The Top 10 Things That Separate Pros From Amateurs

By Jared Levy, Editor, WaveStrength Options Weekly

Dear Reader,

I've just returned from our Global Opportunities Summit in Las Vegas and my mind is swirling with ideas for Smart Investing Daily. I not only had the pleasure of meeting many of you, but also got the chance to have some in-depth conversations with many of my fellow editors from around the country.

At the summit, I noticed that there were common threads that wove their way through the minds of both the speakers and attendees.

Our goal at Taipan Publishing Group is to not only help identify potential investment opportunities, but close the gap between what has made many professional traders successful and what the average investor needs to know.

I assembled 10 of the most important techniques and mantras you should use to take your trading and investments to the next level.

In coming issues, you can be sure I will take each one and more into great detail, but this should at least get you started.

No. 10: Hedge Your Bets/Diversify

• If you are an options trader, you can use spreads to reduce your investment's exposure to the overall market. Some option spreads can not only greatly reduce how volatile your account is, but they actually can put the probability of success on your side.
• Diversify your investment portfolio not only with stocks in different sectors, but also with BETA! Beta tells you how your stock will typically react to the market. If all your stocks have high betas, your account may be susceptible to just as much if not MORE volatility than the market, even if you bought stocks in different sectors.

No. 9: Plan Your Risk Ahead of the Trade

• Have a maximum downside dollar and/or percentage risk spelled out ahead of your investment, not after the fact.
• Use stop-losses, put options or spreads to solidify your plan if you understand how to use them.
• Don't exceed your comfort zone; this may cause irrational decisions in your trade. In other words, don't make your investments too large in any one security.

No. 8: Be a Contrarian

• It's usually better to buy on rumor, sell on news.
• By the time everyone is talking about it, it might be too late.
• Don't be scared to think "outside the box."

No. 7: Sell or Protect While the Trend Is Still Strong

• It's much easier to sell when a stock is rising in value vs. when it's in free fall.
• Remember, insurance is cheaper before you have an accident, so if you are an options trader, buy your puts when the market is complacent, not panicking.
• Think of a climber who is 30 yards from the summit of a mountain and runs out of oxygen. He may touch the top, but he won't get down. This is analogous to a stock that has been rallying for a long time and you take no action to exit. While you may see the top in the stock, stocks can change direction frequently, and most investors don't get to sell the highest high!

No. 6: Learn From Your Losses, NOT Only Your Profits

• Your losses can tell you just as much if not more about your trading personality.
• Sometimes just limiting losses can turn an unsuccessful trader into a thriving one, or at the very least, allow you to live to trade another day.

No. 5: Be Consistent in the Types of Issues You Trade

• Look for similarities in the behaviors of your securities; this will help you to find the patterns you are looking for and will help minimize errors. These attributes include ATR, Price, Volatility, Sector, Chart Patterns.
• Remember that most professionals are specialists in a certain group of stocks or sectors.
• If it feels uncomfortable in a trade, it is probably not for you.

No. 4: Think Three Steps Ahead

• Have a game plan for all possible outcomes in a trade (most retail investors just focus on the best outcome) and have alternatives for a flat investment as well as one that begins to go against you!
• The analogy here is to pretend that you're playing chess or poker; in both games you are thinking about what you might have to do if your opponent (the market) makes a move that puts you in danger. Investing is no different.

No. 3: Trust Yourself

• Professionals are confident in their abilities and their plan.
• NO ONE knows exactly what you are thinking; only you can control your emotions.
• Your risk tolerance and views on the trade are completely unique; therefore even though we can offer trade ideas and theses, you must execute them in your own way and use your individual money management to find how much of your account you will invest.

No. 2: Be Adaptable, Yet Adept in Your Strategy

• Be able to admit you're wrong and change direction when needed.
• Don't apply a strategy you are NOT COMPLETELY comfortable with.

No. 1: Ask Questions

• If there is something you don't know, always ask.
• If there is any piece of the trade that didn't make sense, don't trade it with real money until you are able to quantify it. (Many brokers offer paper-trading platforms to test out new strategies.)
• The only stupid question is the one that is not asked.
• Professionals were not born that way; they too had to learn just like you!

