The Best Kind Of Trades: Inversely Correlated With Positive Expectations

The sooner you start to think of your overall portfolio instead of expectations of individual stocks (although you should think of that too) and start thinking in terms of probabilities of various outcomes, rather than trying to decide exactly where the stock is going, the sooner you can start increasing your profits.

My spreadsheet helps tremendously as long as you can determine a set of potential outcomes and the probabilities of them occurring.

Just to show you what a few “hedges” can do, I considered your average return per any possible outcome for a full strategy decreases 2% by hedging. The bankroll increase “per trade” on just ONE trade with these averages would drop from 1.32 to .84 or 63% of the full value (decrease of 37%). But you add 2 more trades, and it reduces your overall correlation from .70 to .30. What is the outcome per same period of time?

As a result of adding more trades at a lower correlation, it actually goes up.

Before hedging.

fulltradenohedge

AFTER adding just 2 hedges:

addhedge

Finally, 5 hedges, fully neutral, but with 5% decrease in every possible outcome.

fullyhedgedandneutral

The correlation is now zero, but the overall return has dropped to less than the return with 5 bets at a .70 correlation. This is because reducing your return, even with 10 bets at zero correlation is not worth it. You want some hedging, even if it decreases your “per bet return” as it will add to your overall portfolio return. However, you do not want too much hedging or “delta neutral”strategy if it decreases your return too much, even if doing so allows you to leverage multiple bets in excess. There is no “rule of thumb” to this, each trade is different. You could come up with a strategy where “full hedging” is better, as you could come up with a scenario where “no hedging” is better.

However, generally speaking some hedging is always good if it can provide a positive return and the hedge ALSO is negatively correlated with the rest of your portfolio.

So how does one find bets with a positive expected return with inverse correlation?

Most bets are done WITH the market. Bearish bets in a bear market, bullish in a bull market.

But, the bearish confirmation on a White Marubozu candlestick pattern results in a 3 day hold that yields expected returns of -2.81% in a bull market. Although it receives a -3.95% in a bear market, the -2.81% is still good.

The reverse is true, a bullish confirmation on a Black Marubozu candlestick pattern results in a 4.08% return in a bear market (which actually is better than  the 3.86% in a bull market).

In A bull market, a bearish confirmation (breakdown) of the following patterns yield a below negative 2.50 per trade. As such, going short will return more than 2.5% over a 3 day period.

The patterns to HEDGE when in a bull market:

Three White Soldiers
abandoned baby, bullish
morning star
Marubozzu, white
Doji, Dragonfly
piercing pattern
Engulfing Bullish

bullmarkethedges

The Patterns must break BELOW the lowest low of the pattern for bearish confirmation.

There are more bear market hedges. Some people prefer price patterns instead…

Also, there are Bullish bets that work in bear markets. We will get to those later.

 

Are Free Stocks For Real? Learn How You Can Legitimately Start Making Big Money Through Free Stocks

Why Free Stocks Are An Actual Phenomenon, Not A Scam

Depending on who you ask, free stock picks can be a scam, a source of big money, or a myth. Many people are unaware that there are investors who are earning big from free stocks. The birth of the internet age made it possible for investors and programmers to make trends in stock trading. If you are one of those who are aiming to earn big income online, you need to invest time and effort to learn the basics of stock trading online.

This article differs from free stocks relating to commodities, however for informational purposes we will cover that too briefly. These particular types of “free stocks” are commodity stocks owned in the free market, usually by farmers and others in agricultural trade. Since they are traded in the free market, and not owned, controlled, or manipulated by the government, these are considered free stocks. For example, supplies in the food security commodity reserve are controlled by the SEC and the government, and thus are not considered free stocks.

The remainder of this article covers the very uncommon stocks that have no financial cost, or that can be traded for no financial expense.

Today, you do not need to be a genius or a graduate of a business degree to be part of stock trading. All you need to do is to learn the steps and have the tools. Once you have all of them set, you just need to familiarize yourself with the trends in trading free stocks.

There are many ways to know things about the business. You can check resources online such as Investopedia and Money 101. These websites can help you gain the knowledge that you need in doing online stock trading. Although these websites will not provide you a certificate or diploma in Banking and Finance, it would help you understand the flow of investing and financial planning.

After you have gained the knowledge that you need, you can start looking for companies that offer free stocks. Very few do, and these are not without some form of cost, such as employment in that company for a given amount of time. You can try looking for these companies online. Once you have made a list of your prospects, you may want to do some background check to see if they are legitimate. A legitimate company should have a mailing address and other contact details on their website. You may ask any questions that you have in mind before signing up. You would not want to sacrifice your security and money to people you cannot trust. This form of free stocks may be provided by a company like Starbucks or Proctor and Gamble. For example Starbucks allows free stocks, or free stock purchasing in that up to 10% of an employees base pay can go towards the quarterly purchase price of employee stocks. This is essentially free stocks because employee stock purchases are done for 85% of the market price of the regular stock, so a portion of the stocks are free stocks.

As a beginner, you may need to download trader software that will help you in doing trading online. One advantage of having stock trading software is that it is not subject to emotions. People sometimes have a hard time making investments because they are afraid to risk their money and sometimes they are impulsive causing them to make mistakes like investing at the wrong moment. Humans are more prone to miscalculations especially when they are tired. With a trader software, you do not need to check on your screen 24 hours a day, 7 days a week. It will automatically trade your free stocks for you on every opportunity available.

Another form of free stocks is you cut out the broker completely or find one that will sell you free stocks (no commission). Big time stock brokers were not born the way the are. They do a lot of research on market trends and techniques. In order to grow, they often had to offer very low trades, or even provide a limited amount of trading per month for free. This form of free stocks is not the stock itself that is free, but the cost or fee associated with placing the trade. If you are eager to know more about free stock trading, you can read online forums and learn from the tips of experts. You can go to bookstores and look for books about money management and free stocks managing. It can be challenging at first to understand what free online trading is all about but once you get used to the trends in stock trading, earning would be easy. Making free online investments gives you less risk than shelling out thousands of dollars in commission just to buy and sell stocks over and over again. Making most out of your tools will maximize your earning opportunities.

The other way to cut out brokerage costs is through direct stock purchase plans. Hundreds of companies that trade on the major stock exchanges allow you to buy shares directly from their transfer agents for very little or no money.

You usually are not going to get something for nothing. Many of these free stocks have things associated with it. One common form of free stock is the employee stocks or employee stock options that are given after working for a company for an extended period of time. For example, a company like Procter and Gamble or Starbucks have employee stock purchasing plans for their employers to get a limited amount of free stock each month. Additionally, many employers will MATCH your 401ks providing you a form of free stock in the sense that you will put up $1000, and they will match it providing you with $1000 to go towards purchases of mutual funds which hold a basket of stocks. The $1000 is free as an addition to your regular pay. However, it is more of a “buy one get one free” deal rather than actual free stocks or mutual funds, but is as close as many will get.

Many others looking for free stocks actually are really looking for free trading costs. This is possible to some extent. Many stock brokers want your business and as a result will allow a limited number of free trades per month. These free stock trades don’t mean that you get something for nothing, but instead that you can purchase stock for the cost with no additional commission fees. There are other discount brokerage plans which offer very cheap commission.

Another form of “free stocks” is using your dividends paid by the stock of the company to require more stocks. This is known as Dividend Reinvestment Programs or “DRIPs”. This can be considered free for 2 reasons. 1 is that the stock pays for itself over time if the dividend continues to accumulate and the stock stays around the same price. The other reason is DRIPs don’t usually charge you brokerage fees so the cost of commission is zero and another form of 0 commission stock trading. In this sense the stock itself is free, and the cost is also free. This makes it the ultimate free stock strategy.

