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Musings |
Some Points to Ponder
On Share Prices
The following snippets are (edited) copies of posts I made at various times in various Fora on a variety of (loosely trading-related) topics.
Some of the opinions expressed here have caused controversy, to the point of upsetting some people; some of it is tongue-in-cheek; some is just irreverent.
If you cherish some "Holy Cows" of your own, don't read any further.
List of Topics
On Press Articles influencing Markets
On Conspiracy Theories
On Hedge Funds, Derivatives, and Short Selling
On Fundamentals
On Technicals and Funnies
On Annual Reports
On Gann Cycles and Fans
On Elliott Waves
On Predictability of Exchange Rates
On Doom and Gloom
On "The End is Nigh"
On Fibonacci Numbers, Logarithms, and Price Scales
On Fibonacci Analysis and Projections
To Be or FSB
On How Many Stocks to Trade
On Share Reconstruction
A piece of advice from Phil Carret’s The Art of Speculation:
If you have 1000 shares of a stock worth currently, say, $9, disregard entirely the price you paid for it. Rather ask yourself this question: “If I had $9,000 cash today and wished to buy some security, would I choose this stock in preference to every one of the thousands of other securities available to me?”
If the answer is strongly negative, sell the stock! It should not make the slightest difference whether the stock cost you $5 or $13.
Your entry price is totally irrelevant, but the average punter gives it considerable weight.
On Press Articles influencing Markets
I think the more that publications ... make retail participants aware of seasonal price action, the less reliable these seasonal moves may become.
As any first year Engineering student will tell you, "positive feedback" in a closed system leads to explosive self-destruction.
The global sharemarket has become such a closed system. Ironically, this has come about because each local economy has been opened up, and every participant can now trade equities, derivatives, futures, currencies, even CFD bets across markets the globe over.
"Closed because it opened up"? That may sound paradox, but becomes clearer when we consider the past:
Earlier last century, you would have rarely found people in Australia taking an interest in French share options, deutschmarks, and Chicago pork bellies - all at the same time. Few would even have heard about hedging a position. So, we had lots of local markets, each pretty much a closed system, with only a tiny number of players straddling some boundaries. Those small links between national markets actually served as "safety valves", which avoided the perils of positive feedback. In addition, the information was rarely fed back to all; it was reaching its audience a lot slower, if at all; and the reports on facts, opinions, and conjecture were far less uniform than they are today.
Since opening into a single global market, which is accessible by everybody with access to a computer, the sharemarket is now covering the entire world, and as long as we can't trade with other galaxies or alien intelligences, this Global Market doesn't have any external safety valve left.
In this situation, the only way to avoid self-destruction is to dampen the positive feedback. Which, I think, is already happening: Thanks to the internet, the uniformity that was lost when Financial Media became concentrated in the hands of The Few, is being gradually restored by an abundance of "free advisories". No matter how far-fetched a theory, it will have its loyal followers.
The complexity of all its different components may also help avoid self-destruction: So far, it is unlikely that even the biggest players can agree on a common interpretation of all the facts. The diversity in valuation models, and the time it takes each to come to its own conclusion, looks like a good damper.
Lastly (tongue pushed only a tiny bit across the molars ;-)) let's not forget government committees: If there ever was a need for an "organism with 100 bellies but no brain", it is their knack to come up with rules and regulations ("positive feedback"? yeah, right) to control the market.
On Conspiracy Theories
Ohh yesss!
Isn't it great to have a nice round conspiracy theory! Let's blame everything on the daleks and robots and "them with the computers". Makes coping with disappointments so much easier when things don't turn out the way our preconceived ideas predicted. Certainly beats checking our analysis and learning from experience to improve our own game.
How often have we read excuses like "...had to finish with an inside day, but this once it fooled us..." or "...must surely collapse now, and would have if the plunge protection team hadn't thrown more worthless paper at..." or "...needed a decent pullback, but robots bought..."
What has become of basic chart reading skills?
Nothing wrong with having an educated guess: What's the most likely direction an instrument or index may take into the next few candles? That's the result of everybody's analysis - or at least should be. But "It's got to... because I say so, and I'm right" won't get us very far. If the first guess doesn't materialise, have a Plan B.
Even if some players manipulate the market to their advantage - so what! It's part of the way the market works. The sooner we realise the fact and incorporate that realisation into our trading strategies, the better our bottom line.
On Hedge Funds, Derivatives, and Short Selling
One point I'm afraid is often overlooked is the impact Short-selling and wide-spread Derivatives trading has on the Market as a whole. I was beginning to have doubts about the whole concept several years ago, when my youngest son (a Financial Advisor himself) lambasted Short-selling as inherently wicked and unethical. As I had been playing both sides quite happily, I had to mull it over. But from an overall view, he has a point, I reckon. Here is why:
As an original concept, "Hedging" was a means to an end: a company bought options as an insurance against their best Plans coming unstuck. Just like you and I would spread the risk of a car accident or house fire across a number of fellow travellers with "mutual" interests. The insurance premium was calculated solely on the probability of accidents, with little overhead, and without any incentive for the insurer to wish for a particular outcome.
