Investools Introduction to Trading Stocks Slides

Introduction to Trading Stocks

2

Table of Contents

2011 TD Ameritrade IP Company, Inc. All rights reserved. Terms of use apply.

Getting Started 7

Step 1—Prepare to be an Investor 16

Step 2—Protect Your Investment Capital 40

Step 3—Start Analyzing from the Top Down 55

Step 4—Conduct a Thorough Fundamental Analysis 93

Step 5—Search for Additional Strong Stocks 139

Step 6—Conduct a Thorough Technical Analysis 174

Step 7—Manage Your Portfolio 236

Introduction to Trading Stocks Review 277

Updating Your Education Plan 280


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Disclaimers


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Disclaimers


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Disclaimers


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Disclaimers

“There is no such thing as a rich victim. Take back your power and realize that you create everything that is in your

life and everything that is not in it. Realize that you create your wealth, your non-wealth and every level in between.”

—T. Harv Eker

Ge!ing Started


Congratulations on deciding to learn about the stock market and ways to help improve investing returns. This course is designed to teach you how to take your financial future into your own hands by providing the foundational information and skills necessary to make better, more informed investing decisions.

Before beginning the Introduction to Trading Stocks course, you should have read the Principles of Investing course material and completed all its activities. While many students might be experienced investors, the concepts, vocabulary and principles taught in the Principles of Investing course are vital to successful investing and will be referenced throughout this and other courses.

Getting StartedWelcome


Having completed the Principles of Investing course, you should be able to:

Recognize the need for personal financial planning

Explain how to plan for a financial goal

Explain common investing mistakes

Describe the relationship between risk and return

Identify major investment types

Describe relevant factors for choosing a broker and account type

Describe the principle of diversification

Identify ways to build an investing plan and evaluate performance

Getting StartedPrinciples of Investing Course Learning Outcomes Review


In the Principles of Investing course you learned how to develop different plans that help generate profits. You also learned how financial, investing and education plans assist in determining goals, building a path to those goals and becoming aware of factors that might affect achieving those goals.

The financial plan explained in Principles of Investing should outline your current financial situation, future time frames, amount of savings needed, and what investment choices and strategies to focus on to achieve the necessary return rates.

After outlining goals for a financial plan, you are ready to focus on creating systematic methodologies using investing plans. Prepare to develop and add new investing plans as you continue your education. Having multiple investing plans will help you find growth while reducing risk by decreasing portfolio volatility, which can be accomplished by diversifying with various asset classes and stocks sectors. To properly diversify consider investing in all financial markets, such as stocks, bonds, commodities, currencies, etc., and dividing assets among stock sectors, industry groups and capitalizations.

Getting StartedFinancial Plans and Investing Plans


Because there are so many aspects to being properly diversified, plan how you will become better educated to meet these important investment principles. An education plan that determines a course of action will help you get started on a path to success. Many students start with Introduction to Trading Stocks and then move on to Advanced Fundamental Analysis or Advanced Technical Analysis or both. These three courses can make up the core of a student’s financial plan; however, you don’t have to be satisfied with these three courses. There are other strategies taught in the Basic Options and Advanced Options courses, among many others, that can help optimize different market situations, define risk and give greater rewards. Contact an Investools Education Counselor today for assistance in designing your own unique education plan.

Getting StartedEducation Plans


Recall from the Principles of Investing course that every successful investor has an investing methodology. These can be as varied as the investors who use them. Some investors use short-term practices, while others prefer long-term techniques. In this course you will learn about the 7-Step Investing Formula®. You will want to develop an investing plan in the Education tab by filling in each section of the plan that corresponds with each lesson of the course. The investing plan will be saved in the Education tab and can be revised, added to or reviewed as you discover new information and strategies or seek to make investing decisions. By now, you should have completed the Resources and Allocation portions of your investing plan since you have completed the Principles of Investing course. Now you will begin to create investing plans for the strategy taught in the Introduction to Trading Stocks course and can add other strategies as you continue your Investools education.

Getting Started7-Step Investing Formula®


The 7-Step Investing Formula® incorporates the following steps:

Prepare to be an Investor (Trading Psychology)

Protect Your Investment Capital (Money Management & Diversification)

Start Analyzing from the Top Down (Top-down Analysis)

Conduct a thorough Fundamental Analysis (Fundamental Analysis)

Search for Additional Strong Stocks (Searching)

Conduct a thorough Technical Analysis (Technical Analysis)

Manage Your Portfolio (Portfolio Management)

Learning to follow these seven steps will help put you well on your way to successfully managing your own investments. The Investor Toolbox® is the primary instrument for applying the 7-Step Investing Formula®. It will help you simplify, categorize and act on the information necessary to complete the seven steps.

Getting StartedThe 7 Steps


After completing this course, you should be able to:

Create an investing plan

Calculate proper risk and position size for a stock trade

Use the top-down analysis process

Build a watch list using fundamental analysis

Recognize entry and exit signals for a stock trade using technical analysis

Set up daily and weekly routines

Define criteria for and create a trade journal To successfully complete this course, read all the material, update your investing plan and complete all activities.

Getting StartedIntroduction to Trading Stocks Learning Outcomes


Ensure the best start for your investment education by reviewing the available investing resources, exploring the tools, and establishing education and investing goals. Then, you will want to start a new investing plan for this course in the Education tab.

One final word before beginning: background matters very little. Successful investors can be found in all personality types and professional backgrounds. Surprisingly, despite how much a student can learn, investing success has more to do with what you will learn. For this reason, a positive, committed and patient attitude can go a long way to improving the success of your education and your performance as an investor.

To get the most from this course, commit to making your education a priority. Many times, the difference between failure and success is caused by doing something nearly right and doing it exactly right, and all that is required to bridge the gap may be a little more time and patience.

Getting StartedReview

“No profession requires more hard work, intelligence, patience and mental discipline

than successful speculation”—Robert Rhea

Step 1—Prepare to be an Investor


The individual is the most important component of successful investing. If an investor can keep emotions in check when approaching the market and adhere to a set of personally fitted trading rules, he or she will have a higher likelihood of success, rather than letting emotions take control and buy and sell at random. In this lesson you will learn to identify common myths and mistakes when investing, and build an investing plan that will help you make educated investment decisions.

Step 1—Prepare to be an InvestorIntroduction

Introduction to Trading Stocks Learning Outcomes







Define criteria for and create a trade journal


After deciding to invest money, investors must choose whether to invest on their own or let someone else do it for them. To some, the idea of self-directed investing seems fraught with peril. But getting past some common misconceptions about investing through education will reveal that taking control of one’s own investing isn’t so perilous after all.

If you stop and think about it, anything you do with your money is a form of self-directed investing. Whether it’s spending it on necessities, luxuries, hobbies, a home, education, starting a business or investing in the financial markets (either independently or by turning it over to someone else), you are still determining how your money works (or doesn’t work). So no matter which investment strategy you choose, it’s a good idea to learn as much as possible about how to use it and what it means for your financial future. Ultimately, education is the best tool for building investments and confronting the myths surrounding self-directed investing.

Dispelling the Six Myths of Self-directed Investing Step 1—Prepare to be an Investor


Investing on Your Own Takes Too Much Time

Never before has the world of investing been so accessible to everyone. In past decades investment information was difficult to come by, and investors relied on rumor and rampant speculation to drive market rallies. While there is still no shortage of rumors and misinformation, new Internet-based technologies enable investors to filter through the hype and focus on what matters most.

You now have access to state-of-the-art educational resources that can drive the process of learning how to invest, build a pattern of successful decision-making and manage an investment portfolio in the shortest time possible.

Myth #1 Step 1—Prepare to be an Investor


Investing in the Stock Market is Like Gambling

People connect the concepts of investing and gambling because both involve money and both appear to deal with the element of chance. And it is true that with no education to guide investing, you might as well close your eyes and roll the dice. But investing doesn’t need to be a game of chance; in fact, successful investing never is.

The art of investing is primarily concerned with balancing risk and opportunity. In games of chance, the rules explicitly state what the opportunity is, and gamblers do not have the ability to control balance. Over the long run the rules of the game dictate that the gambler will hand money over to those running the game. Gambling is designed not to provide any opportunity for growth, and, considering the real limitations of the money involved, there’s no outcome that could increase the amount of value among participants.

Myth #2 Step 1—Prepare to be an Investor


Myth #2

Investing in the Stock Market is Like Gambling (continued)

On the other hand, investors traditionally want to receive the mutual benefit that comes from funding businesses’ improvements. Investors can be proud to say that they participate in raising society’s collective standard of living by providing monetary resources that can bolster a company’s success. But like all aspects of life, risk is involved, and investors must use their best judgment to balance the cost of risk with the rewards of successful investments. Investools believes that with proper training you can learn how to manage risk and determine potential rewards.



Myth #3

Paying a Professional is Be!er than Making Your Own Investment Decisions

Whether to direct investments independently or pay someone else to manage them is the first investment decision you will make. Remember that no one cares more about your money than you do, so how can anyone else decide if hiring a professional is the right thing to do?

Without sufficient training to evaluate investment performance, it can be difficult to choose a skilled investment adviser. You may simply say, “If a professional manager grows my money, then I know she’s doing a good job.” But is it really that simple? Most mutual fund managers command high salaries, but a majority will not beat the S&P 500 Index, which conveys the average performance of 500 of the most widely held, publicly traded U.S. stocks. Unfortunately, many of the same managers don’t beat the averages year after year. That means if an investor switches to a fund that outperformed last year, there is no guarantee that its success will continue.



Myth #4

Investing on Your Own Increases Risk

Investing without the right education truly is risky because, in order to balance risk and opportunity, you must be able to create and implement an informed investing plan. Many investors increased their account size during the 1990s without such a plan, only to give back all their gains later when the market retreated. Yet with proper training, investors can reduce risk—especially those who direct their own investments.

In this course you will learn a methodology for identifying appropriate entry and exit strategies—these help investors know when to buy or sell a stock. You will receive training on how to analyze the broad market, investigate the fundamental health of individual companies, use and set stop-loss orders, trailing sell-stop orders and other mechanisms for managing investments. The learning doesn’t stop there; there is much, much more to discover and apply on the path to reducing risk in self-directed investing.



Myth #5

Investing is as Simple as Knowing Which Stock to Buy

Over the past 10 years, many investors have discovered that knowing when to buy a stock is only part of the equation. Knowing when to sell is even more important. Successful investing experts repeatedly stress that exit strategies make a larger impact on investment performance than buying strategies. In fact, some researchers have found that it’s possible to make money in the stock market even when choosing stocks randomly if proper money management and exit strategies are applied.



Myth #6

Investors Who Invest on Their Own Are Intellectually Gi"ed

Researchers consistently stress the fact that there is no correlation between high IQ and investment performance, but it is true that training and education can improve investors’ chances. Getting the right kind of training is critical for investment success. This course teaches how to evaluate every aspect of an investment, from fundamental values to technical studies and investment risk, so you can exert greater control over your investments.



Returns and Performance Expectations in the Capital Markets

Historically, the stock market has provided tremendous returns compared to other asset classes. During the past 20 years (1989 to 2009), the Dow Jones Industrial Average enjoyed an annualized return of more than 8 percent (with dividends reinvested), while U.S. Treasury bills eked out an annualized return of just under 4 percent. This means that even after the significant market drop in 2008, the Dow Jones Industrial Average outstripped U.S. Treasury bills by more than double over the past two decades. To truly appreciate what a difference this is, let’s review an example that shows the compounded effect on returns.

An investor invested $50,000. At the end of 20 years, he would have the following:

If earning an annualized rate of return of 4 percent, he would have $109,559.16

If earning an annualized rate of return of 8 percent, he would have $233,047.86



Noteworthy

Many people have mused on the idea of whether they could outperform the market. The truth is, few people can do so consistently. However, there are some notable individuals who have accomplished this task: Peter Lynch, Paul Tudor Jones and Jim Cramer. Each famous investor posted returns that were more than double the Dow Jones Industrial Average. Here are their average annual estimated returns:

Peter Lynch—29 percent over 13 years

Paul Tudor Jones—24 percent over 21 years

Jim Cramer—24 percent over 12 years Any stock investor would love to earn an annualized return of 24 percent to 30 percent. But remember that these professional money managers are paid millions, if not billions, of dollars because they were able to make these kinds of returns on a consistent basis. Their experience is statistically unusual, and thus their notoriety.



The Individual Investor

Meanwhile, most individual investors aren’t trying to become the next great fund manager. They are probably looking to simply boost returns and achieve sustainable growth in their investment accounts.

So let’s consider the question, what difference would it make? Would it matter if investors could do only half as well as the least of those mentioned above? What if investors were able to make 12 percent a year?

Let’s go back to that imaginary investment of $50,000 and compare the difference between making an annual 4 percent from T-bills, making the market average of 8 percent, or outperforming the market at an annual rate of 12 percent growth per year. At the end of 20 years, here is how much difference it would make:

At 4 percent, the investor would have $109,556.16





The Individual Investor

In other words, improving investment returns to 12 percent annually could increase the account total by more than double after 20 years.

It takes a lot of education and hard work to beat the market year after year. The information in this course will help you determine whether this kind of work is something you find interesting enough to continue, or whether you would be better off seeking the help of professional advisors instead. Either way, this information will prepare you to make better decisions about your investing future.



Trading Psychology

“I started out by worrying about the system I was going to use to trade. The second factor I worked on was risk management and volatility control. The third area I focused on was the psychology of trading. If I had it to do over again, I would reverse the process completely. I think investment psychology is by far the most important element, followed by risk control, with the least important consideration being the question of where you buy and sell.”

–Tom Basso, as quoted in New Market Wizards by Jack Schwagger, 1991



Trading Psychology

Before you start trading, it is crucial that you identify and understand both your strengths and weaknesses as an investor in order to avoid becoming your own worst enemy. Some of the most common trading mistakes can be traced back to an investor’s individual psychology. The following 10 mistakes can derail an individual’s investing in any market:

Trading without a Plan

Setting Unrealistic Expectations

Cutting Profits Short, Letting Losers Run

Impatience Leading to Overtrading

Improper Position Sizing


Lack of Diversification

Poor Risk Management

Timing Tops and Bottoms

Trading Against the Trend

Focusing on Being Right


Two Keys to Overcoming Psychological Traps

To overcome the psychological traps into which many investors fall, you will want to do the following two things:

Become aware of habits, biases and tendencies

Develop a strong trading plan that overcomes psychological weaknesses

You will have an opportunity to do both as you progress through the Investools Investor Education, starting with identifying some common biases and tendencies that may affect investing.



Preferential Bias

Preferential bias means that once investors develop a preference for a particular trade, they often distort additional information to support their view. This can explain why an otherwise conscientious investor may choose (either consciously or subconsciously) to ignore how the market or stock is really performing. Investors can convince themselves that a market or stock is going up when, in fact, it is trending down. They ask friends or brokers, or call a hotline, searching for an opinion that agrees with their own. Then they either enter or stay in the biased trade based upon that opinion.

