Thursday, April 30, 2009
by Chris Rowe.
Since early March, demand has been in control of the stock market, and this trend is set to continue for the intermediate term (i.e., weeks to months).
To stay ahead of the market curve, I've been reducing bullish exposure lately, as I have seen signs of weakness in the stock market. But, nonetheless, demand is still in control until further notice. So, if there are some stocks that you want to take a bullish position in, you might be asking yourself when the best time to buy would be.
You Don't Have to Wait for a Bull Market to Be a Buyer
First of all, what you want to do, if you are going to be bullish, is to buy the strongest stocks within the strongest sectors -- but you want to buy them on a pullback.
But, how do we know how much a stock is going to retreat before its next advance?
There are a number of ways to predict a stock's behavior, most having to do with past support levels.
A stock's support level is exactly what it sounds like -- a floor through which the stock has trouble breaking. The opposite term is resistance, which is a ceiling through which a stock has difficulty penetrating. When a stock is trading between these two levels, it is said to be in a trading channel.
I have a number of simple indicators that I use to decide what to trade and when, some of which come in the form of popular moving averages and trendlines.
But today I'm going to go over one of the most basic "technical analysis 101" principles that will lay down a foundation for understanding how far a stock is likely to retreat before the next bull run.
Don't forget, these are just the basics, but knowing them will help increase your accuracy, especially when you consider the following principle in conjunction with identification of past support and resistance levels.
The Secret is Not So Secret After All -- Just Trade the Trend!
Bottom line, you always want to trade in the direction of the trend. And a trend is obviously a series of zig-zags. These zig-zags move in the direction of the trend and then retrace before continuing in that same direction. (Like I said, it's technical analysis 101.)
While secondary parameters are set at 33% and 66% (as outlined in the chart above), the most-common percentage retracement before resumption is the (approximately) 50% retracement.
I know, this might sound absolutely crazy if this is your first time hearing it, but if you look at a bunch of stock or index charts after reading this article and apply these percentage retracement principles, you'll be absolutely amazed!
Two Steps Forward, One Step Back
The way that traders use this application, for example, would be to look for approximately a 5-point retracement after a stock advances by 10 points from a low to a new high (because 5 points is 50% of the 10-point gain).
So, when a stock trades 10 points higher from $15 to $25 and then reverses lower, traders would look for support around $20.
Again, this is certainly not a strict rule, and the secondary parameters wouldn't have been set near 33% and 66% if it were. In fact, other theories set retracement parameters around 62% and 38%, while maintaining the 50% point as the average retracement.
When it comes to retracements, 66% is a critical area. For instance, in the case of an uptrend, if a stock advances higher, and then retraces 66% of the recent move and starts to bounce higher again, it's considered to be a relatively low-risk buying opportunity.
But if the 66% retracement area is violated (if the stock retraces by more than 66%), a reversal of the prior uptrend is very likely.
This is also true in the case of a downtrend, so listen up if you are looking for a good place to enter bearish positions to take advantage of the next downtrend in the general stock market. (Learn How to Pick the Right Put Option.)
If a downtrending stock retraces about 66% of the recent decline and begins to resume its downtrend, that area is a good place to sell short the stock or buy put options. If the downtrending stock retraces more than 66% of the recent decline, then the downtrend is likely to reverse to an uptrend.
In 'Support' of Trading on Retracements
Let's take a look at how to find retracements, which can serve as fantastic buying opportunities.
• he stock moves from about $2.20 to about $3.50 (not counting intraday movements). This is a $1.30 advance, half of which is 65 cents. The stock retraced by about 60 cents. (This retracement also coincided with the gap higher, which tends to act as the new support level.)
• The stock then moves from about $2.90 to $3.25 (a 35-cent move). Fifty percent of that is 17.5 cents. The stock retraced by nearly that amount before moving higher.
• Then focus on the blue box. You can see that after a 50% pullback, the stock gapped even lower, and the trend reversed from an uptrend to a downtrend.
• Between August and September, the stock traded from about $2.60 to $3.20 (a 60-cent move), followed by a retracement of about 30 cents.
• Then, if you check out the blue line, the intermediate move was from $2.90 to about $4.20 (a $1.30 move), followed by a retracement of nearly 65 cents.
• If you look at many of the short-term retracements and resumptions within the intermediate move (blue line), you'll see similar action.
This chart happens to have lots of 50% retracements. But remember the secondary parameters, and try to match them with past established support or resistance levels to estimate retracements.
And remember, this is a very basic principle. I thought I would give you something today that was far from complex. The good news is that other, more "sophisticated" parameters that traders look for are just as easy to understand!
Good investing, Kingsley.
Tuesday, April 28, 2009
by Michael Shulman
Swine flu, first identified in Mexico, has spread to the United States, Canada and many other countries.
What makes pandemic flu like this more dangerous than regular flu is its virulence -- it kills (more than 100, according to press reports) -- and the inability of current vaccines to prevent the spread of the disease.
A few years ago, the bird flu scare put a few companies on traders' and analysts' radars, and these stocks have already exploded in value, beginning Friday and accelerating today.
Is it too late to get in on the swine flu stocks?
It all depends on the severity of the outbreak. If it passes quickly, these stocks will probably come down. If the flu spreads, they may go up. Sorry, I am no an epidemiologist.
But here are some of the most prominent swine flu stocks:
4 Swine Flu Stocks to Watch
As the news plays out, there are four companies you should take a look at: BioCryst Pharmaceuticals (BCRX), Novavax Inc. (NVAX), Crucell (CRXL) and Cerus (CERS).
Swine Flu Stock #1: BioCryst Pharmaceuticals
BioCryst Pharmaceuticals (BCRX) has a flu treatment for common and pandemic flu in development called Peramivir, which is much more potent than Roche's Tamiflu. Due to previous trial for an oral version of the product (the new version is injected), most of the scientific community believes it will pass through final trials.
There is a special provision that allows the federal government to stockpile a treatment after it has passed a 12-person safety trial, and Peramivir has done this. So even though the company is going forward with all trials to get a general approval, in a real emergency the government could legally buy and distribute this treatment.
More importantly, it is made in the USA, and it is the only flu treatment of note that is made here.
Swine Flu Stock #2: Novavax Inc.
Novavax Inc. (NVAX) has exploded on the recent swine flu news. This vaccine company's primary focus is the flu, and it can actually make a new flu vaccine in roughly thee months. And it has a manufacturing platform that is extensible to other manufacturers.
Novavax has a broad-based vaccine development program that is heavily, if not completely, dependent on government support. The company is cash-poor and burns cash at a furious pace. And it has committed heavily to a new development program in India with pharma company partner, Cadila Pharmaceuticals.
Swine Flu Stock #3: Crucell
Crucell (CRXL) is the 21st-century vaccine technology company, and its business model is to be the "Intel Inside" for many vaccine makers. Crucell owns a traditional vaccine business and is also developing new vaccines for many infectious diseases.
Its technology platform -- cell-line manufacturing -- is much more efficient than traditional egg-based vaccine production, and the company has partnered with many of the major players in the vaccine business.
Swine Flu Stock #4: Cerus
Cerus (CERS) is the oblique play on this scare. I wrote about Cerus recently, saying that it was one penny stock you have to own.
This company has the technology and products to clean blood, removing infectious pathogens and making blood banks indifferent to the health of donors' blood. Cerus' INTERCEPT Blood System has been shown to work on HN51 flu strains (avian flu) in laboratory work that has been published and subject to peer review.
The INTERCEPT Blood has approvals in 18 countries, and with the pressing need to make sure the blood supply is safe from pandemic flu, HIV and other pathogens, there is a huge market for its product line.
The biggest upside catalyst for CERS would be the creation of a shortened regulatory pathway by the FDA for approval in the United States.
How to Play Swine Flu
I see these four stocks as long-term plays, albeit risky ones, especially is the swine flu pandemic takes hold. But these stocks shot up today, with BioCryst and Novavax actually doubling.
