Trader's Digest

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Veteran, successful market timers and traders stay detached. They know that the markets are impersonal and they trade they strategies methodically. But novice market timers often have trouble achieving this rational mind set.

Stay Detached From Trading Decisions

For example, novice timers (and traders) may take market timing losses and subsequent drawdowns personally. Seeing it as a hit to their ego, and attaching personal significance to what is just an everyday fact of all timing and trading decisions.

Small losses should be expected, and it's vital that you don't take them personally. What is important is keeping them small. Never allowing any loss to grow into a big one. That is accomplished by following a timing strategy that is designed to protect capital.

Disappointment Is Natural

It is natural for a person to feel disappointed after experiencing a drawdown. Financially, real money has been lost.

It's perfectly reasonable to feel a little disappointed, but it isn't useful to take it personally. Disappointment is a natural emotion, but not very helpful in market timing.

In fact, if you take it personally, you might then try to gain back that small loss, by exiting your strategy and taking an ego inspired trade. The odds are good that you will be the poorer for it.

Market Timing Requires Doing The Unnatural

Although we spend a lifetime building up an array of emotional responses to help us cope with uncomfortable feelings, those same, quite normal emotional responses are exactly the opposite of what is needed to succeed in market timing.

Timing requires that you do the unnatural, and control your emotions. A lifetime of learning how to respond to uncomfortable feelings or situations MUST by unlearned to succeed in market timing (or any trading for that matter). Responses that are correct in personal and even business situations, are sure to cause losses in trading the financial markets.

You expect to make a profit over time, but in the short term, even a winning timing strategy is bound to have losers. That's just the nature of probability theory.

So why make it personal? Why put your ego on the line with each trade?

Why brag when you are lucky enough to have the odds work in your favor and then be depressed when the odds go against you? Both emotional responses are normal, yet they are dangerous to successful market timing.

But how do you control perfectly natural emotional responses?

"Unlearning" A Lifetime Of Lessons

When it comes to market timing, you've got to UNLEARN responses that you've spent your whole life learning.

Market timing isn't about you. It is just a strategy that works over time.

In other fields, probability plays little if any role. You put in effort, make sure you meet the expectations of the people who pay you, and you're a success.

In the traditional workplace, it makes sense to put a little ego and pride into your work. Your effort and talent often have a direct payoff.

But with market timing, the odds can go against you, no matter how much work you put in. The perfect trade can go wrong.

That's hard to accept for most people because it means that being a successful (profitable) market timer or trader, to some extent, is just a matter of the odds randomly working in your favor. But there is good logic behind this randomness. And a successful timing or trading strategy uses this logic to profit.

A successful timing strategy will exit losses quickly. It will not stay with a bullish or bearish position to sooth the ego of the strategy's designer. It will also stay with a successful trade and not exit quickly to lock in a profit. That may feel good for a day, but if the profitable trend lasts two, three, five times longer, you have lost out on a huge profit.

Recognizing that odds are part of trading takes some of the glory out of it. But on the other hand, understanding odds helps you cope with inevitable drawdowns.

Conclusion

If you are a seasoned market timer who really has mastered his or her emotions, you are assured that the odds will, over time, work in your favor.

You will enjoy your times of glory as the gains add up. You will hunker down and quietly follow the signals during unprofitable sideways markets or during failed trends.

Taking a detached, unemotional approach may take some of the glory out of market timing, but on the other hand, that same unemotional approach is the KEY to market timing success.

Most importantly, the unemotional market timer will implement the timing strategy. He or she will make each trade consistently, with the certainty that over time the odds will make him or her a successful timer.

At FibTimer we offer strategies with years of success behind them. But all of them, at one time or another, have had losing trades. Staying with the chosen strategy eventually paid off. Timing strategies are designed to make their profits over time, not in a few weeks or even months, though it is always nice when that occurs

Remaining unemotional, so that a timing strategy is adhered to not only in easy (profitable) trading conditions, but also during the tough (unprofitable) ones, leads to success in a field where the majority fail.

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Time Decay

2007-09-29T13:50:00.001-07:00

By Ron Lanieri

Time decay, also known as theta, is defined as the rate by which an option's value erodes into expiration. The value of the option over parity to the stock is called extrinsic value.

Since an option is a depreciating asset, meaning it has a limited life, the extrinsic value in the option will wither away daily until expiration. This "decay" is not a linear function meaning it is not equally distributed between all of the days to expiration.

As the option gets closer to expiration, the daily rate of decay increases and continues to increase daily until expiration of the option. At expiration, all options in the expiration month, calls and puts, in-the-money and out-of-the-money must be completely devoid of extrinsic value as noted in the time value decay charts below.

As more time goes by, the options extrinsic value decreases. Again, it is important to note that the rate of this decrease is not linear, meaning not smooth and even throughout the life of the option contract. An option contract starts feeling the decay curve increasing when the option has about 45 days to expiration. It increases rapidly again at about 30 days out and really starts losing its value in the last two weeks before expiration.

This is like a boulder rolling down a hill. The further it goes down the hill, the more steam it picks up until the hill ends.

By selling the option and owning the stock, the covered call seller captures the extrinsic value in the option by holding the short call until expiration.

As mentioned earlier, an option's loss of extrinsic value over its life is called time decay. In the covered call strategy the option's time decay works to the seller's advantage in that the more that time goes by, the more the extrinsic value decreases.

Key Point – The covered call strategy provides the investor with another opportunity to gain income from a long stock position. The strategy not only produces gains when the stock trades up, but also provides above average gains in a stagnant period, while offsetting losses when the stock declines in price.

We have now seen how a covered call strategy is constructed and how it is supposed to work. Keep in mind that the trade can be entered into in two ways. You can either sell calls against stock you already own (Covered Call) or you can buy stock and sell calls against them at the same time (Buy Write).

Example 1

You own 1000 shares of Oracle at $9.50.

The stock has been stuck around this level for a long time now and you have grown impatient. You finally give in and sell the front month (November for example) at-the-money calls. The at-the-money calls would have a strike price of $10 if the stock was trading at $9.50.

You sell the calls at a $.50 premium per contract which creates a $10.50 breakeven point. Remember, in a buy-write, the breakeven point is the strike price plus the option premium. Let's look at what our returns will be in each of the three scenarios.

About author:
Ron Ianieri is a professional options trader, former floor trader, and market maker on the PHLx options exchange. As co-founder of the Options University, Ron teaches hundreds of aspiring options traders from all over the world how to trade options 'the right way'. Click here to learn more: optionsuniversity.com

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Trading Naked Calls & Puts

2007-09-29T13:48:00.000-07:00

By Ron Lanieri

An option is a derivative trading product that is best used by investors as a hedging tool providing profit protection and profit enhancement. Although it is a powerful risk management tool, it can also be used effectively as a stand-alone trading vehicle.

Under the proper conditions, options do not have to be paired with stock or another option to be an effective trading tool. To successfully trade naked options, an investor must realize that certain options will fit certain scenarios and certain options will not.

One of the major misconceptions that investors have about options stems from the fact that most do not know how to trade them properly. When they lose money trading them, they feel that there is something wrong with the option. They do not understand that options are on a higher, more sophisticated level when compared to stocks.

Stock trading has fewer variables involved and is therefore easier. No one is saying that the individual investor isn't smart enough to trade options. The problem is not intelligence; it's just education and experience. Most investors have not been properly educated in the proper use of options, and even fewer have had any real experience trading them.

One of the biggest problems investors have is this: Even if you buy a call and the stock goes up, you can still lose money. Most investors tend to buy out of the money options at a cheap price. The stock trades up a little, which is the right direction, but the option still loses money and the investor wonders why.

What the investor fails to realize is that in order for the option to be profitable the options delta must out-pace its rate of decay. Implied volatility also plays a key role if the stock does trade up while implied volatility decreases, the options delta must then outperform the decrease in volatility. Remember, when volatility increases, the price of all options goes up. When volatility decreases, the price of all options goes down.

We have categorized options in several ways. One way is by the option's strike price, and its distance from the stock price. We identified these options as either in-the-money, at-the-money, or out-of-the-money.

In our discussion about trading naked calls and puts, we will identify trading opportunities or situations that fit each of these types of options, for both calls and puts. But it is important to first review the definition of Delta before continuing.

Remember, delta tells you how much the option will move with a similar move in the stock and is given as a percentage. For example, a 33 delta option means that the option will move 33% of the movement of the stock and 70 delta option will move 70%. In-the-money options act like stock. The deeper in the money the calls are, the more they act like the stock. As the call moves deeper and deeper in the money, the calls delta approaches 100 which means it's price movement will reflect 100% of the stock's movement. (This is discussed in more detail later in “The Stock Replacement Covered Call Strategy”).

In fact, deep-in-the-money options are sometimes even used to replace stock positions. If you look at the charts below, you can see how closely the in-the-money call mimics the upward movement of the stock (2nd quadrant).

In the money options are best used for smaller stock movements. The reason is that in-the-money options contain less extrinsic value. The extrinsic value can work against you when purchasing an option because extrinsic value is affected by time decay.

As you wait for your stock movement, the in-the-money option will decay less than either the at-the-money or out-of-the-money options because it has less extrinsic value. The amount of money you lose in time decay must then be made back by additional stock movement.

Obviously, the less you lose in decay, the less the stock has to move for you to be profitable because it has less decay loss to make up for.

This is because an in-the-money call has a high delta and a much higher percentage chance of finishing in-the-money by expiration so they follow the stock more closely.

With less extrinsic value loss to make up for, a smaller movement in the stock will produce a greater profit. For a call example, as you can see in the chart below, the in-the-money produces a profit with the least amount of stock movement. With less extrinsic value, the ITM option has a lower break-even point.

For chart below, stock price = $35.00

Strike Price Option Price Delta Breakeven Extrinsic Value

$30 5.20 85 35.20 $.20

$35 1.00 52 36.00 $1.00

$40 .30 20 40.30 $.30

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The Yen Carry Trade

2007-09-19T12:09:00.000-07:00

By Peter Marsden

The carry trade is one of the popular trades in the FX market. This potentially lucrative form of trading involves selling a currency with a low interest rate and buying a currency with a higher interest rate and earning from the interest rate differentials. This can be traded using as much or as little leverage as the trader feels suits his risk appetite.

For many years now, carry trades involving selling the Japanese Yen have been very popular due to Japan having a low central bank rate for many many years. In fact, Japan had 0% interest rates between 2000-2006 to try and help their poorly performing economy, this of course was highly attractive for carry traders. Today they are at 0.5%, still very attractive when we look at the central bank rates of many other countries:

* New Zealand 8.25%

* Australia 6.5%

* United Kingdom 5.75%

* United States 5.25%

* Canada 4.5%

* Eurozone 4%

* Japan 0.5%

Currently, The New Zealand Dollar (NZD) really stands out. If we wanted to do a carry trade that involved buying New Zealand Dollars and selling Japanese Yens there would be a 7.75% interest rate differential (8.25%-0.5%). This mean if we bought NZ$10,000 and sold the equipment number of yens, the trade would earn NZ$775 over a year. However, In reality we do not get this exact rate, the brokers take a slight cut and there are other factors too. I am sure some people find 7.75% per year attractive whilst other people may seek much higher returns in a trade off for greater risk. This is where leverage comes in. Many FX brokers nowadays allow very high amounts of leverage, I have seen upto 500:1. I will start writing about the risk factors involved in the carry trade before I go into detail about leverage, it will become clear why if you read on.

As with all FX trading there is considerable risk in the carry trades. When we buy our New Zealand Dollars and sell our Yens we are taking the risk on the currency pair NZD/JPY. Historically this pair has been on a strong uptrend until July 2007, so your carry trades would have earned the income from the interest rate differentials as well as the appreciation of value of your New Zealand Dollars against the Yen. However, with carry trades, there is always the risk of a major carry unwind. This where a huge number of carry trades are closed and the money goes back into japan. Historically, there have been a number of very major carry trade unwinds. The most obvious recent one was in July 2007. On the 22nd July 2007 the NZD/JPY rate was around 97. On the 17th August the rate hit 74.25. A huge drop. If had invested those NZ$10,000 at the top, they would only be worth around NZ$7600 at the bottom. A huge loss.

Trading the Carry Trade using leverage can be highly profitable. For example if you traded the NZD/JPY carry trade with 4:1 leverage, you would earn 4 times the income from the interest rate differentials, which would equate to around 30% in a year. However, the currency movements would affect you 4 times as much, both up and down. For example if price went from 60-90 during your carry trade. That would be a 50% gain. However, if 4:1 leverage was used it would be four times that, 200%. Now lets look at the recent occurrence where the nzd/jpy carry trade went from 97 to around 74.25 in a very short time. This is around a 24% loss, multiply this by 4 and it equates to a 96% loss. This would probably result in a margin call from your broker resulting in most of your account being lost. It is very important to fully understand the potential risks and rewards before acting live carry trades.

Some people prefer to trade GBP/JPY or EUR/JPY instead, the differential is currently smaller but swings tend to be considerably less in percentage terms.

On a final note, most FX brokers pay the interest differentials on a daily basis. If you use an MT4 broker, there is a SWAP section in your terming showing your open positions, this is the interest you have earned. If you open a position with negative interest rate differentials (e.g. A short nzd/jpy) you will have to pay the interest rather than receive it.

In Conclusion, The carry trade is a potentially lucrative way of trading/investing, however it is not without considerable risks, especially when traded with a large amount of leverage.

http://www.forexpm.com - A free forex resource containing information, news, signals, ebooks and much much more.