Here is a little experiment that helps illustrate this point. How long does it take to read these words?

Dmeracot Rpbieuacln Ggoree Bsuh Bkacra Omaab

What did you see? Did you see six nonsense words or did you spend a few seconds unscrambling the spelling? The instructions were not to unscramble the words, just to read them, yet most people find themselves naturally trying to read the words “Democrat”, “Republican”, “George Bush”, “Barack Obama”.



Preferential Bias

Preferential bias comes from a natural human instinct to impose patterns and predict our world. This instinct gives us a better chance at basic survival by speeding up decision making, so it isn’t inherently bad. However, this natural instinct can also work against investors because it continually draws them into making the assumption that past performance predicts future results.



Prospect Theory

Prospect theory—also known as loss-aversion theory—is the idea that people do not equate a $1,000 loss and a $1,000 gain. According to this theory people assign more weight to losses than they do to gains because they want to avoid pain at all costs. Ask yourself whether the joy you would feel if your account increased 50 percent would equal the pain you would feel if it decreased 50 percent?

Answering the following two questions will help in understanding prospect theory:

Which investment is preferable?

Investment A has an 80 percent probability that it will net $4,000

Investment B has a 100 percent probability that it will net $3,000 Which investment is preferable?

Investment A has an 80 percent probability that it will lose $4,000

Investment B has a 100 percent probability that it will lose $3,000



Results

Here are the results.

Results:

Selecting Investment A suggests you will let the winners run—which is exactly what investors should do

Selecting Investment B suggests you will cut the winners short—which is exactly what investors shouldn’t do

Results:

Selecting Investment A suggests you will let the losers run—exactly what investors shouldn’t do

Selecting Investment B suggests you will cut the losers short—exactly what investors should do



Disposition E"ect

Disposition effect is short for “predisposition toward get-evenitis.” Because people tend to dislike incurring losses much more than they enjoy making gains and are willing to gamble in the domain of losses, they will hold on to stocks that have lost value (relative to the reference point of their purchase) and are eager to sell stocks that have risen in value. This is referred to as the disposition effect (Shefrin and Statman, 1985).

Bottom line: Investors are predisposed to hold losers too long and sell winners too early.



Myopic Loss Aversion (MLA)

Myopia is a lack of foresight or discernment, a narrow view of something. Aversion is the avoidance of anything associated with an unpleasant or painful stimulus.

Loss aversion applies when investors avoid a loss, even if it means accepting a higher risk.

MLA can be reduced by analyzing trading results as a set of data, instead of one trade at a time.



Review

Individual investors face many obstacles when they first begin controlling their own investments. Doing the following three things can help you start off right:

Clear up misconceptions about investing that others may have planted in your mind.

Set realistic expectations to prevent yourself from taking risky trades and adopting foolish strategies.

Learn to identify and control your psychological strengths and weaknesses as an investor, so you can reduce many of the challenges you will encounter.

Two effective tools for minimizing the effects of psychological weaknesses are money management and diversification, which will be introduced in the next lesson.


“A loss never bothers me a#er I take it. I forget it overnight. But being wrong—not taking the loss—that is

what does damage to the pocketbook and to the soul”—Jesse Livermore

famous investor from the early 1900s

Step 2—Protect YourInvestment Capital


In the previous lesson you learned to mentally prepare yourself to invest like the experts by dispelling common myths associated with taking control of your portfolio, as well as creating awareness of tendencies in human nature that can often lead to self-sabotage. You supported this learning by beginning an investing plan. Step 2 of the 7-Step Investing Formula® is Protect Your Investment Capital. In this lesson you will learn how to calculate proper risk and position size for a stock trade.

To successfully complete this lesson, read all materials, update your investing plan and complete all activities.

Step 2—Protect Your Investment CapitalIntroduction










Money management is the practice of allocating capital among various investments to avoid risking too much of it in any one trade. The most important money management task is to properly determine the size of the investment. Investors who can enter a trade with the right amount of risk have a much better chance of a profitable exit. This notion is even more important in bear market conditions like those of 2008 and 2009. Too many investors are conditioned to simply buy and hold their investments and are even encouraged to buy more as the market is going down.

Money Management Step 2—Protect Your Investment Capital


The big question is, how many shares should an investor buy? If the target buying price is known, and the price at which the stock should be sold if it loses too much value (called a stop-loss order) has been set, then determining the appropriate number of shares to buy becomes simple. An investor should buy only enough shares so that if the stock loses value and hits the stop order, the value loss is not uncomfortable.

A good rule is to never lose more than 1 percent to 2 percent of the total account value on any single trade. This does not mean putting only 1 percent to 2 percent of an account into each trade; it means that you should buy only enough shares so that the maximum loss of value is 1 percent to 2 percent of the total account value if the stock hits the stop-loss order and triggers a market order.

For example, an investor with a $100,000 account should never lose more than $1,000 to $2,000 (1 percent to 2 percent) on any one trade. Beginning investors should use a smaller percentage until they are consistently making money, after which the percentage can be increased.

Position Sizing Step 2—Protect Your Investment Capital


Position Sizing

An investor with an account that has less than $10,000 in it may feel the need to be more liberal with this rule and accept more loss. Investors who do so are taking on significant risk. Investors whose accounts grow to $20,000 or $30,000 could then consider holding more conservatively to the 2 percent rule. The larger an investor’s account grows, the more likely that investor will feel the need to reduce that percentage even further.

Step 2—Protect Your Investment Capital


Four Steps to Proper Position Sizing

The following four-step procedure can determine the correct position size and keep risk at no more than 2 percent.

Start with three numbers:

The account value at the time a trade is placed

The price at which the stock is to be bought (buy price)

The lowest price at which the stock should be sold (stop order price) Calculate acceptable lossTotal Account Value $ Risk Percentage = Acceptable Loss

Calculate riskBuy Price – Stop Order Price = Risk

Calculate the number of shares to be boughtAcceptable Loss ÷ Risk = Position Size



Four Steps to Proper Position Sizing

This four-step procedure can determine the proper number of shares to be bought while keeping risk at no more than 2 percent of the total account value. This protects capital from a dangerous level of drawdown.



Drawdown E"ect

Position sizing is important because every investor experiences losing runs, but how they manage those runs during a series of losses determines their ability to recover. The larger the drawdown, the greater the percentage needed to recover. One guideline is to make sure that a significant number of losing trades in a row does not result in a drawdown that exceeds 20 percent (i.e., 80 percent of the account value is retained).

% Loss to Account % Gain Required to Recover Loss

10% 11%

20% 25%

30% 43%

40% 67%

50% 100%

60% 150%

70% 233%

80% 400%

90% 900%

100% Broke



Drawdown E"ect

Investors may make a profit on half of their investments, yet over the course of 1,000 trades they might experience a string of 10 losers at least once. Suppose an investor did have a losing streak like this. How much money would he lose? If he risked just 2 percent on each trade, he would be down only 20 percent. More than 20 percent drawdown requires that an investor make large percentage gains to recover. The larger the drawdown, the larger percentage gain is required to recover from the loss as illustrated in the table on the right.


% Loss to Account % Gain Required to Recover Loss

10% 11%

20% 25%

30% 43%

40% 67%

50% 100%

60% 150%

70% 233%

80% 400%

90% 900%

100% Broke


Stop-loss Orders

Employing stop-loss orders when placing trades helps manage losses and can be adjusted to help lock in gains. However, stop-loss orders are not guaranteed to exit positions at the desired price. Gaps between closes, illiquidity (low volume) and quick changes in volatility can impact where and if stop-loss orders are executed. That said, stop-loss orders are necessary to manage risk and apply proper position sizing. Even though there is no perfect stop-loss order system, properly placed stop-losses help more than they hurt.

A stop-loss order is an order to sell a security when its price hits a level determined by you. Once the price hits or passes the predefined exit point, the stop-loss order becomes a market order.

Market orders do not guarantee that you will get out at the desired entry or exit points. The stop-loss order is usually executed at the lower bid price. If the market moves quickly or gaps, such an order could be executed at a price lower than expected.



Determining Risk per Trade

Many successful investors risk no more than % percent to 2 percent in any single trade. For example, assume an investor has an account with $50,000 and has determined he is willing to risk only 1 percent of his account in any one trade. This means the investor does not want to risk more than $500 in a position.

If the investor determines to purchase a stock valued at $10 while using a $2.50 stop loss, he can buy 200 shares of stock without risking more than the $500. The investor would also be investing $2,000 of the account. The total amount invested in any one trade is known as portfolio heat and will be discussed in more detail in the Portfolio Management section of this course. The table on the following page summarizes the example above.



Determining Risk per Trade

Account Balance $50,000

Acceptable Risk Percentage 1%

Max Risk per Trade $500 ($50,000 X 1%)

Stock Value $10.00

Stop-loss Amount $2.50 ($10.00 - $2.50 = $7.50 so the stop-loss order is at $7.50)

Max # of Shares to buy 200 ($500 max risk/$2.50 stop loss)

Total Invested $2,000 (200 max shares X $10.00 stock value)



Market Diversification

Proper money management is an extension of diversification. The difference is that while money management prevents losing too much money in any one trade, diversification prevents losing too much money in a particular industry group or sector.

You learned in the Principles of Investing course that highly correlated stocks, or stocks that tend to move at the same time in similar directions, can hurt a portfolio if the sector turns sour. To individual investors, diversification means that they have spread their risk across a broad group of stocks or investment vehicles. As your investing talents grow, you may eventually manage a diversified portfolio including options, foreign exchange and fixed income markets, as well as stocks.

Remember the principles of diversification still apply to stocks found using the 7-Step Investing Formula®.



Updating Your Investing Plan

Apply the information learned in this lesson by updating your investing plan for the Introduction to Trading Stocks course. Investing plans might contain rules that look similar to the following examples:

Never risk more than 1 percent of your portfolio on any one particular trade (this rule may be as low as % percent or as high as 2 percent, but it should be definitive)

Always use stop-loss orders

Stocks should be purchased from at least five different sectors before choosing a second stock purchase in a particular sector



Review

To help protect your investment capital, you should consider the following:

Sufficiently plan your trades so you know how much risk you are prepared to take

Select the right position size to fit your desired risk

Use stops that correspond to your risk and position size

Create and maintain an investing plan that lists rules and guidelines to be followed

You have learned two key factors of successful investing: money management and diversification. It is critical to recognize the advantage of a properly managed, well-diversified portfolio, because protecting capital ensures that it will be around to grow in the future.


“Spend at least as much time researching a stock as you would choosing a refrigerator.”

—Peter Lynch

Step 3—Start Analyzingfrom the Top Down


In the previous lesson you learned how to protect your investing capital by calculating proper position size for a stock trade. In this lesson you will learn to start analyzing a stock from the top-down and identify how it fits within your investing plan based on watch list criteria.

To successfully complete this lesson, read all material, update your investing plan and complete all activities.

Step 3—Start Analyzing from the Top DownIntroduction










Introduction

Imagine two swimmers in a river, one downstream from the other. They are having a contest to see which one can swim to a point in the middle of the two swimmers. One goes with the current, while the other swims against it. Obviously, the swimmer going with the current has a huge advantage over the swimmer going against it. In fact, a novice swimmer going with a strong enough current could beat an Olympic gold medalist.

The same concept applies to the stock market. It is easier to invest with the trend, or current, of the market than against it. Too many investors try to pick the one stock that is going in the opposite direction of most other stocks in the market. Top-down analysis helps investors identify a trend and focus on investing in stocks that are moving with it.

Step 3—Start Analyzing from the Top Down


Top-down Overview

The stock market moves in one of three directions: up (bullish), down (bearish) and sideways (neutral). These are also called market postures. Market posture often depends on the time frame being considered and can create a bias for numerous stock choices. To successfully invest over the long term, it is useful to have a method of establishing a posture for the markets, sectors, industries and individual stocks. This method is called top-down analysis. As shown, this process begins with analyzing the markets, then specific sectors and industries, and concludes with selecting a specific stock. This type of correlated movement among markets, sectors, industries and stocks takes place because of what is called big money or institutional money flow. Institutions are the primary participants who move the market. If investors can first find the top-performing market, then top-performing sectors and industries, and then the best stocks, at the best times, their capability to outperform the market and their personal benchmark increases.



Big Chart Trend

Changes in the Big Chart value can help identify shifts in institutional buying and selling within an industry group. If the Big Chart rank is increasing from week to week, it indicates the industry is attracting institutional money. If the Big Chart rank is decreasing from week to week, it indicates institutional money is likely leaving the industry group. A good rule is to look for increases in rankings week over week for at least a six-week period or a progression from red to yellow to green.



Define Market

Before diving deeper into the process of top-down analysis, it’s necessary to first define what a market, sector and industry are, and where stocks fit into each.

MarketA market is a broad group of stocks that combine to make an index. Some indexes focus on large-cap stocks like the Dow Jones Industrial Average and Standard & Poor’s (S&P) 500, while others are sector or industry specific. It may be helpful to think of top-down analysis in terms of narrowing in on real estate as a multi-national real estate tycoon would do. In this case, a market represents the country in which a tycoon wants to purchase real estate. As a market, the country is broad in scope, and it contains various states or providences, cities and towns, and finally real estate that the tycoon can invest in.

The stocks that combine to make these markets may or may not have anything in common as far as what the companies do. You might be familiar with the two markets mentioned earlier, the Dow Jones or S&P 500, simply from watching and hearing the news, but there are many other markets to explore, some of which will be identified later in this lesson.



Define Sector and Industry

SectorIf the market is like a country, a sector would be like a state. Sectors group stocks together based on what the companies do for business. Sector group stocks do not necessarily have to have the same exact business as one another, they just need to be in the same general area of business. Energy, Financials, Industrials are just a few examples of sectors.

IndustryIf a sector is the state within a country (market), then an industry is a city within that state. Several industries combine to make up a sector, just as several cities combine to make up a state.



Trend Analysis

“Trade with the trend!” This is one of the golden rules of investing and should be in every student’s investing plan. So what is a trend and how do investors trade with it? To recall and expand on the analogy of the two swimmers in the river, think of a trend as the direction of ocean currents. To get somewhere fast and with relative ease, ships should follow the direction of the current and flow with it. When looking at a chart, the flow or the trend is a series of increasingly higher waves.

In order to better understand the concept of trend, you’ll want to become familiar with recognizing peaks and troughs on a stock chart. The next series of graphs will demonstrate up, down and sideways trends.



Uptrend

Uptrend is defined as higher highs and higher lows and is “bullish.”



Downtrend

Downtrend is defined as lower highs and lower lows and is “bearish.”



Sideways

Sideways is defined as relatively equal highs and equal lows and is “neutral.”



Trend Duration

Trends are like the ocean—the tide rises, waves hit the shore and ripples stream across the beach. Within the long-term trend are intermediate-term trends. Within the intermediate-term trend are short-term trends.

As you develop posture around trend, it is important you remember the time frame you are considering. For example, if an investor makes decisions based on the intermediate trend and they get caught up in the emotion of the short-term trend, they may do things out of fear that they later regret. This is an example of how important it is to create and define this in an investing plan.

