The Weekly Trader

Here’s an article I wrote about the differences between fundamental and technical analysis (below): http://bit.ly/NeZTam

Trading: Art Meets Science

Fundamental or technical analysis? You don’t have to choose. A combination can help with potential entries and exits.

Words By Michael Sincere

Which is better, fundamental or technical analysis? For traders and investors, this debate may rival the classics: Hatfields & McCoys or cats vs. dogs. There can be subtle or profound differences, depending on who you ask.

Fundamental trading is a little more “art.” That is, subjective (See Figure 1). Past company earnings are fact. Yet, where company profit might be headed is anyone’s “educated” guess. Or, take share-price valuation. It’s based on math, but also requires that traders check their gut before jumping.

FIGURE 1: A quote detail on TD Ameritrade’s Trade Architect platform provides news, earnings, analyst estimates for upcoming quarterly results, and more. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

FIGURE 1: A quote detail on TD Ameritrade’s Trade Architect platform provides news, earnings, analyst estimates for upcoming quarterly results, and more. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

Technical trading (the “science” for our purposes) hinges less on why a market is performing the way it is and more on what a chart shows at a particular time. Like any science, this method isn’t fool proof either.

Below, two active home-based traders invite us for a peak over their shoulder. One considers herself a fundamentalist who leans on chart readings for support. The other is a technician who generates trading ideas by skimming the fundamentals. Study their research methods, analysis, and chart tricks, but keep in mind, their level of expertise or particular approach may not be the best fit for your goals and risk tolerance, or it may contradict your own preferred style. Still, you’ll get an idea of how a fundamentalist works versus how a technician works. In reality, you’ll likely find that both mix a little art and science.

Meet Toni Turner

FUNDAMENTALIST USING TECHNICAL CONFIRMATION

Why take this approach? “You wouldn’t walk onto a golf course with only half your clubs. To get my own reading of what a stock is worth, I combine both,” said Toni.

Let’s watch Toni trade.

5:30 A.M. ET I begin my research by checking the stock index futures, the Asian and European markets, or choosing a sector or industry group that, as I see it, has a chance of advancing (or declining) in the current market environment. Once I focus on a sector or industry, I create a watch list of five or six equities.

TONI’S RESEARCH APPROACH

Once logged in to tdameritade.com, I open Research & Ideas > Stocks. I’ll check the overview page on each stock, and check the earnings per share, the price/earnings (P/E) ratio, and the annual dividend and yield. For position trades, I tend to like value stocks with dividends. If a company has an extremely high P/E ratio, then I will probably avoid that stock no matter what the technicals tell me. Why? Because if the market takes a sudden downturn, over-priced stocks with poor fundamentals are potentially “shorting targets” of hedge funds. I check out how my target company compares to the same industry group and I see what analysts are saying.

Within ten to fifteen minutes, I can usually learn a tremendous amount about my target stocks using both technical and fundamental analysis. If my stock has good fundamentals, it probably has big institutional support. And if it has crummy fundamentals, it could be one of the first stocks to potentially fall in a downturn.

8:00 A.M. Using technical analysis, I go through the daily charts of each of my target stocks. When I find a setup on the daily chart that I like, I’ll flip that daily chart to a weekly chart because the buy-and-sell signals on a weekly or monthly chart are stronger than on a daily chart.

If my weekly chart confirms it is indeed a buy signal, then I go into my TD Ameritrade account and read fundamental research. I am interested in earnings growth over the last four quarters, and also projected earnings growth. For me, the most important piece of information on the fundamental side is earnings. It only takes a few seconds to check this.

9:00 A.M. Now that I have an overview of the fundamentals, I look at setups using moving averages (MA), such as the 10-day, 21-day, 50-day, and 200-day. I like my target stock either in an uptrend or forming a base, and consolidating in a neat, orderly pattern. I’m looking for a stock that could break out of this pattern. If the stock on a daily candlestick chart (See Figure 2) has long shadows on the top or bottom of its body, that indicates intraday volatility, and I might remove that stock from my buy list. I’m not interested in a stock that has high intraday volatility if I’m swing trading. In that case, I prefer ordering patterns.

