Finance Knowledge, Glossary, H-M

Investment Risk

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The average individual investor is saving for retirement, a house, travel money, or some other goal. They want some certainty that the money they put back now will be there when they need it. Because of this, it is important not only to analyze the opportunity an investment represents, but also the risk. Your ideal investment or investment portfolio gives you the most opportunity for the risk you can bear. In this sense, it is important to understand the risk inherent in an investment before you look for the opportunity. Unfortunately, the average investor does not understand risks even on a basic level. Most individual investors do not look at risk in any objective way. They base their decisions on perceptions and fear. They think things like “Google is popular, the stock won’t go down” and “Lehman Brothers has been around as long as I can remember, it seems like they’re pretty stable.” In a best-case scenario they will look at the beta of a stock. Unfortunately beta is a measure of volatility and is a poor substitute for analyzing risk. Even more importantly, beta is always a historical figure and does not in any way represent what might happen tomorrow. Though investors often do not analyze it, most do realize there is risk inherent in investing. Let’s look at the various types of risk investors face:

Market Risk

The risk most are familiar risk is Market Risk. Market risk is the risk that the market changes it’s perception of value for a particular investment. This risk is one of the most important risks when it comes to stocks, options, and commodities. This is exhibited clearly with the daily changes in share prices for any publicly traded stock. This risk can be analyzed by looking at the factors making up the perceived value of the investment. You would then determine how accurate these assumptions are and how they might change in the future. Some of these factors include earnings, dividends, growth, and perceived opportunities.

Default Risk

Another important risk that many people are familiar with is Default Risk. This comes into play more with debt investments than equity. Bonds, for instance, all carry the risk that the issuer will not be able to make a payment when it is due. The primary factor in default risk is cash flow, which can be different from income or revenue. If you own a bond that an issuer does not have the cash to pay, you would lose your accrued interest and principle. Default risk also has an indirect but important effect on stock equity investments because default on debt can put a company into bankruptcy. In bankruptcy, the debt holders get paid before equity holders. As a result the stock will generally be worth less after a default and can in extreme cases lose all of its value. Diversification is very important in reducing the effects of default risk.

Interest Rate Risk

Interest Rate Risk is another risk that affects primarily bonds. The price for a bond can be easily estimated by determining the required rate of return (yield) and adjusting the price to bring the yield in line with what is required. In practice, this means that with the exclusion of other factors, when interest rates fall, bond prices go up. When interest rates rise, prices go down. This is particularly important when we are at historically low interest rate levels. Low risk bonds that were purchased several years ago at higher yields are now selling at significant premiums, netting their sellers significant gains. Today’s buyers will have the opposite effect buying when rates are low. As rates rise, the prices they can sell at will drop. This is very important to institutional buyers but often overlooked by individuals trying to buy into something “safe.”

Opportunity Risk

Opportunity Risk is the risk that by buying one investment, you are reducing the amount of money you have to invest elsewhere. This means that when you consider investing in Google (GOOG), for instance, you are giving up the opportunity to invest the same money in Apple (AAPL). One is likely to gain more or lose less than the other, so you are forgoing the opportunity for that gain by buying one over the other. You can reduce this risk with careful research or diversification.

Liquidity Risk

Liquidity Risk is somewhat related to opportunity risk, though in a somewhat more tangible way. This is simply the risk that you will not have money available at the time you need it. It may be that a CD has a significant penalty to be broken or it may be that a bond is not heavily traded and cannot be sold for a fair price in the open market. Your best yield would be to wait until maturity, but the risk is that you will need it sooner.

Inflation Risk

Inflation Risk is one of the risks most overlooked by so-called conservative investors. This is the risk that returns on your investment will be lower than the rate of inflation. This results in having less purchasing power at the end of an investment period than at the beginning. Because this doesn’t show up clearly in the dollars and cents of an investment, people easily discount its importance. If you invest money for retirement today, you hope to be able to spend the same amount in the future. The reality is that if you invest in a security that does not exhibit the other risks discussed but yields only 1% in a world with 3% inflation, you will effectively have less than you invested to spend in retirement. It is dangerous to discount this risk because you will end up with less market and default risk at the expense of inflation risk.

Systemic Risk

Systematic Risk, Political Risk, Event Risk and Country Risk are all similar in that they refer to risks outside the control of the investor or the company to control. They represent the risk that something will happen in the external environment to change the value of an investment. A major hurricane or flood is an event risk closely related to real estate or insurance investments. When Katrina hit Louisiana, a number of insurance companies took bigger losses than investors expected them to take, reducing the value of investments in those companies. Health related investments are facing political risks right now in the form of health reform. It is currently unclear how any potential reforms will affect profitability for hospitals or insurers. There is a risk that the changes will make investments in health companies will be adversely effected.

Summary

These are the major risks associated with investing and can be found in most investments. Favorable trade-offs between these risks is important when picking the right portfolio for your needs. It is important to understand, for instance, that while Treasury Bonds have low default and market risk components, they have higher inflation, opportunity, and interest rate risks. It is dangerous to invest without concern for these risks, or to ignore risk altogether. An investor that is well informed of all the investment risks will be able to make better decisions with his/her money.

A -G, Glossary, Strategies for Beginners

Buy and Hold Strategy

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The buy and hold strategy is essentially just what it sounds like: Purchase stocks and then hold them for an extended period of time. The underlying assumption for the buy and hold strategy is that stocks tend to go up in price over extended periods of time. Research supports this trend in a growing capitalist economy and the strategy has made millions rich. There is also something to be said about not having to ride the emotional roller coaster with every increase and dip in the market…just buy the stock and check on it once in awhile. Is a buy and hold strategy right for you? Take this quick quiz to find out:

1. You are investing with long term goals in mind.
2. You are unlikely to need the additional cash on short notice.
3. You would like to reduce commissions and other fees.
4. You would like to reduce or defer taxes.

If you answered “yes” to any of the above then a buy and hold strategy might be a good fit for at least a portion of your portfolio. A Buy and Hold strategy is a traditional long-term investment strategy of buying a stock long and holding on to it for an indefinite period of time, usually 3-5 years. This classic strategy is associated with a bottom-up investment management style where the portfolio analyst uses the financial statements to forecast growth in earnings and buys the stock long-term, anticipating growth and therefore price appreciation for the stock over a period of time. Buy and Hold strategies are most often strategies used with registered non-taxable accounts, such as a 401k or RRSP’s, where the manager is limited to long only positions and does not have the ability to use derivatives or to sell short stock. For example, after extensive research and due diligence, a portfolio manager learns that a new small-cap company, Stock-Trak Group, has some earnings and is expected to be a leader in their industry. The portfolio manager decides that this is a potential great investment and sees good growth for the firm in the long-term. After analyzing his valuation models, the manager believes Stock-Trak Group is highly undervalued and that with growth in revenue and earnings over the next 3 years, the stock’s price will appreciate very quickly. He decides to purchase the stock today and hold for the 3 year term, unless some unanticipated events occur, and sell with a target gain of 300% (tripling the client’s money).

