Archives for August 2011

Untouched Stocks can Sometimes be Worthy!

S&P 500 futureMany times we come across “cheap stocks”; stocks which are relatively unknown. These stocks do not attract extensive analysts’ coverage. As a result, investors desert those stocks as it may look less appealing. Leave alone the retail investor even the large institutional investors shun such stocks as they only consider investing when the stock is covered by minimum number of analysts.

However, unknown stocks can be rewarding if the investors are ready to be patient for longer period of time. It is highly likely that this so called “cheap stock” trading at low price may belong to company which has excellent fundamentals and has a great potential to grow in the near future. But on the other hand such stocks also has some drawbacks as peaking of such stocks may take a very long time testing the patience of the investor.

How to identify such stocks?                                             

Hated stocks- Typically these are stocks which come under  the category of those stocks which are disliked by analysts because such stocks have disappointed them in the past by missing estimates, or by some other disappointing result or decision by the company. As result such stocks are valued at considerably lower price than what they actually command.  Still nobody wants to touch those shares which keep the demand of such stocks negligible. Smart investors should always be look out for such stocks. The biggest benefit of buying such stocks is these stocks are priced inappropriately and buying such stocks can reap huge rewards for smart investors as such stocks have enormous turnaround potential.

The misinterpreted/ misunderstood stock- Stocks come under this category when investors or analysts have wrong story about the company.   Typically, these companies have had the management which was once disliked by the analysts or some divisions of a company were not appealing to analysts and investors. But what analyst and investors do not realize is the company now has a new management or it has spun-off its loss making divisions or units.

Often people fail to find out change in the company’s management structure or restructuring of business which creates a turnaround potential. If investors are ready to pay lot more attention to details and do the due diligence then they can gain a lot by investing in such companies. A little bit of knowledge can create winning situation for an investor without taking too much of risk.

Hyped yet cheap stocks- This is a very dangerous category simply because stocks appear cheap only because of overhype, overestimation and assumptions which are not realistic. In fact such stocks are not cheap but the overexcitement and the bullishness over some sector or stock makes stock look very cheap. This category is ideal for short sellers as the momentum is very quick which make such stocks from expensive to “too or ridiculously expensive”. The dotcom boom is the best example when all shares related internet based or ecommerce based companies’ rose exponentially giving huge profits to those investors who were smart enough to sell those stocks quickly.

Unemployment Rate and the Markets

If you pick-up almost any business paper, you’ll see a mention of the monthly unemployment rate. This number is almost as ever-present as the monthly GDP figures or the monthly housing price percentage decreases or increases that can be seen all over the news. This monthly unemployment rate can have an effect on the financial markets since it essentially measures the strength of a nation’s workforce and underlying economy. If the unemployment figures constantly increase, that can directly affect the perception of a possible weakening economy. On the other hand, decreasing unemployment figures or percentages can positively affect the view of an economy’s overall health.

The unemployment figure is taken as a lagging indicator, which means that changes take place after economic changes. If the economy were gaining vigor, that vigor would only show up a few months later in unemployment figures. If the economy were waning, then that weakness would only be echoing in unemployment figures a few months down the line. The unemployment figure is also seen as a counter cyclic indicator, which means that it moves in the opposite direction of the economy. If the economy were robust, the unemployment figures would decrease, while if the economy were fragile, the unemployment figures would increase.

Even though unemployment figures are highly renowned statistics, which can affect financial markets on a whole, it does have intrinsic flaws. First, the unemployment figure is based upon a tiny sample size On the other hand; surveys don’t essentially have to include everyone in the process to be meaningful. Second, the survey keeps out a certain portion of the population – volunteers and those people who are not actively looking for unemployment for one reason or another. Even so, the unemployment rate is still a precious economic indicator that’s used in investment decisions.

Understanding Option Pricing

stocksMany fundamental investors have a very good track record in trading stocks. Many of these investors do not support the use of derivatives or options as a trading tool. The reason is that the complex nature of derivatives increases the chances of a making a loss. However, derivatives such as options also allow investors and traders to make a profit using limited capital.

Trading in options is very different than trading in stocks. The pricing mechanism for options is very different from stock pricing. In this article, we will explore the factors that should be considered if you plan to trade on options and be successful.

Determinants of Option Pricings:

Before starting with the option pricing traders should have a good understanding of the factors that determine the value of the options. These are current stock price, strike price, time value or time to expiration, intrinsic value, interest rates and cash dividends paid. Let us understand then one by one.