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The Art of Contrary Thinking - You Need to know it to Trade Successfully!

2007-09-15T14:01:00.001-07:00

By Stephen Todd

The art of contrary thinking is one of the most powerful tools a trader can use, and is a trait with which all true great traders are familiar.

What is the Art of Contrary Thinking?

The art of contrary thinking consists in training your mind to ruminate in directions opposite to general public opinions; but basing your opinion in the light of current events and human behaviour.

Humphrey Neill’s book, "the art of contrary thinking,” the best known work on the subject, is based on the simple yet powerful idea that:

"When everybody thinks alike, everybody is likely to be wrong"

Why Contrary Trading Works

By spotting situations when the consensus is either extremely bullish or bearish, then a trend change is imminent, as it is likely the emotions of greed and fear have pushed prices too far away from true value.

This is evident in such events as the 1987 stock market crash.

Here we have a short-term, self-fulfilling prophecy. When the change occurred, everyone changed his or her mind at once, causing a huge move.

Of course, if you can step aside from the crowd and take a contrary view at these turning points you can make big profits.

Why Contrary Thinking will always be Valid

While Humphrey Neil's work, "the art of contrary thinking,” (published in 1954), is the most famous book on the subject, there existed a century earlier a book on contrary thinking.

Charles MacKay’s book, "Extraordinary Popular Delusions and the Madness of Crowds,” (published in 1854), covered three important financial crashes:

he tulip mania, the Mississippi madness, and the south sea bubble. He reflected upon how investors always pushed prices too far when caught in a consensus:

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

It is clear that to succeed in trading you need to think independently of the majority at important market turning points.

Becoming a Contrary Trader

Gann was one of the greatest traders and traded in the early 20th century. He realized that human nature would always mean that you had to think independently of the crowd to succeed.

“ We cannot escape it (emotion). In the future, it will cause another panic in stocks. When it comes, both traders and investors will sell stocks, as usual, after it is too late, or in the latter stages of a bear market”.

He was aware that human nature was constant and influenced the majority of traders:

“Therefore, in order to make a success, the trader must act in a way to overcome the weak points that have caused the ruin of others”

How to Predict a Major Change

Gann was not just a writer; he was a successful trader and had an extraordinary record of accomplishment in the stock market, for example:

Gann used to publish a forecast for the following year. In 1928 he published a forecast which predicted the date of the September 1929 US Stock Market High, and that a Black Friday would occur, a year in advance of the actual events.

In 1932, he also recommended buying stocks at the all time low in the Dow in June and July.

Gann was one of the most successful stock market investors ever, and developed a strategy to set him apart form the crowd, and simply let market action indicate where prices were going.

To learn more about using Gann methods to improve your trading performance please visit our web site: http://www.gann.co.uk

Market Sectors - Organizing The Stock Market

2007-09-14T14:09:00.001-07:00

By Stephen Bigalow

Market Sectors - Organizing The Stock Market Are you a clean freak? Does it drive you crazy when things are out of place or when a picture isn’t quite level? If you are at your friend’s house, do you wipe dust from a shelf or line up the towels when no one is looking? If so, you will like today’s topic; but don’t worry, we won’t lecture you on your obsessive compulsive side! The topic is market sectors and understanding and using them will not only tidy up your stock portfolio but will also help you to strengthen your trading plan as well. A Definition of Market Sectors They say a problem will defined is nearly solved; this can be applied to stocks as well. An investor needs a way to sort stocks; the basis of stock technical analysis relies on this comparison. If you can find common ground between two stocks, you can find a measurement of comparison. The best form of association is market sectors. “Market sectors” is a qualification method which looks at the type of business and groups them based on generally accepted names One of the most common classifications breaks the market down into 11 different market sectors. Two are generally regarded as “defensive” and the other nine are referred to as “cyclical”. These market sectors are:

Cyclical Stocks
Transportation
Technology
Health Care
Financial
Energy
Consumer Cyclical
Communication
Capital Goods
Basic Materials

Defensive Stocks
Utilities
Consumer Staples

Defensive Stocks
Defensive investing with defensive stocks are beneficial to a portfolio because companies in these market sectors typically don’t experience as much stock volatility when the market has problems because people still use energy and eat. These are good stabilizers to use for portfolio diversification and offer protection in a falling market. The downside of defensive stocks is that they don’t climb with a rising market. Although the market is doing well people necessarily use more energy or eat more food. Defensive market sectors follow the image that their name implies; they can be used quite well as hedge funds, stable stocks that prevent too much volatility in a portfolio.

Cyclical Stocks
Cyclical stocks cover the remaining market sectors and they typically react to a variety of market conditions. They do move independently, however, as one may be going up while another is going down. Because of this, purchasing from the cyclical market sectors requires good stock market strategies.

Why do we care about market sectors?
There are two important concepts with market sectors. First, by understanding the different market sectors, it is possible to find relationships between different companies. If you don’t know that one company is in the health care sector and another is in the energy sector, you might compare their earnings per share and draw conclusions that don’t apply. Second, understanding market sectors allows you to add valuable protection to your stock portfolio. By investing in a number of different stock sectors, you can build a higher level of security for your investment. For example, if you invested $11,000 only in the communications sector and it dropped by 50% you will have lost $5,500 or 50% of your investment. If you invested equally in all eleven market sectors and the communications sector dropped by 50%, you will have only lost $500 or 4.5% of your investment. While the example is simplistic, the meaning is very clear; by spreading your investments over a number of market sectors you minimize your risks from a tumble by an entire sector.

Conclusion
Feel like doing a little “spring cleaning” on your portfolio now? By putting the stock market in the right baskets, you can know how to both evaluate a stock and insulate your portfolio from extreme risk. Most analysis matrixes start by comparing businesses from the same sector; as you use your trading plan to evaluate companies in similar market sectors, you will improve your decision making process. Then you can start trying to understand other important things like why those uneven towels bother you so much!

http://www.candlestickforum.com/PPF/Parameters/1_21_/candlestick.asp A site dedicated to stock market investing using Japanese Candlesticks

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Do You Know When to Buy and Sell? Use The Sine Wave Model

2007-09-14T14:06:00.001-07:00

By David Van Knapp

Probably the hardest decision for most stock investors is knowing when to buy or sell a stock. Some investors trade at a fast rate, buying and selling very actively. Others buy stocks on a regular schedule, but don’t know when, if ever, to sell. Some investors believe the answer is to “never” sell, buying and holding essentially forever. There is a whole spectrum of philosophies and approaches.

What makes the most sense? Is there even a single right answer?

In order to get started thinking logically about this all-important issue, let’s create a simple model of how stock prices change. The model is idealized and represents no real stock, but it is a powerful tool for thinking about the questions of when to buy and when to sell.

Here’s the model:

Picture a simple sine wave, with a horizontal line straight through the center of it. The straight line represents time, while the sine wave represents the changing price of your stock over time. The price starts at the left end of the timeline, or “time = 0,” which could be right now. The sine wave starts at the centerline, rises for a while, levels off at a peak, declines for a while, passes down through the centerline (so that the price goes below where it started), levels off again forming a trough, rises smoothly back up through the centerline, goes on to another peak, and so on. Each full rise, fall, and re-rise to the centerline is a cycle.

Anybody familiar with stock price movements knows that prices are volatile. They go up, they come down. None of them, of course, traces a perfect sine wave shape, but the sine wave picture is a simplifying assumption: It is a smoothed-out version of what stock prices actually do.

For our idealized model, let’s say that each peak in the cycle is 20% above the centerline, and that each trough is 20% below the centerline. So there is a 40% difference between the peak price and the lowest price of each cycle. That happens to be the difference in the real world between many stocks’ high and low prices for a year. So in our model, let’s make each cycle one year long.

Finally, tilt the whole thing upwards slightly, so that the centerline, rather than being horizontal, is pointed upward at 10% per year. This represents the average return of the stock market over the past century or so.

That’s our idealized model. Let’s call the company that it represents Sine, Inc. Sine’s stock has behaved like this since the company went public 100 years ago, and it will behave like this infinitely into the future.

What can we learn from this simple model? Plenty!

Question: What would be the ideal times to buy and sell Sine? There are at least four good answers:

(1) Since we know that the model is tilted upwards at 10% per year, just buy the stock at time = 0 (when the sine wave is at the center line) and hold it as long as possible. Or if you are buying Sine in chunks over an extended period as money becomes available, you can make your purchases at any time. You don’t care where Sine is in its cycle, because you know that, over time, you’ll make 10% per year on your average chunk. You know that because the centerline is tilted upwards at a 10% grade. There’s a name for this approach: Dollar cost averaging. You buy, say, $100 of Sine every month, so you’re buying it at every point along its cycle, sometimes getting a good price, sometimes not. Your blended return from all those purchases, however, will match the 10% upward tilt of the chart itself. This is a widely recommended approach.

(2) But you can do better. Wait a few months and purchase the stock at the exact bottom of its price cycle. There’s a name for this approach too: Buy on the dip. That will increase your returns by a surprising amount, because you will get more shares for your money. For example, if Sine’s price is $100 at time = 0, and you wait nine months until the cycle hits its low point at $80, then $1000 will get you 12½ shares instead of 10. That’s 25% more shares for the same amount of money. You’ll benefit from those extra shares forever. By the way, this is exactly what value investors aim to do. This is also a widely recommended approach, although in the real world it is impossible to know exactly when the exact bottom of the cycle has been hit.

(3) Next, let’s surmise that you have perfect knowledge about Sine’s price behavior and know that it is going to keep repeating its steady performance year after year, cycle after cycle. Then you can improve on #2 above. Buy at the bottom of a cycle, hold until the top of the cycle, sell right there, bide your time for six months until the next bottom, re-buy, sell at the next top, and so on. Your returns would be astronomical. Let’s just follow this through two years of the cycle (and make it simple by ignoring the tilt). Your first purchase would get you 12.5 shares at $80 each, same as in #2 above. At the top of the cycle (six months later), you would sell those shares for $112 each (40% more than you paid), or $1400 total. Wait six months for the next trough, and that money will buy you 17.5 shares at the bottom of the cycle. Wait six more months, and the sale of the 17.5 will bring in $1960 at the top. Wait six more months and the $1960 will buy you 24.5 shares. After 6 more months, the cycle will reach another peak, and your shares will have gone up 40% again to $2744. And so on. In the first 18 months from time = 0, you make 174% ($2744 divided by your original $1000), and every year after that it gets better and better as everything compounds. And that’s ignoring the 10% upward tilt, which brings in even more money. Your $1000 will turn into $1,000,000 in just a few years, even though on average the stock’s price is rising just 10% per year. The name for this is timing or trend following.

(4) Actually, trend following has an additional component that increases returns even more. Rather than biding your time during the downward portion of the cycle, many trend followers simply reverse their position from long (owning the stock) to short (betting against the stock). That way, they make money when the stock’s price is declining. This adds more orders of magnitude to the theoretical returns of our idealized model.

OK, that is the model. Now let’s inject reality into the model and see how it impacts our real-life decisions.

First and most obviously, no one knows the future. No stock’s price in the real world is guaranteed to have a clear trend line pointing upwards at 10% a year, or any other percentage. No one can foresee with confidence that such a trend will last into perpetuity. We only can look at what has happened in the past and try to discern probabilities of what is likely to happen in the future.

Second, stock prices in the real world do not follow smooth sine waves. Their movement is jagged, subject to sudden reversals, unclear as to both long-term and short-term trends, and certainly not as predictably cyclical as is our idealized model.

Nevertheless, the model points to a systematic method of looking for advantageous buy and sell points. The model epitomizes “buy low and sell high.”

For the Sensible Stock Investor, the model tells us that value investors have it figured out exactly right on the “buy” side of the equation. Wait for a low valuation, a low price, the price at the very trough of its cycle. That’s the best time to buy a stock.

How do you know when a stock has hit its low? You don’t, exactly. But by insisting on favorable valuations—when the stock’s price appears to be low compared to the long-term value of the company—you can come pretty close to buying at the trough of the sine wave. Some investors wait for a turn upwards from an actual recent low price to confirm that the stock just hit its low. They are willing to forego a little bit of the upturn in return for a little more certainty that the stock isn’t going to keep going down after they buy it.

How do you know when a stock has hit its high? You don’t know that exactly, either. But when valuations become high, when they suggest that the price is too much for the underlying worth of the company, it becomes more likely that the stock is approaching a peak, and that the market will soon “correct” the price of the stock. What the Sensible Stock Investor can do is use a trailing sell-stop to protect himself or herself on the downside. Set the stop at, say, 15% below the stock’s current price. Reset it once per week, and keep moving it up as long as the price keeps going up. If the stock starts to reverse, you can depend on your trailing stop to get you out before too much damage has been done. In practice, you will sometimes find (especially for stocks that are not especially volatile) that your trailing sell-stop never triggers a sale, and you become a long-term holder of an excellent stock. In other cases, your trailing stop will trigger and preserve most of your gains if the stock’s price goes into a protracted decline. You will have caught and sold the stock near the peak of its cycle.

If you would like to learn about a stock investment approach that that uses the same strategies reflected in this article, consider "Sensible Stock Investing: How to Pick, Value, and Manage Stocks." The book has a perfect 5-star reader rating on Amazon.com. To learn more about the book and its systematic approach to investing designed specifically for busy individual investors, click here: http://www.SensibleStocks.com Thank you.

