(C) Copyright 2014 (Second Edition) All Rights Reserved Christopher M. Quigley
B.Sc., M.M.I.I., M.A.
Dedicated to Linda, Aoife and Niamh Quigley.
Chapter 1. Introduction: The 12 Cardinal Rules. Chapter 2. The Difference Between Stock Market Investment and Speculation. Chapter 3. Three Elements of Investment Success. Chapter 4. Understanding Contracts for Difference. Chapter 5. Dow Theory: The Key to Understanding Stock Market Price Action. Chapter 6 . Successful Day Trading Brief. Chapter 7. Introduction to Technical Analysis.
Chapter 1. Introduction: The 12 Cardinal Rules.
There are few more exciting yet challenging careers than stock market trading and investment. If you get it right the world becomes your oyster. This slim volume is meant to set you on the right path to understanding what it takes to succeed in this area. Whether you want to earn an income, plan for retirement or trade to try to become rich, this volume is the place to commence and for a perfect start I recommend you learn and remember the following 12 cardinal rules to success: 1. To trade/invest successfully you must develop your own system and approach. To do this you must learn to think and act for yourself. The best way to start this process is to first learn how others before you mastered this task successfully. Thus become educated, informed and aware and stay that way. With the advent of the web this task has never been easier for those prepared to put in the time. 2. Never purchase equities at market price: always use a price limit.
3. Upon entering a position a stop loss should immediately be put in place. Be prepared to cut your losses early should the price action go against you. 4. As the price of a stock rises (or falls if you are short) raise (or lower) your stop accordingly, this allows your winners to run. Allowing your winners to run is the only way to become rich in the stock market. 5. Prior to investing in any equity, pay particular attention to the risk/reward ratio. The essence of the market is opportunity and risk so you must always exploit the potential opportunity by being mindful of the actual risk exposure. 6. Your portfolio of chosen stocks by fundamental analysis ideally should comprise of no more than 7/10 stocks. Know everything there is to know about listing including; price history, financials, business model, management style and earnings dates. 7. When starting out do not invest more than 10% of your investment fund until you have proven to yourself your actual ability to make good investment decisions in real time. Ideally you should paper or virtual trade for 3-6 months prior to investing this 10% hard cash.
Always keep a trading diary for note taking, analysis and review. The ideal time to trade is the last 1-2 hours of trading.
10. Be consistent in your approach. Discipline will help you to eliminate emotion from the process and allow experience, logic and technique to prevail. 11. Always know the trend of the market and work with it. Remember; "the trend is your friend". 12. The key to investment and trading success is PATIENCE. If no investment opportunity presents itself wait. Experience will teach you that very often the best place to be is in CASH because the cardinal rule above all others is PROTECT YOUR CAPITAL.
Chapter 2. The Difference Between Stock Market Investment and Speculation.