Even if fundamentals are good but my stock is trading below its major moving averages, and indicators such as Relative Strength Index (RSI) [See The Chartist in the June issue for more on RSI] are pointing down, I’m not going into it. I use technicals for entries, and fundamentals to confirm them.

9:30 A.M. The only opening-bell trades I make are taking profits in positions that gap up from the night before, or if I need to make an emergency exit.

FIGURE 2: The “candlestick” for each trading day marks the high, low, open, and close. From there, moving averages and volatility can be tracked. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

FIGURE 2: The “candlestick” for each trading day marks the high, low, open, and close. From there, moving averages and volatility can be tracked. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

11:00 A.M. During the day, I’ll look at economic reports due to come out the next day. I might also take some profits off the table on intraday trades.

1:30 P.M. I’ll continue scanning daily, and 5-minute, charts for strong stocks in an uptrend (or downtrend for down days) that have pulled back from their session highs. I’ll focus on the stocks that are closing in on their highs (which is reversed, if shorting).

1:45 P.M. I might add a little money to open positions depending on the mood of the market. I’m still looking for potential profit-taking opportunities.

3:15 P.M. Before the 4:00 p.m. EST market close, I want to cash in on profits before other traders exit and drive prices down.

Meet Deron Wagner

TECHNICIAN WITH A FUNDAMENTAL SCREENER

Deron primarily sticks to technical analysis, focusing on RSI (See Figure 3). He uses fundamental analysis to find stock candidates.

“For my own trading, technical analysis tells me everything I need to know about deciding my bias on the direction a stock is going: up, down, or sideways. My number one indicator is price. Volume is second,” said Deron.

9:00 P.M. ET The night before a given trading day, I filter through 300 to 500 charts that meet my trading criteria. I like stocks that are consolidating after making highs for at least several weeks, which form bullish chart patterns. The stocks that I think will be the strongest will probably be the ones with strong earnings. Other than earnings, I don’t really care about P/E ratios or other fundamental data, because I think it doesn’t determine the price action of a stock in the near term, and I’m primarily a short-term trader.

7:30 A.M. In the morning, I check out the U.S. futures market and study the Asian and European markets for breaking news.

8:00 A.M. I look for potential gaps in the stock positions on my watch list, or any stocks I’m already in. Then I look at economic data, and check for analyst upgrades or downgrades. Finally, I create a game plan, which helps me to know exactly what I will buy or sell using my target prices. By 9:15 a.m., all of my information is collected and I’m ready to start the trading day.

9:30 A.M. I am managing positions—that is, buying and selling stocks. Meanwhile, I am filtering through the stocks on my watch list (a very short list) to make sure I don’t miss any entries. On the long side, I look for stocks showing relative strength to the broad market.

11:30 A.M. I go over any stock positions to see how they traded during the morning session. I determine if I need to adjust any stops or change position size.

2:15 P.M. Because, as I see it, this is often a reversal period, I keep an eye out for potential sharp reversals.

3:30 P.M. Near the end of the closing day, I check to see where the stocks I own close. If I don’t have many positions, I scan my nightly watch list to see how the stocks performed during the day.

4:00 P.M. At the market close, I log my trades into a spreadsheet and analyze profitable, or unprofitable, positions.

Deron, in fact, finds a little art and science within technical trading. “In my opinion, technical analysis is probably 70% science and 30% art. The art is learning how to translate what you see into deciding whether to buy or sell. The science part of technical analysis is really the personal trading rules, which; for me, are already in place,” he said.

The bottom line: Both approaches offer strengths and weaknesses. Combining fundamentals with a solid charting skill set may become a more popular way for traders to call it as they see it.

http://bit.ly/NeZTam

Here are some of the lessons I learned about the stock market:

Commentary: John Bogle, Peter Lynch and other remarkable teachers

MIAMI, Fla. (MarketWatch) — Although this column is primarily about trading, I’ve also interviewed and learned from hundreds of longer-term investors. Successful traders and investors often have similar goals: manage risk; diversify, and learn to control emotions. The main differences are the tools they use and how long they hold a position.

Here are a few notable investors I’ve interviewed over the years, and what I learned:

John Bogle: When I interviewed Vanguard Group founder John Bogle for my first book, his most useful advice was “stay the course.” He told me that people are the most optimistic when the market is at an all-time high, and most pessimistic when it’s at an all-time low.