When this concept was abandoned - de-mutualisation, I believe it was called - that's where the trouble started. All of a sudden, the counter party to provide insurance cover (or hedge to the short side) had an increased incentive to "make money" from those derivatives. How? Easy to figure out, when you have "contracts" that expire at a particular time, e.g. the last Thursday of a month. You can "calculate" all the Greeks in the world and sell your options at a higher or lower delta: what you want is for them to expire worthless, so you can keep the premium.
And this is where short selling becomes a double-edged sword: You have an interest for BHP to come down below $35? Easy: Short the proverbial out of it, scare the nervous nellies to sell it down from $36 to $34.99 - and then have them exercise the $35 Puts you sold them earlier.
Instead of being a protective mechanism with a genuine spread of risk, it now becomes a means to make money and try and "fleece" the other side by bringing about a situation that, for a brief period at least, invalidates the "insurance". Anybody who has watched share prices being mm..moved to the "right side" of an Open Interest, will know what I'm talking about.
Question: Who is usually the winner of such mm..movements?
Well, it appears not even BNP was smart enough to stay on the winning side long enough. And with easy money becoming harder to get, the smaller firms (e.g. mortgage providers) didn't stand a chance; there just aren't enough smart cookies (or huge computer conglomerates) around for them all to prosper.
But Hey - what about the entire Market being a "Zero Sum Game"?
In a "mutual" situation, the game was usually pretty balanced, as the premiums (plus) only had to cover the accidents (minus) - take a little "friction" for the guy who manages the transactions.
Where those derivatives become an end in itself, and are offered to every citizen who can hold a newspaper right side up, the equation changes: The hedge fund managers are now extracting a disproportionate slice out of the cake. Winners get exorbitant bonuses, losers still get a base salary that most battlers on minimum wages can only dream about. Add (or rather: subtract) taxes - GST and CGT, and there is another huge outflux to only benefit lipopygian parasites - oops: "Government Consultants" and "Lobbyists".
And to make things even easier for those citizens, and catch those that can't afford to "invest" in shares or detivatives, you offer them easy credit. If you can't repay your Bankcard debt, put it on Visa till next month. But whatever you do, Don't stop spending!!! Only increased consumption guarantees GST income to feed more lipopygian parasites - oops, I've done it again!
When I was young, rolling out one debt into a longer-dated future debt, was called "Wechsel-Reiterei", which was a criminal offence under German Law. It's classed a fraud and/or unethical (§ 138 BGB).
Maybe, in the US and some other parts of the world, it may be acceptable. I'm sure the British-born have at least a word for it: "flying a kite"?
PS Ed: no, I don't wish for all those options to be banned; using them myself to a certain extent - mainly hedging, but also for profit. But my above assessment still stands: The wide-spread promotion and use of derivatives facilitates the transfer of wealth from the less sophisticated Many to the powerful unscrupulous Few.
On Fundamentals
Every now and again we have to deal with the slippery concepts of Technical Analysis vs Fundamentals.
What exactly are Fundamentals? Is it P/E? Dividends? Evolution of turnover and profit over the years? Ratio of strikes vs dry holes over time? Or do Fundamentals also include the comments and predictions on various websites, magazines, advisory services?
Most Technical Analysts, I believe, use primarily (maybe even exclusively) the former meaning. Any measurable data should always be included in stock Analysis, even though some are more likely to be "prettied-up" than others. In the short term, P/E and yield are usually stable, if we exclude the brief periods of Reporting. Any sudden changes based on such fundamentals are usually preceded by some twitches in the chart.
For longer holdings - "investment" - P/E and other success rates deserve even greater consideration; even though I would contend that longer-period charts will also favour the stronger companies. That's because The Market Knows and factors these qualities into the valuation.
However, should we accept newspaper articles and general Internet commentary as reliable entry indicators? In my opinion, the answer to that is No: I am extremely cynical about others' opinion and usually unproven and highly contentious conjecture, especially as they're often based on rather fuzzy assumptions of alleged market influences. Can we be certain the writer is genuine? Could there be a hidden agenda? Maybe it's a pet theory they try to "prove"? To me, the touchstone is: Can it be measured? And to how many decimal places?
If I cannot measure the historic veracity of these people's predictions, I'd rather not waste my time studying them. Isn't it peculiar how, at year's end, every paper publishes "crystal ball views" by representatives of various persuasion, yet nobody goes back and compares the predictions against reality! The only "clues" we can get is the rate at which the forecasters change each year. (The most obvious are astrologers and clairvoyants: Try and find the same name twice :-)) But even that requires us to keep records ourselves.
