The Tycoon Report

How Much Money Should You Risk?

Wed, 15 Jul 2009 07:00:00 -0500

During the next several weeks, be sure to tune into this space every Wednesday to learn eight tips aimed at making you a stronger, more-confident and -- most importantly -- a more-profitable investor. We plan to cover the following topics, and much more (see below). Last week, I covered the importance of focusing both your mental and your financial capital. (Check out the first installment of this series here.) This week, I'm going to tackle the thorny question of position sizing! Exactly how much should you put into any one trade? 1. Focus -- You can't trade everything; how gaining focus will help make you money. 2. Position Sizing -- How much should you place in any single trade? 3. Mitigating Risk: Exchange-Traded Funds vs. Individual Stocks -- What is the risk/reward difference between stocks and ETFs? 4. Stop-loss Points -- Where should you place your stop-loss? 5. Entering Positions -- Where should you place your buy order or short sale order? What type of orders can you use? 6. Exiting Positions -- How to lock in as much of your profits as possible. How to use option strategies to exit your positions 7. Shorting -- What does it mean to "short" and why should you be doing it? 8. Leverage -- The ins and outs of why, how and when to use leverage. *Note: As we go through this journey together, I may add to, or consolidate, some of these topics. Rule No. 2: Position Sizing The classic mistake I see many investors, both new and seasoned alike, consistently make is over-concentrating their capital into a single position. In the early days of my investing career, I made this mistake as well. In fact, there isn't much information out there to tell us how big our positions should be, so we must figure it out through trial-and-error ... probably with a lot of emphasis on "error." Today, I'm going to show you the best way to size your positions to save you a lot of the pain (and money) that other investors are encountering. What I've learned from my own investing journey is that our position size must be determined not by how much money we hope to make but instead by how much money we are willing to lose if we are wrong! That's a subtle but important distinction. My 3% Rule Being wrong is just a part of ultimately being right. The key is to make sure that, when you are wrong, you don't lose too much of your equity while you are on the road to being right. My general rule of thumb is to risk no more than 3% of my starting equity on any individual trade. Let's assume that you have a $40,000 account. Does this mean that you only put 3% of $40,000 into your trade? No! The 3% is the amount you are willing to lose if your stock position gets stopped out. In order for this technique to work, it means that you must attach a stop-loss to each of your trades. A stop-loss is an order you put in with your broker that will get you out of the trade when the stock hits a certain point. We use stop-loss points to manage our risk. Here's How it Works Let's work through the above example, 3% of $40,000 is $1,200. That means if our position hits our stop-loss point, our position size is such that we will lose no more than $1,200. To take this a step further, let's assume that we want to buy a $20 stock and we want to figure out how much to put into this new position. The first thing we have to do, before we buy a single share of stock, is figure out our stop-loss point. (This is such a critical part of managing your own portfolio that I plan to do an entire article on this subject as part of this series.) Let's assume that we have looked at the stock and we've chosen a stop-loss point of $17 per share. Once we know where our stop-loss point is ($17), we can begin to work out how many shares we can buy. To do this, we simply divide the amount we are willing to risk ($1,200, which is 3% of $40,000) by the amount of points of our stop-loss is (3 points) from our entry price. The entry price is $20 and the stop-loss point is 3 points below our entry price, so $1,200 divided by 3 equals 400. So, this tells us that we can buy 400 shares of the stock at $20 with a $17 stop-loss point. If we get stopped out at $17, our loss on 400 shares (assuming we paid $20 for them) would be $1,200, or 3% of our total starting equity of $40,000. Keep Your Powder Dry Till Your Guns Start Blazing By using this approach, we prevent ourselves from over-leveraging our positions and creating unnecessary stress. It also allows us to make several attempts to get into a position without risking too much money. How many times have you been in a trade, got stopped out and then watched the shares skyrocket higher? This used to happen to me a lot, but when I started using the "3% rule" approach, it enabled me to keep enough powder dry that I could make several attempts to get into a position until I got the trade to "stick" without murdering my capital. At market bottoms and at market tops, this is a very savvy way of "probing" the market in an attempt to catch big, deep-trending moves without "betting the ranch." As the position becomes profitable, I start adding to it so I can catch as much of the move as possible while always moving my stop-loss along with the stock price to protect my principal and accumulated profits. Now that we've talked about how to zero in on the strategies and securities you want to have in your portfolio, and how much money to put into each position, next week we'll move on to how to mitigate risk -- specifically when looking at Exchange-Traded Funds vs. individual stocks. In the comments section, be sure to tell me how you are applying these strategies and any questions that arise during your journey. I look forward to hearing from you!

Timing the Opportunity that Most Will Miss

Wed, 15 Jul 2009 07:00:00 -0500

Happy Thursday to you all. Just to let you know, next Thursday I’ll be taking my first week off since I started writing for The Tycoon Report in November, as it's my birthday. On top of that, the show I’m directing, "SOUVENIR: A Fantasia on the Life of Florence Foster Jenkins," is opening next Friday night and I’ve got to get busy buying opening-night gifts! Last week, in a very informative article, Chris Rowe wrote about the Relative Strength Index (RSI). Today, we’re going to look at one of my favorite indicators, which I’ve been putting to the test over the last few months, the StochRSI. Once a trend has been identified, this indicator is great for timing entrances and exits in the short term. As Chris mentioned, the RSI is a momentum indicator that compares gains to losses over a period of time. Stochastics, as students of the "ETF Master Trader" program well know, provide a momentum oscillator that compares a security’s closing price to the high/low range over a specified period of time. The thing about the RSI is it often doesn’t go to extremes -- instead, it will remain between the oversold and overbought levels (that is, between 20 and 80). If, for example, you want an entry into the trend and are looking for a price extreme, it’s possible that the RSI won’t give you one. That’s where StochRSI comes in. The StochRSI is a crossbred creation of Tushard Chande and Stanley Kroll. RSI acts as the base and the stochastic calculation is applied to it. The formula is mind-numbing, so I won’t show you its details. Suffice it to say that the resultant number fluctuates between 0 and 1 and gives us an oscillator that measures the level of RSI relative to its recent high/low range, thereby providing short-term momentum extremes. As Chande and Kroll point out in their book, "The New Technical Trader," “The StochRSI is a more consistent indicator of overbought and oversold conditions simply because we are measuring its position within the most recent range.” The group of charts below shows a security chart with RSI, Full Stochastics and StochRSI beneath. Uptrends and Downtrends -- What the Levels Mean At the end of 2006 and well into 2007, United States Steel (X) had a steady rise. The green lines show opportunities to buy into this uptrend when the StochRSI line crosses from below the 0.20 to above it. Just like in the RSI or the BPI, which have overbought and oversold ranges (above 70 and below 30, respectively), the StochRSI is considered overbought above 0.8 and oversold below 0.2. (A 0.2 StochRSI reading actually means that the current RSI is 20% above the lowest level of the time range measured, or 80% below the highest level or the RSI for the period.) So, during the steep descent of U.S. Steel starting in mid-2008, the red lines show opportunities to: 1) Get out of the stock if you’d been long, or 2) Short the stock (or buy puts) After spending some time studying this indicator in conjunction with bunches o’ charts and figuring out how best to use it, I’ve discovered that the most-dependable signals are given when the move goes straight from overbought to oversold or vice versa. But I circled the StochRSI in October-November 2007 (in blue) to point out that sometimes the signal fails when it returns quickly from overbought to oversold (the late-October quick jump). It didn’t really break out until mid-November. This is why this indicator works best when used in conjunction with other longer-term indicators. (I’ve found the Moving Average Convergence/Divergence and the StochRSI are a dynamic duo.) Also, in an uptrend, the reverse moves downward usually constitute a brief consolidation as opposed to signaling the time to exit a position. This does not mean, however, that you should not have a stop-loss in place. Always use stop-losses! Likewise, in a downtrend a move upward should be noted but not necessarily acted upon. This can vary from security to security and may or may not depend on the severity of the move, so be sure to study the StochRSI in conjunction with the long-term (historical) tendencies of the security. Another way to use the signal is similar to the plain-vanilla RSI, where you watch for centerline crossovers. A move above the StochRSI centerline (0.5) would constitute a buy signal that remains in effect until a decline below 0.5. Conversely, a drop below 0.5 would signal a sell until an advance back above 0.5. Although this can have you in and out of the market more than you might like, it can also help eliminate whipsaws. Positive and Negative Divergences can also be plotted using StochRSI, although I personally like to use MACD histogram divergences. Here’s a closer look at recent activity for a chemical company, Omnova Solutions Inc. (OMN): The first red line at left marks the December downtrend. As we all know, the market was a bit wacky through the first couple of months this year, then started rallying. I’ve marked the recent moves below 0.8 on the StochRSI as red vertical lines and the points where I bought into the stock -- where the StochRSI moved above 0.2 -- as blue vertical lines. Now here’s a perfect example of a consolidation in an uptrend. I could have sold off my position at each dip below 0.8 and bought in again at the next move above 0.2, but my stop-losses were never activated. (With stocks under $5, I use a fixed-amount stop-loss.) The green boxes show that the stock never really turned down, just took a breather. After the second occurrence in April, I knew that this particular security was likely to follow this pattern again, as it confirmed in May-June. The bottom line is that I more than doubled my money, buying into four positions when the StochRSI moved above 0.2. (Some of you eagle-eyed traders may ask why I didn’t buy in on April 13 or May 13 or May 26 or June 1. The answer for the first three dates is that the move happened too soon after the drop and I suspected a false signal. On the first June crossover, I wasn’t actively monitoring my position as I had had oral surgery and was in la-la land.) To Recap When RSI registers a brand-new low, StochRSI will be at 0. When RSI registers a brand-new high, StochRSI will be at 1. Remember that StochRSI is really an indicator of an indicator. We’re using it to track the price change of a security, but it’s designed to track RSI. As such, it is one step further removed from the actual price of the security it tracks. And it serves to predict RSI, which means it’s more sensitive and therefore more prone to false signals. So, know the security you’re tracking, know the market and industry conditions, and know the trend. And use other longer-term indicators to make sure you’re on the right side of the action. Once you’ve done all that, StochRSI will give you an advantage over the rest of the crowd, getting you into or out of a trade early, instead of too late.

