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LESSON 1: Discipline, Discipline, Discipline
The market is complex because so many factors influence it. But when you play the market, that game is all about numbers – yesterday''s, today''s and tomorrow''s stock prices. Numbers don''t respond to emotional appeals, so relying on your emotions will, more often than not, get you in trouble. The counterpoint to emotion is a well-thought-out, fact-based strategy that you follow consistently. No matter how you feel, stick to your plan and your odds of success will improve. Discipline is the real key to investing.
The Four-Step Game Plan
If you follow this four-step plan every time you make a stock purchase, you can gain more confidence in your investment actions. You will have gathered your facts, covered all the bases and made a disciplined decision.
Step 1: Analyze the Market
This course will teach you to construct easy analytical charts – all on your own – that can help you determine if the market is trending upward or downward. Even if the market doesn''t always play fair, there are recognizable patterns in price trends that you can use to predict future movement. This is the information you need first in making a buying decision. If the market is moving upward or about to surge, you may want to aggressively pursue new opportunities. However, if conditions look less promising, perhaps you should focus on protecting your capital.
Step 2: Select Bullish Sectors
The same techniques you use to chart the market as a whole can also be used to analyze specific industries. You will learn how to find the industry sectors that are on the rise. The sector picture changes more often than most investors realize. Internet stocks had a deceptively long – and flamboyant – bullish period, but did you notice or take advantage of the shorter bullish cycles of food, utilities, banks and insurance stocks that occurred while the technology stocks were bearish in 2000?
Step 3: Create a Catalogue of Sound Stocks
Many sources offer information you can use to compile a list of companies that have a sound financial and marketing basis for success. For information on a company''s price-to-earnings range, sales, assets, markets, products, etc., you can look at a variety of research sources online. Compile a short-list of high-quality stocks and choose from this list in building your portfolio.
Step 4: Identify Equities That Are on Their Way Up
To make money, you want to purchase sound stocks with prices poised to move upward. We will show you how to find out when your "short list" stocks are in this position. Remember the pricing patterns in Step 1 that we said could help you predict how the market may move? You can also use the techniques you''ll learn to chart trends in individual stocks. You''ll be able to see when a stock price is on the rise or when it is bottoming out, as well as when a buying frenzy is beginning and when most potential buyers have already made their moves. This information will help you pinpoint the most profitable time to buy.
You may have heard about value-based investment strategies. These support finding stocks whose quality and excellent business prospects seem "undervalued" by their current stock price. This isn''t a bad idea, but according to Tom Dorsey and other technical analysts it may not be enough. Why? Because prices aren''t determined by quality, they''re determined by supply and demand. In addition to a stock''s value, you need to know if anyone''s buying.
LESSON 2: Why You Need Technical Analysis
No matter how terrific your stock, it won''t rise in price unless someone wants it badly enough to pay more for it than you did. That''s the law of supply and demand, and it controls prices on every open market.
Quality, the basis of value investment strategies, is one of the factors in whether or not anyone wants your stock. That''s why you need to create a list of sound stocks. To do this, you use fundamental analysis. Fundamental factors entail everything that affects a company''s business prospects, including its assets, earnings, products, markets, competition and management.
For fundamental analysis, you should rely on professional analysts. No one person could possibly do all the necessary research, but many sources can provide you with the information you need. The resources you will want to use depend on many factors, including the amount of your own time you have to spend, whether you use a conventional or online brokerage service, how much you are willing to pay for help and which new Internet resources are available.
However, to determine whether your high-quality stock is going to make you any money, you need to add technical analysis. Technical analysis is the study of stock price and volume movements. Simply stated, are prices rising or falling? Technical analysis is much more simple than fundamental analysis; knowing how to do it yourself can put you ahead of the pack.
Popular Charting Methods
Technical analysts use a variety of charting methodologies. All of them can be used to plot prices over a period of time, but they differ in visual format and in which price points are represented. The four most common chart types are line, bar, candlestick and point and figure charts.
Line charts are simple, formed by plotting one price point of a stock – usually the closing price – each day, and connecting these dots, or price points, with lines.
Bar charts contain more information. They show high, low and closing prices, on a daily or weekly basis. A vertical bar is drawn between the high price and the low price, and a short horizontal line going through the bar represents the closing price.
Candlestick charts use four daily or weekly price points – opening, closing, high and low. As in bar charts, a vertical bar is drawn between the high and low points. A box or "candle" is drawn between the opening and closing prices. If the closing price is higher than the opening price, the candle is white. If the closing price is lower than the opening price, the candle is black.