The difference between science and the fuzzy subjects is that science requires reasoning, while those other subjects merely require scholarship. R.A.Heinlein, "The Notebooks of Lazarus Long"
On Technicals and Funnies
or in long-hand: To what extent can Fundamental considerations enhance Technical Analysis?
I am not claiming to be the authority on either, and with English being only my third language, I can't even claim authority on the "real" meaning of the words in question. This memo is merely meant to explain the way I use certain terms, and what I think of them in the context of my trading. So, anybody knowing better, please enlighten me (NOT!).
Let's start with an often misquoted outline statement:
Fundamentals can suggest certain stocks that may be worth trading; Technical Analysis determines when and in which direction.
Technical Analysis, abbreviated TA.
This is the reason why we bought the Analyser. Sometimes, it's also referred to as Charting, but that is only one of the TA tools. We can calculate and compare indicators without the need to draw a chart. We can sort tables or base decisions on key dates, such as ex-div. We can develop our Trading Plan, analyse stocks and how they perform under the rules of our Trading Plan. All is possible with spreadsheets, back testing, market scans, but not a single chart in sight.
TA is based on Technical Data: mostly OHLC&V (stands for "Open, High, Low, Close {prices}, and Volume".)
I also include data like dividends paid and due to be paid, ex-div dates, number of shares and company options on issue, etc. These are sometimes labelled "Fundamentals", as if there was a difference between a share's price and its last dividend.
Well, I beg to differ: If it's used for Technical Analysis, it should be called Technical Data. The touchstone as to whether an item qualifies as Technical Data is: Can it be verified? Is its measure objective and comparable across all stocks?
This is the cornerstone of my approach to Trading. Having a background in Sciences, I only feel comfortable with data that can be measured, calculated, verified, and normalised.
More importantly, I recommend that all L-platers concentrate on TA and make it the basis of their trading. It is not even necessary to know ALL the TA methods, indicators, and systems. Start with a few simple rules; get to know their strong points and their limitations; never stop learning, but stop complicating things once they work to your satisfaction.
Funnymentals, in the opposite corner is, well, the opposite: Fanciful Forecasts; opinion; press reports; anything that does NOT stand up to scientific scrutiny.
The key attribute here is "opinion". Where creating a certain belief among a number of people could benefit the originator, I definitely consider it tainted as opinion. The benefit need not be purely material. And the originator need not be the person who puts it forward. "Quo bono?" = "Who benefits most?"
If this sounds like "Guilty unless proved innocent", I make no apology: that's exactly how I treat most published opinion that does not reconcile with observed Technical Facts. And when, as sometimes happens, such opinion is sold to us as Fundamental Truth, I shall continue to use the term "Funny Mentals".
Admittedly, between sheer White and absolute Black, there is an infinite number of shades of Grey. There is a limited group of Fundamentals deserving of the name and deserving to be taken into account by advanced traders:
These include the Sector; statutory periodic reports; forthcoming events; next AGM; sector-specific schedules: eg spudding of oil wells, campaigns to define boundaries of ore bodies, etc; Moody's credit rating; S&P weighting and indexing; even some independent Analysts' reports (but be mindful of "Quo bono?")
How important are these? Does the additional benefit, measured in terms of successful trades, justify the additional costs, measured in subscription $$'s and time spent trying to make sense of it all?
For my personal Trading, I'm not sure. On even-numbered days, I concede a remote possibility that basing my decisions on a greater number of items ought to improve the results; on odd-numbered days, I am certain my trading is just as successful, but far less cluttered, if I simply stick to Trinity and study the charts. Today is the 31st.
On Annual Reports
In a Market Wrap (30 August 2007), David Taylor reported a few spectacular results. Profit up, but what did the share price do? Up/ down/ sideways - in no recognizeable relationship to the result. To me, that highlighted yet again the apparent independence of profit reports and share price movement.
Take MGX for example:
NPAT up 103%, revenue up 119%, NTA up 316%.
Market reaction: Ho-hum.
But - Looking back 5-6 months, the chart shows the real picture: As early as mid-March, MGX started a 4-month rally that saw its share price more than double by late July. If somebody "anticipated" the report, they must've had an awesome intuition. More likely though, "somebody" kept an eye on shipments and whatever backroom analysts are paid to keep an eye on, and suggested to buy MGX. Now, that the report has come out, the early buyers get confirmation "Yup, it's worth about twice as much as it was then. Time to take profit..."
Of course, the press takes the numbers and gushes "Awesome result! What a great company! Fancy that!" And retailers rush out and buy at the top. Like they have to because the profit takers need a bunny :-)
See how it works?
Exercise for a quiet evening/ weekend:
Pick any stock that has recently reported its FY 2006/07 results.
Bring up the chart and look at the day when the report came out.
Can you guess, just from the price movement, the profit increase or decrease to the nearest 100%?