A New Candlestick Pattern Just Rode Into Town

Tue, 14 Jul 2009 07:00:00 -0500

Everyone who is familiar with Japanese Candlesticks knows about the “Morning Star,” because it is one of the most familiar bullish reversal patterns. A variant of the Morning Star set off the Great Rally of 2009. When we see it appear, we await expectantly for good things to happen.Here are the distinguishing characteristics of the Morning Star: It is composed of three price bars. The first of the three will be a tall black candle, which describes a substantial “down” day (assuming that we are working with a Daily chart). The middle bar, the “Star,” will show a small “real body,” the price area between the opening price and the closing price, and the real body will be below or near the low price of the tall black candle. The third bar will be a tall white candle, denoting a strong “up” day and a reversal of trend. The Morning Star is universally considered to be bullish.There is a variant of the Morning Star which contains two Stars between the tall black candle and the tall white candle. It, too, appears to have at least some bullish characteristics. If it is true that “the proof is in the pudding,” then this variant is indeed powerful, because it is the one which ignited the Rally of 2009. We call it the “Tokyo Express.”Now it seems at least possible that there is another variant of the Morning Star, about which we have not seen anything in writing. This one contains the tall black bar and the tall white bar; but instead of a single small Star in between them, or even two Stars, this one has three.We see it today in the Dow Industrials and in the S&P 500. The latter is probably the better, or best, example. We do indeed see the tall black bar as the first bar and the tall white bar as the final bar; but there are three Stars in between them; and today (the day following completion of the pattern) prices are up nicely.So perhaps the door is not closed to the identification of new Candlestick patterns. This one appears to be off to a good start. Only time will tell whether its present bullish promise bears fruit.We ought to give it a name, just in case it turns out to be real. My suggestion for it is “Kobe Cruiser.”William KurtzJuly 14. 2009http://www.candelaabra.com

What is Delta? This Answer Changed My Trading Life Forever (Part 1)