And if the swine flu scare dies down in the next 24-48 hours, these four stocks will be excellent shorting candidates.
A Bonus Swine Flu Options Trade
Tamiflu is the recognized treatment for the flu and has been shown to work on the swine flu strain. Governments stocked up on this product a couple of years back, but then slowed down purchases. However, they may begin buying it again.
Tamiflu is made by Roche -- possibly the best Big Pharma company in the world -- but the play here is Gilead Sciences (GILD).
Gilead invented Tamiflu, and gets a roughly 20% royalty on sales -- 100% pure profit. Any uptick in government purchases for stockpiles or use puts a new floor under Gilead's already incredible profits, earnings and real cash flow.
Look at a call option with a longer-term expiration date if you are a longer-term player, but consider a short-term call option if this scare gets worse.
Good investing, Kingsley.
Thursday, April 23, 2009
Insider trading is an often misunderstood investing tool. It can be helpful for traders, but its value is usually overstated.
This is a good topic to tackle right now as we are seeing an uptick in the number of insiders buying in late 2008 and early 2009 compared with the last year. This could indicate that insiders are becoming a little more optimistic about the market's prospects in the near term.
Insiders are technically classified as anyone with material non-public information. Usually this means employees, officers, directors or shareholders who own more than 10% of the company's stock. Insiders can trade their own stock but have certain restrictions on how, when, and how much they can sell or buy. Part of those restrictions are reporting requirements.
Because insiders must report their trades to the SEC, ordinary investors can get access to that information and can see what insiders are doing.
It makes some sense to assume that if insiders are selling stock, then they are pessimistic about the company, or if they are buying, then they must be optimistic.
On average, stocks with high insider buying do show some correlation with a rise in price; however, selling does not appear to be reliably predictive.
Peter Lynch famously said, "Insiders might sell their shares for any number of reasons, but they buy them for only one: They think the price will rise."
This statement seems reasonable and may be a good explanation for why insider buying is more predictive than selling.
There have been many studies on the topic of returns and insider trading, and one notable example suggests that a diversified portfolio of stocks with high insider buying outperformed large stock indexes by as much as 9%. This justifies some time and attention paid to the subject.
In the following video, I will cover the definition of insider trading and show an example of the impact that this activity can have on a stock's price.
Two Ways to Make Insider Trading Work For Your Portfolio
As I mentioned above, insider trading information can be useful, but it can also be overstated or over-relied on. Used prudently, it may alert you to increased risk in stocks you already own and could even be used to find stocks and options to add to a watch list as a potential investment.
Insider trading information be used in two ways:
1. Monitoring insider sentiment in stocks you own.
If insiders are suddenly buying a stock you own, it may indicate that there is some very positive sentiment inside the company. That may change your risk control behavior by encouraging you to leave the position uncovered or to add to the position within your portfolio. Before making a decision based on insider trading, you should consider who is buying and how much they are acquiring.
For example, if an officer like the CFO is buying, that may be much more relevant than a director. Similarly, if an officer or director is buying very large quantities of stock, that may be something that deserves attention.
Yahoo (YHOO) experienced significant insider buying by Carl Icahn in his effort to increase his strategic influence on the company's management in late November 2008, and the stock rallied.
2. Using insider buying to find stocks for investment.
The filtering process to find stocks that you do not already own with high insider buying could be very daunting if it were not automated. Fortunately, there are both free and pay services that do an excellent job at filtering and reporting the data for you. In the video below I will cover three services that I recommend for this kind of research.
Insider buying should not be the only qualification you use to decide on a company to buy. It is merely an alert that something interesting might be happening. Doing fundamental analysis, and making sure a potential investment conforms to your portfolio diversification strategy is still critical.
Good investing, Kingsley.
Monday, April 20, 2009
From Learning Markets.
There are a lot of marketing materials out there explaining why the spot market is so much better and cheaper than the currency futures market, but how much of it is fact and how much is hype?
What are the real differences between these two closely related markets? Is it really cheaper to trade spot forex? Aren’t there also advantages to trading futures? This is an important topic because so many of the differences are related to trading costs, which is often a neglected subject among new and experienced traders.
Let’s begin by analyzing the major attributes of each market -- futures and spot. Doing so will help us determine if either market really has an advantage.
24-Hour Market -- Advantage: Neither
Some spot forex advertising makes it seem like the only place you can trade 24/7 is in the spot forex market. That is not actually true. Both currency futures and spot forex effectively trade 23-24 hours a day, five days per week. The market is essentially closed from Friday afternoon through Sunday afternoon if you are in North America.
Spread -- Advantage: Currency Futures
The spread in the currency futures market is not fixed. Depending on the liquidity of the market at the time, the spread can be one pip or less, and an effective limit order may cut the spread to nothing. In the spot forex market, you can have a variable spread like this, which may widen with market conditions or a fixed spread, which does not change but is usually wider (2-3 pips on the majors) on average than a variable spread.
It is important to note that some spot dealers offer spreads on some pairs that are below one pip, but that is not the case for all pairs they offer. On average, the spread in the futures market is narrower across the majors and major crosses than the spot market because the futures market has more liquidity and price competition than an individual dealer.
Commissions -- Advantage: Spot Forex
Spot forex dealers do not usually charge commissions. The spread is where they make their money, which is one reason it is a little wider on average than the currency futures market. However, let’s put this in perspective.
A quick survey of good futures brokers put the average commission costs at $3.15 per side. That means an entry and exit (round trip) would cost $6.30 per contract or 6/10ths of a pip. Once commissions are added to the spread cost above, the advantages between currency futures versus spot forex become much closer to neutral.
Flexibility -- Advantage: Spot Forex
Spot forex dealers are extremely flexible on lot sizes. This is great since a full 100,000 unit lot may be too large for many new traders. Some dealers will slice the lot sizes anywhere from 10,000 to 1,000 units. The currency futures market generally has two lot sizes.
A full-size contract is usually a little larger than the 100,000 unit lot in the spot market. A mini contract, which is only available on some pairs, is usually about one half the size of a full-size contract. Larger lot sizes can make money management in a small account extremely difficult and may be the only clear advantage spot forex has over the currency futures market.
Roll Over Interest vs. Carrying Charges -- Advantage: Currency Futures
Because one of the ways a forex dealer makes money is by trimming the interest payment or increasing the interest charge on a particular pair, this premium tends to be a little higher in the futures contract. However, the cost or benefit of this interest is integrated into the price of the futures contract itself, which makes it harder to see at first glance.
Here’s how it works. Imagine that you are 45 days away from the GBP/USD futures contract expiring. That contract’s current price is 1.9811 but the spot price is 1.9866. This difference (also known as the cost of carry) is created by the value of the interest that will accrue between now and expiration. By the time this contract expires, in 45 days, the futures price will equal the current spot price exactly. That means that if prices were held steady you would make the equivalent of 55 pips as the futures price came up to meet the spot price. By contrast, the highest rollover rate we could find from a forex dealer on the GBP/USD would pay the equivalent of 38 pips in interest premium during the same 45 day period. Similarly, the charges for being on the non-interest paying side of the transaction is less in the futures market than with a spot forex dealer.
Transparency -- Advantage: Currency Futures
Currency futures are exchange traded, which means that you can see order flow, volume, open interest and outstanding orders. Forex dealers do not share that information, and because the market is so distributed, information available from any one dealer is probably not comprehensive enough to give a clear picture of what is happening in the market as a whole. $83 billion worth of currency futures trade on the CME exchange every day alone. The largest retail forex dealer in the market trades $11 billion a day in total notional value.
Which is Right for You?
The fact that forex dealers will split up a lot into very small slices makes the spot forex market the hands-down winner for small traders.
Larger retail traders should seriously consider the futures market as an alternative to the spot forex market. Trading costs are nearly identical, the exchange is more transparent, the product breadth is equivalent and interest is better.