Point and figure charting is the only one of these formats that isn''t time-dependent. Price points are not plotted at regular intervals, but rather whenever they move significantly. Xs are used to represent upticks, and Os are used to represent declines.
Tom Dorsey recommends point and figure charting because the dominance of price movement over time makes trends easier to see and interpret. Small, insignificant moves are ignored, but all significant moves are recorded, no matter how quickly they occur. This prevents chart users from getting bogged down in short-term minutiae, while enabling them to catch any substantial movements that occur within the space of a single day – and these can be important in today''s fast-paced market.
Basic Charting Skills
In a point and figure chart, a price scale is located on the vertical axis. The range of your price scale will obviously reflect the range of prices your stock tends to move through. The intervals represented in your scale will also depend on this price range. Tom Dorsey recommends the following intervals:
1/4 point per box from $0 to $5
1/2 point per box from $5 to $20
1 point per box from $20 to $100
2 points per box from $100 to $200
4 points per box above $200
These scale adjustments help you show the larger price movements found in higher-priced stocks without running out of paper!
Placing Xs and Os
Placing Xs and Os in the boxes on the chart plots the price movements. Xs represent upward movement, while Os are always moving downward. When a stock''s price rises one interval of your scale, you represent this by placing an X in the appropriate box. But you don''t plot this upward movement unless or until the stock has risen at least three scale intervals. In other words, no column can show fewer than three Xs (or Os). You continue plotting Xs in this same column until the stock begins to drop (at least three scale intervals). Then move to the next column and begin plotting Os to show the downward movement. You continue plotting Os in this column until the trend turns around again and you move to the next column to plot your rising Xs.
In point and figure charts:
Columns of Xs and Os alternate.
Xs and Os can never mix in the same column. (Each column is either a price rise or a price fall, not both!)
There must be at least three Xs or Os per column (eliminating insignificant movement).
The numbers within such a chart are used to identify the months of the year. For instance, 1 stands for January, 2 for February, 3 for March and so forth through September. October, November and December are represented by A, B and C respectively. This is the method Tom Dorsey and his analysts use to indicate time. Other analysts using the point and figure method may place the months along the horizontal axis – not at regular intervals, but wherever they fall as the chart is constructed.
That''s all there is to plotting a point and figure chart. Simple? Yes. But charting doesn''t begin to get really interesting until you''ve been covering your stock (or sector or market) for a while, and patterns begin to emerge.
Charting the High Flyers
Be aware that as you get more sophisticated in plotting point and figure charts, you may want to adjust the price scale for stocks that experience wild price swings. In 2000, some Internet stocks showed intra-day swings of as much as 10 points! When this occurs, increasing the price interval can eliminate excessive ups and downs that muddy the overall pattern. It''s easier to see what''s really going on.
Pattern Recognition: Buy Signals
Technical analysts use past price movements to predict future price movements. They do this by recognizing certain patterns that recur again and again. When you''ve done this type of charting for a while and have seen these patterns over and over, you''ll begin to recognize them quickly. They are the basis for your buy and sell decisions.
Bullish chart patterns signal that a stock is in demand. The price is on the rise and it''s a good time to buy. Tom Dorsey and his analysts have identified six bullish chart patterns:
Double Top: This simple signal occurs when an X, or up, column exceeds the previous X column.
Triple Top: An X column exceeds two previous columns.
Shakeout: The stock makes two tops then breaks a double bottom (when an O column exceeds the previous O column). It is completed when a triple top is broken.
Bullish Triangle: Five columns are required to make this buy signal pattern, identified by a series of lower highs and higher lows that form what looks like a triangle. When the stock comes to a point at which it must break to the upside or the downside, it breaks to the upside.
Bullish Catapult: This buy signal pattern is a combination of a triple top breakout followed by a double top breakout.
Bearish Signal Reversed: This signal features a series of lower highs and lower lows that abruptly "reverses" that pattern and breaks out.
In addition to patterns that signal buying opportunities, there are also patterns that alert you when it''s time to sell.
Pattern Recognition: Sell Signals
You must make two major decisions for every stock in your portfolio – when to buy and when to sell. Too many investors spend more effort on the first decision than on the second. To avoid this mistake, keep in mind that you realize your profits only at sale time!
Bearish chart patterns signal a time to sell. Here are the five bearish chart patterns that Tom Dorsey and his analysts identify:
Double Bottom: In this simple sell signal pattern, an O, or down, column exceeds the previous O column.
Triple Bottom: An O column here exceeds two previous columns.
