My Resolution

It’s the New Year, and one of my resolutions was to write more, and this seems as good a vehicle as any to get me going.

While I don’t pretend to be an expert at the stock market, I have read enough about it to feel like I can contribute to other’s pursuits of knowledge, the reason being that I’ve studied writing for the last five years. I should be able to make some of this mess accessible.

So the hope is that you all will benefit from reading what I offer, and that I will get a little more practice making things make sense on paper.

And if you resolved to learn a bit more about how to handle your finances, this may the beginning of a beautiful relationship…

Analytics: Stock screens as a fundamental tool

It’s hard to tackle the huge amount of information available at our fingertips whenever we choose to trade stock. With so much available free, and so much being sold to us, how do we manage to get past our fear and finally commit to one position?

The stock screen is one important part.

There are few tools more important to the investor than the screen. It helps us define our strategy and find out stocks. It keeps us honest and it does most of the hard work for us. Most of all, it narrows the playing fields to the things we need to see.

There are many services that offer stock screeners on a subscription basis, and many of the screens are very useful. However, given the wealth of free screens online, it seems a waste to bypass them completely.

When you are setting up a custom screen, you want to aim for a reasonable amount of final results, probably no more than 200 stocks. You can try to narrow you results through the criteria, or just choose the highest scoring.

What criteria you select will depend heavily on your strategy: a long term strategy will look for low debt and good free cash flow while a momentum strategy will look at recent price gains. The beauty of creating your own screen is that it will help you define exactly where your strategy is going.

It’s important to not just blindly buy the stocks that come up after your screen. Look at them more closely (in both their financial statements and their charts). Remember, screens are a tool, but the real deciding factor is your own judgment—never let your tools take that away from you.

For more information on screens, check out this article by Jon Markman on MSN Money.

Education: The mighty pairs trade

I’ll be the first to admit I have no clue what direction the market is going in right now, but that doesn’t mean I want to sit out. No matter how crazy the economy on the whole is, some companies are strong, while others are weak. Just because the market can sink or raise both doesn’t men I should be completely afraid.

Enter pairs trading.

When you trade pairs, you are betting on two stocks in the same industry and sector at the same time: one that you think highly of you buy long while you go short (sell borrowed shares) on one you think is not long for this Earth. This works because you have both long and short positions, so if the market takes a tumble or makes a gain regardless of the economics of the stock, your two positions cancel out. In essence, their similarities make their differences safer to play.

Since the market can move stocks more than their own companies can (the last couple of weeks have shown that) this strategy can be a boon for traders looking to get some money back on the table without exposing themselves to much to mean old Mr. Market.

Just remember it is important to pairs trade with companies that are in very similar industries. You don’t want news that only affects one moving the stocks: it’s an all or nothing proposition.

If you want more information on pairs trading, check out Investopedia’s section on it.

News: Finance blogs are boring! *sob*

The new blog carnivals for personal finance and investing are up. There are some really great articles in both, and they are worth checking out.

One that really caught my eye was about the relevance of investing and financial blogs posted at Adult ADD and Money. Apparently, as far as interest levels go, they are at the bottom of the heap. Not altogether surprising, I guess, since people go on to blogs expecting to hear about nasty breakups, sex or cats, rather than pro-forma business ratios.

I’m not surprised that people find investing blogs boring. I mean, it really doesn’t sound all that interesting unless you have ever invested seriously. That doesn’t mean the readers are wrong for not being interested, that just means the writers have try harder to get them interested.

I guess I’m a little guilty of using the wrong medium. Oh well, I am in to deep now. The challenge is just to make this material interesting and entertaining.

How do I do that?

I’m open to suggestions. Hopefully none of them involve nasty breakups, sex or cats, but I guess beggars can’t be choosers.

I’ll take an honest stab at beating this whole boring thing.

Financial: Planning for investors

It’s easy to talk about investing in really abstract terms without realizing that large sums of money are on the line. At least I acknowledge I’m guilty of it.

So, before we start talking about support and resistance, fundamentals and inflation, it’s best that we do some planning on how to build investment capital.