Every trader should realize that trading cost differences are not just limited to whether or not you are paying commissions. Trading costs include average spread, commissions and interest premiums or charges. When looked at together, these two markets look a lot more similar than you may have thought.
Good investing, Kingsley.
By Ken Trester.
Commodity futures contracts allow you to directly purchase a wide variety of commodities. Commodities include corn, wheat, soybeans, gold, silver, crude oil, cocoa and coffee, but there are many others. But why are these contracts called futures?
They're called futures because when you buy and sell these commodities, they are not to be delivered until a specified future date. When you buy or sell a futures contract, all you have to do is put down a good faith deposit, similar to the way you would when you open escrow on the purchase of a new home.
Is a Futures Contract an Option?
An option contract is the right (not the obligation) to buy something at a future date, but a futures contract is an obligation to purchase or sell something at a future date. Therefore, a futures contract is not an option.
For example, when you buy a corn futures contract, you have bought that commodity (i.e., an entire 5,000 bushels of corn). However, you don't have to pay for it until the date of delivery. The only thing you have to pay for upfront is the good faith deposit.
In more formal terms, a commodity futures contract is simply a contract between a buyer and seller -- one agreeing to purchase a specified quantity of a commodity on a future date, the other agreeing to deliver at a price worked out today.
Where Will I Put All Those Pork Bellies?
Of course, few commodity traders want a truckload of soybeans or pork bellies dumped on their front lawn, nor do they plan to dump them on someone else's lawn. What usually happens is that most futures positions are closed out before the deliver date.
Because they seldom make or take delivery, commodity futures traders are only required to deposit a portion of the contract's value. This is called the "initial margin," and it's the equivalent of that good faith deposit mentioned earlier.
The minimum initial margin for each futures contract is set by the commodity exchanges, but brokerage firms usually require traders to deposit more than just the minimum required by the exchange. Typically, margin is between 2% and 10% of the contract value. Volatile futures contracts require larger deposits than less-volatile ones, and either the exchange or your broker can change the margin requirements at any time.
Futures and Margin
When the price of a contract changes, you may find yourself with too much or too little margin deposit. If the price rises, traders with short positions must increase their deposits. If the price falls, traders with long positions must add to their accounts. In both cases, traders will receive a "margin call" from their broker ordering them to deposit enough money to bring their account balance back to a "maintenance" level. If they do not respond immediately, a broker will liquidate their position.
When you buy options on a futures contract, there are no margin requirements. Like stock or index options, you can't lose more than your initial investment. However, if you write options on futures or if you implement any kind of spread strategies, you may be subject to margin restrictions.
Spot vs. Futures Prices
If you wanted to go out today and buy 5,000 ounces of silver, you would purchase it in what's called the spot market. But with a futures contract, you won't pay for the silver for months, or even years. You do, however, profit or lose just as if you owned 5,000 ounces of silver.
Because owners of silver, who would be the sellers of futures contracts, must pay for insurance, interest and storage (all referred to as "carrying costs"), the prices of futures contracts is usually higher than the spot price. The difference between these two prices is called the "basis." The basis for more distant futures contracts is usually wider than for near-term ones.
What's Up With That?
Newcomers to the commodities markets usually don't know what to make of the price discrepancies between identical futures contracts calling for delivery in different months. The reason is that the more distant futures contracts have higher prices than those calling for delivery this month or next.
It costs more to store copper, silver, cattle, orange juice, pork bellies or virtually any commodity. Costs include storage, insurance, interest, and in some cases, feed (as in the case of cattle futures). Here again we see the carrying charges, and these charges have a direct influence on futures prices.
How This Works
Here's an example to illustrate my point. Let's say you're a hog farmer who wants to sell some inventory soon. You can sell a futures contract calling for delivery in April or June. Unless the price of the June contract exceeds the price of April by an amount equal to the carrying charges, to compensate for feeding costs, etc., you would sell an April contract.
Long-term contracts usually sell for more than near-term futures, and the difference almost never exceeds the carrying charges. For example, if carrying charges are 2 cents per month, June hogs would sell for 4 cents more than April. But the price of the June contract cannot exceed the April price by more than 4 cents.
More about trading: 12 Keys to Trading Earnings
Let's say the difference widened to 5 cents. What would happen?
A knowledgeable hog farmer would buy some hogs today and immediately sell a June futures contract for 5 cents more than his purchase price. Since it will only cost him 4 cents to bivouac and feed his hogs for two months (the carrying charges), he has guaranteed himself a 1-cent profit.
In an efficient market, large commercial hog farmers do the same thing, driving the price difference down if it widens to more than the carrying charges.
Commodity Option Prices
Commodity options control futures contracts; and futures contracts, in turn, control physical commodities. With options, however, your risk is much less than with futures, which is why many people prefer them. But how much do you make if a futures contract rises above a call option's strike price?
Commodity options are different than stock options. With stock options each contract controls 100 shares of stock. Of all commodity futures options, only the 100-ounce gold contract is the same as stock options. Many commodity futures contracts, including those on cattle, hogs, copper and coffee, are priced in cents per pound. The value of a 1-cent move in a given contract differs from commodity to commodity, because each contract is for a different size or quantity of the underlying commodity.
For example, a coffee contract covers 37,500 pounds, making a one-cent move worth $375, while a copper contract covers 25,000 pounds, so a penny move is worth $250. Wheat, corn, oats and soybeans are priced in cents per bushel, usually with a 5,000-bushel contract, so each 1-cent move equals $50.
Time to Start Your Journey
As you can see, there's a lot to learn when dealing with options on commodity futures. Once you learn the terms of contracts and what factors drive specific markets, you'll discover why many people find trading options on commodity futures an excellent way to make big profits.
Good investing, kingsley.
Friday, April 17, 2009
By Chris Johnson and Jon Lewis.
There are few constants in the market and even fewer things you can rely on. Everyone searches for those constants, those reliable indicators that provide an edge. But they're hard, if not nearly impossible, to find.
There is, however, one constant that you can count on. It happens throughout the year, although it's more concentrated during four quarterly "seasons." We're talking, of course, about earnings, the mandatory quarterly reports required of all publicly traded companies.
#1 The Earnings Season Trade
We say earnings "season" because that's the convention (although as you'll find out, we tend to avoid "convention"). "Official" earnings season typically kicks off with Alcoa (AA) during the first or second week of January, April, July and October.
For the ensuing month, the majority of S&P 500, Dow Jones Industrial, and Nasdaq 100 companies will report their earnings for the previous quarter. In fact, two-thirds of the S&P (330 companies) usually report within four weeks of Alcoa's announcement. Many will also provide outlooks for the following quarter and possibly the full year as well.
Actually, earnings reports hit the tape throughout the year. Sure, there are dead spots during a quarter, but they don't last long. For instance, many major financial companies report in mid-quarter, while results from retailers are spread throughout the quarter.
The bottom line is that earnings provide trading opportunities all year round, with certain periods being heavier than others.
So what's the big deal?
Earnings create expectations. They create volatility. They create trading volume. And they do it like clockwork -- four times every year -- for every stock on the market.
That's a lot of opportunities.
#2 How Does This Increased Activity Translate Into Real Dollar Gains?
Just consider these moves in some of today's most heavily traded stocks:
In July 2006, Yahoo! (YHOO) fell 21.8% after earnings were released.
During the same earnings period, shares of Apple (AAPL) shot up 11.8% in a day.
In April 2008, Google (GOOG) gained 20% the day after earnings.
Cisco (CSCO) dropped more than 9% the day after reporting first-quarter earnings in November 2007.
Amazon (AMZN) popped 24% after second-quarter earnings in 2007.
In 2008, Research In Motion (RIMM) gained an average of 12.6% on the day after each quarterly report.