“Time is your friend, impulse is your enemy,” Bogle said. Bogle is a huge proponent of diversification, and also advised holding stocks in an amount that lets you sleep at night. “Sell down to the sleeping point,” he said.

William O’Neil: He explained how to manage risk. When first entering a position, he often buys half of a normal position, and adds a little to it if the stock goes up. O’Neil’s most useful advice to me: Make bigger money when you’re right, and cut losses when you’re wrong. O’Neil, a veteran trader and founder of newspaper Investor’s Business Daily, also stresses that you do not always need to be in the market. Knowing when to lock in gains and move to the sidelines is just as important as knowing how to capture gains in the first place.

Peter Lynch: I learned from Peter Lynch that if you understand what you own, and what the company does, you won’t panic if the market or your stock goes down. The former Fidelity Magellan Fund manager doesn’t panic during bear markets, and takes them in stride.

John Templeton: In 1998, while doing research for a book, many sources spoke highly of legendary stock investor Sir John Templeton. So I picked up the phone and spoke to his secretary, who gave me his number in the Bahamas.

I was surprised when Sir John answered the phone. I spoke with him for 15 minutes and asked if he’d agree to a longer interview. He politely declined.

The lesson I learned: First, do your research. Second, be prepared for anything. Unfortunately, I learned this on my own, because I don’t remember one thing Sir John told me about the stock market. I wasn’t recording the conversation and I didn’t take notes. Why? Because I didn’t fully appreciate to whom I was speaking. Calling Sir John was similar to speaking with Warren Buffett on his private line.

Now, before I do any interviews, I do my research, and I am prepared for any possibility. I have applied these same lessons to investing or trading in the stock market. I don’t invest or trade in a stock, bond, or option unless I’ve done my homework.

10 other lessons

Even though I’ve learned many lessons about the stock market, some of the best advice came from my grandfather, the president of a successful stock brokerage. He wrote the following to my father:

  1. Begin by paying off all your debts.
  2. After being debt-free, you must not be tempted to blow your money on risky financial adventures.
  3. It is hard enough for most people to earn a bare living, including 95% who are unable to keep and acquire a fortune. This is not to discourage you but to warn you and give you courage to fight harder to be one of the 5%.
  4. Always be prepared for the possibility that you may have to support your parents. In addition, you owe it to your spouse and your family to buy life insurance.
  5. You want the privilege of helping those who are afflicted and impoverished.
  6. The most important measure of success is integrity, hard work, and being right more than 55% of the time. This also means diversifying risks so that when you are wrong it won’t break or crimp you.
  7. Never co-sign promissory notes to help others.
  8. Never buy stocks in small corporations to please friends — easy to buy, hard to sell.
  9. Don’t be easy in loaning money except in extreme cases (i.e. don’t let down a worthy friend).
  10. Only hard experience, proven by fact, should impress you and cause you to follow the rules just outlined.

In addition to this common-sense advice, I also learned that the simplest strategies are often the most successful. Warren Buffett famously said that he doesn’t invest in anything he doesn’t understand. Stick to strategies you know and understand.

Most important, be aware of your emotions. If you’re too bearish, you’ll miss out on profitable investing opportunities. And if you’re too bullish, you’ll be unprepared for worst-case scenarios. Getting too emotional about the market may cloud your judgment and damage your portfolio.

Whether an investor or trader, it’s important to create target prices for buying, selling, and emergencies. Stop-losses can be mental or manual, but know in advance when to get in or out.

Finally, it’s a personal choice whether to use technical, fundamental, or sentiment analysis. But no matter how you analyze the market, get out of a stock when you’re wrong, and stay in when you’re right. It’s easier said than done, but essential for stock market survival.

As a followup to my previous column, It Might Be Time to Sell, I wrote an article for Marketwatch on trading in a bear market. Although this market could have a snapback rally, the technical damage to this market has been severe. Being on the short side of this market seems like the right place to be, at least for now. Here is the article:

MIAMI, Fla. (MarketWatch) — One of the most frustrating aspects of the stock market is that by the time you figure out what’s happened, it’s already too late.

To stay on top of the market, be open to when one trend ends and another begins. According to one professional trader, that time is now: the bull market has ended and a bear market has begun.