Also, there is a theoretically “free stock” in a sense called “net-nets” by Benjamin Graham. For example, if a company has enough money to pay off all of it’s debt obligations and liabilities and expenses, plus an additional $200M in cash on the sides and the market cap of the company is less than $200M, anyone that could pay for the entire $200M company would essentially be able to liquidate the company, keep the assets and immediately gain, or pay off the obligations plus pocket the initial investment and keep whatever part of the company is operational for free. As a smalltime investor you do not have that much control over a company, but you can own a limited stake of that same company. If you own say 1% of that company, than you are only putting up 1% of the cost but you are sharing in 1% of the companies earnings through either price appreciation or dividend or buyouts. When someone comes along willing to buy up the company from you, you then will be able to get the investment back. Even if the buyout is at liquidation value you still will keep your initial investment. The problem with this version of “free” stock is that unless you have the money to pay for the entire company or enough to influence the decisions, you may be tying your money up for a long time, and it is possible management will actually lose money and company value until the company no longer is worth what it was due to malinvestment. So a “net-net” should at least provide positive earnings, and/or you should at least understand the risks and account for them.

If you can buy a stock in which the company continues to accumulate earnings until the point that they eventually either pay out the value of the company when you bought shares, it is a form of having it for free. A dividend payer which grows over time will eventually allow you to get back your capital and leave the remaining investment effectively for “free”.

There are “free stock picks” of course in which someone gives you the list of stocks to buy without charging you. of course you still have to take on the risk of buying the stock and the stock pick may be very bad. So be very careful to avoid free stock picks unless you are going to do detailed investigation upon what these stocks are worth.

If you want to make money through multiple variations of “free stock picks”, Find a discount stock brokerage firm that allows stock trades for free or no commission stock trades, and use it to buy “net-nets” a form of buying a portion of a company which at the current price can be bought for free using it’s strong balance sheet to pay for the liabilities and the company itself and have more cash than you started with, and if possible become employed by that company and start acquiring free stock through employee stock purchasing programs and 401k matches. Meanwhile, if you also have a DRIP plan you can use the companies dividends to require more stock without cost. Over time, the company will grow, your lack of commission costs will give you an edge, and working for an undervalued company that pays employee stock options and stock purchasing will give you free stocks that you need to make money online.

Technical Analysis And Intraday Trading Strategies

Are Intraday Trading Strategies Right For You?

There are many that love the action of a quick day trade and are going to require great intraday trading strategies. Though we have come to associate trading with elite investment banks and opaque commodity houses, there are still individuals who seek to make a living through intraday trading. What is day trading? Day trading is a term given to individuals who buy financial instruments ranging from stocks and options to complex derivatives and simple commodities, and complete the purchase and sale of said instruments before the market closes, thus making them intraday traders. Day traders generally operate on a short-term basis, looking to profit from movements in price of a security. This article will cover some intraday trading strategies that elite traders employ.

Technical analysis is the key to success, and it is usually the best of all intraday trading strategies. Day traders take advantage of automatic trading (aka algorithmic trading) which is the use of electronic platforms to execute high frequency trading within a short amount of time. Automatic trading can lead to large intraday market movements. That is where traders can profit: when markets move, whether up or down, profits can be made.

There is a solid set of day trading rules that day traders should also abide to:
1. Have an entry price, an exit price and an escape price. These are known as the three E’s. Set your limits and stick to them, do not allow emotion into the equation, if a price dips below your preset limits, time to take the loss. If a price surges ahead, cut your profits there and exit from your position. Optimism can take you to the cleaners.

2. Avoid trading on margin.
Sure, we have all seen the success of highly leveraged deals on the front page of the Wall Street Journal, but day traders do not have a cushy back office to take care of the losses. One wrong move and creditors will be at your door for the rest of your life.

3. Never act on tips from uninformed sources.
Although we would all like to be the next Gordon Gekko, insider information rarely leaks out to day traders. Do not expect to gain an edge from a hot stop tip from bar buddy. Usually these rumors have been priced in.

4. Be willing to lose.
Anyone can handle of their portfolio moving up, but only seasoned day traders can shore their positions even after a large loss. Be careful if you are waiting for an upswing, you may wind up at the bottom of the lake.

Day traders operate on technical analysis, so what are some intraday trading strategies you can employ now?
1. Scalping
Scalping is the immediate exit out of position almost as soon as the trade becomes profitable. These usually result in smaller margins. It uses the momentum and buying orders coming in to grab a quick gain, with a possibility that it trades lower, but it is unlikely. This strategy can be dangerous if you do not also exit in a short time period if the trade goes against you.

2. Fading
Fading is shorting securities after a recent surge, this anticipates pricing corrections and assume the position has been overbought.

3. Daily Pivots
Daily Pivots involves watching the price and trying to catch it at its lowest point while selling it at its highest point in the day. Traders can thumb through historical prices to better position themselves at the trough and peak of the pricing.

4. Momentum
Momentum involves trading on a public release of information. Information generally draws volume and price fluctuations will be more pronounced. Intraday traders will try to ride the movement and exit as soon as volume dies down.

Money Management Strategies Of Day Trading

The most important of the trading strategies of any kind is how you are going to manage the trade to prevent losses and lock in gains. You may look at ratios of target price to stop prices so that you plan to sell at a 6% gain or -2% (2% loss) for example.

I look at “time stops” and list the following as “days” as it may apply to swing trades, but when adjusting for intraday trading strategies, you merely are going to use 5 units of time intervals, whether that be a 15 minute chart (3 15 minute periods or 35 minutes) or 1 minute chart (5 intervals= 5 minutes). Additionally the point is not to give you the exact day you should use but an example of what one may consider.

I believe in using TIME stops since a stock trade is a success if it performs well in a limited period of time. If you take a significantly long amount of time in a trade, it requires larger results to provide the same annualized rate of return. I have no problem with turning a intraday trade into a swing trade, and then swing trade into a position trade as long as it is performing. I like the prospects of a 5 day stop.
A Time stop is based upon qualifications of a stock within a set amount period of time.

A 5 day time stop in a swing trade can for example be either where you buy a stock and the moment it hasn’t made a new high within the last 5 days, the trade is over, and you either exit immediately or use some signal such as selling the next overbought signal or trending signal, (perhaps on a shorter time period). That version seeks to only continue holding if it makes new highs and continues doing so without allowing much opportunity for anything else. This is ideal for momentum stocks. With intraday trading strategies, this is anywhere from a 5 minute stop (on minute intervals), to a 5 hour stop (60 min intervals)

A version of the 5 day time stop that seeks to keep watch on the losses a bit tighter instead, but still trails them higher, and doesn’t mind a stock trading sideways as long as support is not broken may instead say, as long as a stock has not traded below it’s most recent lowest low within the last 5 days, you are going to hold it. This is similar to watching a particular moving average and selling on a move below it such as a 5 day moving average, only a big gain will skew a 5 day moving average, but also allow you to lock in the gains sooner, where a 5 day low stop will keep you from selling out on a volatile move up followed by a shakeout and then a move higher. A combination of both must use different time intervals. For example, you might say you want to give stock more flexibility on how much time it has to gain, but you are more strict on the downside. If this is the case, you might go with a new high on 15 day basis to a 5 day basis for the new lows. In other words, you look at a stock’s 5 day low and the moment it is breached, you sell it, while you also are watchig to make sure a stock at least makes a new high in the last 15 days. You may also have a market based trigger such as if the 5 day moving average in the S&P index dips below the 20 day, you exit all your trades.
You can apply an intraday trader’s money management strategy such as using a 5 minute interval instead of 5 day, or 5 5 minute candles or bars (or 15 mnutes). The time may vary. So you will have to identify what you believe works best for the particular trade. One way may be to look at the particular stock and adjust it based on the stock’s history. For example, if a stock has a tendency to trade down to the 5-7 day low before a big run up, you may want to give 8-10 days or more. If a stock tends to consolidate and work sideways without making new relative highs for awhile before it trades much higher, you may want to expand the number of days before you sell out on stock.