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Surviving The Commodity Markets, PART 1 - Trading Guidelines For Different Account Sizes

2007-09-14T13:08:00.000-07:00

Of all the important skills in trading, survival is number one. For unless we make it through the inevitable bad times, we won't be around to capitalize on the good. I've laid out some trading account guidelines that specify the account size required to conduct various commodity futures and option trading activities. Stick within these guidelines and you will have an edge on most of the commodity trading public.

The most important factor to success in commodity futures trading is our ability to survive the bad times. The second most important factor is our ability to identify and then take low risk, high probability commodity trades. Conquer these two and you are well on our way to trading success.

Yes, taking low risk, high probability commodity trade recommendations isn't enough. It's up to you to take the next step and follow the account survival guidelines discussed here. By surviving, you will be ready and able to participate in the favorable commodity trades that eventually come along, like buses in the night.

The commodity markets always change from trending to choppy and back again. There will be tough markets. You can count on this. We need to have several methods to cope with this uncertainty. We can never be sure of each individual trade’s outcome, so we need to put probability on our side to prepare for a losing string of trades.

One way is to have more chips at the table than our competition. A way to simulate this is by trading small – breaking our account equity into ten to twenty parts (or more) and never risking more than 7.5% maximum on any one trade or idea. Many professionals with large accounts risk even less, like well under 5% a trade.

The problem with this plan is when we are dealing with smaller accounts. When the commodity trading account is under $20,000, to comply with 5% to 7.5% risk can mean taking on very small positions. Some commodity traders tend to get restless for bigger action and start breaking the rules. For example, with a $10,000 account, we should look to risk no more than $1,000 on each trade. (10%) Even this figure is too high.

If we risk less, like, 5% ($500), then the bad times are more survivable. The thing to remember is you can do all the in and out trading you want. You can grant options, spread options, hedge, buy dips, sell rallies day trade, etc - do whatever suits you. Just keep the risk for each trade down below 10% and preferably at 5% and you increase your chances of success markedly over the reckless plunger.

Next we will talk about actual account sizes and suggested activity.

Part Two of Six Parts - Next

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course". http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Surviving The Commodity Markets, PART 2 - Trading Guidelines For Different Account Sizes

2007-09-14T13:06:00.001-07:00

When buying commodity options, I usually think in terms of them expiring worthless. This is the worst-case situation and will keep us honest about the real risk. With a $10,000 account buying a $500 option, this would permit us to make 20 losing trades in a row. The chances of trading this poorly are remote, but it’s still possible.

Just think of how much better our chances for survival and success are compared to someone risking everything - like the whole $10,000 on two trades. Many traders do just that, believe me. At 5% risk a trade we are trading more within our means and essentially have much deeper pockets to survive than the other guy. Who’s going to be around after the commodity market acts badly? And who’s going to be gone in a heartbeat?

A trader with a $50,000 commodity trading account has much more flexibility. He can risk 5% ($2500) on each futures or options trade to have the staying power to take 20 losers in a row. A more conservative trader might even risk only $1250 per trade (2.5%) and be able to take 40 losers in a row before being wiped out. Now there is a survivor!

See the point? We are focusing on the worst-case scenario to give us every edge possible for survival. When the big profitable commodity trades come along that go a long way in our favor, we want to be ready and able to take full advantage. Normally, we only want to take “high probability” trades in the first place. A few good trades that are handled well can make up for the losses and make your whole year profitable! You must be present and liquid when they come along.

The commodity market will not always accommodate our opinion of a low risk, high probability trade. So by splitting the account into many parts we let probability favor us by permitting us to trade longer than the average guy before being wiped out by a long string of losers.

Most commodity traders take on positions that are much too large for their account equity. This is a universal problem with the public. This causes emotional decisions and early exits when the market should have been given more time and space to fluctuate. Some accounts are simply wiped out after a few bad trades. Certainly there are times to get out of a trade that does not work out early in the game. Every commodity trade is different and must be handled as such.

Once we understand these concepts we will find it hard to trade any other way. I’ve observed many traders who had tremendous raw trading skills that set them apart from the crowd. These people made serious money for a short period of time. But making money consistently over a long period time is the hard part.

Every one I’ve known who’s pushed the commodity market too hard has failed in the end. They make money until they start breaking the 5-10% rule. It’s easy to say you will follow this rule, but it’s another thing to stick to it when you are making serious money and want to ramp it up.

The guidelines I’m about to lay out will apply to buying commodity options, buying commodity futures on margin and selling commodity options. In my examples, the risk of buying options refers to the options expiring worthless.

The risk of a futures contract is usually where the stop loss order is placed, but not always. It could mean a bigger loss if the stop loss gets triggered by an overnight gap through it. Commodity option writing is similar in risk to commodity futures, since they are sold on the same margin requirements and can go in-the-money lock-step with the futures contract.

Bear in mind these guidelines are for YOUR survival and success. You will be committing yourself to proper money management. If used, your broker will make fewer commissions and at a slower pace as a result. But over time he will have a happier client with better chances of success for a longer-term trading relationship. He should happy to have informed commodity clients who make an effort to keep their emotions and risk in check.

There is nothing wrong with losing money if you have followed your rules and given yourself the best chance possible. The anguish is in losing after you correctly predicted the market direction and took the right position, only to ruin it by over-leveraging yourself.

Taking on a small position that goes a long way is the key. You know it’s the right size when you don’t really care if THIS particular commodity trade works out or not. It’s all about being around for a long series of trades to let probability favor you.

Enough said. Now let's look at specific account sizes and recommended trading for each.

Part Three of Six Parts - Next!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course".
http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Surviving The Commodity Markets, PART 3 - Trading Guidelines For Different Account Sizes

2007-09-14T13:04:00.000-07:00

Here are my general money management guidelines to improve your chances of commodity market survival and trading success:

$5,000 ACCOUNT
Risk no more than 10% max ($500)

A $5,000 account is really too small to follow these guidelines exactly, so your risk will be higher. You must really pick and choose your markets and entry points carefully - until the account grows to $10,000.

OPTIONS:

Buy one $500 option for each unrelated market. Buying one soybean, one soybean oil and one soybean meal is like buying three soybean options in the first place - unacceptable. Getting a good option for only $500 is not easy to do sometimes since we like to buy plenty of time and have the market reasonably close to the strike price for the best chance of profit.

With a $5,000 account we should not worried about making big percentage gains as much as participating in a reasonable move with an option delta of at least 0.6 or more. Buying multiple cheap commodity options far out-of-the-money is a sucker’s game over the long haul. Many times the futures contract market move will take place but we will still lose in the commodity option.

Stay as close to the money as possible (strike price close to the market price) to better simulate a futures contract and the real cash market. If the trade does not work out according to the Timeline forecast, it may be prudent to take a loss and preserve some of the option premium. Bear in mind we generally like to consider the total option premium as the “stop loss” order. Also, read the “Thomas Swing Method” lesson to give you an idea of how to trade the swings and do commodity option "granting”.

FUTURES CONTRACTS

The challenge with a $5,000 account is that some futures contact margins can be $2,000 and more. This will mean that only two different positions can be put on at one time, which is plenty for a $5,000 account. But if the TimeLine has a signal in four different markets at once, we will have to decide which two markets are best. This is usually just a guess, since we try to take all “high probability” commodity trades and never really know which ones will work out in the end. No one really does. Out of twenty-two markets you go with the chosen two to four and let them unfold.

Mother Probability is what decides the outcome. In addition, if we risk only $500 for each futures trade, there is not much price fluctuation room for some commodity markets. It may be enough for low priced corn and a few other normally quiet markets, but not enough for the majority. For example, many of the currencies have $1,000 swings each day.

For an overnight trade, placing a stop just $500 away from entry is like giving money away. The only alternative is to risk more, like $1000, but then we are risking 20% a trade and need only five losers in a row to wipe out the account. See the problem here? Because of this, for longer-term moves, a $5,000 account may be better suited for option spreads or even writing far out-of-the-money options. In other words, try to fund the account to a starting value of $10,000, if possible.

WRITING OPTIONS:

I personally believe one of the better methods for success with a $5,000 account may be writing commodity options (selling options). When writing options we have to be satisfied with smaller gains as a result of selling them far out-of-the-money, taking in $200-$300 each time. It will depend greatly on the particular market. Three hundred dollars every two months equals $1800 a year. This is a 36% return on a $5,000 account. Be sure to set realistic goals.

Once the account is built up, the numbers can be increased. As they say, after a period of success, “you can always add a zero" to the quantity. Each option that is sold should be treated as if it were a commodity futures contract for risk and margin requirements. As long as the premium does expand past a $500 loss, we can continue to hold the option and let it erode in our favor.

We'll talk about the flexibility of larger trading accounts next.

Part Four of Six Parts - Next!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course".
http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Surviving The Commodity Markets, PART 4 - Trading Guidelines For Different Account Sizes

2007-09-14T13:03:00.001-07:00

$10,000 ACCOUNT:

Risk no more than 7.5% maximum a trade ($750)

A $10,000 account is probably the minimum commodity amount to begin trading with. Remember that a bigger account is NOT for buying more futures contracts or commodity options, but being able to easily split it into fifteen to twenty different parts. We want to have enough money to support each new position, for many tries, until we hit the great trades that make up for all the losses, expenses and turn a profit.

Probability allows us to have times when we do everything right and have a good run of winners. But the outcome of INDIVIDUAL trades is impossible to predict. Only by doing things right over the long run will probability favor us over the commodity trader who is reckless and random.

The reckless trader will have times when he does very well. But in the end the odds will take him out and give his money to the ones who maintain control. We don’t have to trade perfectly - just better than most.

OPTIONS:

With a $10,000 account you can now buy a “better quality” commodity option that has lots of time and is closer to the money. This may not be possible if the “cat is out of the bag”. This is a market that is already running strong and the option premium is inflated.

You want to purchase commodity options before the crowd starts chasing the futures market. We use our Timeline program for timing as well as commercial option analysis software to signal high probability trades that have undervalued options and room for the premiums to expand. The bottom line is you can risk $500 (5%) or perhaps even $750 (7.5%). But for a $10,000 account, a $1,000 option is high risk and done only if the trade looks exceptional and it permits you to purchase a great option value. In this case you would look to salvage some premium if wrong, rather than let it expire worthless.

FUTURES:

A $10,000 commodity account gives you more margin money, thus the ability to hold two to three different positions at one time. Remember that we don’t know which "high probability" trade will work out, if any, so this is one place where diversification may help.

I’ve seen many times in the past where an account was too small to safely take advantage of four good trade opportunities at once. As sometimes happens, the trades that were picked did not work out, while the ones let go were stellar performers. Remember to risk no more than $750 per trade to stay within the risk parameters of 7.5%.

OPTION WRITING:

With a $10,000 commodity account, we are just beginning to get a small amount of flexibility. Very often when the TimeLine or Option Writing program signals an option CALL write, it may later signal a PUT write before the initial call is covered. We will then have two positions. This requires two margins instead of one.

We may even get the opportunity to average in a second lot if the options are far out-of-the-money. And we also have the money to do an “adjustment”. This is taking a small loss and then immediately selling a new option farther away to possibly recoup the loss and make a profit.

As you can see, the advantage of a larger account is survivability - that is, being able to risk a smaller percentage of the total account. In addition, it permits more flexible strategies that involve multiple option writes and more complex positions. A larger account ($10,000) is NOT for taking on larger quantities of the same position. In other words, don't treat it like two $5,000 accounts.

Part Five of Six Parts- Next!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course".
http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Surviving The Commodity Markets, PART 5 - Trading Guidelines For Different Account Sizes

2007-09-14T13:01:00.001-07:00

$20,000 ACCOUNT
(Risk no more than 5% max ($1000)

A $20,000 account is a where you can begin to manage your money like a pro. Risking $1,000 a trade is usually prudent for many commodity markets. My philosophy is if you cannot enter a “normal” market for less than $1000 risk per futures contract or option, you do not have a low risk, high probability trade in the first place. Wait for a better entry point.

The same basic rules apply for $20,000 as for the $10,000 account, except you now have even more flexibility. Remember that EACH trading idea can have no more than $1,000 (5%) associated with it. This leaves out pyramiding on profits or adding to commodity positions at all. I’ve found over time that adding to positions after a good low risk entry is a formula for messing up a would-be good trade. Just put on your initial position and let the market run.

When you let your average price creep up when averaging up, (pyramiding) it’s as if you staggered in at a higher price in the first place. The first sharp correction will many times put you in average loss territory. Forget the romantic stories about traders starting with $1,000 and pyramiding it to $1 million. This stuff is fantasy and the cause of $billions in losses by the public over the years. Yes, it is possible, but so is winning the $100 million lottery. Commodity gambling is where most of the money comes from to pay the disciplined, realistic, winning traders...the type of trader you are striving to be.

Your best method of surviving and making money in the long run is to find a low-risk, high-probability trade, put on whatever position your risk management dictates and let it run. Then wait for the next DIFFERENT low risk, high probability trade and repeat. This will more safely and methodically spread the risk and probabilities in your favor.

$50,000 ACCOUNT

Risk no more than 5% max ($2500)

Here’s where you can begin doing two of everything if you wish. You can now risk two futures contracts, two commodity options, etc. (per trade) Some very conservative traders may even stay with one futures contract to reduce the risk to 2.5% ($1250). I like that idea best. Just think how long you could survive if you could be wrong forty times in a row before being carried out? Just think about how much money you can make if you are around to eventually catch your big string of winning trades? Most traders don't hang around long enough to get their share.

