Investment In Current Market

Read an article about investing and trading in stock by Thomas Sutton. Thought it will be great to share it with friends here too...

The market can be especially impulsive during earnings season, and every trader feels the g-forces when stocks choose to mimic roller coasters. Here are a few suggestions that will help you stay on track no matter what route the market decides to take ...

- Check Your Emotions. The market is much more powerful than any individual. Though you have no control over what it does, you do have control over how you respond to its actions. Getting emotional when the market goes down doesn't make it go back up. On the other hand, the stress could cause you to make unwise decisions. Avoid this sort of self-sabotage.
Remember - although your actions won't change the market, they WILL determine how much money you make.

- Be Sure Of Your Time Horizon. Most people buy stocks without first considering the time frame that suits them best. Are your plans short-term or long-term? It makes a big difference. A teenager that opens her first trading account has a much different time horizon than a sixty-five year old that plans to retire next year. Before entering a position, always consider which time frame will best serve your needs.

- Use Risk Management. Losing trades are a fact of life. Applying risk control tactics will quickly eliminate losers and insure they don't hurt you. Your advanced winners can provide the gains to offset any minor losses AND leave you with a good profit. You also have the option to stand aside when nothing seems to work. Just bear in mind that while the sidelines offer a temporary safe refuge, you have to be in the market to make money.

- Choose Your Attitude. Success in the stock market requires more than just a proven trading strategy. Winning is a reflection of your state of mind. Never let the negative attitude of others cause you unnecessary grief. Genuine confidence dissolves fear, and paves the way to a prosperous future.

Trade well,
- Thomas Sutton, Editor

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Investors and Traders Must Know This...Risk And Money Management

In an age where it has become fashionable to manage one's own investments, every investor needs to apply professional risk and money management strategies.

Preservation of capital is the foundation of long-term success in today's volatile markets.

One common adage on this subject that is completely wrongheaded is:
"You can't go broke taking profits." That's precisely how many traders do go broke. While amateurs go broke by taking large losses, professionals go broke by taking small profits. The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of a gain.

The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to
performance.

The market does behave very much like a tutor who is trying to instill poor trading techniques. Most people learn this lesson only too well...

Since most small to moderate profits tend to vanish, the market teaches you to cash them in before they get away.

Since the market spends more time in consolidations than in trends, it teaches you to buy dips and sell rallies.

Since the market trades through the same prices again and again and seems, if only you wait long enough, to return to prices it has visited before, it teaches you to hold on to bad trades.

The market likes to lull you into the false security of high success rate techniques, which often lose disastrously in the long run.

The general idea is that what works most of the time is nearly the opposite of what works in the long run.

When asked about risk and money management, we often hear the same two phrases from investors: "I'm diversified" or "I have a balanced portfolio".

But are they really?

And does this have anything to do with risk and money management?

We all know the oldest clichés in the world of investing:
"Buy low, Sell high and Make Money."
"Cut Losses Short, Let Profits Run."

This is easier said than done.

Some investors devote countless hours to stock
picking by spending their time doing research, using either fundamental or
technical analysis. Others visit chat rooms, message boards or get tips from
neighbors. Many approach investing as if it were a gamble, without knowing the risk reward equation. In the never-ending quest to find the next momentum stock to buy, the most important factor in long-term profitability is overlooked - the exit strategy.

Managing one's risk and capital is undoubtedly the two most important, yet among novices the most ignored, tasks in establishing long term trading success.

Sharing some quotes from the top traders to further emphasize the importance of risk and money management:

"You should always have a worst case point. The only choice should be to get out quicker." - Richard Dennis

"If I have positions going against me, I get right out; if they are going for me, I
keep them... Risk control is the most important thing in trading. If you have a
losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in." - Paul Tudor Jones

"The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3)
cutting losses. If you can follow these three rules, you may have a chance." - Ed
Seykota

"Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don't take a hard look at risk, it will take you." - Larry Hite

"Frankly, I don't see markets; I see risks, rewards, and money." - Larry Hite

"My philosophy is that all stocks are bad. There are no good stocks unless they go up in price. If they go down instead, you have to cut your losses fast... Letting losses run is the most serious mistake made by most investors." - William O'Neil

"When I became a winner, I said, 'I figured it out, but if I'm wrong, I'm getting the hell out, because I want to save my money and go on to the next trade.'" - Marty Schwartz

"I always define my risk, and I don't have to worry about it." - Tony Saliba

"When I get hurt in the market, I get the hell out. It doesn't matter at all where the market is trading. I just get out, because I believe that once you're hurt in the market, your decisions are going to be far less objective than they are when you're doing well... If you stick around when the market is severely against you, sooner or later they are going to carry you out." - Randy McKay

"The key to trading success is emotional discipline. If intelligence were the key,
there would be a lot more people making money trading... I know this will sound like a cliché, but the single most important reason that people lose money in the financial markets is that they don't cut their losses short." - Victor Sperandeo

"Never fear making a mistake. If you do make a mistake, don't complicate the
position by trying to hedge it - just get out." - Linda Bradford Raschke

Market React Positively To Fed's Recent Interest Rate Cut...

Last week is a very volatile week for the market averages but posted gains in four out of the five sessions. Small and mid-caps paced the way higher above last week's recovery highs on Friday...

Roughly 20% of the S&P 500 reported their quarterly earnings results in the past week, yet that cascade of results seemed insignificant at times to other developments that included the FOMC meeting, manic reports about bond insurers' credit ratings, January employment data, and a blockbuster announcement from Microsoft that it was offering $31 per share, or nearly $45 billion, to acquire Yahoo!

Looking at the week, the FOMC meeting has to be regarded as the most important happening. The rate-setting committee convened in a two-day affair that culminated in a widely anticipated decision Wednesday afternoon. Specifically, the FOMC elected to cut the fed funds rate another 50 basis points to 3.00%. In a related move, the discount rate was also cut 50 basis points to 3.50%.

The stock market responded favorably to the FOMC decision, sending the major indices sharply higher in its wake. The FOMC-related rally on Wednesday was short-lived, however, as speculation that one of the major bond insurers was on the cusp of being downgraded fueled a sense of angst that led to a broad-based wave of selling pressure.

Still, the indices suffered only modest losses on Wednesday that were quickly recouped on Thursday after MBIA held an assertive four-hour conference call in which it declared that its capital raising plan will exceed triple-A rating requirements and that it was virtually impossible to imagine a situation where it would become insolvent.

On Friday it was also reported that eight banks were in the midst of trying to work out a rescue plan for Ambac Financial.

For the most part, market participants were in rescue mode all week, coming to the aid of battered stock prices, primarily in the financial and retail sectors. The prospect of further rate cuts, and then the rate cut itself, fueled the bullish bias that had been missing for most of January.

The unique element to the past week, though, was the shift in sentiment. Although bad news invited some dips at times in the broader averages, it was the good news that resonated with participants.

To the latter point, if we told you at the beginning of the week that Yahoo!, Google, Boeing, Bristol-Myers and Starbucks would disappoint with their earnings results and/or guidance, that new home sales would fall to a 13-year low, that weekly initial claims would jump to 375K from 306K, that it would be reported Q4 GDP grew just 0.6%, and that January nonfarm payrolls declined by 17K, you would have probably thought we'd be in for more tough sledding.

All of those things happened, yet the market digested them with relative ease, preferring instead to focus on the positives like reassuring earnings news from 3M, Burlington Northern, UPS and Verizon, a report that durable orders rose 5.2%, a jump in the manufacturing sector's ISM Index to 50.7 (a number above 50 reflects growth), and the Microsoft buyout offer for Yahoo!.

The proposed acquisition dominated conversations Friday on account of the 62% premium that the bid represented relative to Yahoo's previous closing price. Additionally, it drew a lot of praise for being a good strategic move on Microsoft's part and raised concerns about a new level of competition for Google, which suffered a 9.0% drop on Friday, bringing its year-to-date decline to 25%.

Underlying all of the positive activity during the week, though, was the Fed and its accommodative policy. The FOMC has now slashed the fed funds rate 225 basis points since Sept. 18 - and that's with initial claims still running below recession levels, the labor market still operating at full employment, and final sales in the fourth quarter, which excludes inventories, increasing 1.9%.

Granted there are clear signs of an economic slowdown, but the Fed is very much acting in a preemptive manner. We think this week's trading action reflected a growing acceptance of that viewpoint. Accordingly, there was broad-based strength behind the move. The financial sector led the way with an impressive 8.5% advance and was followed by telecom services (+6.8%), consumer discretionary (+6.7%), basic materials (+6.2%) and industrials (+5.5%).

The scope of those moves was driven in part by short-covering activity, yet it's not a stretch to think either that in the past week a fear of missing out on future gains following the Fed's rate cuts supplanted the fear of a fallout that has prevailed most of this year.

Enjoy your weekend!

--Patrick J. O'Hare, Briefing.com

Market Rally Towards The Close Of Jan 2008 - Is that the true picture?

The first 5 trading days in this Election Year of 2008 finished down. This has signaled the possibility of a bearish January which in turn a signal of down year for 2008.

