest that remains relatively constant during a market uptrend indicates that the supply of losers has stopped growing as the only potential candidates to enter into a contract are previous buyers who are looking to make a profit from their position. In this case, the uptrend is likely nearing its end.

During a downtrend, shorts are selling aggressively while the only participants that are buying are bottom pickers. But even value investors exit their positions when prices fall too far, so prices will go even lower. If open interest rises in a declining market, the downtrend is likely to continue. If open interest remains flat in a downtrend, there are few remaining bottom pickers, and the only remaining candidates for the contract are additional bears that shorted earlier and now want to cover and leave the market. Bears that exit with a profit cause a flat open interest in a downtrend, meaning that the best gains from the downtrend have probably already been had.

Finally, a falling open interest shows that losers are exiting positions while winners are taking profits. It also shows there are no additional losers to take the place of those who have given up. The falling open interest is a clear signal that winners are taking their profits and running for the border while losers are giving up hope. A loss of a contract (and a declining open interest) points to the likely end of a trend.

by Jason Van Bergen, investopedia.com

Youh should knoe before and after trade

2008-09-29T00:00:00.000-07:00

Is stress an ultimately meaningless but inevitable part of trading or is your psyche trying to tell you something about your trading approach? Find out what your emotions can reveal about how you trade.

Ask yourself the following question: Have your ever, before placing a trade, thought of all the reasons the trade was a good idea, but once you pulled the trigger obsessed about all the things that could go wrong? Has this nervousness caused you to abandon your trading plan and, perhaps, exit a trade too early — resulting either in an unnecessary loss or unnecessarily small gain?

Before seeking the advice of a Freudian analyst to discover the traumatic events in your childhood that are causing you to abandon discipline, it may be worthwhile to consider more immediate explanations. Most likely, one of three things is going on here or, possibly, a blend of the three.

The first possibility is you simply have trouble putting money at risk. In the past,you’ve never really liked anything more unpredictable than a treasury-bond fund, and you immediately get knots in your stomach when a trade moves one tick against you. The “paranoid” feelings you experience in a trade are completely detached from the reality of the market situation and your trading strategy.

Some people are inherently riskaverse. Regardless of the causes of such feelings, some people can work through them. Others, though, are better off not trading. Because the first rule of trading is capital preservation, refraining from trading can be the best money-management decision some people can make.

The second possibility is you are not really working with a fully developed trading plan. If you can immediately think of 10 things that are wrong with your trade right after you click “buy” or “sell,” you must ask yourself why you didn’t think of them before. The rush of enthusiasm that can accompany an attractive trade setup can quickly disappear once you’ve executed the trade and realize you don’t really know how you’re going to get out or how much you’re risking.

Finally, it might simply be you’re not trading with enough money. No trader or trading strategy can survive undercapitalization. If even a small loss represents a significant percentage of your trading capital — say, 10, 15 or 20 percent — the stress will likely be so great that you will not be able to stick with the trade long enough to profit from it. Lack of capital is the No. 1 killer of most new businesses and almost all new traders.

Paper trades that do not risk real money tend to have less psychological baggage than those that do.

Are you paranoid or are you really being followed?

The problem comes in determining whether your negative feelings are really “risk paranoia” or whether they are tipping you off to flaws in either the design or execution of your trade. In the latter case, there are some simple techniques to consider to reduce or eliminate this problem.

The first solution is to only trade systematically. Removing emotions from trading is the very reason many traders adopt a systematic approach, even if they think they might have better performance trading with discretion.

Truly systematic or mechanical trading approaches leave no room for interpretation. Trades must be executed without hesitation or reflection on the current market circumstances or the possible outcome. Of course, to have the confidence to automatically follow a system requires a great deal of research, historical testing and trial trading — not to mention discipline when it comes time to execute. The upside of mechanical trading is that it can greatly reduce the emotional element of trading.

The second solution is to track your trades and jot down your fears at the time of execution. By comparing these notes to the actual results of the trade, you can see if your fears are unfounded or if your trading plan indeed is flawed. It would be nice to paper trade and make such notes, but trades that do not risk real money tend to have less psychological baggage than those that do.