There are two final version of the 5 day time stop. Remember, when it comes to intraday trading strategies, you will shift your stops from daily intervals to minute or chunks of 5 or 15 minutes rather than days. One is that you have specific resistance or support zones. In order to not get shaken out due to volatility, you must see 5 candles or bars on some interval below that before you get stopped out, and you might need to see that before you make a purchase above resistance.The other is similar, but instead it is adding a bit more time before you sell. For example, your stop is breached. Now if your stop is on the downside rather than a target to the upside, an oversold bounce can still occur. A stock may breakdown and then bounce higher to overbought before plummeting. To avoid selling at a lower point everytime you might give the stock 5 days before you sell. If you do this, you probeabbly want a tenantive stop below first support but then a hard stop under it or another kind of stop. The idea is that if the stock doesn’t bounce very quickly and continues to make new lows, you may not be very forgiving. So if your stop is $100 initially, you might Give a stock until $99 to bounce. If it stays above $99 you sell in 5 days regardless, but if it breaks below, you sell immediately.

Conditional sells are important. You may sell a fraction of your sales at a given target price, but you may want to give 5 more days before selling higher. If a stock moves a certain amount such as 5% or higher in 3 days, you may give a full 10 days before you sell, unless another stop is breached such as making a new 5 day low and holding for 15 minutes below that mark or whatever.

Any trading method can work, but you have to put the odds in your favor somehow. If for example you do not, and you say you take profits every small % amount higher without a plan if things go against you and thus you fail to sell out the stock goes much lower, you are very likely to never end up ahead. Even if you win a high percentage of the time (minus commission which will be very high if you trade like that), eventually you will land in a stock that goes to zero, and wipe out all of your gains. It doesn’t really matter how high your upside is or downside, as long as proportionally they make sense, and you give enough time for it to realistically get to those targets. Any intraday trading strategy is going to occur much more quickly than a regular trading strategy, and action is going to have to take place often. The trap is overtrading without having a method of having upside outweigh downside. So you should look for systems that have an upside of 3 times the downside for example, and you should track the percentage of times that you hit the upside target or higher and percentage that you hit your sell points and make sure that the method is profitable. Only then can you consider different securities or trading methodologies.

How to achieve the best annualized returns stock trading

Don’t just look at price patterns or target potential returns, or even reward/risk… time it.

 

By doing this you will be able to acheive fabulous and more optimal returns.

What I have received is a list of technical price patterns. The service I use (“recognia” through trade king technical analysis). What I do is I set alerts for all price patterns with over a 20% target.

Once I get these, what I want to do is look at multiple things.

So I get out a spreadsheet and I plug some numbers in.

I will sort by technical pattern. So for the bullish patterns, I will get something like 2 ascending continuation triangles, 9 symmetrical triangles, 4 continuation diamonds, 12 continuation wedges and 2 bullish flags.

It will give me the “event duration” in number of days and the closing price and the price target.

Now, based on the Encyclopedia of chart patterns, I can identify the probability of that pattern hitting the price target.

So I plug these numbers in.

Now based on the probability of success, I can enter the potential results in with the corresponding percentage gain when I win, the probability of achieving that win and the amount I lose when I lose, and the probability of the loss.

This will then let me know how much I can risk in a particular trade through calculation of the kelly criterion…

It also gives me the expected “bankroll growth”.

But I’m not done yet.

After entering this data in I can then take the “growth” and divide it by the number of days to get a “expected bankroll growth per day”. Now I get to sort my results and determine in order the best trades.

Now from this point you could easily be done. However one other thing to consider is calculating the average moves for that particular pattern (rather than the individual stock forming that pattern) and the number of days based on the average for the pattern (not the stock forming the pattern), and use other numbers to verify the results.

Now many times I do not have to actually crunch the numbers because it’s blatantly obvious. If there is a bullish flag with the highest return and only an 8 day pattern, it’s going to almost always be one of, if not the best return.  It’s possible that there’s another somewhat short pattern with a high success rate that has a lot of upside that has more, but you can usually tell just by looking once you’ve done this a few times.

If you want to go one step further, you can run the Kelly criterion with options. Options can use a traditional kelly criterion calculator if you would like as you can place out of money options expecting to either hit a home run or lose the entire value. There are many formulas as a result of the kelly criterion, but the more common one is the one used in blackjack with a slight edge where it’s usually an all or nothing edge. In reality, you may want to use the investment based kelly criterion calculator, as this will allow you to account for the possibility of selling it at some price before expiration.

By running through the kelly criterion with every single option available, you may be able to identify other opportunities that yield very high average returns per day. Additionally with some of the otm options, you may want to try calculate at what price you need to bid to achieve a given return (such as the highest return you can find based on a reasonable price between the bid and ask price). This way you may have certain opportunities available if you get your ordered filled. It’s important to understand that the out of money options will have a HUGE difference in return based on the limit price being just 5 or 10 cents different because it will already be so cheap.

 

There’s also a “value weighted” approach. It’s not entirely value weighted it’s more “Kelly Criterion Long Term Growth rate per day weighted”, but the concept is the same. Basically you sum up the total of your daily expected growth and then you divide each individual number by the total to get the weighting. This provides more of a diversified approach and also accounts for probabilities that other stocks will produce higher returns.

7/19 alerts produced the following results.

In order:

MOBI,HSTM,FHWY,VRNM,ROIA,RMTI,FNMAS,COCO,FNMAT,PERY,INUV,TISA,IKAN,HLIT,DTLK,RNGC,SSN,HDY,EDAP,WLT,HNR,AXIH,SKNY,PRO,MTL,ORBC,NR,ASRV,GRVY

 

As far as raw returns, the MOBI $7.50 calls look great unless you can get a good fill ($0.60)on the $10 calls. But make sure to do the math on the Kelly Criterion and manage your trade.

Follow The Trend WIth Golden Cross and Death Cross

In most markets you enter a trending market. There are occasionally periods of time where the market does not trend, however the majority of the market tends to trend. This is due to a number of things.

First, capital flows into a company through stock investments. Shareholder equity is then reinvested in projects, and with more capital companies have access to more opportunities. Generally when more people start to realize this they start to invest and then the earnings improve. This leads to higher expectation of stock growth and higher prices. Expectations of a stocks future value is why we invest, but eventually this will lead to a point when the companies can no longer invest in further projects without a phase of planting the seeds. Investors cannot expect a company to reap before they sow. So there is an impatience that is formed after this high trend. Soon many of the companies had so much money flowing in they were expected to invest it all quickly and they anticipated more coming in. But the impatience shows and people become complacent. It is then when things turn and the markets eventually start to trend downwards.

The capital is withdrawn and suddenly companies need to raise cash to meet day to day obligations depending on how dependent upon new capital and existing capital they were. Expectations of growth slow and banks tend to have problems on their balance sheets and need to raise cash. When they raise cash it has a slow down of money velocity which results in a slow down of goods exchanged. The slowdown usually manifests itself in lower numbers until the value investors step in and create a floor and the trend goes upwards…

In a rangebound market, capital flows in and out and uncertainty is either high or the trend changes back and forth much quicker.

There are two skills involved that are very basic in trading. One is to simply “follow the trend” and get in early enough on the trend” and the other is to either avoid or have a different strategy for range bound markets.

One very powerful signal when markets enter a trend is either the “golden cross” or the “death cross”. The golden cross is sign of a bottom and new trend forming after the bottom. The death cross is a sign of a top and downtrend forming. Although these are lagging indcators, they are still pretty powerful.

This is what a golden cross and death cross look like.