True enough, Dow Jones closed at 12,650 on Jan 31, 2008 i.e. DJI is down 611 in Jan 2008. Even the Fed cuts the fed funds rate by 50 basis points to 3.00% and the discount rate by 50 basis points to 3.50% on 30 Jan (Wed) on top of the sudden cut of 75 basis points a week ago, that's not good enough to bring the market up to rally. Do you think the sentiment lifted yesterday due to bond insurer's positive outlook will last? I doubt...

Let's see how will the overall market react today after Google (GOOG), the internet giant, announced disappointing result after market close yesterday. Google tanked $37 to $527.40 after trading hours...

Jan 31, 2008
Dow +207.53 at 12650.36, Nasdaq +40.86 at 2389.86, S&P +22.74 at 12650.36

[BRIEFING.COM] On Thursday, the major indices were able to rally, despite opening sharply lower in the wake of a disappointing unemployment claim report. Sentiment was lifted due to a bond insurer's positive outlook. This is in contrast to Wednesday, when concerns over bond insurers caused the stock market to give up all of its FOMC induced gains.

The major indices finished modestly off their highs on a report released with five minutes left in the session that said Standard & Poor's put MBIA's (MBI 15.50, +1.54) credit rating on negative watch and downgraded FGIC to AA from AAA. Yesteday, Fitch cut FGIC's rating, so its downgrade was not surprising. S&P affirmed Ambac's (ABK 11.64, +0.79) AAA rating.

Despite the S&P report, the major indices still finished sharply higher, led by financials (+2.7%), retailers (+4.4%) and consumer discretionary (+3.4%). These three areas were the main laggards in 2007, and stand to benefit from the recent rate cutting cycle. The Dow, Nasdaq and S&P all closed 3.3% above their session lows.

Bond insurers weighed on sentiment in the early going after MBIA reported a larger than expected loss. MBIA said it had an operating loss of $3.38 per share in the fourth quarter, compared to a profit of $1.16 a year ago.

Sentiment then turned positve, as MBIA led financials and the broader market higher. MBIA's conference call, which lasted four hours, eased traders' uneasiness.

Specifically, the company acknowledged it will have significant losses, but nothing to justify the 80% decline in the share price since last year. The company said its capital plan will exceed all AAA rating requirements. It said a downgrade would impact capital by $100 million to $200 million in a worst case scenario. The company said it will not be forced into bankruptcy and that it is virtually impossible to imagine a situation where MBI would become insolvent.

In economic news, a Dept. of Labor report showed jobless claims for the week ended Jan. 26 jumped to 375,000 from 306,000. Economists expected 320,000 claims. Stocks opened sharply lower on the report. The knee jerk reaction was overdone, as one week does not make a trend, and Briefing.com expected claims to increase due to seasonal factors.

The Dept. of Commerce said December personal income rose 0.5% and spending rose 0.2%, which were mostly in-line with expectations. Separately, fourth quarter employment costs rose 0.8%, in-line with expectations.

All ten sectors closed higher. Energy (+0.3%) underperformed on a relative basis due to a 0.8% slip in crude oil prices.

..Nasdaq 100 +1.8%. ..S&P Midcap 400 +2.2%. ..Russell 2000 +2.6%. ..NYSE Adv/Dec 2384/776. ..NASDAQ Adv/Dec 2039/966.

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Market Forecast of 2008 - What's Your View? (part 3)

Hope you find the previous market forecast 2008 part 1 and part 2 interesting...
Here is the bottom line summaried by Bernie Schaeffer...

The Bottom Line

** I expect that stock-market volatility will begin to recede in 2008 from the elevated levels seen in 2007. As the risk aversion trade begins to unwind, risk appetites will likely return to more normal levels. I also project outflows from domestic equity mutual funds - which approached record levels in 2007 - to moderate substantially and perhaps even revert to inflows as volatility begins to diminish and U.S. stocks begin to rally. Such a reversal would be quite supportive for further gains in the U.S. stock market.

** The fourth year of a Presidential term has historically been bullish for stocks, as has a situation of bipartisan rule (Republicans in the White House; Democrats ruling Congress, or vice versa). Both of these factors are likely to have an impact on stocks in the next 12 months.

** Crude oil may remain near all-time highs, but I would not be surprised if they pulled back to levels that would cause less alarm. The recent surge in prices has been the result of demand, not supply. Consumers have continued to adjust to rising fuel prices, and $3.00 unleaded didn't crimp spending any more than $2.00 gasoline did. In fact, a dramatic plunge in oil prices could potentially signify that something was off with the overall economy or market.

** Earnings across the board will remain challenged as the housing and credit crises proliferate in the coming quarters. But strong growth in sectors such as technology and utilities will help boost the average, potentially well beyond the dour expectations of many analysts. Positive earnings surprises could be a major catalyst for buying power for stocks in the first half of next year.

** Long-term trendlines held up despite dramatic pullbacks this year, confirming that the bull market remains intact. One of the primary moving averages to watch is the 80-week trendline on the S&P 500 Index.

** Concerns that the current market is at risk of a "bubble burst" similar to that endured in 2000 are unfounded. Stocks are priced at more reasonable levels, fear and caution dominates investors' minds as opposed to greed, and there is skepticism (if not downright pessimism) on Wall Street and in the financial press in their outlooks for 2008.

** Look at outperforming, underloved names from the alternative energy and e-commerce sectors for profitable opportunities in 2008 (see below). Metals stocks (particularly from the copper sector) also look promising.

** One sector to avoid in the new year is the large-cap healthcare group. Drug stocks have, as a collective, made virtually no progress this decade after a huge run higher in the 1990s. The combination of the well-known challenges of the industry (generic encroachment, FDA challenges) and continued optimism among analysts should keep capping the appreciation potential of this sector. This is a very broad sector, however, and there could still be some opportunities from the small-cap biotech segment.

** Pay attention to small- and mid-cap growth groups, e-commerce stocks, metals issues, and industrial cyclicals. Also, opportunities in international stocks, which along with multinational companies should continue to benefit from a weak dollar.

** And finally, the real "bottom line to the bottom line" is that while long-term levels of technical support look very reliable, and the backdrop of skepticism is compelling, the wild card is the Fed. All projections come with the very real caveat that an error in monetary policy will almost certainly result in taxing times ahead. The wrong decision could spur a selling campaign that forces long-term moving averages to give way, effectively justifying some of the pessimistic sentiment we've seen. I just hope that Bernanke and his cohorts make the right choice for the economy and the stock market - which is to cut interest rates aggressively without regard to bogus inflation fears.

(Disclaimer: the information provided here is served as reference only and does not constitute financial advice. Pls seek professional consultancy, if needed.)

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Market Forecast of 2008 - What's Your View? (part 2)

Hope you enjoy exploring the earlier market forecast and continue to have fun in part2 of the Market Forecast 2008 by Bernie Schaeffer

Technicals

Key Levels and Trendlines

In the first half of 2007, technical analysts concerned themselves with historical levels. Former all-time highs and significant round-number zones challenged the major market indices, but by the waning weeks of summer, these areas of looming resistance had been overtaken. The Dow toppled 14,000, the S&P 500 Index broke 1,500 and then exceeded its March 2000 closing and intraday highs of 1,527.36 and 1,553.11, respectively. The Russell 2000 Index (RUT) muscled through the 800 mark to hit a new all-time high. And the Nasdaq Composite (COMP) hurdled the 2,500 level to reach its highest point in six years. Additionally, the tech-rich index moved above the 2,566 mark, which represents half of its March 2000 high of 5,132.

The final quarter of the year was defined by a successful test of long-term trendlines of support, which refused to yield even when selling pressure mounted. Most notable is the 80-week moving average on the S&P 500 Index, which contained pullbacks in mid-August and late November. Barring a colossal mistake from the Fed in terms of monetary policy, we have confidence in these levels being supportive heading into 2008.

Where We Could Be Headed

The S&P previously rallied off its 80-week moving average in August 2004, October 2005, and June 2006. The average rally following these pullbacks was 18.6%, and the average duration was eight months.

For the S&P in 2008, I'm looking to a mid-year S&P mark of 1,625, with a move to 1,700 by year-end. So I'm essentially projecting a bigger pop higher sooner rather than later.

For the Dow, I believe we could add about 15% in 2008. By mid-year, I think we could see the average hit 14,600, taking out the 15,000 mark sometime thereafter to close the year around 15,300.

I'd expect the Nasdaq to rise to 2,900 by mid-year and reach 3,100 by the year's close. If the index behaves better than I anticipate, the 3,120 mark could come into focus. This is the 50% retracement point between the index's March 2000 peak and its October 2002 nadir. As for the Russell 2000 Index, I still have faith that some of the best bullish opportunities are in the small- and mid-cap growth area. Retailing growth names, biotechnology issues, and alternative-energy stocks are some particular pockets of strength among the smaller-cap sect. But in recent months, the RUT itself has been weighed down by its components in the beleaguered housing and finance sectors. That said, despite this struggle, I expect to see the RUT retake the 800 level early next year and move to 850 by the middle of the year. By the end of 2008, I'd like to see the RUT hit the 900 mark.