The issue of successful stock market investment affects us all. Even if we are not directly engaged in the industry, all of us will need some form of pension to fund our retirement. Whether we like it or not most of our retirement funds will find their way into the financial markets. For this very reason, the issue of pensions has moved politically centre stage, in particular the investment strategies used to direct pension funds. Due to mismanagement over the last seven years, many retirement portfolios have become under-funded at best, or, at worst, totally bust. This situation is a direct result of the managed funds having been speculated rather than invested. Many cynics will say that the whole investment environment today has more of the characteristics of a casino than of a professional market of equities and, therefore, they doubt that one can ever achieve a faithful and fair return on capital. However, this view is erroneous as there is a distinct difference between speculation and investment. This essay sets out to explain some simple rules for successful long-term investment. Benjamin Graham, the father of security analysis, and mentor of Warren Buffett, long believed in the stock market as a means to achieve financial freedom. The wealth he accumulated and the school of successful investment gurus he educated are testament to his insight and genius. The key to his formula has always been one simple concept: VALUE. His central message never changed and in a financial community which bores easily, his conservative investment style became "classical" and then "old fashioned". Graham ultimately derided the fads and trends that engulfed Wall Street and he eventually gave up trading and managing funds. However, his "baton" of value was spectacularly taken up by his acolyte, Warren Buffett, who went on to become the most successful investor of all time. Buffett, like Graham, believes the policy of investing does not require high qualities of insight or forethought, as long as some simple rules are applied. In essence these simple rules are: 1. 2. Safety of Capital Adequacy of Return
An operation that does not seek both of the above is not an investment but a speculation. Now in today's complex, volatile, media-driven and fast-moving market environment how does one actually apply these simple rules? The essential thing to realise is that when you buy an equity, you are purchasing part of a business. Investment is most intelligent when it is most business like. For my part, the best
way to achieve this business-like goal is to focus on price, and through systematic analysis of this factor, the grail of value will be discovered. At Wealthbuilder, for pension purposes, we educate clients in how to review up to three thousand stocks every quarter. Using a number of filters, equity prospects are identified and compiled into watch lists. Then, through the use of basic technical analysis, appropriate buy-in and sell-out points are pinpointed. The main criteria that are used to filter these stocks are: 1. 2. 3. 4. 5. 6. 7. Dividend Yield Financial Strength Price/Earnings Ratio Dividend Growth Sales/Earnings Growth Return On Capital Business Model Strength & Sustainability
Of these seven elements, dividend yield and dividend growth are the most important. Let me explain. The big driver of investment returns over time is not figuring out which sector is going to do best, or which country will surpass the rest, or what investment style will be in vogue, or which consumer group will prevail. No, the biggest driver is: INVESTMENT INCOME RECEIVED AND RE-INVESTED. The facts are that with dividend yielding stocks, over a rolling five-year period, 40% of your return will be based on income. Over a twenty-five year period (the time frame of most pension portfolios) 60% of total return will be attributable to income and its reinvestment. The reason being, that income buys more shares, and the additional shares buy you more income and so on, increasing your overall return through the power of compound mathematics. If distributable income received is our key driver, then the objective of successful investment analysis is to find those higher yielding stocks. Higher yield comes from high dividends and high dividends are funded from earnings. We must seek out those superior, earnings-driven companies. However, this alone is not sufficient. Since we are dealing with pension funds that have correspondingly long time-frames, those earnings must also be sustainable and growing. The profile of such profit generating institutions can only come from companies in large markets with proven solid products, such as: financial services, consumer staples, healthcare, energy, technology and insurance. With regard to the power of sustainable growth over investment portfolios, some statistics may be helpful in understanding the essence of our focus and our strategy. Earnings growth in the 5-10% per annum range is ideal. If you increase
your earnings and dividends at 5% a year, in 12-14 years you will have doubled the yield on your entire original investment. Moreover if your increase is 10% per annum, in just 7 years you will have doubled your return on the original capital. Studies have shown that the companies with the most consistently rising dividends and the most quickly rising dividends outperform the market by far. In summary, the investment formula is as follows: 1. Financially Strong Businesses Plus 2. Large Growing Sustainable Markets Plus 3. Growing Earnings Plus 4. High Dividend Yield Plus 5. High Dividend Growth = Superior Value. In terms of value one cannot really compare a company that fits into our high dividend yield model with a company that offers no return, other than potential capital gain. Unfortunately, the majority of equities traded on the financial markets fit into this latter category. These stocks, in the main, benefit only stock exchanges and brokers who obtain commissions and fees through trading activity. This is why we classify such stocks as "speculations" and not "investments". Despite appearing to be a complex matter, the path to investment success is quite simple, as pointed out by Graham all those years ago. The financial achievements of his students: Warren Buffett, Charkie Munger, Ed Anderson, Bill Ryane, Rick Guerin and Stan Perlmeter, are testament to the enduring power of his investment philosophy. By applying this philosophy the average investor, using discipline and patience, has within his or her grasp the power to earn superior returns in the stock markets and thereby win for themselves and their families financial freedom and independence.