Strategies for Beginners

The Art of Market Timing

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Learn the classic market cycles of accumulation, mark up, distribution and mark down so that you can time the market -consistently – and make steady profits any time. When you hear someone on TV say that “market timing” is impossible, they are wrong. Let me be the first to say that market timing is not only possible, but also profitable on a consistent basis. As a technical trader, your purpose is to find the best trades and to time your entry and exit points. After all, you can find the best trade in the world, but if it is not timed well, it may turn into a loss. Every stock or asset class goes through a classic market cycle. When you look at the chart of any stock or index, it moves in cycles. We are all going through a life cycle, and we are also in the autumn stage of the seasonal cycle. By observing cycles, we know what to expect next. This is true for stocks. If you noticed, all three were homebuilders and they have completed their market cycles which has ranged from 5 to 10 years. If you are a long-term investor or trader, your understanding of market cycles will greatly benefit you. Let’s talk about each stage and what is going on during each stage of the cycle:

Stages of a Market Cycle

  • Accumulation Phase – This is the bottom (or near the bottom) of the market for a particular stock, sector, or general market. At this stage, prices do not move upward but rather stay within a neutral range. At this level, the smart money begins to buy up large blocks of shares to accumulate a large position for their portfolio. They are patient enough to be able to wait years, if needed, because it is difficult to determine how long a stock or sector will be in this stage. Regular individual retail investors do not even consider buying at this level because, in most cases, they have recently sold close to the lows. It is at this stage where you pick up the biggest discounted stocks. This is where long-term investors should be buying to realize the greatest long-term gains.
  • Mark Up Phase – This phase follows the Accumulation phase and the way to know if this phase is occurring is to see a stock or sector that has “broken out” of its neutral range. This means that it must break above the upper trend line of the neutral range. From this point on, you should see an obvious increase in volume. Most of the institutions and individuals who are aware of this early trend will jump on board and bring along significant buying power with them. Another way to tell if you’re in this stage is to see if we are forming higher lows and higher highs, confirming the start of a new uptrend. Toward the end of the mark up phase, you will see full market participation, meaning everyone from the shoe shiner to the cab driver will most likely have made an investment. This sets us up for the next phase:
  • Distribution Phase – This is the top of the market for a particular stock, sector, or general market. Supply overwhelms demand after the smart money sells their shares to the “greater fools” who buy at the top. Because there are no other buyers left to raise the price, a stock or sector cannot advance higher, and thus, will collapse under its own weight. The sentiment is extremely bullish. This phase is marked with extreme greed and fear. The best way to identify a top is through chart patterns, most notably, the head-and-shoulder and double top formations combined with breakdowns at the 200-day MA. This phase is usually marked by the greatest volume levels for a stock until we reach the Accumulation phase once again.
  • Mark Down Phase – Prices are in free fall and stocks are in full liquidation mode. This group is made up of people who held beyond the Distribution phase and did not sell, or those who bought at or near the top and refuse to sell at a loss. Either way, a loss will be incurred, and the size of it will be determined when an investor wishes to cut it. You should not be buying at this stage and those that try to find a bottom will be disappointed.
  • Return to Accumulation Phase

Phase Strategies

Accumulation Phase

  • Investors: Cash » Buy
  • Traders: Cover/ Buy

Mark Up Phase

  • Investors: Buy
  • Traders: Buy

Distribution Phase

  • Investors: Sell » Cash
  • Traders: Sell/ Short

Mark Down Phase

  • Investors: Cash
  • Traders: Short

Sentiment Cycle

In addition to the actual price cycle, there is also a sentiment cycle which accompanies each stock, sector, or overall market. Here is the general range of emotions that follow (each chart is different, so this model is not exact for every situation):   You may have found yourself within each of these emotional phases. Now that you know what to expect for each cycle, you’ll have to harness your emotional involvement and separate it from your trading activities. You are your own worst enemy because emotions give room for destructive impulse trading. By understanding each cycle and what emotions follow, you’ll be better prepared. By now, you understand why high flying stocks crash to their lowest levels. Market cycles are a normal and necessary function in balancing the financial markets and restoring equilibrium to the forces of supply and demand. You are now positioned to take advantage of every market cycle for every stock and every sector in the future. Take a look at 3-year charts for TRA, CROX, and MON for additional examples of full-length charts.

Glossary, N-T, Tools

Timing System

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Definition

A “Timing System” is a methodology to try to “time” the markets; the best way to “buy low and sell high”. Timing systems are often marketed by “stock gurus” who claim to know some market secret to making millions; other timing systems are based on strong technical analysis. The unifying factor of timing systems is that they are supposed to be a methodology one can follow to know the high and low points of a stock’s price within a given time frame.

Do They Work?

It is hard to tell if a stock timing system really works, but look at it this way; who is trying to sell it to you? By definition, a stock timing system cannot work if everyone is using it; you cannot “buy low and sell high” if everyone else is trying to buy when you buy, since many buyers and few sellers drives prices up.

Conversely, if one person is trying to buy when everyone else is selling, they will probably get it for a cheaper price. If someone is selling a “stock timing” method, are they profiting more from using their system, or just making money by selling it to other people?

Beginners generally should avoid market timing systems because it is very easy to get “in over your head”; all market timing strategies involve buying and selling at critical moments, which is both the highest possible point for profits AND losses. However, if you are able to build a strong background in technical analysis, the Kansas City Federal Reserve Bank has released a report of examples where market timing systems have worked well. Click Here to view.

Who Uses Timing Systems?

Timing systems are often used by traders who are fluent in technical analysis; analyzing chart patterns, knowing which macroeconomic factors most directly impact one or two stock’s prices, and hopefully make the right trades before the market as a whole. Again, all timing strategies are inherently risky; long-term investors should be more concerned with strong stock fundamentals rather than the specific minute, hour, or day to buy or sell a particular stock.

Beginners, Glossary, N-T

Offer Price

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The offer price, or the Bid price is what an investor is willing to pay for an investment. If Apple shares are trading at $93.75, an investor’s offer price could be at $93.70.  In other words, what are you willing to pay (offer) for this security? It is only an offer and will not be accepted if the seller is not willing to let go at the offer price.  This offer price pertains to all traded investments, whether it be a stock, an option, future or even a bond. As the term Offer Price is very much self-explanatory, it is very easy for us to conclude that it can be used almost anytime a buyer or seller are negotiating a product or a service.

Beginners, Glossary, N-T

Spread

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A bid price is the highest price at which a buyer is willing to purchase a stock. Conversely, the ask price is the lowest price at which a seller is willing to sell a stock. The role of the stock market is to match buyers with sellers at a price at or nearest to their threshold.  The difference between the ask price and the sell price is called the “spread” and it is kept by the broker. This is not the same as the commission, which is paid regardless of the spread. Generally, stocks that trade with the most volume will have the smallest spreads while stocks that trade with less volume (such as OTCBB, penny stocks or pink sheet stocks) will have larger spreads.

Beginners, Glossary, N-T, Stocks

Stock Symbols

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Definition

A “Stock Symbol” is the symbol used by exchanges to identify the shares of one particular company. For example, AAPL is the symbol for Apple, Inc, and F is the symbol for Ford. Stock Symbols are also referred to as “Ticker Symbols”.