Even trading conservatively, you can make serious money when you are right. Remember that the commodity markets are leveraged at 5-10% margin down. For every $1000 in margin money you may control $10,000- $20,000 of commodity futures. If you are right on a string of big trades, you can can do very well. By having forty chances to perform this is what it’s all about. A $50,000 account holding two contracts in four markets (good risk management) can control between $500K to $1 million in commodities. (depending on markets) A 10% move in the futures means a $50,000 - $100,000 move.

If you do well and double your account, you can then double your risk and go from there. It’s all about having a conservative plan and staying that way through the entire trading cycle. Most commodity traders start out with high hopes and good intentions, make some money and then think they are invincible. When you lose control, the commodity market doesn’t take the money away – you give it away.

Part Six of Six Parts - Next!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course".
http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Surviving The Commodity Markets, PART 6 - Trading Guidelines For Different Account Sizes

2007-09-14T12:59:00.000-07:00

$100,000 ACCOUNT and HIGHER Risk no more than 2.5% - 5% max ($2500 - $5,000 per idea for $100K)

Now we’re talking. Ask most professionals and they will often tell you this is the minimum commodity amount to make a modest living from IF you are a good trader. Think about it. A really good trader can make 30% a year. Some make much more. This equates to about $30,000 a year. Many of us can barely survive on $30,000 a year.

As you can see, if you want to take this commodity trading business seriously, you need a good size account, approaching $50,000 - $100,000++. As a commodity pro, you don’t have the luxury of wiping the account out or else you are on the street. That’s the way to trade any account of any size. Think like a pro and you may have a better chance of doing well. If you don’t, and trade recklessly, it is almost 100% probability you will eventually give all your money to these commodity market pros.

By the way, the biggest way to reduce your fear of the markets is to reduce the size of your trading. You must get to the point of trusting yourself to do the right thing when the going gets tough. By having this structured money management plan and sticking with it, you will be on the road to trusting yourself. And remember, the only reason you will break this plan is because of greed – wanting to get there faster. Think about it.

These conservative guidelines will give you the best money management probability for success that I can think of. Gunslingers may laugh and feel they need to risk much more a trade. But ask any professional that has been profitable for years and he will probably agree with these guidelines. He might suggest to make them even more conservative!

I encourage you to commit to these money management principles. It is a big step towards developing your own personal trading discipline.

Good Trading!

There is substantial risk of loss trading futures and options and may not be suitable for all types of investors. Only risk capital should be used.

Thomas Cathey - 27-year trading veteran heads the managed futures division of Thomas Capital Management, LLC. View his TimeLine Trading market predictions and get his complete, free 44+ lesson, "Thomas Commodity Trading Course".
http://www.thomascapitalmanagement.com/commodity/welcome.htm

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Stop Losses - An Important Part of Stockmarket Trading

2007-09-14T12:17:00.001-07:00

By Mike Estrey

If there is one area guaranteed to confuse many traders and lead to multiple opinions on the most appropriate approach, it is the subject of stop losses. The science and the art of placing stops is featured extensively in many trading books and guides, but the bottom line is that there is no right or wrong answer, simply the fact that stop losses must be used to limit potential downside exposure when trading. Traders should also be careful not to confuse stop losses with buy stops, which trigger an opening position rather than closing the trade.

It is very important not to package together the placing of stops with money management, as the two represent different strands of trading. Simply put, stops are there to protect profits and limit the potential downside at any time once a trade has been opened, and are part of an exit strategy for trades that are already open. Money management covers position sizing or amounts to be risked within each trade of a portfolio.

Within this potentially complex subject, there are many different types of stops, and it should be added that stops are never guaranteed unless that facility is offered by the broker for an additional charge. Nevertheless, their use is an essential part of any trading strategy. For the examples below share prices are used, but stop losses should also be used when trading CFDs in commodities, forex or indices.

The uses and abuses of stops

Much has been written about the placing of stops and how to avoid them being triggered without too much risk. This of course is the $64m question for most CFD traders and very often causes more consternation than any other aspect of the trading process.

The basic idea behind where to place a stop is by reference to the overall trend or trading range within which the share is moving. As to the actual level of the stop, it depends on several factors including the trader’s overall money management rules, the amount of leverage, the time frame, and crucially the underlying volatility of the share chosen. The stop should aim to be placed at a level which if triggered would confirm the trade was incorrect.

There is no point in trading a highly leveraged CFD account with routine 5% stops as eight losses in a row, which statistically can be expected every few hundred trades, would lead to a minimum 40% drawdown on the account.

Having said that, there is equally no point in attempting to reduce the risk too far by setting 1.5% or 2% stops in highly volatile stocks or takeover situations as each trade needs room to breathe, and stops this tight are likely to be triggered within the normal daily ebb and flow of price movements.

A good rule of thumb is that if you cannot see at least double the potential profit in a trade compared to where you expect to place your stop loss, that trade should be passed over. Indeed some CFD traders look for three times profits achieved against losses as a starting ratio. Consequently an approach like this can be very successful by winning just three or four times out of ten, and is the hallmark of many of the world’s leading traders.

Many losing traders look for an entry point or strategy that wins six or seven times out of ten, but this is very hard to achieve consistently. Although the feeling of winning regularly is certainly warm, the win/loss ratio here very often tends to be very poor as too many winners are taken quickly, so the correct use of initial and running stops placement is crucial.

Types of stops:

The basic maximum loss stop

The maximum loss stop is the starting point for most traders and is triggered when the share price hits a level below or above the opening price of the trade, depending on whether it is a long or short position. It can be measured in percentage points or actual money terms, but for these examples percentages are used. So if a CFD trader buys shares in British Telecom at 330p with a 2% stop loss, then the allowed loss is 6.6p and the position is closed if the bid or selling price falls to 323.4p or lower.

Note that no mention is made of how many shares are purchased or how much is being risked, as this is part of the client’s overall money management.

If the shares gap down below the stop either intra-day or at the open of trading the next day, the closing trade is triggered at the first price available in the market for that size, which is why stops are not guaranteed.

As to the percentage size of the stop to be chosen, that depends on several factors including the trader’s overall money management rules, amount of leverage, time frame and crucially the underlying volatility of the share chosen, which is very important.

Volatility stops and the ATR

Clearly, a percentage based stop is likely to be triggered more quickly in a highly volatile share and one of the ways traders can adjust stop levels is by ratio to the underlying volatility. There are various measures of volatility available, but a simple way is to use a stop related to a multiple of the average true range indicator, which is featured in most software packages.

The ATR determines a share’s volatility over a set period that can be defaulted as desired. The daily ATR indicator is very simple to calculate and is the highest of:

The difference between the current high and the current low
The difference between the current high and the previous close
The difference between the current low and the previous close

Basically this is the maximum range in which the share has traded from the previous close to the current high and low. The average is then taken over a set number of days (ten is often used), and the stop is then calculated as a multiple of the ATR.

The reason this indicator is useful is that it becomes easier to place a stop outside the normal range of trading so that it is not hit by the short term random action of individual shares based on their average volatility.

As to the multiple of the ATR to be used, that is for the trader to decide, but longer term players and seasoned stockmarket investors tend to find a 2.7 to 3.3 multiple (which can equate to 5% to 15% stop losses) is applicable. Shorter term or highly leveraged players need to tighten the stop accordingly by adjusting this multiple.

The breakeven stop

This is a commonly used stop in which the trader closes the position if it reaches a minimum profit and then returns to even or back to a loss. So in the above example, if the price of BT rises say 2% to 336p, the stop is moved up to 330p, which was the opening price of the trade.

Please note that the breakeven stop here is not simply a new 2% stop loss – it’s very slightly different – but very often this approach is used as a rough and ready way to protect the downside. This leads on to the important subject of trailing stops.

Trailing stops

Trailing stops are widely used by professional traders as they provide an element of protection for winning positions without sacrificing too much of the profit.

The idea here is that once the position is opened, the trailing stop runs behind of the best profit achieved throughout the trade and the stop (whether percentage or price) is moved up accordingly.

There are three rules and suggestions (examples here are for long positions):

1. The stop can and must never be lowered

2. The percentage or price of the stop at each stage of the trade does not have to be the same. For example, the trader in the above example may begin with a 2% stop in BT, and then the share price might rise to 346.5p, which represents a 5% profit. At that point, the trader may wish to tighten the stop to 1%, so that a minimum 4% profit can be taken but with more potential upside. This approach is to the discretion of each player, but it is a very useful way of nailing down profits.

3. Another approach is to raise the stop loss with reference to recent action after a certain profit has been reached. Instead of a percentage stop, the trader might move the stop up behind daily lows, thus protecting against a potential trend change.

4. The stop might be triggered if there is a sudden rise in volatility with a reversal in the shares, and some traders use as a trigger if the day’s ATR is double the average ATR of the last ten days. This is very useful where a wider initial stop has been taken and there is the potential for a trend change before the trailing stop is hit, thus protecting the downside.

Mike Estrey is the Head of Research for Blue Index, the Online CFD Trading Specialists A free 15 day trial of their CFD Research is available, along with CFD Trading Seminars and Workshops

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http://EzineArticles.com/?Stop-Losses---An-Important-Part-of-Stockmarket-Trading&id=702009

How to Win The Futures Trading Game (Part I)

2007-09-13T18:32:00.000-07:00

By David James Bennett

As a new trader, you are probably impatient to get to the study of charts and evaluation of various trading strategies. Surely, winning involves predicting future market direction using sophisticated technical analysis to identify the best entry and exit points for our trades? So why delay discussion of all that stuff for a look at a bit of mundane statistics?

The reason is simple. If you regard the trading game as some kind of super intelligence test where you are pitching your skills against the rest of the world, you are unlikely to play the game with the right attitude and expectations. On the other hand, if you see trading as a numbers game, then you are more likely to approach it correctly.

So, if it is a numbers game (which it is), then you need to know what numbers are important for a speculator in the futures markets.

When you read books about trading you will be struck by the great emphasis placed on psychological aspects of the business. There are good reasons for that, because many traders suffer greatly from stress. They are distressed when their picks turn out to be wrong, and they are beset with doubts when they have a run of losing trades. This stress causes them to make mistakes, which increases stress even more. It becomes a vicious circle.

One of the reasons for this is a fundamental misunderstanding of the trading business (especially futures trading). As long as you believe that trading is a contest of your intelligence against the rest, or a test of your market knowledge, you are doomed to have a difficult time.

The trick is to understand that trading is a game, a probability game. Your job is to set up the parameters of the game so that you have a long term edge, and then execute your strategy consistently. With the right attitude to the game, your stress levels are reduced and eventually profits begin to come, reducing stress further. It leads to a virtuous circle.

Try to strip away your self-image of whiz kid financial trader, and start thinking in very basic terms. You need to really understand that future market action cannot be predicted with a high degree of accuracy, so nobody gets it right all the time.

This is not to say that you will not make predictions and it is all dumb luck. Quite the contrary, you will need to take decisions based on partial knowledge and probabilities, not certainties. Working in the fuzzy world of probabilities is harder than working with certainties.

Others may disagree, but I choose to see a futures trader as a gambler playing a simple game repeatedly. It is a bit like betting on coin tosses for a living. If you win money when you call the toss correctly and lose money when you call incorrectly, you can intuitively see how this game is likely to play out.

One thing you know is that you are likely to lose as often as you win. You know this because you realize that it is not possible to predict what the outcome of a fair coin toss is going to be. You are unlikely to spend time trying to develop better strategies for selecting heads or tails, because you can see that whatever you do you will never improve on a 50% chance of being right for any specific toss of the coin.

You also know that there will be runs of heads or tails, but in the long term they will tend to even out. If your first four tosses all turn out to be heads, you will not assume that it is better to call heads rather than tails in the future, although you can see it would have been better in the small sample you have looked at so far. Small samples are not much use for reliably determining statistics for future action.

Assuming an unbiased coin, what would induce you to play this (rather boring) game for a living? Well, suppose I give you $200 every time you make a correct call, and you give me $100 whenever you call incorrectly. That should be attractive.

Intuitively you can tell you will make money over time, although in the short term you might easily have a series of five or six losses. You would want to have enough money when you start the game to ride out a bad sequence which could bankrupt you before you start to win. For example, if you start off with capital of $200, you can be sent broke by guessing wrong just twice. If your starting capital is $10,000 the odds of going broke are negligible.

You can see that if there is only time to toss the coin once a day, you are not going to make as much money as you would if there is time to toss it 100 times a day. In other words, even a game with favourable odds is unattractive if it does not provide enough opportunities to profit.

You can work out that your Expectancy, over time, is an average of $50 per coin toss. (Think of 10 tosses where you are right half the time. You would win $1000 and lose $500, for a net $500 profit. $500 over 10 tosses is an average of $50 per toss.) Only games with a positive expectation make money in the long run.

As another example, how about rolling a die for a living? Suppose the winning and losing rewards are equal, say $100.

What might make this game attractive? Well, what if you win when you roll a 3,4,5 or 6 and lose if you roll a 1 or a 2. Once again it is obvious that you are going to win quite a bit of money if you play long enough.

This time you will not profit because a win has a bigger payout than a loss, but rather because you are more likely to win than lose. Over time you expect to win two thirds of the time and lose one third of the time. Your Expectancy is $33.33 per throw. (Think of 30 throws where you win 20 and lose 10 times. You would win $2,000 and lose $1,000 for a $1,000 profit. $1,000 over 30 throws is $33.33 per throw.)