There exists the possibility of a range bound market. While historically this period does not last all that long, it can be a nuisance on any trending strategy and the golden cross and death cross will not be effective. There are ways of recognizing this by being aware of the distance between the moving averages and the overall trend. It’s possible that the trend will be signaled up by a golden cross, and eventually the rally will slow but the overall long term trend will remain up as will the shorter 50 day average. When this happens, it’s very possible that the death cross will not be that dangerous. It’s possible that instead the market will be range-bound and only after awhile of range bound markets will you see a conclusive trend resume.

Of course it’s also possible that the trend will first slow and then start a downtrend and that the peak will start to form around that period of time. When you notice the 50 day moving average get too far ahead of the 200 day it can be an early sign of a “bubble” or at least an over reaction to the upside. It’s important to have a strategy that can handle such situations.

There are many ways to use this.
One could initially change the position sizes drastically during the early stages of a new trend especially as it conclusively enters a trending market. If you dollar cost average, this is a great time to increase the amount you dollar cost average in. The key is having enough money on the side at all times and being prepared for unseen circumstances so that when capital remains scarce for most, it is still easy to access for you. I cover this in dollar cost averaging fraud where I detail the pitfalls and offer an alternative, although I do not cover how to use the moving averages to adjust your strategy.

For many, dollar cost averaging is a worry free approach with a buy and hold for a very long time approach one either has the money go into equities and/or commodities (bullish) or bonds and/or cash/currency.

A more aggressive approach is to actually use signals to go short the market on death crosses and to go long the market during golden crosses. You might be slightly less aggressive and just move to cash in the bearish phases.

You may also just use existing systems and only use the bullish or bearish cross and other indicators to determine whether or not the market is oscillating and rangebound or trending. Using this may be used to determine whether you will use one style or another. Typically market timing, especially through buying oversold indicators and selling overbought indicators is more effective in a rangebound market where you can more effectively buy the dips and sell the rips. When the market enters a golden cross, you may shift to buying and holding breakouts such as a CANSLIM approach detailed by William O’Neil.

Identifying a new trend can be done through other indicators as well. Here are some indicators and what they accomplish.
From this list the following may be helpful.
Overlays
Ichimoku Clouds – A comprehensive indicator that defines support and resistance, identifies trend direction, gauges momentum and provides trading signals.
Parabolic SAR- A chart overlay that shows reversal points below prices in an uptrend and above prices in a downtrend.
Pivot Points- A chart overlay that shows reversal points below prices in an uptrend and above prices in a downtrend.

Indicators
Aroon – Shows whether a stock is trending or oscillating.
Average Directional Index (ADX) – Shows whether a stock is trending or oscillating.

Right now the market has not made the “death cross”, however examination of the overlays and indicators above could help give us some indication on whether or not we are range-bound and oscillating, or if the trend remains upward, and at what point can we anticipate a potential new trend. Technical analysis success is something that can be developed through enough time and diligence.

Should I trade stocks?

One of the most important questions is “should I trade stocks”? For someone looking for a positive investment, this is a great question. Whether you are a trader or an investor, it’s wise to ask whether or not you should trade stocks or invest them, and if you aren’t an investor the question is still relevant.

If you take the return over the last 150 years it’s somewhere around 6% per year. So one great way to determine whether you should trade vs investing in an S&P index fund is whether or not you can beat this. One good test is by using the game “chart arcade” and spending a couple hours on it every day for awhile. If you can get your CAGR (compound annual growth rate) at 6% or higher, it’s at least worth a consideration.

An investment system in the long term may be able to beat 6% however, it’s very difficult to determine if you are capable of doing so unless you have already had over 10 years of practice. An intelligent investor who reads enough books on investing and is emotionally disciplined may be able to however it’s easier said than done.

If you are looking for an alternative, you may try paper trading. Backtesting a particular method is another way of deciding whether or not you are able to achieve superior returns with a method, but the problem is historic returns are no indication of future returns. Being that many things change back to the average 6% per year average over time, a screening system most likely will eventually return back to this as well. The other reason to consider investing for the long term is that if hyperinflation occurs, long term investing will crush all traders. The larger the bull market, the fewer market timers can beat the market. Of course, knowing whether or not this will occur sometime in your lifetime is a difficult thing to determine as well.

The place to test trading through paper trading is either thinkorswim’s paper trading platform, or chartarcade.com.

Recognizing Good Penny Stocks To Invest In 2011

It is not really easy to recognize good penny stocks to invest in 2011. In fact, it is far easier to recognize good blue chip stocks than to pick out good penny stocks. For the smart investor, the right thing would be to fall back on a bit of economic theory. One rule of investing in the stock market states that a boom follows a recession. The American investment world has experienced a recession. The economy is now recovering. Therefore, it is time for a stock market boom. People who buy penny stocks wisely in the year 2011 will make money from their investments but the truth is that they need to know which stocks to buy. They also need to know why they should buy these stocks. This is the very first step.

Again, it will make a lot of sense to understand what penny stocks are and how they can make money for the discerning investor. A penny stock can be described as a stock that sells for a relatively low price. This makes it attractive to investors because a large quantity of the stocks can be purchased for a relatively low amount of money. Penny stocks are also likely to experience an appreciation in price because, as the company grows, the price of the stock is likely o get higher.

Good penny stocks to invest in 2011 are the ones that meet all the requirements of viable stocks. This means that the firm in question needs to be solid in a number of ways. First, the company should have a good reputation and have a good product as well. The potential for growth should be there as well. More to the point, the company will need to have a good management team. If all these are in place, investors can go ahead and purchase the stocks.

Finally, it has to be stated that investing in the stock exchange is a long-term thing. The penny stock of 2011 may well become the blue chip stock of 2012. For this reason, good penny stocks to invest in 2011 are the ones that have long-term prospects.

How to hedge

A “hedge” is something you do to protect another investment or trade. For example, if you wanted to short banks, but recognized value in WFC, you would be able to buy SKF (ultra inverse banks ETF) (or short UYG), and buy WFC, . Your WFC position would cancel out the position in short banks or at least cancel out the exposure to being short WFC through the SKF. Another example would be if you’re bullish on commodities, but don’t want to bet on oil, you could short the USO while being long DBC for example. Another form of hedging is known as a “paired trade” this is when you recognize two similar stocks, recognizing the value relative to the industry is better or the upside is better for a particular investment than another. By clearly identifying say netflix is overvalued relative to coinstar, you might short netflix and buy coinstar. The idea is that you don’t want to bet on market direction in say “technology” area, but you might want to bet that if the market goes down stock A will tank more than stock B, and if the market goes up stock B will do better than stock A, so you short A and go long B and this way you don’t need to recognize market direction.

A hedge can bet directionally on the market and just be something to reduce your exposure. A hedge can also create neutrality so you have neither long nor short exposure overall, while being both long and short individual names or areas of the market. For example, if you have expectations where you have to invest a certain percentage of capital, you might simply take simultaneous positions that are both short and long, even though you may be betting long the market, you may seek to avoid being overexposed.

How might you hedge by value?
I believe you need to first identify portfolio allocation by value. The key is then to average the difference in value. So hypothetically say you have the allocation based on earnings yield
1) ABC earnings yield: 15%
2) BCD earnings yield: 10%
3) CDE earnings yield:5%
Your allocation would be the given companies earnings yield divided by the sum of all earnings yield or
50% ABC
33.33% BCD
16.67% CDE
If instead you wanted to “hedge” you would need to instead set each companies “value” to the average. In this case you take the sum of all earnings yield divided by 3 or 10. Therefore, anything below earnings yield of 10 will be short, anything above an earnings yield of 10 will be long, and anything equal will be ignored. Then it would be weighted according to the return.
In this case you would take 10/15 minus 1 or 0.50 or 50% long in ABC 1 minus 0 or 0% in BDC and 5/10=0.50 minus 1 or negative 50% in CDE.