One idea is to put on very small trades, even if winning trades merely squeak out a small profit (or small loss) after commissions. It’s amazing how even putting a little money at risk can up the psychological ante. It’s similar to being in a quarter/50-cent/dollar poker game: After you go around the table a few of times, that $40 pot seems like all the money in the world. Using this technique gives you the opportunity to analyze your strategy, execution process and mindset with some degree of realism while limiting risk exposure.

A dose of reality

Truth be told, even some veteran traders have difficulty completely removing the fear factor from their trades. This only makes sense, because experienced traders understand the inherent unpredictability of the markets.

Following any strategy — whether it includes discretion or is completely mechanical — requires a fully developed plan, with entry, exit (where you get out with a profit or loss) and moneymanagement (how much you risk) rules.

You also need to know why your system works and when it is likely to fail. Only then will you have enough confidence to survive the bad trades as well as enjoy the good ones.

The Importance Of Diversification

2008-09-28T23:56:00.000-07:00

Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk. Here we look at why this is true, and how to accomplish diversification in your portfolio.

Different Types of Risk
Investors confront two main types of risk when investing:

Undiversifiable - Also known as "systematic" or "market risk", undiversifiable risk is associated with every company. Causes are things like inflation rates, exchange rates, political instability, war and interest rates. This type of risk is not specific to a particular company and/or industry, and it cannot be eliminated or reduced through diversification; it is just a risk that investors must accept.
Diversifiable - This risk is also known as "unsystematic risk", and it is specific to a company, industry, market, economy or country; it can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so that they will not all be affected the same way by market events.

Why You Should Diversify
Let's say you have a portfolio of only airline stocks. If it is publicly announced that airline pilots are going on an indefinite strike and that all flights are canceled, share prices of airline stocks will drop. Your portfolio will experience a noticeable drop in value. If, however, you counterbalanced the airline industry stocks with a couple of railway stocks, only part of your portfolio would be affected. In fact, there is a good chance that the railway stocks' prices would climb as passengers turn to trains as an alternative form of transportation.

But you could diversify even further because there are many risks that affect both rail and air because each is involved in transportation. An event that reduces any form of travel hurts both types of companies - statisticians would say that rail and air stocks have a strong correlation. Therefore, to achieve superior diversification, you would want to diversify across not only different types of companies but also different types of industries. The more uncorrelated your stocks are, the better.

It's also important that you diversify among different asset classes. Because different assets - such as bonds and stocks - will not react in the same way to adverse events, a combination of asset classes will reduce your portfolio's sensitivity to market swings. Generally, the bond and equity markets move in opposite directions, so, if your portfolio is diversified across both areas, unpleasant movements in one will be offset by positive results in another.

There are additional types of diversification and many synthetic investment products have been created to accommodate investors' risk tolerance levels; however, these products can be very complicated and are not meant to be created by beginner or small investors. For those who have less investment experience and do not have the financial backing to enter into hedging activities, bonds are the most popular way to diversify against the stock market.

Unfortunately, even the best analysis of a company and its financial statements cannot guarantee that it won't be a losing investment. Diversification won't prevent a loss, but it can reduce the impact of fraud and bad information on your portfolio.

How Many Stocks You Should Have
Obviously owning five stocks is better than owning one, but there comes a point when adding more stocks to your portfolio ceases to make a difference. There is a debate over how many stocks are needed to reduce risk while maintaining a high return. The most conventional view argues that an investor can achieve optimal diversification with only 15 to 20 stocks spread across various industries.

Summary
Diversification can help an investor manage risk and reduce the volatility of an asset's price movements. Remember though, that no matter how diversified your portfolio is, risk can never be eliminated completely. You can reduce risk associated with individual stocks, but general market risks affect nearly every stock, so it is important to diversify also among different asset classes. The key is to find a medium between risk and return; this ensures that you achieve your financial goals while still getting a good night's rest.

by Investopedia .com

Investment Scams: Conclusion

2008-09-27T23:51:00.000-07:00

Now that you're familiar with the various kinds of online investment scams, we hope you'll be prepared for anything the fraudsters throw at you. We'll be happy if this tutorial saves one person from being scammed out of their hard-earned money.

To recap:

Many scams on the 'Net aren't new at all. They're just variations on classic Ponzi schemes, pump and dump scams, and offshore investing scams.
Bulletin boards are especially dangerous because you don't know the identity of who is posting. Take all posts with a grain of salt.
Newsletters are often written by paid promoters. Always be skeptical: if things sound too good to be true, they probably are.
Spam isn't even worth the second it takes to hit delete.
If you encounter a scam, contact the SEC.