Why Do We Use “Tickers”?

Most beginning investors hate tickers; wouldn’t it just be easier if we used the company names? We try to help this with our Smart Trade Drop-Down, where by typing the company name in the trading window, we will give you tickers that match. Click Here to try! However, lets take a look at where ticker symbols came from, and why we still use them today.

Early Tickers

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Ticker machines first came into use during the 1800’s as a fast way to move news across far distances; they used telegraph lines to transmit messages electronically. However, with a telegraph machine, each letter of the message had to be speed out in Morse Code (a series of dots and dashes), read by the operator on the other end, and then typed out onto a message to be actually read by anyone.

This was a time-consuming process; the longer the message, the longer it took to write, translate, and read. To speed things up, short-hand writing (the predecessor of today’s “text speak”) was invented. Famously, an old British admiral was the first person to use “OMG” as shorthand in a message to one of his colleagues.

For investors looking to get the latest stock prices, this was also a problem. Since there were dozens, then hundreds, of companies being traded and prices being updated every day, the longer it took to communicate a company’s price meant the whole stream of information was held up. Thus, company names were shortened down to 1-5 characters, and the first ticker symbols were born.

Rise of Electronic Trading

Today, the original reason for tickers is still important; computers still take time to process longer names, so shorter codes can be a lot faster when executing billions of trades per day (if you are making trades as fast as you could, it would take almost 5 times as long to write “The Coca-Cola Company” than it would “KO”). However, there is another reason why we continue to use tickers: sometimes companies have multiple “types” of stock, or multiple companies have very similar names.

For example, Google has stock both under the symbol “GOOGL“. These stocks are very similar, but they were issued at different times and have different prices, since each share represents a different “slice” of the company.

Finance Knowledge, Glossary, N-T

Risk Management

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Many people start trading stocks and never learn about stock trading risk management. The one’s that do learn, usually learn after they have been trading for a while, not before they start trading. Here is a timeline for a typical trader:

  • They start off and have a few winning trades in a row.
  • They read about other people making money trading and think “Hey, I have just had a couple of winning trades in a row, I CAN do this.”
  • Now after a few of these winning trades, they become confident that they can continue having the same success over and over again.
  • Next, they become Over Confident and they now think that nothing can stop them, and that trading is easy.
  • Now reality sets in. The same traders now experience one or two losing trades that wipe out their trading account or come darn close to doing so.
  • The people who have money left in their account, now stop and take a look to see what went wrong. They start to learn about Stock Trading Risk Management.

If this sounds like you, you’re not alone. If you haven’t been through these steps, great, now is as good a time as any to skip over the hard earned lessons above and learn about risk management now, rather than later. Keep in mind that every trader will have losses and the people who get wiped out with large losses are the ones who do not manage risk well, if at all. In order to be around to take advantage of the next trading opportunity, you must learn to mange risk on each and every trade. Here are some of the things you will be learning about when exploring stock trading risk management:

  • Determining your risk tolerance
  • Risk to Reward ratio
  • Determining Position Size for trades
  • Different order types to help minimize losses and capture profits
  • Diversification
  • Learning to identify possible entry and exit price points
  • When to cut your losses

Once you learn about these and other risk management topics, you will be able to evaluate each trade before and after entering into a position. You will also be able to make any necessary adjustments as the position moves either against you or “in your favor”. You may have noticed I mentioned “in your favor” also. Yes, that’s right. I have seen and read about many traders who at one time or another had a sizeable profit in a position only to keep holding it and watch as it turned into a losing trade, and finally selling when they can’t stomach the continued, increasing losses. These people need to learn about risk management also. Stock Trading risk management is not just about limiting or controlling losses, but understanding how to capture and try to maximize profits as well. All of these things can be learned and adjusted based on each person’s particular trading plan or system that they use. Whether you are an intraday scalper or a long term investor, risk management should be a part of every traders plan to achieve long term success. While there will be other area’s to explore in addition to these, having a place to start will help you get started and hopefully avoid some of the costly mistakes many traders make over and over again.

ETFs, Glossary, N-T

REITs

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Real estate can be a wise investment but beyond purchasing a home of your own, what is the best way to invest in real estate without getting your hands dirty and spending your spare time chasing tenants for rent? A REIT or Real Estate Investment Trust may be the perfect investment vehicle. REITs own, and often operate, real estate but are publicly traded like stock. Profit is paid as dividend to stock owners. To invest in a REIT, it is imperative that you do your homework. Real estate is a tangible asset, but there are major holding costs including maintenance, taxes and insurance. Local market conditions change dramatically and can take years to recuperate. Before investing in REITs research the following:

  • Is the REIT registered with the SEC and publicly traded? Use caution before investing in an REIT that isn’t registered or publicly traded.
  • Determine the type of REIT: equity, mortgage, hybrid?
  • What type of property does the REIT invest in? What is the economic forecast related to that industry?
  • Who is on the board and management team? What is their experience?
  • How will it impact your taxes? Most REIT distributions are taxed as ordinary income.

Some well known and actively traded REIT’s include:

Boston Properties Inc. (BXP), Simon Property Group Inc. (SPG), and .

A -G, ETFs, Glossary

Currency ETFs

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Since 2002, the U.S. Dollar has lost more than 30 percent of its value relative to other world currencies. Shorting the U.S. dollar and buying other world currencies is one way to make money from this trend. Instead of playing the very risky and complicated foreign exchange markets, these exchange traded funds make it easy to short the U.S. dollar or go long foreign currencies. Now, you can buy euros, yen, pesos and pounds just as easily as you would buy a stock.
PowerShares DB U.S. Dollar Index Bearish Fund (UDN) gives you exposure to all the major world currencies and is designed to replicate a short position in the USDX, an index that tracks the U.S. dollar against the Euro (57.6%), Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish Korona (4.2%) and Swiss franc (3.6%).

In other words, UDN goes up as the U.S. dollar goes down against this basket of other major currencies. PowerShares DB U.S. Dollar Index Bullish Fund (UUP)allows you to take the opposite position as the UDN. This one goes UP as the currencies mentioned above fall when measured against the greenback. CurrencyShares British Pound Sterling Trust (FXB) is an ETF that holds a position in the United Kingdom’s currency, the pound. CurrencyShares Japanese Yen (FXY) gives you a chance to profit when the Japanese yen is outpacing the dollar. The ProShares UltraShort Yen (YCS) is a bearish yen fund. It’s 2X leveraged, so your gains are amplified if your bet is correct. If the yen drops 10 percent, this ETF’s shares stand to rise 20 percent.

However, if you’re wrong, your losses can add up quickly. The PowerShares DB G10 Currency Harvest Fund (DBV) tracks an index that shifts exposure based on the yield of the ten top world currencies in the world — the G10. With DBV, you’ll have the equivalent of a long position in the three highest-yielding G10 currencies and a short position in the three lowest-yielding G10 currencies. If you know anything about hedge funds, you probably recognize this as the so-called “carry trade.” Put simply, it’s borrowing at low interest rates and using the loan to buy higher yielding assets elsewhere. It was an easy way to make big bucks for years. But those managers had their heads handed to them in 2008.