If instead the earnings yield were
1) ABC earnings yield: 25%
2) BCD earnings yield: 10%
3) CDE earnings yield:2%
sum of all earnings is 37 divided by 3 is 12.33. You would allocate 50% long ABC, 9.2% short BCD and 40.8% short CDE.
Whenever you are short, you have to worry about margin calls, having enough cash, and being able to cover your position. It’s very important that you understand these risks and how tohandle it, otherwise you are not read to hedge.
Such a value weighted balanced hedged approach to each particular industry may be a good idea. What if instead you had the allocation as follows and you wanted to instead convert it to a hedged approach?
35% commodities
20% stocks
5% real estate
20% bonds
20% currency etfs
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You would still look at this the same averaging each position. You would be short 50% real estate and long 50% commodities. You might instead consider being a much smaller portion long and short, and instead being neutral in each area by finding individual names to be long and short within the other areas.
What I mean by this is if you are instead long 15% commodities, short 15% real estate with a paired trade in stocks that leaves you neutral in the stock market, and a paired trade in bonds and a paired trade in currency etfs. Alternatively, you might instead have a 20% allocation to each area overall, and if you normally are 35% long in a non hedged account, you instead take on shorts and longs so that you are neutral for the 20% (long 10%, short 10%) and long with the remaining 15%. The point is to make your investments according to your confidence in that particular area and basically with all else being equal the probability of it outperforming the other assets. If you are to hedge, you must still maintain that bias, but with shorts. If you want to bias how much long exposure you have if you are slightly bullish, you might take the percentages reserved for shorting and decrease them all proportionally while going long with a slight bias.

A hedge can be done by shorting stocks, or by being long inverse ETFs. You could even be long two stocks if one particular industry does well under certain conditions. For example, if you were long coca cola, you can hedge against rising aluminum prices by buying an aluminum etf or a stock in an aluminum miner just as an example. This way if coca cola suffers from high aluminum prices, your gains offset the risk of higher aluminum prices. However, you can also hedge by being an options trader, or using LEAPs (Long Term AnticiPation Securities, which are longer term options). Within options trading you can hedge option risks by being long and short options such as selling a near term call while being long a long term option, or selling a higher strike price call which limits your potential upside in the event of appreciation, but lowers your break even point, gives you a premium, and allows you to reduce risk to theta decay which is when the option loses extrinsic value. This is complicated if you’ve never heard of options. However using options can be used to make leveraged plays on particular securities and you don’t need to sell options to make a hedge. In fact, rather than buying a stock while sleling another, you can buy a put of that stock while buying a put on another one, or you can even hedge against the downside with buying both a put and a call.

Options can be a hedge to your long stock position as well, and effectively are a more expensive stop loss. What you gain vs a stop loss is that if it gaps down overnight past your stop loss, you still get the benefits.
If you want to hedge against a big decline when you own a stock, buy a put. You will be protected as long as the stock declines beyond the strike price of the option and is sold or assigned before expiration.
If you are short and want to prevent unlimited loss risk, you might buy a put which will cover you past the strike price and cost of the option which acts as insurance in these instances.

You can use multiple asset classes to diversify, and options to provide leverage, leaving more cash, from which you can consider using to even buy some put in some areas as well.

Ultimately a complex strategy might involve having a “hedge” approach only use long term puts and calls rather than shorts and long, and keeping extra cash, while simultaneously shorting short term puts and calls in some instances. Rebalancing is more effective with options as a smaller gain represents a larger percentage gain and can be done more frequently, or instead can reduce the fees as a percentage of your costs.

Of course, there are increased risks associated with options and as in any case, read our disclaimer and trade at your own risk and understand the risk you are taking before making any decisions.

how to value a good stock

Valuing a good companies stock is easy because with a good company the earnings are stable, the management is there, and you can project going forward what a company will be worth. If the company has poor management it may be difficult.

Some things to look at when classifying a stock as “good” might be “ROA” (return on assets), earnings growth history and a positive quick ratio. This indicates that management is investing in assets and producing a good return, and that management has more assets than liabilities and that management is able to produce earnings growth. Other things such as sales growth are also important as increases in sales sometimes leads to future earnings growth.

Things that determine the quality of the company are listed above, but the value is based on the companies price.

Things like price to sales, price to book, price to earnings, price to earnings growth, and things of this nature.

Relative pricing depends on the companies pricing in it’s industry. For example, if the competitor on average has a P/E of 18 with a PEG of 2 and this company has a P/E of 10 and a PEG of 1 it is undervalued relative to the competitor.Comparisons are good to do especially if you plan on hedging.
Hedging is the act of buying and selling securities in the same industry. If you go long and buy Ford while you sell Toyota, the sale of Toyota hedges your position in Ford because if the auto industry does poorly, you anticipate profiting from betting against Toyota. If it does well, you will benefit from the growth in Ford. The goal of both of these trades (known as a “paired trade”) is to pick overpriced stocks as well as underpriced stocks and buy the underpriced stocks that represent good value with good management, and buy the overvalued companies with poor management. It’s not always easy and may require some time as well as enough cash on the side to manage the position, and this should be done across many, many industries if you want to do this properly. The problem with hedging is that you have to choose between either buing exposed to oneside more than another, or being perfectly hedged prevents you from gaining exposure to the most undervalued companies. Ideally you want to increase allocation to a particular stock if it is overvalued significantly and you are betting against it as well as those that are undervalued significantly. You also would have to endure the possibilities of buy outs on stocks you are betting against, and fraud which is rare but possible, or overnight drops in stocks you are long. That is why if you are hedged you have to spread your funds against a ton of positions so that no one position can negatively impact you. The other option would be to use stock options as a way of hedging.

Just because you can identify a company that is undervalued, does not mean it won’t stay that way for a length of time, or even go down in price and become more undervalued, or possibly some of the facts you have may even be wrong. Perhaps a lawsuit against a company occurs or is pending, or perhaps a company claims to own assets it does not. The SEC more heavily regulates companies but in China there is ironically less regulation (as most people think of China as the “communist” country and the US as “capitalist”, you might expect less regulation in the US)

Looking at what companies were bought out at is a good way to value a company as well. What was the P/E of the buyout price? The PEG? There really is no sure way to value a company. Biotech for example is valued completely upon the ability for FDA approval of it’s drug, and how close to approval and the likelihood of it being approved and how that will possibly impact it’s earnings in the future. Biotech companies are among the hardest to value. Natural resource stocks such as mining stocks are valued based on the price of the natural resources it mines and it’s ability to expand and get new mines and possibility of it’s discoveries and the future outlook of the natural resources same goes for many oil wells and service and oil driller and oil holding trust companies.

Earnings based valuations (price to earnings ratio, PEG, etc:
An earnings based valuation can be done in one of two ways, either using the data you have now, or by projecting a companies earnings into the future. If you want it’s earnings now look at a companies P/E ratio. If the EPS is $1 per share and the price is $20 the P/E is 20/1 or 20. On the other hand, you can divide 1 by the P/E to get the E/P or earnings yield. 1/20 is .05 or 5%. This is how much one year of earnings will yield back for the investor. In other words, someone who had complete ownership of the company would pay $20 per share for every share to buy it out. For every share they got they would directly receive $1 in earnings the next year. They would receive a 5% return on their investment in the first year. If they continued to get $1 it would take them 20 years until they get their investment return, assuming they don’t reinvest the earnings. As an individual shareholder of a public company, you are hoping that others will recognize the value, and as the earnings improves the book value of the company, eventually they will buy and the stock price will increase to reflect the changes of the company.