Note: In Step 6 of this course, it will become apparent that the 7-Step Investing Formula® is based on an intermediate-term time frame; however, this should not keep you from selecting a time frame that fits your own trading preferences.



Long-term

Long-term is generally considered to be nine months or longer. When looking at a long-term chart of five years, each bar represents one week. This long-term trend is similar to the ocean tide that continues to rise even when waves ebb.



Intermediate

Intermediate-term is generally considered to be three to nine months in length. An investor hoping to determine this trend length typically uses charts that show six months to a year. The image below shows an intermediate chart, identifiable by higher highs and higher lows as distinguished by the green arrow. In a six-month or 12-month chart, each bar represents one day. This trend is akin to the waves of the ocean that ebb and flow with a rising of falling tide.


Short-term Uptrend

Short-term Downtrend

Intermediate-term Uptrend


Short-term

Short-term is generally considered to be three months or less; therefore, a short-term investor would use a three-month chart to determine trend. This chart shows short-term uptrends (blue arrows) and downtrends (red arrows) within the intermediate chart. Short-term trends are similar to ripples on the waves that create small ebbs and flows as the larger waves ebb and flow.


Short-term Uptrend

Short-term Downtrend

Intermediate-term Uptrend


Broad Index Analysis

When you begin a top-down analysis to identify and analyze market trends, start with the broadest indexes like the Dow Jones Industrial Average, S&P 500 and NASDAQ Composite. Then narrow your focus; work your way down to the various market segments and finally to individual stocks. Only after checking the trends of these three levels will you be prepared to make an investing decision.

Students should decide never to go against the trend recognized in their analysis—this should be a personal trading rule in students’ investing plans.

Keep in mind that trends tell investors what to do, while indicators tell investors when to do it. Often, investors put too much trust in indicators and ignore current trends, ending in disastrous consequences. Pay attention to trends first and indicators second in order to avoid some of the more obvious pitfalls.



Identifying the Current Market Trend and Conditions

Before looking for stocks, consider identifying current market trends using the tools on the Investor Toolbox®. In the Strategies section, Market Forecast graphs of the Dow Jones Industrial Average, NASDAQ and S&P 500 are used to identify the current market trend.



These tools allow you to start at the top with an overall view of the markets, and then prepare you to move to a lower level of detail about industries within a market. The list below describes an approach you can take to understand the market’s direction, trend and undercurrents. This provides finer details about how trends and conditions may develop or change.

Identifying the Current Market Trend and Conditions Step 3—Start Analyzing from the Top Down

Tool Activity

Dow, S&P 500 and NASDAQ charts

Identify the market’s current direction Find its pattern of highs and lows (the trend)

Market Forecast GraphsConfirm the trend Recognize the movements of different trend investor groups

Market Sentiment Graphs

Identify the market’s long-term conditions Recognize the market’s mood


Forming an Opinion of the Market’s Direction

A six-month snapshot of the Dow and NASDAQ can help identify the market’s direction. You can find this graph by clicking the Market Posture link, located on the Strategies page.



Read the Market Forecast Graphs

After identifying direction and trend, look at Market Forecast graphs to discover some details within this trend. The Market Forecast graph is exclusively for Investools students; it was derived from proprietary technical indicators and provides a wealth of information. You can find this graph in the Strategies section of the Investor Toolbox® by clicking Market Forecast in the left menu.



A Closer Look at the Market Forecast

There are three lines on a Market Forecast graph:

1. Red momentum

2. Blue near term

3. Green intermediate Each line represents market cycles based on time spans that are progressively longer. These cycles correspond to the time spans used by some investors to open and close their positions.

The momentum line is red and has the shortest cycle. It corresponds to short-term trading, i.e., entry and exit decisions are made within a couple days or even a few hours.



A Closer Look at the Market Forecast

The near-term line is blue, and its cycles correspond to slightly longer periods of time, which are used by many retail investors. Generally, entry and exit decisions are made within three to 10 days.

The intermediate-term line is green and corresponds to an even longer time frame, which is used by intermediate-term investors who hold positions for a matter of weeks to months.



Interpreting the Lines

Each line oscillates between overbought (above 80) and oversold territory (below 20). These overbought and oversold regions are called reversal zones. When market cycle lines are above the 80 percent mark, they indicate a high probability of a downward reversal in market direction occurring in the near term. If the lines are below 20 percent, the market may be oversold and may move higher in the near term.

The Market Forecast graph provides early warnings of potential trend changes and is an effective way to help assess the level of risk within the current market environment because it shows how strong or weak the current market trend is on a daily basis.

Begin with the strongest line—intermediate—and work down to the weakest line—momentum—when conducting a trend analysis. If the market is trending higher and the intermediate line is moving upward, there is underlying strength in the current market trend. If the market is trending higher but the intermediate line is trending downward, there may be inherent market weakness. This signals a higher level of risk. When the intermediate line enters an upper-reversal zone, it signals the possibility that a reversal could soon occur. If a reversal occurs and the intermediate line begins to fall out of the upper-reversal zone, it confirms elevated risk.



Confirming the Current Market Trend

The short-term lines—momentum (red) and near term (blue)—are used in a similar fashion, though the severity of a reversal is usually less. If the short-term lines are in upper- or lower-reversal zones, a mild reversal may occur in the near term, but the fall or rise is not usually large enough to warrant a material change in an investor’s market posture. Extreme highs or lows in the short-term lines can provide opportunities to tighten stop losses or begin looking for potential market reversals.



Confirming the Current Market Trend

When the green line is trending downward, peaks formed by the blue and red lines tend to get shorter, as long as the bearish trend continues. When the green line is trending upward, dips in the blue and red lines tend to get shorter, as long as the bullish trend continues.



Potential Trend Reversals

The Market Forecast graph also helps identify when the current market trend may be about to change. The primary signal that can alert an investor to potential changes in the market trend is referred to as a cluster signal and can be bullish or bearish. A bullish cluster signal occurs when the intermediate, near-term and momentum lines are all in the lower-reversal zone (below the 20 line) on the same day. A bearish cluster signal occurs when all three lines are in the upper-reversal zone (above the 80 line).



Potential Trend Reversals

Clusters are infrequent but generally very reliable and are good indicators of possible market reversals.

If all three lines are at an extreme reading on the same day, then investor groups have quite possibly done the same thing recently. This means larger numbers of investors may be ready to reverse their behavior at the same time. It could take a week or more for them to begin buying instead of selling (or selling instead of buying), but when they do, it often creates a significant new trend.

You may want to look at the example of a bullish cluster signal on the Market Forecast graph shown above and compare it to the actual charts for the Dow Index.



Read the Market Sentiment Graph

The Market Sentiment graph is the final component in this process. It includes a single orange line and indicates a measure of the market’s current likely sentiment or mood. Sometimes investors are optimistic about stock market profits. During such times, bad news is commonly shrugged off and even the tiniest glimmer of good news can be greeted with enthusiastic buying.



Read the Market Sentiment Graph

At other times, even the best news is dismissed by the marketplace. When this occurs, nervous investors begin to worry and may sell more quickly than usual. Notice, the Market Sentiment shows a clear downward turn. This means the market mood may be changing from optimistic to pessimistic.

In general, the Market Sentiment line moves up and down. When the line is high and moving down, the market mood is pessimistic. Investors may ignore good news on individual stocks or even on the market as a whole. The line moves very slowly, and its inertia is like that of a large ocean liner. It takes time to turn its course.

This indicator is important when establishing an overall investing bias. A sentiment line trending up might be considered a signal to seek bullish opportunities to add to a portfolio.



Sector Analysis

After your market posture is complete, focus on specific sectors. There are 12 sectors represented on Investools Online®.

This table shows all the sectors and their ticker symbols.

Sector Symbol

Basic Materials $BASICM

Capital Goods (Industrials) $CAPGDS

Conglomerates $CONGLO

Consumer Cyclical (Discretionary) $CYCLIC

Consumer/Non-Cyclical $NONCYC

Energy $ENERGY

Financial $FINANC

Healthcare $HEALTH

Services $SERVIC

Technology $TECHNO

Transportation $TRANSP

Utilities $UTILIT



Industry Group Analysis

Investools’ proprietary industry group analysis tools can help students focus attention on the part of the market that best matches their criteria. Top-down analysis helps you find industries that meet your search criteria, and then find the best-performing stocks in those industries. This analysis quickly focuses on industries and stocks that appear to be receiving the most interest and money from institutional investors.

There are two methods of locating the closest-matching industries:

Big Chart

Best & Worst Industries List Using the Big Chart, you can see which industries are attracting or losing institutional investments.



The Best & Worst Industries list allows you to find the best-performing industries during various time periods and observe the performance of stocks in those industries. Knowing which of the 102 industries are strong right now allows investors to invest with more control and helps increase their probability for success.

Industry Group Analysis Step 3—Start Analyzing from the Top Down


Big Chart

The Big Chart enables you to visualize which industries may be rotating into favor (attracting more institutional money) and which may be rotating out of favor (losing institutional money). To access this tool, click the Industry Groups tab in the Investor Toolbox® main toolbar to bring up the Industry Groups page. Then in the left menu under the Big Chart heading, choose to view the chart By Rank or By Name.

80-99 = Green

60-79 = Yellow

0-59 = Red



Best & Worst Industries List

The Best & Worst Industries list ranks industries according to their percentage gains during specified time periods in the past. You can use this tool to employ an alternative top-down approach to finding stocks by first finding industries that performed the best in the recent past, and then locating stocks that had previously performed best in the recent past within those industries.



Overweight in an Industry Group

Diversity makes a lot of sense, but investing in stocks within the same group may reduce the benefits of diversification. Why? Stocks in the same group often move in the same direction because they are subject to the same industry and market risks.

For example—IDT, a telecommunication services firm, issued a disappointing earnings release. Ericsson (ERIC), a similar company, was also affected by the news at the same time. Owning two stocks that drop on the same day for the same reason can be avoided by diversifying across industry groups.

An effective way for investors to approach diversification across industry groups is to evenly divide asset allocation across a range of groups. One approach is to have half as many industry groups represented in their portfolio as there are stocks. So, a hypothetical portfolio of 20 stocks should represent at least 10 different industry groups. Consider these easy guidelines when making your own buying decisions:



Diversification Guidelines

Look out for similar groups. There is very little difference between Oil Well Services & Equipment ($OILSRV) and Oil & Gas Operations ($OILPRD). Putting two energy roups into a single portfolio may expose it to more risk than appropriate.

Watch industry group rotation. When an industry group begins to drift out of favor and into the red on the Big Chart, it may be time to shift to a group that is showing promise by emerging from the Big Chart’s yellow ranks. Industry group rotation is a professional tool that can be used to identify potential new opportunities and as a potential signal to unload losing positions.

Industry groups with more components provide more choices, while those with fewer components can make it difficult to find good opportunities.




You should be considering ways to update your investing plan based on this lesson. One way is to add rules similar to the example rules below:

Search for stocks with Big Chart rank of 80 or higher

Search for stocks with a Big Chart rank of 60 or higher

Search for stocks that have increasing rankings over at least five weeks



Review

In this lesson you learned that searching for stocks can be similar to searching for real estate because you need to be looking in the best markets, the best regions or sectors, the best neighborhoods or industry groups and the best homes or stocks. The next section is designed to help you do an inspection on these “homes” by conducting fundamental analysis. Fundamental analysis allows investors to tour the property and inspect the plumbing and the wiring. Investools Online has automated most of this inspection process, making it quick and easy, so you don’t have to get dirty.


“Buy a stock the way you would buy a house. Understand and like it such that you’d be content

to own it in the absence of any market.”—Warren Bu!e"

Step 4—Conduct a Thorough Fundamental Analysis


In the previous lesson you focused on how to identify potential watch list stocks by using a top-down approach. The top-down approach starts the process by examining various markets, narrowing them down to favorable sectors, and then dividing those sectors by industry groups to find ones benefiting from institutional attention. Because industry groups are made up of stocks, the search ends by identifying top stocks in an industry group. The top stocks in an industry group are determined by their fundamental strength. Step 4 of the 7-Step Investing formula® is Conduct a thorough Fundamental Analysis.

Step 4 —Conduct a Thorough Fundamental AnalysisIntroduction










Introduction

In this lesson you will learn how to generate a list of criteria to create a watch list of stocks that are potential investment candidates.


Step 4 —Conduct a Thorough Fundamental Analysis


Introduction to Fundamental Analysis

Fundamental analysis is a systematic process of determining whether a particular company appears to be a good investment.

The first step in fundamental analysis is Phase 1. However, it is only a shortcut to determining whether you should continue the process in Phase 2.

Phase 2 is the most important part of the fundamental investigative process. The Investor Toolbox® automatically calculates a Phase 2 score that can be used to identify a fundamentally sound company. This lesson shows point by point how the Phase 2 score is calculated.

By conducting a fundamental analysis on a company, investors can reduce or limit how much emotion comes with their investment decision—a stock either passes a fundamental screening or it doesn’t. Fundamentals tell you the good and bad, helping reduce risk. Good fundamentals provide a solid foundation on which companies can build. It’s been said, “Know the fundamentals and trade the technicals.”



Phase 1

The Phase 1 score is the first step in a fundamental analysis. To calculate it, the Investor Toolbox® examines 13 criteria and returns a score presented as a ratio—8/3, for example—with the number of positive readings listed before the number of negative readings. When looking at a stock’s Phase 1 score, pay close attention to the first number. With the criteria used, a stock may be generally considered a candidate for further examination if it shows a positive score of five or higher. Each stock’s Phase 1 score is updated every 24 hours.



Finding the Phase 1 Score

A stock’s Phase 1 score can be found by going to the stock’s Snapshot (by clicking the stock’s symbol) and looking at the right side of the stock chart.



Calculations

Take a look at how various items in Phase 1 are calculated.

Indicator Positive Negative

Volume Ratio 5/30 Day Higher than 150% Lower than 50%

P/E Ratio 6–20 > 40 or < 6

P/E Relative Ratio 30 or lower 70 or higher

Projected EPS 1 Mo. Chg. Positive Negative

EPS Growth 5 Year 20% or more 10% or less

Company Growth Ratio Above 1.2 Below 0.8

Acc/Dist Current 60 or higher 40 or lower

Cash Flow Growth 5 Yr. Positive Negative

Debt/Equity Ratio 20 or lower Above 100

Insider Trading Positive Negative

EPS Rank 70% or higher 30% or lower

Price Rank 70% or higher 30% or lower

Group Rank 70% or higher 30% or lower



Phase 2

Phase 2 is a systematic, repeatable process that looks more closely at a company’s fundamentals. It has been completely automated by the Investor Toolbox®.

With the Phase 2 scoring system, a stock either scores well or it doesn’t. Before watching a stock for a potential buy signal (as will be outlined in this step), the stock must score well in Phase 2.



Phase 2

When scoring Phase 2, evaluate the following five criteria:

Price Pattern: Indicates whether the stock was recently moving up, down or sideways.