Keep in mind that these gains were possible only if you had been on the right side of the move and were holding shares. At the same time, those holding the right options on these stocks could have made a fortune. (We'll talk more about options a bit later.)
If there's one thing investors want to see in their investments, it's movement. And there is no better time to see movement in share prices than during earnings season.
#3 Finding the Movers ... "Expectations"
So, how do you know which stocks are going to move?
The answer lies in expectations. It's not whether a company beats earnings estimates; it's whether they beat the market's expectations. This is a time when the reaction to news is more important than the news itself.
In fact, in 2008, Microsoft (MSFT) beat the Street's consensus earnings estimate by four cents and three cents. But two weeks after each report, the shares had dropped 15% and 8%. On the other hand, Qualcomm (QCOM) missed by a penny in January, and the stock spiked more than 10% higher in just one day.
#4 Why Does That Happen To Earnings?
Let's say the market is expecting a blowout earnings report from a particular company and many investors have purchased call options in anticipation of great earnings.
At that point, it becomes very hard for the company to impress the market and for the stock to climb. Even if the company meets or beats estimates, most of the buyers are already on board. So there's no one left to push up the price.
Investors who bid up the price of a stock or buy call options ahead of earnings don't take too kindly when a company merely meets estimates. They want more.
Once the report is made public, if the stock fails to move very much, those who anticipated a big gain begin selling. As other shareholders see the price falling, they too begin to sell.
That's why knowing the true expectations of investors (as gauged by what people are actually doing with their money) is so important around earnings season.
#5 The Key to Earnings Analysis
There are all sorts of ways to analyze the market. Everyone knows about fundamental analysis -- earnings, interest rates, P/E ratios, innovative products, etc. And most are aware of technical analysis -- charts, moving averages, trends, momentum, etc.
These are fine tools, but almost everyone is aware of them. So does that really provide an edge? After all, isn't an edge an advantage? How can you have an advantage doing what everyone else is doing?
Ultimately it comes down to the people doing the buying and selling. And it's their desires or sentiment that dictates their behavior that determines whether to buy or sell.
That's where we gain our edge. By analyzing sentiment, we can derive a predictive model of the resulting behavior that will be displayed toward a stock. Fundamentals and technicals (the tools used by most to define their "edge") are inputs to the model, but they're not sufficient. We add sentiment, measured both qualitatively and quantitatively, to give a behavioral picture of how a stock should move. In other words, we use this model to value a stock based upon its behavioral characteristics.
#6 Investor Sentiment
So what is sentiment and why is it so important? Investor sentiment is simply the collective feelings and actions of those in the market. We've found that the most-accurate sentiment indicators generally reflect what investors are actually doing (what they're buying or selling) rather than what they're feeling and saying (poll results), although both have validity in our analysis.
We've all seen a stock drop in price despite an earnings report that met or even beat expectations. Or one that rallies furiously after merely meeting expectations. Why does the stock seemingly move against the fundamentals?
Two kinds of investor sentiment usually lead to stocks moving against the fundamentals:
Excessively Bullish Sentiment: A stock with relatively low expectations (pessimism) stands a good chance of rallying, as there is plenty of sideline cash available to boost the price.
Excessively Bearish Sentiment: High expectations (the crowded trade) can put downward pressure on a stock, as there is little to no sideline cash to drive the price higher. In fact, the path of least resistance for cash is to flow out of the stock, resulting in declining prices.
#7 Look for the Contrary Indicator
Sentiment can be a contrary indicator. And the power of sentiment is much greater when it runs counter to the direction of the stock (pessimism during an uptrend, optimism during a downtrend).
The key to finding the most-optimal earnings plays is to find situations in which expectations are either high or low, and are running counter to the technicals. This is especially important during earnings season, because sentiment tends to be polarized prior to an announcement.
High expectations (low put/call ratio, low short interest, and high percentage of analyst "buy" recommendations) usually require a company to blow out earnings in order for the stock to rally. Such stocks are vulnerable to disappointments if the company simply meets estimates or issues a tepid outlook for next quarter.
Low expectations (high put/call ratio, high short interest, and a low "buy" rating percentage) mean that a stock will not have to work as hard to overcome sentiment. Such stocks are less crowded, and thus have a greater potential to rally.
Thus, capturing the sentiment backdrop prior to earnings, along with assessing the technicals and the company's past earnings history, are the keys underlying your success.
Let's examine some of these indicators and how you can use them to improve your earnings trading results.
#8 Put/Call Ratios
We've found that using option data is an excellent way to measure sentiment. We have found that option volume and open interest (the number of open contracts on an option at the end of each day) data in the form of a put/call ratio is one of the better ways to quantify investor sentiment. This straightforward indicator tells whether a stock is poised for a rally based upon large amounts of potential buying strength (as a result of the crowd leaning too far to the bearish side of the market), or poised to stall out due to a lack of cash available to push it higher (a result of leaning too far to the bullish side).
High put/call ratios often indicate excessive pessimism that translates into large amounts of money on the "sidelines."
Low put/call ratios indicate a point at which there is so much optimism that very little money is left to push the market higher (i.e., a crowded trade).
By comparing the current put/call ratio to previous readings for that stock, we can accurately gauge relative levels of investor optimism and pessimism. This is extremely important because we have found that the absolute ratio readings can vary substantially from stock to stock.
Thus, comparing an equity's ratio to previous ratios sets up an "apples to apples" comparison that provides a truer picture of relative sentiment for that particular stock Higher relative ratios indicate more pessimism (which can have bullish implications), while lower ratios suggest optimism (potential bearish implications).
#9 Short Interest
Monitoring short interest is an effective method for deriving valuable sentiment data for stocks. Short interest is created when an investor sells borrowed stock. The strategy is profitable when the price of the shorted stock declines, allowing the short seller to buy the stock back at a lower price.
As short interest is a bearish strategy, monitoring semi-monthly short-interest figures provides a glimpse of the level of pessimism toward a security. In most instances, large amounts of short interest indicate a negative general outlook.
Besides serving as a contrary indicator, short interest has a mechanical component that an investor can exploit. If a stock's price is rising, short positions are losing money (in fact, short players have unlimited risk). This often causes the shorts to close their positions by buying back their shares. This added buying pressure forces the stock price even higher (known as a "short squeeze"), which in many cases makes the uptrend persist longer than most would anticipate.
We especially like heavy short interest on a stock displaying strong price action with pullbacks contained at key support levels. This is where you will potentially see quick, significant moves caused by short-squeeze buying among the shorts looking to limit their losses.
#10 Analyst Ratings
A sentiment measure that is more easily tracked is the composite analyst rating, which is available from many major financial Web sites. These ratings simply track the total number of analysts who designate a particular stock as a "buy," "hold" or "sell." Though the vast majority of ratings fall on the "buy" side (something the industry is roundly criticized for), we'll often see a smattering of "sells" that typically reflect a fairly strong degree of negative sentiment toward a stock.
On the other hand, a heavy weighting of "buys" means that optimism is at a peak and that there is much more room for downgrades than upgrades. In other words, the ratings are as optimistic as they are likely to ever be. This can be a warning sign, especially for a stock showing technical weakness.
#11 Putting It All Together
At this point, it should be clear that sentiment is a crucial ingredient to analyzing a stock. So how do you combine sentiment, technicals and fundamentals within our behavioral analysis framework to pick a winning earnings play?
For bullish trades, look for stocks in uptrends with strong fundamentals (e.g., strong earnings growth or new product innovations) that are the target of negative sentiment.
Of course, you have to understand that the indicators will rarely all line up the same way and that stocks behave differently given a particular sentiment environment. It's the job of the "behavioral analyst" (you) to distinguish the relative level of sentiment based on the tools above and then compare the strength of the contrary indicator to the stock's technical strength and fundamental health.
Keep in mind that behavioral valuation works on the bearish side as well. Weak technicals (running into a declining 50-day moving average) and fundamentals peppered with optimistic sentiment is a bearish combination. It's only when pessimism reaches an extreme and most everyone has thrown in the towel that a tradable bottom can be formed.