How to use Bollinger Bands to preempt market moves

In a congesting market
Upper and lower bands act as S/R
Bands are usually horizontal
When bands narrow and constrict, watch for breakout! Watch for volume too.
Prices will break out into the band.


In a trending market
Bands open up to signal start of a move
Prices trade along the upper/lower bands (sloping), not S/R
When prices trade outside the band, it may be the end of the move soon, and prices will usually move sideways for a while to get back inside the band
Midband can serve as S/R
Rounded top/bot signals end of move (not trend)
The opposite side of the BB tends to curve inwards first in signaling end of move
When bands close up – possible congestion
When bands continue to slope – resumption of trend

Understand the Investment Clock

The clock tells you the most appropriate investment medium, considering the prevailing economic indicators such as interest rates, commodity prices and inflation. It shows that the share cycle is followed by the real estate and then the fixed interest cycles. The investment clock has proved accurate in reflecting the market forces that drive the various investment cycles. And the order in which they occur.

Looking at the clock, twelve o'clock is the boom and a rapid increase in the demand for real estate results in property prices rising. Often property prices rise by 20% per annum during these boom years.

As property purchases are primarily funded by borrowing, the increased demand for funds causes the cost of funds, that is interest rates, to rise. As interest rates rise, companies find it harder to make profits, and this together with the fact that the booming property market and fixed interest investments seem more attractive, causes share prices to fall or at least stagnate. As property prices tend to boom at these times and because interest rates rise, the rapid growth of the property market cannot be sustained for more than a few years. Property prices stagnate and even fall.

At about 3 o'clock in the investment clock, the share market is usually doing little and offers few prospects for investors and interest rates are too high to make borrowing for property an attractive option. This is the fixed interest or cash part of the cycle when cashed up investors can take advantage of the high interest rates on offer to lenders by way of bonds, debentures and cash deposits in financial institutions.

Other investors just try and battle on paying more interest on their borrowed funds.

High interest rates slow the economy and lead us into the recession.

This brings us down to six o’clock; in the depths of a recession and as mentioned Australia has a recession of varying magnitude every seven to nine years. Now investors are either too scared, or cannot afford to borrow money and in time interest rates slowly start falling. Also during these times companies are forced to become leaner and increase productivity. These measures and the slowly improving economy translate into increased company profits and this gradually stimulates share prices to recover.

We are now at about 7 o'clock. At this point in the cycle most people have left the market having sold their shares as a result of the economic downturn and retreated to cash, fixed interest or even property. Interest rates range down to historically low levels and eventually the point is reached where long term investors see value in the market and start to accumulate the better performing stocks. The seeds of the next recovery are sown and eventually equity and commodity prises will rise.

Understanding the cycle and the cyclical relationship between the share, property and fixed interest markets is critical if you want to maximise the return on your investment dollar, with the minimum of risk.

You may well ask - why do economic cycles occur in the first place? Why doesn't our market driven economy find a nice equilibrium? The simple answer is that the world economy is a collection of many nations each at their own individual point of the economic clock. And each nation is made up of millions of people each making their own financial decisions as a reaction to, or in the expectation of, other people’s decisions. The sheer momentum of all these economies means that they always over swing the mark, resulting in cyclical economic movements.

If the economic clock is well understood and the benefits of being a countercyclical investor are evident, why doesn't everyone make a killing? The simple reason is human nature. Two factors drive the share market: greed and fear. As the value of shares in the share market rises, most investors want a piece of the action and will buy more and more shares. This drives the prices up and leads to further buying. Such a market is known as a bull market. Everyone is happy, as long as the prices keep rising.

However, we know that such activity cannot continue indefinitely. The problem is that the emotion of greed is often stronger than rational thought. Conversely, when prices start falling, uncertainty sets in and most shareholders begin selling their shares before the price falls too far. As selling intensifies, share prices continue to fall. Before too long panic sets in as most investors try to divest themselves of their share holdings.

This is known as a bear market.

Although investors who keep their stocks should be able to sell them for a higher price once the next cycle comes around, the fear of loss forces many investors to sell their shares. Keeping a level head and understanding the market will give you a distinct advantage. Think how much profit you could make if you stood away from the crowd and were in a position to buy when everyone else is selling, and to sell when the pack wants to buy.