Tue, 14 Jul 2009 07:00:00 -0500

Happy Tuesday, Tycoons! Given the current market environment, where an overbought market has begun to sell off and people are wondering how low the drop will be, I thought that it would be a good idea for me to revisit this three-part series that I wrote last year because of its high level of importance. I've improved it with a few changes geared toward helping you to improve your trading game even more. Even if you remember reading it, it's still a good idea to review it. This will be one of the most important and influential lessons you have ever learned about investing. Even if you don't trade options, you should read it. Why? Because they can significantly reduce your risk in this market. You can replace your overpriced stock with some call options ... but you MUST know which option to buy, or else you might actually increase your risk instead. Learning about delta and using it to make better trades is not really complex, so don't be intimidated. Just remember the two most important things: 1) If you sell your stock and buy call options to replace it, then buy "in-the-money" call options. 2) Only buy one call option for every 100 shares of stock that you own (or, would want to own). In other words, if you have 100 shares of Capital One Financial (COF), and want to close the position at $21.60, you will have $2,160. To establish an option position, you should buy only one call option contract (which represents 100 shares). If you buy the COF Jan 15 Call and pay $8 per contract (an $800 investment), then you should put the remaining $1,360 in a safe, interest-bearing security, such as a money-market fund or Treasuries. This three-part series will help you understand why it's important to buy in-the-money call options in place of stock (as opposed to at-the-money or out-of-the-money). And Now, to Change the Lives (and Returns) of People Smart Enough to Listen... Most stockbrokers and money managers have no real concept of what I’m about to talk about. Don't worry, that doesn't mean it's complicated at all. And if you are a professional money manager of some sort, then pay close attention. If you understand options, you can use the following knowledge to help your customers, as well as your business, enormously! Today, You Will Learn About 'Delta' The "delta" of an option measures how much the option changes in price when the underlying security moves one point. For example: Let’s say that ExxonMobil (XOM) is trading at $65 per share, and the XOM Jan 65 Call is selling for $5. (NOTE: Because XOM’s stock price is the same as this option’s strike price, this option is trading "at-the-money.") When XOM rises one point (from $65 to $66), the Jan 65 Call should then sell for $5.50. Thus, the option only increases by 50 cents when the stock rises by one full point. This at-the-money option is said to have a delta of 0.50. Decoding the Delta The delta of an option is a number that ranges from 0.00 to 1.00, and the delta of a put option is a number that ranges from -1.00 to 0.00. Hint: A call with a delta of 0.70 implies virtually the same thing as a put with a delta of -0.70. You will notice that when a call option is far out-of-the-money (for example, the XOM Jan 95 Call is 30 points out-of-the-money), it will either move only slightly, or not move at all, when the stock rises by one point. The delta of this FAR out-of-the-money call is only 0.04. So theoretically, if XOM moved up by one point, the price of the $95 calls should advance by 4 cents. Now, that might seem like a lot in terms of the percentage gain since the theoretical value of this far out of the money option is about 27 cents. (A 4 cent gain would be a 15% gain on a 27 cent call option). But you have to consider the fact that the spread between the bid and ask price can be much larger than the 4 cent gain in the option (so you can still end up with a losing position). The rule of thumb here is the higher the delta is, the more likely it is the option ends up profitable. And out-of-the-money options have the lowest delta, and in-the-money options have the highest delta. So you'd want to avoid the out-of-the-money option that has the delta of 0.04 like the plague. On the other hand, if the stock is trading far above the call option’s strike price -- or, said differently, the option is deep "IN-the-money" (i.e., the XOM Jan 45 Call, which is 20 points in-the-money with the stock trading at $65), then the call option would likely have a delta of 0.96. Thus, when the stock moves up one full point, the option will likely move up 96 cents. (Almost point-for-point, aka trading at "parity" with the stock.) If a call option moved up one full point due to the underlying stock moving up one full point, then the option has a delta of 1.00, and so on. A put option would work the same way whereas, if XOM moved down one point, a PUT option that has a delta of -0.70 would move up by 70 cents. 2 Important Notes 1) An option’s delta changes as the price of the stock changes. This is because the deeper in-the-money that an option becomes (due to the price movement of the underlying stock,) the higher the delta becomes. In other words, in the ExxonMobil example, when XOM moves up 5 points from $65 to $70, the delta of the Jan 65 Call would move up from 0.50 to 0.65. Theoretically, at that point (with XOM at $70), if the stock moved up one point (from $70 to $71) then the call (which now has a delta of 0.65) would increase by 65 cents. So don't mistakenly think, if a call option has a delta of 0.50, that the call option would only move up by 5 points if the stock moves up by 10. That is incorrect because, again, the call option's delta increases as the option moves further above its strike price. The more the stock advances, the more sensitive the option's price will be to each one-point movement of the stock. In fact, if ExxonMobil traded up 10 points (from $65 to $75), the Jan 65 Call -- which currently has a delta of 50 -- would actually advance by approximately $7 (from $5 to $12). By the time the stock is trading at $75, the delta would move up to about 0.78. 2) Today we are only discussing delta. But an option’s price (and the option's delta) can be affected by other factors. The two major factors that impact an option's price and delta are "time decay" and a change in "volatility" of the underlying stock, Exchange-Traded Fund, index, etc. Replacing Stock with Options vs. Gambling with Options The reason that so many people shy away from options trading and think that they are so risky is because the option novice tends to be attracted to the lower-priced options, which are the options that are the most difficult to profit from. This is similar to the situation when people say that they would rather buy a stock that trades at $2 instead of a stock which trades at $20. They make the mistake of ignoring the probability of the stock trading higher. That is one of the absolute WORST ways to approach investing in the market, and it happens to be a common mistake made by inexperienced investors. The two reasons investors mistakenly think cheap options are better are: 1) If the investor is successful, the win will be greater, percentage-wise. 2) If the investor is wrong, then he or she will have only lost the small amount invested. But clearly, you can't argue both. You can't say the percentage gain is larger and then make the argument for the loss that the absolute number is "all you would lose." And consider the first reason. Sure, the percentage gain might be higher if everything works out. But when the odds of success are low, you wouldn't feel comfortable putting any real money behind the investment. Personally, I don't care if it's $5 or $500,000. No matter how much money you are putting at risk, the odds of success should be good. If odds favor a loss, why invest $1? We must look at our investment portfolio as a business, and not a lottery ticket. Is Purchasing Out-of-the-Money Options Ever a Good Trade? No. More specifically, not if you're purchasing those options by themselves. However, if you buy them as a hedge, or as part of an multi-leg option position, that's a different story. But today, we are talking about stock replacement, which just involves buying an option instead of a stock. I'm going to show you how to take less risk than the traditional stockholder. First, you should understand that an out-of-the-money call option is an option that has a higher strike price than the current price of the stock. (With put options, it's the opposite. With puts, the out-of-the-money options are those with a strike price that is lower than the stock price. But let's stick with call options in our examples.) Below you can see eight call options listed. The strike prices are circled in red. The stock is trading at $65.70. The call options that are highlighted in yellow are the out-of-the-money options. You can also see these are the cheaper options, and they get cheaper with higher strike prices. The option that is the absolute least likely to advance is the Jan 85 Call (at the bottom), and the option that is the absolute most likely to advance is the Jan 50 Call (which is 15.7 points in-the-money). Many option traders lose money trading out-of-the-money options because they are overly confident in their prediction. For example: They may think a stock will trade from $65 to $80 in a given period of time. But most of the time, markets and stocks trade plus one or minus one standard deviation from the mean. That is why "time decay" tends to be a factor that new, out-of-the-money option, traders learn about very quickly (and painfully). An out-of-the-money option’s delta will trend toward zero as time passes. And remember, the lower the delta is, the less the price of the option will be impacted by the movement in the stock. Therefore, the underlying stock can trade much higher over time, but the call option with a very low delta could still trade lower, even to zero, even though the stock traded higher. I'm sure many of the people reading this have bought an out-of-the-money call option because they thought the stock was going to advance, and they were right because the stock advanced, but disappointed because the call options traded lower anyway. That's because they bought the wrong call option. At the same time, other call options traded higher with the stock. Trading with (what I consider to be) a Low Delta Suppose XOM were trading at $80, and a trader was looking to buy call options because he was looking for a move of one point from $80 to $81. If the trader were to buy the Oct 85 Call (which is five points out-of-the-money), the trader would pay $2.35 for the call option. This call option has a delta of 0.37. That means that if XOM traded from $80 to 81, (all other factors being equal -- such as ZERO time decay -- so we assume that the stock moved the very same day), you could assume that the Oct 85 Call options would move approximately 37 cents higher. The Low-Delta 'POSITIVE' Argument If we bought the option at $2.35 and sold it 37 cents higher (within a day or two) at $2.72, then we would realize a fast 15.74% return on our money. Not bad. If I have $7,050, I could buy 30 call options (representing 3,000 shares), and I would make $1,110 within a day or two. If I got lucky, and I underestimated XOM’s upside move, and it happened to trade to $95 (instead of $81), then I would make a killing (over $30,000 on my $7,050). However, before you start mentally spending those profits ... STOP IT! I can see the greed seeping out of your ears right now. A wise man once told me that the traders who make the HUGE profits like that are the same ones that take LOTS of huge losses. Remember, the low-delta options are the out-of-the-money options, and it's very likely that they don't end up profitable. The Low-Delta 'NEGATIVE' Argument I usually don’t like to buy an option with a low delta unless I am covering (hedging) myself against a significant stock movement/loss. (Such is the case when using a protective put.) There are two main reasons why, and both reasons spell a higher risk with lower delta. The first is one that most people understand; the second is what many people overlook. 1) The lower the delta, the more extrinsic value your option contract consists of. Extrinsic value (aka, time value) is what is left over after calculating intrinsic value. Extrinsic value is affected by time decay. Intrinsic value is the amount by which your option is in-the-money. Intrinsic value is NOT affected by time decay. If I own a Schering-Plough (SGP) Jan 20 Call, with the stock trading at $22.50, then my call option is $2.50 in-the-money. If that SGP Jan 20 Call is trading at $3, then $2.50 of that $3 is intrinsic value, and the remaining 50 cents is extrinsic value and is exposed to time decay. (Remember, these are not recommendations but, rather, examples to illustrate the power of delta.) Remember: The extrinsic value (or time value) portion of an option is at the mercy of the clock. Time decay has zero effect on the intrinsic value portion of my options premium. That's why we like to trade in-the-money options that have minimal extrinsic value (time value). Notice in the table above that the percentage of the value of the option contract, that is extrinsic value, increases as the delta decreases. So, the lower the delta, the more extrinsic value exists. And that extrinsic value is at the mercy of time decay. For example: The extrinsic value of the Jan 17.50 Call (with the highest delta of 0.97) only accounts for 5.7% of the entire value of the option. This means that only 5.7% of the value can be lost due to time passing. Any other loss in the option would have to do with the actual stock moving lower. Twenty percent of the Jan 20 Call is extrinsic value and is therefore at the mercy of time decay. The other two options have 100% extrinsic value. Now, just about every options trader understands that time decay occurs as time passes, and most are familiar with what a time decay curve looks like. The deterioration of the extrinsic value portion of the call option’s value accelerates, especially in the last 90 days before expiration. By purchasing an option that has a high delta, I can significantly reduce the effect that time decay has on my option's value (or the option's premium). 2) Starting with a high delta reduces your loss when the stock moves in the wrong direction. This is what an alarming number of option traders either don’t understand, or only have a slight understanding of. Remember how I said that the delta of a stock option changes as the stock fluctuates? For example, in the table above, you see that the delta of the Jan 20 Call (which is 2.5 points in-the-money) is 0.84. It has such a high delta because it is 2.5 points in-the-money. But if SGP traded down to $21, the Jan 20 Call would only be one point in-the-money. Thus, the delta would change from 0.84 to 0.69. This is a good thing if you are the owner of that call option. It means that as SGP stock trades lower, the call option actually loses less in value (dollar-wise) than the stock! In other words, you stand to lose a lot less by owning the call option. This is especially true when you are talking about an option that has an expiration day further out than 90 days. (Remember, 90 days before expiration is when the extrinsic value decay tends to speed up.) NOTE: When you buy an option strictly for the upside (and you aren’t using it for hedging purposes), you should always give yourself extra time for it to work. Try to buy it with an expiration month that is at least 90 days after the time that you wish to sell it. Think about that for a second. This is the part that many newer option traders tend to overlook, and it's one of the most important considerations when using beginner, intermediate or advanced option strategies. Buy More Delta, Lose Less if Trade Goes South When you buy options with a high delta (which are deep in-the-money) and the stock trades lower, your option loses less value than the stock does! So, you put up less capital (and therefore ultimately risk less capital), and the call option holder will actually lose less value when the stock trades down a few points. If Schering-Plough traded from $22.50 down three points to $19.50, the Jan 20 Call is likely to lose only about $2.30 in value. So, why even bother trading stock? What if the stock drops by 10 points? You'd only lose a maximum of $3 that you committed to the option as opposed to the $10 that the stockholders lost! There's more to this, and it gets even better. Tune in next week, and I will give you PART TWO of "What is Delta? The Answer Changed My Trading Life Forever," where you are sure to add invaluable weapons to your arsenal that even your broker can't comprehend. Don't forget to click on the link below to rate this article and to leave comments! Until next week,

A New Definition of Slippage?

