Understanding Stocks

by Michael Sincere

The stock rises again to form the right shoulder but fails to break resistance. Keep your eye on the neckline, because when the stock breaks below the neckline, the chances are good there is profit to be made

short side (or money can be saved by exiting a long position). The broken neckline confirms that the upward

trend of the stock has ended and reversed. In addition, volume decreases as the pattern plays out until it almost disappears. Once the stock falls below the neckline, however, volume may increase if the st...

Double Bottom (Bullish—Looks Like a W) The double ...

for weeks or months before breaking out to the upside. Although this is an easily recognizable pattern, the double bottom doesn’t always give an actionable signal. Therefore, confirm the pattern with other

before making a trade. Figure 13.11 is an example of a double bottom. If the stock fails to break out, it could fall to that baseline once again, forming a triple bottom.

Double Top (Bearish—Looks Like an M) The double top is another common bearish pattern that shows two peaks

price level. After an uptrend, the stock has failed to break resistance after two attempts. If the stock tries to break through the top of the second leg but it fails, and sells off, the double top pattern is complete. The stock could consolidate for weeks or months before the trend changes from bullish to bearish. If the double top pattern is confirmed, it’s a clue that you may want to switch from buying to selling. Note the increased volume (circled at

changes. Just as with the double bottom, the double top doesn’t always give actionable signals. It’s easy to spot, but you should confirm the pattern with other tec...

Gaps are simply open spaces in the stock pattern. For whatever reason (perhaps breaking news when the markets are closed), there was no trading at a particular price level, and the stock jumps. Gaps are significant because

they indicate strong buying or selling demand. Most gaps occur in the premarket or aftermarket and are clearly visible on a daily chart.

Technicians have identified three types of gaps: continuation, breakaway, and exhaustion. How is this useful? If you own a stock that gapped higher on strong volume, you can continue holding the stock. If you identify a stock that gaps higher (or lower) but doesn’t reach a new high (or low), you might consider selling (it’s

exhaustion gap). If anything, a stock that gaps up but doesn’t reach a new high might return to fill the gap (retreat to the earlier, pre-gap, price).

Advanced note: Breakaway gaps occur when a stock gaps up (moves higher) on higher than normal volume. This may be the start of a significant move, or so the bulls hope. A continuation gap, however, which appears similar to a breakaway gap, occurs abou...

the gap openings, but it’s not easy. For example, one strategy is to “fade the gap,” that is, trade in the opposite direction of the gap (i.e., selling into the higher gap, or buy the dip on a lower gap opening). This strategy is effective when you correctly anticipate market conditions. If you’re a beginner, however, you can learn to identify gaps on a chart, and watch how the stock reacts. Hint: Don’t trade gaps until you gain a lot more experience. Figure 13.13 shows an example

The Market: The Most Powerful Indicator in the World

Volume: An Underestimated but Important Indicator

In today’s market, billions of shares are traded every day on all the stock exchanges. Most of that volume is generated by institutional traders and high-frequency

fact, one of the ways to follow volume is to determine what institutional investors are doing. For example, if the market (or your stock) is falling on heavy volume, that is a bad sign. It means a lot of investors (probably institutions) are selling.

On the other hand, if the market (or a stock) is rising on heavy volume, it’s a clue that institutions such as mutual f...

Hint: If a stock is rising on low volume, it means that the stock doesn’t have a lot of institutional support, which is a negative signal. Sometimes you

will hear people on Wall Street talk about a liquid stock.

This is another way of saying that it is easy to buy and sell shares of the stock. When you buy or sell shares of individual stocks, you want liquidity. For example, a stock without liquidity may be easy to...

indicators for both investors and traders is the moving average (MA). In fact, if I had to choose one indicator

use and interpret, and they give valuable clues to market (or stock) direction. A moving average is the average value of a security’s price over a certain time period, such as the last 20, 50, 100, or 200 days. By overlaying the moving average on a chart of the stock or market, you get a visual idea of how the stock (or market) has performed over the specified time period. When plotted on a chart, moving averages appear as curved lines that move higher

with each trading day. They offer clues about where a...

Many technical analysts use moving averages as support (which acts like a floor) and resistance (which acts like a ceiling). If the stock price rises above (i.e., breaks through) the moving average, this is seen as a bullish sign. Conversely, if the ...

In particular, many institutional investors use the almighty 200-day MA to define support and resistance. For example, if the stock price moves below the 200-day MA, this is a signal to sell. If the stock pr...