Sentiment

Then and Now

While 2007 faced comparisons to 2000, with the tech bubble of then compared to the housing bubble of now, the reality is that it was a different market environment entirely.

First, stocks are much more fairly priced from a valuation standpoint. As of mid-December, the price-to-earnings ratio on the S&P 500 Index overall stood around 20.50, down from the 37-38 area in late 2000.

Most importantly, the overwhelming sentiment that ruled the market in 2007 was one defined by hesitation and caution. The issues plaguing the 2007 market overshadowed any good news, investors were bailing out of domestic equity funds at record levels in favor of foreign alternatives, and the news stands regularly featured doom-and-gloom predictions.

In 1999 and 2000, greed played a part in every financial decision. The sky was the limit, and losing wasn't on anyone's radar. Euphoria was palpable … and it was dangerous. While I wouldn't say the current market was quite one defined by "despair," it's certainly arguable that we're in the "disbelief" stage.

The Short Story

The short-selling contingent remains a force to be reckoned with as 2007 draws to a close. By the end of November, the total number of Big Board shares sold short rose 3.1% to 12.77 million, up 3% from mid-November, when 12.39 million shares were sold short.

The short-interest ratio reached 8.2 in late November. In other words, total short interest across the New York Stock Exchange (NYSE) is more than eight times greater than the average daily volume on the exchange. This short-interest ratio on the NYSE is on par with the 1997 level, when we were in the middle of a raging bull market.

In addition, put open interest in the options market is at record levels, perhaps a reflection of the huge growth in the dollars managed by hedge funds in recent years. This contingent by definition "has derivatives exposure and knows how to use it".

The bottom line is that the large and ever growing short trade keeps a lid on market rallies (thus reining in any "irrational exuberance") and provides support on market pullbacks (as shorts take profits on declines and as portfolios with put protection in place become exempt from panic liquidation). Market crashes are very unlikely to occur when major money is already positioned for them.

Analysts' Apprehension

The "Big Money Poll," conducted by Barron's every six months, poses a variety of market-related questions to more than 100 investment professionals and money managers.

The latest installment revealed that just 47% of those polled have a "bullish" or "very bullish" outlook for equities through the middle of next year. This is quite a drop from the 64% of managers self-described as "bullish" in late 2005. Profit growth on the S&P 500 Index is expected to be a modest 4.6% for next year.

Meanwhile, 20%, or a fifth of the Big Money Poll respondents, say they are "bearish" or "very bearish" about the market's prospects, up from 17% in the last Poll, conducted in the spring of 2007. Those describing themselves as "neutral" account for 33%, down from 37% seven months ago. This caution among money managers is healthy as markets tend to climb a "wall of worry."

Using Zacks.com data to check in on the overall tone on Wall Street, the percentage of "buy" ratings is underwhelming. Of all analysts' ratings on S&P 500 stocks, just 47.7% are "buys," leaving 46.8% in "hold" territory and 5.5% as "sells."

Meanwhile, in June 2000, when the market's peak had long come and gone, the percentage of "buy" rankings stood at a whopping 72.0%. What's more, 50.3% of analysts' ratings were "buys" even when the market was at its 2002 low!

In other words, the Wall-Street collective is positioned more bearishly right now than they were during the bear market of roughly 5 years ago.

The outlook on mid-cap and small-caps stocks is equally skeptical. Specifically, 42.9% of the ratings on mid-cap stocks are "buys"; 43.89% of small-cap stocks have earned "buy" ratings. This is reflective of a "lowered expectation bar" that is very conducive to analyst upgrades should the 2008 environment prove less gloomy than the consensus believes.

Negativity on the Newsstand

One of my favorite and time-honored measures of anecdotal contrarian analysis has always been the cover story. When a trend in the market (or on an individual stock or sector) has gained such attention that it is appearing on the covers of many widely read publications, it could be about time for that trend to turn. This is based on the theory that once a trend hits the covers it is so widely known and universally accepted that it is set to turn not long after the unsophisticated public jumps aboard based on the "big news" in the cover stories.

A recent commentary from Paul Montgomery, whose work I greatly admire, pointed out the slew of doom-and-gloom headlines we've seen in the financial press related to the housing crisis and the dollar. Granted, as Montgomery also points out, financially-focused magazines don't carry quite the contrarian punch as a more general periodical such as Time, but the contrarian cover-story indicator is still undeniable. Here's a mere sampling of some cover-story headlines we've seen in the past three months:

• BusinessWeek, "The Consumer Crunch," (November 26, 2007)
• The Economist, "America's Vulnerable Economy," (November 15, 2007)
• The Economist, "Lessons from the Credit Crunch," (October 18, 2007)
• BusinessWeek, "That Sinking Feeling," (October 15, 2007)

This is, of course, not to mention the myriad of non-cover articles with bearish themes in the daily, weekly, and monthly press (a recession in 2008 is considered to be a slam dunk). When negativity turns so prevalent that warnings scream to us from the newsstands, pessimism could be nearing a peak. Given the broad market's decent price action amid so many fundamental challenges as highlighted by the headlines we see on a daily basis, this should be good intermediate-term news for the bulls.

Fund Flows

As I alluded to above, one element that makes today's market backdrop dissimilar to the wild ride of 1999-2000 that ended so badly is the fact that investors are bailing out of domestic equity funds. (Around the turn of the millennium, annual fund inflows into domestic funds were setting records in the $200 billion neighborhood).

According to TrimTabs, U.S. equity funds lost roughly $8.3 billion in November alone, marking the seventh consecutive monthly outflow. In May through November, $50.3 billion was pulled out of U.S. funds; this is equal to 56% of the record-setting seven-month outflow of $90 billion seen as the bear-market era was carving out a bottom in June 2002 through December 2002.

But fund players aren't just taking their money to the craps tables or tucking it under their mattresses. Global funds have reaped the benefit of rejected domestic opportunities. In November, $7.9 billion in assets was funneled into global equity funds. What's more, while that $50.3 billion was being erased from locally-based funds, international equity funds have seen $70.9 billion in inflows, huge with respect to the outflows from domestic funds, but small in comparison to the $200 billion in domestic inflows in 2000.

The advent of hedge funds is another major change to the world of investing in the past seven years. And in October, hedge funds posted an inflow of roughly $16 billion (according to TrimTabs data). During the first 10 months of 2007, nearly $280 billion in assets were funneled into hedge funds. In other words, there is a definite preference for funds in which hedging is an instrumental part of the strategy, such as shorting stocks.

So the market in 2007 held together despite headwinds on the economic front and despite headwinds from big money flows into short selling strategies and despite outflows from domestic mutual funds. As fear subsides and the risk/reward profile shifts in 2008, outflows from domestic funds could lessen and possibly even shift back to inflows as pessimism collectively unwinds. A reversal in the fund-flows environment would be very supportive for the U.S. stock market.

Margin Madness

Just a few of weeks ago, I came across the news that the level of margin debt recently exceeded that posted in the 1999-2000 market. This fact seemed diametrically opposed to the sentiment underlying the massive outflows we've seen in the mutual-fund arena, and I hardly believe it's the product of small investors borrowing above their means to buy U.S. stocks (the traditional view when margin debt ramps up).

My sense is that these ramped-up margin-debt figures are tremendously skewed (and rendered practically meaningless) by current present-day factors as hedge-fund activities and exchange-traded funds. (Hedge funds are also largely responsible for the increased demand for short positions referenced above).

Exchange-traded funds (ETF) were practically non-existent during the 1999/2000 bubble, and they are a hugely popular investment vehicle now. There is far less risk in buying an ETF on margin than in buying individual equities.

The risk of buying, say, the Select Sector SPDR Financial Fund (XLF) on margin in no way compares to buying a risky dot-com venture on margin eight years ago. And back to the hedge funds, I'd imagine it would be common practice for them to hedge stocks on margin against short positions in ETFs on margin for a net trade that is actually lower risk than buying stocks with cash.

Stay tune for the summary and net-net bottom line that is going to be revealed in part 3...

Market Forecast of 2008 - What's your view? (part 1)

I read this interesting Market Forecast of 2008 by Bernie Schaeffer.

Just want to share with friends here too...

Year In Review

Imagine the impossible happened around this time last year. You're minding your own business with a nice cup of green tea and you're presented with a truly functional crystal ball (or the souped-up time-traveling De Lorean from Back to the Future). You suddenly have the ability to look one year into the future - a dream come true for an investor (or gambler). With your newfound clairvoyance, perhaps you'd decide to keep those Apple shares in your portfolio or invest in a little thing called Baidu.com. Maybe you'd laugh at the notion of the Boston Red Sox capturing a second World-Series crown in four years. You'd be incredulous at the notion that Kevin Federline would be ruled a better parent than his estranged wife Britney Spears. And then one little prophecy would be absolutely flabbergasting.