Bearish Triangle: Five columns are required to make this sell signal pattern, characterized by a series of lower highs and higher lows that form what looks like a triangle. When the stock comes to a point at which it must break to the upside or the downside, it breaks to the downside.
Bearish Catapult: A triple bottom sell signal followed by a double bottom sell signal.
Bullish Signal Reversed: A seven-column-minimum sell signal featuring a series of higher highs and higher lows.
Notice that the bearish patterns are essentially upside-down versions of bullish patterns. The same principles apply.
You''ve now seen the basic patterns that analysts look for. In later lessons, we''ll refine your understanding of them a little more so you can maximize your benefits.
Versatility: Price Isn''t Everything
Point and figure charts are very versatile and can be used to plot information other than individual stock prices. You can use the charting you''ve learned to follow the pricing patterns of NASDAQ, the Dow, the Standard & Poor 500 or industry indices. Price trends are critical in technical analysis, but they aren''t everything. In a strong market, for example, it isn''t enough to know that your chosen sector is going up. If it''s rising more slowly than other sectors, this may not be your best opportunity. Fortunately, in addition to tracking prices, you can use point and figure charts to plot the relative strength of a stock or sector.
You can also use this type of charting to ensure that you''re getting into the market or a sector when it''s not only headed up, but when there is also plenty of room left for growth. If you bought technology stocks near the end of their run, you didn''t have the same profit opportunity you would have had if you''d bought near the beginning. A concept known as "bullish percent" can help you determine if demand is just beginning or has nearly run its course.
LESSON 3: Market and Sector Factors
The 80/20 Phenomenon
Now that you''ve learned the basics of point and figure charting, it''s time to use this analytical method to implement your investing game plan.
Once again, the four steps of our recommended game plan:
1. Analyze the market.
2. Select bullish industry sectors.
3. Create an inventory of sound stocks.
4. Identify equities that are on their way up.
Although for learning purposes we first applied our charting method to individual stocks, your first steps in stock selection should be to evaluate the overall market and the stock''s industry group. This is where most of the movement in stock prices is generated.
According to Tom Dorsey, 80 percent of the price movement in any given stock is attributable to the market and sector. Yet, typically, investors and brokers allocate only 20 percent of their research time here. You can get off to a sound start by effectively analyzing market and sector factors.
Bulls or Bears?
A bearish (downtrending) market shouldn''t necessarily deter you from buying, but it should encourage caution and a defensive stance. Did you know that stocks go down almost twice as fast as they go up? In a bearish market, you may want to buy smaller blocks of stock, weed out weaker performers and be rigorous about selling losers.
A bullish (uptrending) market can, of course, be a good buying opportunity. How good? That depends on your point of entry. In the early stages of an upswing, word isn''t out yet and demand (hence prices) may still be low. As more investors seek the benefits of the bullish market, demand rises and drives prices up. At a certain point, most of the potential investors are already in, and demand begins to drop again.
The best place on this swing to buy is early on. Odds are that you''ll get the best prices then and take the least risk. Later, when demand and prices are higher, you may still make a profit, but a smaller one. Towards the top of the swing, the market becomes what is known as "overbought." Buying at this point is risky, because lessening demand will slow price gains and ultimately reverse them. Investors who bought Internet stocks late in the market''s most recent upswing may be painfully familiar with this concept.
"Bullish percent" acts as an indicator of the market''s current position in an upswing cycle. It''s calculated by dividing the number of stocks within a given universe that are on a point-and-figure buy signal by the total number of stocks in that universe. For example, if there are 3,000 stocks in the over-the-counter (OTC) market and 1,500 show bullish patterns with buy signals, the bullish percent reading for the OTC market is 50 percent. Levels of 30 percent or lower (at the beginning of an upswing) are considered low risk. Levels above 70 percent are considered overbought or high risk. You can also plot these percentage figures on a point and figure chart. The optimal time to buy is actually when the bullish percent has dipped below 30 percent and starts to reverse upward. The best time to sell is when, having moved above 70 percent, it then drops down below this point.
When a bullish percent chart shows a long string of Os, which represent a serious downward trend (see the period in the above chart between April and September of 1998, for example), you should be employing your defensive investment strategies. Focus on preserving assets rather than aggressively accumulating them.
Stay aware of the market as a whole, but also realize that it doesn''t move as an integrated whole. Within the market, industries rise and fall at different times. It''s important to know who''s on top today.