Mon, 13 Jul 2009 07:00:00 -0500

Last week, we witnessed the creation of an entirely new definition for the concept of "slippage." If we look at Wikipedia, its definition for "slippage" is the difference between estimated transaction costs and the amount actually paid. How amateurish and naive can Wikipedia be? No, these days the new definition for "slippage" seems to be defined -- at least by Goldman Sachs -- as "let's trade in front of everyone. We'll get filled and what's left to fill is what anyone else gets. Why? Because we, at Goldman Sachs, are 'risk-averse.'" Now, I'm not picking on GS for the fun of it. But last week, supposedly GS was very quietly told that it could no longer do computerized quant trades at the New York Stock Exchange. What exactly is "quant trading"? Quantitative (or quant, for short) trading encompasses investing techniques employed by sophisticated, technically advanced hedge funds or brokerages. Quant shops use ultra-fast computers to predict trading patterns inside financial data. A "quant," also known as a "geek," now refers to programmers who code quantitative-analysis algorithms for insider computer trading. Is quant trading illegal? Ordinarily, no, but the way Goldman Sachs coded the program seems suspicious. And, by the way, it is reported that GS represents 60% of program trading. In order to trade from your desktop, your computer program sends your offer to buy or sell to the exchange. The computer program that is behind the scenes of your desktop-trading platform uses what is known as a "FIX" protocol. FIX is now generally considered the industry standard. Seems what the GS program can do is intercept the FIX messages being sent to the exchange from the large institutions, interpret what was is being bought or sold, and then put their trade in ahead of those trades for the same buys or sells. Then the trades coming in afterward may or may not get filled, depending upon how large GS's trades were. How would this work in the marketplace? Say an institution wanted to sell 10,000 shares of IBM. GS would intercept the message, and sell 10,000 ahead of the institution. Say only 12,000 shares were available to sell. GS would sell its 10,000 and the institution could only sell 2,000. A new definition for "slippage," right? What is being investigated is whether GS illegally used security-access codes to acquire the messages prior to "transaction_commit" timepoints at the NYSE. This may have only resulted in a nanosecond trading advantage but, with ultra-high-speed computers, a nanosecond is a lifetime. How was GS found out? Because quant trading recently hit an all-time high of 48.6% of all NYSE trading. And since GS represents 60% of all program trades ... hmmm, well, you do the math. The NYSE keeps close tabs on program trading and was startled that nearly half of all trades suddenly came from program trading. Wasn't it Goldman Sachs that received $12 billion in bailout money to help it overcome complete disaster? One might opine that GS makes money the old-fashioned way ... by stealing it. Who leaked the story? Matt Goldstein at Reuters. We'll keep an eye on this to see how it unfolds and whether we're looking at a scandal or just another day on Wall Street. But since truth tends to turn out far stranger than fiction, it all makes you wonder why anyone would want to buy stocks. Thanks, but for my money, I'll just stay on the Chicago Mercantile Exchange (CME) side, where I trade futures -- away from the NYSE!

Would You Rent to This Tenant?

Fri, 10 Jul 2009 07:00:00 -0500

There's an old relationship adage of "I'd rather be alone than wish I were." When you own rental properties, the same attitude of not settling for just any tenant in this tough economic environment and waiting "till the right one comes along" can pay off big for the discerning property owner. This month, a couple of my rental properties are going vacant. This is something every landlord has to deal with once in a while, but recently the task of finding good-quality tenants has become -- well, shall I say -- a bit more challenging. For example, I received this e-mail recently, in response to an ad I had posted for one of the rentals: "My lease is up where I'm currently renting at the end of this month, and I'm very interested in renting a home. We are good, responsible tenants with no pets, and we are non-smokers. "We don't have the money upfront for first-month's rent and security deposit. Is there any flexibility with the security deposit? We could pay a couple hundred a month extra for the first four or five months, if that's an option." This gentleman must think I am clueless! Oh, I see, they are "responsible," but they don't have enough in savings for a $900 security deposit? Won't they get back their deposit money when they leave their current rental? If not, I have to wonder why. This woman probably thinks she is 'responsible' too... So I responded, as politely as I could -- something along the lines of: "Sorry, but I won't assume the risk of taking someone on who does not have the first month's rent and the security deposit. If tenants are so low on savings that they can't come up with first-month's rent and security, then they are just one emergency (expensive car repair, job cutback, illness, etc.) away from not being able to pay the rent at all." Furthermore, the chances of my getting the security deposit a few hundred at a time over four to five months are slim to none. Believe me, I have been there. Who needs that? A Changing Dynamic These days, I am noticing a big difference when I interview tenants in comparison with years past. Now, not only am I interviewing them, but they are interviewing me back! Prospective applicants now routinely ask me things that tenants have never asked before: Are you going to sell the house? Is it going into foreclosure? Are you behind in your mortgage payments? These are all valid questions, for sure, but they really took me by surprise when I first heard them. Tenants may not realize that -- even if the home is sold -- because they have a valid lease, they cannot be evicted. The new owner simply becomes the new landlord, and must follow the terms of the pre-existing lease, until it is finished. However, at that point, the tenant could be asked to vacate. Additionally, there are landlords who are taking payments from tenants without telling them that the home is going into foreclosure. Some of these landlords are upside-down on their mortgages, and they simply pocket the tenant's money without making any mortgage payments. Then, one day, there comes a knock on the door, and a local authority or process server is telling the bewildered tenant that the home that they just moved into, is soon going to be sold at auction. Tenants' Rights Can Actually Benefit the Owner The good news for tenants is that the law is now looking out for them a bit more. Recent federal legislation requires banks to give tenants at least 90 days' notice of any pending foreclosure, and if there is a signed lease in effect, the bank must honor the length of the lease. In my home state of Florida, a bank previously had the right to remove a tenant from a home in default within 24 hours. If the tenants balked at leaving, they would face a forced eviction. What a terrible plight for an innocent tenant who has been making their rent payments regularly to their landlord! One weakness of the new law is that it does not require the owner to disclose foreclosure proceedings to prospective tenants. On the one hand, this is great for the owner, because no tenant in their right mind would want to lease from them under the threat of removal. It's also possible that the owner could be behind in his mortgage payments and needs the rent to help him catch up and stave off foreclosure. On the other hand, there is an ethical problem (at least in my mind) with an owner setting up a tenant for an eviction by not divulging the possibility of the foreclosure. Unless he asks, the only way a tenant can find out this information on his own is to do the research through the county clerk's office, to see if a lis pendens (first notice of foreclosure) has been filed against the property. But most tenants are unaware that they can or need to do this, or how to even find out that information. So, some of them have taken to asking the landlords now before they sign the lease. Timeline from first missed payment through foreclosure auction... Some property-management companies have now begun asking the property owners to attest that they are not behind in their payments or facing foreclosure, before signing an agreement with them to manage the property. However, unless the property management company were to send the owner an updated notice every few months, they would have no way of knowing if at any point in the future the owner were falling behind on his payments. How Can You 'Secure' the Right Tenant? As an owner, you've got some research of your own to do. In these tough times, when I am looking for a new tenant -- in addition to the usual things that I look for, such as having decent credit and a job -- I need to find out, how secure is that tenant's job? It would be better to have an empty property for a while longer, than to have a new tenant lose their job shortly after moving into the rental and then stop making, or start being late with, their monthly payments. While very few jobs are 100% "guaranteed," there are some jobs that are more stable than others. In my area of Northeast Florida, we have several navy bases. Military jobs are about as stable as one can expect. I have one tenant who is in the navy, and her monthly rent check arrives on time like clockwork. For landlords who are concerned about the stability of their tenants' jobs, I would recommend doing a routine check of their place of employment. Another option would be to rent to tenants on the Section 8 program, in which case the government guarantees a large percentage of the monthly rent to the landlord. However, the Section 8 program can be risky for many other reasons, such as unlawful activity or damage to the home. So, one has to weigh the risks against the potential rewards. Military personnel make excellent tenants... 'Because I Said So!' Successful landlords have always had to be tough, because the landlord-tenant relationship tends to mimic the parent-child roles. Tenants can behave like small children at times. They will test you time and again to see how much they can get away with, before you have to put your foot down. Landlords who are afraid of being assertive with their tenants will quickly find themselves on the short end of the financial stick. Overall, tenants do not care, nor want to hear about, your mortgage payment or your other expenses. 'Tenant' reacts to landlord's pleas of needing his overdue rent to pay the mortgage... Incidentally, a landlord should never rent to friends, family or co-workers, because it becomes much more difficult to take the necessary actions if and when the rent is not paid. Personal relationships can be ruined over disputes, whether related to rent, repairs, property condition or anything else that occurs. Landlords should never befriend their tenants, either. I knew a landlord who would go over to his rental property and watch football with the tenants on Sunday afternoons. They would have a few beers and enjoy the game together like old pals. But a few months later, when the tenants couldn't pay their rent, they were sure that their new "buddy," the landlord, would understand and cut them some slack. Soon thereafter, this landlord lamented to me that he still wasn't getting his rent money, but he admitted that he didn't want to be "mean" to the tenants. MEAN?! So, during the next week, this tough landlord and Tycoon writer is looking for a few tough tenants. I want a tenant who is tough enough to have learned the discipline of saving a few bucks in the bank in case of emergencies. I want a tenant who is tough enough to do his job effectively and competently, so he becomes the last guy the boss wants to lay off during a recession. However, if he does get laid off, I want a tenant who is tough enough to go out and deliver pizzas or work at McDonald's -- anything rather than sitting on his keister awaiting his unemployment check, while he whines to me that he can't pay his rent. I consider myself to be a high-quality landlord, one who provides his tenants with a pristine, clean property that's in good repair. The quid pro quo that I expect from the tenants is for them to simply pay their rent on time and take good care of the home for the length of their lease. So here I am, looking for a few tough men and women to rent my properties during the tough times ahead... A 'sign' of the times... Tycoon landlords: Have an interesting recent story to share about your tenants? I'd love to hear it. See you next week!