First things first: if you don’t have the fiscal discipline to keep your money in order, than you probably don’t want to be investing. If you don’t have the risk capital, investing quickly becomes gambling and gamblers almost always lose (unless they are really good, in which case they are investing in games).

I would say investing when you are in heavy debt is a poor plan. If you have credit cards charging 20% interest, you need to make an investment with 20% returns to break even vs. paying of debt. Ouch.

So if you are out of debt, you should next look to having an ample amount of safety money (in case you quickly end up in debt or out of a job). If you have a comfort zone, and are saving regularly (taking 15 to 20 percent right of your paycheck is a good way to go) then you can start investing.

Albert Einstein famously said that compound interest was the greatest power in the universe. You really don’t want it to work against you, do you?

Get out of debt. Get to saving. Get to investing. That sounds like a plan to me. Of course, I don’t want to browbeat anyone, that’s just a suggestion…

Education: Overhead supply and admitting mistakes

I, like everyone else, hates admitting I’m wrong—especially to myself.  

Jason over at InvestorGeeks has started his foray into technical investing by looking at Microsoft through the lenses of support and resistance levels. His article points to the way that MSFT is trading in between a range of support on the downside and resistance on the topside, something that’s fairly common in big name stocks.  

His post touched on an occurrence called “overhead supply”, something that I think we will see a lot more of soon.  

Overhead supply occurs when a stock reaches a point where it had been for a long time, and since fallen.  There, the stock finds an immense amount of selling pressure.  You may think that this is just nonsense with no reasoning, but it actually all comes back to my not wanting to admit my mistakes.

The investing community is a lot like me—they don’t want to admit they’re wrong. They especially don’t want to admit they’re wrong with their money.  Suppose MSFT has been trading at $26 for weeks. That means for weeks, people were buying it at $26, which was their perceived approximate value. Then BAM! MSFT tumbles. Everyone feels frustrated and slightly embarrassed—until the chance for redemption comes, that is.

If it regains its bearings, everyone who was in at 26, or got used to 26, will be waiting for that watershed mark.  Once it hits, they will simply want to close their position for breakeven and a small loss simply to prove to themselves that the stock was worth what they paid.  It’s not smart, it’s not pretty, but it is how the subconscious works.  

The same pattern occurs when a stock that lagged heads toward it’s old 52-week high.  Everyone remembers that number and they want to get out where they wished they had before.  This leads to immense pressure at the top and it is a partial explanation of the commonly cited double-top pattern.

This may seem overly simple, and it’s not always true.  But it is likely to be true, meaning it is of some value.  I’ll be sure to follow up with some more rationales about stock patterns in upcoming posts.  

Flaws (like not accepting mistakes) can be useful… as long as you can predict others will share them.

Analytics: The greater fool theory and weak closes

Here is a definition I love, and everyone who trades the markets should know:

Greater fool theory:  A theory that it is possible to make money by buying securities, whether overvalued or not, and later selling them at a profit because there will always be someone (a bigger fool) who is willing to pay the higher price. Courtesy of Investopedia.com

With the greatest of fools in mind, consider the implications for the tail end of a bull market.  As stocks become overvalued and no longer wise purchasers, the only buyers become those with the least knowledge, information or experience (the greatest of fools).

If you can tell that the only ups in a market are coming from the fools, you know it’s time to trade places with one of them.

How do you do this you ask?

Time is probably the simplest answer.  There is an old market adage that says something to the effect that “Novices control the opening; professionals control the close.” There is a logic to this statement: the amateur traders only devote the time before or after their day job to placing trades and doing research (usually). This means that they place their trades in the morning before they leave for work, or in the afternoon after the markets close.

If you notice the last couple of weeks, stocks have opened high and closed lower, ending the day in the red.  This tells me that the professionals are selling into the “greater fools.” The trend has been happening almost every day: strong start, painful finish.

The crux of the situation is that people will only keep buying for so long and then all the buyers will fall out. Keep in mind what the market is seemingly telling us. If this isn’t just noise, it may be time to let the “fools” take over and side with the pros.