The Sector Cycle
Sectors hit their highs and lows at different times. There are always some that are doing better than others. In bullish markets, these are the sectors that carry the indices to new highs. Internet stocks led the charge in 1999. In bearish markets, the best-performing sectors don''t decline as much. Some of them may even earn profits for their investors. In 2000, when Internet stocks – and the market as a whole – took a dizzying slide, food, utilities, banks, restaurants and insurance were better bets.
Sector rotation is an under-used but extremely important phenomenon. Sector is the greatest contributor to price fluctuation in a stock. And it is particularly significant during periods of market uncertainty.
You want to determine which sectors are outperforming the market. Determining a sector''s strength, relative to the market in general, involves a simple calculation. Using Tuesday evening closing data, divide the price of the sector index by the price of the S&P 500 and then multiply by 100. This number, known as the sector relative strength, can be used to compare sector with sector.
Sector relative strength can be plotted on a point and figure chart, just as bullish percent can. The start of a new, strong column of Xs, particularly if it tops the last X column, is a buy signal, while reversal into a column of Os is a warning sign or sell signal. You can also apply the concept of bullish percent to sectors, to fine-tune the timing of transactions. Divide the number of stocks that are on a point-and-figure buy signal within the sector by the total number of stocks in that sector. As with market-wide bullish percent, the 30 percent level and below, where demand is high, is considered the low-risk area, while the area above 70 percent, where demand is low, is considered high-risk. To maximize your potential profits, try to buy when the sector has dipped below 30 percent and is headed back up. Sell when it has topped 70 percent and is dropping back down.
It is possible to base an effective investment strategy on just the first one or two steps of Dorsey''s four-step process. You might decide that you are interested in playing the broader market or the sector cycle, rather than taking your game plan down to the level of individual stocks. New products have made these strategies easier to implement.
QQQs, XLFs, PPHs: Alphabet Soup Shortcuts
If you wanted to bet on the price movements of the S&P 500, you could buy shares of all 500 stocks. Fortunately, given the amount of time and effort that would require, you don''t have to. Today''s markets can move with amazing speed, so being able to get into the market or a given sector easily can be crucial.
Over the past few years, the major exchanges have developed products that enable investors to play the broader market with a single product. Instead of buying 500 S&P stocks, you can make one purchase of S&P 500 Depositary Receipts, known as SPDRs (market symbol SPY). The NASDAQ 100 Shares (QQQ) is a similar product designed to help you invest in the over-the-counter market. You can own a portfolio of Dow Jones Industrial Average stocks through Dow Jones DIAMONDS (DIA).
The same type of product exists for market sectors, although these are even newer and do not yet exist for every sector. The American Stock Exchange offers Select SPDRs, each covering a broad industry group such as financials (market symbol XLF) or technology. Several financial institutions have also begun to offer these products. Two of the first were Merrill Lynch''s HOLDRs and Barclay''s iShares.
These products offer good diversification and simplicity. You trade them just as you would an individual stock. Use the bullish percent concept and sector relative strength charting you learned in this lesson to help make buy and sell decisions.
These sector and market products are not identical to their underlying indices in composition or the way they are weighted (by price, capitalization, etc.). This can affect your investing results. Be sure to read Chapter 3 of Tom Dorsey''s Trading Tips for additional information.
LESSON 4: Stock Selection
Quality Counts: Create a Catalogue of Sound Stocks
Investing is much like a retail business. You purchase inventory and hope to sell it to someone else for more than you paid. To make this possible, your inventory should be inexpensive to buy but valuable enough to entice people to purchase it for a higher price later. Look for quality and reputation in the stocks you purchase, and you will reduce your risk and gain an edge in creating profit.
You could look for stocks with rising prices and then research their quality (fundamental factors). However, if you don''t narrow your choices up front, you''ll be tracking the price trends of the entire universe of stocks. In addition, you will have to spend time on research after you''ve identified a bullish trend. In today''s fast-paced market, that time could cost you the technical advantage you worked hard to gain, as well as your profits. The best approach is to do your fundamental research ahead of time and establish a catalogue of sound stocks to choose from.
Many sources offer fundamental information you can use to evaluate a company''s business prospects. For information on a company''s price-to-earnings range, sales, assets, markets, products, etc., you can look to the Bloomberg Professional service, Bloomberg.com, brokerage firm research departments, annual stockholders'' reports or any of hundreds of fundamental online research sites.
When you''ve finished your fundamental research and chosen your catalogue of stocks, track these equities using the technical tools described in this lesson. When you identify a good buying opportunity, jump on it! Of course, you should review your catalogue from time to time, adding new prospects that look fundamentally strong and dropping any that show signs of weakness.