The crystal ball (or your "future self") would warn of a hiccup called "subprime," a problem that grew out of short-sightedness and flourished in an environment riddled with rising interest rates and falling home prices. Foreclosures hit record numbers, major mortgage lenders crumbled, and homebuilders hit the skids. The crisis had a self-perpetuating effect - gun-shy banks and lending institutions were hesitant to offer credit, making the landscape that much more challenging for home sellers and builders.

This meltdown in the mortgage market trickled down into global credit markets, as liquidity evaporated. Hedge funds that were largely invested in subprime equities collapsed, banks and brokerage firms wrote off billions of dollars in bad debt, and the merger-and-acquisition deals that dominated headlines in the early part of 2007 became few and far between. Earnings were stunted for financial and homebuilding names, leading to aggregate results that fell short of already-lowered expectations late in the year. And on top of that, crude oil made a charge at the $100 a barrel.

So a clairvoyant investor at the end of 2006 would foresee a shrinking credit market and sparse relief from the housing market's infirmity or crude oil's climb. But if the crystal ball broke before he went back to the future to check out the stock market in 2007, hopefully he didn't spill his tea and rush to protect his portfolio against the worst bear market of the past 15 years. Because - and this is where the other shoe drops - despite all of this madness that transpired but 11-plus months in, the major market averages are sitting near breakeven or even slightly higher for the year. In fact, the Dow (DJIA) overtook two millennium marks (13,000 and 14,000) for the first time, the S&P 500 (SPX) hit a new all-time high, and the Nasdaq Composite (COMP) surged to a new six-year peak. And these gains occurred after the subprime crisis began to reveal itself. Someone looking a year into the future would never believe it. But then, going back to the Red Sox and Kevin Federline, 2007 has been a year of outrageous events.

When you look at all we've stomached, it's frankly quite impressive that stocks have weathered the storm. In light of the fundamental struggles that have plagued the market environment of late, long-term technical support and a sentiment backdrop of caution and skepticism have kept cataclysmic selling at bay. The three separate rate cuts from the Federal Reserve (amounting to a combined drop of one percentage point) have also certainly helped, but they arrived a little late (more on this later).

Currently, we're facing the monetary equivalent of a double-edged sword. Bad news on the economic front is clearly undesirable, in that we never want to see symptoms of an economic slowdown. But if the news is bad enough, the collective conclusion is that the Fed's hand will be forced, spurring another rate cut, and a return to a low-rate environment can signal good news for the market's recovery and the eventual upturn in the housing and credit markets.

As we shift gears into 2008 - a Presidential election year - we look to the Fed for answers. They are the one major wild card here, and a policy misstep from the central bank could cause an unraveling of the technical support that has been so pivotal for keeping the market on an even keel.

Fundamentals

Ben There, Done What?

In the past few months, there has been plenty of hemming and hawing among the most powerful men and women in finance, as Fed officials worry that continued rate cuts could steer the market into an inflationary spiral. I simply cannot emphasize enough how imperative I think it is to this market that an aggressive rate-cutting campaign continue into 2008. I remain floored by the articles I read listing every indication why the bottom will fall out amid the subprime-crises mess, and how many of these pieces fail to even hint that a rate-cutting campaign from the Fed could help ameliorate this problem.

Of course, the hawkish advocate will argue inflationary pressures and the weak dollar. First of all, the greenback stands to benefit from a more prosperous environment - currency traders are as worried as anyone about an implosion in the U.S. economy. And as I've noted before - in The Option Advisor and on SchaeffersResearch.com - lower rates are already built into the dollar - it is the Fed that is lagging behind market rates. With regard to inflation, it is mind-boggling to me that this is a serious concern in the wake of a deflationary banking crisis, a scenario that has never been followed by accelerated inflation.

The yield on the two-year note is below the 3% mark. Libor rates are reflecting a level of tightness in the market not seen since the early 1990s, when we were plagued with the savings-and-loans crisis. The yield curve for the Fed funds and 10-year note has been inverted for nearly 560 days and counting - but we've yet to see recessionary indications. The point is - we're looking at the risk of deflation here, not inflation. This market and this economy need more rate cuts, and if we don't get them, all bets are off.

Recession Ruminations

The idea that the economy is poised to tap the brakes may appear at odds with the notion that stocks will continue to trend higher. In fact, these seemingly diametrically opposed concepts have a historical precedent of going hand in hand. Data reported in a December 10 Bloomberg article reveals that in the past 60 years, the S&P has moved higher in eight of the 10 years that the economy has grown by 1% or less.

But here's the rub … six of those eight increases coincided with periods during which the Federal Reserve was dedicated to a rate-cutting campaign. Since the 1950s, the Fed has cut rates at least three times consecutively on 12 different occasions. In 11 of these instances, higher stock prices followed; the S&P posted an average annual gain of 19.2%. What's more, in the six years when these rate cuts coincided with economic growth of 1% or less, the average gain in the S&P was 23%. Are you listening, Ben?

Earnings Expectations Expose Ennui

When it came to earnings, the trend toward the end of 2007 was increased caution, which came in the form of reduced estimates. By December, the average estimate for fourth-quarter earnings (the lion's share of which will be reported in January) was less than 1.7%. For 2007 as a whole, total earnings are on pace to grow 3.2%, the worst collective earnings growth rate since 2002. This is down from the 9.3% earnings growth projected at the beginning of the year.

This backdrop shows me two things.

First, it's another testament to the underlying strength of the market, which was able to hold steady despite such a disappointing turn in the earnings department. Additionally, from a sentiment standpoint, these low expectations, which are likely to trickle into early 2008 outlooks, sets up the potential for upside surprises to blaze a trail through the market early next year. When analysts and investors are expecting the worst, the slightest bit of good news can spark buying interest. Also remember that the overall earnings picture has been clouded by weakness in finance and housing. Take these problematical pockets out of the equation, and earnings remain on solid ground - perhaps on shockingly solid ground as evidenced by recent very strong earnings reports from major technology stocks.

For the S&P 500 Index overall, I expect earnings growth of around 7% in 2007. My assumption is that consumer spending will not suffer a major hit next year, as Fed rate cuts (again, the wild card here) and other steps to ameliorate the housing slump will shore things up. I'm also expecting to see oil prices moderate and income growth remain strong.

While the financial sector will face continued earnings challenges as the impact of the credit-market woes trickle down, this weakness will be offset by strong earnings growth in such sectors as utilities and technology. I'd expect the weak dollar to act as an overall economic stimulant in addition to boosting the overseas earnings of multinational companies and encouraging foreign buying of U.S. assets. If the Fed cooperates, fourth-quarter 2008 earnings growth could rebound strongly across all sectors, causing a real surge in buying demand.

Lame Duck = Good Luck?

For the first time since 2000, one thing is certain in the upcoming year's political landscape … by the end of the year, a new person will have been elected Commander in Chief (I'd say by the end of Election Day, but we've seen how that can go). No matter the turnout - Democrat, Republican, man, woman, Hollywood actor, or dark horse - the White House will have a new resident come January 2009. What does the changing tide mean for the stock market? Potentially a lot.

But before we get to our 44th President, let's see what we can expect from the final months of George W. Bush, from a market perspective. Historically speaking (back to 1952), the fourth year of the Presidential cycle has been the second best for the market (the best being the third year, although this cyclical pattern didn't live up to expectations in 2007). On average, the fourth year in the Presidential cycle has seen an average annual return of 7.35% in the broad market. The best year by far was 1996. As Bill Clinton easily nabbed a second term against Bob Dole, the market charged 26.01% higher. The worst two years were 1960, when the market fell 9.35% and a controversial election resulted in John F. Kennedy defeating then-Vice President Richard Nixon, and 2000, when the market gave back 6.18% amid the technology bubble-bust.

It's also interesting to note the potentially bullish impact of bipartisan rule. In the past, a discord between Congress and the President has been good for the stock market (possibly because warring factions lead to inaction by government). Noted economist Ed Yardini once observed: "I wholeheartedly encourage people to vote for gridlock; it's good for Wall Street and for Main Street too."

Currently, there's a stalemate, with the White House controlled by Republicans while Democrats hold Congress. Next November, with 35 Senate seats and the Presidential slot up for grabs, we could wind up with a change in both branches. This will be something to keep in mind as we make our financial decisions for 2009.

Crude Awakening

In the fourth quarter of last year, the price of crude per barrel was lower relative the first quarter of 2006. This was certainly not the case this year, as black gold muscled continuously higher for most of the year and briefly threatened to overtake the psychologically significant $100 level.

At press time, long-term crude futures were nearly 43% higher for the year and the average price at the pumps (for regular-grade unleaded) was still hovering around $3.00. The simple fact of the matter is, since crude toppled the $30-per-barrel level in May 2003, black gold has been on an indefatigable run higher. People lamented $50-a-barrel oil and $80-a-barrel oil. And though the rising price of fuel has ultimately impacted everyone, from the commuter fueling up every week to the airline traveler feeling the brunt of higher ticket prices (to the consumer, who has seen the cost of many products increase to compensate for rising fuel), the overall jump in crude futures has been somewhat of a non-issue for the stock market.