Short-term traders tend to use the 40- or 50-day MA to determine support and ...

neutral. If more than 60 or 70 percent of the members are bullish, it’s a sell signal. If more than 60 or 70 percent of members are bearish, it’s a buy. Although people can remain irrationally exuberant for a long time (and also irrationally bearish),

Many people use real estate as an investment. This includes buying a residential property, such as a single-family home, condominium, or townhouse. You also have the chance to sell it for a higher price or rent it out. As with investing in the stock market, you never want to buy real estate until you have done extensive research. An alternative to buying real estate is to invest in a REIT, a publicly traded company whose stock can be bought and sold on one of the stock exchanges. These companies purchase and manage various real estate properties. Note: It is more convenient to buy a REIT mutual fund or REIT ETF. Unlike real estate, the main advantage of REITs is their liquidity. In addition, REITs offer the benefits of buying and selling real estate without having

When you first get started with currencies, you can choose to trade in the currency futures market, which is a physical exchange, or on the forex “spot” market, where you will trade using a broker.

If you are a beginner, you’ll probably start with the spot market because you don’t need a lot of up-front money to get started.

If you want to participate in an IPO, however, be sure you read the prospectus, a legally binding document filed with the SEC that includes the company’s future plans as well as its current financial condition. Even after reading about all the risks, you can always ask your broker for some shares.

delivery of 1,000 tons of coffee, you can simply buy and sell the contracts.) The futures market uses a form of margining based on the principle of mark to market. If a futures contract was worth $1,000 and the contract is worth only $500 by the end of the day, the $500 loss is taken out of your account (in cash). In addition to mark-to-market rules, futures trades are also cash-secured, meaning that your account must be paid off or settled in cash by the end of the day. The mark-to-market rule has ruined many unsuspecting

futures traders who were forced by the rules to pay for their losses immediately.

The bottom line is that the futures market, although a useful and necessary trading platform, is not recommended for rookies.

(www.bloomberg.com) to see the U.S. stock futures or to look at market index

Stocks go up or down depending on the mood of the country and the state of the economy. Once again, a lot is based on perception. If people believe that economic conditions are improving and that the country is on the right track, they will be more inclined to invest in the stock market. Conversely, if people are worried about the economy, jobs, or whether we’ll go into a recession, they might pull their money out of the stock market.

One economic indicator that you should keep your eye on is the dollar. When the dollar is strong against other currencies, such as the yen and euro, foreign investors will buy our Treasuries and invest in our stock market. That’s the good news.

The bad news is that the strong dollar makes our goods

undesirable to foreigners (and exports decline) because they are expensive. A strong dollar also makes it hard for people to travel to the Un...

On the other hand, when the dollar is falling and is weak against other currencies, foreigners may pull their money out of our stock market. (Basically, they get hit twice, once when their U.S. stocks fall in...

If the dollar is falling, it is not a good time to travel overseas because it is more expensive. Perhaps the only positive thing that comes from a weak dollar is that foreigners can afford to buy our goods and ser...

Bottom line: If you are in the markets, keep your eye on the strength or weakness of the dollar co...

Inflation refers to the rate (as a percentage) at which the prices of the goods and services increase each year. When studying economics, you learn a lot about inflation. One of the reasons that people invest in the stock market is to try to beat inflation, that is, to increase their net worth by more than the effects of inflation. For example, suppose inflation is currently at 1 percent. This means that it costs 1 percent more to buy goods and services than it cost one year earlier. When you go shopping, you find that the prices of groceries, cars, and homes are higher. Because of inflation, the McDonald’s hamburger that cost you 15 cents in 1959 now costs $1.20. A seat at the movies that cost 25 cents back in 1960 now costs $10.00. That is the

Note: Many people forget that although the prices of goods rise over time, wages also rise. When hamburgers were 25 cents, the minimum wage was $1.00 an hour. And although a movie ticket might now cost $10, moviegoers earn a lot more now than they did in 1960.

Inflation that is too high is not good for the economy, which is why the markets respond negatively. It means that people are getting less for their dollars. Conversely, low inflation is good for consumers because they can afford to borrow, charge purchases on credit cards, and buy houses. The more consumers spend, the better

Note: Each month, the Bureau of Labor Statistics (BLS) prints inflation rates along with other fascinating data such as the unemployment rate, average hourly earnings, consumer price index (CPI), and labor productivity.

year, when everything costs more, this is inflation. Deflation, on the other hand, is an economic condition