"Oh, but it failed to meet/ it by far exceeded/ it wasn't as bad as market expectation", goes the explanation. So, pray, whose is this "expectation" then? Where could we find the truth about this expectancy? - assuming it's been out there at all.
You guessed it: It's been in the chart!
Price went up - "the market" expected good performance. Is it worth gambling on the report? How closely will the reported figures match that mystical "expectation"?
Rouge ou Noir? Faites votre jeu.
On Predictability of Exchange Rates
No use looking at one component in isolation and repeat running commentary of what may be around the next corner. Those that do have the clout to move markets (if they exist at all) will do their darnedest to keep everyone guessing. And if one published opinion comes close to the truth, there'll be dozens of others that throw us off the scent. Of course, if somebody finds an event close to a grain of their pet theory's prediction, it's "told you so. spot on!"
The more complex the influences and relationships become, the less likely it is that anybody's published opinion will last, and the more important it is to go back to charting basics: Support, Resistance, and Trends.
quote
Nonetheless, despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin.
endquote
Alan Greenspan - 20/11/2003: http://www.federalreserve.gov/boarddocs/speeches/2003/20031120/default.htm
On Gann Cycles and Fans
I have seen examples where cycles seem to fit; sometimes even two or three times in succession. However, I haven't yet seen a Gann-centric Trading System with entry scripts that say "buy if..." or "sell now". Without such firm and repeatable rules, I lack the ability to backtest and verify those claims of 80% success rates. Indeed, all my research into periodicity of Turning Points has resulted only in a random distribution of such "important lows" or "significant highs". Nothing to hang an "edge" on. So, it's not for me.
As a scientist, I cannot take serious anything that is based on Astrology or Numerology. However, since a large number of people seem to believe in the Stars - just look at magazines in your Doctor's waiting room, even regular newspapers and websites! - there is a fair chance of some predictions becoming a self-fulfilling prophecy, when the gullible follow the lead of the unscrupulous.
Having said that, I have always respected {Gann disciples'} passion for cycles; where their analysis matches my own, I take it as reassurance; just like I appreciate ... channel studies, ... Heikin-Ashi, or any other approach. If a different method disagrees with my own, I may take a second look to see whether doubts are justified.
For an independent assessment of Gann's theories, including serious questions about their general validity, visit the Wikipedia website.
http://en.wikipedia.org/wiki/Gann_angles refutes the theory of Gann fans and angles.
However, if enough people believe in Astrology, http://en.wikipedia.org/wiki/Financial_astrology may explain why - especially in hindsight - matching cycles can be construed.
On Elliott Waves
Being able to "predict" price targets in the short and medium term - whatever that timescale is - has its merits. That's why I've never joined in the chorus of critics that blankly condemn EW and Gann as superstitious nonsense. Too often have I seen examples where their suggestions have come close. So, their model "may have something". Whether that "something" is intuition, superstition that becomes self-fulfilling, or divine revelation: I keep an open and tolerant mind about it until proven otherwise. Where I find evidence to the contrary, I try and put it as rationally as possible. Where it confirms my own analysis, I'm happy to take it as additional confirmation.
The problem with any model - scientists call it "working hypothesis" - is this: If it's not well-enough understood why and how it works, and which conditions are essential to the underlying theory, then any extrapolation is fraught with danger.
That's why I mentioned Chaos Theory in this context: If that butterfly in Beijing bats its wing, we can set up wave equations describing perfectly how the air molocules will move and how the tiny pressure changes will expand outwards. But the tacit assumption is: This will only continue for a short while, before other forces take over. Whether they are the waves of other butterflies that were "outside the picture", or an inherent inaccuracy in the initial parameter set, that's unimportant: It's the "tacit assumption" at the basis of the theory that draws the limits.
Take Newton's model of gravity. To all intents and purposes, in the "real world" for which it was observed and formulated, it worked perfectly. It was the extrapolation into hypersonic speeds and inter-galactic spaces, where it needed Einstein's refinements. Likewise, drilling down into atomic spaces turned up situations that needed Planck's qnantum.
Back to those models of social and economical behaviour: They are based on statistical principles, which have some "tacit assumptions" at their base:
* We need a large "statistical universe" of data for statements based on "probability". And Trading is all about those, don't we know it.
* If we drill down to the atomic level - in Trading, that can be a single stock or a short timeframe - we run out of numbers.
* If we expand beyond the "real world" where our model has been proven to work, we run into problems with Chaos Theory. Those unknown and unknowable factors ("out of left field" or accumulation of tiny inaccuracies) pull the rug out from under our feet.
Conclusion
Over a large number of stocks and wave structures, the evidence may well show that the 5th wave turns into a correction of 3 waves from a certain Fibonacci level in a reasonably high percentage of cases. However, using the model for a single case (e.g. one particular wave sequence of one particular index) we "run out of numbers", and statistical probability loses its meaning.