To identify equities that are on their way up, look at a variety of technical factors. The three most important things to analyze are short-term price patterns, longer-term price trends and relative strength.
Peer Relative Strength and Other Technical Criteria
For good buying opportunities, focus on stocks that are in an overall uptrend, have positive strength relative to the market and their peers and are on a point-and-figure buy signal.
Sighting an Uptrend
To find out if a stock is in an overall uptrend, you need a new tool – the Bullish Support Line or uptrend line. On a point and figure chart, the bullish support line is drawn from just below a stock''s apparent "bottoming-out" point, upward to the right at a 45 degree angle. See Chapter 4 in the course textbook, Tom Dorsey''s Trading Tips, for an example.
If a stock is trading above this bullish support line, it is considered to be in an overall uptrend and a candidate for purchase.
When a stock''s price breaks down below this line, it may signal a change in the overall trend. At this point, you want to look closely at the stock''s other criteria to determine if it''s time to sell.
When one of your "catalogue" stocks is in an uptrend, look next at its relative strength readings. Just as you can compare a sector''s performance to that of the market, you can find out how an individual stock is performing relative to the overall market. This is an important factor, especially when the market''s performance is unimpressive. For this calculation, divide the stock''s closing price (Tuesday''s is generally used) by the closing price of the Dow or any other market index, and multiply by 1,000.
You can also compare the performance of a stock with those of other stocks within its sector – its peers. To calculate peer relative strength, simply divide the stock''s closing price by the closing price of an applicable sector index. Once you have found a strong sector in Step 2 of your game plan, you can use this tool to invest in the sector''s best performers.
To spot reliable relative strength (RS) trends, RS readings should be plotted on a point and figure chart. Bullish and bearish patterns, buy and sell signals, will be the same as on other point and figure charts.
When you know the stock you''re watching is in an overall uptrend with positive strength relative to the market and its peers, your next step is to pinpoint the best time to buy. For this, go back to the patterns you learned earlier.
Constructive Buys in a Bearish Market
When the market has declined, you may wonder if you should take advantage of the low prices and buy. Yes, but choose carefully. You can use RS tools to find stocks that are holding up well in the bearish market. These are often leaders when the market turns back up. (Don''t buy all high-yield stocks – these can become relatively overvalued in a market decline.)
Best Entry Point
Should you buy on a triple top or wait for a bullish catapult? In a bullish triangle, which X in the final column should be your buy point?
Even with all of the data at hand, you will still need to use your experience and judgment. Finding the best entry point in a bullish pattern is an art rather than an exact science.
Consider the bullish triangle pattern in Chapter 1 of the course textbook. After a series of increasingly lower tops and increasingly higher bottoms, the chart breaks out of the pattern in an upward direction. You shouldn''t take action until this breakout occurs. However, one tactic that can increase your chances for profit is to resist buying a stock on the original breakout and wait for it to pull back.
Pullbacks take place fairly often, and using them can be a good strategy for improving your portfolio''s performance. The risk of waiting for a pullback is that you may miss a move. However, there are many, many stocks in the market, and missing one here and there will not offset the benefits of regularly waiting for the pullback. Try to exercise patience. Remember that the classic instruction to investors is, "Buy low and sell high," not "Buy high and sell higher."
While patience is a virtue when you wait for a pullback, it can be a handicap if you wait for reassurance in a bullish pattern. Look at the textbook referenced figures and consider the questions asked at the top of this lesson page. In both of those cases, if you wait, you will buy at a higher price – resulting in more risk for less reward.
So now that you have an idea when to buy, when should you sell?
Don''t Fall in Love
Investors often have more trouble selling than buying. If a stock is headed up, they wait, hoping to increase their gains. If it''s headed down, they wait, hoping to recoup their losses. Of the two, the latter is the bigger problem. It''s important to limit your losses. No one can be right all the time in the market. If you limit your losses, you can afford to be wrong more often, with less of an impact on your portfolio, than if you let your losses run.
You should constantly evaluate the positions in your portfolio. When a stock starts to go bad, get rid of it and replace it with something that will do better for you. The bearish patterns in point and figure methodology provide objective indicators that it is time to sell.
The signs of weakness in a stock are just the opposite of the signs of health. If you own a stock that is showing violations of its bullish support line, a high bullish percent figure, deteriorating relative strength or sell signals in its price chart, it may be time to let go.