Though oil has tripled in value in the past four-plus years, economic growth has remained healthy. The annual gross domestic product (GDP) rose an average of 5.95% from 2003 through 2006 and is currently expected to rise approximately 4.8% in 2007. Unlike the oil crisis in the mid-1970s, when supply was crimped, prices spiked, and filling stations were forced to deal with lines of frustrated customers, today's gains in oil are the product of increased demand. If we were to see oil suddenly fall back even as low as the $50-per-barrel mark, it would probably be the result of some deeper-seeded economic issues. Consumers and the economy have put up with rising oil this long; fuel costs should continue to be digested rather effortlessly in 2008 as well. However, forecasts for GDP growth in 2008 are just above 1.5%. Thus, a slowdown is factored into the market.

Finally, from a contrarian perspective I note that those forecasting crude oil prices for 2008 have adopted a "fool me 10 times, shame on me" attitude, vowing that they will not again be fooled into predicting (as they have, year after year) that the price of oil will revert to the mean and retreat. One of Mr. Market's favorite tricks is to blow away those who modify a long-held stance because they feel they've finally "learned their lesson".

Stay tune for more from part 2 that will further analyze the technical trend and market sentiment...

Options Trading - Collar Strategy

How Does Collar Strategy work?

Assuming the current underlying stock price is $28.50.

We buy 100 shares @ $28.50.

For the sake of simplicity and to make our calculations easy let's establish the collar using the January 27.5 put and the January 30 call, with both options trading at $1.00. The cost of the collar will be $0 because we paid $1.00 for the put but you collected $1.00 from the sale of the call.

How does the collar work in our usual three scenarios: the up, down and sideway market scenario?

Up scenario:
We find that when the stock rises, the investor gains penny for penny until the stock reaches the call strike at $30. Once the stock reaches that level, the position no longer gains because the stock is at the point where it will be called away.

Capital gains of the position are maximized when the stock reaches the call's strike price.

Let's take a closer look at what happens as the stock price goes up. With the stock at $29.00, both the Jan 30 calls and the Jan 27.5 puts are out of the money and thus worthless.

Since there was no debit or credit incurred in the options, the option profit (loss) is $0. Only the stock position remains. The stock purchased at $28.50 is now trading at $29.00 for a $0.50 profit.

Let's say the stock price increase to $30.00. The puts and calls are again worthless so our profit (loss) is solely determined by the stock. The stock, which was purchased for $28.50 is now worth $30.00 and represents a gain of $1.50. This $1.50 gain is the maximum gain the position allows.

Once the stock goes over $30.00, the Jan 30 call, which we are short, would become in-the-money and therefore the stock position would be called away at that price. When the stock price rises to $31.00, the puts would be out-of-the-money thus worthless but the calls would be worth $1.00.

We received no money for the establishment of the collar, so, we would have a $1.00 loss in the options. Meanwhile, the stock that we purchased at$ 28.50 is now worth $31.00 at expiration, which is a $2.50 gain.

Combine the $2.50 gain in the stock less the $1.00 options loss; we have a $1.50 profit again. We may do this calculation with higher and higher stock prices but the outcome will always be the same. This example shows how us that upside potential is limited.

Obviously, if the option portion of the collar incurred a debit or credit, that inflow or outflow of money must be added to or subtracted from the stock gain to get the overall return of the position.

Normally, there will be a debit or credit incurred in the collar. It is usually difficult to find a put and a call that we want to use in the collar trading at an equal value. Let's use our last example with some minor price changes.

If the put had been trading at $1.25 instead of $1.00, then there would be a $0.25 capital outflow that would have to be subtracted from the $1.50 gain to reduce it to only a $1.25 gain.

On the other hand, if the call was trading at $1.25 then we would have collected an extra $0.25 which added to the $1.50 gain would produce a $1.75 gain. The cost of the collar always impacts the bottom line profit or loss of the position.

Sideway scenario:
The stock price would be unchanged thus neutral in terms of return. Therefore, the potential profit or loss would come strictly from the debit or credit of the two options.

If the stock does not move, as in our example, both the put and call would finish out-of-the-money and be worthless.

Our profit or loss would simply be calculated from whether we paid for the collar or collected from the collar and how much that amount was.

Down scenario:
Using the same prices as the previous example (the stock purchase price of $28.00, the Jan 27.5 put $1.00 and the Jan 30 call $1.00) we will now take a look at the downside. Let's set the stock price at $28.00 on expiration. At this price both the Jan 27.5 put and the Jan 30 call are out-of-the money and worthless. Since there is no credit or debit incurred in the option position ($1.00 inflow from the calls, $1.00 outflow from puts) the total return of the position is simply the gain or loss from the stock.

With the stock purchase price of $28.50 and a stock price of $28.00 on expiration, there will be a $0.50 loss in the position. Setting the stock price at $27.50, we see that the Jan 27.50 puts and the Jan 30 calls are again worthless and with no debit or credit incurred, the positions profit or loss will come down to the gain or loss on the stock.

With the purchase price of the stock being $28.50 and the stock price at expiration $27.50, there will be a $1.00 loss. In this case, we have reached the maximum loss. No matter how low the stock goes, we can only incur a maximum loss of $1.00.

Now, let's set the stock price at $26.00 and see if this holds true. With the stock at $26.00 on expiration, the Jan 30 calls are out-of-the-money and worthless. The Jan 27.5 puts, however, are in-the-money and now worth $1.50.

The stock you purchased for $28.50 is now worth $26.00 on expiration which is a $2.50 loss. Combining the $2.50 stock loss with the $1.50 gain in the puts and we have a $1.00 loss in the overall position.

This demonstrates that $1.00 is the maximum loss of the position. Keep in mind that if the stock position creates a debit or a credit, it must be added to, or subtracted from the stock loss.

Most of the time, there will be a small debit or credit incurred in the option position. It is relatively infrequent that the put and call used in the collar are trading at the exact same price.

Feed Shark

Stock down and options volatility down...what's next?

Just want to share another interesting observation by Dr Brett Steenbarger.
You can visit Brett's blog at: http://traderfeed.blogspot.com/2007/12/stocks-down-option-volatility-vix-down.html

Interestingly, over the past five trading sessions, the S&P 500 Index ($SPX) has been down about 1.9%, but the VIX has also been down 8.8%. I went back to the start of 2004 (N = 995 trading days) and found that the average VIX change when the five-day $SPX has been down more than 1% has been +16.46%. We've only had six occasions during that time in which $SPX has been down more than 1% over a five-day period and VIX has also been down. The S&P 500 Index was lower five days later on four of those six occasions, for an average loss of -.77%.

Indeed, when $SPX has been down more than 1% over a five-day period and VIX has been up less than 4% during that same time (N = 29), the S&P 500 Index has been higher only 7 times and lower 22 times over the next five trading days (average loss = -.84%). When stocks have been lower but options participants are displaying relative complacency, short-term returns have been subnormal.

Interesting article about trading coach

Just to want to share an interesting article about trading coach by Brett Steenbarger, Ph.D. from TraderFeed.com. I agree that when there is no positive result and relationship with the trading coach. We should just treat it like a bad trade. Accept the loss. Cut loss and Move on!
Enjoy...

Three Predictors of Coaching Success

When a trader or trading firm hires a coach, there is a significant investment of time, effort, and (often) money. Coaches are generally sought when trading results are substandard, which means that time is at a premium. Hiring the wrong coach or seeking the wrong goals with the right coach is thus more than a missed opportunity. It can dig traders further into a hole and reduce the odds of eventual success.

So how do we know if coaching will be helpful to a trader?

The psychology research on change processes in counseling and therapy, as well as my own experience across a variety of trading settings, suggest three predictors of coaching success:

1) Relationship Between Coach and Trader - It's the quality of the relationship that often gets people through the inevitable "two steps forward, one step back" frustrations of change. In a good helping relationship, the coach sees the trader's potential, demonstrates a concrete understanding and empathy for the trader's situation, and is seen by the trader as both caring and competent. Very often, I find, the good helping relationship is one that transcends the pure business relationship. Every trader I work with gets my email address and home phone number; I do not charge for those contacts and, indeed, strongly encourage those. It's one way of demonstrating that my level of commitment will match that of the trader. Too, when traders make significant progress, I get excited; it's a real rush for me. I think traders can sense that. They know when a coach is emotionally invested in their success. If the coaching relationship lacks that commitment and spark, the odds of it being successful are meaningfully reduced.

2) Readiness For Change - Research in psychology finds that change is most likely to occur when people are prepared to take actions necessary to make changes. Many times, traders are aware of problems but don't know what to do--or aren't emotionally prepared to take action--to change those problems. A good example is a trader who might need to alter his trading style to adapt to changing market conditions. He might be reluctant to tackle the uncertainty of remaking his trading, which will necessarily extend the length of time it takes to make changes. The traders who are most ready to make changes are often those who are in some discomfort and who have tried all the easy fixes. They are prepared to do what it takes to turn things around. If you're seeking a coach and aren't ready to work on yourself every day and week, you might be best off saving time and money and waiting until the readiness is higher.