For further study, visit the Wikipedia website, where supporters and critics of Elliott Waves have a say. Unlike Gann's Astrolgy-based theories, Elliott Wave theory is a compulsory test subject for obtaining accreditation as a Chartered Market Technician in the US.
Read http://en.wikipedia.org/wiki/Elliott_wave_theory, especially the last two chapters, and form your own opinion.
On "Doom and Gloom" (Jan 2007)
I try to think positive. Even the mention of doom and gloom is anathema to me. Not because there can never be a downturn, but because negative talk creates a negative mindset, which blocks rational analysis and planning. The Market moves without pity, joy, or any other emotion. Every move it makes can be seen as a threat to my wellbeing, or as an opportunity to improve my position. Rather than dreading the next catastrophe, I prefer looking forward to another stimulating day, doing something I really enjoy.
I've got nothing against the Market, be it Bullish or Bearish. I'd really be "off with the fairies" if I thought the Market gave a hoot for what I thought of it. But I object to negativity, flawed reasoning, and unproven theories.
Every trend has its little swings, pauses, channel crossings - ups and downs. But when the XJO has been rising for several years, staying inside a channel that saw it just about double, I find it somewhat amusing to hear it called Bearish. Likewise, if correlations between two independent entities are postulated, I want to see mathematical proof - especially if even the most superficial glance at an Overlay chart seems to disprove the theory.
As "Proof", I'll accept any reference to an authoritative source. Even a simple picture counting the "ayes and nayes" will do. For example, I'm quite happy to accept "E = m c square", knowing Einstein proved it to everybody's satisfaction. It's repetition without reference to a recognised source that I won't accept on blind faith.
There's money to be made in either direction: short opportunities in Bullish, and Long ones in Bearish cycles. I therefore hope that all the peripheral talk about "end and imminent doom" doesn't spook anybody out of their Trading plans if they intended to trade the long side.
On "The End Is Nigh" (6 Jan 2007)
Ahh - "The End is Nigh!" How often have we heard that before?
Pity I didn't keep records - but it's probably fair to say that since 1999, similar alarms have been raised just about each time the All Ords or XJO (or Dow or ...) showed two red candles in succession. So, let's calm the waters and keep it all in perspective.
there was mention of a theory that increasing volatility precedes a change of trend.
I've been discussing that subject with a fellow trader, and we found that Average True Range is probably much under-utilised as a measure for price volatility. So I put ATR on an XJO chart - and indeed, it looked as if ATR had gone up a lot over the past couple of years. Similar to the way it increased in 2001 and 2003.
Might therefore, if not the end, at least a 20% correction be nigh again?
But hang on: ATR measures volatility in terms of daily price changes. Of course, you'd expect the XJO to vary by a greater margin around 5,500 than it did four years ago when it was only half as high.
Out comes the programming pad: Calculate ATR in terms of percentage relative to the median price level.
click here for attached chart
Interesting observations on the side: It seems that volatility spikes coincide predominantly with down days, confirming the old saying "up by escalator, down by elevator".
(It would require a lot more research, but could a spike in Daily True Range possibly be transformed into a leading alert indicator?)
But back to the XJO chart:
Since early 2003, the XJO has been steadily moving in a rising channel. While doing so, it's also swung between the upper and lower banks of that channel, as you do in a channel. In April/May 2006, we saw a short-lived false break to the upside, followed in June by a retracement back to the rising support. A smaller and shorter break to the downside merely proved 5,000 to be holding support, and we're back near the top.
So, what if we were getting a retracement to the bottom line? Would the sky fall? Would the world end?
Let's keep it in perspective, please: Most of us have survived the period March 2002 to March 2003 quite well (notwithstanding the occasional need for a change of undies ;-)) That period involved a drop by about 20% - "correction"? OK. But "The End"?
On a "non-technical" footnote: It has been widely commented how obscenely high bonuses and commissions have been syphoned off managed funds. Now here is a thought: If bonuses are calculated on Funds making a certain % gain, calculated over the calendar year 2006, where would your average fund manager prefer the overall market to end the year: On a High? Or on a Low? (Subtle hint: Their bonuses increase exponentially, not linear, with each point of gain. And they know how to use a computer to figure out their bonuses in advance. It's called a "what-if" scenario ;-))
Conclusion: For the time being, I see no need to panic. A retracement towards 5,300 seems a reasonable thing to expect; XJO may even retest the congestion zone just above 5,000. I would become concerned if volatility spikes (relative DTR) were to rise again into the 4 and 5% area; that just might cause the support level to fail, leading to a correction or a period of consolidation. But the chart will tell, and a good Trading Plan will cope with either.
On Fibonacci Numbers, Logarithms, and Price Scales
Let's start with the terms "logarithmic" and "linear" (subdivisions of Fibonacci retracement analysis). I'd prefer calling them "natural" and "rational". Why is that?