“The market temperature has changed. I’m seeing technical signals, which we haven’t seen since the 2007 top. This is a bear market, which could last for the next year,” said Dr. Alexander Elder, author of several bestselling books, including “Come Into My Trading Room,” and his latest, “To Trade or Not to Trade.”

Not surprisingly, Elder is short the U.S. market, which means he is selling individual stocks at a high price and planning to buy them back at a lower price in the future.

Another way to short the market is to buy an inverse exchange traded fund, or a bear market mutual fund. If you’re not comfortable being on the short side, you can always move to cash, at least temporarily. And if you don’t want to sell now, you can protect your stocks with stop loss orders.

“I am heavily short,” Elder said, “and I’m loving this market. I switched from a long position to a short position in mid-April. In a series of Marketwatch articles, Elder wrote that the top was when Apple hit its all time high on April 12th. Here is a link to one of his articles: “Three Major Signs the Bull Market has Ended.”

When will Elder be bullish again? Not anytime soon, he said. “It will be an unpleasant bear market but I don’t think it will be a disaster.”

1. Basic trading

A new trader might wonder how to make money in this difficult market environment. Elder has some advice: “Lots of smart people stumble into trading but don’t know the most basic rules. I think a terrible mistake that beginners make is wanting to make money from the get-go…you have to spend time educating yourself.”

Then, start with small positions, perhaps 100 or 200 shares, Elder said. “Money will come later if you play it right,” he added. “A beginner should open an account and trade a small size to learn how to do it.”

2. Diary of a trader

Elder is a proponent of maintaining a trading diary. “You have to keep track of your trades,” he said. “Keeping a diary makes you more thoughtful, and helps you learn from your successes and losses. You become your own teacher.”

He primarily uses technical indicators to make trading decisions, but does consider a few fundamentals. Said Elder: “When something comes across my screen that looks interesting, such as a new technology, it will put me on alert. Then I go to my charts and make the decision to buy or not to buy, to short or not to short.”

Elder doesn’t rely heavily on fundamentals “because they are always late,” he said. “By the time the fundamentals come out, prices have already started to change. That is why my primary attention is on technical analysis, but once in a while an exceptional piece of fundamental news appears.”

He relies on a short list of technical indicators and insists on using two time frames: a weekly and daily chart. “I use the weekly chart for strategic decisions and the daily chart to look for entries and exits.”

3. New High-New Low Index

Elder’s favorite leading indicator of the stock market is the New High-New Low Index.

This index tracks stocks that are making new highs or new lows for a specific time period. Elder uses this indicator to monitor the underlying breadth of the market (i.e. the number of stocks participating in the market’s move).

If stocks making new highs are expanding, this indicates the market breadth is positive, and the market is likely to rise. Conversely, if stocks making new lows are expanding, then market breadth is negative and the market is likely to fall. The most important signal is a divergence, when the market is rising but the number of stocks making new highs is falling.

“The New High-New Low is the single best leading indicator of the stock market,” Elder said. “I’m looking to see if it’s positive or negative, which tells me whether the bulls or bears are leading the market. Also, if the market goes to new highs but the New High-New Low indicator traces a bearish divergence, this is a tremendously dangerous sign.”

In the middle of May, Elder saw his signal: the number of stocks making new highs plummeted (although it’s recovered a bit since then). That brings us back to the beginning: Elder now believes the market breadth is negative, and a bear market has started.

“It’s not unusual to have a bear market,” he said. “The average duration of a bull market is three years, and this bull market started in March 2009. We could have a bear market for the next year.”

Day trading sounds so easy, doesn’t it? After all, isn’t it just sitting at your computer all day, buying and selling stocks — and piling up profits? Well, not exactly. Few people realize how much experience and skill is needed to make money as a day trader. It’s easy to get tripped up by mistakes, especially during your first year.

Here are 10 of the most common errors many day traders make.

1. Not having a Plan

“The most common mistake traders make is entering a trade without a good plan,” says Toni Turner, author of “A Beginner’s Guide to Day Trading Online.”

“Nearly every mistake can usually be traced to trading without a plan.” Too many rookie day traders enter the market without appreciating that they are wading into potentially dangerous waters. Protective planning against losses means determining your entry price for buying a particular stock, your exit price and an escape price — also known as a stop loss.