Knowing what investors are doing with their money and what their expectations are ahead of earnings allows us to form an assessment of the downside risk vs. upside risk. And it allows us to make highly accurate bullish or bearish recommendations for stocks ahead of their earnings reports.
#12 Leveraging the Earnings Advantage
While buying or shorting stocks based on earnings should provide handsome returns, the real money is made by buying call options on stocks that are due for a sharp move to the upside ... and buying puts on those that are likely to disappoint. The leverage provided by short-term options (we usually recommend options due to expire within a month for earnings plays) can be dramatic if the stock moves sharply in the expected direction.
But why should you consider options? Actually, there are several reasons to trade them for any portfolio.
The Case for Trading Options in Your Portfolio
1. Limited dollar risk: It costs far less to lease the movement of a stock (either up or down) using options than an outright purchase or short of a stock. And the amount you pay for an option is the most you can lose on a trade. Thus, your potential maximum dollar loss is limited.
2. Leverage: This is probably the most-attractive and well-known benefit of options. For those who are pleased to capture a quick 10%, move in a stock, they often could have made 50%, 100%, or more by buying an option on that stock.
3. Accessibility: Option profits are available in virtually any type of market. Strategies of buying and selling options alone or in combination can produce sizable profits in up or down markets, trading ranges, volatile or non-volatile markets, etc. You name the market environment, and we're willing to bet that there's an option strategy that can profit from it.
Good investing, kingsley.
by Kathy Lien,
Whenever you devote money to trading, it is important to take it seriously. For traders who are getting into the forex (FX) market for the first time, it basically means starting from square one. But new traders don't have to be left in the dark when it comes to learning to trade currencies; unlike with some of the other markets, there is a variety of free learning tools and resources available to light the way. You can become FX-savvy with the help of virtual demo accounts, mentoring services, online courses, print and online resources, signal services and charts. With so much to choose from, the question you're most likely to ask is, "Where do I start?" Here we cover the preliminary steps you need to take to find your footing in the FX market.
Finding a Broker
The first step is to pick a market maker with which to trade. Some are larger than others, some have tighter spreads and others offer additional bells and whistles. Each market maker has its own advantages and disadvantages, but here are some of the key questions to ask when doing your due diligence:
Where is the FX market maker incorporated? Is it in a country such as the U.S. or the U.K., or is it offshore?
Is the FX market maker regulated? If so, in how many countries?
How large is the market maker? How much excess capital does it have? How many employees?
Does the market maker have 24-hour telephone support?
In order to ensure that the money you are sending will be safe and that you have a jurisdiction to appeal to in the event of a bankruptcy, you want to find a large market maker that is regulated in at least one or two major countries. Furthermore, the larger the market maker, the more resources it can put toward making sure that its trading platforms and servers remain stable and do not crash when the market becomes very active. Third, you want a market maker with a larger number of employees so that you can place a trade over the phone without having to worry about getting a busy signal. Bottom line, you want to find someone legitimate to trade with and avoid a bucket shop. (For related reading, see Understanding Dishonest Broker Tactics.)
Checking Their Stats
In the U.S., all registered futures commission merchants (FCMs) are required to meet strict financial standards, including capital adequacy requirements, and are required to submit monthly financial reports to regulators. You can visit the website of the Commodity Futures Trading Commission (an independent agency of the U.S. government) to access the latest financial statements of all registered FCMs in the U.S.
Another advantage of dealing with a registered FCM is greater transparency of business practices. The National Futures Association keeps records of all formal proceedings against FCMs, and traders can find out if the firm has had any serious problems with clients or regulators by checking the NFA's Background Affiliation Status Information Center (BASIC) online.
Once you've found a broker, the next step is to test drive its software by opening a demo account. The availability of demo or virtual trading accounts is something unique to this market and one that you'll want to exploit to your advantage. Your goal is to learn how to use the trading platform and, while you're doing that, to find the trading platform that suits you best. Most demo accounts have exactly the same functionalities as live accounts, with real-time market prices. The only difference, of course, is that you are not trading with real money.
Demo trading allows you not only to make sure that you fully understand how to use the trading platform, but also to practice some trading strategies and to make money in the paper account before you move on to a live account funded with real money. In other words, it gives you a chance to get a feel for the FX market. (To learn more, see Demo Before You Dive In.)
Do Your Research
When you trade, you never want to trade impulsively. You need to be able to justify your trades, and the way to find justification is by doing your research. There are many books, newspapers and other publications with information about trading the FX market. When choosing a source to consult, make sure it covers:
The basics of the FX market
Key fundamental news and events
Because the FX market is primarily a technically driven market, the best book that you can read as a new trader is one on technical analysis. The better you get at technical analysis, the better you can trade the FX market from a speculative perspective. (For further reading, see our Introduction To Technical Analysis.)
When it comes to newspapers, seasoned foreign exchange traders typically refer to the Financial Times and the Wall Street Journal simply because they contain international news. Trading FX involves looking beyond mere economics, since politics and geopolitical risks can also affect a currency's trading behavior. Therefore, it's also important to keep up with major non-financial news sources such as the International Herald Tribune and the BBC (online, on TV or on the radio) for the big stories of the day.
One of the most popular magazines among FX traders is the Economist, because it covers many macro themes; however, currency-specific and trading magazines are also popular.
Once you have a solid foundation in FX trading, you need to keep up to date on daily fundamental and technical developments in the FX market. A variety of free FX-specific research websites, which can be found easily on the internet, will do the trick.
Education and Mentoring Programs - Are They Worth It?
The benefit of online or live courses over books, newspapers and magazines is that you can get answers to the questions that perplex you. Hearing or seeing other people's questions is also extremely valuable, since no one person can think of every possible question. In a classroom setting, either online or live, you can learn from the experiences and frustrations of others. As for a mentor, he or she can draw on personal experience and hopefully teach you to avoid the mistakes he or she has made in the past, saving you both time and money.
What About Trading Systems and Signals?
Many traders wonder whether it is worthwhile to buy into a system or a signal package. Systems and signals fall into three general categories depending on their methodology: trend, range or fundamental. Fundamental systems are very rare in the FX market; they are mostly used by large hedge funds or banks because they are very long term in nature and do not give many trading signals. The systems that are available to individual traders are typically trend systems or range systems - rarely will you get one system that is able to exploit both markets, because if you do, then you have pretty much found the holy grail of trading.
Even the largest hedge funds in the world are still looking for the switch that can identify whether they are in a trend or a range-bound market. Most large hedge funds tend to be trend following, which is why hedge funds as a group did so poorly in 2004, when the market was trapped in a tight trading range. Range-bound systems will only perform well in range-bound markets, while trend systems will make money in trending markets and lose money in range-bound markets. So, when you buy into a system or a signal provider, you should try to find out whether the signals are mostly range-bound signals or trend signals. This way you can know when to take the signals and when to avoid them. (To learn more, see Identifying Trending & Range-Bound Currencies.)
Trading Setups - Finding What Works Best for You
Every trader is different, but the best trading style is probably a combination of both technical and fundamental analysis. Fundamentals can easily throw off technicals, while technicals can explain movements that fundamentals cannot. Smart traders will always be aware of the broader fundamental picture while using their technicals to pinpoint good entry and exit levels; combining both will keep you out of as many bad trades as possible, and it works for both day traders and swing traders. Most free charting packages have everything that a new trader needs, and many trading platforms offer real-time news feeds to keep you up to date on economic news. (For further reading, see Devising A Medium-Term Forex Trading Strategy.)
Learning to trade in the FX market can seem like a daunting task when you're just starting out, but thanks to the many practical and educational resources available to the individual trader, it is not impossible. Learning as much as possible before you put actual money at risk should be at the forefront of your agenda. Print and online publications, trading magazines, personal mentors, online demo accounts and more can all act as invaluable guides on your journey into currency trading.