"rational" got its name from the fact that all intervals are divided into simple ratios of small integer numbers, such as 1/2, 1/3, 2/3, 1/4, etc. It's the very fact that they're so easily obtained and every first grader knows them, that makes them appealing. However, they rarely occur in nature.
The "natural logarithm" is not a rational number, but part of the infinitely larger range of "irrational" and "transcendental" numbers. Quite imprecisely, the Fibonacci numbers and natural logarithms are lumped together, although they're two different animals. Both are frequently found in Nature.
If you divide two successive Fibonacci numbers, you'll get 0.618 - the larger the Fib numbers, the closer the result. (Try 13 / 21 and 89 / 144)
Divide the other way around, and the result is 1.618... with an infinite number of subsequent digits, but 4 will suffice for this exercise. This number is commonly called the "Golden Section" and represented by the Greek letter Φ which is pronounced "phi", as in "pie-with-an-Eff". You've probably heard about the Golden Section and its significance in growing things, as well as in Arts and Architecture.
The other important number is e, short for "exponential", the value of which starts with 2.71828182845... etc ad infinitum. It is the base number of the "natural logarithms" and also occurs in natural growth processes. It may please the Traders among us to know that capital growth (say, from compounding interest or company earnings) is also subject to the same mathematical principles, and therefore considered "natural growth".
Using the semi-logarithmic scale in price charts makes sense - particularly in cases where a share price has doubled or done better still within a single page.
The "Linear" scale gives a $1 rise the same length on the price axis, regardless whether it represents a doubling from $1 to $2 or a mere 10% rise from $10 to $11.
Reducing the price scale to (natural) logarithms puts such a rise into perspective - ie the distance from $1 to $2 is the same as from $2 to $4 or that from $10 to $20. In other words, it's the relative performance from a normalised base that is measured.
I'm sure every Trader will much rather make $1 profit from an investment of $1 than having to fork out $10, yet wait the same time.
Where "e" has a bearing on the final result of a growth process, the Fibonacci numbers and "phi" describe the steps how a "living thing" (like a share or bank account) got there. Therefore, we might consider the retracement from 100% to 61.8% and back up to 161.8% as "a natural sequence", involving 3 steps along the Golden Section:
The first step, retracement from 100 to 61.8 is a drop by 38.2%, which is exactly 61.8% of the target level: Just check it with your calculator: 61.8% of the target 61.8 is 38.2.
The second move, back to 100%, is again 61.8% - of the starting point 61.8.
As we're now in growth mode, the next growth spurt, third move, is expected to be 61.8% off the new base, which is now 100 - hence the target 161.8 after a "strong" bounce based on the "Golden Section".
Were we to apply the same principles to a retracement to 66.7%, we'd have to use 50% (of 66.7) in steps one (retracement) and two (bounce back to 100), followed by a run-up to only 150 - which apparently doesn't happen where "natural growth processes" are involved. This is something I haven't researched myself, but am happy to take the scientists' word for it. In any case, logic would suggest that a bounce off a "stronger" - ie higher - retracement level should achieve a higher target, not a lower one.
You may rightly argue that these levels aren't always met. I don't even doubt that you can find stocks that don't seem to have this "natural behaviour" in their DNA at all. But on balance of probabilities, I'm inclined to go with Nature.
On Fibonacci Analysis and Projections
There seems to be some degree of confusion about "correct" application of the Fibonacci tool.
Some charts that I published may actually have contributed to misunderstanding; therefore, let me put matters in perspective.
(1) I do not lay claim to "the only right way" of applying and interpreting Fibonacci levels. I use the tool only as an aid to locate probable support or resistance levels. That way, they work for me.
(2) There is an abundance of reading material on the Internet. A Google for "fibonacci retracement" yielded 10,400 hits. A lot of it will flog "secret software" or "newsletters that will blow you away".
(3) In my most sincere opinion, there is no "deep secret" that guarantees $ucce$$. (Let me qualify that: "success" for the buyer, that is. The seller of such newsletters will of course be successful in separating $$ from $ucker$.)
(4) As far as I know, all serious traders agree on two basic premises: A: The Fibonacci Tool is drawn between the two extremes of a significant trading range. In Market Analyser terms, that means we use two TP's (High and Low) of comparable periods. And B: The direction 0% to 100% must match the direction of the intended trade. The latter ought to be a no-brainer: How else do the projection levels 161.8%, 261.8%, 323.6%, and 423.6% make sense?
(5) Not everybody may agree, but I've found that some stocks follow Fibonacci levels better than others. Even if it bores yuo to tears: Check your stock's DNA! A corollary to this is: Not all trading ranges are equally well suited for Fibonacci-style analysis.
Now, the point that may have caused some confusion among L-Platers: When determining break-out from a Trinity trend-reversal, I use the tool between the (tentative) TP and the FTFF level. This will rarely satisfy premise A ("significant trading range").