2. Misusing Margin

If there is anything that can destroy a day trader’s account, it’s margin. That’s when you borrow from a broker to buy securities. If used properly, margin is a valuable tool that can boost profits and give traders breathing room. When margin is used improperly, financing a trade with borrowed money can be dangerous to your wealth. In the past, many people misused margin, borrowing more from the brokerage than they could afford. It wiped out some traders’ accounts and helped to give day trading a bad name. It’s best to day trade with money you actually have, not money you borrowed.

3. Chasing Trades

One of the most common day-trading errors is chasing a fast-moving stock on the way up or down. More than likely, this could lead to an unprofitable trade. “When we see a stock go higher and higher, we all want to join in the celebration,” Turner says. “The problem is that experienced traders are going out the back door while new traders are coming in.” If you miss a stock on the way up or down, let it go. There will be other trading opportunities.

4. Not Understanding Market and Limit Orders

Not everyone agrees on which is best — market orders or limit orders. A market order is an order to buy or sell a stock at the current market price. With a limit order, you can establish your maximum or minimum price for trading a security. Market orders get filled fast, but you let the market control your order. Conversely, limit orders allow you to control the parameters.

“Now that spreads are a penny or two on many stocks, limit orders make no sense,” says Deron Wagner, founder and head trader of Morpheus Trading Group. “You could miss a fast-moving stock just to save a few cents.” With high-quality liquid stocks, you can use either a market or limit order.

5. Listening to Tips

At least once, nearly every trader gets fooled into buying stocks based on tips from persuasive sources. Even when the tipsters are right, they aren’t there to tell you when to sell. It takes a lot of self-control to keep your ears closed, but successful day traders rely on their own judgment — not on what others are saying.

6. Refusing to Cut Losses

It’s human nature to hope that a losing stock turns around. But if you’re a day trader, refusing to cut losses can damage your account. “Instead of hoping for a stock to go back up, take that money and transfer it into a stock that is really going up,” says day trader John Kurisko, host of Day Trading Radio. When a stock is headed south, be disciplined enough to prevent a small loss from turning into a much bigger one.

7. Trading Too Early or Too Late in the Day

The first and last 15 to 20 minutes of the trading day are usually chaotic, as market orders are filled from anxious investors rushing to make moves near the opening or closing bell. You also are competing with institutional and high-frequency traders. “The first and last 15 minutes are too volatile for new traders,” Kurisko says. “It’s like the Wild West, and sometimes there is no rhyme or reason to it. Also, the indicators don’t have enough data, so they get choppy.”

8. Letting Your Emotions Rule

What does it take to become a better trader? Discipline. “You need to develop a set of strict rules that takes the emotion out of a trade,” Kurisko says. “Most day traders use technical analysis.”

For example, Kurisko uses stochastics, an indicator used by many traders to determine if a stock is overbought or oversold. If the stock is oversold, then he starts to buy. “You must listen to the charts, not the news,” he adds.

9. Having Unrealistic Expectations

Some rookie day traders keep looking for something magical that will bring them easy profits. A few have already calculated how much money they plan to make in the market. Unfortunately, the market has other ideas. “Don’t seek a silver bullet,” Wagner says, “because there isn’t one. Some people will jump around looking for different instruments and strategies without taking an honest assessment of themselves. There is no easy way to play the market.” He says traders need a strategy, rules and discipline to become profitable.

10. Going Into day Trading Uneducated

Uninformed day traders think that anyone can make money day trading. But to be successful at it, you’ll need training. “If you were laying on the operating table, waiting for your surgeon to take out your appendix, you wouldn’t want that surgeon to walk in reading a pamphlet, ‘How to Remove an Appendix in 10 Easy Lessons,'” Turner says. She says to be a consistently winning trader, you should start with paper trades, and then study hard so you understand how the market works. “Learning to day trade successfully can take as long as going through college and obtaining a degree,” she says.

My latest article for Marketwatch.com on the one Muppet that trades well, and the eight Muppets that lose money 🙂

Many investors were taken aback last month when an ex-Goldman Sachs executive revealed that clients were sometimes referred to as “muppets” in interoffice emails. If you know anything about Muppets, you’d know that being called a Muppet isn’t necessarily an insult.  http://bit.ly/HIMU0j