Chapter 3. Three Elements of Investment Success.
Success in a career in investing requires knowledge, patience, focus and discipline. It is not a path to “getting rich quick”. When you see such “quicky” schemes advertised for any investment “product” you should run a mile. “Quick rich” schemes aside, disciplined investing can offer excellent returns when married to the “magic” of compounding. Here is what Richard Russell, of Dow Theory Letter fame, has to say about compounding: “Compounding: One of the most important lessons for living in the modern world is that to survive you've got to have money. But to live (survive) happily, you must have love, health (mental and physical), freedom, intellectual stimulation -- and money. When I taught my kids about money, the first thing I taught them was the use of the "money bible." What's the money bible? Simple, it's a volume of the compounding interest tables. Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time. But there are two catches in the compounding process. The first is obvious -compounding may involve sacrifice (you can't spend it and still save it). Second, compounding is boring -- b-o-r-i-n-g. Or I should say it's boring until (after seven or eight years) the money starts to pour in. Then, believe me, compounding becomes very interesting. In fact, it becomes downright fascinating.” 2. Value
To me the fundamental reality of the stock market is that it is not efficient. Quite often the market does not correctly value a company and when you diligently search for value and have the courage to trust your judgment you will “beat the market” consistently. This is the key to the success of investors such as Warren Buffett and his partner Charlie Munger. In his classic essay “The Superinvestors of Graham-and-Doddsville” here is what Warren Buffett has to say about value:
“I'm convinced that there is much inefficiency in the market. These Grahamand-Doddsville investors have successfully exploited gaps between price and value. When the price of a stock can be influenced by a "herd" on Wall Street with prices set at the margin by the most emotional person, or the greediest person, or the most depressed person, it is hard to argue that the market always prices rationally. In fact, market prices are frequently nonsensical. I would like to say one important thing about risk and reward. Sometimes risk and reward are correlated in a positive fashion. If someone were to say to me, "I have here a six-shooter and I have slipped one cartridge into it. Why don't you just spin it and pull it once? If you survive, I will give you $1 million." I would decline -- perhaps stating that $1 million is not enough. Then he might offer me $5 million to pull the trigger twice -- now that would be a positive correlation between risk and reward! The exact opposite is true with value investing. If you buy a dollar bill for 60 cents, it's riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is. One quick example: The Washington Post Company in 1973 was selling for $80 million in the market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more. The company owned the Post, Newsweek, plus several television stations in major markets. Those same properties are worth $2 billion now, so the person who would have paid $400 million would not have been crazy. Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater. And to people that think beta measures risk, the cheaper price would have made it look riskier. This is truly Alice in Wonderland. I have never been able to figure out why it's riskier to buy $400 million worth of properties for $40 million than $80 million. And, as a matter of fact, if you buy a group of such securities and you know anything at all about business valuation, there is essentially no risk in buying $400 million for $80 million, particularly if you do it by buying ten $40 million piles of $8 million each. Since you don't have your hands on the $400 million, you want to be sure you are in with honest and reasonably competent people, but that's not a difficult job.” 3. Patient Risk Aversion
Of all the personal qualities required to make a successful investor for me patience is on the top of the list. The patient investor waits until he finds value. Once invested the patient investor allows time for the target investment to grow in value. The patient investor avoids the emotion of daily swings and roundabouts. The patient investor if she does not find value sits on her hands, in cash, protecting her capital. The patient investor seeks to avoid losses first and make money second.