Glossary, N-T

Stock Index

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By measuring the compilation of similar stocks instead of just one or two stocks, a stock index provides information about that particular market or segment. One of the most talked about and popular indexes is The Dow Jones Industrial Average (DJIA) which consists of 30 of the biggest companies in the U.S.  Stock indices are typically related by some commonality: for example, the Dow Jones Wilshire 5000 is an index that measures or tracks almost every publicly traded stock in the United States. The Morgan Stanley Biotech Index is a small index that follows the biotechnology market. Each stock index has a specific focus that can provide highly specific or very generalized information.  Interested in learning more? Explore new stock market indexes such as: Ethical Stock Market Indexes and Environmental Stock Market Indexes.

Glossary, H-M

Institutional Investor

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Definition

A non-bank organization that regularly trades large blocks of stocks. Because of the size of their investments, they qualify for preferential treatment and lower commissions. Institutional investors have less protective regulations as it is assumed that they have more experience with the market and are better able to protect themselves.

There are many consumer based investment strategies that watch what the big money (institutional investors) is buying and follow their lead. The larger the percent volume increase relative to a regular day sold of one company’s stock, the more likely institutional investors have identified that company as having strong growth prospects for the future. The most well known strategy is taught by Investor Business Daily.

Advanced, Technical Analysis

Market Indicators (list of Market Indicators)

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List of Market Indicators

A series of technical indicators used by traders to predict the direction of the major financial indexes. Most market indicators are created by analyzing the number of companies that have reached new highs relative to the number that created new lows, also known as market breadth.  By weighing those indicators showing Bullish signs against those showing Bearish signs, you are able to weigh your risk in the current market.

LIST OF THE BEST MARKET INDICATORS

1) Percent of S&P 100 Stocks Above 200 Day Moving Average: Many consider this the best indicator available of a market sweet spot for positive results.

2) DOW Relative Strength Index RSI: A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.  When RSI is above 50, it is considered a positive indicator for market direction. It is calculated using the following formula:

RSI = 100 – 100/(1 + RS*)
*Where RS = Average of x days’ up closes / Average of x days’ down closes.
3) NYSE MACD: A trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.  The black line above red is a positive indicator.

4) NYSE Fast Stochastic: The stochastic momentum oscillator is used to compare where a security’s price closed relative to its price range over a given period of time.

5)NYSE McClellan Oscillator: The McClellan Oscillator offers many types of structures for interpretation, but there are two main ones. First, when the Oscillator is positive, it generally portrays money coming into the market; conversely, when it is negative, it reflects money leaving the market. Second, when the Oscillator reaches extreme readings, it can reflect an overbought or oversold condition.

6) Advance/Decline Line: Every day that stocks  are traded, financial publications list the number of stocks that closed higher (advances) and that closed lower (declines). The difference  between these numbers is called the daily breadth. The running cumulative  total (starting at 0) of daily breadth is known as the Daily Advance-Decline Line. It is important because it shows great correlation to the movements of the stock market, and because it gives us another way to quantify the movements of the market other than looking at the price levels of indices.

A -G, Advanced, Beginners, Country Specific Investing, Glossary

Debtor Nation

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A national government that owes money to international financial institutions such as the World Bank, foreign governments, or to foreign lenders. A debtor nation will have a negative balance of trade because the amount of money coming into the country from outside sources is greater than the amount of exports and money that the country sends out.

Glossary, N-T

Seasonal Indicators

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Definition

Indicators related to specific times of the year that predict year end stock market results with amazing results.  The success ratios of these trends are often far stronger than most other indicators.  For example, the First Five Days of January Indicator has an 85% success ratio for years where the first five trading days have positive results.  The January Barometer has a 90% success ratio.

A -G, Glossary

Arms Index

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A technical analysis indicator that compares advancing and declining stock issues and trading volume as an indicator of overall market sentiment. The Arms Index, or TRIN (Traders Index), is used as a predictor of future price movements in the market primarily on an intraday basis.

Short Term ARMS Index
Short-Term Trading Arms Index

A -G, Glossary

Absolute Breadth Index

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Definition

A market indicator used to determine volatility levels in the market without factoring in price direction. It is calculated by taking the absolute value of the difference between the number of advancing issues and the number of declining issues. Typically, large numbers suggest volatility is increasing, which is likely to cause significant changes in stock prices in the coming weeks.

A -G, Advanced, Glossary

Advance/Decline Index (AD Line)

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Definition

A technical analysis tool that represents the total difference between the number of advancing and declining security prices. This index is considered one of the best indicators of market movements as a whole. Stock indexes such as the Dow Jones Industrial Average only tell us the strength of 30 stocks, whereas the advance/decline index can provide much more insight into the movements of the market.

In general, rising values of the advance/decline can be used to confirm the likelihood that an upward trend will continue. If the market is up but there are more declining issues than advancing ones, it’s usually a sign that the market is losing its breadth and may be getting ready to change direction.

Imagine that the advance/decline index on the S&P 500 is currently at 1835. If at the end of the last trading day, 300 stocks were up (advance) and 200 were down (decline), 100 would be added to the advance/decline index value, pushing it to 1935.

Glossary, H-M

Market Index

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Definition

By aggregating the value of a related group of stocks or other investment vehicles together and expressing their total values against a base value from a specific date. Market indexes help to represent an entire stock market and thus give investors a way to monitor the market’s changes over time.

Explanation

Index values are used by investors to track changes in the stock market over long periods of time. For example, the widely used S&P 500 Index is computed by combining 500 large-cap U.S. stocks together into one index value. Investors can track changes in the index’s value over time and use it as a benchmark against which to compare their own portfolio returns.

Finance Knowledge, Glossary, N-T

Sole Proprietorship

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Simplest, oldest, and most common form of business ownership in which only one individual acquires all the benefits and risks of running an enterprise. In a sole-proprietorship there is no legal distinction between the assets and liabilities of a business and those of its owner. It is by far the most popular business structure for startups because of its ease of formation, least record keeping, minimal regulatory controls, and avoidance of double taxation.

Glossary, H-M

Maintenance Margin

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Definition

The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an investor has bought securities on margin, the minimum required level of margin is 25% of the total market value of the securities in the margin account. Keep in mind that this level is a minimum, and many brokerages have higher maintenance requirements of 30-40%.

Advanced, Glossary, H-M

Margin Call

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Definition

When a broker requires an investor that is using margin to add additional deposit funds so that the margin account returns to the minimum maintenance margin amount. Margin calls happen when your account value drops to a value below that allowed by a broker.  For example, if a stock, purchased on margin, drops in value, the amount of your money in an account may drop below the specified percent of the investment that you agreed to when you chose to buy the stock with margin.