Volatility: Shows how fast the stock has moved up and down on a daily, weekly and monthly basis. Scoring volatility helps investors determine how comfortable owning the stock will be.

Estimates: What analysts (professionals in the investing world) are projecting for the company’s future earnings.

Financials: Analyzes how well the company’s earnings have done in the past.

News: Measures what is happening with a company at the present time. Recent company news can affect the overall Phase 2 score positively or negatively.

Scoring Phase 2 involves giving individual numbers to each component (Price Pattern, Volatility, Estimates, Financials and News). The automated Phase 2 scoring uses a four-point scale, similar to how most schools report grades. 4.0 is a strong “A” and 0.0 is a failing grade, or “F.”



Price Pa!ern

The first step in this systematic process is to identify the Price Pattern score. The Price Pattern score determines which way the stock is moving (up, down or sideways) on a stock chart.



Price Pa!ern

The Investor Toolbox® compares one-year and five-year charts to determine an overall Price Pattern score, with the most recent price movements carrying more weight.

To score 4.0 (A), the stock must have been moving upward on both one-year and five-year charts. If the stock was primarily moving sideways, it scores 2.0 (C). If the stock was moving downward, it scores 0.0 (F).



Volatility

The next step in this systematic process is to assess the Volatility score, which indicates risk and measures the magnitude of a stock’s price movements up and down in a given time period. The Volatility score provides an idea of how wide the stock’s price swings may be in the future.

Looking at a chart’s price movements can be helpful in preparing for the experience of owning a particular stock. On average, monthly price movement of 10 percent to 20 percent is considered normal for some stocks, but for others, the price may fluctuate even more.

If a stock is highly volatile, most investors find that they spend too much energy on excitement and worry as the stock moves up and down. To be prepared, try to recognize the extent of this characteristic before buying the stock.

The Investor Toolbox® scores Volatility based on how a stock compares to the baseline average. To arrive at this average, the system looks at the price movement of all optionable stocks during the past year and measures how fast they move up and down on a monthly basis.



Volatility

The system then does the same analysis on the stock that the student is analyzing and compares its volatility to the baseline average. The Investor Toolbox® then calculates the Volatility score for that stock according to the following criteria:

If the stock has the SAME or has LESS volatility as the large basket of stocks, it scores 4.0

The lower the volatility score, the MORE volatile the stock is

If the stock scores BELOW 2.0, it could be a warning sign



Earnings Estimates

The next step in the systematic process is the Earnings Estimates score, which looks at what analysts are saying about the company’s future earnings growth potential.

Here is an idea of how the Earnings Estimates score is derived:

Go to a company’s Snapshot (found by clicking on the stock symbol)

Click on the Earnings Estimates link under the Phase 2 heading in the left navigation menu



Wall Street Estimates

The Wall Street Estimates score is based on analysts’ predictions for a company’s future earnings per share (EPS) and overall growth rate.



Wall Street Estimates

In each of the following, meeting the criteria means keeping the score as 4.0 (A). Failing to meet the criteria means dropping the score one point.

In the Mean row, look for the year-over-year earnings estimates to increase. This means the number in the Next Fiscal Year End column should be larger than the number in the Current Fiscal Year End column.

In the Mean row, look for quarter-over-quarter earnings estimates to increase. The Next Quarter End number should be larger than the Current Quarter End number.

In the Mean row of the Next 5 Year Growth column, look for a number above 20 percent.

In the Mean Change row, positive numbers (upgrades) are good, and negative numbers (downgrades) are cause for concern. Score the first four numbers from left to right as a unit, not individually.



Company vs. Industry EPS Growth Rates

Company vs. Industry EPS Growth Rates compares how fast the company’s earnings per share (EPS) have grown and are expected to grow, to the average EPS growth rates in the industry and other indexes.




In the Last 5 Years Actual column, look to see if the number in the Company row is larger than the number in the Industry row.

In the Current/Last column, look to see if the number in the Company row is larger than the number in the Industry row.

In the Next/Current column, look to see if the number in the Company row is larger than the number in the Industry row.

In the Next 5 Years column, look to see if the number in the Company row is larger than the number in the Industry row. If it is, keep the score the same. If it is not, drop the score one point.

Company vs. Industry EPS Growth Rates, the second section of the Estimates, scores 4.0 (A).

Company vs. Industry EPS Growth Rates Step 4 —Conduct a Thorough Fundamental Analysis


Historical Surprises

Public companies announce their earnings once every quarter. Prior to these announcements, Wall Street analysts predict what they believe these earnings will be. The analysts are usually pretty close in their predictions, but every now and then a company surprises Wall Street with its earnings.

These surprises can be either positive or negative. Positive surprises are generally good for a stock’s price, while negative surprises are usually bad. Consider looking for a company that consistently meets or beats analyst estimates each quarter. Let’s look at how to score these surprises using AAPL as an example.



Scoring Historical Surprises




Scoring Historical Surprises

In the first row, look to see if the number in the Actual column is larger than the number in the Estimate column.

In the second row, look to see if the number in the Actual column is larger than the number in the Estimate column.

In the third row, look to see if the number in the Actual column is larger than the number in the Estimate column.

In the fourth row, look to see if the number in the Actual column is larger than the number in the Estimate column.

In the fifth row, look to see if the number in the Actual column is larger than the number in the Estimate column.

Overall, AAPL scores 4.0 (A) in Historical Surprises, the third section of the Estimates score.



Analyst Recommendations and Revisions

Looking at analysts’ recommendations can help determine what you think of a company’s future prospects. For the stock to score well in this section, consider finding analysts recommending to “buy” the stock.

To score Analyst Recommendations and Revisions, find the Mean Rating number in the Current column and score it according to the following scale:

1.0–1.5 = A 1.6–2.5 = B 2.6–3.5 = C 3.6+ = F



In this example, AAPL has a rating of 1.55, which gives it a 4.0 (A) for Analyst Recommendations and Revisions.

Analyst Recommendations and Revisions Step 4 —Conduct a Thorough Fundamental Analysis


Calculating the Estimates Score

After scoring each of the four Estimates categories individually, combine the scores and calculate an average. First, take all four scores and add them together. Using the following scores from AAPL in this example, you can discover the final Estimates score:

Wall Street Estimates 3.0 (B) Company vs. Industry EPS Growth Rates 4.0 (A) Historical Surprises 4.0 (A) Analyst Recommendations and Revisions 4.0 (A) TOTAL 15.0

The total is then divided by four to find the average Estimates score of 3.75 (A).

Average Score = 15.0 ÷ 4 = 3.75 (A)

And as you can see, the Investor Toolbox® calculated the same Estimates score for AAPL that was arrived at by calculating the score by hand.



Financials

The next step in the systematic process is the Financials score, which looks at a company’s past performance. If a company has been strong in the past, it has a better chance of continuing to be strong in the future. That’s great news for investors.

Calculate the Financials score by going to the Snapshot of the company you are interested in analyzing and then clicking on Financials under the Phase 2 heading in the left navigation menu.

At the top of the page is the most recent stock data for the company, followed by the Company Information section. This section includes a brief Business Summary for the company, along with important contact information should you decide to check out the investor relations section of the company’s Web site.



Financials

Within the Financials page, there are four sections to examine when scoring. Pay close attention to each of the following:

Return on Equity

Growth Rates

Revenue

Earnings Per Share (EPS)



Return on Equity (ROE)

The Key Ratios and Statistics section of the page provides broad performance data, illustrating how well the company performed in the past. All this information is useful, but there is one key piece of information in this section needed to score the Financials: return on equity (ROE).

ROE reflects the management team’s effectiveness in using investor equity to grow profits. The higher the ROE, the more likely some investors consider continued profitability to be.

To score ROE, look under Management Effectiveness and consider using the following scale:

18+ 4.0 (A) 15–17.99 3.0 (B) 12–14.99 2.0 (C) 9–11.99 1.0 (D) Below 9 0.0 (F)



Return on Equity (ROE)

For this method, ROE should be 18 percent or better. If ROE is greater than 18 percent, give it a 4.0 (A). If the ROE is less than 18 percent, then reduce the ROE score by one grade for every three points below the 18 percent standard.



Growth Rates

Growth rates depict how quickly a company’s sales have grown, as well as how quickly EPS has grown compared to sales.

When looking at growth rates, focus on the 1 Year column, where you’ll want to see the following three things:

Sales Growth Rates of 25 percent or more

EPS Growth Rates of 25 percent or more

EPS growing faster than sales



Scoring Growth Rates


1. In the Sales % row, the number should be greater than 25.

In the example the number for AAPL is 14.02, which drops the score to 3.0 (B).

2. In the EPS % row, the number should be greater than 25.

In this example the number for AAPL is 36.91, which keeps the score at 3.0 (B).

3. The number in the EPS % row should be greater than the number in the Sales % row.

The EPS % number for AAPL is 36.91 while the Sales % number is 14.02, which keeps the score at 3.0 (B).



Revenue

Revenue is how much money the company brings in before expenses. Ideally, revenue increases year-over-year proving company growth, thus increasing the chances that the value of its stock will also grow.



Revenue

To score Revenue, consider the following steps:

1. Is the number in the second yearly column larger than the number in the first yearly column?

2. Is the number in the third yearly column larger than the number in the second yearly column?

3. Is the number in the fourth yearly column larger than the number in the third yearly column?

4. Is the number in the fifth yearly column larger than the number in the fourth yearly column?

If the numbers are not getting consecutively larger, drop the score one point each time.



Revenue

The numbers for AAPL (29,182 and 42,905) would normally drop the score to 3.0 (B). However, because the numbers are incomplete, compare quarterly numbers for the final year with quarterly numbers for the second-to-last year.

Calculating for an incomplete fiscal year, AAPL receives a 4.0 (A) for Revenue.



Earnings Per Share

Earnings per share (EPS) tells how much the company is making in profits per share of stock. Naturally, investors want the EPS of a stock they own to be as high as possible and also want to see the EPS grow from year to year.



To score EPS, students should consider the following steps:

1. Is the number in the second yearly column larger than the number in the first yearly column?

2. Is the number in the third yearly column larger than the number in the second yearly column?

3. Is the number in the fourth yearly column larger than the number in the third yearly column?

4. Is the number in the fifth yearly column larger than the number in the fourth yearly column?

If the numbers are not getting consecutively larger, drop the score one point each time.In this example, the numbers for AAPL are 7.00 and 9.08, which would normally drop the score to 3.0 (B). However, because the numbers are incomplete, compare quarterly numbers for the final year with quarterly numbers for the second-to-last year. Correcting our calculations for an incomplete fiscal year, AAPL receives a 4.0 (A) for EPS in this example.

Earnings Per Share Step 4 —Conduct a Thorough Fundamental Analysis


Calculating the Financials Score

After scoring each of the four Financials categories individually, consider combining them and calculating an average. First, add all four of them together. In this example we’ll use the following scores from AAPL again:

Return on Equity (ROE) 4.0 (A) Growth Rates 3.0 (C) Revenues 4.0 (A) Earnings per Share (EPS) 4.0 (A) TOTAL 15.0

Dividing the total by four reveals the average Financials score, 3.75 (A).

Average Score = 15.0 ÷ 4 = 3.75 (A)

This outcome is the same as the Investor Toolbox® score for AAPL as shown in the image above.



News

The last step in our systematic process is the News score. Positive or negative, news may impact the Phase 2 score. While earnings may refer to results that are months past, news offers information about what is happening with a company right now. When examining the news, students should determine whether the information is good or bad in terms of how it might impact the stock.

News is considered good when a company announces it beat earnings estimates, received a significant contract, opened new facilities and so on. Such events might indicate that the company is moving in a direction of increased revenue and earnings, which is always good.

News is considered bad when, for example, a company doesn’t meet earnings estimates, someone files a class action lawsuit against the company or it loses a major contract. These kinds of events might negatively impact the stock.

To read the news within the Investor Toolbox®, go to the Snapshot page for any company (found by clicking the stock symbol). Scrolling down past the stock chart and industry group information will lead to the Company News section.



The Headlines

Begin by reading headlines for the company’s name or stock symbol. These may be generally positive, like earnings reports, new product announcements, and so on, or generally negative, like a drop in earnings. If students want to read an entire news story, click its headline to load the full article.



Scoring the News

As you read the headlines and appropriate articles, you can score the news as either “pass” or “fail.” At the beginning of the scoring process, you should assume that the news will receive a passing grade. Before a news item can fail, there must be sufficient negative evidence. In fact, the following two things must happen:

Negative news must occur (bad earnings, losing a major contract, etc.).

The stock must go down as a result of bad news.

Both conditions must apply before giving the News a failing grade. It may seem intuitive that if negative news occurs, a stock will go down. But what an investor might consider to be negative news, the market might not care about because it has already absorbed or factored that news in. Remember, news drives stock prices to the extent that it is new news or different from what was expected.

After seeing positive news for AAPL in this example, consider giving the company a passing score for News. This means AAPL receives 4.0 (A).



What is the AutoAnalyzer®

The Investor Toolbox® offers the AutoAnalyzer feature, which automates most of the Phase 2 process. This feature automatically scores four of the five areas of Phase 2. It does not, however, score News (which students should analyze). This feature is very powerful and saves a tremendous amount of time. The AutoAnalyzer even simplifies the Estimates and Financials scores by averaging the two scores to create the F/E Score. After reviewing the Phase 2components, you should be comfortable understanding what the numbers mean and why they are good or bad.



What is the AutoAnalyzer®

The Phase 2 scores are broken down here, using our example of AAPL:

F/E: 3.75 Estimates: 3.75 Financials: 3.75 Price Pattern: 4.00 Volatility: 3.50

Based on these numbers you should ask yourself the following question, “Do these scores meet the minimum requirements for a passing Phase 2 score?”



Applying the AutoAnalyzer®

The following criteria can help determine if AAPL earned a passing Phase 2 score:

F/E: 3.25 or higher Price Pattern: 2.5 or higher Volatility: 3.00 and above (conservative); 1.00 and below (aggressive) News: Pass



Applying the AutoAnalyzer®

Looking at the criteria above, consider the following:

Only the combined F/E score needs to be looked at. It is not necessary to spend extra time fretting over individual Financials and Estimates scores.

This system emphasizes stocks with Price Pattern scores that indicate moving upward in the recent past.

You can make a personal choice when analyzing the Volatility score. There is no right or wrong answer; rather, it depends on how much volatility each individual investor feels comfortable with.

Score the news as passing or failing. Failing news must both sound bad and cause the stock price to drop precipitously because of it.

If the stock does not meet the requirements of the F/E, Price Pattern, Volatility and News scores, the stock is less likely to provide satisfactory returns compared to a stock that fits this profile.



Phase 2 Review

Conducting a Phase 2 analysis allows you to dive deeper into the past and projected financial performance of a stock. Look for the following:

F/E score of 3.25 or higher

Price Pattern score of 2.5 or higher

Acceptable Volatility score

Passing News score

It is important for investors to know if a company has profited in the past and if analysts believe it can profit in the future before considering the stock for purchase. While having a good Phase 2 score doesn’t guarantee the stock will go up, it does suggest a strong financial company. A strong Phase 2 score in combination with a strong buy signal for a stock in a strong industry group may qualify that stock for potential purchase.