Now patience might seem like a simple everyday quality but unfortunately it is not. Many investors equate “activity” with success. In fact in my experience the opposite is the case. “Smart inactivity” is the key to long term portfolio growth. Now risk aversion does not mean you completely avoid risk. No, risk is the nature of the investment game. However, the risk must be worthy and this means that the risk reward probability ratio of the chosen equity or instrument must provide excellent upside potential once the market starts to correctly price in identified inherent value. Taking the time to ferret out correct risk reward candidates and then waiting for the market to signal the correct time to invest is not something that is exciting or “sexy”. Patient value investing does not require two, three or four “workstations”; it does not require subscription to forty financial publications; it does not need five TV screens tuned into CNN, Bloomberg, CNBC, BBC World News and Asia Today. For these reasons it is almost the exact opposite to the fashionable media driven profile of the modern investor. But who ever said making money had to be “sexy” or “exciting”. This is why most investors lose money because instead of doing what they should be doing they do what they think they should be doing. Of course the perverse reality about this state of affairs is that the longer the majority of investors carry on “chasing their tail”, trading instead of investing and losing their fortunes the easier it is for patient intelligent investors to prosper. Long may it last.
Chapter 4. Understanding Contracts for Difference.
One of the most innovative financial instruments that have been developed over the last decade or so is the CONTRACT FOR DIFFENCE, better know as a CFD. The explosion in the use of this product is one of the reasons why London, as opposed to New York, is becoming the financial location of preference for many financial managers and hedge traders. CFD's are not allowed in the U.S. due to legal restrictions imposed by the American Regulators. Contracts for Difference were developed in London in the early 1990's. The innovation is accredited to Mr. Brian Keelan and Mr. Jon Wood of UBS Warburg. They were then initially used by institutional investors and hedge funds to limit their exposure to volatility on the London Stock Exchange in a cost-effective way, for in addition to being traded on margin, they helped avoid stamp duty (a government tax on purchase and sale of securities). A CFD is in essence a contract between two parties agreeing that the buyer will be paid by the seller the difference between the contract value of the underlying equity and its value at time of contract. This means that traders and investors can participate in the gains and losses (if shorting) of the market for a fraction of capital exposed if the equity was purchased outright. In This regard the CDS's operate like option contracts, but unlike calls and puts, there are no fixed expiration dates and contract amounts. However contract values are normally subject to interest and commission charges. For this reason they are not really suitable to investors with a long-term buy and hold strategies. CFd's allow traders to invest long or short using margin. This fixed margin is usually about 5-10% of the value of the underlying financial instrument. Once the contract is purchased there is a variable adjustment in the value of the clients account based on the "marked to market" valuation process that happens in real time when the market is open. Thus for example if a stock ABC Inc. is trading at $100 it would cost approx. $10 to trade a CFD in ABC. If 1000 units were traded it would therefore cost the investor $10,000 to "control" $100,000 worth or stock. If the stock increased in value to $110 the "marked to market" process would add $10,000 to the client's account (110-100 by 1000). As we can see the situation works very similarly to options but for the fact that there are no standard option contract sizes and expiration dates and complicated strike levels. Their simplicity has added greatly to their popular appeal amount the retail public. Contracts For Difference are currently available in over the counter markets in Sweden, Spain, France, Canada, New Zealand, Australia, South Africa, Australia, Singapore, Switzerland, Italy, Germany and the United Kingdom. Their power and scope continue to grow. This development poses a problem to American financial institutions in that unless there is a change in security regulation Wall Street will lose out on a financial instrument that is changing the manner in which the greater public and aggressive financial managers are investing for the future. It is expected that Contracts for
Difference will become the medium of transaction for the majority of World traders within the next decade. If you are interested in becoming a successful trader, introduce yourself to CFD's immediately.
Chapter 5. Dow Theory: The Key to Understanding Stock Market Price Action.