A -G, Beginners, Glossary

Corporation

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An entity that abides by specific legal requirements that sets it apart as having a legal existence, as an entity separate and distinct from its stockholders (owners). Corporations are owned by their stockholders who have the right to share in profits and losses produced by the firm’s operation. Corporations have three distinct characteristics:

(1) Legal existence: a Corporation can (as can a person) buy, sell, own, enter into a contract, and sue people or other corporations and be sued by them. A corporation can be charitable or commit criminal offenses.

(2) Limited liability: a corporation and its stockholders have limited liability with the corporation’s creditors unless the owners give personal-guaranties.

(3) Continuity of existence: a corporation will continue to exist beyond the life spans of its stockholders and founders because ownership in a corporation (stocks) can be sold, donated or bequeathed.

Finance Knowledge, Glossary, N-T

Retained Earnings

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Retained earnings is calculated by adding net income to (or subtracting any net losses from) the beginning retained earnings and then subtracting the dividends that were paid to shareholders:

Retained Earnings (RE) = Beginning RE + Net Income – Dividends

This equation is also known as the “retention ratio” or “retained surplus”.

Companies retain their earnings to invest  in projects or plant improvements that will help the company grow.  Examples of these type of investments would be buying machinery or research and development.

If the net loss for the period is greater than the retained earnings at the beginning of the period, retained earnings will be negative, creating a deficit.

Retained earnings is calculated by adding net income to (or subtracting any net losses from) the beginning retained earnings and then subtracting the dividends that were paid to shareholders:

Retained Earnings (RE) = Beginning RE + Net Income – Dividends

This equation is also known as the “retention ratio” or “retained surplus”.

Companies retain their earnings to invest  in projects or plant improvements that will help the company grow.  Examples of these type of investments would be buying machinery or research and development.

If the net loss for the period is greater than the retained earnings at the beginning of the period, retained earnings will be negative, creating a deficit.

A -G, Glossary

Dividend Reinvestment Plan – DRIP

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Definition of a Dividend Reinvestment Plan

A plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date. A DRIP is an excellent way to increase the value of your investment. Most DRIPs allow you to buy shares commission free and at a significant discount to the current share price. Most DRIPS don’t allow reinvestments much lower than $10.

This term is sometimes abbreviated as “DRP”.

Definition of a Dividend Reinvestment Plan

A plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date. A DRIP is an excellent way to increase the value of your investment. Most DRIPs allow you to buy shares commission free and at a significant discount to the current share price. Most DRIPS don’t allow reinvestments much lower than $10.

This term is sometimes abbreviated as “DRP”.

A -G, Advanced, Glossary, Technical Analysis

Chart Analysis

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Chart analysis is the same as Technical Analysis.

SIMPLE DEFINITION: Technical Analysis is the use of technical indicator to predict which direction the stock price will move in the future.  Technical indicators use past stock prices to calculate their value.

COMPLETE DEFINITION: Technical analysis evolved from analyzing 100s of years of stock data. The theories for technical analysis began in Joseph de la Vega’s accounts of the Dutch markets in the 17th century.  In the 1920s and 1930s Richard W. Schabacker wrote books continuing the work of Charles Dow and William Peter Hamilton from their books Stock Market Theory and Practice and Technical Market Analysis. In 1948 Robert D. Edwards and John Magee published Technical Analysis of Stock Trends. This book is considered to be the break through works of the discipline.

study
A -G, Glossary

Blue Sky Laws

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State regulations governing the sale of securities and mutual funds, designed to safeguard investors from being lured into fraudulent or unscrupulous deals. Under this memorandum, only appointed brokers or agents, who are appropriately licensed within the jurisdiction, are allowed to make securities transactions.

A -G, Glossary

Direct stock purchase plans

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Definition:  An investment service that allows individuals to purchase a stock directly from a company or through a transfer agent. Not all companies offer DSPPs and the plans often have restrictions on when an individual can purchase shares.

Example:  The greatest benefit of using direct stock purchase plans for investors is the ability to avoid commissions by not going through brokers. DSPPs often have minimum deposit requirements that range from $100 to $500. They are perfect for investors who have a long-term trading strategy and are looking for an inexpensive way to begin investing.

Bonds

How Interest Rates Affect Bond Prices

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Since the bottom fell out of the stock market in 2008, investors have been shifting money from stocks into bond funds. Since 2007, there have been $1.39 trillion invested in Bond Funds versus $193 billion in stock funds. The most logical explanation is an attempt to find income and safety, but are bonds truly safe? To explore that question we need to understand where interest rates are now, where they will be in the future, and how changes in the interest rates will affect bonds.

Interest Rates

In response the financial crisis, the Federal Reserve (the Fed) lowered the federal funds rate to a historic low of 0% – 0.25% and they have remained there ever since. In their recent guidance, the Fed announced their intention to keep the rate at that low level until the unemployment rate falls below 6.5% which they predict will happen in 2015. The accuracy of their estimation can be argued but it really isn’t they key issue. What is important is that interest rates are as low as they will go and the next change in interest rates will be up. When that happens, bond investors may find their portfolios in trouble.

Bond Prices

The rule is simple. When interest rates go up, bond prices go down.

Suppose you buy a $1000 bond today which pays 5% interest. Every year the bond will pay $50 until the bond matures and then you receive the $1000 back. You pay $1000 for the $1000 bond. In investment terms, you just purchased the bond at Par Value.

Tomorrow, the same bond issuer raises the interest rate on new bonds to 6%. Those bonds pay $60 every year until the face amount is returned to the investor. If someone else is looking to buy a bond, they would obviously chose the 6% bond for their $1000 over your 5% bond… unless you were willing to sell your $1000 bond for less than $1000. At some discounted price, the 5% bond is just as attractive as the 6% bond for $1000.


Relationship between bond prices and interest rates: Why bond prices move inversely to changes in interest rate

Bond fund buyers need to be aware (or should they beware?). There is no argument that interest rates will be going up. The only unknown is when it will happen. When it does, the prices of the bonds in bond funds will fall and the fund values will go down.

Key Terms

  • Par Value – the face amount of a bond. It is what an investor paid for the bond when it was initially issued and what will be repaid to an investor when the bond matures.
  • Discount Bond – a bond which is currently trading for less than its par value.
  • Premium Bond – a bond which is currently trading for more than its par value.

Recommended Reading

Advanced, Fundamental Analysis, Technical Analysis

Technical Analysis vs. Fundamental Analysis – Which is better

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In the world of stock analysis, fundamental and technical analysis are on completely opposite sides of the spectrum. Earnings, expenses, assets and liabilities are all important characteristics to fundamental analysts, whereas technical analysts could not care less about these numbers and only focus on price and volume. Which strategy works best is always debated, and many volumes of textbooks have been written on both of these methods.

A Technical Analyst would criticize Fundamental analysis as they consider it worthless because company numbers are frequently cooked and they only come out once a quarter. Government statistics usually have a huge lag time, sometimes months after the time period in question. A Technical Analyst would rather look at market information (price and volume) only. This is where true information is as the institutional buyers have a better inside track and will buy/sell in huge volumes based on their inside knowledge. Therefore, a retail investor should buy things that are going up and sell things that are going down.