You’ll want to consider the material learned in this lesson in order to update your investing plan with new or modified rules. You might add rules such as these:

Phase 1 should have at least five good scores

Phase 1 shouldn’t have more than three bad scores

Stocks should have an F/E score of 3.25 or higher

Stocks should have a Volatility score of 2.0 or higher

Stocks should have a Price Pattern score of 2.5 or higher



Review

Fundamental analysis helps investors know what to trade, while technical analysis helps them know when to trade. We encourage you to build watch lists consisting of stocks that meet the criteria as outlined in your investing plan. The idea is to create a list of stocks in good industry groups with strong fundamental scores for potential buying candidates. These stocks should remain in a watch list until buy signals appear.

Whether you choose to select stocks from a top-down approach or in the use of a bottom-up search is up to you. However, learning how to use the various searches for more fundamentally sound companies can help. The next lesson introduces other ways to search for stocks to build watch lists.


“Don’t confuse brains with a bull market.”—Humphrey Neill

Step 5—Search for Additional Strong Stocks


In the previous lesson you learned how to evaluate a stock using fundamental analysis. You discovered that the Investor Toolbox® will actually do most of the hard work, making this analysis easy.

In this section, you will learn various searches for building a watch list. These searches can be a bottom-up approach (looking for stocks with strong fundamental indicators) or they can be a used in a top-down approach (searching for good fundamental stocks in good industry groups). The robust searching tools available can cut down the amount of time spent searching for stocks.

Step 5—Search for Additional Strong StocksIntroduction










Introduction

To successfully complete this course, read all material, update your investing plans and complete all activities.

The Investor Toolbox® offers many prebuilt searches to help investors find potential investment candidates. Each prebuilt search looks at all the stocks in the database using specific screening criteria and displays the top 25 stocks that most closely match the criteria of the chosen search.

At the click of the mouse, 25 of the best-performing stocks from the entire database appear in seconds. Consider using these results to choose stocks to perform a fundamental analysis on. Those that pass the analysis may be watch list candidates.



Conducting a Prebuilt Search

To conduct a prebuilt search, go to the Searches tab under the main Investor Toolbox® tab.

The main Search page appears with more than 40 different prebuilt searches.

Students often ask, “Which of these searches should I run?” The first set of searches is the “Most Popular Searches.” Consider beginning with these.



Conducting a Prebuilt Search Step 5—Search for Additional Strong Stocks


Understanding Your Search

To learn more about a particular search and the parameters it uses to screen stocks, click on its name.

This brings up a page outlining which criteria the search is looking for.



Performing the Search

From the Searches page you can perform a search by clicking one of the prebuilt searches. For the purpose of this example, use the Strongest Stocks in Multiple Time Periods. As the name suggests, this search looks for strong stocks in numerous time periods.



The Search Results

The Investor Toolbox® searches its database of more than 12,000 stocks to find the top 25 that best meet the selected search criteria. The top 25 stocks are displayed on the Results page.



The Search Results

A stock symbol with four or more letters means it is traded on the NASDAQ. If the stock symbol has less than four letters, it is traded on the New York or American Stock Exchange. If you click on any symbol link on the Results page, the Corporate Snapshot for that stock is launched.



Understanding the List of Stocks

As shown in our example, the Results page shows a wide range of information, including the following:

Name: name of the company the stock represents

Industry: the market industry of which the company is a part; each symbol is a clickable link that launches the Industry Group Snapshot for that industry

Symbol: the ticker used to represent a company; each symbol is a clickable link that launches the Corporate Snapshot for that security

Options: signifies whether a particular stock offers options; this is a clickable link that displays options available for that company, if applicable

Phase 1: a measure of the stock’s likely attractiveness to investors

F/E Score: automated fundamental score

Price Pattern: automated Price Pattern score

Volatility: automated Volatility score



Navigating the List of Stocks

Scrolling down the page will display the entire list of the top 25 stocks that meet the search criteria.

Statistically speaking, the 25th stock is as good as the first because it is still one of the best stocks out of 12,000 screened by the search. Also, just because a stock appears in the search results does not mean an investor should buy it. A more rigorous analysis (described later) often eliminates many of these stocks. The goal of the search is to find stocks that best match the search criteria.

When conducting an analysis of the search results, pay special attention to the following three columns on the Results page:

Symbol

Industry

Options



Symbol

After a stock has been selected—Apple Inc. (AAPL) will be used for the purpose of this example—click on the stock symbol link to load the Corporate Snapshot.



Corporate Snapshot

The default view of the Corporate Snapshot is a one-year chart, with the most recent month appearing on the right side of the graph.



The Short-term Chart

Below the chart are time span buttons, which can be used to change the graph’s time frame. For example, you can bring up a one-month chart, a five-year chart or any of the other time frames indicated simply by clicking on the corresponding button.

On the one-year chart, each bar of data represents one full day of trading (the open, high, low and closing price of each day).

A better view of a recent buy or sell signal is available by magnifying the signal through the one-month, three-month or six-month view. On these charts each bar still represents one full day of trading, and the buy and sell signals appear in the same way.



The Short-term Chart

Here is an example of a one-month chart.

On the one-day, five-day or 10-day charts, each bar represents just a few minutes of time. This information provides short-term trading signals, which are different from buy and sell signals on the one-month to two-year charts. Each chart uses a bar to represent one day of time.



The Long-term Chart

On the five-year chart, each bar of data represents a full week of trading. On the10-year chart, each bar represents a month. The stock chart shows five years of performance for AAPL, with each bar representing a week of trading.



ProphetCharts®

ProphetCharts is a powerful interactive charting tool developed for more advanced students. Though it is not covered in detail in this course, the technology is available to you, and as you continue your education, ProphetCharts will be used more often than basic charts.



ProphetCharts®

To bring up a ProphetCharts window of a stock, click ProphetCharts in the left menu.

The ProphetCharts software includes additional tools for basic and more advanced technical analysis, including trend line, historical on-screen data and other customized features. It also allows candlestick charting and other tools, if you prefer. More in-depth information about using ProphetCharts is included in the Investools Advanced Technical Analysis course.



Industry

Go back to the Results page and look at the Industry column.

Each industry is distinguished by a six-letter ticker symbol that begins with a $. Clicking on the symbol for the industry ($CMPTRS in this example) brings up a chart that illustrates how well that industry has been performing in the recent past. You can also see a chart of the industry by typing the symbol (complete with $) into the Get Quote field in the upper-left corner of the page.



Industry

The industry chart depicts which direction the group was recently moving and if institutional money may have been moving into the stocks in that group. Industry movement often affects stock movement, so some investors prefer to look at the direction the industry has recently been moving when considering investing in a stock.

There are times when you might find what looks like an excellent investment opportunity, where everything about the stock looks great except the trend of its industry. Such circumstances imply that, in the current time frame, any increase to price on the stock must occur independent of the industry group. The company may have to swim against the current, so to speak, to attract investors.



Industry Example

Continuing with the example of AAPL, from the Results page click the ticker symbol for AAPL’s industry, $CMPTRS, to launch its graph.

The industry group was trending upward but has recently started to trend sideways.



Are Options Available?

The next column on the searches page is Options. Back on the Results page, click on the Options link for AAPL.

If this column is blank, there are no options available for that stock.



Clicking on the Options link for a stock with options brings up its option chain. The option chain lists all available options (both calls and puts).

An in-depth treatment of options can be found in the Basic Options Course.

Viewing the Options Step 5—Search for Additional Strong Stocks


Organizing by Column Heading

Search results can be organized according to a particular characteristic by clicking on the characteristic’s column heading to sort the results automatically. For example, to place the stocks with the highest Phase 1 Scores at the top of the list, click on the Phase 1 column heading.



Viewing the Charts

All search results are viewable by selecting an option from the Arrange Charts drop-down menu. Consider using this feature to avoid clicking back and forth among the Corporate Snapshots for every stock on a list.



Adding Stocks to a Portfolio or Watch List

From the search results you can select stocks to add to watch lists by clicking the checkbox next to each stock(s).



After making selections, click on either the Portfolio or Watch List button, depending on where those stocks should be saved for future reference. To finish, click the Portfolio or Watch List button.

Adding Stocks to a Portfolio or Watch List Step 5—Search for Additional Strong Stocks


Di"erent Search Types Available

In addition to the PreBuilt Searches - Backtested and the Global Search, the Investor Toolbox® has a variety of other searches to assist you in finding stocks and options that meet specific criteria.

Here are some of the available searches:

Prebuilt TurboSearch – A group of prebuilt searches using the Global Search engine.Strategy Searches – Four categories of searches built by investing coaches on the Power ProSearch engine for different investing strategies.

Green Red Arrows Search – A search to find recent stocks that have either three green arrows or three red arrows.

ETF Search – Searches to find exchange-traded funds (ETFs) exhibiting specific behavior.

Options ProSearch – Searches built to find stocks with options and options with specific pricing and criteria.



Discovering the Global Search

One of the most remarkable features of the Investor Toolbox® is the Global Search. Global Search searches the entire database of 12,000+ stocks and prepares a list of stocks with positive Phase 2 scores.

Start by clicking on the Searches tab under the main Investor Toolbox® tab at the top of the page. Next, click on the Global Search link on the left side of the screen as shown here.



Entering Your Criteria

Select 3.25 in the Min drop-down menu for the F/E score, 2.50 for Price Pattern and 2.00 for Volatility.

The next step is to click the Run Search button at the bottom of the page. Global Search will scan all 12,000+ stocks in the database and bring back the ones with the best Phase 2 scores. By default, the computer ranks the top 25.



Other Variables

Through the remainder of this course, you will learn more about the importance of industry groups and investing in stocks that are considered to be in strong groups. You can restrict the results in Global Search to show only stocks containing acceptable F/E, Price Pattern and Volatility scores, as well as those in strong industry groups. Industry group criteria can be added to Global Search as follows:

In the Industry Group Criteria section of Global Search, choose a Big Chart Indicator.

In the Big Chart Indicator drop-down menu, select Big Chart Current Rank.

From the Minimum drop-down menu, select 80.

Note: A group rank of 80 means that the stock is in an industry group with a price history that had recently outperformed 80 percent of all the other groups followed. Typically, adding the industry restrictor significantly reduces the number of stocks to analyze.



Other Variables Step 5—Search for Additional Strong Stocks


Global Search Review

Global Search can be an incredibly useful investing tool. One of its best features is that you only need to run it every week or so. Focusing on stocks that are considered to be strong and researching investment decisions on when to buy and sell them can help improve investing results.




Searching in the Investor Toolbox® can help speed up the watch list building process because you can search for stocks that meet a particular criterion. You should be able to search directly for the stocks that are described in the Watch List Criteria section of your investing plan.

At this point, you might decide when you want to conduct searches and make note of this in your investing plans. Many investors choose to search on the weekends when the markets are closed and there is some emotional distance. Because the purpose of searching is to build a watch list, you can build your watch list and then not have to search throughout the week, but instead focus on entry signals for the stocks in your watch lists.



Review

In this lesson, you explored some of the various searches and searching tools in the Investor Toolboxvv that will allow you to build watch lists according to your investing plans. Those searches included Most Popular Searches, Strongest Stocks in Multiple Time Periods and Global Search.

You may find that part of your investing plan routine will be to determine which day of the week you want to conduct searches and build watch lists. Searching for stocks every day would be a less effective use of time, which could be spent monitoring watch lists for buy signals. The next lesson will focus on how to recognize these signals as they occur.


“Charts not only tell what was, they tell what is; and a trend from was to is (projected linearly into the ‘will be’)

contains be!er percentages than clumsy guessing”—R. A. Levy

Step 6—Conduct a ThoroughTechnical Analysis


In previous lessons, you learned that, after outlining certain fundamental factors for your investing plan, you can use various searches to help you find stocks to build watch lists. Build watch lists of stocks that are in favorable industry groups and have good fundamental scores. Then, monitor this list on a daily basis for buying opportunities. But how do you know when to buy?

Step 6—Conduct a Thorough Technical AnalysisIntroduction










Introduction

This lesson will help you recognize entry and exit signals for a stock investment using technical analysis, Step 6 of the 7-Step Investing Formula®: Conduct a thorough Technical Analysis. Technical analysis is the study of price and volume movement on a stock chart to identify trend direction, support and resistance levels and momentum changes as a means to making informed investing decisions. Understanding how to read different stock chart types is critical to technical analysis, and so this lesson will begin by explaining basic charts.


Step 6—Conduct a Thorough Technical Analysis


Basic Charts

Technical analysis relies on many different chart types used by technicians. The oldest is the Japanese candlestick chart. Another popular type is the bar chart, a Western invention that has been used for more than 100 years. A less popular type for analysts but most commonly seen in the financial news is the line chart, which can provide valuable information in specific situations. These chart types will be explained in greater detail in this lesson.



Using ProphetCharts®

ProphetCharts in the Investor Toolbox® allows you to view a number of chart types. The chart type can be adjusted at the top of the ProphetCharts window by clicking Chart Settings and finding Graph Type in the drop-down menu to reveal the available chart types. As shown on the S&P 500 (SPY) chart, the candle chart type is selected.



Bar Charts

A bar chart is a commonly used method of charting price movement. A long vertical line—the bar—represents each period’s trading range, including the day’s high and low prices. A horizontal line on the bar’s left side represents the day’s opening price. A horizontal line on the bar’s right side represents the day’s closing price.

Technicians who use this chart type can quickly see whether the market is rising, falling or moving sideways during a particular trading period.



Japanese Candlestick Charts

In 1989, Steven Nison introduced Japanese candlestick charts to the Western trading world. The candlestick chart shows the same open, high, low and close information as the bar chart, but does so by connecting the open and close with a rectangle. The rectangle is called the body.

As shown here, the body is white when the close is higher than the open, and black when the close is lower than the open.

The size of the body also shows the strength of the buyers and sellers between the open and close. A large white body shows buyers in strong control, while a large black body shows sellers in strong control. In contrast a small body shows that buyers (white body) or sellers (black body) might have been in control at the open, but did not have strong control at the close. The easy visual contrast between an up and down day as well as the day-to-day relative strength of buyers and sellers has made candlestick charts very popular with investors.



Define the Trend

Defining the trend enables you to follow the prevailing direction of a stock’s price movement. It is said, “A trend in motion stays in motion.” Identifying and trading a particular trend is how investors increase probability on their side. Remember, it is easier to swim with the current than against it.

Determine trend by comparing a series of high and low price points on a chart over an observed period of time.

Trend has three directions:

Uptrend

Downtrend

Sideways



Uptrend

An uptrend is defined as a series of higher highs and higher lows on a price chart.



Downtrend

A downtrend is defined as a series of lower highs and lower lows on a price chart.



Side Trend, Line, or No Trend

A side trend, line or no trend is defined as a series of relatively similar highs and lows.