Dow Theory has been around for almost 100 years. Developed by Charles Dow and refined by William Hamilton, many of the ideas put forward by these two men have become axioms of Wall Street. Background: Charles Dow developed the Dow Theory from his analysis of market price action in the late 19th. Century. Until his death in 1902, Dow was part owner as well as editor of the Wall Street Journal. Even though Charles Dow is credited with initiating Dow Theory, it was S.A. Nelson and William Hamilton who later refined the theory into what it is today. In 1932 Robert Rhea further refined the analysis. Rhea studied and deciphered some 252 editorials through which Dow and Hamilton conveyed their thoughts on the market. Main Assumptions: 1. Manipulation of the primary trend as not being possible is the primary assumption of the Dow Theory. Hamilton also believed that while individual stocks could be influenced it would be virtually impossible to manipulate the market as a whole. 2. Averages discount everything. This assumption means that the markets reflect all known information. Everything there is to know is already reflected in the markets through price. Price represents the sum total of all the hopes, fears and expectations of all participants. The un-expected will occur, but usually this will affect the short-term trend. The primary trend will remain unaffected. Hamilton noted that sometimes the market would react negatively to good news. For Hamilton the reason was simple: the markets look ahead, this explains the old Wall Street axiom "buy on the rumour and sell on the news". Even though the Dow Theory is not meant for short-term trading, it can still add value for traders. Thus no matter what your time frame; it always helps to be able to identify the primary trend. According to Hamilton those who successfully applied the Dow Theory rarely traded on too regular a basis. Hamilton and Dow were not concerned with the risks involved in getting exact tops and bottoms. Their main concern was catching large moves. They advised the close study of the markets on a daily basis, but they also sought to minimise the effects of random movements and recommended concentration on the primary trend.
Price Movement: Dow and Hamilton identified three types of price movement for the Dow: A. Primary movements B. Secondary movements C. Daily fluctuations A. Primary moves last from a few months to many years and represent the broad underlying trend of the market. B. Secondary or reaction movements last for a few weeks to many months and move counter to the primary trend. C. Daily fluctuations can move with or against the primary trend and last from a few hours to a few days, but usually not more than a week. Primary movements, as mentioned, represent the broad underlying trend. These actions are typically referred to as BULL or BEAR trends. Bull means buying or positive trends and Bear means negative or selling trends. Once the primary trend has been identified, it will remain in effect until proven otherwise. Hamilton believed that the length and the duration of the trend were largely undeterminable. Many traders and investors get hung up on price and time targets. The reality of the situation is that nobody knows where and when the primary trend will end. The objective of Dow Theory is to utilize what we do know, not to haphazardly guess about what we do not. Through a set of guidelines. Dow Theory enables investors to identify the primary trend and invest accordingly. Trying to predict the length and duration of the trend is an exercise in futility. Success according to Hamilton and Dow is measured by the ability to identify the primary trend and stay with it. Secondary movements run counter to the primary trend and are reactionary in nature. In a bull market a secondary move is considered a correction. In a bear market, secondary moves are sometimes called reaction rallies. Hamilton characterized secondary moves as a necessary phenomenon to combat excessive speculation. Corrections and counter moves kept speculators in check and added a healthy dose of guess work to market movements. Because of their complexity and deceptive nature, secondary movements require extra careful study and analysis. He discovered investors often mistake a secondary move as the beginning of a new primary trend. Daily fluctuations, while important when viewed as a group, can be dangerous and unreliable individually. Getting too caught up in the movement of one or two days can lead to hasty decisions that are based on emotion. To invest successfully it is vitally important to keep the whole picture in mind when
analyzing daily price movements. In general they agreed the study of daily price action can add valuable insight, but only when taken in greater context. The Three Stages of Primary Bull Markets and Primary Bear Markets:
Primary Bull Market Stages: Stage 1. Accumulation Hamilton noted that the first stage of a bull market was largely indistinguishable from the last reaction rally in a bear market. Pessimism, which was excessive at the end of the bear market, still reigns at the beginning of a bull market. In the first stage of a bull market, stocks begin to find a bottom and quietly firm up. After the first leg peaks and starts to head down, the bears come out proclaiming that the bear market is not over. It is at this stage that careful analysis is warranted to determine if the decline is a secondary movement. If is a secondary move, then the low forms above the previous low, a quiet period will ensue as the market firms and then an advance will begin. When the previous peak is surpassed, the beginning of the second leg and a primary bull will be confirmed. Stage 2. Movement With Strength
The second stage of a primary bull market is usually the longest, and sees the largest advance in prices. It is a period marked by improving business conditions and increased valuations in stocks. This is considered the easiest stage to make profit as participation is broad and the trend followers begin to participate. Stage 3. Excess
Marked by excess speculation and the appearance of inflationary pressures. During the third and final stage, the public is fully involved in the market, valuations are excessive and confidence is extraordinarily high. Primary Bear Market Stages: Stage 1. Distribution Just as accumulation is the hallmark of the first stage of a primary bull market, distribution marks the beginning of a bear market. As the "smart money" begins to realise that business conditions are not quite as good as once thought, and thus they begin to sell stock. There is little in the headlines to indicate a bear market is at hand and general business conditions remain good. However stocks begin to lose their lustre and the decline begins to take hand. After a moderate decline, there is a reaction rally that retraces a portion of the decline. Hamilton noted that reaction rallies during a bear market were quite swift and sharp. This quick and sudden movement would invigorate the bulls to proclaim the bull market alive and well. However the reaction high of the secondary move would form and be lower than the previous high. After making a lower high, a break below the previous low, would confirm that this was the second stage of a bear market.