A fundamental analyst would say that technical analysis ignores all the valuable information about profit, dividends, growth rates and other information that any CEO would use to judge the value of a company.

The bottom line is that you should do some reading for yourself and figure out which system you feel most comfortable with.

Key Terms

  • Fundamental Analysis – Fundamental analysis looks at factors like balance sheets, income statements, profit ratios, the economy, etc.
  • Technical Analysis – Primarily focuses on stock price and the volume of stock purchases and sales.
  • Technical Indicators / Chart Patterns – A list of Chart Patterns that professional WallStreet traders use on a daily basis.
  • Chart Analysis – Focuses on the same factors as a Technical Analyst.

Recommended Reading

A -G, Advanced, Charts and Patterns, Glossary

Falling Knife

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Definition: Falling Knife

A phrase used for a stock where the price has dropped significantly in a short period of time. A falling knife security can rebound, or it can lose all of its value where the shares become worthless.

A stock with a falling knife situation occurs when a business results have a big drop in net earnings or because of increasingly negative investor sentiment.  This phrase is often used to teach new investors not to buy a stock (even one that has been popular) with a dropping price until they see the stock price confirm a turn around.

Economics, Finance Knowledge, Glossary, N-T

National Debt

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The total amount that the federal government has borrowed including internal debt (borrowed from national creditors) and external debt (borrowed from foreign creditors). National debt is comprised of: (1) Floating debt which is short term borrowings using treasury bills, ways-and-means advances, and money from the central bank. (2) Funded debt, short-term debt converted into long-term debt. (3) Unfunded debt, national savings certificates, savings bonds, premium bonds, and securities from the foreign exchange. National debt has an important role in a country’s finances as government securities are a critical part of the reserves of its financial institutions.

Glossary, N-T

Stop Limit

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DEFINITION: A Stop Limit is an order that combines the features of stop order with the features of a limit order. A stop limit order executes at a specified price (or better) after a specified stop price is reached. After the stop price is reached, the stop limit order becomes a limit order to buy (or sell) at the limit price or better.

EXAMPLE: The benefit of a stop limit order is that the buyer/seller has more control over when the stock should be purchased or sold. On the downside, since it is a limit order, the trade is not guaranteed to buy or sell the stock if the stock/commodity does not exceed the stop price.

For example, if stock ABC Inc. is trading at $30 and the investor wants to buy stock after it starts to show serious upward momentum (around $35 but not more than $36), the buyer must use a stop limit order to buy with a stop price of $35 and the limit price at $36. If the price of the stock moves above the $35 stop price, the order is activated as a limit order. The stock will be bought as long as it can be filled under $46 (the limit price). If the stock gaps above $46, the order will not be filled.

Glossary, H-M

Horizontal Integration

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The merger of companies at the same stage of production in the same or different industries. When the products of both companies are similar, it is a merger of competitors. When all producers of a good or service in a market merge, it is the creation of a monopoly. If only a few competitors remain, it is termed an oligopoly. Also called lateral integration. See also vertical integration.

Glossary, N-T

Sherman Antitrust Act

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US federal legislation of 1890 that prohibited the creation of monopolies by outlawing direct or indirect attempts to interfere with the free and competitive nature of the production and distribution of goods. Amended by the Clayton Act of 1914. Also called Sherman Act.

A -G, Beginners, Glossary

GTC Order (Good Til Cancel)

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Definition: An order to buy or sell a stock at a fixed price.  This order is active until 1) the trade is executed, 2) the investor decides to cancel it or 3) a specified time period elapses.

Explanation: Typically, GTC orders are canceled by brokerage firms after a specified time period like 30-90 days. Investors use this type of order typically to buy a stock at a lower price or sell a stock at a higher price. For example if an investor owned a stock that is currently $40 and the investor wants to sell it if it reaches $50,  you can use a GTC order. Once the GTC order to sell is placed, if the price of the stock reaches $50 at any point over the next few months your shares will be sold.

Economics, Stocks

The Power of Supply and Demand on Stock Prices

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Investor periodicals supply countless explanations why stock prices fluctuate as they do.  You will hear about the influences on stock prices like earnings or the economy or the credit markets. While these factors impact buyers and sellers of stocks, in reality they have minimal direct impact on prices. These and many other factors do is change the balance of supply and demand.

Stock prices are a direct result of supply and demand. All the other influences like debt, balance sheets, earnings and so on affect the desirability of owning (or selling) a stock. If a company surprises stock owners with low earnings, demand for the stock may wither. As it does, the equilibrium between buyers and sellers of the stock is changed.

Future buyers will require a discount in the stock’s price and many sellers will be motivated to accommodate. More sellers than buyers means that supply will exceed demand, so the price falls.

Prices Drop

At some point, a stock’s price will drop enough that buyers will find it attractive.  There are many factors that can changes this dynamic. As buyers move into the market for a stock, demand grows faster than supply and so the price will increase.

Often supply and demand find equilibrium at a price that buyers accept and sellers accommodate. When supply and demand balance, so they are roughly equal, prices will gyrate up and down in a narrow price range.  We can find many examples of stocks staying in a flat range for days or months before an event disrupts the supply/demand balance.

If demand for a stock exceeds the supply, its price will rise. However, it will only rise to the point where buyers find the price attractive.  After which, demand will typically wane.  As you know, declining demand will cause stock owners to sell. As owners sell (for any reason), the price will fall as there is now more supply than demand. By dropping the price, sellers of the stock hope to encourage someone to buy it. The dynamic works just the same when demand increases but in reverse. As the price falls, it will reach a level where buyers find the stock attractive and demand will increase.  When investors start buying, the stock’s price will rise as more and more sellers need to be enticed to sell their shares.

This mechanics of supply and demand is the most important truth that new investors need to learn about stock prices. It is the the give and take between supply and demand that sets the price.


Who can Impact the Supply Demand Equilibrium

Only Institutions like Mutual Funds, Pension Funds and Banks trade in sufficient volume to impact stock prices. These large transactions drive prices up or down depending on the number and speed with which they buy or sell stocks. Stocks are subject to the law of supply and demand as much as any other product. Identifying stocks with the proper technical indicators to motivate institutional buying or selling is critical in locating stocks that are ready to make large price moves.

“It takes big demand to move price up, and the largest source of demand for stocks is by far the institutional buyer.” — William J. O’Neil

people
A -G, Economics, Finance Knowledge, Glossary

Economies of Scale

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Decreasing the long-run average and marginal costs that come from an increase in the size of a factory or plant. Economics of scale can be from the inner workings of an organization. This would include the lower cost from adding technology and better organization.

Glossary, Options, U-Z

Uncovered Call

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A short call option position where the writer does not own the specified number of shares specified by the option nor has deposited cash equal to the exercise value of the call. These type of options are also called naked call and are the opposite of covered calls.

Bonds, Glossary, H-M

Junk Bonds

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A high-risk bond with a low credit rating. Junk Bonds usually have a much higher yield than investment-grade bonds.