Dealing With Investment Fraud

2008-09-26T23:50:00.000-07:00

If you come across or are the victim of an investment scam, the best thing to do is report it to the Security and Exchange Commission (SEC). They have online forms to contact them at their complaint site: http://www.sec.gov/complaint.shtml.

You can also write them at:

Securities and Exchange Commission
Office of Investor Education & Assistance
450 Fifth Street, N.W.
Washington, D.C. 20549-0213
Fax: 202-942-9634

You can forward spam or copies of fraudulent message board postings to:
enforcement@sec.gov.

When contacting the SEC, you only need to give as much personal information as you wish. However, the more information you give them, the better they will be able to help you. Include specific details of how, why and when you were defrauded with any contact info you have on the fraudulent person or company you are reporting.

Investment Scams: Newsletters

2008-09-25T23:47:00.000-07:00

Almost every stock pick site offers a newsletter that is supposedly full of useful insights and great stocks. There are many good newsletters out there, but some are just promoting stocks under the guise of presenting investors with "free unbiased information."

In fact, many companies hire employees or pay people to write online newsletters to promote their stock. In theory, this practice is not illegal. But federal securities laws require newsletters to disclose who paid them, the amount paid, and the type of payment. Most fraudulent newsletters fail to provide this information. Instead, they lie about the income they receive, their independence, their research, and their historical results. They stand to profit handsomely if they convince investors to buy or sell particular stocks. Newsletters also use the pump and dump technique discussed earlier. With enough people on the list, it is possible to create movement in the price of small stocks.

Even worse is junk e-mail or "spam." As spam costs next to nothing to create, it has become the tool of choice for many fraudsters. Often these messages consist of “get-rich-quick” schemes and offer "guaranteed results." If the sender is unfamiliar to you or the message is addressed generally (great investment tip) it is likely a scam. Brokers and traders don't give away good tips to random people for free. Besides, no reputable company would spam to get their name out. The smartest thing you can do is hit your delete button.

Identifying these shady e-mails isn't tough. Besides promising huge results with no risk, look for CAPITALIZED LETTERS WITH MANY EXCLAMATION MARKS!!! FOR SOME REASON SCAM ARTISTS THINK YOU'LL LISTEN IF THEY WRITE LIKE THEY ARE SCREAMING AT YOU!!! Another clue is when the e-mail comes from free e-mail providers such as yahoo.com or hotmail.com. Spammers use these addresses to hide where the original message comes from.
Below are some examples of e-mails to watch out for. These are real, uncut, uncensored, spam scams sent to our Inbox at Investopedia:

Example 1 ;

-----Original Message-----

From: madlyn1538j78@mailcity.lycos.co.jp

Sent: Thursday, May 23, 2002 4:30 PM

To: Maire

Subject: Introducing the "Energy" Market

Get The Wealth You Deserve

Unlock the Doors to STAGGERING PROFITS!

Take Advantage of Market Trends As They Happen!

NOW is the Time to Embrace The ENERGY Markets!

Commodity Trading Makes Millions Every Day!

Powerful Profits Await YOU In The ENERGY Markets!!!

Fortunes will literally be made in the next few months!

Summer Driving Vacations alone will drive gas prices up very soon!

*We all NEED ENERGY...every day!

*We all U.S.E Energy...every day!

*Your Life Resolves around ENERGY!

*Every Major Country in the world consumes ENERGY daily!

Prices reach extremes for reasons...

Do you want to know the reasons WHY?

Get Your FREE Energy Investment Information Packet at:

http://www.ynotuweb.com/energymarkets

The Five Major Energy Markets are:

*Unleaded Gasoline

*Electricity

*Natural Gas

*Heating Oil

*Crude Oil

OPEC announced 11/1/01 they would be cutting oil production

because prices were just too low.  OPEC AGAIN announced

on 12/28/01 to cut production another 6% starting 1/1/02!

"The Department of Energy says that the national average price

of a gallon of unleaded regular gasoline has soared 25 percent

this year, and is currently $1.37, up from $1.22 on March 11.

That's a 12 percent increase in three weeks. Prices are expected

to rise even further when the summer driving season gets underway."