Movement With Strength
As with the primary bull market stage two of a primary bear market provides the largest move. This is when the trend has been identified as down and business conditions begin to deteriorate. Earnings estimates are reduced, shortfalls occur, profit margins shrink and revenues fall. Stage 3. Despair
At the final stage of a bear market all hope is lost and stocks are frowned upon. Valuations are low, but the selling continues as participants seek to sell no matter what. The news from corporate America is bad, the economic outlook is bleak and no buyers are to be found. The market will continue to decline until all the bad news is fully priced into the stocks. Once stocks fully reflect the worst possible outcome, the cycle begins again. Stage Signals: Identification Of The Trend The first step in the identifying the primary trend is to analyse the individual trend of the Dow Jones Industrial Average and the Dow Jones Transport Average. Hamilton used peak and trough analysis to ascertain the identity of the trend. An uptrend is defined by prices that form a series of rising peaks and rising troughs [higher highs and higher lows]. In contrast, a downtrend is defined by prices that form a series of declining peaks and declining troughs [lower highs and lower lows]. Once the trend has been identified, it is assumed valid until proven otherwise. A downtrend is considered valid until a higher low forms and the ensuing advance off the higher low surpasses the previous reaction high. Conversely, an uptrend is considered in place until a lower low forms. Averages Must Confirm: Hamilton and Dow stressed that for a primary trend or sell signal to be valid, both the Dow Jones Industrial and The Transport averages must confirm each other. For example if one average records a new high or new low, then the other must soon follow for a Dow theory signal to be considered valid. Volume: Though Hamilton did analyse statistics, price action was the ultimate determinant. Volume is more important when confirming the strength of advances and can also help to identify potential reversals. Hamilton thought that volume should increase in the direction of the primary trend. For example in a primary bull market, volume should be heavier on advances than during corrections. The opposite is true in a primary bear market. Volume should increase on the declines and decrease during the reaction rallies. Thus by analysing the reaction rallies and corrections, it is possible to judge the underlying strength of the primary trend.
Trading Ranges: In his commentaries over the years, Hamilton referred many times to "lines". Lines are horizontal lines that form trading ranges. Trading ranges develop when the averages move sideways over a period of time and make it possible to draw horizontal lines connecting the tops and the bottoms. These trading ranges indicate either accumulation or distribution, but is was virtually impossible to tell which until there was a clear break to the upside or the downside.
Conclusion: The goal of Dow and Hamilton was to identify the primary trend and catch the big moves up and be out of the market the rest of the time. They well understood that the market was influenced by emotion and prone to over-reaction, both up and down. With this in mind, they concentrated on identification and following the trend. Dow theory [or set of assumptions] helps investors identify facts. It can form an excellent basis for analysis and has become the cornerstone for many professional traders in understanding market movement. Hamilton and Dow believed that success in the markets required serious study and analysis. They realised that success was a great thing, but also realised that failure, while painful, should be looked upon as learning experiences. Technical analysis is an art form and the eye and mind grow keener with practice.