A -G, Glossary

403 (b)

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An alternative retirement plan to a 401(k) plan offered by non-profit organizations such as universities and charitable organizations, rather than corporations. There are advantages to 403(b) plans: contributions lower taxable income, larger contributions can be made to the account, earnings can grow tax-deferred, and some plans allow loans. Contributions grow tax-deferred until withdrawal. Withdrawals are taxed as ordinary income (which is sometimes a disadvantage).

 

carpet-salesman-4871_640
A -G, Glossary

Exchange Offer

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When a company offers to trade one security in return for another security. The most common use of an exchange offer is when a company offers to give shares of a certain held company if the shareholders will return shares of another held company. Exchange offers can use any type of securities, such as bonds.

Beginners, Strategies for Beginners

What Affects Stock Prices

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Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.

Introduction

Stock market prices are affected by business fundamentals, company and world events, human psychology, and much more.

Stock trading is driven by psychology just as much as it is by business fundamentals, believe it or not. Fear and greed are the two of the strongest human emotions that affect the market. For example, it is easy to get caught in the trap of selling a stock prematurely because it dipped temporarily and fear set in. On the other hand, it is also easy to miss out on a respectable gain because greed was telling you to hold out for more, and then the stock drops back down.

One of the main business factors in determining a stock’s price is a company’s earnings, including the current earnings and estimated future earnings. News from the company and other national and world events also plays a large role in the direction of the stock market. Some examples of this are oil prices, inflation, and terrorist attacks.

Every analyst and trader has a different perception of what that stock price should be now and where it might be in the future, and trading decisions are made accordingly.

Bad News or “Good” Bad News?

  • Layoffs

    This is usually good for the company and its stock price because expenses will be reduced significantly and quickly. This should help increase earnings right away. It is not always a major warning sign; it could just be a reaction to a slower economy. It is one of the quickest ways a company can cut expenses if sales have not been meeting expectations.

  • Store Closings

    This event often causes the stock price to go up for the same reasons as layoffs. However, this is not always the case. Closing stores actually requires a lot of money, and the positive effects of it do not take place immediately. This could be a sign that the company is truly in trouble at the moment. They probably have lower sales and higher expenses than they want, possibly due to a slowdown in the industry or the overall economy. The good news is that their management is being pro-active about maintaining profitability. Unfortunately, the stock price may go down for the next few months.

  • Firing of CEO or Company Official(s)

    This may sound very negative at first, but it does show that the company’s board of directors was bold enough to take drastic actions to help the company in the long run. The stock price could go up or down after this announcement, depending on the situation. In some cases this event could be a sign of corruption that reaches beyond these individuals and there could be more negative announcements to come.

  • Market Scandals

    Traders tend to frown upon corruption in the stock market. Mutual fund scandals that have occurred in the past few years and corporate corruption such as Enron are two such examples. If people cannot trust the stock market, why would they invest their hard-earned money in it? In these situations it is harder for the market to go up because there is a lower demand for stocks.

Analyst Recommendations

Many traders rely on experts’ opinions about companies and future stock prices. Are they always correct? Of course not. Nobody can predict what will happen in the future. They can, however, make educated guesses based on past performances and future prospects for the companies and industries they follow.

Round Numbers

Traders often like nice round numbers for their perceived stock price, such as $10.00 or $35.00. It is common for prices to settle near these round numbers, at least briefly. Also, many traders place automatic buy or sell orders right near these round numbers, causing the stock price to become slightly erratic when it first reaches that target.

Technical Analysis

One of the most popular methods for helping predict a stock’s price, at least in the short term, is called Technical Analysis. This method involves looking for patterns or indicators in stock prices, volumes, moving averages, and many others, over time. Obviously nobody can predict the future but this method can be effective in many cases because human beings are somewhat predictable. For example, when people see a stock start falling dramatically they often panic and sell their positions without investigating what caused the fall. This causes even more people to sell their shares and this often leads to an “overshoot” of the stock price. If you believe the price went too far down you can try to buy it at the bottom and hope that it will come back up to a more reasonable level.

Another common example involves Moving Averages. Many traders like to chart the 50-day and 200-day Moving Averages of their stock prices along with the prices themselves. When they see the current price cross over one of these Moving Averages on the charts it can be an indicator of a change in a long-term trend and it may be time to buy (or sell) the stock.

Advanced, Current Events, Technical Analysis

How do candlesticks imply volume? Why is that critically important?

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Reading candlestick charts is an effective way to study the emotions of other traders and to interpret price. Candles provide a trader with a picture of human emotions that are used to make buy and sell decisions.

On a piece of paper, write down the following statement with a big black marker:

There is nothing on a chart that matters more than price. Everything else is secondary.
*Please note that this author implies volume from the range of price on any given day so it is as easy to say that nothing is more important than volume.  I like to point out that traders should consider price and volume.  Volume to identify interest level of institutional buyers and price to identify the direction of the market.

Take that piece of paper and tape it to the top of your monitor! I think too often swing traders get caught up in so many other forms of technical analysis that they miss the most important thing on a chart.

You do not need anything else on a stock chart but the candles themselves to be a successful swing trader! And, there is nothing that can improve your trading more than learning the art of reading candlestick charts. Believe it.

Who are the buyers and sellers?

There are only two groups of people in the stock market. There are buyers and sellers. We want to find out which group is in control of the price action now. We use candles to figure that out.

https://learn.stocktrak.com/wp-content/uploads/2015/10/candles.gif

The picture above shows how candlesticks are constructed. The highs and lows of the time period are called the “wicks” and the open and close form the “body”. The candle itself is the “range”. When stocks close at the bottom of the range we conclude that the sellers are in control. When stocks close at the top of the range we conclude that buyers are in control.

Note: In the stock market, for every buyer there has to be a seller and for every seller there has to be a buyer.

If a stock closes at the top of the range, this means that buyers were more aggressive and were willing to get in at any price. The sellers were only willing to sell at higher prices. This causes the stock to move up.

If a stock closes at the bottom of the range, this means that sellers were more aggressive and were willing to get out at any price. The buyers were only willing to buy at lower prices. This causes the stock to move down.

Where a stock closes in relation to the range tells us who is winning the war between buyers and sellers. This is the most important thing to know when reading candlestick charts.

We can classify candles in two categories: wide range candles (WRC) and narrow range candles (NRC). Wide range candles state that there is high volatility (interest in the stock) and narrow range candles state that there is low volatility (little interest in the stock).

The arrows on the chart below show how stocks move in relation to the range and closing prices. You’ll notice that stocks tend to move in the direction of wide range candles. This is important!

candlestick chart

Wide range candles

If we know that stocks tend to move in the direction of wide range candles, we can look to the left of any chart to gauge the interest of either the buyers or sellers and trade in the direction of the trend and the candles.

The importance of this cannot be overstated! You want to know if there is interest in the stock and if it is being accumulated or distributed by institutional traders.

Narrow range candles

Narrow range candles imply low volatility. This is a period of time when there is very little interest in the stock. Looking at the chart above you can see that these narrow range candles often lead to reversals (up or down) because:

Low volatility leads to high volatility and high volatility leads to low volatility. So, knowing this, doesn’t it make sense to enter a stock in periods of low volatility and exit a stock in periods of high volatility? Yes.