(ABCNews.Com) 4/03/02

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example 2 ;

-----Original Message-----

From: Christinia [mailto:pzgky@gomail.com.ua]

Sent: Saturday, March 23, 2002 4:49 AM

To: yfbyqbwvh@hotmail.com

Subject: Our Last 3 Picks Are Up Over 400%

SPECIAL SITUATION ALERTS HOT PICK OF THE YEAR

Environmental Remediation Holding Corp. (OTCBB: ERHC)

URGENT BUY: $ .17

SELL TARGET: $1.25

INVESTOR ALERT: ERHC enters into joint-venture license agreement

with SCHLUMBERGER LTD (NYSE: SLB, $60) and BAKER HUGHES, INC.

(NYSE: BHI, $40) for seismic data on some of the richest offshore

oil blocks where ERHC controls a huge working interest!

INVESTORS - WE HAVE FOUND THE HIDDEN GEM: (OTCBB: ERHC)!

ERHC's joint-venture with SCHLUMBERGER and BAKER HUGHES puts them in

world-class company with these leaders in oil exploration and reservoir

imaging services.  The involvement of SLB and BHI reinforces the

$MULTI-BILLION DOLLAR VALUE that has been placed in this offshore

drilling haven.  ERHC's goal is to maximize shareholder value from

existing contractual rights, making them a significant player in

this region.

THE BIG MONEY ROLLS IN:

The seismic data from this joint-venture is being made available for

further involvement by the LARGEST OIL COMPANIES IN THE WORLD over

the next 2 weeks!!

Bidding wars have already developed between major oil companies suchas:

SHELL, CHEVRON/TEXACO, CONOCO, EXXON/MOBIL, PHILIPS, and MARATHON who

are willing to pay $Hundreds of Millions to drill in these zones and

partner with ERHC.

STOCK SET TO EXPLODE ON EARNINGS BOOM:

ERHC's exclusive right to participate in exploration and production

along with OIL INDU.S.TRY GIANTS could be worth up to $FIFTY MILLION

as these oil blocks are adjacent to Billion Barrel producing regions!

SPECIAL SITUATION ALERTS' newsletter offers valuable research that

builds your wealth.  We target serious gains for serious investors

with a 700% investment return on ERHC.

DISCLAIMER: Certain statements contained in this newsletter may be

forward-looking statements within the meaning of The Private Securities

Litigation Reform Act of 1995. These statements may be identified by

such terms as "expect", "believe", "may", "will", and "intend" or

similar terms. We are NOT a registered investment advisor or a broker

dealer. This is NOT an offer to buy or sell securities. No

recommendation that the securities of the companies profiled should be

purchased, sold or held by individuals or entities that learn of the

profiled companies. This is an independent electronic publication that

was paid $10,000 by a third party for the electronic dissemination of

this company information. Be advised that investments in companies

profiled are considered to be high-risk and use of the information

provided is for reading purposes only. If anyone decides to act as an

investor they are advised not to invest without the proper advisement

from an attorney or a registered financial broker, if any party decides

to participate as an investor then it will be that investor's sole risk.


Be advised that the purchase of such high-risk securities may resultin

the loss of some or all of the investment. The publisher of this

newsletter makes no warranties or guarantees as to the accuracy or the

completeness of the disclosure. Investors should not rely solely on the

information presented. Rather, investors should use the information

provided in this newsletter as a starting point for doing additional

independent research on the profiled companies in order to allow the

investor to form their own opinion regarding investing in the profiled

companies. Factual statements made about the profiled companies are made

as of the date stated and are subject to change without notice.

Investing in micro-cap securities is highly speculative and carries an

extremely high degree of risk.

Example 3 ;

-----Original Message-----

From: Merry7173h62@mailasia.com

Sent: Friday, July 10, 2893 6:44 PM

To: Investopedia

Subject: 10k could return 25k

$10,000 INVESTMENT COULD HAVE RETURNED $25,000

SEE HOW A 200% RETURN COULD HAVE BEEN

ACHIEVED IN LESS THAN 30 DAYS

CLICK HERE TO

Learn about our strategy trading in the Forex foreign currency exchange.

GET our FREE NO OBLIGATION REPORTS, CHARTS and STRATEGIES on the

U.S. DOLLAR VS. THE EURO

EXAMPLE!