Length of Trends

Long-term and Intermediate

Trends occur over different time cycles or time horizons. Think of trends in terms of an ocean, where ripples, waves and tides relate to these cycles.



Length of Trends

Long-term and Intermediate (continued)

A long-term trend is analogous to the tide and is generally months to years in length—usually nine months or longer. This chart shows the long-term up- and downtrends of the iShares Real Estate ETF (IYR). The uptrend is a series of higher lows and higher highs, while the downtrend is a series of lower lows and lower highs. The long-term trend is sometimes referred to as the primary or secular trend.

An intermediate trend is similar to a wave. It can go on for weeks to months—usually from three to nine months. The chart shows that IYR’s long-term highs and lows are made up of intermediate up- and downtrends. The highs and lows of the intermediate trend are made up of short-term trends.



Length of Trends

Short-term

A short-term trend is a ripple that lasts from days to weeks but is not more than three months.



Length of Trends

Short-term (continued)

Regardless of the time frame, try to identify long-, intermediate- and short-term trends. When riding ripples or waves of a stock, it helps to know if the stock’s tide may be going in the preferred direction so you can go with the current. This is a main tenet of trend and swing trading: go with the tide and ride the waves in.



Support and Resistance

Support and resistance are additional indicators of trend and can be useful to investors when determining entry or exit signs for a stock.



Support and Resistance

Support is any price area a stock has dropped down to and rallied up off in the past. It’s helpful to think of support as the stock’s floor. The more times a stock moves down to this price area and then rallies back up, the more significant the support. Watch this area closely. If a stock clearly falls below support, many technical investors expect the fall to continue. Some may even expect it to accelerate downward.

Resistance is any price area a stock has rallied up to and dropped back down from in the past. It is helpful to think of resistance as the stock’s ceiling. The more times a stock moves up to this price area and then falls back, the more significant the resistance. Watch this area closely as well. If a stock clearly breaks up through an established resistance level, many technical investors expect heavier buying to occur and for the stock to continue upward.



Support and Resistance Key Concepts

Notice that support and resistance refer to price areas. Very rarely does a stock go up or down to the exact same price over and over. Keep this in mind, particularly for a support area that is around the moving average, because sometimes a stock comes down to exactly the moving average point, finds support and then rallies back up. Other times the stock stops just above or just below the moving average before it begins to rally. In each case, the area around the moving average is considered support. Remember, there is never any guarantee that a past resistance or support level will continue to hold in the future.

Consider the following key concepts when analyzing support and resistance levels:

After resistance is broken, it often becomes new support. In other words, when a stock breaks out above resistance and then pulls back, the old resistance area commonly acts as a new support area.

After support is broken, it often becomes new resistance. This means that when a stock breaks down below support and then tries to rally back, the old support area commonly acts as a new resistance area.



Using the Arrows

Moving Averages

A moving average visually shows a stock’s average price during a set period of time. Stocks tend to follow their trends. Knowing this can help students more accurately forecast.



Using the Arrows

Moving Averages (continued)

On the one-month, three-month, six-month and one-year charts, the moving average indicator shows a stock’s average price during the past 30 days. On the five-year and 10-year charts, this indicator shows the stock’s average price during the past 30 weeks (this is the long-term trend).

For the charts on the Corporate Snapshot page, the red line represents the moving average.

Moving averages are trending indicators, meaning they give much more useful information when a stock is in a trend. These measures sometimes appear to act as a support level for stocks temporarily pulling back in the middle of an uptrend. Conversely, they may appear to provide resistance for stocks temporarily rising during a downtrend. After a moving average is broken, it can help identify when a trend is ending.



Moving Averages When There Is No Trend

When a stock is trending sideways, a high number of red and green arrows will appear on the moving average. This kind of chatter may be confusing for some investors.



Acting on the Arrows

When green and red arrows appear along the moving average indicator consider the following:

The “up” green arrow indicates the price bar moved above the 30-day moving average.



Acting on the Arrows

The “down” red arrow indicates the price bar dropped below the 30-day moving average.

Note: Green and red arrows appear during the day as the stock price moves above and below the moving average. However, permanent green and red arrows appear on the chart only if the stock’s closing price is above or below the moving average.

Remember, moving averages are most useful when a stock is in a trend. When analyzing stocks that score well in Phase 2, the 30-day moving average may commonly act as support when a stock pulls back temporarily in the middle of an uptrend. Support is an area where a stock starts to rally.



Moving Averages When a Trend Exists

Once broken, the moving average can also act as a resistance level during a downtrend. Resistance is an area where a stock has difficulty rallying above.

How can an investor tell when a downtrend may be ending? When a downtrending stock rallies above the moving average, pulls back and gives a new buy signal at or above the moving average, the downtrend is likely over.

Entering a trade on buy signals in a downtrend before this kind of activity occurs might result in a loss or poor performance.

Knowing this can help you pinpoint likely areas of resistance, as well as entry and exit points for such trades.



Using the Arrows

MACD Indicator

The Moving Average Convergence Divergence (MACD) short-term momentum indicator appears as a purple histogram at the bottom of the chart. The horizontal line running through the MACD indicator’s center is called the signal, or zero, line.



Using the Arrows

MACD Indicator (continued)

The MACD indicator combines two moving averages, fast and slow, and measures the distance between them to determine if they are converging or diverging. The measurement between the two moving averages is then plotted on a MACD line. The next chart shows the MACD line with a nine-day exponential moving average (EMA). In the histogram the EMA is leveled out to create the zero line and the MACD line crosses above and below the zero line to create the red and green arrows. However, it isn’t necessary to understand the mathematical make-up of the indicator.



The Histogram

Because it is much easier to read the histogram, the charts use a histogram to display the MACD indicator. When reading the MACD indicator, remember the following:

When a red “down” arrow appears, the MACD has dropped below the zero signal line.

When a green “up” arrow appears, the MACD has moved above the zero signal line.

The MACD indicator tends to be the chart’s short-term indicator. During a year, it usually displays the most green and red arrows.



The Histogram

Using the MACD indicator as an early warning alerts investors to stocks to consider following more closely for potential buy or sell signals.

When the MACD indicator is above the signal line and surging higher, watch for it to roll over. Many technicians see this action as the first sign that short-term momentum may be slowing down.



When the Arrows Appear

A red arrow will appear when the indicator crosses below the signal line. For stocks in strong uptrends, the MACD can form multiple momentum peaks before the red arrow appears. The opposite is true for stocks in strong downtrends. Consider viewing the MACD arrow as a possible warning of an approaching valid buy or sell signal, signaling that the stock should be watched closely.



Using the Arrows

Stochastic Indicator

The widely used stochastic indicator measures who is winning the daily battle between the bears (they are selling and driving the stock down) and the bulls (they are buying and driving the stock up). It uses crossover lines of 25 percent and 75 percent to determine when the stock may be overbought (bullish) or oversold (bearish).



Understanding the Stochastic Indicator

A stock may be overbought when the indicator crosses above the 75 percent line. Just because a stock may be overbought does not mean there are no more buyers. All it means is that buyers are in control of the stock, dictating its trading action. Stocks in strong uptrends can remain overbought for months. Be careful not to sell simply because a stock becomes overbought. Instead, consider waiting for the red arrow and confirmation from other indicators to appear.

A stock may be oversold when the indicator drops below the 25 percent line. Just because a stock may be oversold does not mean there are no more sellers. All it means is that sellers are in control of the stock, dictating its trading action. Stocks in strong downtrends can remain oversold for months. Be careful not to buy simply because a stock becomes oversold. Instead, consider waiting for the green arrow and confirmation from other indicators to appear.

The red arrow indicates the stochastic has dropped below the 75 percent line and the market may be selling out of the stock. This may be a sign that sellers are gaining control of the stock. The red arrow appears only when the indicator has been above the 75 percent line and then drops below it.



The green arrow indicates the stochastic has moved above the 25 percent line and the market might be buying back into the stock. It is a sign that buyers might be gaining control of the stock. The green arrow appears only when the indicator has been below the 25 percent line and then rallies above it.

Understanding the Stochastic Indicator Step 6—Conduct a Thorough Technical Analysis


Additional Notes for the Stochastic Indicator

Note that the stochastic indicator moves between zero and 100. The math behind the indicator compares the highest and lowest prices at which a stock has traded during the past 14 trading days (roughly three weeks). This process establishes the trading range. The current position of the stochastic indicator tells where a stock’s current price is in relation to this range.

A stock with a stochastic reading of 75 or above is trading in the upper 75 percent of its recent trading range, while a stock with a reading of 25 or below is trading in the lower 25 percent of its recent trading range. The math behind the indicator is a little more complex than that, but this is basically what it shows.



Phantom Green Arrows

Occasionally, the stochastic indicator reverses its trend before the line has had a chance to either rise above the 75 percent line or fall below the 25 percent line. Had the line made it to either one of these levels before it reversed direction, the stochastic indicator would have shown a red or green arrow. But because the line was somewhere between the 25 percent and 75 percent levels, it did not show an arrow. This situation is called a “phantom” green or red arrow, and can be treated just as any green or red arrow that appears on the chart.

You can see how the stochastic indicator dropped down to just above the 25 percent level before it turned around and moved higher. However, because the line never dropped below 25, the indicator did not add a green arrow. This is an example of a phantom green arrow. It is possible to view this turnaround as the equivalent of an actual green arrow.



Phantom Red Arrows

Here is an example of how the stochastic indicator climbed to just below the 75 percent level before it turned around and moved lower. However, because the line never rose above 75, the indicator did not add a red arrow. This is an example of a phantom red arrow. It is possible to view this turnaround as the equivalent of an actual red arrow.

When the stochastic indicator is between the 25 percent and 75 percent lines, look at the direction it is heading to determine its signal (up is green, down is red). The closer the stochastic is to the 25 percent or 75 percent lines, the more significant the turn.



Phantom Red Arrows

If the other indicators are green and the stochastic is between the 25 percent and 75 percent lines and turning upward, regard this as a potential buy signal for the stock. Similarly, if the other indicators are red and the stochastic is between the 25 percent and 75 percent lines and turning downward, regard this as a potential sell signal.



Volume

Black bars below the price bars are a visual representation of how many shares of the stock trade each day. Taller bars represent spikes in volume, where trading activity significantly increased for that day. This surge in activity is usually a sign that large amounts of institutional money (mutual funds, banks and so on) are entering or exiting the stock. Volume spikes may mark the beginning of significant trends.



Volume

A volume surge is considered to be 50 percent higher than normal volume. The Investor Toolbox® calculates this percentage in the virtual volume reading. This percentage takes into account the average volume before the current date, as well as time of day. It then estimates the amount of volume the stock may trade by the end of the current session.



Using Volume to Filter Entry Signals

Some investors prefer to see a volume surge accompanying their buy signals before entering a stock that has been moving sideways. To break through resistance and start an uptrend, stocks may need a significant volume surge. Imagine sitting on a bicycle and wanting to start going up a hill. The bike requires a little more energy to begin moving from a dead stop. Some investors see additional volume as the equivalent of extra energy needed to make that extra push and start the stock moving higher in price.

So imagine analyzing a stock that normally trades 200,000 shares per day. Investors looking for additional volume would want to see at least 300,000 shares being traded (1.5 times the average) to confirm the buy signal.

For example, if a stock normally trades 1,000,000 shares per day, the stock must trade at least 1,500,000 shares to confirm a buy signal in a sideways trend.

When entering a stock that is giving a buy signal without confirming increased volume, consider being more conservative on your position size to compensate for the risk that comes with the stock.



Potential Buy-Signal Rules—Uptrending

The following are possible buy-signal rules for stocks that grade well in Phase 2:

An uptrending stock with three green arrows. When the most recent arrow on each indicator (moving average, MACD and stochastic) is green in an uptrending stock.

A sideways moving stock with three green arrows and a volume surge. A sideways moving stock needs confirmation of big money coming into the stock, which may be shown by a volume surge. This must happen before the signal on a sideways-moving stock can be considered valid.

This is an example of a possible buy signal on an uptrending stock, with three green arrows—one on the moving average, one on the stochastic indicator (phantom green arrow) and one on the MACD indicator.



Potential Buy-Signal Rules—Sideways

Here is an example of a buy signal on a sideways moving stock, with three green arrows—moving average, stochastic indicator and MACD indicator—accompanied by a volume surge.



Pu!ing It All Together to Buy a Stock

This is an example of an uptrending stock with three green arrows (one is a phantom green arrow) meeting the simple buy-signal rules. The buy-signal price is the closing price on the day of the last green arrow.



Pu!ing It All Together to Buy a Stock

Buy signals that are several days old may no longer be valid for consideration. Some investors feel that if the stock’s price is still the same, the buy signal may still be a useful indicator, but this is a matter of personal preference. If you are uncertain about whether the buy signal is too old to be useful, consider waiting for the next buy signal, or simply move on to a different stock.



Volume Surge

As previously discussed, if the volume of a stock is 50 percent higher-than-normal average volume at any point from the first green arrow to the last green arrow, it may be a sign that institutional money is coming in. Make sure the high-volume day occurs when the stock is going up, not down.

A volume surge may occur when a stock is breaking out of a sideways move, but it can also occur during a trend. Volume surges are commonly considered to indicate that big money is entering the stock at the time of the buy signal, increasing the probability of a profitable trade.

This chart on the following page shows an example of a volume surge that occurred around a major buy signal.



Volume Surge Step 6—Conduct a Thorough Technical Analysis


Accumulation/Distribution (Acc. Dist Current) of 60 or Higher

Accumulation/Distribution (Acc. Dist Current) is an indicator that measures whether big money might have recently entered or exited the stock. If a stock’s rise on the day’s volume is above average, then Acc. Dist Current increases, which might be a sign that big money has recently entered the stock. If a stock trends downward on days of above-average volume, it may be a sign that big money has recently exited the stock.

Readings of 60 or higher usually indicate high-volume days were consistently uptrending, while readings below 40 usually indicate high-volume days were consistently downtrending. For confirmation on buy signals within an established uptrend, consider using Acc. Dist Current instead of looking for a 50 percent volume surge.



Acc. Dist Current can be found in the Phase 1 score. The Acc. Dist Current is well above 60.

This stock had both a surge in volume and an increase in Acc. Dist Current. While it is nice to have both indicators moving in the stock’s favor, only one is needed to fulfill requirement 4.

Accumulation/Distribution (Acc. Dist Current) of 60 or Higher Step 6—Conduct a Thorough Technical Analysis


Interpreting Green Arrows that Do Not Line Up Directly—Situation 1

While most buy signals consist of green arrows that line up within a few days of each other, there are times when green arrows appear many days apart, or phantom arrows are detectable. These are still considered signals. Consider the following situations as examples.

Situation 1The moving average turned green several weeks ago and the stock pulled back a little. Now the MACD and stochastic indictors are turning green and the stock is still above the moving average.

Because the stock never closed below the moving average, another green arrow will not appear. So while it may seem that there are only two green arrows, in reality, the most recent arrow on each indicator is green, making this buy signal valid. Remember, as long as the most recent arrow on each individual indicator is green, it is still considered to be a potential buy signal.