3) Involvement In Change - When I reviewed the research literature on change in counseling and therapy some years back, the brief conclusion that I came to is that "talk is cheap". Coaching needs to be more than talk: it needs to produce new skills and new experiences. Good coaching is hands on and goal-focused; it targets specific areas for change and introduces concrete strategies for accomplishing those changes. Too often, coaching talks about trading rather than works directly on trading. Some of my best work has occurred while I was watching a trader trade and could make very specific suggestions about improvements. That made the change work very immediate and involving. The more emotionally and behaviorally involved a trader is in the change process, the more successful that process is likely to be.

One interesting study found that, if positive changes and a solid relationship had not materialized by the third meeting, the counseling was unlikely to be successful--ever. Within a short time, you should have a good feel for the quality of the working relationship, the specific goals you'd be working on, and the concrete ways you'll be tackling those. Within those first few meetings, you should already be feeling that you're on a promising path. If you don't experience all the above with a new trading coach, treat the coaching like a trade and quickly exit the losers.

What Lies Beneath...

I read this article: '90% of Our Trades Make Money' and Other Expensive Half-Truths by Philip Guziec from Morningstar.com and learn about the thought beneath all the big headlines of the marketing materials that I received and read especially from internet, emails, newspaper, etc. Thinking about the key message of this article again, it is true to certain extent. Hence, I would like to share this article with all my trading buddies and friends. Be careful and think again whether it is the truth or lie beneath the headlines in future...

On my desk is a stack of marketing pitches I've received over the past year hawking option classes, strategies, and systems. These advertisements range from the relatively benign to the borderline criminal, but the key thing to keep in mind is that the objective of the guys making these pitches is to sell courses, newsletters, or systems. That means that the sale needs to be simple and emotionally appealing, but not necessarily that the system will make you money.

I'll walk through a few of these pitches in an attempt to prevent you and your money from parting prematurely.

"90% of our trades make money…"
This is my personal favorite, and it preys on the typical neophyte option user's ignorance of statistics. Anyone can come up with a strategy in seconds where 90% of the trades make money, but the unspoken second half of this sentence is, "…and on the other 10% of trades, you lose your shirt."

There is probably a bunch of fancy option lingo and complexity wrapped around the strategy to disguise the simplicity of this fact, but the bottom line is that any strategy where 90% of the trades make money includes big losses on the other 10% of the trades, and those bring your total return down dramatically. I'll be writing quite a bit about option statistics, but the simple version of the "90% of our trades make money" strategy is to write far-out-of-the-money naked calls. Easily 90% of them will make money if they're far enough out-of-the-money, but a loss on any one of the remaining 10% could bankrupt you.

"We bought xxx calls and made 182%," or "We bought yyy puts and made 367%," etc., etc.
Assuming that these "investments" were even made up front, and not generated by picking the winners after the fact, these are just emotionally gripping numbers that were chosen by selecting from among the winners. What isn't being said is that in the same set of investments, "Our xyz calls expired worthless, losing us 100% of our investment," and "Our pdq puts expired worthless, losing us 100% of our investment." To really evaluate an investment strategy, you need to examine a portfolio return over time.

While we're on the topic of emotionally gripping, let's address this one:

"Joe Schmo was living on the street in a box, but he made $100,000 last year with our secret option strategy." This is just like a casino ad showing the smiling face of a big jackpot winner: "Ed Superlucky won $7,200,000 at the Loseyourshirt casino." In this case, you're hearing from the winner, not the 9,000 other casino "customers" who lost an average of $1,000 apiece. To illustrate further, imagine giving 1,000 vagrants each a credit card with a $1,000 cash advance, and having them all make a 100-to-1 bet at a casino. Ten of them will make $99,000 from nothing, and the rest will wind up defaulting on $1,000 in debt. Joe Schmo, who was living on the street in a box, is the options equivalent of one of those 10 winners.

"Our list of recommended trades last year averaged an 82% return."
These near-lies work in a couple of ways. First, there is the fine-print version, where you'll find something like: "This trading performance assumes that each trade was exited at the high trading price during the period." Think that through for a second. If I buy something, figure I sold it at the same price I paid for it if it goes down in price (the high trading price during the period), and figure I sold it at the highest price it reached if it goes up, of course my calculations will show a huge return!

The second version of the near-lie is slightly more insidious, and it depends on the fact that many options are still relatively illiquid (rarely traded, so a big purchase will move the price of the options). If an options service buys relatively illiquid options, and then pitches the trade to thousands of people, the demand generated will push the price in the service's favor, at which point it will typically sell. The service's portfolio may well make money, but the individual options investors probably won't because they overpaid for the options. When this is done with penny stocks via pitches in e-mails or faxes, it is a little more obvious, and it is rightfully called "pump and dump."

"We've found back-tested strategies that have returned 376% annually, and you can, too, using our back-testing tools."
Back-testing is also called data mining, and it's another way to scam with statistics. In any large set of data, one can statistically find patterns that worked historically, but with no reliable reason the same strategy will work in the future. For example, the Super Bowl Indicator says that most years after the NFC wins are good years for stocks, and most years after the AFC wins are bad years for stocks. The technical term is spurious correlation, and blindly using back-tested strategies should provide a solid, and expensive, education on how schemes that could have worked in the past don't necessarily work in the future.

"Our charting strategy generates signals that blah blah blah… Fibonacci retracement blah blah blah… Candlestick charts blah blah blah…"
Find me one "technical analyst," as they call themselves, among the 500 richest people in the world, and I'll quit my job and read every book ever written on technical analysis.

"XYZ Corp. just got FDA approval for the cure to cancer. We recommend buying the calls on XYZ at…"
Some services seem to add credibility to their analysis by coupling the official release of positive facts with recommendations. This is another strategy for selling services that prey on human psychology. People tend to infer causality when there is none stated. In this case, the sentence adds no value from an investing perspective for two reasons. First, any obvious public news should already have caused the price of the stock and the options to move. Second, even if the news wasn't public, there is no explicit link between the statement and the recommendation. What this service is likely doing is simply linking a news feed to a random generator that suggests the option purchase, knowing full well that human nature will cause many unsuspecting and trusting investors to fall for this strategy, and pay money for the worthless service.

"If you wrote options following our strategy over the past five years, you would have made an average of 22% return on your account."
This is the momentum element of options investing, and the one claim that comes close to an undistorted truth. The securities markets have been in a prolonged period of falling volatility. Another way of putting this is that stock prices have been wiggling around less and less each year since 2001. Because of this, writing options has been a winning game over buying options (technically speaking, realized volatility has been less than implied volatility). Will this continue? Not likely. Volatility has been at historic lows, and the world rarely remains a stable place forever. The one sure thing we know is that volatility won't go to zero. Continuing to blindly follow the strategy of mindlessly writing options is a bit akin to buying tech stocks in 2000. The trend will probably eventually blow up in your face, but you don't know exactly when.

Hopefully these examples will help you better evaluate the marketing materials that show up in your mailboxes, and let you save that money for real investing.

Feed Shark

US Market dancing up and down

The US stock market opened sharply higher right after open (its second-largest open in the past four years) after the Fed announced its joint effort with the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank to establish a temporary Term Auction Facility in an attempt to improve liquidity. This is the effort that Fed tried to counter the disappointment from the market after a 25 basis point cut yesterday.

The Fed plans to use term funds auctions that will allow it to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations. The Fed also plans to utilize foreign exchange swap lines. The plan is more ambitious than added easing in the fed funds or discount rates. The operations are open to thousands of banks rather than the 20 or so primary dealers involved with the daily Fed operations. In addition, there should be no stigma against these operations as, like it or not, discount borrowing from the Fed still carries the presumption of troubled borrowing, leaving hesitancy from the market. However, the opening range highs have proven to be the highest prints of the day as the market has subsequently slid lower throughout the session.

Financials, which led yesterday's post-FOMC decline, are underperforming the broader market this session because of several reasons...

Bank of America (BAC) said this morning at a conference that it expects quarterly results to be disappointing. The company expects write-downs will be larger than reported, and described final write-downs of collateralized debt obligations are "unknowable."

Wachovia (WB) said at the same conference that it now expects fourth quarter 2007 provision expense to be $1 bln higher than charge-offs.

There is also a report that Morgan Stanley is picking Citigroup (C) as a stock to sell short as it believes Citi's earnings are deteriorating. The firm expects new management to deliver a dividend cut, and also expects further hybrid issuance, diluting current shareholders.

Finally, JP Morgan (JPM), Bank of America and Wachovia were downgraded at Merrill Lynch based on credit risks...

Day Traders need to know this...

For traders who getting in and out of the same position on the same day, you definitely need to know this....

