Understanding Stocks

by Michael Sincere

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”)

preventing large losses is more important than earning big profits.

In other words, sell winning stocks gradually; sell losing stocks at one time.

selling my winning stocks gradually (scaling out of a position) makes sense.

Brazil index fund.

Warning: Do Not Buy Leveraged ETFs Although there are many advantages to ETFs, there is

one type of ETF that should be avoided. It is called a leveraged ETF, and it promises to give you two or three times the return of the underlying index. In reality, leveraged ETFs are primarily for traders who and buy sell on the same day.

limit potential losses to 7 or 8 percent using stop losses.

CAN SLIM

C: Current quarterly earnings and sales A: Annual earnings increases N: New products, new management, new highs S: Supply and demand L: Leader or laggard I: Institutional sponsorship M: Market direction

O’Neil: Learn the rules. Learn to read charts. Study your mistakes.

After talking to Mr. O’Neil and studying CAN SLIM, I developed 26 rules.

The rules

Note: You can find company fundamentals on a number of websites such as Bloomberg, Briefing.com, Investor’s Business Daily, MarketWatch, Yahoo! Finance, and Google Finance, to name a few.

Sites to learn fundamental analysis

The financial newspaper Investor’s Business Daily rates the relative price strength (RS) of stocks in leading industries, giving them a score between 1 and 99. A relative

price strength rating higher than 90 is considered excellent. (Note: Relative price strength compares a stock’s price performance over the next 12 months with other stocks in the IBD database.)

(The Value Line Investment Survey

(Warren Buffett, for example, once said that he only buys companies

with trailing P/Es of 10 or less.) Nevertheless, although the P/E is useful, it should not be the only reason that you buy a stock.

Note: Pay attention to the P/E of the entire market. Typically, the P/E of the S&P 500 hovers around 15, its historical average. If it spikes higher, perhaps the market is overvalued. And if it drops well below 15, perhaps the market is undervalued.

A guideline for PEG users is as follows: A stock with a PEG of less than 0.50 is desirable (undervalued). A stock with a PEG between 0.50 and 1 is good (fair value). A stock with a PEG higher than 1 is not recommended, especially if the PEG is over 2 (overvalued).

Return on Equity (ROE): Measuring the Financial Health of a Company

Other Stock Measurements There are many other fundamental stock measurements, including return on investment (ROI), debt-to-equity ratio, price-to-book ratio (P/B), return on assets (ROA), cash flow per share, and dividend yield.

Institute for Supply Management (ISM) Indexes for Manufacturing and Non-Manufacturing activity. 2. Private-sector employment 3. Personal spending

The Secrets of Economic Indicators

(CPI) measures changes in prices such as those of housing and clothing. Some people refer to it as the “inflation number” or the “cost-of-living” index. If the CPI goes up, this means that inflation is rising.

All About Market Indicators (McGraw-Hill), aimed at beginning investors. In the book, I included interviews with the creators of the most popular indicators and explained the best way to use each.

Note: If you are interested in learning more about candlesticks, read the book Japanese Candlestick Charting Techniques, by Steve Nison.

Predict the Next Bull or Bear Market and Win (Adams Media).

Head and Shoulders Top Reversal (Bearish)

Double Bottom (Bullish—Looks Like a W)

Double Top (Bearish—Looks Like an M)

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.

For example, if the stock price moves below the 200-day MA, this is a signal to sell. If the stock price moves above the 200-day MA, this is a signal to buy. Short-term traders tend to use the 40- or 50-day MA to determine support and resistance levels. It’s sometimes uncanny how a stock can nudge up to the 40- or 50-day MA and then immediately reverse direction.

MACD (Moving Average Convergence Divergence)

There is much more to learn about MACD, which I include in my book All About Market Indicators (I couldn’t resist mentioning it again!). MACD, like any other indicator, is not perfect. Sometimes the signals are not clear, especially at market tops. Also, just as with moving averages, MACD can be a little slow to generate a signal. Still, MACD can keep you on the right side of a trend, which is why it’s so valuable.

Book recommendation

Bollinger Bands, RSI, and stochastics measure whether stocks are overbought or oversold. If a stock is overbought, this is a short-term signal to sell. If a stock is oversold, it is a signal to buy. The problem is that stocks can remain overbought or oversold for long time periods before reversing. It’s worth your while to study these indicators closely, especially when using short-term trading strategies.

Indicators for overbought and oversold

Selling Covered Calls

Selling covered calls, mentioned as a conservative investment option

The Federal Reserve System: A Government Group You Can’t Ignore

The Federal Reserve System (the Fed), created in 1913, is so powerful that anything it does influences the stock market. Often, you will hear about the actions of the Board of Governors, a seven-member group that directs the actions of the Federal Reserve System.

The Media

The Dollar: I’m Falling and I Can’t Get Up

Inflation

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.

Deflation: An Unusual Nightmare

Mistake 1: Not Selling Losing Stocks

As I’ve said earlier, if you lose more than 7 or 8 percent on an investment, sell. (If I lose more than 5 percent, my 5 percent rule, this is a warning sign. I then put the stock on my alert list. If it does not recover and continues to fall, I will sell it without hesitation.)

I really need to implement this

Mistake 2: Allowing Profitable Trades to Turn into Losers

Mistake 3: Getting Too Emotional (About Stocks)

To refresh your memory, some of the signs of a potential market reversal include: the market is going higher on declining volume, leading stocks are faltering, there is a strong market opening but a weak close, and there is more than a day or two of weak closes. All these clues indicate that institutional investors, who collectively move the market, are selling.

The best attitude you can have is a neutral one. Don’t come into the market with preconceived ideas of how much money you are going to make (always a bad sign) or that the market is going to go up or down. Let the market be your guide.

“Let the market be your guide” Troy Tropp would tell me that at times. Good advice, a person can’t “force” the market to move the way that one would want.... better to learn what it wants to do and make money working with it, where it is going.