Situation 2The stochastic indicator has a shallow pullback, but does not go completely into the oversold end zone (below the 25 percent line). A green arrow does not appear.

Step 6—Conduct a Thorough Technical AnalysisInterpreting Green Arrows that Do Not Line Up Directly—Situation 2


Because the green arrow appears only when crossing back over the 25 percent line, there is no green arrow on the stochastic indicator. However, this is a phantom green arrow. If the stochastic is between the 25 percent and 75 percent lines look at the indicator’s slope to determine the arrow’s color:

Sloping Upward = Green

Sloping Downward = Red You can see a phantom green arrow.

Step 6—Conduct a Thorough Technical AnalysisInterpreting Green Arrows that Do Not Line Up Directly—Situation 2


Selling Stocks

Red arrows (sell signals) appear on the chart’s indicators (moving average, MACD indicator and stochastic indicator) when it is time to consider selling a stock. If the stock price breaks through support at this point, many investors consider exiting their positions, depending on their desired time frame for the trade. This is a basic sell signal.

It is prudent to determine an exit strategy before considering a trade. This ensures that an investor will already have determined how to respond to a sell signal. You can note your own exit strategies in your investing plan.

When faced with a sell signal, you have at least two choices: sell immediately, or employ a procedure as you continue to wait. This course refers to this waiting procedure as the three-and-three Rule.



Three-and-three Rule

Rather than selling immediately when the most recent arrows on the indicators are all red, consider moving an existing sell-stop order up to a price that is 3 percent below the most recent support level. The most recent support level can be defined by the lowest price at which the stock traded when the three red arrows were appearing. It does not matter how many days apart the red arrows appeared; when following this rule, simply determine the lowest price from the day of the first red to the day of the last red, and consider moving the stop order up accordingly. To better visualize the three-and-three rule review the example on the following page.



Here, you see a signal that appeared over a two-day period. The lowest price at which the stock traded during those two days was $34.26. Notice that a red arrow appeared on the moving average when the stock closed just below it.

Three-and-three Rule Step 6—Conduct a Thorough Technical Analysis


Other Considerations of the Three-and-three Rule

Some investors consider a common support area in a trending stock to be the moving average. Remember, support is an area, not an exact price. A stock may be a little above or below the moving average before turning around and rallying. Many investors choose not to sell immediately when the stock breaks below the moving average on speculation that it might find support just a little below that point.

An investor following the three-and-three rule in this example might decide to move his stop order up to $33.23 (3 percent below $34.26) after the third red arrow appears. Notice that on this chart, the day after a third red arrow appeared, the stock dropped to $34.22, but then turned around and started climbing higher. This kind of activity happens all the time to bullish stocks in strong markets. So, even though three red arrows appeared, the investor following the three-and-three rule gave the stock an opportunity to bounce back up off support by moving the stop order up 3 percent. In this example, that was exactly the right decision because the stock rallied all the way to $42. If the investor had chosen to sell immediately, some very good profits would have escaped unclaimed.



Stop-loss Orders

A stop-loss order is a protective order placed below the current stock price. It automatically sells the stock if the price falls to or below the price specified.

Stop-loss orders need to be placed at realistic levels and should consider support and resistance lines, time horizon and trading style. The following are guidelines for setting stop-losses:

Stop-losses should be based on support or resistance levels

For bullish trades: 3 percent below support for intermediate-trend trades, closer to 1 percent on shorter term swing bounce or breakout momentum trades

For bearish trades: 3 percent above resistance for intermediate-trend trades, closer to 1 percent on shorter term swing bounce or breakout momentum trades

Use trend lines, moving averages and previous highs and lows as reference points for setting and adjusting stops.



Stop-loss Orders

Every now and then, bad news comes out on a stock and it falls very rapidly, or gaps below the price for a loss. With a stop-loss order, you can get out of positions at the best available price after the stock penetrates the stop-loss price. Usually this type of fast, downward move is the kick-off to a much larger downward thrust. Under such circumstances, many investors prefer to preserve whatever capital they can rather than hold on—even if the sale price is lower price than what was specified by the stop order.



Creating Stop-loss Orders

A regular stop-loss order differs from a stop-loss limit order. A regular stop-loss order becomes a market order as soon as the stock falls to or below the price specified. A stop-loss limit order turns into a limit order and sells only at the specified price or higher when the stop-loss level is hit. Thus, a stop-loss limit order may not complete the sale of the stock if really bad news occurs and its price rapidly falls through the stop-loss price specified or gaps below it.

Some brokers refer to stop-loss orders as sell-stop orders, or simply stop orders, but they are the same thing.



Adjusting a Stop-loss Order

You can usually cancel or modify a stop-loss order without cost, but it is important to check the broker’s policies to avoid surprise commission costs. A regular commission is commonly charged only if the stock falls below the specified price and the system actually executes the order. However, some brokerage firms may charge the investor to cancel or modify the order.

Stop-losses should be adjusted when forming a new support or resistance level. New highs and lows or changing values on trend lines and moving averages can be used to adjust stop-losses.

The purpose of these adjustments is to help lock in gains when the price reverses:

Bullish trend investors normally adjust stop-losses based on the recent low, current trend line or moving average.

Bullish swing investors adjust stop-losses based on a recent high to capture most of the swing.



Adjusting a Stop-loss Order

Stop-losses can also be adjusted based on the amount at risk:

If the stock price gains to a point that equals the amount of the initial risk, investors should move the stop-loss to the breakeven price.

When the stock gains twice the amount of the initial risk, investors should sell part of the position.




You have probably been thinking about what to include in your investing plan. You may have been updating your plan as you read. For instance, entry and exit rules could’ve been added. To ensure that you are updating your investing plan as needed, here are some examples of rules that could be included:

Invest only in uptrending stocks

Three green arrows is a buy signal

Buy stocks that have three green arrows and are breaking resistance with higher volume

Set a stop 3 percent below support

Set a stop 3 percent below the moving average

Adjust stops 3 percent below new support

Adjust stops each day to 3 percent below the moving average

Stop-loss orders should only be raised and never lowered




These are just some examples of rules to consider adding to your investing plan. No matter what rules you include, they should be clear and concise, making investing easier, and remove some of the emotional attachment that often accompanies stock purchasing.



Review

In this lesson you discovered how to identify uptrending stocks with entry signals and eventually with exit signal. You should now be able to indentify when to buy and sell a stock.

Practice identifying support and resistance levels, pinpointing trends and determining where to set stop-loss and profit-targets. Portfolio management concepts—understanding how much to buy and how it can fit within your portfolio framework—were also introduced. The next lesson will build upon these concepts, as well as help you determine daily, weekly and monthly routines.


“I measure what’s going on and I adapt to it. I try to get my ego out of the way. The market

is smarter than I am, so I bend.” —Martin Zweig

Step 7—Manage Your Portfolio


In the previous lesson, you learned to recognize entry and exit signals for a stock trade. In this lesson, you will learn more about calculating proper risk and position size for a stock trade. You will also learn to identify daily and weekly routines necessary to manage a portfolio, and identify criteria used in a trading journal.


Introduction Step 7—Manage Your Portfolio










Powerful portfolio tools can help you closely track stocks you own, as well as those you would like to own. The Investor Toolbox® features portfolio tracking tools that help you efficiently manage investments. These unique features put the investor solidly in control.

To keep up with continuous advancements in the Internet and technology, Investools is constantly adding new capabilities to the Investor Toolbox®, making it easier for investors to manage their portfolios. In addition to tracking stocks in a watch list (stocks you are thinking of buying) you can also track stocks that you already own.

After creating a new portfolio of stocks, the Investor Toolbox® adds information on those stocks for you. Your portfolio then operates off the server, which means that no matter where you are or which computer you’re using, as long as you have Internet access, you can access your portfolio.

Within the portfolio, you can view information such as number of shares owned, transaction price, price paid, current stock price, current value and so on. You can also click on a stock to access its one-year graph.

Portfolio Management Tools Step 7—Manage Your Portfolio


To access portfolios already set up or to create a new portfolio, click on the Portfolio tab under the Investor Toolbox® tab in the main menu.

This automatically brings up the existing default portfolio, if there is one. If accessing this area for the first time, a new, empty portfolio is brought up.

To create a new stock portfolio, click on the Create New Portfolio button or the Create Portfolio link in the left navigation menu under the Portfolios heading.

Creating a Portfolio Step 7—Manage Your Portfolio


After opening a new portfolio page, clicking on the Rename button lets you change the portfolio’s name. A portfolio should be named in a way that suggests what stocks are in it (e.g., a portfolio of bullish stocks might be named “Bullish Stocks”).

Creating a Portfolio Step 7—Manage Your Portfolio


Next, determine whether this particular portfolio is the default (the portfolio that automatically comes up when the Portfolio tab is clicked). Clicking on Set it to Default will do this.

After making these selections, you can begin entering stocks into the portfolio. Clicking on the Add Symbol button will start this process.

Adding Symbols Step 7—Manage Your Portfolio


Now, you can add stock symbols by clicking in the Add Symbol(s) field and typing them in. Multiple symbols can be added at one time by separating each with a comma (There is no need to put a space either before or after the comma). For example, if you want to track ETFs that follow major market indexes, she would type in the following:

SPY,QQQQ,DIA,IWM

After entering ticker symbols, click the Add button. This expands the window with the new symbols.

Adding Symbols Step 7—Manage Your Portfolio


You can now enter the information you would like to monitor for each of these stocks. Information can be added to each of the following columns (moving from left to right):

Initial Shares—For the number of shares purchased when tracking an actual position. This should not be used if creating a watch list.

Transaction Price—For the price paid for a stock in an actual position. Again, this should not be used if creating a watch list.

Commission—For the commission paid on a stock purchase (if any). This also should not be used if creating a watch list.

Transaction Type—For the type of transaction made on an actual position. Long indicates the stock was bought. Short indicates the stock was shorted, or sold. This also should not be used if creating a watch list.

Transaction Date—For the date on which the transaction of an actual position was completed. This also should not be used if creating a watch list.

Understanding the Portfolio Step 7—Manage Your Portfolio


Notes—For making notes regarding the stock—e.g., why it looks like a promising stock to watch.

Checkbox—Selects a stock for or creating an alert for a stock or deleting it from a portfolio. This should be followed by clicking on either the Create Alert(s) or Delete Symbol(s) buttons at the top of the tool.

Understanding the Portfolio Step 7—Manage Your Portfolio


After entering all pertinent information, click the Save button at the top of the page to save the portfolio.

Now that the information is saved, the Detail View page is automatically loaded.

You can access any of your portfolios by selecting the one you want to view from the Portfolio drop-down menu.

Saving the Portfolio Step 7—Manage Your Portfolio


A number of powerful, yet user-friendly features on the Investor Toolbox® make it easier to manage your portfolios.

When accessing a portfolio, the Investor Toolbox® automatically brings up the Current Valuations, or Details, page. This page can also be accessed by clicking on the Details tab at the top of the portfolio or on the Current Valuations link in the left navigation menu of the Portfolio section.

The Current Valuations, or Details, table is used to keep track of investment performance. It displays the following:

Managing a Portfolio: Current Valuations Step 7—Manage Your Portfolio


How many shares are owned

Transaction price for the trade

Initial trade value when it was entered

Current price of the stock

What the trade is now worth

Amount of dollars the stock moved today

Percentage price change today

Profit or loss in dollars

Profit or loss in percentages

Transaction type

Any alerts set for the stock

Any notes created

Managing a Portfolio: Current Valuations Step 7—Manage Your Portfolio


AutoAnalyzer® can be accessed by clicking on the AutoAnalyzer tab at the top of the portfolio. This tool takes all the stocks in a portfolio and analyses them by automatically scoring Phase 1 and Phase 2. This allows you to make sure stocks are fundamentally sound.

Managing a Portfolio: AutoAnalyzer® Step 7—Manage Your Portfolio


The AutoAnalyzer® lists the following information for each stock:

Symbol—clicking on the ticker symbol shows the stock’s Corporate Snapshot

F/E score—combined Financials and Estimates score

Estimates—score of analysts’ predictions for the stock

Financials—score of how well the company performed in the past

Price Pattern—score of the stock’s current trend

Volatility—score of the stock’s volatility level

Phase 1—score of the stock’s current valuation

News—link to news stories about the stock

Industry group—clicking on the ticker symbol for the stock’s industry group shows the group’s chart

Notes—link to any notes created for the stock

Other Useful Features of the AutoAnalyzer® Step 7—Manage Your Portfolio


The Thumbnails feature is a time-saver that allows you to view a thumbnail chart of each stock in a portfolio, all on one page. This feature can be accessed by clicking on the Thumbnails tab at the top of the portfolio, or on the Thumbnail Charts link in the left navigation menu. The page displays small, six-month graphs. From here, you can make a quick check of each chart to determine its characteristics.

Managing a Portfolio: Thumbnails Step 7—Manage Your Portfolio


A Corporate Snapshot for any stock shown in Thumbnails is available by clicking on the stock’s thumbnail chart. When scanning through and checking these charts, some students like to focus attention on the stochastic indicator’s position because it tends to be the slowest-moving indicator, giving the fewest signals throughout the year. If the stochastic indicator is below the 25 percent line, the next signal will be a buy signal. If the stochastic indicator is above the 75 percent line, the next signal will be a sell signal.

You can click on a stock’s thumbnail to bring up a larger, one-year graph.

Managing a Portfolio: Thumbnails Step 7—Manage Your Portfolio


Alerts for any stock in a portfolio can be created by clicking in the box on the right side of the page, then clicking on the Create Alert(s) button. This brings up the Alerts setup page, where investors can specify which alert to add.

Managing a Portfolio: Alerts Step 7—Manage Your Portfolio


An alert requires entering an e-mail address in the upper-right corner—this is the address to which the alerts will be sent. One or all of the following eight alerts can be set for the stock:

Price low breakout—sends e-mail when the stock’s price breaks below a specified level

Price high breakout—sends e-mail when the stock’s price breaks above a specified level

Technical breakout: MACD—sends e-mail when the MACD indicator shows a green or red arrow

Technical breakout: Moving average—sends e-mail when the moving average shows a green or red arrow

Technical breakout: Stochastic—sends e-mail when the stochastic indicator shows a green or red arrow

Earnings release: Week ahead alert—sends e-mail one week before the company is scheduled to release its earnings numbers (continued...)

Alert Choices Step 7—Manage Your Portfolio


Earnings release: Actual earnings release—sends e-mail on the day the company is scheduled to release its earnings numbers

News alert—sends e-mail when company-specific news is released (Note: some companies are frequently in the news, and so this setting may trigger quite a few e-mails throughout the course of a day)

After the alerts are set they can be saved by clicking the Save button.

Step 7—Manage Your PortfolioAlert Choices


These alerts can be accessed at any time by clicking the Alerts tab at the top of the portfolio, or the Alerts link in the left navigation menu.