These two simple examples tell you a lot about the trading game. You know that you can only win a game where your Expectancy is positive. You can increase expectancy by (a) increasing the size of wins versus losses, and/or (b) increasing the probability of winning versus losing.

You know that a profitable strategy with a good positive Expectancy will nevertheless have bad runs where you lose money for a while.

So what does all this tell us about how to trade? Consider the following points:

Your strategy must be repetitive and consistent. You will be unable to define system parameters with any accuracy if you are doing something different every time you trade. (If you are a prodigy who can make a fortune trading your gut instincts, I congratulate you and you certainly will not need any help from me. For the rest of us, we need to define one or more favourable strategies and repeat them consistently whenever we get the opportunity.)

You need to know what your probability of winning is, whenever you place a trade. (Knowing the probability of winning, you automatically know the probability of losing.) This can be a difficult statistic to get a handle on in real life. Tossing a coin is easy; obviously the Probability of Winning = 50%. But with a market strategy, the probability will not be intuitively obvious, so you will have to figure out a way of measuring it. You can only measure it on the basis of historical information and there is no guarantee that your estimate will be correct in the future. You can have greater confidence that your estimate is correct if it is derived from a logical trading strategy based on your knowledge of the ways markets work.

You need to know the size of your average winning trade and the size of your average losing trade. Depending on your strategy, this may be well defined, or you may need to figure out a way to estimate it from historical data (again with the caveat that history does not necessarily repeat itself).

Based on these numbers, your Expectancy must be positive. Expectancy can be worked out from the following formula:
- Expectancy = (Probability of Winning x Average Win) - (Probability of Loss x Average Loss)
- In the die throwing example I used before: Probability of a Win = 2/3; Probability of a Loss = 1/3; the Average Win and Average Loss are both $100.
- Therefore Expectancy = 2/3 x 100 - 1/3 x 100 = 66.66 - 33.33 = 33.33.
- Remember, this means that over time you will earn an average of $33.33 every time you play the game.

You know that statistics gleaned from small samples are of little value, and also that strategies with a good expectancy are almost certain to have bad runs of several losses in succession. Such runs are simply random fluctuations in a series of results which will revert to the statistical norms in the long run.

Because bad runs are to be expected, you must anticipate them when determining the amount of capital needed to play the game.

An important part of any strategy is the opportunity to profit provided. A good strategy which provides few opportunities may well be a lot less profitable than a mediocre strategy which provides a lot of opportunities.

Think about the casino owner, or your local bookmaker. They do not berate themselves if one of their clients has a big win. They do not change their entire business plan if they have a few unprofitable days. They do not tinker with the rules of their games after a few losses. They know the odds are in their favour, and in the long run their profits are assured.

If you can really internalize the simple concepts in this article, not just read and understand them, your attitude to futures trading will be much more realistic. You will expect strings of losses to occur at times. You won't get down on yourself because you have made a wrong bet on something that is, after all, basically unknowable.

You understand that if you act consistently over time, and take care to employ sufficient capital to ride out bad runs, then you will be profitable in the long run providing your strategy has a profitable expectation.

David Bennett is an independent Futures Trader. He lives on the Gold Coast of Australia, trading financial and grains futures contracts in Chicago. Visit http://12oclocktrades.com for more articles.

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Futures Trading - How To Win (Part II)

2007-09-13T18:31:00.001-07:00

By David James Bennett

To win at the trading game you need a strategy with a positive expectancy. The system parameters that determine expectancy are the Probability of Winning, the size of the Average Win and the size of the Average Loss.

You apply this strategy consistently, without variation, as often as possible. The positive expectancy asserts itself in the long run and profits accrue, although there will be bad runs which cause short term losses.

When you look at examples like tossing a coin or rolling a die, it is easy to see what the Probability of Winning is, but in real trading situations it is far from obvious. The only way of determining system parameters is by estimating them from samples of market action.

The usual way of doing this is by obtaining historical data and back-testing your strategy to see how it performed in the past, or by paper trading the strategy for a test period. In either case, your objective is to get reliable estimates of the system parameters.

There are some important caveats to emphasize:

Small samples provide unreliable estimates of system parameters! Your test period should include a minimum of 20 trades, and preferably 50 or more.
A strategy may not work in all market conditions. If you back-test your strategy in different periods when market conditions vary (bull market, bear market, sideways market), your parameter estimates are more reliable.
The greatest trap of all is curve fitting.
- This occurs when you define rules in your strategy to optimize results obtained in a test period. If you look at any particular set of historical data, you can often specify trading rules which produce magnificent results applied over that period. (If only we could trade in the past, we would all be wealthy.)
- Curve fitted strategies can usually be recognized by their complexity and large number of rules and exceptions.
- Curve fitting is a very natural thing to do, so it is vital that you are on guard against it. The problem is that markets are infinitely variable, and a strategy optimized on data from one time period is most unlikely to perform well in other periods.
- The other problem with curve fitting is that the sample estimates of system parameters are no longer accurate, since they have been deliberately optimized.
- The best way of avoiding curve fitting is to define a strategy based on a trading idea (I will look at some of these in future articles). A strategy based on an idea of how markets work, or other traders react to certain events, can be developed independent of past data. If you then back-test that strategy, the results will not be curve fitted.
- But if, as a result of observations you make during the test period, you decide to make adjustments to the strategy, that is the time to beware. Any change you make must have a logical trading rationale - otherwise you will be falling into the curve fitting trap.

Consider a soybean futures strategy traded at the Chicago Board of Trade (CBOT). The strategy is based on the simple idea of trading price breakouts which occur during the first 30 minutes of the trading day. If no breakout occurs, there is no trade for the day. Otherwise the market is entered with a Buy or Sell order in the direction of the price breakout.

(A price breakout occurs when the price moves out of a previously established trading range.)

The target profit for the trade is determined from the chart pattern forming the trade setup, and the stop loss is set at an equal amount. In other words, the amount risked is equal to the potential profit in this strategy. If neither the profit target not the stop loss are reached during the trading day, the position is closed at the end of the session.

Results for trading this strategy since Feb 6, 2007, are recorded in this spreadsheet.

For each date when the setup occurs, the trade result is entered as a number of points. In the soybean market, each point is worth $50, so the first result of -4.25 points represents a loss of $212.50 on the trade.

The third column shows the number of contracts traded. Next is a column showing the cumulative profit (in points), followed by the contract code (ZS).

Then there is a column indicating whether the trade is a win or a loss. Note the runs that occur here. It is interesting that 4 out of the first 5 trades were losers, although the strategy as a whole has proven successful. This illustrates the futility of relying on small samples for useful information.

Next come columns showing the cumulative winning amount, cumulative loss amount, number of wins and number of losses. This enables calculation of the Average Win and Average Loss.

Finally, the three highlighted columns show the ratio of the average win to average loss, the probability of winning, and the Expectancy.

As results for each day are added, the sample size gets larger and a better picture of performance emerges. Note how the estimates in the highlighted columns vary a lot in the first few rows, but settle down as the number of results increase. After about 20 trades, the numbers do not change much, giving confidence that they are converging to good estimates of the system parameters.

On the date of writing this article, 23 April, 2007, the Win/Loss ratio is estimated at 0.97. This means the average win is about the same as the average loss.

The Probability of Winning is estimated at 0.66. In other words, the strategy wins about 2 out of 3 times.

The expectancy is estimated at 1.1 points (1 point = $50). So, on average, the strategy has made just over 1 point every time it is traded. Brokerage costs of about $5 would have to be deducted from this.

This is an example only. It shows how testing can be used to estimate the Expectancy for a trading strategy. It may be possible to improve this strategy in a number of ways.

You can improve your win/loss ratio by using a tighter stop loss. For example, instead of risking the same amount as the target profit, you might choose to risk only one quarter of that amount before quitting the trade. That would mean your Average Win should come out at about four times the Average Loss, which is certainly a good thing. Unfortunately the Probability of Winning will also reduce, because some trades which are winners at the moment would hit the tighter stop loss point, and be closed for a loss.
Alternatively you could increase the Probability of Winning by specifying a smaller Profit Target, leaving the stop loss amount unchanged. For example, if the profit target is reduced to just 1 point, then some trades which currently end up as losers would reach this reduced target, changing them to winners. However, the higher Probability of Winning will be offset by a reduced Win/Loss ratio because your average winning amount will be smaller.
At this point you might be tempted to program your computer to work through all the different combinations of Profit Target and Stop Loss levels to see which gives the best Expectancy during the test period. However, this would be an example of curve fitting.
The point is that the original trading idea puts the stop loss point just beyond a major support or resistance area on the chart. It is a logical thing to do because it is known that other players in the trading game will perceive the support or resistance areas as a barrier. That barrier would have to be penetrated before the stop is triggered. This trading idea is arrived at quite independently of the test data.
However, if your computer analysis shows that a fixed stop loss level of (say) 1.5 points would have doubled returns during the test period, and you change the rules of your strategy to incorporate this value instead of the original rule, you are guilty of curve fitting!
Remember this concept. You can not use test results to optimize a strategy and still expect those same test results to provide valid estimates of the underlying parameters for the strategy.
If you truly understand this point, you will save yourself a lot of wasted effort. You will also look at the results quoted for advertised trading systems with a jaundiced eye, because many of them rely on curve fitting to achieve high returns.
I will continue to update this spreadsheet with trading results on a daily basis. It will be interesting to see if the key parameters remain consistent as time passes and the market moves through different conditions.

Back tested results can be used to get an idea of how much capital you need to trade a particular strategy. As of April 23, 2007, the largest draw-down has been about 10 points. (The draw-down is the difference between the previous highest cumulative profit and a subsequent low point. For example, the cumulative profit on 16 Mar reaches 31 points and then subsides to a low of 20.25 points on 5 April. That is a draw-down of 10.75 points, equivalent to $537.50 per contract traded.)

Conservatively, you should be able to withstand a draw-down of at least five times that experienced in a relatively small sample like this, so think in terms of around $3,000 risk capital to trade this strategy with one contract. Some brokers require $2,000 in your account before you can trade, so you would need a $5,000 account to feel comfortable trading the strategy. With $8,000 you might trade 2 contracts, with $11,000 you could look at 3 contracts, and so on.

The results also indicate that this strategy has quite a good level of opportunity to profit, with most market days yielding a trade opportunity.

Finally, you can see that the strategy produced a profit of over 40 points ($2,000) in the period from 6 Feb to 23 April, 2007. On a $5,000 trading account, that would be a 40% return in less than 3 months, giving you an idea of the rate of return anticipated for this particular trading game!

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http://EzineArticles.com/?Futures-Trading---How-To-Win-(Part-II)&id=538575

Following The Crowd... To Conform Or Not To Conform?

2007-09-13T14:15:00.001-07:00

Humans have a natural tendency to follow the crowd, but when timing the markets, following the crowd can often result in losses.

Unless you are in the middle of a long term trend, it usually doesn't work to conform to the masses.

Expert market timers know how to spot trends and they make sure to climb on board and profit. But often, the very same buy and sell decisions, which must be executed to jump on board that trend, are in direct conflict with current market sentiment.

It is not easy to make that trade when it conflicts with what seemingly everyone else is doing.

Interestingly, your ability to break away from what the masses are doing, from current sentiment, may have a lot to do with your personality.

Following The Crowd

There is safety and comfort in numbers. In following the crowd. Across the generations, people learned that survival depended on banding together and working as a group.

All humans inherited this legacy, and it is shown in the security we feel when we follow the crowd.

The most successful members of society have seen the virtues in following the crowd. They have learned to look for rules to follow and to decide which standards to strive for. Blind obedience to authority may not be beneficial but compromise is.

To be successful, it was vital to protect one's self interests yet also stay within the bounds of acceptable behavior.

Although you've been frequently warned about the pitfalls of following the crowd, it's important to recognize that it is a survival instinct that is ingrained not only in humans, but in most animals too. Think of herds of deer, flocks of birds, swarms of insects, schools of fish. There is safety in numbers.

Going Our Own Way

Although following the crowd isn't bad all the time, such as during a long term rally, there are times when a market timer should not follow the crowd.

If all we had to do to be profitable was follow our instincts, we would likely be making the same buy and sell decisions as the vast majority of traders. But just as the vast majority of traders are NOT profitable... as market timers we want to "break away" from their emotional trading and BE profitable.

Market timers trade market trends. Trends are created by the masses. Those same masses who are buying stocks at the top of a rally, and selling stocks at the bottom of a correction.

This means that most of the time, as market timers, we must go our own way. And right there is the crux of the problem.

As soon as our timing strategy, which is NOT based on the emotions of the masses, issues a buy or sell signal contrary to the current sentiment, our very human survival instincts kick in. We want to STAY with the crowd. It is hard to do what your instincts tell you not to do.

But those market timers who are successful, have learned to do just that.

Breaking Away From The Masses

We WANT to follow the masses. It is comforting.

But if we want to profit when the masses do not, we must learn to push down those same instincts which have made us successful in life, and refuse to allow them to control our buy and sell decisions.

It is true that the crowd is often right... until a turning point occurs. But when the markets turn, the crowd holds on, often until most if not all their gains have evaporated.

Going against the crowd takes a special kind of person, a person who isn't afraid of risk but doesn't seek it out, a person who looks inward only, and doesn't need reassurance from others.

FibTimer has spent years developing and fine tuning market timing strategies that are profitable. Look at the historical trading results of individual trading strategies. These results can be yours, but you must commit to trading the strategies for the months and years necessary to realize them.

Break away from the masses and you too can realize the profits that we have achieved over the years.