Day trading requirement established by Nasdaq and most of the brokerage firms:

• Pattern Day-Traders are characterized by transacting 4 or more stock or options day-trades within a five-day period in a margin account.
• Pattern Day-Traders must maintain at least $25,000.00 in account value in order to continue day-trading practices.
• In the event that a Pattern Day-Trader does not maintain $25,000.00 in account value they will be required to provide cash-on-hand for same-day stock transactions.
• Additionally, an account may be flagged for day-trading if it regularly recycles funds within the same day, for example, an investor sells a security (stock or option) for a premium of $400 and proceeds to purchase another security (stock or option) for $400 when no other capital is available and prior to funds being cleared.

If an account becomes designated as a pattern day-trading account and does not maintain the minimum required equity i.e. minimum $25,000.00, a call will be issued which must be met within 5 business days, otherwise the account will be restricted to Cash only for a period of 90 days or until the account equity is brought above the minimum equity requirement or minimum $25,000.00."

The Nasdaq Day-Trading Risk Disclosure Statement also sets out some considerations for the potential day trader (one who uses an overall trading strategy characterized by the regular transmission by a customer of intra-day orders to effect both the purchase and sale of the same security or securities).

One should consider these as serious warnings because day trading can be extremely risky and is not appropriate for trader who has limited resources and/or limited trading experience. The trader should be prepared to lose everything used for day trading. They also indicate that "certain evidence" indicates that an investment of less than $50,000 will significantly impair the day traders ability to make a profit.

In addition, day trading on margin could result in losses beyond the initial investment. At the same time, with multiple commissions incurred will definitely make it more challenging to attain profits.

On a neutral ground, there are traders who make a fortune from day trading and that make it very tempting for a lot of people. At the same time, there are a lot of people lost so much through day trading. So, we should do our homework before considering this strategy.

Other than obtaining an understanding of the significant risks, the prospective day trader needs to understand his own trading emotions very well and be able to attain great discipline before putting any money at risk.

Happy trading!

When Trading Performance Falls Off a Cliff

US Market sentiment has changed in the past few months and I find this article by Dr Brett Steenbarger very relevant to traders. Just want to share with all my trading buddies and friends.

“I’ve been a successful trader, but lately I’ve been losing money. Nothing I try seems to work. What should I do?”

I’ve heard variations of this problem quite a few times in recent months. Good traders are struggling, despite volatile markets that—on the surface—should offer opportunity. It’s a frustrating and demoralizing situation.

So what should a trader do?

The important thing here is that the trader has been successful over a period of years, not just months. The problem is not simply one of inexperience. This is what makes the problem so perplexing: the trader knows he or she has skills, but it’s as if all that experience has flown out the window.

Let’s take an analogous situation: Suppose you’ve had good health for years, but now feel persistently sick and run down. You’re just not your old self. What should you do?

Clearly, you would seek professional help for a thorough and objective evaluation and for an accurate diagnosis of the problem. What you would not do is let the situation continue to deteriorate. You would also not simply assume that the problem must be “in your head” and immediately seek psychological assistance.

Similarly, the experienced and successful trader whose performance has fallen off a cliff should not let the situation fester and should not assume that the problem is psychological. If health has deteriorated, there’s most likely a health problem that needs to be identified and treated. If the health of one’s portfolio has deteriorated, there’s most likely a trading problem that requires similar assessment and intervention.

Having worked with traders across a variety of markets and strategies—from market making and prop desks at banks to global macro portfolio managers and Chicago prop traders—I’ve found three common sources of performance decline:

1) Diminishing Opportunity in the Trader’s Market – Perhaps you’ve been making markets or trading spreads and the bid-offer has narrowed significantly. Perhaps your market has entered an extended period of reduced volatility. The market has changed significantly and your old strategies no longer work.

2) Altered Market Behavior – Perhaps you’re a short-term trader who looks for advantages in short-term price/volume patterns or in shifts within the order book (depth of market); perhaps you depend on execution (buying bids and selling offers, entering long on pullbacks, short on bounces) for much of your profitability. The presence of new large traders in your market, including automated trading systems/black boxes, has shifted how markets trade in the short-run, disrupting the patterns you’ve counted upon for your profitability.

3) Shifting Market Regimes – Markets that used to behave independently now are more correlated. Countertrend patterns that once ruled markets now are giving way to greater trending moves. Enhanced intraday volatility is making it difficult to participate in longer-term market moves. We’ve seen a variety of changes in market trading patterns and it has been difficult for traders and investors to adapt to these.

Notice that these are variations on a single theme: markets have changed in some ways and what once worked is no longer working. It’s no wonder that struggling traders feel as though they’ve “lost it”. In a sense, they have.

Does this mean that trading problems don’t have a psychological component? Not at all. When markets change and traders are caught in the transitions, the usual outcome is frustration, then self-doubt. These emotional reactions can interact with the trading problems to create vicious downward spirals, both in mood and P/L. What begins as a trading problem can escalate into emotional one. Frustrated, reactive trading can undermine serious efforts at adaptation.

My advice for traders in a prolonged tailspin is severalfold:

1) Cut Risk – It’s that “above all else, do no harm” principle. If you don’t have a feel for the market, trade small while you regain your feel. Preserve as much of your capital as possible to lay the foundation for your recovery;

2) Focus on Your Strengths – It’s not unusual for frustrated traders to try to make all kinds of changes in their trading in a frantic effort to gain some traction. These efforts can compound difficulties by getting traders further and further from their strengths. During rebuilding periods, you want to focus on the markets and strategies that you know most about, that represent your strengths.

3) Reach Out – It’s especially helpful to reach out to traders who trade markets and strategies similar to yours. Are they also struggling? If so, this suggests that market changes, indeed, may be at the root of the problem. If the traders you contact are succeeding, try to find out what they’re doing differently from you. It may well be that a simple tweaking of execution, holding times, and risk management could turn your performance around.

4) Stay Constructive – You may well be in a rebuilding period. This happens to the best athletes and sports franchises. It doesn’t mean you’ve lost all talent and skill. Identifying the kinds of trades that are working for you is a start toward rebuilding: you want to find the common denominators behind your successful trades so that you can emphasize these going forward.

5) Work on Your Self-Talk – Hard as it is, it’s important to stay positive during a rebuilding period. The last thing you want to do is create additional interference by beating up on yourself and dampening your motivation. This is one of the areas where coaching can be helpful. Setting attainable goals and creating plans for learning new patterns and trading strategies can fuel optimism, determination, and focus.

6) Control the Budget – It very much helps to have a cash cushion to weather these rainy day periods. Living within one’s means also helps greatly. I’ve generally found that traders can adapt to shifting markets if they have enough time to make the transition. It’s when the pressures of bringing in money month to month add to the performance pressures of a drawdown period that turnarounds become difficult to sustain.

Perhaps the best advice, however, is preventive.

Identify slumps early and control losses before they get out of hand. Perform regular inventories of your winning and losing trades, so that you’re always on top of what’s working for you and minimizing what’s hurting performance. During your best times, remember that markets always change and keep powder dry to weather the inevitable lean times. Ironically, the best way to master declines in trading performance is to embrace them early and turn them into prods for learning and development.

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Are you a warrior in options trading?

Before we start on our options trading journey, we need to understand the various styles of equity or options traders. This is because one of the most confusing aspects of the trading profession is there is no single definition of "traders". Traders come in many different styles, sizes, behaviors, characters and varieties.

Professional options traders will generally undertake one of several styles and stick only to that style. This is an important point since traders are always at the risk of being distracted by various market commentaries, analysts’ opinion and conflicting trading styles.

Find out which types of trading warriors you are.

1. Fundamental Warriors

Fundamental trading is a method by which traders focus on company-specific events to determine which stock to buy and when to buy it. Trading on fundamentals is more closely associated with the buy-and-hold strategy of investing than short-term day trading. There are, however, specific instances in which trading on fundamentals can generate some nice profits in a short period.

This type of traders trade companies based on fundamental analysis, which examines things like corporate events such as actual or anticipated earnings reports, stock splits, reorganizations or acquisitions. One of the richest man in this planet earth, Warren Buffett, is famous of investing in companies which are underpriced based on some form of fundamental analysis.

Most of the equity investors are aware of the most common financial data used in fundamental analysis: earnings per share, revenue and cash flow. These quantitative factors can include any figures found on a company's earnings report, cash-flow statement or balance sheet; these factors can also include the results of financial ratios such as return on equity and debt to equity. Fundamental traders may use such quantitative data to identify trading opportunities if, for example, a company issues earnings results that catch the market by surprise.

2. Swing Warriors

Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamental traders are actually swing traders since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit.

Swing trading is actually a mix of day trading and trend trading. A day trader will hold a stock anywhere from a few seconds to a few hours but never more than a day; a trend trader examines the long-term fundamental trends of a stock or index and may hold the stock for a few weeks or months. Swing traders hold a particular stock for a period of time, generally a few days or two or three weeks, which is between those extremes, and they will trade the stock on the basis of its intra-week or intra-month oscillations between optimism and pessimism.

3. Technical Warriors

Technical traders are obsessed with charts and graphs, watching lines (esp support and resistant lines) on stock or index graphs for signs of convergence or divergence that might indicate buy or sell signals.