However, what if in year 2 they get $2 in earnings, and in year 3 they get $4 in earnings. The earnings growth would be geometrical and grow at 100%. Before you know it the company would be worth much more than it is now. For this reason, many people like Warren Buffet might project the company’s earnings forward by several years. However small difference in earnings growth predictions will make a huge difference in the results, and as such guys like Warren Buffett only choose companies that they understand and know well, and companies that have predictable earnings. Without the predictability you are at risk of a big loss that will be difficult to recover from. Additionally it’s a lot easier to value a company if you know what the earnings will be, rather than just guessing what they might be. Lets pretend that this P/E of 20 has EPS of $1 and price of $20 and the EPS growth is 50%. Where will the company be in 10 years? The earnings will in fact be $57 per share.What if we are wrong and instead the company grows at 50% the first year, 40% the next year 35% the next year 30% the next 2 years and then 25% the remaining? The EPS would then only be 14.6 at the end of year 10. While this still may represent decent growth in earnings over 10 years, it shows that valuing a company is not easy, and how this investment compares to a more stable earnings of 30% stable growth in a company that is $20 with a P/E of 10and $2 EPS would drastically depend on which of the 2 exqaamples the company follows. The 2nd company would be better if the earnings of the 1st one dropsas explained in the second example as it would have an EPS of $27.57 in 10 years.

Valuing a company can be either adding up 10 years of projected earnings and just saying that is how much the company is worth over a 10 year period, or instead looking at the PE after 10 years and looking at the historical valuation of this particular industry. For example, if the stock is P/E of 10 with earnings growth of 30% over 10 years, we can either add up the earnings to get $110 in 10 years, or instead we can look at the final year earnings per share of $27 and at a historical valuation of maybe a PE of 16 for that industry, we multiply that $27 by 16 to get $441. These two methods in this example are drastically different, again illustrating why valuing a company can be so difficult. Additionally, if a company excels and grows quickly, it will soon become a bigger cap stock, which means it will be increasingly difficult to grow. Imagine a beverage company that is growing well and is very small so it only has to compete with smaller companies. Then it contrinues to grow fast being a hundred millon dollar company and soon a 1 billion. Now you want to invest in it’s growth but you may not notice it until it’s a billion dollar company because it may not even be publically traded for awhile, and when it does it won’t have proven growth to track and when it does it may be valued in the billions. Now it is increasingly difficult to go from $1 billion to $10 billion compared to going from $100 million to $1 billion. If the company keeps growing, soon it will have to compete with Coca Cola and Pepsi rather than Jones Soda and Shasta and other smaller names. It may have sold well at all the mom and pop businesses and kwikimarts and gas stations of the world, but how will it do as it moves into major retail and starts a vending machine route. Will stores even put it in, or ould stores prefer the coca cola machine which may produce many more sales. Will the company be a fad that eventually ends, or will it actually compete. The chances of it being able to overtake the brand of Coke or Pepsi is very unlikely. As such the growth may not continue at the same rate forever, and generally not only is valued at a lower premium as it reaches it’s growth potential, but will probably be less likely to continue to grow. As such, using this value method while well intentioned and maybe even the best you can do, it may not be correct. The good news is, you are not the only one imn this issue. If you play tag blindfolded, while everyone else has there eyes open, you will not have a good chance. But if everyone else is blindfolded, you have as good as chance as any. So it’s difficult for others too, not just you.

Also, a shortcut to projecting the earnings forward, is to just value companies by their PEG or price to earnings growth rate. Lower is better as with the P/E. a P/E of 1 could be said to be half the price based on it’s earnings growth as a PEG of 2 and therefore it could be said to be twice as valuable with all other things being equal (which is great in theory but may often not be true in real life).

Revenue based valuations (price to sales valuation): If a companies price to sales is low, it’s earnings may increase. Rather than projecting the future earnings, you can just look at sales as an indicator of future earnings and recognize that the more undervalued a stock is relative to it’s sales, the more likely a company is undervalued to it’s future earnings. So look at a companies price to sales, the lower the better. More importantly look at similar companies, the way you would look at similar properties in the area if you were buying real estate. Look at the companies in the industry that have similar numbers and see how they compare. What is the average price to sales ratio of the company vs the price to sales average of the industry? of the sector? If you prefer looking at valuing a higher number as better, you can of course reverse this and use a sales to price yield just like you did with earnings and take 1 divided by the p/s ratio. The difference is sales effects future earnings. Sales can be manipulated by reducing prices just to make the sales look good while the earnings suffer, but the idea is that the company will bring in more loyal customers through this manipulation so it’s not always a bad thing. The difficulty is, how do you really use P/S to assign a value to the company?

A P/s of .5 should be 2/.5 or 4 times more valuable than a P/s of 2. You can look at the average p/s divided by the P/S of a company and use that as the “multiplier of the current price. For example, if the sector average (or better yet industry average) p/s is 2.5 and the company is 2 you take 2.5/2=1.25. Multiply this by the current price of the company and you will get the valuation which will be 25% higher than it’s current value.

No valuation method is that great in a vacuum, but using all methods and considering which ones are more important will help you identify which stocks to buy, and which stocks to invest more money in (you should generally weight your portfolio according to value so you have more money in the stocks that represent greater value.)

Equity based valuation (price to book value)
Some say a company is worth all peices of it’s business sold individually minus it’s liabilities. This also may be referred to as “liquidation value”. Many say the sum of all parts is not always equal to the whole though. For example, a company that coul sell all it’s inventory, pay off the debt and have excess cash of $1 billion afterwards, would be said to have a book value of $1billion. If the market cap was 500million the price to book value would be 500M divided by 1 billion or 0.5. The company would be significantly undervalued. In some cases, a company is not in a position to manage it’s debts, in other cases, the company can not simply sell off it’s peices of the business so easily and what’s on the books as it’s value, may not be it’s true value as is the case sometimes after a major crash in the price of that inventory. By purchasing these you must be aware of the situation, because whether or not it’s undervalued may depend on the price of steel rebounding to previous levels just as an example. In some cases the company is more dependent upon earnings than book value as the book value will grow. So in some cases, the company will be much more valuable because of it’s ability to produce in the future. For example, if you just look at McDonald’s properties, you are missing a huge peice of the business. If a famer bought out the little mcDonald’s real estate or even had the same number of square feet of land in good farming land, it would not be worth very much. If McDonalds bought a little peice of farmland in a developing area where shoppin centers and other areas are coming up, it would be worth much more. McDonalds has “intangible” value which is the company brand, the earnings and earnings growth, customer loyalty, etc. Coca Cola doesn’t have aluminum and the actual components of it’s soft drink hat gives it’s value, it converts that into earnings. So there are serious drawbacks to this model UNLESS you are able to somehow give a number to the intangibles yourself effectively. What would Coca Cola pay to have Pepsi’s brand loyalty and take out their competitor? What would Google pay to have Apple’s brand loyalty or to have Steve Jobs as the CEO or to have the constant innovative product lin? What would Microsoft pay to have Google’s advertising program and search user loyalty? Figuring these things out is not easy, which can make such a model of valuation not so difficult. However, take a mining company. It doesn’t really have competative advantages, nor does it really need it. As long as it has access to lots of gold and land for future gold access, it will produce earnings. You could simply look at how much gold a mining company has access to after looking at it’s book value and determine it’s value. A timber company would be worth the value of all it’s timber. Buying at a significant discount is to book value is important as it will help you find good deals, assuming the company can stay afloat. So if you are going to use book value as a ways to investing in a company and valuing it, you probably want to make sure other criteria is in place. A company must already be “good” if it is already “good” and has low book value it may be a bargain. Don’t be afraid to pay more for a good company when using the equity valutation model. Additional return on it’s equity is also important. The ROE will measure how well a company invests this equity to produce growth. High ROE means high future book value. So you might take a companies book value per share and use it’s ROE to project it’s bookvalue in 10 years the way you did with the earnings so the company should be worth what the Bookvalue per share is 10 years from now, but must also be compared to a fixed interest rate of say a treasury bond. This is a much more preferred method than just the price to book value without considering ROE, but as with the earnings projection the weakness has the drastic possibility for large error given even a small error compounded over a long period of time. Just using book value however is a problem. Say a company is worth $1billion and is valued at $500 million. What if 10 years later the price has not reached “fair value”? Your 100% return turns into an annualized return of only just over 7% per year. This method values a company but does not give a set amount of time for when the company will be worth that much. Additionally, it misses out on the companies that are possibly overvalued but will grow their book value over time. However, considering book value valuation as just one component of your evaluation may be a good idea. But considering the book value with the ROE projecting the value forward may be even better. The ROE can obviously cary greatly, so just as with earnings, you need a predictable business, or else find one that has a projection that is head and shoulders above the rest to make up for it, and a smaller investment size to compensate for the increase risk of tying your money up in something that doesn’t produce a great return.