The reason you need to look at all these factors is that strong stocks do often fall in price. Is this just a breather before a continuing climb, or the start of a nasty fall? With more information, you can form a clearer picture. When relative strength remains positive and the stock is trading above its bullish support line, it is probably healthy even if it''s in a column of Os.
If you are still unsure, remember the importance of limiting losses. If you aren''t ready to sell off your entire position, consider selling half of it and reducing potential loss while retaining some opportunity for gain.
For Aggressive Traders
Chapter 4 of Tom Dorsey''s Trading Tips is a good supplement to this lesson. If you are interested in short-term trading, you may also want to study Chapter 6, which covers short-term trading techniques. Becoming an expert short-term trader (day trader) is difficult and can be dangerous, but Dorsey shares his best tactics and shows you how point and figure methodology applies.
LESSON 5: Risk and Reward
There Are No Perfect Trades
You''ve acquired tools that can help you make effective buy and sell decisions in the stock market. You should be ready to use these tools to locate stocks with positive attributes. Look carefully, but don''t make the mistake of waiting for the perfect trade. Rarely, if ever, will you find a stock that has all the pluses on its side. Focus on the critical aspects, such as relative strength, trend and signal.
When you find major positives, act on them, but keep the minor negatives in mind. They should remind you that every trade involves some risk. In fact, risk is the foundation of the market. As an investor, you are paid to risk your money. No risk, no reward. That''s how the system works.
No investing strategy can eliminate risk. Tom Dorsey designed his game plan to ensure that you have enough objective information to read the market fairly accurately much of the time. That gives you an edge – not a guarantee. Basing your decisions on what the investment tools tell you can improve your odds. Unfortunately, even when you make the proper decision, the outcome may not be the one you anticipate. Stocks can go against you for any number of unforeseen reasons.
When you take a loss, always look back at how you handled the situation. Yes, you can do everything 100 percent right and still have a stock go against you, but did you do everything right? Or did you buy when the sector was 90 percent bullish? Or follow the media instead of your game plan? Or disregard the sell signals? Learn from your mistakes and you''ll make fewer of them in the long run.
Know What You Want: Price Objectives and Stop-Loss Points
To help avoid mistakes – particularly big ones – you should always establish your expectations before entering a trade. Your expectations should be based on two sets of factors: personal and technical.
Personal factors include how much you want to gain and how much you are comfortable losing, based on your level of assets, investing goals and time frame. Technical factors include where you expect the stock to go and where it shouldn''t go (below the bullish support line, for example).
Possibly the most important way to control risk is by knowing when to sell. Before you buy, set a stop-loss point based on your personal and technical factors. Then if your stock drops down to this price, let go. You want to avoid riding a stock down.
If you can''t resist waiting just a little longer to see if your stock bounces back, set a time limit. For example, once your stock hits the stop-loss point, give it three days to recover. If it doesn''t, don''t be stubborn – SELL.
If a trade goes in your favor, you still need a sell discipline to lock in profits. Dorsey recommends that once you are up 30 percent in a position, you should sell one-third of it and take the gains. If the stock continues to rise, sell another third when you are up 50 percent. Hold the last third until the technical picture starts to deteriorate. You can adjust these percentages, based on your personal goals and risk tolerance.
When you follow this advice and sell partial positions along the way, you reduce your risk. Not only do you lock in profits, but you avoid letting one position become too high a percentage of your overall portfolio. Keeping a diversified portfolio is another important strategy for risk management.
Diversification is a very basic risk-management strategy. Most of you probably learned it long ago. But there''s a reason for returning to Investing 101 now and then: Those simple concepts always apply, and we should be careful not to forget them in our search for more sophisticated answers.
Don''t put all your eggs in one basket, no matter how pretty that basket is. Remember that there is no perfect trade. But with multiple trades, gains in some may offset losses in others, and you will be more likely to come out consistently on the plus side of the ledger.
Numbers aren''t the entire story. Variety is equally important. Not all of your investments should be stocks. You should put some of your assets into fixed-income and cash equivalents. And your stock positions should be varied in kind. Avoid buying all small-cap or all large-cap stocks. Invest in multiple sectors that are outperforming the general market.
And don''t let any one basket get too big. Remember Xerox''s 1999 loss? Let''s say you had a $1,000,000 portfolio in 1999, with 2 percent in Xerox stock. If you had let your losses run, you would have suffered a $16,800 loss. However, if you''d held 20 percent of your portfolio in Xerox stock, that same mistake would have delivered a $168,000 beating. It isn''t difficult for a successful position, stockpiled for a number of years, to rise to 20 percent or more of a portfolio. But it can be disastrous under the wrong circumstances.