Chapter 6 . Successful Day Trading Brief.
Judging from the contents of an increasing number of emails more and more investors are choosing to "actively" trade the market rather than "buy and hold." In the main, this is due to the fact that in a bear market the latter strategy creates losses that are difficult to accept long term. However another reason is that with limited business opportunity available investors are seeking "income" rather than capital gain from their investments. Accordingly I set out below some parameters to help these new "traders" avoid the worse pitfalls and hopefully guide them towards the mindset required for long term success. 1. Start: Markets are rational. The best theory to gain this insight is Dow Theory. Learn everything you can about Hamilton's and Dow's perceptions and make it part of your investment "macro-view". 2. Due to the growing complexity in financial reporting and the opportunity for abuse therein, with its concomitant risk, it may be advisable to trade through exchange traded funds (ETF') or Contracts for Difference (CFD's). These funds trade like stocks but offer exposure to equity sectors, commodities, currencies and interest rates. Thus you have better opportunity for diversification with less risk. 3. When you enter a position know beforehand your exit point. Always place a sell stop thus limiting your potential loss. 4. As your profits rise adjust your sell stop upwards thus locking in your profits. 5. A trading platform offering discount commissions is absolutely vital. I like IG Markets or Ameritrade. 6. Technical analysis data is vital to judge your entry and exit points. Get a good system that offers "real time" streaming providing one minute, five minute, ten minute and one hour ticker readings in addition to the regular daily timelines. I prefer the five minute screen. I use Worden Bros. 7. Using too many technical indicators creates "paralysis by analysis". Get to know the indicators that work for you and stick to them. Consistency will bring greater reward. I like MACD (moving average convergence divergence, 10 and 20 DMA's (daily moving averages) and purchase volume. For price I use the candlestick format rather than the simple line as it gives more information on the market psychology of actual price movement. See note 1. below on MACD. 8. You must adopt a trading strategy. If you do not have one find one. If you are new to trading use the many simulation packages available online to test and retest your knowledge and approach. Do not start to spend a major part of
your capital until you have proven to yourself that you can consistently make good investment decisions in real time. It is better to be losing time rather than time and money. For me the best strategy to successfully day trade is our Wealth-builder MOMENTUM STRATEGY. This strategy highlights top stocks which are going long and going short. Our BUY indicator is a BULLISH ENGULFING candlestick moving up through a DMA on high volume. Ideally with a MACD changing from negative to positive. Our SELL indicator is a BEARISH ENGULFING candlestick moving down through a DMA, ideally with MACD moving from positive to negative. 9. The holy grail of trading is patience. If you do not have a trade that has a good probability to work profitably for you the best place to be is in cash. This is hard to learn but is absolutely essential. 10. If you think trading is gambling you have missed the point and need to be re-educated. Go back to "start" and get your thinking rational. Note 1: Moving Average Convergence Divergence (MACD): Developed by Gerald Appel, MACD is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero. The most popular formula for the standard MACD is the difference between a stock's 26-day and 12-day exponential moving averages. However Appel and others have since tinkered with these original settings to come up with a MACD that is better suited for faster or slower securities. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer averages will produce a slower indicator. What does MACD do? MACD measures the difference between two moving averages. A positive MACD indicates that the 12-day EMA (exponential moving average) is trading above the 26-day EMA. A negative MACD indicates that the 12-day EMA is trading below the 26-EMA. If MACD is positive and rising, then the gap between the 12-day EMA and the 26-day EMA is widening. This indicates that the rate-of-change of the faster moving average is higher than the rate-of-change for the slower moving average. Positive momentum is increasing and this would be considered bullish. If MACD is negative and declining further, then the negative gap between the faster moving average and the slower moving average is expanding. Downward momentum is accelerating and this would be considered bearish. MACD centerline crossovers occur when the faster moving average crosses the slower moving average. One of the primary benefits of MACD is that it does incorporate aspects of both momentum and trend in one indicator. As a trend following indicator, it will not be wrong for long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security.