My remark:
I do not know the date of the article. The writer mentioned that the time was around 7 o'clock in the article.  It may correspond to the state of economy at the time of writing.

Source: http://www.paritech.com.au

Where are we now?

It seems that the economy of most developed countries moves in a regular pattern, known as the boom and bust cycle. I know that I'd like to know what time it is now so that I could prepare for what's likely to occur in the near future. While the clock is not foolproof, it does demonstrate indicators to watch out for.

Application

This article will be of interest to:
Business Owners who want to under stand more about how the economy works and how they might be affected at different stages of the cycle.
Private Investors who want some independent guidance on when is the right time to own stocks, property and fixed interest deposits.
Real Estate Investors who need to understand why property prices move in cycles and how the comment that real estate prices only ever increase is not true.

What Is The Economic Clock?

The economic clock, pictured above, demonstrates that as an economy moves through its economic cycle there is a time to buy certain types of investments and possible a time not to buy. Notice that I don't say 'sell', because one of the most important investment habits to develop is a long-term investment horizon.
The economic clock is not a signal about what to buy to quickly become wealthy. Rather, it identifies that the return a particular investment will generate depends on what time it is in the economic cycle.
For example, if it was two o'clock then neither share or property is likely to be the best investment option.
To understand the process of the economic clock, let's go through one full cycle.

The Six O'Clock Recession

Recessions mark the peak of a downward swing in an economic cycle.

A recession is defined as a period of two or more successive quarters of decreasing production. Production is usually measured in terms of Gross Domestic Product (GDP), so in layman's terms, any two consecutive periods of negative GDP will constitute a recession.
Recessions are characterised by high unemployment, caused by employers shedding staff as production levels fall, cutting profitability and the need for labour.
With less employment comes a drop in the average weekly earnings and with fewer dollars to spend, consumers demand less, resulting in even lower consumption.
Historically Australia has entered a period of recession every seven to nine years with our last recession in 1990.

Recovery 'Till Midnight

A recovery from recession begins with increased government spending (known as fiscal policy) and control of interest rates (known as monetary policy).
More spending on government projects increases the demand on private sector businesses, which in turn look to employ more staff to cope with increased production needs. Lower interest rates prompt businesses to borrow and invest in capital projects.
Market analysts believe the beginning of the recovery phase is an excellent time to invest in the stockmarket. Companies which survived the recession will be efficient and well placed to obtain higher earnings from growth in target markets resulting in higher share prices and bigger profit distributions.
Share prices move through a period of gradual increases as the hour hands pass between six o'clock until about eleven o'clock when those who have missed out on the stockmarket gain start buying leading to more aggressive market highs. A frenzy begins which marks the beginning of the end of the recovery cycle, which peaks when the economy is booming.
Just before midnight a phenomenon known as 'the greater fool theory' begins. The greater fool theory suggests that no matter what price an investor pays for a share, someone (the greater fool), with less education and less understanding of the market, will buy it at a higher price. Eventually the price rises to a figure when the greatest fool buys because s/he cannot find anyone to buy it at a higher price. When the greatest fool buys the market has reached its peak and is set for a correction.
You know you are in the 'great fool' period when you hear that investors with little or no knowledge of the fundamentals of investing believe they can't lose.

Midnight Boom Before The Impending Correction

Just as the greatest fool has purchased articles appear in the media about how wonderful the stockmarket is and how the good times are never going to end. In recent times stockbrokers coined the term 'new economy' stocks only to see traditional economic theory pierce the hype and bring stock values down.
Well before the clock strikes midnight the wise investors have exited stocks and are looking for the next opportunity. They have left because they understand that there is likely to be a correction in the market, since share prices cannot be justified by traditional stock valuation methods, such as asset backing per share or earnings multiples.
As investors leave the market, supply (sales) become higher than demand (purchasers) triggering a sell off and a slump in share prices. Investors who were too slow (or greedy) are burned, particularly those that have leveraged (via margin lending facilities) and the panic begins as people scream 'sell'.