The purpose of diversification is to protect your portfolio against major shocks. In a strong bull market, it''s difficult to go wrong, even if you ignore some of the "rules of risk." However, it''s painfully easy to go wrong in a bearish market. You need to pay extra attention to risk management then, and call on your defensive plays.
If you don''t want to take the time and effort to buy a lot of individual securities, consider packaged investment products that offer instant diversity with a single purchase. In addition to equity and bond mutual funds, these include the market and sector securities we discussed earlier. These index-based products are exchange-traded and enable you to easily enter or exit the market or specific sector when the indicators dictate.
Defensive Plays for Bearish Markets
Many investors, looking for the silver lining, strive to view bear markets as a great chance to buy low. This can be true, if you''re careful. However, the risks in bear markets are enormous. Remember that stocks go down almost twice as fast as they go up! The key to managing risk in these conditions is to protect yourself first; then look for opportunities. Here are some of the defensive plays Dorsey suggests you consider once your bullish percent market indicators suggest defense (See Lesson 3, "Are You Playing Offense or Defense?".
Come off margin.
Stop buying, or at least buy less.
Wait for the pull-back to initiate new positions (See the earlier section on the Best Entry Point).
Pay close attention to sector rotation (See the earlier section on the Sector Cycle).
If you do buy, make sure you have a stop-loss point selected.
Weed out weak performers in your portfolio. (If they were languishing in a good market, they''re not likely to thrive in a decline.)
If you have strong performers, sell a percentage to lock in profits.
Buy protective puts as insurance.
Sell calls against a position.
These last two defensive plays involve the use of options.
The defensive plays for bearish markets are explained in more depth in Chapter 7 of the textbook, Tom Dorsey''s Trading Tips. Be sure to read it. Whatever market conditions prevail, keep returning to the advice in that first lesson: Don''t be your own worst enemy! Following your emotions rather than your game plan is the worst risk strategy, especially when a favored stock starts to drop.
Cut Losses and Let Winners Run
Many investors have a strong dose of competitive spirit. We tend to look at losses as defeat and we don''t like admitting defeat. That is why many of us have a tendency to hold on to stocks that are dropping, hoping for a turnaround that will enable us to declare victory. Sometimes that turnaround comes, but too often it doesn''t, and we suffer unnecessary losses.
It''s important to realize that a single trade going against you is not defeat. It''s just the way one play of the game has run. If a receiver in football drops the ball, his team doesn''t forfeit the entire game. They know it''s the final score that counts. The same is true in investing. Some plays will go against you, but it''s only the final tally that matters.
Dorsey offers an example in Chapter 5 of what can happen to those who let their losses run in a bearish market like today''s. Two investors, Freddie Free-Wheeler and Deborah Discipline, each start with a portfolio of ten stocks, 100 shares apiece, priced at $50 each. Deborah Discipline has a sell discipline to limit her losses, while Freddie Free-Wheeler does not. After six months, five of Freddie''s stocks have dropped 50 percent and five have risen 20 percent. His account is down $7,500. Deborah''s account contains no gainers at all. Seven of her stocks are down 20 percent and three stayed even. Even though more of her trades went against her and none made a profit, Deborah is down only $3,500. The difference is simply that she limited her losses.
In the long run, the most important thing you can do to control risk and maximize return is to cut your losses short and let your winners run!
To learn more about strategies for risk management, refer to Chapter 5 in Tom Dorsey''s Trading Tips.
Although the theory of supply and demand and most of the tools and tips you have learned in this course will remain relevant and useful, analysts and investors are always developing new ways to predict and cope with the ever-changing conditions of the market. Learn these lessons well and practice what you''ve learned, but don''t stop there. Keep your eyes open throughout your investing career for advancements in investment technology.
Accumulation/Distribution (A/D) merupakan indikator yang ditentukan oleh perubahan harga dan volume. A/D dihitung berdasarkan harga penutupan relatif terhadap nilai tengah harga maksimum dan minimum dalam satu hari. Jika harga penutupan lebih tinggi dari nilai tengah tersebut, maka diasumsikan bahwa investor lebih banyak membeli saham daripada menjualnya.
Volume perdagangan berguna sebagai koefisien pembobot setiap perubahan harga. Semakin tinggi koefisien (volume) ini, maka semakin besar kontribusi perubahan harga (dalam perioda waktu tertentu) pada nilai indikator. Biasanya indikator ini menjadi varian dari indikator lain seperti On Balance Volume. Keduanya digunakan untuk mengonfirmasi perubahan harga, dengan cara mengukur volume penjualan.