Good investing, Kingsley.
Thursday, April 16, 2009
By Dan Ferris, editor, Extreme Value
Not one investor in a hundred realizes this, but now is a once-in-a-lifetime opportunity for income investors.
Most people will never recognize this opportunity because they don't know what a truly great income investment is. Most income seekers like to buy things like commercial real estate stocks (REITs) to collect rents.
REITs have a big problem: They're required by law to pay out 90% of their distributable earnings. So if they want to grow, they have no choice but to take on debt or dilute your interest by selling more shares. That's why so many REIT dividends have been cut over the past two years. Banks are in horrible shape and getting worse all the time, so it's only going to get worse for businesses like REITs that depend on a lot of debt financing.
Take another traditional income investment: risky commodity stocks with high current yields. Investors love royalty trusts because most of them are in the energy business. These stocks paid double-digit dividends when oil was over $100 a barrel. It was great earning those big yields... until the sector fell more than 70%.
I'm not interested in those traditional income investments because right now we can buy mature, World Dominator businesses that have large competitive advantages at huge discounts. These are – and always will be – the Holy Grail of income investing.
A "World Dominator" is a company with an absolutely dominant position in its industry... like Procter & Gamble, ExxonMobil, or Wal-Mart. World Dominators can raise prices to keep ahead of inflation, get financing (or not need it) when other companies are finance-starved (like right now), and are large and well-managed enough that you can count on fewer (if any) bad surprises happening to them.
You should be looking for companies like these if you're interested in collecting large amounts of investment income for decades. Here's why...
Most World Dominators are past their capital-intensive, high-growth cycle... so they can funnel surplus cash to shareholders in the form of dividends and share buybacks. Instead of funding growth, cash goes to you.
World Dominators are also usually the lowest-cost provider of their product or service. They tend to crush the competition and have exceptional brand names. That means they often generate enormous amounts of cash. And that cash can support dividends through good times and bad.
Here's where most investors don't "get it." World Dominators aren't yielding in the eye-popping double digits. They yield 3%-5%. But that yield grows like an oak in your
portfolio. ExxonMobil, for example, has raised its dividend every year for 26 years. Procter & Gamble has increased its dividend every year for 53 years.
Now is a great time to buy these stocks. Without times of great financial turmoil, it's hard to make a lot of money in stocks. We need bad times to buy stocks cheaply enough to make us rich over the long term. As I'm sure you're aware, we're in "bad times" right now. The Dow Industrials just turned in the third worst year in its history... and the worst ever since the Great Depression. This has set off a fire sale in these companies. Most World Dominators go for less than 10 times annual cash flow.
If you have, say, seven or more years until you're going to need an alternative income source, you should load up on World Dominators now and reinvest the growing dividends until you need to live off them. By the time you actually need the income, the yield over your cost will be much higher, and you won't make the mistake of chasing high current yields on REITs or energy trusts.
Think about it: Which is more certain, Procter & Gamble's 53 consecutive years of dividend growth or the price of oil? It's an easy choice.
Good investing, Kingsley.
Friday, April 10, 2009
By Jon Herring
“Put out the fire first and then think about the fire code.”
That was Ben Bernanke speaking at the London School of Economics a few weeks ago. He was talking about his efforts to re-inflate the bubble economy with every tool at his disposal, including helicopters filled with cash.
What it sounds like is that he lacks an exit plan. And even if he does, there is little doubt that the unprecedented (at least in terms of the world’s reserve currency) monetary inflation we are seeing, will eventually lead to consumer price inflation. The only question is timing. So with inflation hedges still cheap, now is the time to prepare.
You should certainly have some allocation to precious metals and energy. If you have the portfolio size to justify it, your precious metals holdings should be divided among a graduating risk strata, with the foundation of your holdings in physical metals stored in a safe place (not a bank deposit box), then mining stock ETFs or mutual funds, followed by individual major mining stocks, and finally some of the smaller mining stocks and junior companies to round out your allocation.
Years ago, I would have suggested a 10% allocation to precious metals. Today, considering the incendiary efforts of the world’s central banks to “put out the fire”, I believe up to a 30% allocation is prudent and reasonable – as long as you have a time horizon of at least a few years and can withstand some volatility.
But historically speaking, the best long-term inflation-fighting assets are rock-solid companies with a long history of paying and raising their dividends. And with the S&P dividend yield near 20-year highs, now is the time to begin accumulating these stocks.
Note that I suggest accumulating. I do not believe we have seen a bottom for the stock market. But picking bottoms is a fool’s game. Your long-term investment analysis should focus on companies, not the market. And when you see world-class companies with a dominant competitive advantage, selling for low valuations, you buy them – especially those with a long history of raising their dividend payments.
Here is why that is so important.
Let’s assume you buy a stock for $50 that pays $2.50 in dividends annually. That equates to a 5% dividend yield. We’ll assume you own 100 shares. So your original investment is $5,000 and your first year, you receive $250 in dividend payments. Now, let’s assume the company raises the dividend by 10% each year. In this case, the dividend on these shares would be $3.66 after five years (representing a 7.3% yield on your original investment)… and $5.89 after 10 years (representing a 12% yield on your original investment). That would equate to the annual long-term return of the stock market itself. By year 15 your dividend payments would equal $9.49 annually, per share. That means you would be making $949 per year on your original $5,000 investment… a yield of 19%.
When you are holding the stock, you aren’t interested in the “current yield” based on the stock’s price at the time. Your yield is based on when you invested in the stock.
If you were to re-invest those dividends over the years, the compounded return would be significantly higher. And compounding is the key to wealth. That’s why you should always seek investments that generate a positive cash flow. Dividend growth and compounding are how Warren Buffett currently receives dividends from Coca-Cola that equate to a 30% annual yield on his original investment.
That’s good work, if you can get it. And you can…
Every quarter, Mergent publishes a list called the “Dividend Achievers.” These are companies that have raised their dividends for at least 10 years in a row. You can buy the list through Amazon. You might also consider the “Dividend Aristocrats” these are companies that have increased their dividends for 25 consecutive years.
Choose the companies with the highest 10-year dividend growth, then reinvest the dividends and hold these stocks for as long as possible. The miracle of compounding will make you wealthy… and the growing yield will protect your portfolio from the coming inflation.
You might also consider Master Limited Partnerships (MLPs). These are companies with a special tax status that hold energy transportation assets – usually pipelines. Right now, as a group, these companies are paying a safe 10% yield.
MLPs also have inflation adjustments built in to the rates they charge to transport the fuel – so your dividends will go up as inflation rises. These companies are also inherently extremely safe. After all, you’re investing in a pipe that is buried underground. Once the asset is built, you just sit back and collect your dividends for years to come.
Inflation is coming. Buy gold and silver to protect your wealth. But don’t forget to load up on select dividend-payers too.
To your success, kingsley.
Thursday, April 9, 2009
John Lansing, April 10, 2009
Let's face it, no one ever went broke taking a profit, and in a fast-moving, volatile market like this, you can make HUGE profits in a short amount of time ... even (and especially) when it's going down! And by keeping your "core" positions in place, you won't miss out on the bigger moves that you expect.
Think of all the bear market rallies you can play via calls, and think of all the puts you can buy when the rallies fade and stocks/indices tank back to new lows. But remember, when you approach a volatile market without bias, you will win much more often than you lose.
Good Money-Management Strategies
I recommend using solid money-management strategies with your active trading portfolio in a difficult and volatile market. When it comes to trading options, that means buying contracts on dips and closing out positions on rips.
Speaking of getting good prices, when you get in cheap, it only makes sense to close out your position on a nice pop in the options. (For more on when to close out a trade, see Closing Out Option Trades for Triple-Digit Profits.)