Building Your ETF Portfolio, BRIC by BRIC

Thu, 9 Jul 2009 07:00:00 -0500

By now, in the search for portfolio opportunities globally, you've likely heard the term "BRIC" used to describe the fast-growing markets in Brazil, Russia, India and China. As stock markets around the world have shown a nice recovery in the past several months, including the United States, it's still useful to look at some big-picture, longer-term trends. Based on demographics on population trends, China and India (often referred to as "ChIndia") appear to offer some of the most attractive opportunities, while Brazil and then Russia also merit long-term consideration as commodity-driven countries. Let's explore these Exchange-Traded Fund (ETF) ideas further. The Emerging Economic Dominance of China, India This is hardly a new idea, in that the billions of individuals who are moving up thanks to the outsourcing trends from the United States and other relatively higher-cost labor pools (what I call "labor arbitrage" from big corporations looking to lower their costs with cheaper labor in these huge, upwardly mobile populations) will help to drive economic growth at a much faster pace than we can expect domestically. ChIndia's massive populations present the enticing prospect of billions of people entering the middle and lower-middle classes for the first time, and global corporations feeding off the prospect of a surge in consumer spending as these personal income levels rise dramatically in coming years At the same time, I prefer the BRIC ETFs as a way to play these global trends, as the the individually listed companies may be more-volatile and less-certain due to the accounting and shareholder rights for these stocks, which are not on the same level as our own current rules here in the United States. Stocks from these countries have declined dramatically since late 2007, as global growth prospects cooled. But China's annual growth rate went from dropping 9% or 10% to being a positive 5% or 6% currently. So, you'll still see plenty more growth there than in the United States going forward. For the purposes of today's discussion, we will use the following ETFs as proxies for China and India: FXI (the iShares Xinhua China 25 Index) and PIN (PowerShares India). The SPY and QQQQ ETFs are used to track the S&P 500 Index and Nasdaq-100 Index, respectively, in the United States. When the market bottom started to form in March, these two "fallen dragons" began to show impressive outperformance. The resurgence of China began on March 1, several days before the markets bottomed in the U.S. around March 9. India's surge in performance began around March 23, when it began to diverge from the U.S. indices ... the PIN basically matched the FXI performance over this time frame. The outperformance of these two emerging giants would seem to show that they are leading the anticipated world economic "recovery" ... or what may be called a stabilization phase, in my view, after the dark days of the fall of 2008. Continued strength by FXI and PIN would bode well for a continued market rally here. Hard Commodities Will Experience a Continued Resurgence in Popularity With the possible exception of oil (because gasoline literally could become worthless due to technology and, quite honestly, I hope it does in order to stabilize world politics, among other reasons), commodities are poised to gain value in the coming years, or at least hold value in relation to many broader stock market indices. The main reason for this is the total devaluation of paper money by governments worldwide. Because the dollar and every other currency in the world is printed on a piece of paper, actual commodities will gain in relative value (and I'm not just talking about gold). Once again, the possible exception is crude oil, but I may be wrong there. The other main reason is basically "it is what it is" -- meaning, these are actual, tangible products that have an inherent value and multiple uses. For example, if society completely denigrates to Stone-Age economics, lumber (wood) will still have a value in order to build shelters (obviously an extreme example). Who does this benefit? Resource-rich countries likes Brazil, Canada, Russia, Argentina, et al. And savvy ETF (and ETF option) players, as well. Does This Theory Hold Water? You Bet it Does... Water is included in this as a commodity ... drinkable and usable water will be a growing issue in the future, and multiple investment opportunities abound there as well. At the same time, the volatility of these global economies and stock markets allows us to trade both sides. The RSX (Russia Index) is one we have a bear position on right now, helping us benefit from the 14% decline in the Russian ETF in the last week. You also want to look for divergences in relative performance. For example, in FXI vs. RSX recently -- China (FXI) remains strong from a relative performance analysis while Russia (RSX) is breaking down. For those individual investors who want some BRIC exposure without having to pick one of the four major countries, you can also consider buying a BRIC ETF that tracks all of these global economies, such as the Claymore/BNY BRIC ETF (EEB). Here, you get a mix of these countries, with the EEB's latest list of top 10 holdings (from Yahoo! Finance) showing heavier exposure to Brazil and China. Regardless of which BRIC exposure you decide to start building, I'm confident that investors who can handle a bit more volatility will see greater longer-term growth by including a solid BRIC foundation.