Company solvency valuations: The more solvent a company is, the more undervalued it is in rare situations such as deflation and forced selling. In deflation, cash is king, debt becomes increasingly dangerous, and cash becomes more valuable. The cash rich companies in deflation can buy out other companies. In periods of drastic forced selling, you might see a company such as FCX and TX were, where they had more cash on hand than the company was worth. That is their balance sheet was such that after paying off all the debts, they had a cash excess that exceeded the market cap. This is generally insanely rare evaluations that only occur when the bears are giving the stock away due to the unloading of margin positions, while others also fear global banking default. But thatA companies book value is important, but it’s quick ratio and it’s cashflow and it’s low debt levels becomes important. Valuing a company purly on it’s cash on hand after subtracting it’s debts and comparing that to the book value is only something that can be and should be done in major deflation because there will be so many deeply undervalued companies to choose from, but at the same time a lot of risk of lower prices, and fears of a complete financial meltdown that everyone needs to sell stock and aise cash to pay off their own debt and meanwhile banks may continue to increase restrictions on the amount of capital for margin accounts and for interest rates. In rare situations, you can own a company for free essentially. That’s not to say that you can’t get shares without paying cash, but it is more like buying a treasure chest for $100 that contains more than $100 in cash. You may not be able to find the key at the moment, but you know you have it, and it’s only a matter of time before you can gain access to the cash (when other traders are done deleveraging and when the banks start lending and the credit gets moving again.) It’s a little bit different than that metaphor because you actually gain access to it’s business as well. The only potential issue is if in fact there is global deflation and the banks never start lending again and no one is there to borrow because everyone deleverages until all the credit is deflated. Even so, the company still is sitting on enough cash and even if it’s inventory is useless, at some point the company can be bought out completely and the person buying it gains access to the cash. Of course its rare but possible that the shareholders don’t reject a buyout that is above where you bought it becuse they are that desperate for the money and rthere are no buyers, but that would be an absolutely financial armegheddon situation, and if you aren’t going to invest when everyone fears the worse (yourself included even) you shouldn’t invest in the first place, because if you think this situation is possible and likely, most likely when everything actually hits the fan it isn’t any more possible or likely than before, people are just starting to notice it and watch it unfold.
The other thing about company solvency valuation is about reading the balance sheets. If a company is insolvent that means they will go bankrupt. shares in this company should be shorted. The more sound the financial statement, the more confidence you can have in you other valuations. It’s not really so much a valuation method as it is something that should increase the confidence in your other valuations. Things should be quick ratio and cash ratio. Cash on hand and long term debt. Debt/equity and things of this nature. Cashflow positive companies are a plus, but don’t write off those with no cashflow if the cash is flowing into assets.
Price Target Valuations:
There are many ways to use price targets. You can either look at an analysts price target and put your faith in them, or you can use technical analysis and put your faith in that. Technical analysis will give you price targets depending on the price target. The general principal behind technical analysis is that you usually will expect a pattern to extend from it’s base low to it’s base high, that’s where it breaks out and the amount it’s target price is, is the difference between the base high and the base low. This is not always the case, and sometimes the price pattern will have two different targets depending on if you are a swing trader or trend trader. However, these price targets will generally be met more than 50% of the time, making them profitable patterns if you can successfully manage your downside with stoplosses, and if the stock doesn’t stop out and then reach it’s target a high percentage of that over 50%. Technical analysis is generally more of a short term trade, which is usually not so compatable with value investing for long periods of time. However, you can combine the two. The advantage is, generally technical analysis will give you a shortened timeframe from which to expect the price appreciation, and will generally give you clues when institutions are buying.

Combination Valuations
I believe that all valuations have their strengths and weaknesses. By considering all evaluations before buying stocks, you stand a better chance of avoiding a mistake. It’s possible that a companies earnings are derrived from large price hikes that jeopordize sales. It’s equally possible that a companies sales are manipulated by artificially low prices. A company with good earnings may also be having temporary earnings such as a one time contract approval, or sale of their cash producing assets or excess inventory, and as a result may suffer lower earnings in the future. By using a combination, you provide the best chance of having a more accurate evaluation, or at least a more stable one. It’s important to weigh each factor with a certain confidence. If earnings doesn’t seem to be important in an industry, you would provide a lower weighting.

I consider good valuation of a company part of “Buffettology” even if it includes other factors, because of Buffett’s ability to identify such companies, but with all these things in mind, you should be able to identify stocks that are undervalued. As long as you manage risk, you should be able to find a good investment to hold for a long time using the correct combination of these things. I will be posting a video on the methodology shortly.

Bull Flag Trading System

Bull Flag Pattern

A Bull flag is a great pattern because of it’s ability to rise quickly. A Flag pattern is classified as a “continuation pattern”, meaning that the trend formed prior to the pattern will generally continue after the pattern. In other words, the stock rises for a period of time in an upward trend, consolidates then breaks out. After it breaks out the trend upwards generally resumes.

Why Trade Bull Flags?
The reason to trade bull flags is they are quick and have a high success rate. This is great when your overall portfolio return is going to be judged by return over a given amount of time. This means that if you ever want to trade options, you should consider bull flag patterns as well as bear flag patterns in a flag trading system, but you can trade bull flags without options as well. But there are other patterns out there. The High tight flag is a type of bull flag that is superior in results to the bull flag. As such, you should have a reason for sticking to just bull flags. The reason should usually be that you have a list of stocks on a watchlist already, and you merely scan for bull flags as a way to identify entry and exit points.

Building a Bull Flag Watchlist

When Identifying a bull flag, you can either start with a watchlist of technically sound stocks and manually look at the charts on a regular basis and watch for bull flags, or you can use a screener to identify bull flags. There are in depth customizable stock trading chart software programs available like Telechart, or more basic ones that allow you to adjust price changes based on a set length of time like the Zacks Screener. Although I use Zack’s screeners when Identifying High Tight Flags, I do not think it is suitable for identifying regular bull flags. The problem is a stock could consolidate for any length of time and you really can’t narrow it down very well. You could at least narrow the list down to maybe 500 stocks by setting the screen to find stocks that rose 10% or more in the last 12 weeks (prior uptrend), and then consolidated (gains or loses less than 2 and more than negative 2 in the last 4 weeks), but that is no guarantee to find a flag, so you would have to manually go through a huge list to find the best looking bull flags to buy. Plus it would limit some more volatile stocks or flags that form in a shorter amount of time. In other words, it just won’t work very well. For this reason, and in reasons covered in why to trade flags, you probably should just have a strong fundamental watchlist to go with, and manually use something like finviz to identify bull flags. So what types of things might you look for? There are a number of ways to identify strong stocks, but for this method, we will take a page out of IBD, and look for the top stocks of the top performing industries first. This can also take some work. A quick free way to do this is to use barchart.com to see the top industry groups sorted by performance. This has more industry groups at 277, more than the IBD which I believe has 197 industry groups. However the principals taught by William O’Neil remain the same. We will include the top 30 industry groups instead of 20 because of this. Now once you identify the top 30 groups, you need to identify stocks with strong fundamentals and technicals too within these groups. So far this is really close to the CANSLIM method, and that’s a testament to the strength of William O’Neil’s research, but we will be trading bull flags which is more short term and requires slightly different timing and management strategies. Additionally “fundamentals” used can be slightly different. We might use earnings growth, but we might also use PEG and price/book or price/sales. You could use ROE but you might instead use ROA. Basically, I’m going to suggest using the IBD composite rating because it’s easier for me, but you do not have to be confined to this method. You can either grab an IBD newspaper, or you can subscribe to their services. Just look for any composite rating above 90 and add it to the watchlist. If you want to have a wider list so you are more prepared each week to just sort through the names you already have, include maybe a rating of 85 or higher or just look at the EPS rating and make sure it’s over 90 as the technical strength will improve the rating. If you want the free method, just make a zacks screen to identify good fundamentals. You will find several example screens on this site, and just one by one look through the stocks and see if they are contained within barchart’s top performing industries. The main idea is to get a watchlist. Since you are building a watchlist, you may want to build a watchlist for the top 50 industries, at least from the perspective of recognizing the top stocks in that industry, and just only agree to trade the top 30 industries. You have to do work regularly to keep up with the changing strength of sectors, but fortunately it’s much easier with the tools available online.