A $10,000 INVESTMENT IN THE EURO VS. THE U.S. DOLLAR

PROPERLY POSITIONED, ON 02/26/02 COULD POSSIBLY HAVE

RETURNED $25,000 ON 03/07/02

CLICK HERE NOW!

Includes initial investment and excludes any commission, fees and mark ups.

MU.S.T BE 21 OR OLDER TO QUALIFY, RISK CAPITAL ONLY.

PAST PERFORMANCE NOT INDICATIVE OF FUTURE PERFORMANCE.

$5,000 MINIMUM INVESTMENT

Investment Scams: Bulletin Boards

2008-09-24T23:46:00.000-07:00

There are literally hundreds of investment boards where anyone can rant, rave, or post BS. Online bulletin boards (BBs) come in various forms, including newsgroups, usenet, or web-based boards. Some of the larger BBs, like those found on sites such as Raging Bull, Boards on Yahoo! Finance, and Silicon Investor, see thousands of messages posted on an hourly basis.

While there are many valid and useful posts on these boards, a large number of tips turn out to be bogus. Fraudsters most often use a pump and dump scheme on BBs by pretending to reveal inside information about big upcoming announcements, great new products, or lucrative contracts. The opposite can be done too. If fraudsters hold a short position in a company, they will try to spread negative rumors in the hope that investors will panic and push prices down.

Here's the tricky part about BBs: anonymity. You don't know for sure who you're dealing with and how credible they are. People claiming to be unbiased observers who've carefully researched a company may actually be company insiders, large shareholders, or paid promoters. A single person can easily create the illusion of widespread interest in a small, thinly-traded stock by posting a series of messages under various aliases.

In the aftermath of the dotcom bubble, bulletin boards experienced a dramatic drop in traffic. Thankfully, many investors realized they couldn't believe everything they read online. But that's not to say there is no valuable information on BBs. Before Enron went bankrupt, posts were made online that revealed many of the fraudulent practices taking place at the energy giant. Regrettably, at the same time, there were countless posts that were bullish on Enron. It's nearly impossible to sort out the valuable posts from the fake ones.

Investment Scams: Different Types Of Scams

2008-09-23T23:44:00.000-07:00

Very few of the scams on the Internet are new. Most of the swindling techniques we see today originated long ago as telemarketing, direct mail, or even door-to-door selling schemes. But the Internet adds another troubling dimension to these old tricks. For example, a fancy Web site can create the illusion of a large and reputable company, especially if it provides links to legitimate sites.

Here are some of the largest and most successful investment scams:

Ponzi Scheme - A type of pyramid scheme, this is where money from new investors is used to provide a return to previous investors. The scheme collapses when money owed to previous investors is greater than the money that can be raised from new ones. Ponzi schemes always collapse eventually.
Pump and Dump - A highly illegal practice where a small group of informed people buy a stock before they recommend it to thousands of investors. The result is a quick spike in stock price followed by an equally fast downfall. The perpetrators who bought the stock early sell off when the price peaks at a huge profit. Most pump and dump schemes recommend companies that are over-the-counter bulletin board (OTCBB) and have a small float. Small companies are more volatile and it's easier to manipulate a stock when there's little or no information available about the company. There is also a variation of this scam called the "short and distort." Instead of spreading positive news, fraudsters use a smear campaign and attempt to drive the stock price down. Profit is then made by short selling.
Off Shore Investing - These are becoming one of the more popular scams to trap U.S. and Canadian investors. Conflicting time zones, differing currencies, and the high costs of international telephone calls made it difficult for fraudsters to prey on North American residents. The Internet has eroded these barriers. Be all the more cautious when considering an investment opportunity originating in another country. It's extremely difficult for your local law enforcement agencies to investigate and prosecute foreign criminals.
Prime Bank - This term usually describes the top 50 banks (or thereabouts) in the world. Prime banks trade high quality and low risk instruments such as world paper, International Monetary Fund bonds, and Federal Reserve notes. You should be very wary when you hear this term--it is often used by fraudsters looking to lend legitimacy to their cause. Prime bank programs often claim investors' funds will be used to purchase and trade "prime bank" financial instruments for huge gains. Unfortunately these "prime bank" instruments often never exist and people lose all of their money.