Alerts can be edited or deleted by placing a check mark in the box to the right of the alert, then clicking on either the Delete Alert(s) or Edit Alert(s) button.

Altering an Alert Step 7—Manage Your Portfolio


The Technicals page can be accessed by clicking the Technicals tab at the top of the portfolio. This page provides a tabular view of charts for all stocks in the portfolio. Instead of seeing red and green arrows and other information graphically, this view shows numbers signifying those arrows as well as other information on the stock charts.

Managing a Portfolio: Technicals Step 7—Manage Your Portfolio


The Technicals page lists the following information for each stock in the portfolio:

Symbol—clicking on the ticker symbol for the stock shows the stock’s Corporate Snapshot

Current price—current trading price of the stock

Transaction price—price at which the stock was bought

Profit/Loss %—percentage made or lost in the trade

MACD 8-17-9 day breakout—number of days since the last green or red arrow on the MACD indicator (Positive numbers indicate green arrows, while negative numbers indicate red arrows)

Stochastic 14-5 breakout—number of days since the last green or red arrow on the stochastic indicator (Positive numbers indicate green arrows, while negative numbers indicate red arrows)

Viewing the Technicals Page Step 7—Manage Your Portfolio


30-day moving average breakout—number of days since the last green or red arrow on the 30-day moving average (Positive numbers indicate green arrows, while negative numbers indicate red arrows)

One-day to 10-day volume—percentage of one-day volume, when compared to 10-day volume

Five-day to 30-day volume—percentage of five-day volume, when compared to 30-day volume

Notes—link to any notes created for the stock

Viewing the Technicals Page Step 7—Manage Your Portfolio


The paperMoney platform is a state-of-the-art portfolio tracker that offers an extremely robust suite of paper-trading tools. It is very useful to simulate trading experiences, and encourages learning by doing.

Take some time to become acquainted with the information and tools available in the paperMoney system. Investools Online® offers an interactive introduction and tutorial to help you get up to speed. The tutorial is accessible by clicking on the Education tab, then selecting the Tutorials link below. From there, the My Free Tutorials box is located in the left navigation bar, which includes a paperMoney link that leads to the tutorial.

Portfolio Tool: paperMoney® Step 7—Manage Your Portfolio


In Step 2 of this course, the concept of protecting investor capital by using stop losses was introduced. This introduced the idea of money management, which deserves a more in-depth explanation.

Some of the material in this section will be a refresher from Steps 2 and 6. The material will expand on these concepts and introduce new and exciting techniques.

As you have learned, investing carries risk, so controlling that risk is paramount. You may have updated your investing plans with reference to risking no more than 2 percent of your portfolio on any particular trade (as was taught in Step 6). For the purposes of this course, a risk between % percent and 2 percent per trade will be considered the maximum acceptable risk.

Portfolio Risk and Allocation Step 7—Manage Your Portfolio


There are different ratios that go into risk management: trade risk, portfolio risk, maximum investment and portfolio heat. Here are the key terms and concepts to focus on:

Portfolio Risk (PR): Acceptable portfolio exposure

Stop Loss (SL): Difference between purchase price and stop-loss price

Position Size (PS): Portfolio risk divided by stop loss

Trade Risk: Position size times stop loss (should be equal to or smaller than portfolio risk)

Total Stock Investment: Position size times stock value

Maximum Invested per Trade: portfolio amount multiplied by the maximum investable percentage (10 percent)

Total Portfolio Investment: All open positions’ stock value

Portfolio Heat: Maximum loss or drawdown if all positions were to hit your stop losses

Portfolio Risk and Allocation Step 7—Manage Your Portfolio


Using an example portfolio with five identical positions, we have listed the various risks here.

Portfolio Amount $50,000Portfolio Risk Percentage 1%Portfolio Risk $500 ($50,000 X 1%)Stock Value $10.00Stop-loss Value $7.50Position Size 200 shares ($500 max. risk/$2.50 stop risk)Trade Risk $500 (200 X $2.50 stop risk)Total Stock Investment $2,000 (200 max. shares X $10.00 stock value)Maximum Invested per Trade $5,000 (10% x portfolio equity)Total Portfolio Investment $10,000 (5 X $2,000)Portfolio Heat $2,500 (5 X $500)

Step 7—Manage Your PortfolioPortfolio Risk and Allocation Example


Portfolio Amount – The example portfolio is $50,000.

Portfolio Risk Percentage – in this example students will only risk 1 percent for greater risk controls.

Portfolio Risk – This is the risk percentage multiplied by the portfolio amount to determine how much money can be risked in any one trade. Using the portfolio amount of $50,000 multiplied by the risk percentage of 1 percent, we have a portfolio risk of $500, which means we shouldn’t risk more than $500 on any trade.

Stock Value – For simplicity, assume that each stock in this example is at a price of $10.

Stop-loss Value – For this example, all stop losses are set $2.50 from the stock’s current price.

Position Size – This is the number of shares that can be purchased of each stock. This was determined by dividing the portfolio risk amount of $500 by the $2.50 stop risk.

Portfolio Risk and Allocation Example Specifics Step 7—Manage Your Portfolio


Trade Risk – Each trade will risk $500 or the number of shares purchased multiplied by the stop loss.

Total Invested – Trades will consist of 200 shares at the $10 stock price for a total of $2,000 invested.

Maximum Invested per Trade – Using a rule that no more than 10 percent of the portfolio is invested in any trade, no more than $5,000 can be used for each trade (10% x $50,000 = $5,000). In this case, each trade only amounts to $2,000 for each stock. The trades are well below the specified amount.

Total Invested – Five trades with $2,000 being employed for each one, equals $10,000 being invested.

Portfolio Heat – This is the amount of the entire portfolio that is at risk. Because $500 can be lost on each trade, if each trade was to fail, the portfolio could experience a $2,500 loss.

Portfolio Risk and Allocation Example Specifics Step 7—Manage Your Portfolio


In this example, if all five trades hit their stop loss at the same time, the account would lose $2,500, which is 5 percent of the $50,000 portfolio value. As explained previously in this course, large drawdowns are difficult to recover from. Here are the drawdown percentages for this example, including what return would be required to recoup the losses. If the example portfolio was to lose $12,500 or 25 percent of its value, the portfolio would have to gain more than 30 percent to recover!

Step 7—Manage Your PortfolioGains and Losses

% Loss of Capital10%20%30%40%50%60%70%80%90%100%

% Gain Required to Recoup Loss11.11%25.00%42.85%66.66%100%150%233%400%900%Broke!


Investors can avoid large losses like these by diversifying their investments. In the Principles of Investing course, you learned about correlated securities. When some investments fall, other investments rise. Avoiding large drawdowns is a benefit of diversification and when coupled with controls like stop losses, investors have more control over risk.

Step 7—Manage Your PortfolioGains and Losses


After learning how to analyze stocks from a fundamental and technical basis, developing routines for trading provides investors with consistency in the types of stocks they find as well as the returns from stocks over time. Creating a routine and following it, keeps a watch list full and up-to-date with potential trading opportunities. It also creates a repeatable pattern for daily, weekly and monthly activities. As you study these routines consider adding them to your investing plans. When the routines are pushed aside, trading results and risk management can suffer.

Here are some examples of daily and weekly routines.

Routines Step 7—Manage Your Portfolio


Check current positions and look to tighten stop losses

Add to current positions

Look at watch list for Set-Ups and Triggers (Set-Ups = stock setting up to give an entry signal in the next few days, while Trigger = the actual buy signal)

Look at the major markets

Continue investing education

Tune in to Virtual Coaching and Trading Rooms

Read the daily “Market Commentary”

Call coaches for clarification before paper trading

Daily Routines Step 7—Manage Your Portfolio


Run a top-down analysis

Determine long-, intermediate-, short-term trends of the global markets

Determine which sectors are leading the market

Determine which areas of the globe are outperforming others

Risk and diversification analysis

Analyze overall portfolio heat (continued...)

Step 7—Manage Your PortfolioWeekly Routines


Review which sectors and countries are invested in

Review trading journal

Plan and Complete Education

& Determine education path by speaking with an Education Counselor

& Determine study times

& Attend weekly Market Wrap

After creating easy-to-follow routines, it is time to integrate them into an investing plan and document trades in a trading journal.

Step 7—Manage Your PortfolioWeekly Routines


An investing plan can serve as part of your personally designed roadmap to reaching financial goals. At this point you should be very familiar with the area on Investools Online® for creating investing plans. The investing plan area of the site has a sample plan, and allows you to develop and save numerous plans to the Web site. Saving your investing plan to the Web site makes it accessible anywhere there is an Internet connection, and allows an Investools coach to view the plan with you while on a coaching call.

There are six categories of information that should be included on each investing plan:

Definition of Success

Watch List Criteria

Entry Rules

Exit Rules

Money Management

Routines

Updating Your Investing Plan Step 7—Manage Your Portfolio


In addition to the sample investing plan available on Investools Online, Below is a sample investing plan that includes some of the example rules and routines listed throughout this course.

Sample Investing Plan—Page 1 Step 7—Manage Your Portfolio


Sample Investing Plan—Page 2 Step 7—Manage Your Portfolio


In Step 2 of this course, you learned about evaluating performance via benchmarking. It is simple enough to look at specific benchmarks, but to know whether an investing plan is successful when compared to these benchmarks is a bit more complex. Keeping a track record or trade journal can help.

A personal trade journal helps you test strategies, adjust strategies (investing plans) and measure success (or failure) when compared to indexes or other benchmarks.

Numerous trade journals can be found in the Community section of Investools Online or a trading journal could be kept simply in a spiral notebook. It doesn’t matter the tracking instrument used, as long as investors track and measure results. Here are some key components to consider placing in a trading journal:

Trade Journal Step 7—Manage Your Portfolio


Stock Name Entry Price Portfolio Risk

Stock Ticker Entry Date Net Profit and Loss

Number of Shares Traded Exit Price Exit Date Investing Plan Used

Industry Group Initial Stop Loss Notes

Fundamental Scores Trade Risk

Certainly too much information can be just that: too much, rendering the information unusable. Too little information can also keep you from being able to truly analyze the success of an investing plan. Remember, successful goals are measurable goals.

Trade Journal Step 7—Manage Your Portfolio


In this lesson you focused on the principles of portfolio management by exploring concepts of money management, position sizing, portfolio heat and diversification. You should also have finished up your investing plans for stocks based on concepts taught in this course. And you should have started a trading journal to measure the success of each plan. Testing investing plans through paper trading will eventually lead to success as you move into the markets.

Review Step 7—Manage Your Portfolio

“Furious activity is no substitute for understanding.”

—H. H. Williams

Introduction to Trading Stocks Review


Every successful investor—including you—has an investing methodology. You can now begin applying the 7-Step Investing Formula® in your own account. As you progress through the Investools education, you may choose to refine your personal methodology as you incorporate options and currency investing. But for now, focus on laying a strong investing foundation.

Here’s a quick reminder of the seven steps taught in this course:

1. Prepare to be an investor: Trading Psychology

2. Protect your investment capital: Money Management & Diversification

3. Begin analyzing from the top down: Top-down Analysis

4. Conduct a thorough fundamental analysis: Fundamental Analysis

5. Search for additional strong stocks: Searching

6. Conduct a thorough technical analysis: Technical Analysis

7. Manage your portfolio: Portfolio Management

Investools 7-Step Investing Formula® Review Stocks 101 Review


Each step is a task with its own activities. You may not perform each step in sequence every day, but you should repeat each one on a regular basis. Some daily, some weekly and others less frequently. As you master these seven steps, you will find that you are well on your way to successfully managing risk and achieving success. But even then, the journey is not complete.

As your investing abilities and activities grow, there are other investing vehicles you might want to explore. Investing professionals use these tools to enhance returns or protect assets, or both.

Investools 7-Step Investing Formula® Review Stocks 101 Review

“Good luck is what happens when preparation meets opportunity, bad luck is what happens when lack of preparation meets a challenge.”

—Paul Krugman

Updating YourEducation Plan


In Step 7, you learned to how to manage a portfolio using the tools on the Investor Toolbox®, determining daily and weekly routines and figuring asset allocation applications. At this point you should have your initial investing plan in place. Of course the plan means very little if it isn’t being applied. A systematic methodology of making educated investment decisions will help investors become successful. Similarly, having a systematic methodology for becoming educated will help investors become successful.

To successfully complete this lesson, contact your Education Counselor to update your education plan.

Proper diversification doesn’t occur in just selecting stocks from various markets, sectors and industry groups, but through the ability to invest in any market. A diversification of strategy is as important as the diversification of assets. In its essence the 7-Step Investing Formula® is an intermediate trend-following methodology. The fundamental and technical factors have been carefully selected to help an investor capitalize on stocks during this time frame. However, there are a variety of other avenues that will help investors become better diversified and increase portfolio returns.

Updating Your Education PlanThe Next Step


Updating Your Education The Next Step

If you prefer to focus on stock investing consider pursuing the Advanced Fundamental Analysis and Advanced Technical Analysis courses. These two courses explore various avenues of investing from an expansion on growth, value, income or a blend of each. You will learn how to focus on trend lengths from intraday trading to long-term investing. Each of these courses offers more insights to evaluating the markets from the top down.


If you want the benefit of stocks without expensive stock prices, start your options education with the Basic Options course and then move on to the Advanced Options course. These two courses contain a copious quiver of strategies that can help an investor profit in any market. Speculators and income collectors can find a number of strategies that will help them define risk while increasing returns. These courses are designed to help you get the most out of the paperMoney platform by using the powerful analysis tools available.

Students who plan to take control of their financial future have already discovered the power of education and will want to obtain more to maximize their ability to succeed in investing. Whether the focus in on stocks, options or any other investment vehicle, you should start meeting with your Education Counselor to outline your education plan today.

Updating Your Education PlanFurther Education


Quotations

Buffett, Warren. Stock Trader’s Almanac 2005. Hoboken: John Wiley and Sons, 2005.

Eker, Harv T. Secrets of the Millionaire Mind. New York: HarperCollins, 2005.

Krugman, Paul. Stock Trader’s Almanac 2010. Hoboken: John Wiley and Sons, 2010.

Levy, R.A. Stock Trader’s Almanac 2005. Hoboken: John Wiley and Sons, 2005.

Livermore, Jesse. Reminiscences of a Stock Operator. New York: George H. Doran Co., 1922.

Lynch, Peter. One Up on Wall Street. Philadelphia: Running Press, 2001.

Neil, Humphrey. Stock Trader’s Almanac 2005. Hoboken: John Wiley and Sons, 2005.

Rhea, Robert. Stock Trader’s Almanac 2005. Hoboken: John Wiley and Sons, 2005.

Bibliography


Bibliography

Williams, H.H. “The Quotations Page.” 23 September 2010 <http://www.quotationspage.com/quote/929.html>

Zweig, Martin. All About the Market Timing: The Easy Way to get Started. New York: McGraw-Hill Professional, 2003.

Investools Introduction to Trading Stocks Slides

Documents

Transcript of Investools Introduction to Trading Stocks Slides