Write Your Own Investment Success Story

Thu, 9 Jul 2009 07:00:00 -0500

It's earnings season (again), as Alcoa (AA) got the party started last night by issuing the inaugural report of the season. With its numbers coming in better-than-expected, there is a sense of hope on Wall Street that there is money to be made in this market. With the onslaught of reports set to arrive in earnest during the coming weeks, it's important to tune out the noise, broaden your focus and take a look beyond individual stocks to the strongest and weakest sectors. Today we'll take a look at the recent performance of four sectors and examine how you can generate your own "seasons of earnings" in sectors ... oftentimes more frequently than every quarter! In an article I wrote at the end of April, "2 Sectors Poised to Provide Serious Trading Profits," we took a look at the NYSE Bullish Percent Index charts for the steel-and-iron and restaurant sectors. They were in overbought territory and we were anticipating a fall. We revisited these sectors again in mid-May in "'Steel' Yourself Against Becoming Bear Food." Back then, the steel-and-iron sector did a head fake and moved back up. Our stop-losses would have done their job and gotten us out of the trade with just a scratch. Well, on June 22, Sector Hunter put in a 70% Sell Signal in the steel-and-iron sector, followed by the same signal in the restaurant sector on June 26. Below is Tuesday's Industry Bell Curve from Investors Intelligence. I've circled the current positions of the two sectors, right at that 70% mark. 'Feed Me, Seymour!' Speaking of bears and food, let's take a look at the restaurant industry first. Back in April, this sector was at 86.21% on the BPI, its highest level since 1999. By May, it had fallen to 74.14%. (Remember, Sector Hunter doesn't put in a sell signal till the 70% line is broached.) Here's where it was on Tuesday: So, restaurants also gave us a quick turnaround (note the circled "O" in the third-from-last column, just before the stock went up), where we would have been stopped out, similar to the one in early 2004. But it was too good to be true; the sector couldn't sustain its overbought status and reversed again on June 11 to start its downward tumble. If you got stopped out and waited for the second reversal below 80%, you would have turned a quick profit. Since the June 26 Sector Hunter alert, the sector has continued to move down and can still be a viable play. Notice the next three support levels, as indicated by the green lines on the above chart. We could easily see a move to 52% or lower before any turnaround in the trend, based on this sector's history. Whether you're a stock trader shorting Burger King (BKC) or Sonic (SONC), or you're buying put options on the PowerShares Leisure & Entertainment Holdings ETF (PEJ), this sector could earn you a decent return in the near term. (Please note that these are not recommendations, but simply examples to illustrate the many ways to play the restaurant sector.) 'Steel' Away Into the Night Although I did not personally make a restaurant sector play, I did take positions in the steel-and-iron sector recently. Here's why: The sector turned around from the circled "O" (pointed to by the arrow on the right) and rose to 95.45%. Then some companies put in point-and-figure sell signals, and it again dove to 83.33%. Another turn and it surpassed its previous high, reaching a whopping 95.83%. For perspective, the previous high for the last 10 years was late December 2003, at 89.19%. So the sector was incredibly overbought. In my eyes, it had nowhere to go but down. I waited, however, for the turn -- knowing that a sector can stay overbought for a very long time. So, I decided to do an experiment. In my trading account, I shorted United States Steel (X) -- a security with which I'm pretty familiar and, as such, I've had great success with trading it in the past. In my IRA, I bought put options on United States Steel. After my positions were entered, the sector continued downward. Now, as you see above, there was a brief interlude where the sector traded up again, in a similar fashion as it did in 2008 (the large circled area just left-of-center). It rose again to a level of previous resistance and reversed. But look at what happened last time it rose to this level! Given this sector's history (always an important consideration), I wasn't too worried by this toying with the previous top. As of today, the shorted stock (purchased on the 23rd) is up 14.8%. The put options (purchased on the 24th) are up 35.92%. Who says using options are riskier than trading the underlying securities? Not me! Don't Cry for Me, Latin America You probably noticed in the Industry Bell Curve above that I circled the two sectors currently in the 70% region. Both of them are outside the United States. The first of these is Latin America. Here's its Bullish Percent Index chart: I've marked the three most-recent resistance levels in black lines and numbered them. The previous resistance of 2005-'06 could have turned into a support level if the recent activity had held at the January 2007 level, but it didn't. In June, the sector fell through that line. I've also highlighted in pink the 80-90% range to point out the history of the sector at this level. It typically will fall to at least the support represented by the yellow band (58%-62%) before "deciding" to attempt another rise, or simply falling farther. It has generally established a resistance somewhere under 70% (again, the numbered black lines) before tanking. Given this history, the sector is ripe for profit-taking as a short or option play. The cautious among us will wait for Sector Hunter's 70% signal before entering the fray. Gonna Watch That Stock Rise Out of Thin Air The second sector in the 70 percentile is the Asia-Pacific sector. Here's its current BPI: The "O" in the last column is pointed out just to show that the sector has proceeded below two (admittedly very close) points of past resistance (the black lines). The green lines represent past support levels. Again, the pink highlight is meant to show past behavior from this level. In July-August 2007, for example, the sector dropped rapidly and then climbed back up in September and October. But I've also highlighted the middle in tan to point out how volatile this sector can be, therefore making it harder to peg down. And don't be fooled by the blue Bullish Support Line (BSL). The distance between the recent activity and the trendline is too great to ascribe any significance to the BSL. This is easier to see in the line chart: Too much ambiguity here -- we can't be sure it will establish a trading range nor determine the degree to which it will waver. So, while it's quite possible that this sector is also ripe for shorting, I would spend more time researching the weakest securities -- do peer performance relative strength analyses on, for example, Korea Electric (KEP), News Corp. (NWS), Satyam Computer (SAY), Tata Communications (TCL), CNOOC Ltd. (CEO), James Hardie (JHX), PCCW Ltd. (PCCWY) and S.K. Telecom (SKM). And, for good measure, throw in the Short and UltraShort ETFs EEV, EFU and EUM. Keep an eye on the near-term movement for the sector. Then, if you decide to jump in, use whatever timing tools you use to determine when to make an entry. And keep your stop-losses tight. Until next week, happy hunting! P.S. Five points to anyone who catches the musical spin-offs in the section titles!

8 Easy Ways to Boost Your Profits, Part 1

Wed, 8 Jul 2009 07:00:00 -0500

During the next several weeks, be sure to tune into this space every Wednesday to learn eight tips aimed at making you a stronger, more-confident and -- most importantly -- a more-profitable investor. We plan to cover the following topics, and much more.* (Check out my list of "My 6 Favorite Sectors RIGHT NOW" toward the end of this article.): 1. Focus -- You can't trade everything; how gaining focus will help make you money. 2. Position Sizing -- How much should you place in any single trade? 3. Mitigating Risk: Exchange-Traded Funds vs. Individual Stocks -- What is the risk/reward difference between stocks and ETFs? 4. Stop-loss Points -- Where should you place your stop-loss? 5. Entering Positions -- Where should you place your buy order or short sale order? What type of orders can you use? 6. Exiting Positions -- How to lock in as much of your profits as possible. How to use option strategies to exit your positions 7. Shorting -- What does it mean to "short" and why should you be doing it? 8. Leverage -- The ins and outs of why, how and when to use leverage. *Note: As we go through this journey together, I may add to, or consolidate, some of these topics. Rule No. 1: Focus, Focus, Focus ... and Focus Some More So, let us tackle the first subject: focusing, as it is the very foundation upon which the other tenets are built. In my early investing, before I found my own "groove," I'd flit from strategy to strategy -- embracing each new approach like a long-lost loved one. I'd throw myself into each approach with reckless abandon, risking all I had. Sometimes I'd win but, most times, I lost. Even when I found a strategy that worked, I'd dilute it by spreading myself (and my capital) too thin, trying to trade every single stock I could find that fit the strategy. I frittered away a small fortune using this disjointed approach. Conserve Your Emotional, Financial Capital Just like those who practice medicine, I learned that the most successful investors choose a specialty and they stick with it. I had to find one approach and then totally own it. I realized that I could not learn all there was to learn about trading stocks. There are just too many different approaches that one can use. And, certainly, you can master a new technique and add it to your arsenal. But even if you can get a handle on many or even most of them, you simply can't use too many strategies concurrently, successfully. As for me, I had to choose one method and then commit myself to it. The method that ended up making the most sense to me -- and, more importantly, generating regular returns -- was Point-and-Figure charting. Maybe You Can Have it All, But Don't Try to DO it All The other thing I learned was that I could not trade everything. I just couldn't keep track of 100 open positions. I had to limit the amount of trades that I had on the table at any one time. For me, that number is typically six. That is, I typically will only have six trades on at a time. (Note that I'm talking about trades, or short-term investments, which require more diligence to manage than your longer-term holdings.) Are there times when I have more than six open trades? Sure, but the idea is to keep not only the amount of strategies manageable, but also the number of positions because of how easy it is to lose focus when you have too much going on. Now, depending on your style, having six active trades at a time can seem like a lot or maybe that's how many trades you make in an average morning. Either way, I'm going to show you how I make those six trades generate portfolio-sized returns. What Makes Stocks Move? The Secret's Out... When I discovered that more than 68% of what makes a stock go higher is sector-related, I knew that I had to start thinking in terms of sectors rather than stocks. This was yet another filter that served to hone my focus. Instead of looking at a vast sea of 12,000 stocks to choose from, I was able to narrow that down to 46 sectors. This one move alone saved me hundreds of research hours a year. What I started to learn was that some sectors would have long-term bull-market runs that were often punctuated by extreme bouts of downward volatility. I knew that these were the groups that I wanted to be in. Nothing builds wealth faster than timing volatility correctly. The "hottest" sectors are also the most volatile, so I knew that these were the sectors I had to focus on. Over time, I formalized my research process into the system that many of you now know as Sector Hunter, my automated trading service. In the old days, I did all of this by hand; now Sector Hunter saves me hours of tedious research. What I would do then (and what I still do now) is focus on a handful of sectors that I want to be intimately familiar with. Even though I have developed the wherewithal to do so, I would never attempt to trade every alert in every sector put out by the system. Long ago, I made the mistake of trading everything that looked good to me, and I paid dearly for it. These days, I use my sector-hunting system to time my trades into those industries that I believe will be the most volatile. Why? Because volatility is the haven for big money, and big money creates big moves! My 6 Favorite Sectors RIGHT NOW When a sector starts to trend, either up or down, the move tends to get exaggerated in "hot" sectors. Back in the 1990s, those hot sectors were biotech, drugs, computers and the Internet. I traded those sectors because that's where the money was -- that's where the action was. And if you're looking for where to place your bets next, taking a cue from the traders with the biggest coffers of cash to invest can be a pretty good starting place. At the time, I was still perfecting my Sector Hunter approach, but I knew the big money was to be made by catching the volatility correctly. Fast-forward to today, and the hot sectors for this decade (and probably the next) are oil, oil services, metals, China, Latin America and commodities. These are the sectors sucking in and spitting out the big cash. Fortunes are being made in these sectors on both the long and short side. So instead of playing all 46 sectors, I've narrowed down my focus to just five equity sectors plus commodities. In each of these sectors, I've become extremely familiar with the trading patterns of the winners and losers in each group. Now That You're Focused, it's Time to NARROW That Focus To narrow my focus even further, I chose just one ETF from each group and have become an expert in how each representative ETF trades. Within my five favorite ETFs in the equity sector, I've further narrowed my focus to two to three stocks in each group. So from a global list of 12,000 stocks, I have now gone down to a very manageable list of five ETFs and 10 to 15 of their component stocks. The moves in these stocks and ETFs are amazing. I mean, it's really incredible -- just in the China sector alone, we've seen 100% moves in some of the ETFs! So, it pays to specialize -- in fact, it pays very well. Because just as quickly as the markets take them up, they tear them down. When you start specializing by sector, you gain massive clarity and focus. This clarity provides tremendous confidence as you catch these securities on the way up and short them on the way down. So, my message this week is to narrow your focus. Get clear about where you want to "spend" your mental focus and energy. Refine your approach to just a few sectors and a few big, liquid, volatile stocks in each of those sectors and begin to get a feel for how they trade. Do the same for the ETFs that cover those sectors as well. Start to simplify your investment and trading choices. Due to space constraints I can't go into the absolute detail of how why and when we pick sectors and their attendant stocks and ETFs. If my approach interests you, then you may want to take a look at the education course I created called "ETF Master Trader." In it, I break down every facet of our sector approach and show you exactly how to select the best sectors, stocks and ETFs. Next week, I plan to cover one of the biggest areas of confusion for new investors: how much money to place in a trade! Have a great trading week and I'll see you on Wednesday with the second installment in this series. Stay tuned!