So how do I justify it? The Trinity Approach calls for a reversal between TP and FTFF level that should be above 50%. (Sometimes, it may go down to 38.2% and still be successful. Check the stock's DNA.)
A bounce off 61.8% is considered strong and gives us a first breakout target at around 161.8%.
There should be no problem with the starting point of our range: without a "significant" TP, there won't be a Trinity analysis. But the FTFF is usually of a much shorter period, if it can be clearly defined at all.
In short: I'm looking for a measure of the pullback from FTFF and, if it finds "strong enough" support, I want to extrapolate to 161.8%. Well, the Fibonacci tool does both - so I use it in a context that's somewhat "outside specifications".
In any case, I redraw all my lines and ranges each time that an earlier anchor proves tentative or preliminary. My Trading Plan includes learning and adjusting a trade to observed facts.
To Be or FSB
In the Great Debate between Technicians and Fundamentalists, one particular question is at times quite hotly debated: It concerns the merit or otherwise of paying a Full-Service Broker and/or asking a Broker's Analyst for advice.
Here are some of my thoughts on this question: To Be (my own analyst) or (use an) FSB
which came about when a proponent of FSB took exception to a not so flattering comment by a proponent of self-sufficiency.
I'm sure everybody understands that you can't divulge advice that you pay for.
If I had information from a paid-for source - be it a Tech Newsletter, fundamental Analysis subscription, rec sheet, or backroom Analyst - I'd feel equally obliged to honour the copyright/ confidentiality/ nondisclosure agreement. Several of my friends subscribe to MDS' Advice service, but it wouldn't ever occur to me to ask them about today's suggestion. It just wouldn't be ethical, not to mention legal.
But that isn't the main issue here. The point that a number of members are making is this:
We've paid good money for a top program that helps us make our own informed trading decisions. Some of us have also paid extra good money for extra trainig courses, seminars, or workshops; and most have invested an enormous amount of time and effort to really understand how to use these tools within the framework of their personal trading plan.
Given all this amount of self-education and years of studying, it's only natural that those members feel just as well trained and capable as any analyst who is employed by a broking firm to look after their paying corporate clients. Fair question: "Given an equal amount of studies, mental capacity, and time spent on the job: what justifies the additional expense of asking an FSB?" If a conflict of interest came about between a big client offering a commission to sell, which FSB would ring his retail clients and suggest they sell as well? I've heard of claims to the contrary, but common sense (if not personal experience) would suggest otherwise.
There can be a good and valid reason for using services like rec sheets, stock analysis, or various other subscriptions: If I can't find the time, or lack the patience/ understanding/ nerve to do the analysis myself, I pay somebody that does have the time and knows how to use those tools.
As regards "special knowledge" and "little-known background information" - sure, some Analysts have done their homework and collected useful information, which they sell to paying customers. (If I were one of those customers, I'd keep quiet about it: See first paragraph.)
That aside, however, there is also an enormous amount of information freely available on the www. It takes time to research; it helps to have a "network" of similarly interested people you know and trust. We share (group) e-mails, and newly discovered sources are freely discussed in private chatrooms - not to be confused with daytrader playgrounds or ramper forums. Takes an open mind and more time than a phone call or reading a report; but the reward is, it cuts out the middleman's opinion and even a hint of a suggestion of a suspicion of maybe an ulterior motive...
Conclusion:
Let's not get too one-sided about our trading style. If you have learned and really understand what you're doing and why, just do it and get on with it. If you feel unsure and have to rely on somebody else's advice, just do that and get on with it.
Whether I choose one option or the other doesn't say I'm smart or dumb. How successful I am as a result, that's between myself and my accountant/ bank manager.
On How Many Stocks to Trade
This article responds to a beginner's question about the best approach to position size, leverage, etc. As the question appears to be puzzling many - even "old hands" - I'm repeating it in full.
Did you attend any course from a reputable, market-independent institute, like the Share Market College? If not, I strongly suggest you do, before even considering one further trade: You will invest into your trading success.
With their help, you must build a strong, repeatable trading plan for varying market conditions. There are many great templates available to build on.
Leaving aside the question of leverage or what instrument/derivative to trade. That is the least of your worries. Far more important considerations must come first:
(1) Spread of risk.
If you trade one stock only, and "something happens" to it. With 80% of your capital exposed in any one trade, such a single event would "wipe you out".
(2) Varying market conditions.
Even sticking to one sector only will leave you with reduced choice of trades. Choppy or tight sideways moves are often affecting an entire sector - say Property, Oil, or Utilities. Why then sweat over narrow ranges, if other market segments offer lots better trades?
(3) Falling in love with a stock.