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Buy-And-Hold? It Works If You Have 40 Years Or So

2007-09-13T14:13:00.001-07:00

In business schools, the buy-and-hold strategy is still viewed by the majority as the most viable investing strategy for the financial markets.

It is hard to change old beliefs. I often wonder if those who teach such strategies have their own money invested according to their teachings.

"Buy-And-Hold" In The 90s

Most people invested using the buy-and-hold strategy in the 1990s, and as we all know, they lost a bundle when the dot-com bubble burst and we entered the 2000-2002 bear market with losses of 50% to 80%.

Many investment professionals now admit that stock prices are based on the beliefs of the masses. Assets of a company may play a role in the stock price, but the bulk of the price is influenced by popular opinion.

It's hard for many new market timers to accept the idea that prices are based on beliefs of the masses and little more.

But in the acceptance of this truth lies the path to profits.

"Buy-And-Hold" In The 70s

Have you ever talked to people who traded stocks in the 1970s? Many will tell you, "I learned my lesson a long time ago. I put my money in the markets and lost it. Never again."

In the 1970s, just about all investors used a buy-and-hold strategy.

They searched for "undervalued" stocks, purchased shares, held them, and waited for them to increase in value.

Sometimes it worked, but many times it didn't. And even when it did work, profits weren't anything near what an active, market timer or trader can make.

The buy-and-hold strategy misleads investors. The markets don't go in one direction forever, whether the trend is bullish or bearish.

Only by trading the ups and downs of the market can you make significant profits. If you are striving to become a profitable market timer, it is vital that you cast aside the buy-and-hold mindset of the long-term investor, and learn to "think" like a market timer.

The "Trading Edge"

Without a crystal ball, you can't know the future direction of stock prices with any amount of certainty, regardless of whether you use fundamental or technical analysis.

However, once you recognize the market prices are the result of thousands of investors who "believe" they know the direction prices are going to take, you have the "key" to beating the markets.

Knowing that prices are based on the beliefs of the masses is your "trading edge."

If you look at any long term chart of the financial markets, you will see that "most" of the time, the markets are moving up or down in trends that last many months, and sometimes years.

These "trends" reflect the "beliefs" of all those investors. And those "beliefs" are controlled by the "emotions" of fear and greed.

While prices are rising, the majority of investors "believe" they will "continue" to rise.

While prices are "falling" the majority of investors "believe" they will "continue" to fall.

Because emotions are involved, you will see more investors buying near tops and pushing prices higher than anyone expected they would go.

And of course, because emotions are involved, you will also see more investors selling near bottoms, pushing prices lower than anyone expected they would go.

This has been going on since the beginning of free market trading.

Conclusion

FibTimer uses that "trading edge." We know that the "masses" will push the financial markets in big up and down moves. Not all the time, but most of the time. That "trading edge" is our key to profits.

FibTimer does not try to "predict" where the market is going. We trade market "trends." Those very same trends that are created by the masses of investors who are buying into rallies and selling into declines.

We also know that trends will last longer than most expect and that is why we stay "with" the trend all the way.

Over time, the "knowledge" that the masses will push the markets up and down in huge trends, and trading those trends, results in huge profits.

Article Source: http://EzineArticles.com/?expert=Frank_Kollar
http://EzineArticles.com/?Buy-And-Hold?-It-Works-If-You-Have-40-Years-Or-So&id=449051

Enhance Gains With Timing Diversification

2007-09-13T13:59:00.000-07:00

As we have written so many times, "market timing is the following of a long term strategy to profit from the financial markets, that also protects us from the inevitable down trends that occur along the way."

Many investors, who understand the potential of market timing, pay little attention to the potential of diversification. Many novice market timers jump right into an aggressive timing strategy with little thought about how they will handle a period of losing buy and sell signals.

But there is a way to jump right in, and also realize the long-term potential of even the most aggressive strategies. It does require a bit more work, but not all that much. Just a few minutes a day to check for changes and make adjustments.

Aggressive Market Timers Can Benefit

Many market timers already follow well-defined investment plans that include diversification. But as we just discussed above, some do not.

If you are one of those who do not... consider changing. Diversification is not only for those who are afraid of volatility. It has an important place in even the most aggressive of portfolios.

We have been market timing since the early 1980s and although we are quite aggressive, we diversify our timing funds, not just for safety, but also to "enhance" our profit potential.

Those who follow our Bull & Bear Pro Timer strategy will make a great deal of profit over long time frames. Because the markets tend to trend most of the time and the aggressive strategies will catch all trends in "both" directions.

But non-trending markets can be quite frustrating, and aggressive market timers in our experience, become frustrated more quickly than most.

Aggressive timers.... try this strategy: Use the Bull & Bear Pro Timer strategy for 20% and no more than 30% of your timing portfolio. Use the Sector Fund Strategy for the other 70% to 80%.

Although the sector funds go to cash on sell signals, these industry specific funds are big winners when they trend. Often they will trend much further, by 100% to 200%, than the rest of the market.

When the bear growls, you will have 20-30% of your portfolio profiting on the short side, plus those sector funds that are hot even during a bear market (there are always some).

You will make money, but have only a small percentage of your timing portfolio at risk.

During a bull market, you will be fully invested most of the time, except in those few industry sectors that are not doing well.

Diversified portfolios have a dramatic effect in controlling volatility and drawdowns. Yet they can be extremely profitable over time. The best of all worlds.

Even Conservative Investors / Market Timers Can Benefit

Those conservative market timers who are willing to devote at least a little extra time, can enhance their profits by adding the Sector Timer strategy as a percentage of their timing portfolio.

Being conservative does not mean you cannot be active. Using the Conservative Timer strategy will always do well over the years because it is designed for long trending markets, and makes changes infrequently.

But if you used it as a base for your timing portfolio, say for 50% to 60% of it, you can easily be more active with the other 40% to 50%, and still be well within the guidelines of "conservative" investing.

Again we suggest using the Sector timer. In this case "because" it goes to cash during sell signals, and because it follows a diversified strategy of its own (multiple positions are always used), it can add considerably to your profit potential (sectors tend to trend longer and higher during bull markets). Another possibility is using the Sector Timer for 33% of your timing portfolio, Small Cap Timer for 33% and Bond Timer for 33%. This will create an excellent diversified portfolio for solid gains over the years.

An even more conservative yet simple portfolio might be a your core timing account stays in the Conservative Timer strategy with 70% allocated, plus 10% for the Bull & Bear Pro Timer (or Bull Pro Timer) strategy, 10% for the Bond Timer strategy and 10% for the Small Cap Timer strategy. This will cover most bases, and yet still offer an additional level of safety.

There are many variations that you can come up with using the various strategies and this is something we recommend. Any work that adds diversification will add stability to your investment portfolio.

Conclusion

Consider at least some diversification for your market timing funds.

We mention the Sector Timer in several the diversification scenarios above. This is because it is "already" well diversified (at least eight sectors, if not all, should be used), yet has the tremendous profit potential inherent in industry specific funds (sector funds usually trend farther, percentage wise, than the general market).

Diversification can dramatically help control volatility and drawdowns.

Diversification, when properly applied to your portfolio, will actually enhance your profit potential over time.

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http://EzineArticles.com/?Enhance-Gains-With-Timing-Diversification&id=626483

A Butterfly Flaps Its Wings, Chaos Theory And The Financial Markets

2007-09-13T13:57:00.001-07:00

According to Chaos Theory, a seemingly irrelevant action can precipitate, and contribute to, a major event. The right set of factors comes together and a major event takes place.

It's easy to imagine a fanciful chain of events that would initiate a market move.

A housewife attends to her crying child who has tripped over the newspaper, and in doing so, leaves the refrigerator open during an unseasonably warm day. It breaks down, and the family needs a new one.

To get funds for a new refrigerator and some added home repairs, she sells off a large chunk of IBM stock that her parents gave her as a wedding present.

By pure chance, at the moment that she sells the stock, a specialist monitoring the action gets it in his head that the sale of a large chunk of stock means something, so he sells off his positions in the tech sector.

Next, a financial reporter sees the sale and tries to interpret it. He reports that it reflects a shortage of silicon and suggests investors unload their tech stocks immediately.

Many people follow his advice and a massive sell off takes place.
Perhaps it seems a little unlikely that all of this can happen, but you get the idea.

Just like how scientists claim, according to Chaos Theory, that a butterfly can start a hurricane, you can imagine that a few key seemingly minor events can start a major market move

Is It Economic Factors? Or Fear And Greed?
Many investors view the markets from a traditional long-term buy-and-hold strategy. They look at the markets in terms of fundamental variables, such as consumer confidence, demand, and general economic factors that impact a stock price.

If a company makes profits that are in high demand, the price goes up.

Market timers though, realize that many market moves are the result of psychological factors, such as opinions or emotions of fear and greed. In the short-term, anything can happen, and it is vital to keep this in mind.

Nothing is certain in the markets, but is this something to worry about?

Not if you take precautions. By precautions, we mean "following a strategy that uses the ups and downs (trends) of the market itself to generate buy and sell signals."

This way you are always in the current trend, never miss a trend, and are never trading against the market's trend.

Worry Can Be The Doom Of Market Timers
Indeed, a potential chaotic event can be a good thing.

The initial event that set off a market move isn't important. Who cares why the masses buy or sell, for example, as long as you take advantage of the move?

Market timers must learn to view such moves as opportunities to profit.
If you have a timing signal that is ruined by an unexpected adverse event...the chaotic nature of the markets coming to the forefront... there is no reason to worry.

In fact, it is absolutely "going to happen." Signals will go against you. Accept this and you will profit. Worry so much that you jump out of a tried and true strategy because of a losing trade or two, and you will eventually fail at timing the markets.

If you are following a trend, and it unexpectantly reverses, the (trend following) strategy will quickly reverse and place you right back on the right path.

It is necessary to accept that trading can be chaotic. Anything can happen, but it doesn't need to be a source of worry. As long as losses are kept small, and profits are allowed to run, you will beat the markets.

Worry can be the doom of market timers and traders, but if you accept the fact that uncertainty and chaos are part of the inherent nature of the markets, you will accept it when it occurs and recognize that this same chaos is what will make you profitable in the end.

A losing trade here. A losing trade there. All meaningless in the big picture. By following trends, which is FibTimer's market timing specialty, you are always profitable over time.

You profit in "all" of the big trends. By following trends with FibTimer's timing strategies, you are always with the big market moves when they occur...and there is always a big move (trend) just around the corner.

Article Source: http://EzineArticles.com/?expert=Frank_Kollar
http://EzineArticles.com/?A-Butterfly-Flaps-Its-Wings,-Chaos-Theory-And-The-Financial-Markets&id=644297

Jim Rogers: How Long Will the Commodities Bull Market Last

2007-09-13T13:40:00.000-07:00

By James Finch

We talked, in a taped telephone interview at his home in Singapore, with Billionaire Jim Rogers, legendary commodities trader, who picked the bottom of the commodities bull market in 1999. With George Soros, Jim Rogers co-founded the Quantum Fund in 1970.

Over the next decade, Quantum Fund grew by more than 3,300 percent. Rogers retired, later a guest professor of finance at the Columbia University Graduate School of Business, and still later circumnavigating the globe to firsthand discover new investment opportunities. He is widely and often quoted in the media about his views on the commodities market. Bestselling author, investment biker, adventure capitalist and widely followed, Jim Rogers talks about what he's now investing in.

StockInterview: You began investing heavily in commodities, at very close to the bottom of the cycle. What led you to believe the commodities boom would begin in 1999?

Jim Rogers: I could see that nobody had been investing in productive capacity in crude (oil) specifically. For instance, there had been virtually no offshore drilling rigs built since 1981. There had been virtually no offshore tugboats built to service the offshore rigs since 1981. In the 1970s there were dozens of them built every year. I could see that people had cut back their exploration budgets enormously. It was pretty clear that nobody had been investing for fifteen or twenty year, in looking for new (oil) fields. There hadn’t been any gigantic fields discovered since the 1960s. It was clear the world reserves were running down. That had to lead to a bull market. It so happens that I got almost the exact bottom. I’m not a very good market timer or trader, but I got within a few weeks of the absolute bottom to my surprise. Then you extend that to nearly everything else, whether zinc mines or lead mines or wheat production or anything else, and you have the ingredients for a new bull market.

StockInterview: Will the recent Central Bank rising interest rate policy, which is intended to deflate the commodities bull market, fail?

Jim Rogers: Well, yes. They may cause recessions, and they probably will. We’ve often had recessions. That will affect some commodities markets. But in the 1970s, we had horrible economic conditions everywhere in the world, or nearly everywhere in the world. That did not prevent one of the great bull markets of all time in commodities because supply was going down faster than demand. Remember that these markets are made up of supply and demand. If the supply goes down faster than demand goes down, you still have a bull market. There will be setbacks and consolidations, but that’s just the way the world works. All bull markets have corrections, as I have said before.

StockInterview: What has convinced you to stay in the commodities bull market for this long?

Jim Rogers: Throughout history, bull markets in commodities have lasted a long time. They’ve averaged about 18 years or 19 years. The shortest I could find was fifteen years; the longest was 23 years. It takes a long time to bring new production on stream for commodities. If you and I decide to go into the lead business today, we’ve got to go find a lead deposit. Then, we’ve got to try to raise money. We’ve got to deal with unions, environmentalists, governments and everybody else. And put in infrastructure. It takes on average about ten years for any new mine to be opened these days, not just in the U.S., but anywhere in the world. So, that’s why the bull markets last so long. Eventually, new supplies come to market, and the bull markets have always ended. But, it takes a long, long, long time for that to happen. It’s not like bringing in new shares of a dot com or something, where we go into the garage and start a company and next week we sell stock. Mines and oil fields are much different animals.