We Learn Valuable Lessons From Losing Trades
Where a lot of once-successful traders go wrong is that they start to believe their own hype. That is, they get on a roll and bank a handful of winning trades, but not only do they not stop and take a look at what they did right, but they also neglect to look back at the trades that didn't turn out so well.
Whether it's a bull or a bear market, the more trades you make, the more losers you're going to encounter. It's a fact. But that's why we stay in this game, to go after that growing number of winners that are going to put us within closer reach of our financial goals.
Bottom line, we learn more from our mistakes because we tend to make less of them when we sit back and review what went wrong, versus just focusing on everything that went right.
One That Got Away
Profiting from bearish trades in a bear market sounds simpler than it is. Unfortunately, sometimes options don't work even when the stock does what it's supposed to do.
For example, here is a recent trade I made. Goodrich Petroleum (GDP) made it all the way to target price and then dropped 50% in a matter of 10 trading days. Those puts should have jumped in value, but they didn't.
What Went Wrong?
My analysis of stock and the direction it would take were 100% correct, but the option I picked to take advantage of the stock's move was 100% incorrect because not enough time was allowed.
In options trading, you can get everything right, but if the strike and month are off just a tad, it's 100% wrong. That is where speed comes in.
All the Right Ingredients
Think of options trading in a volatile market like a good soup or a stew, and these are the ingredients you will need to be right more often than you're wrong:
1. One cup of direction
2. One cup of distance
3. One cup of speed (or the duration of time it will take to hit target)
Put all those ingredients into a trading portfolio and — shazzam! — you have a healthy meal for a lifetime!
But what else do you need to actually pull all this off?
The Right Ingredients are Only Half the Battle
Now that you know the recipe for a successful options trade, what else do you need to pull all this off?
Just like with any good recipe, the quality of ingredients doesn't matter if you don't know how to cook with them!
So, whether you're trying to whip up some short-term gains or you're letting longer-term profits simmer, I'll tell you what you need to do to craft a portfolio you can not only digest, but also enjoy.
Keeping Your Powder Dry
You must be capitalized. Yes, you actually need money to make money.
That means keeping some powder dry and being on the lookout for the freshest investment opportunities, so when the price pulls back, you can add to your position.
Don't get into trading, at least not in this kind of market, unless you have the money to build on your good trades.
For more on trading in a volatile market check out 10 Tip to Mangage Risk in a Volatile Market
You Need to Exercise Discipline
This is something that most people only want to talk about when things go wrong.
For example, overleveraged and undercapitalized options traders may score big because they backed up the truck on one or two plays and they both worked. They aren't actually practicing sound judgment; they simply got lucky — and luck runs out.
Scale In and Scale Out
Money management is a form of discipline, and I have found that just following "buy up to" a certain price does not always help less-experienced traders. In this crazy, unpredictable market we've been in for the last year, you have to continue to review your open positions every day to be ready to add or lighten up as volatility builds.
But, no matter how good the advice is from a guru you might follow or the trading technology you have at your disposal, you still have to come to the table with some money-management skills. If you fail in this area, then you will find yourself going from trading idea to trading idea, seeking a Holy Grail that just doesn't exist.
The Will to Come Back From a String of Losses
How does a trader get through tough times without allowing his or her bad habits to take over what sits between the keyboard and chair?
If the trader does not have a proven and well-tested plan, he or she is throwing money at the stock market in much the same way that gamblers put coins into slot machines. They could hit or miss — but the house knows the odds, and we all know what happens in these situations.
If a trader wants to get to the point where he or she is winning more than losing, the trader must take the time and do the work to get a solid trading strategy and plan.
It's More Than Just Good Picks
A plan isn't just good picks; it's following the rules that I keep pounding the table about.
This is why you should keep your positions small and spread them out into all different plays. This way, when you're wrong, it won't kill your portfolio.
You can't win every single trade, so you have to take the necessary measures to ensure you manage profits and losses, because we are in a market like none of us have ever seen before.
Following these guidelines will keep the bear from eating you alive.
Be a better trader.
Wednesday, April 8, 2009
By Ted Peroulakis
I’m not so sure that we have seen the worst of this bear market. We could be in for another stock market crash in the near future. In this article, I will explain why the global economic crisis and the stock markets could get much worse before they get better. Then, I will tell you how to protect your wealth and profit in the current market environment.
Stocks seem really cheap right now, but they could be even cheaper soon. I suggest you wait for a big washout to jump back in. It will seem like the market can’t get any worse and that’s the time to buy.
Nevertheless, I think we are seeing a sucker’s rally right now. The Wall Street cheerleaders that have lost people so much money over the years are now telling us the bottom is in. Why should we trust them now? Of course they want the good old days back so they can get their lavish lifestyles back. Don’t believe the hype. Look at the facts!
Here are just a few reasons to be a bear:
Wealth is disappearing - American households have lost over $12 trillion in stocks, real estate and other assets since the beginning of this economic crisis. When people have less money, they spend less, and this hurts our consumer based economy.
US home prices are still dropping - Recent data suggests that home prices sank by the sharpest annual rate on record in January, and the pace continues to accelerate. Some recent housing figures may have been slightly better than expected, but less bad is still bad.
The toxic asset problem is not going away - The U.S. government said it will help to take some of these bad assets off the bank’s books, but this is no guarantee that banks will re-start lending. Businesses still can’t borrow money and therefore can’t expand and hire new employees.
Unemployment is getting worse - Last month, the unemployment rate hit 8.1% and many companies are still cutting their work force. Many more workers will lose their jobs in the next round of corporate bankruptcies which could include GM and Chrysler. We could hit 10% unemployment soon.
Unfortunately, there is still a large amount of evidence that the economy is headed for more trouble. The credit crisis is not over and investors should be cautious until they see the fundamentals turn positive. Right now manufacturing and productivity are decreasing. Auto sales are still dropping and the construction industry is crippled. We need a major fundamental change before we can pull out of this economic crisis.
How to play this sucker rally and profit from the market’s next decline.
Make sure you’re sitting on a good amount of cash and use every market rally as an opportunity to sell (even at a loss) and increase your cash position.
Buy gold – gold will skyrocket if this economic crisis gets worse and should do exceptionally well if the stock market tanks. Also, gold is an inflation hedge and can protect you against out of control government spending.
You should also think about doing put options or shorts on weak companies. You can make a tremendous amount of money as a company’s stock declines. A good service to look at is Andrew Gordon’s Red Flag Insider. His service has performed extremely well in this bear market.
And, be ready when the market hits rock bottom, you will be able to buy some of the world’s best companies for pennies on the dollar. You will know a real recovery is about to begin and it’s time to buy when Wall Street is certain the world is coming to an end. You will know when this day comes when you see “the blood in the streets” as they say.
Tuesday, April 7, 2009
By Jamie Dlugosch, Editor, InvestorPlace
There is no place for gold on the global financial stage.
I will be very blunt…
I despise gold and everything it stands for.
It's an abhorrent example of materialism and serves no real purpose. Lust for gold is over-the-top excess, and despite the protestations of the goldbugs, there is no real basis for the metal serving the currency needs of the world.
The fear mongers will have you believe that the world is collapsing and that inflation has run amok. As a result, the only real currency out there is gold. Given that gold is in finite supply, it should be bought and hoarded…or so the theory goes. Gold is the only thing that you can count on.
There is no place for gold on the global financial stage.
Reason #1: There Is No Inflation
Whether it's collapsing home prices, discounts on automobiles or reductions in stock prices, asset values across the board are declining, not increasing.
The gold bulls state that enemy number-one of the dollar-denominated currency is inflation. I agree wholeheartedly, and so does the Federal Reserve.
There are many backseat drivers that are claiming that the Federal Reserve does not truly fight inflation. That is a crock. In reality, inflation during the last bull market occurred due to massive amounts of private capital leverage. Indeed, the Federal Reserve did keep interest rates too low for too long in the early part of this decade, but do not forget that the stated goal of the central bank is to fight inflation.