Gasoline Price Outlook Has Sent You a Candlestick "You Will Feel Better Soon" Card

Tue, 7 Jul 2009 07:00:00 -0500

Low gasoline prices were a nice Christmas present seven months ago, but – like some Christmas presents – they didn’t last long. After a long “third wave down” from $3.2571 last September to a low of $0.7877 in December, prices marked a Candlestick bullish “Hammer” pattern for the week of December 26 and then marched upward in a three-wave “a-b-c” upside correction to a high of $2.0386 in June. They stopped dead in their tracks precisely at the 50% retracement level of the decline from last September, which is a perfectly normal expectation. The Weekly chart for the halt depicts a Candlestick “Bearish Engulfing” bar for the week of June 19. Since that time, prices have embarked upon a decline.Since all corrections end at or beyond the point at which they began, we can reasonably expect to see gasoline prices (in the barge) at or below those of last Christmastime. Prices at the pump should fall commensurately.Don’t you feel better now?Respectfully submitted.William KurtzJuly 7, 2009http://www.candlewave.com

How to Sell at the Right Time

Tue, 7 Jul 2009 07:00:00 -0500

When you're entering a stock or option position, not only is it a challenge to find the right one to trade, but also the best time to buy. There are lots of indicators out there that can tell you when it's time to buy, but once you've initiated a position, you've got an equally difficult decision of you -- when do you cash in or cut bait? In other words, how do you know when it's time to sell? Everyone, including the top technical analysts on earth, agrees that picking the right time to close a position is at least three times harder than picking the right time to buy, so you're not alone. However, today I'm going to share with you a signal that you can use to help you decide when to exit a position. Looking for a Sign? Try RSI The Relative Strength Index (RSI) was developed by J. Welles Wilder Jr. in 1978, and is one of the most helpful, widely used indicators used by chartists today. First, it is very important that you don't get this confused with other types of relative-strength indicators. This does not have to do with relative strength when compared to the market, or other sectors. This momentum oscillator is related to the stock's current strength relative to its own recent strength. To way-oversimplify, the relative strength of a stock is the average price change of the advancing periods with the average change of the declining periods each day or week, etc. The number is then "smoothed" by using the previous period's average gain and average loss. When the average gain is greater than the average loss, the RSI rises. And when the average loss is greater than the average gain, the RSI declines. Taking 'Stock' in the Results You can use the average relative strength of any number of time periods (any number of weeks, days, months etc.) but Wilder recommends using time periods of 14. The shorter the time periods used, the more volatile (or sensitive) the reading will be. Depending on your time frame/objectives, you may choose to increase the number of time periods (whether it be days, weeks, months, etc.), as shorter readings are more prone to false signals. This number ranges from 0 to 100 and, similar to the NYSE Bullish Percent Index, a reading of more than 70 indicates overbought territory, and below 30 indicates oversold territory. If the RSI rises from below to above 30, it is considered bullish for the underlying stock, and if the RSI falls from above to below 70, it is a bearish signal. You should also note that, while you can use this leading indicator to find exit points, like when your stock appears overbought while in an uptrend, it works even better when you first identify the current trend and then find the extreme signal for entry points. The RSI in Action You would find a confirmed uptrend, and then use the RSI to find the oversold levels within the uptrend as an entry point. Conversely, you would use it with a stock in a confirmed downtrend to find the overbought point to initiate a short sale. Also noteworthy is that the RSI reading of 50 is considered to be the "centerline" (a key point in the RSI). A reading above 50 indicates that average gains are higher than average losses, and a reading below 50 indicates the opposite (and, basically, that the bears are winning). Why is this noteworthy? Because many traders consider the RSI crossing over the 50 "centerline" to be an extra confirmation of what the RSI seems to be telling you. At this point, it would help to see this on a chart. Making Sense of Sun's Signals Below is a chart of Sun Microsystems, back when it was a $60 stock. (It has since changed tickers and dropped 50 points.) In this example, though, you'll notice that the RSI is highlighted in red in the overbought territory (above 70), and highlighted in green in the oversold territory (below 30). Now remember, stocks can stay overbought for a long time. So, while a reading above 70 is considered overbought, it isn't necessarily a sell signal until the RSI moves back below 70. There are different clues here that could have told you when it was time to sell the stock, and look for something with less risk. First, you can see that from February to March, even though we saw Sun Micro trade higher, the RSI moved lower. This is what we call "Negative Divergence." This negative divergence came after the RSI was slightly above 70 (overbought territory). Negative divergence showed that the momentum was slowing even though the stock was moving higher. Higher moves in a stock's price that are not confirmed by the momentum (in this case, RSI) are likely to be followed by at least a slight decline in the stock. Now, you might be staring at this chart and saying to yourself, "Hey, the RSI had already reversed from an even-higher point in December, to below 70." This is true. But this is typical when a stock takes a breather and trades sideways. Usually, when a stock is overbought, either it needs to correct by moving lower or else it needs to trade flat, which also allows the average price to catch up to the current price. When you think about what the RSI actually is, this makes perfect sense. Notice that this is what occurred in that same time period (December to February). That is why it's important to not only look at the indicator, but to compare this to what the stock is doing. A reading of 50 basically means the momentum is flat. So again, when a stock stops trading higher, and only trades flat, it is normal for the RSI to move to the centerline. Another confirmation that the RSI reading was not signaling a sell was that the support level (blue line), or 50-day exponential moving average (EMA), was not violated. Sure, at this point, you'd want to be extra-cautious, but this is not the same as "negative divergence." After reversing down from overbought territory, the negative divergence did occur, followed by a break in Sun Micro's support level in April, as well as the 50-day EMA. Noticing this and acting could have gotten you out at $45 before the drop to $35. Now look on the right of the chart where the stock topped out at $65. The RSI dropped from above 70 to below 70 and almost immediately dropped below 50. If that wasn't enough for you, the RSI dropped through 50 a second time. And even though the stock seemed to try to bounce back up off of the 50-day EMA, the RSI dropped further down. This was another small (unmarked) negative divergence. This told me to get out above $55 before yet another drop to $35 and, eventually, to the $2 range! 'Goodbye, Moto' Below is a one-year chart of Motorola, before it became the $6 stock that it is today. Again, here you can see that the RSI was in overbought territory, and then reversed back down below 70. You can also see the negative divergence from August to September, and then again from mid-September to October. If these signals weren't enough to spook you, the RSI confirmed its sell signal by crossing over the centerline (50), indicating that the bears were definitely in control. If you didn't listen to the RSI when the stock was trading up above $25, you should definitely have gotten out of the stock when the support level was broken, and the stock moved to $24. You might have been upset that you missed selling at $25, but it would have been way less painful to lose a point then before the stock started skidding into the single-digits. Suncor Shares Run out of Energy Here is a chart of Suncor, a stock that members of my options trading service The Trend Rider made a ton of money on. First take a look at the RSI buy signal in March. You could have bought the stock at $68/share (or the call options, which had traded up several hundred percent). As you can see, after being slightly below 30, the RSI moved higher (showing a higher low) while the stock revisited its same low around $67.80. This was a "positive divergence" after the RSI saw an upside reversal from $30. If that weren't enough for you to buy the stock (a double-bottom, a positive divergence, and a reversal from the $30 level), you will notice that, after the RSI buy signal, the RSI crossed over the centerline as the stock crossed $70, showing that the bulls were clearly in control. Now, what if you bought it at $76 in late March because you saw it gap up above its $75 resistance? That move paid off for many who took that route, as the stock moved above $82. But let's look at it more closely. A 'Flat'-out Sell Signal I highlighted in yellow when the stock essentially traded flat. Usually the RSI would move down near 50 when the stock trades flat (remember?). Even though the RSI, at that point, moved above 70 -- and even slightly below 70 -- it was no big deal, as it would be normal for the RSI to move even lower when Suncor traded sideways. The RSI moved even further above 70 to almost 80. What do you think happened next? That move served as a red flag. But remember, it isn't a sell signal until the RSI drops below 70. When that happens, you want to look for other clues to confirm what the RSI is saying. * Does the RSI move down, but the stock trades sideways? If so, heed the warning a bit less. * Does the RSI drop further and cross under 50? If so, then you have your sell confirmation. Either way, the stock was overbought there, based on the RSI. When you see an overbought stock, it doesn't automatically mean you should run out and short it. But if you own a stock and see these indicators, you know what you will need to do. Until next week.