StockInterview: Is the commodities bull similar to the Internet boom of late 1999? Does it have a few more years to run, as strongly as it has?

Jim Rogers: Well, there’s a bit difference. As I said before, you and I could go into the garage and start a dot com company and bring it public next month. That’s a little bit different from bringing a zinc mine on stream, much harder to bring new production to commodities compared to some of these other things. I do know, if history is any guide, we’re now seven years into this bull market in commodities. If it’s going to last 15 to 23 years, we’re maybe a third of the way through, so we have another 9 to 16 years to go, I guess.

James Finch contributes to StockInterview.com and other publications. StockInterview’s “Investing in the Great Uranium Bull Market” has become the most popular book ever published for uranium mining stock investors. Visit http://www.stockinterview.com

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http://EzineArticles.com/?Jim-Rogers:-How-Long-Will-the-Commodities-Bull-Market-Last&id=239694

Have The Markets Changed?

2007-09-12T22:10:00.001-07:00

Questions we are commonly asked are: Have the markets changed? Is it different this time? Have advances in technology made it so the average trader does not have a chance anymore?

These questions are easy to answer, and with complete certainty: No.

Free markets behave the same as they did 200 hundred years ago. The same as they did 40 years ago. They same as they did in the bull market of the 1990s. They are the same today, and will be the same in the foreseeable future.

Why? Because free markets are never static. Because they always CHANGE. They are subject to the buying and selling of millions of participants, each with his or her own viewpoint and / or expectations.

Any market timer can forecast a rally or a decline and have a chance of being correct. But try and repeat the feat with consistency.

The only thing you can absolutely count on is change. Markets will advance. Markets will decline.

If you have a trading system that is specifically designed to "use" change, you can take advantage of the market "changes" and make money.

Changes will not impact negatively on you if your strategy for handling them is actually based on them. If your buy and sell signals are created by the ups and downs of the market itself.

Predicting The Market's Future

If change is the only "certainty" looking forward, then how can one predict (forecast) the market's future?

That is the point. "No one" can predict, with any certainty, the market's direction. But while no market forecast can be guaranteed, change "is" guaranteed.

One thing we can be sure of; if your plan is to just buy and "hope," you will be in for some very unsettling times.

The markets will have incredible moves in the future, both "up," as well as "down." You will be ecstatic during rallies, and upset and worried during declines (and likely depressed and fearing each day during the inevitable bear markets that "will" occur in the future.)

Sound like talking in circles? Not all... Let's tie it all together.

If change is inevitable, the only certain way to profit from the markets is to follow a plan that is "based" on change. That actually works "because" changes occur. Because change is inevitable.

Advancing (and declining) markets that last months and oftem much more are called trends. Look at the last 200 years of market history and you will see that it was in a "trend," one way or the other, most of the time.

FibTimer follows trends. No matter how ridiculous those trends appear to be at the beginning, and no matter how extended or how irrational they seem at the end, we follow trends.

But Hasn't Technology Changed The Playing Field?

Some would argue that today's markets are different. Technology has given select traders an edge that takes away from the average person's ability to profit.

Buy and sell programs, moving massive amounts of stock, take advantages of fluctuations in prices that no individual can hope to master.

In fact they "create" fluctuations in prices. For every 10 traders with a computer program saying buy, there are 10 other traders with computer programs saying sell.

No matter what you do. No matter what the experts do. No matter what the computer generated programs do. Markets go through different stages: accumulation, advance, distribution and decline.

Prices Will Go Up, Down Or Sideways

One absolute can be taken as gospel: Prices must either go up, down or sideways. One of these three outcomes will occur... change is inevitable.

No advances in technology, no leaps of modern science, no radical shifts in how we see the markets will ever alter this fact.

Thus a market timer does not need to predict the future, or even attempt to predict it. A timer only needs to know the rules of the game and abide by them. If the market goes up, be long. If the market goes down, be short or in cash.

And very importantly, if you can react properly to "changes" in price, you can profit.

Strategy Based On Change

Trend followers are always poised to jump on board the next unexpected major move in the markets, and to profit from it.

While some people focus on the past results of a trading system to gauge its success, and others only think about what happened last month. Both are wrong.

A great trend following system adapts to and uses change. The "future" is its most important ally.

A good trend following strategy lets profitable positions continue, while quickly exiting positions that go against you.

Human Nature

There are always fears that trend following may not work in the future or that the markets have changed and trend following is not the way to go.

This fear is strongest after a drawdown or during unprofitable sideways markets.

Get used to it. They happen!

Then along comes another big move in the markets. Market timers who follow trends "again" make big profits and everyone’s belief in trend following is restored.

But those who dropped by the wayside are still on the outside looking in, trying to understand how to generate profits. After trend followers lock in a nice gain, those who left may even climb on board and try trend following again.

But human nature is fickle.

If the markets are going sideways and current trading is not going well, alternatives begin to look better and better.

Untested or insufficiently tested methods may be implemented in an effort to turn things around. Of course, such acts of desperation rarely work. Market timers should be suspicious of the urge to change, made in the midst of a drawdown.

Article Source: http://EzineArticles.com/?expert=Frank_Kollar
http://EzineArticles.com/?Have-The-Markets-Changed?&id=721733

5 Steps To Becoming A Stock Market Guru

2007-09-12T21:44:00.001-07:00

By Larry Holmes

It has occurred to me that many of the readers of this article may be interested in a career change. If so, I suggest that becoming a stock market guru may be worthy of your consideration. It's a job that -- if you follow my advice -- pays extremely well, doesn't take much your time, requires almost no experience, and can potentially bring you fame and fortune.

I have been observing market gurus for many years and have noticed that there are certain traits that the successful ones have in common. So to get your new venture off to a roaring start, I'm going to tell you exactly how to be successful as a stock market guru.

First of all, you must do something to get the attention of the financial media. The way to do that is to make extreme predictions. No "the market is going up 10%" or "down 5%" kind of forecasts. You have to say things like "the Dow is going to 36,000" or "button down the hatches, the market is going to crash any day now."

The best way to decide whether to be bullish or bearish is to measure the mood of the public. You will be much more popular if you're wildly bullish at market tops or wildly bearish at market bottoms. You want to tell people what they're already predisposed to believe.

Also, you can never change your mind. The media doesn't like that. So be a perma-bull or a perma-bear. But whatever you do, never, ever waver from your original stance.

After you have decided whether you want to make a living being extremely bullish or extremely bearish it is very important that no one remembers when you first made your original prediction. This one is going to be tricky and requires some skill. Don't ever let anyone pin you down on timing issues. The way to do that is to just keep repeating your prediction over and over again until everyone forgets how long you've been making the forecast.

For role models, watch the politicians. They are experts at not allowing anyone to pin them down on anything that they prefer you not to remember.

You must repeat your market prediction loudly, often, and with extreme confidence. When the market goes against you, simply keep repeating that you're very confident of your stance and you have no doubt that the market will go your way very soon. Again, you must make people forget about timing issues and the best way to do that is through repetition.

The market will eventually go your way. It may take years, but it will happen. Now listen closely -- whenever the market finally goes your direction, no matter how small a move it is, proudly declare victory. I mean shout it from the roof tops. You were right all along and it's all because of your astute analysis.

Do not make any mention of when you first made your original market call. If you are cornered and you must make a comment about your entry point, just say that you have been averaging into your position for quite some time. That way no one will know that you actually lost a lot of money.

Speaking of losing money, never follow your own predictions by investing your own funds. Otherwise, the income that you make as a famous guru will be taken away from you by the market.

Good luck in your new career. And when I see you on CNBC promoting your new book -- Boom Times Ahead: Dow 38,437 or How to Get Rich During the Coming Depression -- I'll know that you took my advice to heart.

Larry Holmes invites you to visit http://www.smart-money-report.com/ Your common sense guide for financial and investment success.

Article Source: http://EzineArticles.com/?expert=Larry_Holmes
http://EzineArticles.com/?5-Steps-To-Becoming-A-Stock-Market-Guru&id=87385

6 Reasons Why Exchange Traded Funds Are Better Than Mutual Funds

2007-09-12T21:41:00.001-07:00

By Larry Holmes

Exchange traded funds (or ETFs) are better for most investors than mutual funds. The mutual fund industry has experienced tremendous growth over that last twenty-five years or so. But it's a new era now. It's the era of the ETF.

What are exchange traded funds? ETFs are similar to index mutual funds. Essentially, an ETF is a portfolio of securities that is intended to provide investment results that, before fees and expenses, generally correspond to the price and yield performance of the underlying benchmark index. ETFs trade on the stock exchanges. As such, they offer features of a mutual fund in a stock-like instrument.

There are at least six important advantages that exchange traded funds have over mutual funds…

ETFs, instead of pricing once a day after the market closes (like mutual funds), are traded throughout the day as if they were regular stocks.

Since an ETF trades like a stock, it can be bought and sold (and shorted at any time during market hours.

Investors can calculate the value of an ETF during the day because the composition of the underlying portfolio - normally a published index - doesn't change. For example, the value of the SPDR ETF (SPY) that tracks the S&P 500 index is calculated continuously throughout the day.

An ETF can be exchanged for the underlying assets it represents with the issuing institution for a small fee. It means that ETFs will not trade at significant discounts or premiums to the value of the underlying assets of the fund. This is not true with closed-end mutual funds.

Because they are not actively managed and have very little portfolio turnover, ETFs carry some nice tax advantages over mutual funds because they distribute relatively few capital gains.

Most ETFs have very low management fees, especially compared to mutual funds. And the lower the expenses, the more money goes into the investor's pocket.

So exchange traded funds offer most of the advantages of mutual funds -- instant diversification and many to choose from -- without the major disadvantages.

The primary disadvantage of an ETF is that if you are making small transactions on a regular basis, you will pay a commission on each transaction -- just like you would by buying and selling a stock.

But, all in all, the advantages of an exchange traded fund far outweigh any disadvantages. I suggest that you use ETFs as an important part of your investment strategy.

Larry Holmes invites you to visit http://www.smart-money-report.com/ Your common sense guide for financial and investment success.

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http://EzineArticles.com/?6-Reasons-Why-Exchange-Traded-Funds-Are-Better-Than-Mutual-Funds&id=88199

Trading The Market: Keep It Simple Stupid!

2007-09-12T18:17:00.001-07:00

By James Okada Lee

It seems like each day there is another complicated trading system in development. I am quite surprised to see the trading population dig into more complex methods combining various indicators to profit from the financial markets. How many confirmations does one need? By the time all your indicators confirm a buy or sell signal, your entry point is towards the end of the price swing.

K.I.S.S. Keep it simple stupid! Simple methodologies have been proven to work in the financial markets. There are numerous traders who use a simple breakout strategy, pivot point strategy, or RSI and price divergence. Is there really a need to make trading so complicated when simple systems are proven to work?

I have noticed that academics, engineers, and programmers turned traders are often the ones involved in designing complicated systems. Perhaps they are underestimating the simplicity of trading? Trying to incorporate vast information and multiple indicator confirmation signals can lead to analysis paralysis. This can cause a trader to freeze in the moment of action and to hesitate in pulling the trigger. What happens if 4 of your indicators signal a buy and 4 other indicators signal a sell? As a discretionary trader, I try to keep things as simple as possible. What a trader really needs is to understand the language of the markets.

The market is like a speechless baby. It is impossible to understand exactly what he is saying but through observation, one can start to get a feel of expression. Still, trading is a game of probability. But with the proper training of market understanding and market internals, a trader can put those odds in his favor.

The majority of the trading population refuses to think on their own. Being mentally lazy is deadly in the financial markets. Perhaps this is the reason why people continuously seek for the Holy Grail through indicators and systems. They look in places where there are no answers. The only place they should be looking is in the mirror and in themselves.

Trading should be simple. But the simplicity of it comes through hours of hard work and training. Trying to catch the subway in Tokyo, Japan can be disastrous for the first timer. But after living in the city for some time, one should be able to get across with his eyes closed.

Good luck, best of trading.

James Lee is a full-time day trader specializing in the mini-sized Dow futures. His core trading strategy is based on pivot point clusters and Market Profile. Find out how to identify high probability trading opportunities at http://www.traderslaboratory.com

Article Source: http://EzineArticles.com/?expert=James_Okada_Lee
http://EzineArticles.com/?Trading-The-Market:-Keep-It-Simple-Stupid!&id=314305

Trend Trading or Counter Trend Trading - Which is Best?

2007-09-12T17:54:00.000-07:00

When I first starting designing and testing trading systems, back in the early days of personal computers and trading software, I immediately gravitated toward counter trend trading. I would put up a stochastic, before I even knew what it was measuring, and my eye went right to all the divergences. A divergence is a basic counter trend pattern, where the price makes a new high, for example, and the indicator makes a corresponding lower high, thus forming a divergence with the price. The idea is that the new price high was not confirmed by momentum, which in this case was losing strength. When this pattern is seen, it is thought the market might have put in a high for the move, and it might turn around and go in the other direction.

I liked the idea of picking tops and bottoms. I was getting really good at it, at least on paper. I thought I had found the Holy Grail of trading. It all looked so easy. Almost every new high or new low on the chart was accompanied by a very clear divergence pattern. These patterns just jumped off the charts, screaming at me. I thought I had found the key to my trading plan, and it was going to be to be able to pick the point of a trend change. In other words, I was going to become an expert at picking tops and bottoms.