Perhitungan A/D menggunakan pendekatan yang berbeda dari indikator On Balance Volume (OBV). OBV menggunakan perubahan harga penutupan dari satu perioda ke perioda selanjutnya. Meskipun, harga saham dibuka menurun, dan ditutup pada level yang lebih tinggi, maka nilai OBV akan tetap negatif, sepanjang harga penutupan hari tersebut masih lebih rendah dari hari sebelumnya. A/D menggunakan perhitungan Close Location Value (CLV) yang nilainya berkisar antara -1 hingga +1, dengan nol sebagai titik tengah. CLV ini kemudian dikalikan dengan volume perdagangan saham dihari tersebut yang akan menghasilkan Accumulation/Distribution Line.
Rumus menghitung CLV
( ( (C - L) - (H - C) ) / (H - L) ) = CLV
C: Harga Penutupan
L: Harga Terendah
H: Harga Tertinggi
Indikator A/D saham yang meningkat menandakan adanya akumulasi (pembelian) saham, dan terkait dengan trend kenaikan harga saham. Sebaliknya ketika indikator A/D menurun, hal ini menunjukkan adanya distribusi (penjualan) saham, dan terkait dengan pergerakan turun harga saham.
Perbedaan antara indikator A/D dengan harga saham menunjukkan perubahan harga dalam waktu dekat. Contohnya, ketika indikator A/D meningkat, sementara harga saham cenderung turun, maka ekspektasi penurunan harga saham akan terjadi dalam waktu dekat.
ON BALANCE VOLUME
Monday, 04 August 2008 02:54
On Balance Volume (OBV) dikembangkan oleh Joe Granville pada tahun 1963. OBV merupakan salah satu indikator yang pertama kali dibuat dan paling popular untuk menghitung aliran volume positif ataupun aliran volume negatif. Dasar yang digunakan dalam menggunakan indikator ini adalah: volume bergerak mendahului harga.
OBV adalah suatu indikator sederhana yang menambahkan volume jika harga penutupannya naik dan mengurangi volume jika harga penutupannya turun. Total kumulatif dari penambahan dan pengurangan volume tersebut membentuk garis OBV. Garis ini kemudian dibandingkan dengan grafik harga untuk mencari konfirmasi apakah terjadi penyimpangan arah (divergence) atau tidak.
Penggunaan On Balance Volume
Dasar yang digunakan dalam menggunakan indikator ini adalah perubahan OBV akan bergerak mendahului perubahan harga. Volume yang meningkat dapat mengindikasikan bahwa investor yang berpengalaman sedang membeli suatu produk sekuritas di pasar. Ketika investor lainnya juga mengikuti aktifitas membeli produk sekuritas tersebut, maka harga produk sekuritas tersebut kemungkinan besar akan mengalami kenaikan.
Seperti indikator lainnya, OBV juga digunakan untuk memperkirakan arah pergerakan harga. Jadi nilai OBV tidaklah terlalu penting untuk diperhatikan. Garis OBV yang naik mengindikasikan bahwa volume perdagangan sedang meningkat (bullish). Jika harga juga mengalami kenaikan, maka OBV dapat digunakan sebagai suatu konfirmasi bahwa harga produk sekuritas tersebut sedang mengalami kenaikan. Dalam kasus tersebut, harga meningkat dikarenakan permintaan terhadap produk sekuritas tersebut juga meningkat.
Namun demikian, jika harga meningkat sementara garis OBV menurun, terjadilah yang disebut negatif divergence. Dalam kasus tersebut, tren naik yang sedang berlangsung saat ini tidaklah bertahan lama. Hal ini juga dapat dianggap sebagai sinyal peringatan bahwa tren naik tersebut akan segera berubah. Kasus seperti ini biasanya terjadi pada keadaan pasar jenuh beli (jika harga naik mendahului OBV) atau pasar jenuh jual (jika harga turun mendahului OBV).
Jika terjadi perubahan tren OBV yang tidak melebihi jangka waktu tiga hari, maka hal tersebut dianggap tren yang meragukan. Misalnya, tren OBV berubah dari yang semula naik menjadi tren yang menurun. Akan tetapi tren yang menurun tersebut hanya terjadi dalam dua hari dan pada hari ke tiga meningkat kembali. Dalam kasus ini, tren OBV yang menurun dianggap sebagai tren yang meragukan dan tren OBV tetap dianggap sedang meningkat.