I knew a trader who traded exclusively MIM and its derivatives. He was quite successful - most of the time - because he knew its moves "by heart". If you're a newer trader, you may not have heard of that stock - for a good reason: They got taken over and can't be traded anymore. My poor mate became a "widower", his trading - umm - "stuffed". (Just kidding: He was smart enough to recover and, after a while, find many new loves of his life. Yes, he became as promiscuous as the rest of us ;-))
(4)When in doubt, stay out
In any share's life cycle, and in any trading time frame, the conditions for an entry (regardless whether long or short) are few and far between. Usually, an exit signal - to take your deserved profit or avoid a bigger loss - does not immediately imply a clear invitation to "reverse the direction". Days, even weeks, of sideways indecision and doubt will follow before the next entry is "just right". Can you afford to stay out of the market for extended periods of time? Why would you want to waste your time watching for that one blade of grass to grow? Why not mow the entire lawn and harvest a big hopper full of those blades that kept growing elsewhere?
(5) Our Market Analyser lets us scan the entire world - thousands of stocks
That's what most of us bought the Analyser for: To find all those stocks that suit our individual trading plan at a given time. Then study them and pick the stock that's "just right" when we have the time and cash to have a go.
Conclusion
The above are only a few core considerations, and in a full-size training course you will learn heaps more. Maybe you will find a few stocks that you're comfortable with and trade them like my friend traded MIM. For me, it seems far better to trade a method and spread the risk over a number of concurrent trades. "Trading is all about probabilities", as another friend doesn't tire reminding us. Probabilities are a subject of Statistics, and any statistician will tell you, the greater the numbers, the more reliable the outcome. They call it "Statistical Universe", which sounds impressive; put simply, it means the more you trade, the more predictable your results become.
Let's just do a simple "what if" to illustrate my point.
Let's say your trading plan has a success rate of 70 winners in 100 trades. Problem is, you never know when those "other" 30 trades hit you. If you make 10 trades in a year, each with, say, 1/3rd of your capital, chances of hitting 6 or 8 of those bad ones in close succession are quite high. Even with a good stop-loss, your chance of getting wiped out are considerable. Even three in a row would play havoc with your psychology. (would with mine anyway :-\)
Compare that to making 100 trades, each with, say, 5% of your capital. OK, you still can hit the "jackpot of bad luck" and go down 6-8 trades in short succession; but it's far more likely that the same number of successful ones brings home the bacon at around the same time.
On Share Reconstruction
This article responds to a question about vast price ranges, where a share topping $200 has been declining to penny-dreadful value after a few years.
Remember the old song? "It's not unusual..."
for a company to go through years of dilution, splits, and consolidation.
In 1997, the shares wouldn't have cost $100 each, but probably 10c like today. Except, they may have had a few reconstructions.
Although I cannot get my hands on this particular company's historic figures, in general, it works like this:
Say they're a little explorer. Issued 100 Million shares at 10c each.
Shareholders "hope" they find something that they can dig out and make them rich.
Directors hope the same, and nurture those hopes by encouraging reports.
Exploring costs money - lots of it. And of course, the directors, experts in their field, also don't do it for peanuts: When you next come across a quarterly or half-yearly report of an explorer, check how much the director fees are...
Assume they don't find much that's worthwhile. The $10M are running low. The share price is down to 5c. A Share Purchase Plan is hatched: Share holders can buy 250M shares at a discounted 4c each. Miraculously, the demand for those 5c shares rises to 6 or 7c - so everybody agrees, it's a good buy. Right?
How long do the new $10M last?
Consolidation
After a few years (and repeat performances), there are over 1 Billion shares on issue, each traded at around 1c, so it's time for a consolidation: For every 20 shares held, you get one new share, PLUS the opportunity to buy 2 new shares at a discounted 15c each...
Here comes the tricky bit for us charters: If the share prices from BEFORE the consolidation were left at 1c, the chart AFTER the consolidation would show a jump in value from 1c to 20c - probably drifting off to 15c and lower over coming months. And after some time, we wouldn't know anymore that the underlying security before was actually the equivalent of 20 new shares. In other words: We'd compare (new) apples with crates of (old) apples.
Thankfully, our data provider can fix that for us by multiplying all the old trading history by that factor of 20 (in my example), so the chart looks again "balanced" and all our indicators and conclusions we draw from them is again apples all the way.
Do this 3 times, and the factor you end up with is 8000 times the original share price, turning 10c "then" into $800 "now", because that old share is the equivalent of 20x20x20 = 8000 of today's shares.
Splitting
Now let's assume, "they" did indeed find something worth digging out. Some companies may then turn into producers/ miners. Or they may spin off a new company, funded by the same old shareholders, who are "given" 1 free share in the new company for every old one they hold - provided they buy another new share at 20c, to provide the new mine with the necessary startup capital.
So, presumably, the exploration share "loses" 20c in value because that's what was given away as a new mining share.
Which means, history data has to be adjusted again, this time taking out 20c off the old exploration share.
I hope that explains the background - but remember, the numbers I used in my example are NOT the true history for a particular company.