As a momentum indicator, MACD has the ability to foreshadow moves in the underlying stock. MACD divergences can be a key factor in predicting a trend change. For example a negative divergence on a rising security signifies that bullish momentum is wavering and that there could be a potential change in trend from bullish to bearish. This can serve as an alert for traders and investors. In 1986 Thomas Aspray developed the MACD histogram in order to anticipate MACD crossovers. The MACD histogram represents the difference between MACD and the 9-day EMA of MACD. The plot of this difference is presented as a histogram, making centerline crossovers and divergences more identifiable. Sharp increases in the MACD histogram indicate that MACD is rising faster than the 9-day ema and bullish momentum is strengthening. Sharp declines in the MACD histogram indicate that the MACD is falling faster that its 9-day ema and bearish momentum is increasing. Thomas Aspray recognized the MACD histogram as a tool to anticipate a moving average crossover. Divergences usually appear in the MACD histogram before MACD moving average crossover. Armed with this knowledge, traders and investors can better prepare for potential change. Remember the weekly MACD histogram can be used to generate a long-term signal in order to establish the tradable trend, thus allowing only short-term signals that agree with the major trend to be used for investment action.
Chapter 7. Introduction to Technical Analysis.
1. Technical analysis is a tool to gain insight into market price behaviour and so enable you to more profitably judge investment entry and exit points.
2. In essence Technical Analysis, correctly used, will motivate investment action that brings a higher probability of success than decisions made through the mechanism of pure random choice. 3. Dow Theory demonstrates that the market is not random. 4. This theory has proven itself over more than 100 years. 5.Technical analysis works because price action is a result of human decisions. 6. Historical observation indicates that price conditions may change but human nature does not. 7. Thus Technical Analysis is basically a form of behavioural (social) science. 8. Technical study cannot predict the future, else there would be no market as it is a “zero sum game”, but it can be a guide. 9. In my experience too much use of “Technicals” leads to “Paralysis by Analysis”. Thus I advise the use of some technical indicators but not too many. 10. My favourite analysis indicators are: A. B. C. D. E. A. Moving Averages. MACD. Stochastics. Price (Candlestick Format). The A/D line. Moving Averages to use: 10 Day Line 20 Day Line
50 Day Line 100 Day Line 200 Day Line Moving averages even out price action to enable one ascertain overall trend. B. MACD to use:
Moving Average Convergence/Divergence Use the histogram format 12 – 26 – 9 MACD turns two trend following moving averages into a momentum oscillator by subtracting the longer moving average from the shorter. Thus it merges trend with momentum into one indicator. C. Stochastics to use:
Fast: 14 - 3 - 3 Slow: 28 - 7 - 7 The stochastic oscillator is a momentum indicator that shows the price close relative to the high – low price range over a set number of periods. Thus it follows the momentum of price. As a rule momentum changes before price. It can be used to show oversold and overbought price conditions. D. Price: Candlestick Format
Japanese Candlestick charts are one of the oldest types of charts used for price prediction. They date back to the 1700’s when they were used for predicting rive prices. The Candlestick format shows the full range of price movement i.e. high, low, open and close. Thus we get a sense of the market sentiment behind price changes. This cannot be observed through looking at the standard line format which simply records closing prices. E. The A/D Line:
The Advance Decline Line is a breadth indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks. The AD Line is a cumulative measure of Net Advances. It rises when Net Advances is positive and falls when Net Advances is negative. This indicator is excellent for finding the actual trend in operation in the market at any one time. I use the 10 DMA crossing over the 20 DMA to ascertain short term trend changes and when this is confirmed by the 20 DMA crossing
over the 50 DMA I know that the trend is solid. The A/D line performed brilliantly foreseeing the tech crash in 2000, the Iraq war rally in 2003, the SubPrime bust of 2007 and the Obama election rally of 2009.