Then I started trying to trade all these easy patterns with real money. For some reason, whenever I would take a trade on one of these patterns the market didn't know it was supposed to reverse. It would just keep going in the direction it had been going. I would get several divergences and the results would be the same. That is, of course, until I got so burned out trying to catch the reversal and I would give up. Then, like magic, the perfect divergence pattern would appear, but I would not be in the trade.

I would caution anyone who thinks that they can pick the spot, with any accuracy, of a top or bottom in the market. I know many gurus and market timers claim to be able to do it. It can be quite gratifying to pick the top of a market, especially when all the media and analyst are on one side of the market, and you go the other direction and win. It gives you a very brief sense of superiority. You could see something that nobody else could, and you made a profit with this knowledge. However, after engaging in this activity for any length of time, one should review the account statements to really see if this has been a profitable way to trade.

It is remarkable how the eye can pick out major highs and lows on a chart, and to see many reasons why the top or bottom was so obvious. Maybe there was a classic three drives to a high pattern, or a head and shoulders pattern, along with diverging momentum or volume. It makes picking tops and bottoms look so easy. But if you analyze the chart more carefully, you’ll probably find two or three times as many set-ups that fail. The mind somehow glosses over the failed set-ups and goes right to the successful patterns.

After many frustrating attempts unsuccessfully using the stochastic indicator, I decided to study with the person who developed the indicator. I flew to Chicago to study with George Lane. Here was the guy who developed the indicator that almost everyone at that time was using to spot divergence patterns, and he talked me out of trading divergences, except in rare case. He only used the stochastic as a confirmation if many other conditions of trend change were present. I still like that indicator, but I use it in an entirely different way now. The time spent studying with him probably saved me years of frustration and a lot of money avoiding losses.

When thinking about trend change there are some things to keep in mind. First, trends tend to persist; often longer than you think is logical. When trends are up they often climb that wall of worry. Worry that the market will collapse without warning and take away your profit. Worry that the fundamentals don't justify the prices being traded. Logic might dictate taking profits, but there is worry of leaving money on the table. Uptrends tend to end more leisurely, at least in the stock market. For the public, it is easier to decide to enter a market or take profits in the calm of rising prices, where only greed is the factor. In down markets, traders often panic, and margin calls with fears of losing your home are often a motivator that results in more urgency. Therefore, bottoms can form quickly and sharply. Futures markets seem to be a bit more even regarding uptrends and downtrends, due to the nature of the mix of traders involved. A sideways trending market, or a market with a perceived lack of trend, will often lull traders into complacency, and with attention elsewhere, breakouts into a trend can be missed.

To summarize, I find the best strategy is to find the main, confirmed trend, whatever indicator or method used to determine that trend. Then trade only in the direction of that confirmed trend. Trading pullbacks, such as flag patterns, will usually offer the safest entry points. Trends have smaller cycles within the larger cycle. There are usually pullbacks within the longer term trend. One can still trade turning points of these smaller cycles, as long as they are in the direction of the longer-term trend. I will accept kicking myself for the few times I see major tops or bottoms that I will most certainly miss. This is a small price to pay for missing many losing trades resulting from trying to buck the trend. There are always trends somewhere, and in some timeframe. Going against the trend is like jumping into a river flowing rapidly in one direction, and trying to swim in the opposite direction. It is difficult and exhausting to do. It's much easier to float down the river in the direction that the current wants to go. The ego is more gratified in going the opposite way. The ego is also one of the most difficult aspects of trading to overcome.

Doug Tucker has a blog with daily commentary on stock indexes, precious metals, and other markets. There are many articles on technical analysis and indicator design and interpretation. To visit go to: http://tuckerreport.com/

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http://EzineArticles.com/?Trend-Trading-or-Counter-Trend-Trading---Which-is-Best?&id=673742

ETFs - A Superior Trading and Investment Vehicle

2007-09-12T14:58:00.000-07:00

The ETF, or Exchange Traded Fund, has grown from consisting of a handful of broad-based index products, to now consisting of hundreds of products representing almost every conceivable investment theme or idea. Volume has expanded on many of the issues, making them some of the most liquid trading instruments around.

It seems clear that the debate between choosing a traditional mutual fund or an ETF is clearly in the corner of the ETF. ETF fees are much lower than mutual funds, and even factoring in the small brokerage commission applied to an EFT, the savings in fees will make up for the commission many times over. And, some brokerage firms that deal in no load mutual funds will charge a commission to get out if not held a certain length of time. There is no restriction on the holding period of an ETF. And with and ETF you won't get hit with capital gains distributions, so, with the exception of dividends, you get to control when you pay capital gains, short term or long term. You can get in and out during market hours instead of just the close, and there is the ability to easily trade on the short side with most of the active ETFs, with no uptick rule. And there are options available for outright purchases, or for hedging, or for other option strategies. Also, there are ETFs that have leverage, and some that will be inverse to their index, so a long-term short position could have long-term capital gain potential.

The comparison between ETFs and CEFs (closed-end funds) is a bit different. With CEFs, which are somewhat similar to ETFs, you have a security that can trade on its own supply demand; therefore the fund can go to a premium or a discount to its net asset value, sometimes substantially. With CEFs there is also the chance of dilution if the firm wants to issue more stock, usually with an offer for existing shareholders to purchase more shares at a predetermined price. While brokerage commissions will be the same as with an ETF, the management fees will usually be higher with CEFs. CEFs will often target a more specific type of investment, whereas ETFs are usually more broadly index based. However, that has been changing over the last couple of years.

There are more and more ETFs being issued almost daily with very specific objectives. You can find an ETF for almost any country, style, sub-sector, commodity, and even for currencies. There are so many ETFs coming out, it is getting hard to sort through the list. One way to pare down the list is to look at monthly average trading volume. Liquidity is certainly an issue, as some of the newer, narrowly focused ETFs have very low trading volumes, with correspondingly wider bid ask spreads, while the most popular choices are extremely liquid, with a penny or so spread between bid and ask. In time the best will survive, and many too-specific issues will disappear. In my opinion, some of the too narrowly focused issues defeat the purpose of investing or trading in ETFs.

In comparison to individual stocks, there are valid arguments on both sides of the issue. One theory favoring stocks is that you can just pick the best stocks in whatever group or index you are interested in, and not be weighted down by the dogs of the group. That's true. Of course, that depends on you being an excellent stock picker. Roughly 85% of professional, full time mutual fund managers can't beat a benchmark such as the S&P 500. Individual part time investors think they can do better than professionals. I'm not so sure.

It is difficult enough to pick the direction of a market. Much of the movement of a stock will be influenced by the overall market direction. Some say stock movement is about 70% dependent on overall market direction. I can't verify that number as being correct, but it seems in the ballpark. Picking an individual stock on top of picking market direction adds a second variable. If 70% of a stocks movement is influenced by the overall market, and 85% of professional stock pickers under-perform benchmark stock indexes, it doesn't seem worth the effort to try to sort through the list of thousands of stocks for the small chance of making a larger gain.

It is always gratifying to pick a stock that goes up 200% while the overall market is only up 8%. How many stock picks do this? It is easy to fool ourselves into thinking we know something other people don't when we do pick a big winner. But what is the net result of all the stock picks over a period of years. How many stock picks are down 10% with the market up the same 8%? If you diversify your portfolio, it will probably average out. If you diversity enough, and your stock picking is good, you will probably mirror the indexes. If your have a couple of stinkers in your portfolio then you will probably under-perform the indexes. If you add human emotion and refuse to get out of the stinkers until you break even on those, you might end up severely under-performing the indexes. We all have the same information to work with. It is the information we don't have that will blindside us. It is only our biases and our opinions on the information that we do have that will influence our trading decisions. And, of course, there is a lot of guessing, as long as we do it with the appearance of authority. Is stock picking with the limited amount of information that we have the best approach?

Since most professionals try to beat the indexes and fail, it seems less likely that individual investors can beat the indexes in the long run. So does one have to accept average returns in an index fund if stock picking proves not to provide the desired returns? Not necessarily. Another approach is to try to beat those returns with a combination of asset allocation and market timing. By not focusing on individual stocks, one is not as concerned with company specific issues such as earnings release dates and guidance disappointments, or with worrying about CEO option backdating, or bookkeeping irregularities, or many other assorted insider problems. Without having to baby-sit a portfolio of individual stocks one can better analyze and assess broader, more accessible issues such as which sectors are trending, which countries are in bull or bear markets, which styles are leading and which are lagging. Superior returns on the more active ETFs can also be enhanced by the use of option strategies which have liquidity and pricing advantages over many individual stocks.

If your stock picking performance over the long run has not kept pace with the main benchmark indexes, you might try picking a small number of active, liquid ETFs representing different sectors of the economy, different countries, different styles. Then concentrate your efforts on that small basket. Try to determine which are trending up and which are trending down. Trade accordingly. Rebalance on a regular basis. You might find you've created your own hedge fund without the high fees.

Article Source: http://EzineArticles.com/?expert=Doug_Tucker
http://EzineArticles.com/?ETFs---A-Superior-Trading-and-Investment-Vehicle&id=667548

Intermarket Analysis - Do Intermarket Relationships Help Make Trading Decisions?

2007-09-12T14:50:00.000-07:00

Article Source: http://EzineArticles.com/?expert=Doug_Tucker
http://EzineArticles.com/?Intermarket-Analysis---Do-Intermarket-Relationships-Help-Make-Trading-Decisions?&id=662428

It is generally accepted that there is a relationship, or a measurable correlation between certain markets. There have been many articles, books, trading systems, and approaches based on intermarket relationships. If you turn on the financial news you will usually hear an explanation such as: the stock market was down today because crude oil was up, or maybe the stock market was up today because crude oil was up. It can even get more complex. You might hear something such as the stock market was down today because crude oil, being up sharply today, caused the bond market to be down. With the bond market down and interest rates up, the stock market was under pressure and down it went. Etc. Etc.

I find it a good idea to question everything, especially commonly held beliefs that might not hold up under close inspection.

One can very quickly and easily test these tried and true intermarket relationships with easily available free data and a simple spreadsheet or charting program. The quickest function to use is the simple correlation study, where you plug in one variable, and then compare it to a second variable. The study tries to find a correlation between two data series. If it finds a positive correlation the value will go as high as + 1.0. That would be a perfect and positive correlation between the two series of prices. If it finds a perfect correlation, but inverse, or negative then it will have a value as low as - 1.0. Readings near the zero line would show no discernible correlation between the two samples.

It is rare to have a perfect correlation between any two market for a very long period of time, but most analysts would probably agree that any reading sustained over the +0.7 or under the –0.7 level (which would equate to approximately a 70% correlation) would be statistically significant. Also, if the correlation value went from a positive to a negative correlation frequently, the relationship would most likely be unstable, and probably useless for trading.

If a picture is worth a thousand words, I'll save some of mine by directing you to my blog where I have many examples. I've included a couple of similar markets that did show a high level of correlation just to show what a good, stable correlation would look like. The rest of the markets shown are of relationships that most people believe to have stood the test of time, but the charts show otherwise. The address is below:

http://tuckerreport.com/articles/intermarket-analysis/

The most widely accepted correlation for as long as I can remember is the inverse correlation between stock prices and interest rates. It is assumed and generally accepted that as interest rate go higher, that stock prices go lower, and conversely, as interest rates go down, then stock should go up. On the second point, the Japanese market was in a huge downtrend for a time, and lowering interest rates to near zero did little to help. Back to the first point, the interest rates recently have been increasing steadily and many stock markets around the world, including the Dow Jones Industrials, have recently made all time highs.

In addition, crude oil is supposed to be bearish for bonds and stocks, yet crude is near an all time high along with stocks. Gold is supposed to be inverse to the stock market. It has been briefly a few times in the last couple of decades. Over the last few years it has been in an even steeper uptrend than stocks. As this is being written, the stock market has had a huge sell off, and gold came right down with it. Looks like the inverse correlation has been divorced, or at least separated.

What does any of this tell us? Is the much-touted intermarket analysis a waste of time? In a word: yes.

Many trading systems were bought and sold based on inter-market relationships. Every one of them now is most likely worthless. The problem with those systems, and intermarket approaches in general, is they were designed on relatively small samples of data. If they used much larger samples of data, they most likely would not find the intermarket relationships, they thought existed, to be stable and robust. When an intermarket relationship becomes obvious to everyone, it’s on its way to becoming useless. What everyone knows isn't information that helps make successful trading decisions.

Even if you could find a long lasting, intermarket relationship, how would you use it? I assume the purpose of that analysis would be to find an edge by figuring out which market was leading the other. How can you tell which is leading, if indeed one does lead. You can try to guess at the fundamentals, but that would be a guess about the future. Why not just trade the market you are guessing about and not compound the situation by assuming the guess, if correct, will affect the other market in the way desired. You might be right in your guess, but wrong by assuming the relationship between markets will play out the way you anticipated.

There is even a long held belief that stock market averages influence most of the direction of individual stocks, some say by 70%. But obviously, there are many instances of stocks going down in up markets, and stocks going up in down markets.

My conclusion is that each market should be charted and analyzed individually. Intermarket relationships are fun for discussion, and for financial journalist, but I don't believe they can help in making trading decisions.

Covered Call Writing - Beware of the Pitfalls

2007-09-11T21:24:00.000-07:00