Property 'Till Three O'Clock

The smart investors that 'got out' at the top move into property with reliable 'bricks and mortar'.
Extra demand in property pushes demand above supply and results in higher prices.
This itself isn't a problem, except that the government sees the economy is overheating and looks to introduce measures to enable a 'soft landing' through increasing interest rates to flatten demand by consumers.
With higher interest rates comes less profit in real estate since most investors have leveraged their property purchases. Rises in interest rates continue until it is no longer viable for purchasers to continue investing in property and soon there are more sellers than buyers. Property prices, like share prices, correct.
There is trouble on the way.

Decline Back To Six O'Clock

Decline begins as business confidence begins to fall. Investors find little value in either stocks or property and with impending trouble on the horizon fixed interest securities become very popular again.
Lower business confidence means that new capital ventures are postponed.
Less spending and higher interest rates result in lower demand, which results in less production. With fewer sales there is a squeeze on earnings, resulting in profit downgrades; economic rationalisation becomes a hot topic in the boardrooms.
The economy slows to the point where productivity stalls and then declines. When this happens for two periods in a row, the economy is said to be in a recession.

Pros and Cons of Fundamental and Technical Analysis

1. Fundamental analysis examines the health of a company using balance sheet data, revenue projection models and just plain common sense.
A fundamental analyst might say, "I'm buying XYZ because they have little debt, great cash flow and big profit margins, and everyone around the world seems to love their widgets more and more every day."

Pros
    •    Most of us agree with this thinking and can gather the data fairly easily.
    •    It is generally a smart practice to invest in a company with sound financials that is witnessing material revenue growth.
Cons
    •    The problem with fundamental analysis is that you are still making predictions about the future that may not come true.
    •    Fundamental analysis can be a lengthy, complex process.
    •    Remember that even if a stock looks financially healthy and is relatively cheap compared to its peers, that doesn't mean that it will always rise in value. A stock's price is also determined by the supply and demand of its shares.

2. Technical analysis looks at a chart of a stock's price movements. Analysts look for patterns to determine future movements in the stock. There are hundreds of "indicators" that can help find buy or sell points, or price trends and momentum.
Indicators have been created by investors over the years. They take the data in the chart and apply a mathematical formula. This produces a line, dot, band or other visual cue for the analyst to interpret.
A technical analyst might say, "I'm buying XYZ because the stock price is above its 50- and 200-day moving averages and has strong momentum at the moment."
Pros
    •    Patterns in price and volume can help us identify trends. They can also find price levels where investors tend to buy or sell.
    •    This analysis goes quickly once you know and understand the indicators you want to use.
    •    Technical analysis can help you rationalize the price you are paying. In other words, if you researched a company and simply bought it without looking at a chart, you have no way of knowing where the stock is in relation to its past.
Would you want to buy a stock that is at an all-time high and has just risen over 40% in the past month? What if you then looked at a chart and noticed that it had done that three times in the past, and that each time it hit a new high it then sold off 20%?
Cons
    •    There is an overwhelming amount of different indicators out there. It is tough to find the ones that are most effective for your style of trading.
    •    It takes skill and experience to identify trends and patterns.

What technical indicators should you use?
There are dozens of different indicators to choose from. Some are better than others.
I suggest that you focus on some of the more commonly used ones for your strategy. I believe that basic indicators, followed by many investors, are more reliable than more obscure methods.
Such common indicators include moving averages, volume, Fibonacci levels, Bollinger Bands, trend lines, ATR, MACD and Stochastics.

Hints and Tricks
Support and resistance levels give us price ranges to enter or exit a stock. Sometimes it helps to draw a trend line (like the one in black above) to find those levels.
Average True Range (ATR) and volatility help us measure how much a stock "normally" moves and if it is behaving oddly. This indicator may be either showing you an opportunity or warning you that there might be an underlying problem.
Moving averages help identify trends. A simple technique is to make sure a stock is above its 50- and 200-day moving averages if you are going long. On the chart above, these are the orange and red lines. Once the stock price gets below the 50-day moving average, it may be time to sell.