In general, a technician is somebody who looks back in history, using the recognizable patterns of past trading data to try to predict what might happen to stocks in the future. This is the same general method practiced by economists and meteorologists: looking to the past for insight into the future.

4. Momentum Warriors

Momentum traders look to find stocks that are moving significantly in one direction on high volume and try to jump on board to ride the momentum train to a desired profit. Momentum traders may hold their positions for a few minutes, a couple of hours or even the entire length of the trading day, depending on how quickly the stock moves and when it changes direction.
By watching the momentum line, the momentum trader has already engaged in technical analysis, examining stock charts for signs of the breakout. However, the technical indicators used in momentum trading are very limited and only the tip of the iceberg compared to technical guys.

5. Scalping Warriors

The scalper is an individual who makes dozens or hundreds of trades per day, trying to "scalp" a small profit from each trade by exploiting the bid-ask spread. Scalper generates trading profits from stocks that are not moving, make tiny profits from each trade by buying a stock on the bid and then turning around and selling at the ask.

Personally, I am a fundamental warrior because I do play earning during peak season. At the same time, I am a momentum day trader riding on the wave when I see signals to enter and exit.

How about you?

It is very common that options traders are constantly soul searching and questioning their own chosen approach. Novice traders might try and test each of these techniques to find their style. Some experimentation is advisable, particularly at the beginning of the options trading career, but deviating from a disciplined, focused approach can be disastrous later when we are establishing our style.

At the same time, there are a lot of options trading related books entirely devoted to each style, although many titles such as "Day Trade Online" or "How to Get Started in Electronic Day Trading" are unclear about what type of trading they are deploying.

Ultimately, it is critical that we settle on a single niche, matching our investing knowledge and experience with a style to which we feel that we can devote further research, education and practice.

Happy trading!

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Why Option Trading Is My World?

Options trading becomes the in-thing and most trendy investment strategy nowadays. In fact, option is a much popular financial instrument especial in Asia lately. There was even an Options Trading Championship or competition being organized at Singapore, Malaysia and Indonesia concurrently in Oct 2007 organized by Freely Business School headed by Dr Clemen Chiang.

So, why options trading is so popular and in fact being viewed as a tool to attain financial freedom?

Generally, there are 4 main reasons we should consider options trading:

1. Limited risk and exposure
2. Hedging
3. Leverage
4. Generate additional income on existing portfolio

1. Limited Risk and Exposure

In options trading, buyers benefit from being able to control the movement in a stock for just a fraction of the cost of purchasing that stock. At the same time, we can never lose more than this modest dollar amount. Therefore, we can keep the bulk of the investment dollars in the safety of cash where it is immune to the wild and often scary swings in the market.

2. Hedging

One of the most conservative options trading strategies is to help protecting our investment portfolio against sudden downward pressure on stock prices. It is just like an insurance policy. Investors often buy puts as a hedge to protect their portfolio value.

For a comparatively and fairly minimal investment, through option trading, we can secure the right to sell our stocks at a particular price (a "put") regardless of how is the market doing.

By buying a protective put, an investor increases their break-even point of the stock by the cost of the put and if the stock price rises instead of falls, this strategy may limit the upside potential by the cost of the put.

The way this works is fairly straightforward. Let's imagine you decided to buy 1,000 shares of ABC Corporation for $88. To protect your $88,000 investment, you might consider buying puts.

Since each put controls 100 shares, you would need 10 contracts to protect 1,000 shares.

By choosing a strike price of $85 and an expiration date several months away, you would lock in the right to sell your shares with a maximum loss of $3,000 ($88 purchase price - $85 strike price x 1,000 shares) plus the cost of the puts.
Of course, the best scenario would be for the stock to increase in value so the puts would expire worthless. In either case, knowing that you'll be able to sell your shares at $85 -even if the stock drops to $50- might just help you sleep easier.

3. Leverage

For investors with a high level of risk tolerance, options trading enable us to use relatively moderate sums of money to leverage sizable positions.
For a fraction of what it would cost to purchase large blocks of stocks in high-flying volatile companies, investors can buy calls giving them the right, but not the obligation, to buy shares at a specific price (strike).

If a stock trades at $50, it would take $25,000 to buy 500 shares.
Through options trading, the same investor might buy ten 50 call contracts at $8. Now, for just $8,000 (10 contracts x $8 x 100 shares per contract), the investor owns the rights to buy 1,000 shares of stock at $50, any time before the call options expire.

If the stock price is $70 at expiration, the options will be worth $20 each ($70 - $50) or $20,000 (10 contracts x $20 x 100). The investor will have a profit of $12,000 on a $8,000 investment through options trading.

In contrast, the investor who paid $50 for 500 shares spent $25,000 to make $10,000 ($70 - $50 x 500 shares). That's the power of leverage.

However, the risks are equally high. If the stock doesn't move, the investor who paid $8,000 for the $50 calls will lose the entire investment. Likewise, the investors who bought the stock will have lost nothing because they still own the stock.

4. Generate Additional Income On Existing Portfolio

Another relatively conservative options trading strategy is covered-call writing to generate income on stock positions already held. Many investors use this strategy to help generate additional income from stocks in their portfolio or to lower the breakeven on stock positions being purchased.

This is can be done by selling out-of-the-money calls (i.e. options with a strike price that is above the current stock price). When we sell calls, we take on the obligations (if the buyers of the calls exercise their rights) to deliver the shares at a certain price (strike price) by a certain future date (expiration date). When selling options, we pocket the premium received from selling the options. Normally, the owners of the stock decide to sell calls when they think the stocks will stagnate over the short term. In this case, by selling calls generate income even if the stocks fail to stage a rally.

Here's how the strategy works:Let's imagine that you currently have 1,000 shares and the stock is trading at $67. If you sold 10 calls or less against the stock in your account, they would be considered "covered" because you wouldn't have to buy shares at the open market in the event of an assignment. For this reason, the position is far less risky than uncovered (naked) calls that, by definition, are written without stock as collateral.

If the $70 calls are trading at $3, you could sell 5 contracts and earn $1,500 ($3 x 5 contracts x 100 shares). Now, all you have to do is hope the stock remains below $70. If it does, you keep the $1,500 and all of your stock.
If the stock jumps to $72, you have two choices.

First, to keep the stock, you could buy the calls back. While this may result in a loss, from taxation perspective, this option could be preferable than incurring capital gains.

Your other option would be to wait for the assignment and sell 500 shares to the option holder at $70 per share. In this case, you still keep the $1,500 premium you collected from selling the calls. In addition, you capture the profit associated with the stock's move from $67 to $70 i.e. $3 x 500 shares = $1,500.

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What is Options Trading??!!

Options trading become very popular lately because option is one of the most flexible and versatile instruments that can greatly enhance the performance or reduce the risk of an investment portfolio. By deploying the right strategies, options trading enable us to make money whether the market is bullish or bearish or even when the market going sideway.

So, what is an Option?

Option is a contract that has the right but not obligation to buy or sell a stock at a specific price on or before a specific date.

How does an option work?

An option is very similar to when we want to buy a land to build our home sweet home. For example, when we found an ideal piece of land and need time to obtain permit, land approval, securing financing and seek confirmation from Feng Shui master, etc.

At the same time, we would like to secure the land while putting everything in place. We can go to the land owner and “strike” a deal to buy the land for $5 million. We create a contract that gives us the right to buy the land but it does NOT constitute an obligation that we must purchase the land.

The contract has an expiration of 3 months to put everything in place. Hence, we are controlling the land for 3 months and we must decide whether to buy the land or not before the expiration date.

As a return, the land owner is expecting to collect a premium of $200,000 for being obligated to sell the land to us at $5 million. This premium is based on how much the land might increase in value during the 3 months period.
The land owner will be more than happy to receive and keep the $200,000 premium paid for the contract no matter what happens. At the same time, the agreed upon sales or strike price is likely to be much higher than he or she could obtain if he or she sold the land without obtaining all the necessary approvals.

The contract in this example is very similar to a Call option in stock market. The strike price is $5 million while the option premium is $200,000 for a 3 months expiration contract.

During the 3 months period, if we discover a gold mine underneath the land. The value of the land shoots up to $50 million. However, the land owner is still obliged to sell the land for $5 million. We bought the land for $5.2 million and can now sell it immediately for $50 million to make a $44.8 million profit.
However, if for some reasons such as the application to build a house is unsuccessful or the Feng Shui master confirms that the land is not suitable to build a house. We decide not to exercise the option to buy the land. In this case, we will lose $200,000 premium paid for the option.

Using the similar example and apply it to the share market or options trading, investors who anticipate a bullish market can buy Calls option on the stock to ride on the upward moving wave. When the stock prices go up, the premium of Calls will go up. That’s how an option trader can make money from option but at a fraction of the cost of owning the actual stock.

On the other hand, investors who anticipate a bearish market can buy Puts on stock to profit from falling prices. As the stock prices go down, the premium of Puts will rise to profit the investors. Puts are also used to protect portfolios like insurance to hedge against a fall in stock prices.


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