How to Trade for the Rest of the Year

Mon, 6 Jul 2009 07:00:00 -0500

Half the trading year is over, so it's a great time to stop and do a reality check on what's working (and what isn't) in your individual account. The broader markets have been in a trading range since March. It is now July. You might be asking yourself, if you trade or invest in stocks, whether you should continue to buy-and-hold. You might also be wondering whether to add shorter-term positions to your trading rotation. (There are some great opportunities for daytraders out there. Check out last week's article here for two trading ideas.) There's a lot of money to be made in the markets, and six months left in 2009 in which to do it. As we kick off the third quarter, what can we expect going forward for the remainder of the year? What Do You Do When the Market's Taking a Breather? Right now we are in the summer doldrums -- just look at the trading volumes. In March, the New York Stock Exchange was seeing daily volumes in the range of 8 billion to 9 billion shares. Now, we are barely seeing half that number, with trading volume in the 4 billion to 5 billion range. In March, the trend was nearly vertical, with the Dow Industrials (INDU) regaining 1,500 points. But since March, the Dow has not moved -- and it's almost where it was at the beginning of April. The question on many minds right now is, "Can we expect the Dow to rise again?" Let's compare to 2008, when there was a very troubled economy and the Dow had collapsed. In the summer of 2008, the volume was around 4 billion shares daily. But in September-to-October, volume picked up again, back in the 8 billion to 9 billion range. Don't Wait Till Wall Street Returns to its Trading Desks We know that the market picks up after the Labor Day weekend -- things heat up when the weather starts to cool down. But Labor Day is not until the beginning of September, and it is only July 6. What do we do until then? With a flat market, it seems unreasonable to put your money in a buy-and-hold stock that probably isn't going anywhere. The answer: Find something to trade that is moving for the next two months ... daytrade futures. (Here are my top 3 tips to trading futures.) Something on the near horizon is earnings season, which kicks off this week. On July 8, Alcoa (AA) is the first to report. It is always the first to report each quarter. And for the coming two weeks, we get earnings reports from all the major players, including Google (GOOG), Apple (AAPL), IBM (IBM), the banks, etc. When these companies report, we are given great trading opportunities. These are trades whose average duration is probably 30 to 60 seconds. All it requires is that you be around when the news comes out. That pretty much takes care of this month. So, while we are waiting for the market action to resume in earnest this September, we have lots to trade in July. Also in the Markets This Week ... By the way, expect today (Monday) to be a big trading day because last week, many institutional players were on vacation. Trading volumes were very low during the shortened holiday week ... except in the futures markets, where traders who traded the unemployment news last Thursday (which was a great 30-second trade). Other than that, it seemed, no one else really traded. On Thursday before the holiday, the market went down over 200 points. The Dow is back in the 8,200 range, so we can expect the market to try and put some of those points back on the board this week to remain flat.

Insider Buys and Sells: Weekly Wrap-up

Mon, 6 Jul 2009 07:00:00 -0500

For all the analysts and pundits in the financial media, there is still no better judge of a company's health and future prospects than the owners and executives of those companies themselves, along with major institutional shareholders. That's why insider buying and selling is a critical piece of data that is monitored by people who invest for a living. As part of our continuing efforts here at The Tycoon Report to level the playing field between individual investors and the fat cats on Wall Street, we're keeping you informed -- on a daily basis and at no cost whatsoever -- of the most significant insider buying and selling. Below is a weekly re-cap of the past week's activity of important insider buys and sells. We aim to publish this re-cap every Monday, and it can be accessed in your e-mail issues or on the Tycoon Report Web site. Very important note: While these re-caps are available on the Tycoon Report Web site, if you want the most timely information we provide on insider buying and selling, be sure to read the e-mail issues that we send each weekday morning. SELLS Bed Bath & Beyond Inc. (BBBY) President and CMO Arthur Stark SOLD $1.7 million in options. View details. National Semiconductor Corp. (NSM) President & COO Donald MacLeod SOLD nearly $1.3 million in options. View details. Omnicare Inc. (OCR) President & CEO Joel F. Gemunder SOLD nearly $2 million in options. View details.

This Black Candlestick Has Evil Intent

Sat, 4 Jul 2009 07:00:00 -0500

The Dow Jones Industrials Index fell out of bed on July 2 on the basis of a terrible unemployment report. In so doing, it left in its wake a tall black Candlestick bar, which denotes a decline of 223 points on the day.This followed an outside-down day on June 11 which bearishly engulfed the “real bodies” of the nine - count them, nine – preceding days, as well as a bearish “Evening Star” pattern in the Weekly chart of June 19. These devils are having their effect and are up to no good.The capper is the emergence of a bearish “Head and Shoulders Top” formation. On July 2, the evil black Candle dove to close at 8280.75, which is within ten points of the Neckline. The noose has almost closed. If this Head and Shoulders Top formation continues to develop to completion, it will thereby be forecasting that the Dow will decline to 7614.Just thought you’d like to know.Respectfully submitted.CandleWave, LLCBy William Kurtz, Pres. July 3, 2009 http://www.candelaabra.com info@candlewave.com 906 Whippoorwill Drive Palm Harbor FL 34683 USAPAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.EVERY INVESTOR MAKES HIS OR HER OWN INVESTMENT DECISIONS AND IS SOLELY RESPONSIBLE FOR THEM.THIS COMMUNICATION MAY CONTAIN OR CONTAINS IMPERSONAL INVESTMENT SUGGESTIONS WHICH ARE INTENDED FOR EDUCATIONAL PURPOSES ONLY. IN ANY AND ALL EVENTS, IT IS SUBJECT TO THE TERMS AND CONDITIONS (“DISCLAIMER”) WHICH ARE AN INTEGRAL PART OF THE CANDLEWAVE.COM WEBSITE AT http://www.candlewave.com AND OF THE CANDELAABRA.COM WEBSITE AT http://www.candelaabra.com AND OF THE COMMODITIESJUNCTION.COM WEBSITE AT http://www.commoditiesjunction.com/