Today, the numbers do not support an inflationary environment and fear over current spending and stimulus of the government creating inflation is misplaced.
I say be not afraid!
Reason #2: Gold Prices Are Easily Manipulated
One thing I am very afraid of with gold is manipulation.
Unlike paper currency that is impossible to manipulate in any way, gold can be accumulated by a group of connected buyers for the sole purpose of eliminating supply from the market. A successful cornering of the market can result in volatile swings in price. Unsuspecting buyers acquire bullion at higher prices only to see a flood of supply hit the market resulting in damaging price collapse.
This is exactly what transpired in the 1980s in the silver market. The Hunt brothers did just that with the use of leverage at a time of minimal margin requirements on commodities exchanges.
Although the likelihood is low, investors should be cautious with any commodity that can be manipulated in this way. I prefer to avoid it altogether.
Reason #3: Gold Is in Limited Supply
Related to manipulation, the simple fact is that there is a limited supply of gold.
Those who want to return to the gold standard fail to appreciate that at some point a lack of supply could have disastrous consequences in a gold-based system.
Wars are fought over commodities in short supply. In addition to fighting inflation, the Federal Reserve is also charged with promoting a stable currency. With gold, prices can be far from stable.
Though the dollar is not perfect, the system is much more preferable than to hinge our bets on gold. Look at gold mining towns that went boom and bust when supply eroded. The same can happen on a global scale.
Gold is not the panacea that the proponents make it out to be.
Reason #4: Gold Was Dead for 20 Years
For more than 20 years, the price of gold did nothing. If you invested in gold, you wasted your time. That all changed with fears of inflation and hedge fund speculation several years ago.
Today, the church of gold is full of believers. What changed?
Nothing really except we have experienced an unprecedented upheaval in the global economy and financial markets. No wonder there has been a flight to gold.
The trouble is that the gold rush is not likely to last. In fact, there has been tremendous resistance for gold at $1,000 per ounce. Do you really want to buy at the top? I don't think so.
Once the economy stabilizes and we get a return to normalcy with respect to the business cycle (in other words an ending of the boom/bust period), gold will go back into hibernation. Demand for jewelry cannot absorb the current supply.
As such, a strong dollar is likely to absolutely destroy the price of gold. To me that is the far more likely outcome today.
Reason #5: The Dollar Is the Global Currency
You may have heard the recent calls from China for a global reserve currency that is not the dollar.
Good luck with that one. The dollar is the global reserve currency. Do not underestimate the strength of this country as compared to the rest of the world. Predictions of our demise are premature.
Recently, Treasury Secretary Timothy Geithner emphatically declared his belief in a strong dollar policy. Buying gold is like spitting into the wind then. One thing a trader learns at the start of his training is to never fight the Federal Reserve or the Treasury department.
If you can remove the clouds of crisis, the clear skies ahead provide comfort to me that gold has seen its best days. Those worried about massive deficits need to recall that our country was founded with debt, debt that was ultimately paid back.
We make good on our debts, which is why even during this crisis, buyers of Treasury securities remains strong. Note that such buyers could just as easily buy gold. They are not.
Thursday, April 2, 2009
An Investing Lesson from Bernie Madoff
Petty criminals go to jail, while the biggest criminals of all are promoted, appointed and elected to the highest positions of power. Bernie Madoff didn't exactly run the country. But he did run one of the world's largest financial exchanges, when he served as Chairman of the NASDAQ.
Certainly you're familiar with the story. Madoff ran a classic pyramid scheme, where yesterday's "investors" were paid off with the of new ones. The fraud finally collapsed when there were not enough new victims to support the growing withdrawals. In a story that has become all too common in modern finance money, the former "pillar of the community" turns out to be a slick con man with an amazing lack of conscience.
Certainly Madoff must be in shackles at Guantanamo Bay right now. Perhaps he has already been tortured and moved to solitary confinement. Nope. Even worse. He is currently under home detention with a nightly curfew (a curfew!).
The mainstream press often presents a story like this as if it is an open and shut case. But like many of Madoff's investors, I would venture that there is a LOT we don't know about what went on here.
First, we are asked to believe that not one, but DOZENS of sophisticated hedge funds and international banks circumvented their internal risk control procedures and did not carry out even the most elementary due diligence. They invested in a black box system with constantly high returns, a lack of third party oversight, a total obfuscation of what was actually being invested in, and a one-man accounting firm auditing the multi-billion dollar operation.
We are also asked to believe that Madoff orchestrated the entire fraud, acting alone. Neither his family, his traders, his inner circle, nor his employees had any idea that anything was amiss. Puh-lease!
Neither of these scenarios is fully plausible, in my opinion. My purpose in this essay is not to dissect the scam. I'm sure the details will be forthcoming in the months ahead – if not from the mainstream press, then certainly from other reliable sources.
Rather, my intent is to discuss what we can learn from this situation and how can it guide your investing in the months and years ahead.
What Have We Learned?
We certainly have learned that we cannot always rely on what we hear and what we see at first glance. I am reminded of a sales meeting I had in 2000 with executives of Enron at their headquarters in Houston. After my presentation, I was given a short tour and asked if I wanted to see their trading operation. It turns out that a couple dozen Wall Street analysts were there as well. We all left duly impressed.
It wasn't until a year or so later that I learned the whole thing was a sham. Not only were the company's profits "pretend", but so was the trading floor. It might as well have been a movie set. Enron had staffed and "decorated" the trading floor to impress – make that, deceive – Wall Street analysts into believing that the company was operating a thriving energy trading operation.
In a BBC article, Enron employee Carol Elkin said, "It was an elaborate Hollywood production that we went through every year when the analysts were going to be there to impress them to make our stock go up. It was absurd that we were doing this. But the most absurd part was that it worked."
It has not been a good decade for the reputation of American business. There is an old proverb that says, "The fish rots from the head down." In the case of America, I am saddened to say that the proverb applies. The New York Times suggests that Madoff's scam "may be the largest Ponzi scheme in history." Unfortunately, it is not even close.
The Ponzi Scheme of "Unfunded Liabilities"
There is no bigger Ponzi scheme than those operated by the Federal government – Social Security and Medicare. Both programs are nothing but an inverted pyramid with money from new contributions going to pay withdrawals. The only difference is that Charles Ponzi and Bernie Madoff didn't force people to give them money.
However, the eventual result will be the same, just on a much larger scale. As the withdrawals inevitably swamp the new contributions, both programs will end in disaster and disgrace.
And for that matter, what is the difference from Madoff's scheme and that of the big banks who have finally had to admit that their own financial statements were bogus and many of their "assets" worthless. If nothing else, I hope that people are finally waking up to the fact that in a fiat money system, the entire economy is based on a Ponzi scheme of ever-expanding debt.
Where Was the Regulation?
Inevitably, when a fraud of this magnitude comes to light, politicians and pundits come out of the woodwork saying that we need better regulation and more laws. Wrong! Fraud is already illegal. And as long as we have a crony capitalist system, cronyism will always trump regulation.
The regulators are invariably selected from the organizations they are meant to regulate. The public agencies become corrupted and ultimately beholden to powerful private interests.
And in any case, regulation can actually be part of the problem. The SEC has helped to foster a mentality of trustworthiness in the financial system that we now know was undeserved. When investors are lulled to sleep by the illusion of regulation, they make decisions they would not otherwise make.
So What Can You Trust?
Am I suggesting that you can't trust the government... the banks... the regulators... the financial exchanges... or even the companies we invest in? Well, not necessarily. But I am suggesting that you keep a wary eye on all of the above as far as your money is concerned.
I would also suggest that you invest a portion of your assets in the rare asset that has no counterparty risk – physical gold and silver. Gold that you can hold in your hand. If all else fails, you still have something that has maintained its value and has been desired for virtually all of human history.
Let me get your comments if this post was helpful. Stay tuned for many more helpful investment tips and educative posts.