Summary
I believe that technical analysis works mainly because so many people believe in it and use it. It almost becomes a self-fulfilling prophecy.
It has been used in some form or fashion for thousands of years, dating all the way back to Chinese rice farmers. The patterns and indicators sometimes seem unusual, but amazingly, many still manage to find their way into a stock's chart. You would be amazed at what pops up.
Use a combination of both types of analysis. You would be foolish to omit one or the other.
Remember that there is always more than one solution

Jared A. Levy

The Fed model

To help keep inflation manageable, the Fed watches inflation indicators such as the Consumer Price Index (CPI) and the Producer Price Index (PPI). When these indicators start to rise more than 2-3% a year, the Fed will raise the federal funds rate to keep the rising prices under control. Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall.

A good example of this occurred from 2001 to 2002, when the Fed cut the federal funds rate to 1.25%. This greatly contributed to the economy's 2003 recovery. By raising and lowering the federal funds rate, the Fed can prevent runaway inflation and lessen the severity of recessions.  When interest rates are rising, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop. On the other hand, when interest rates have fallen significantly, consumers and businesses will increase spending, causing stock prices to rise.

Interest rates also affect bond prices. There is an inverse relationship between bond prices and interest rates, meaning that as interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. The longer the maturity of the bond, the more it will fluctuate in relation to interest rates. One way that governments and businesses raise money is through the sale of bonds. As interest rates move up, the cost of borrowing becomes more expensive. This means that demand for lower-yield bonds will drop, causing their price to drop. As interest rates fall, it becomes easier to borrow money and many companies will issue new bonds to finance expansion. This will cause the demand for higher-yielding bonds to increase, forcing bond prices higher. Issuers of callable bonds may choose to refinance by calling their existing bonds so they can lock in a lower interest rate.

The Fed uses its tools to control the supply of money to help stabilize the economy. When the economy is slumping, the Fed increases the supply of money to spur growth. Conversely, when inflation is threatening, the Fed reduces the risk by shrinking the supply.

To implement its primary task of controlling money supply, there are three main tools the Fed uses to change bank reserves:

    1.    A change in reserve ratio is seldom used but is potentially very powerful. The reserve ratio is the percentage of reserves a bank is required to hold against deposits.A decrease in the ratio will allow the bank to lend more, thereby increasing the supply of money. An increase in the ratio will have the opposite effect.

    2.    The discount rate is the interest rate that the central bank charges commercial banks that need to borrow additional reserves. It is an administered interest rate set by the Fed, not a market rate; therefore, much of its importance stems from the signal the Fed is sending to the financial markets (if it's low, the Fed wants to encourage spending and vice versa). As a result, short-term market interest rates tend to follow its movement. If the Fed wants to give banks more reserves, it can reduce the interest rate that it charges, thereby tempting banks to borrow more. Alternatively, it can soak up reserves by raising its rate and persuading the banks to reduce borrowing.

    3.    Open-market operations
Open-market operations consist of the buying and selling of government securities by the Fed. If the Fed buys back issued securities (such as Treasury bills) from large banks and securities dealers, it increases the money supply in the hands of the public. Conversely, the money supply decreases when the Fed sells a security. Note that the terms "purchase" and "sell" refer to actions of the Fed, not the public. For example, an open-market purchase means the Fed is buying but the public is selling. Actually, the Fed carries out open-market operations only with the nation's largest securities dealers and banks, and not with the general public. In the case of an open-market purchase of securities by the Fed, it is more realistic for the seller of the securities to receive a check drawn on the Fed itself. When the seller deposits it in his or her bank, the bank is automatically granted an increased reserve balance with the Fed. Thus, the new reserves can be used to support additional loans. Through this process, the money supply increases.

The monetary expansion following an open-market operation involves adjustments by banks and the public. (To find out more, see Formulating Monetary Policy.) The bank in which the original check from the Fed is deposited now has a reserve ratio that may be too high. In other words, its reserves and deposits have gone up by the same amount; therefore, its ratio of reserves to deposits has risen. To reduce this ratio of reserves to deposits, it chooses to expand loans.

When the bank makes an additional loan, the person receiving the loan gets a bank deposit. At this stage, when the bank makes a loan, the money supply rises by more than the amount of the open-market operation. This multiple expansion of the money supply is called the money multiplier. Bank loans and purchases of securities are described as bank credit. It is the existence of bank credit that makes the money stock larger than the monetary base, also known as "high-powered money". High-powered money consists of currency and bank deposits at the Fed.