Identifying A Bull Flag and Bull Flag Buypoints
Using the criteria above, you are looking for a price run up, a consolidation, and then a breakout. Check out this link for bull flag and bear flag examples. However, you want to identify the stock before it breaks out, so you are going to have to see it start to make that pattern first. THEN you identify the breakout point which should be above the pattern and set a stop buy to buy as it crosses the intraday high of the pattern. Another way is to look at the high of the close of the pattern, wait for the pattern to close above the closing high, and then purchase above the open. In this system we will just look at the intraday price and set it about 10 cents above that mark.

How To Trade Bull Flags
There are two ways to play a bull flag. The first way to trade it is as a swing trader. The other is as a trend trader. In either case you want to play bull flags in a bull market. If you are in a bear market, either bet against bear flags by selling short or buying puts, or instead hold cash and wait for a more opportune time to trade.

Swing Trading Bull Flags
As a swing trader, you are looking to capture one swift upward movement in the stock then sell it at a price target. This type of trading requires you to identify the length of the pattern (duration) as well as the height of the pattern from the pattern high to the pattern low. With this information, you can identify a price target and a price duration. The target is the distance between the high and low of the pattern (the peak before the consolidation and the consolidation low) added onto the breakout price. The duration is generally the length of time it took for the pattern to form. Managing money as a bull flag.

Trend Trading Bull Flags
The other way to trade a bull flag is as a trend trader. Since you expect the trend to resume after such a pattern, you can set a different target, but you shouldn’t always sell at the target price as long as the trend is in tact. A trend trader will look at the minor low before the price run up forming the “bull” part of the bull flag, where as a swing trader just looks at the flag itself. So you would subtract the minor low by the minor high. Most good bull flags will in fact have the “minor high” the same as the 52 week high, but it isn’t required. What you want to see is a rally from a lower point which may also be the 52 week low but isn’t required, and then after a run up a consolidation. Your target price is roughly half the difference added onto the breakout point. In reality it will move closer to the full difference of the minor high and low added to the breakout point, but won’t quite get there most of the time, so you should be willing to accept a smaller gain to ensure a higher success rate. You generally want to use the existing trend line as support, and a break below that represents the pattern being over. However, very often a new steeper trend will emerge upon breakout. Additionally possible topping formation will start to emerge. So this means you should constantly be on the lookout for new sell points. If the stock breaks below a trendline, it’s generally a good time to consider selling. After you reach your price target, you should be on the lookout for any stop at or above your price target. The stock may rise nearly twice as much as anticipated, or much more than anticipated, or even less than anticipated. As such, you must be willing to accept a smaller gain so that if it pulls back to that level, you can still sell without the risk of your gains not gaining enough to offset your losses. What I mean is that you set your stoploss with your target price in mind so that your target price is 2.5 or 3 times your loss or even more if it makes sense to do so.

The postflag move takes slightly longer than the preflag move, the price move is slightly shorter than before it. Keep this in mind and lock in any significant gains

So you would assume about a win rate of about 50% even though historically over 60% of high tight flags reach their target (64% in a bull market, 55% in a bear market) . Given that, you need to manage your stop loss so your upside is greater than your downside. In other words, if your price target from the purchase price is $15 and the stock is $14 at a bare minimum you need a stoploss of $13, but that’s just to break even and that assumes you always sell at $13. You would be wise to set a stop that is such that your target price is 3 times the stoploss. There also is a question of managing money but we will cover that after we get to the 2nd way to play the bull flag.

If the previous trend was upwards, it is classified as a BULL flag, as opposed to a “bear flag” which occurs after a bearish trend starts to rally and then the bearish trend resumes. This is not to be confused with a “high tight flag” a special type of flag that requires 100% price rise in under 2 months before the flag is formed. For more on the high tight flag, see our high tight flag trading system introduction and from there you can read about the rest of the trading system.

Money management system for bull flags
If you want a system that consists of buying a single bull flag, and you are not using this account for anything else, you should consider using the kelly criterion to maximize the upside. This depends heavily on your stoploss, your upside, the possibility of it breaking below your stoploss (and how severely when it does), and your win rate, but based on a 3:1 win ratio and a 50% success, you should risk 1/3rd of your funds on a given trade. The rest should essentially be in cash. To increase effectiveness you might trade options, but your downside is essentially the cost of the option plus commission, so your 3:1 upside means you have to triple your money as your upside target. With options that requires a smaller price move but with greater volatility.
More realistically, if you aren’t using options, you should be able to risk more because a loss will not produce a 100% loss. I would say aim for 50%, or else use this advanced kelly criterion calculator in investing to figure it out yourself, and always risk less than the amount tells you.

 

bull flag trading system management

In the picture above on the left you have a swing trader example, and on the right you have a trend trader example of how you would trade the bull flag. The examples are simple and assumes you buy right at the high where in reality you might wait until it rises 10 cents above the high but the concept is what I am trying to illustrate in a more simplistic way.

Expected Results
It’s very difficult to anticipate the expected results of such a system. First of all the data collected in the past may not continue in the future. Second commissions and fees make a big difference. Third, you may not be able to execute the perfect trade and you may make mistakes. Finally, looking at the “averages” isn’t a good way either as the major losses will effect your position size of your next investment. Regardless, we can use the advanced calculator mentioned earlier to attempt to identify this. So say we risk 50% of our bankroll. We anticipate this might be 1.5% growth after fees.

So you start with $100,000. You might risk $50,000 in a given trade and you might gain 1.5% of your total $100k or $1500 per trade as 1.5% wealth increase (accounting for volatility). This should continue several times. Hypothetical lets say you place 20 trades in a year. Your performance would result in your portfolio climbing to 134685.50 or about 34% per year. I would cut this in half and anticipate losing money initially until you really get the hang of the system and really learn the ropes. It’s really difficult to really put an “expected results” since each bull flag is going to have different price targets and stop losses, so this is basically informational purposes only of me best trying to imagine what kind of return the system might see if the past is any indicator of the future.

 

Conclusion
A bull flag trading system can give you a way to make sure you participate in a number of stocks on your watchlist, each for a relatively short period of time. Bull flags can offer you effective trading, provided you don’t overtrade relative to your account size. You should not try bull flag trading systems if you do not have a significant amount of capital and low fees as you will be making more trades per year than other trend trading systems or other pattern breakout systems for the most part.

As always trade at your own peril and make sure you read our disclaimer and understand risk management and consult with experts before making any investment decisions.