What about hammers, doji’s and shooting stars?

I know what you’re thinking. You thought this page was going to be about hammers, doji’s, and shooting stars. Sorry to disappoint you, but knowing all of the different types of candlestick patterns is really not at all necessary once you understand why a candle represents the struggle between buyers and sellers.

Consider this…

hammer candlestick pattern

In the picture to the right, we see a classic candlestick pattern called a hammer. What happened to cause this? The stock opened, then at some point the sellers took control of the stock and pushed it lower. Many traders were shorting this stock thinking it was headed lower.

But by the end of the day, the buyers took control, forced those short sellers to cover their positions, and the stock had enough strength to close the stock at the top of the range. So, this is obviously very bullish!

When we are reading candlestick charts, why would we need to know the name of the pattern? What we do need to know is why the candle looks the way that it does rather than spending our time memorizing candlestick patterns!

Advanced, Glossary, N-T, Technical Analysis

Support and Resistance

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Support: If the price of a stock falls towards a support level it is a test for the stock: the support will either be reconfirmed or wiped out. It will be reconfirmed if a lot of buyers move into the stock, causing it to rise and move away from the support level. It will be wiped out if buyers will not enter the stock and the stock falls below the support.

Resistance: A chart point or range that caps an increase in the level of a stock or index over a period of time. An area of resistance or resistance level indicates that the stock or index is finding it difficult to break through it, and may head lower in the near term. The more times that the stock or index has tried unsuccessfully to break through the resistance level, the more formidable that area of resistance becomes.

Resistance and support levels are widely used by experienced traders to formulate trading strategies. For example, if a stock is approaching a very strong resistance level, a trader may prefer to close the position rather than take the risk of a significant decline if the stock uptrend reverses.

On an interesting note, resistance levels can often turn into support areas once they have been breached. In a strong uptrend, investors and traders will embark on a buying spree once a stock conclusively breaks through resistance, sending it sharply higher. But traders and investors who missed the move may wait on the sidelines for a better price. This pent-up demand can become a source of support for the stock as it approaches the earlier resistance level.

A -G, Glossary

Average Directional Index (ADX)

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Definition of ‘Average Directional Index – ADX’

An indicator used in technical analysis as an objective value for the strength of trend. ADX is non-directional so it will quantify a trend’s strength regardless of whether it is up or down. ADX is usually plotted in a chart window along with two lines known as the DMI (Directional Movement Indicators). ADX is derived from the relationship of the DMI lines.

ADX2

Analysis of ADX is a method of evaluating trend and can help traders to choose the strongest trends and also how to let profits run when the trend is strong.

A -G, Advanced, Glossary

Day Trading Rules

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Day Trade: Buying and Selling (or Shorting and Covering) the same security on the same day.

How often can I day trade?

There are various laws and regulations with regards to day trading depending on the country you live in. It is important that if you do decide to start day trading in your personal brokerage account that you are aware of the day trading rules of your respective country. Most countries have rules on margin accounts and not necessarily on trading accounts without margin but it is always important to verify.

US:

The SEC governs the rules and you should thoroughly read the SEC’s day trading rules and regulations, as well as FINRA’s guidelines. Essentially, if you are in the US and make four or more trades in a 5 day period you may be flagged as a “Pattern day trader” and could lose your margin account status unless you fulfill certain rules. This only applies to small accounts; if you hold more than $25,000 in assets in your margin brokerage account, you are probably exempt from this criteria.

Stock Market Games:

Other the hand, the rules for paper trading software such as this one are far simpler. If day trading is allowed you are able to trade as many trades are allowed.

Advanced, Charts and Patterns, Technical Analysis

Dead Cat Bounce, Inverted

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An inverted dead cat bounce is quite the opposite of the dead cat bounce. A quick look is if a trader owns a stock following a quick and large (5-20%) gain there is normally a gap up. If you sell on the next day after the gap up day, thus unlocking profits its because prices normally start falling before beginning a new move upward (Bulkowski, 2005).

The inverted dead cat bounce will occur when a company discloses news that will send the stock soaring by 5% to 20% or perhaps even higher. This event isn’t caused by takeover news since that event pattern indicates a stock moving up and staying up. Instead, the inverted dead cat bounce is frequently earnings related or because of positive results from clinical drug trials, patent dispute resolutions, legal awards, contract wins, oil patch discoveries, etc..

After a price spikes upward, it will often drop back down inside a week or two.

A frequency distribution of price momentum over time conveys that less than half the stocks will make a higher high the day after the announcement. But you are able to place a limit order to sell at the prior day’s high and see if it hits. You’ll want to day trade the exit, if possible, to maximize your profits.

A -G, Advanced, Charts and Patterns, Glossary, Technical Analysis

Dead Cat Bounce

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A trading term called a dead cat bounce is used to when a stock is in a severe decline and has a sharp bounce off the lows. It occurs due to the huge amount of short interest in the market. Once the supply and demand has become unbalanced, any type of bear market rally will create a massive short covering which will lead to a swift price move up. This bounce will be short lived and followed up by heavy selling which will break the prior price low. A trader will use a bottom-up approach when choosing the best candidate for taking a long position, since the investor will be quite intimate with the company’s financials and management structure.

The origin of the dead cat bounce phrase comes from the East. The first time this phrase occurred was in 1985 when the Singaporean and Malaysian markets bounced after a very strong bear market declined. A journalist Christopher Sherwell of the Financial Times reported that a stock broker referenced the rally as a “dead cat bounce”.

You’ll need to be a seasoned trader to trade a dead cat bounce. The initial challenge is the stock is often a falling knife, so determining where to pick up some shares is to some extent a gamble. The best approach is to hold off until there is an explosive move in volume, followed by a candlestick reversal pattern. Then take the long position, do not get crazy. Be ready to sell out on the first indication of weakness as the up move will be short lived.

See the chart below of Fannie Mae from late 2007 through mid-2008. Take note how there was a dead cat bounce up to $35, prior to the sharp sell off below $10.

Dead Cat Bounce
Advanced, Charts and Patterns, Technical Analysis

Chart Patterns: Gaps

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A gap in a chart is basically an empty space between one trading period and the one prior to that trading period. They normally form on account of an important and material event that will affect security, like an earnings surprise or a merger agreement.

This will happen when there is a large enough distinctness in the opening price of a trading period where the price and the subsequent price that moves do not fall within the range of the previous trading period. For instance, if a particular price of a company’s stock trades near $40 and then the next trading period opens at $45, there should be a large gap up on the chart between the two periods, as indicated below.

It is said when making reference to gaps that they will always fill, meaning the price will move back and cover at least the empty trading range. Still before you enter a trade that profits the covering, take note that this doesn’t always happen and can at times take some time to fill.The four main types of gaps are: common, breakaway, runaway (measuring), and exhaustion. Each have the same structure and differ only in their location in the trend and subsequent meaning for chartists.The Gap price activity can be found on bar charts and candlestick charts however will not be found on point-and-figure or basic line charts. The reasoning behind this is for that every point on both point-and-figure charts and line charts are connected.