Intrinsic Value:

Intrinsic value of an option is the difference between the current stock price and the strike price of the option. Basically, the in the amount by which the option is ‘in the money’ means profitable by the difference between the current stock price and the strike price of the option. Below are the formulae for calculating Intrinsic Value of Call and Put Option:

Call Option Intrinsic Value = Underlying Stock’s Current Price – Call Strike Price

Put Option Intrinsic Value = Put Strike Price – Underlying Stock’s Current Price

The intrinsic value shows the financial benefit from an immediate exercise of the option. Options trading at the money and out of the money have no intrinsic value.

Time Value or Time to Expiration:

The Time Value of an option is the amount by which the option price is higher than the Intrinsic Value. It shows the relation with the time of the option until expiry. The longer the time of the option until expiry the more expensive or more price of the option. Below is the formula for calculating Time Value:

Time Value = Option Price – Intrinsic Value

The actual derivation of time value is more complex than the above equation. There are different models like the Binomial Option Price Model and Black Sholes Option Pricing Model that are used to determine the exact price of the time value.

Understanding option pricing is very important if you are considering trading options.

Understanding Market Movements with Dow Theory

DowMany consider the father of technical analysis to be Charles Dow, the founder of Dow Jones and Company which publishes the business newspaper Wall Street Journal. At the beginning of the 20th century, he wrote a series of papers which looked at the way prices of the Dow Jones Industrial Average and the Dow Jones Transportation Index moved. After investigating the Indexes he outlined his idea that markets tend to move in similar ways over time. These papers, which were extended by other traders in the years that followed, became known as “Dow Theory”.

Although Dow Theory was written more than 100 years ago most of its points are still applicable today. Dow focused on stock indexes in his writings; however the essential principles are applicable to any market. Dow Theory is broken down into 6 basic doctrines, which we take a look at below.

Markets Have 3 Trends.

  • Up Trends, which can be defined as a time when consecutive rallies in a security price close at levels higher than those attained in previous rallies and when lows happen at levels higher than previous lows.
  • Down Trends, this can be defined as when the market makes consecutive lower lows and lower highs.
  • Corrections, which can be defined as a shift after the market makes a move sharply in one direction where the market moves away in the opposite direction before continuing in its original direction.

Trends Have 3 Phases:

  • The buildup phase which is when the “expert” traders are aggressively taking positions which are against the bulk of people in the market. Price does not alter much during this phase as the “experts” are in the marginal so they cannot move the market.
  • The public involvement phase which is when the public at large catches on to what the “experts” know and start to trade in the same course. Quick price change can happen during this phase as everyone piles onto one side of a trade.
  • The Surplus Phase where out of control speculation takes place and the “smart money” begins to exit their positions.

Markets Discount All News

This means that once news is on the loose, it is quickly reflected in the price of an asset. On this point Dow Theory is aligned with the efficient market hypothesis.

This idea that the markets markdown all news is one that is cited in arguments in favor of utilizing technical analysis as a tool to profit from the markets as if it is true that markets already discount all basic factors then the only way to beat the market would be through technical analysis.

Averages Must Confirm Each Other

The averages must authenticate each other. Here Dow was talking about the Dow Jones Transportation Index and the Dow Jones Industrial Average. To comprehend this point it is vital to keep in mind that in Dow’s time the growth in the US was coming mostly from the Industrial sector. These two indexes were comprised of manufacturing companies and the rail companies which were the main method used to ship the manufacturers goods to market. What Dow was essentially saying here is that you could not have a proper rally in one of the averages without a confirmation from the other since manufacturer’s profits were rising they would have to ship additional goods. This meant that the proceeds of the transportation companies and therefore the transportation average should increase too. Dow stated that when these two averages moved in conflicting directions it was a signal that the market was going to change track.

Trends Are Confirmed by Volume

What Dow was saying here was that there are many reasons why price may shift on low volume, but when prices shift on high volume there is a better chance that the shift is representative of the overall market’s view. Dow was of the opinion that if many traders were participating in a particular price shift and the price shifts significantly in one direction, then this was a sign of a tendency developing as this was the direction the market was anticipated to continue to move.

Trends Exist Until Definitive Signals Prove That They Have Ended

What Dow was saying here is that there will be market shifts which are against the main tendency but this does not mean that the tendency is over and the market will normally resume its prior trend. There is much debate on how to best decide when a definitive indication has been given that the tendency is over.

Understanding Forex Bollinger Bands

TradingThe Forex Bollinger Bands is a gauge created by John Bollinger. Bollinger band helps you to gauge the volatility of the market.

It can tell you the current situation of the market by means of its upper and lower band.

Whenever the market has low volatility, the bands will be tapered and whenever the market has high volatility, the bands will be broad

In this article, we will not be going through the different complicated mathematical calculations for the individual tools as most forex platform automatically help you plot them out.

Here is the structure of the Bollinger bands

1) The upper band – which indicates the simple moving average + 2 x standard deviation

2) The lower band – which indicates the simple moving average – 2 x standard deviation

3) The Simple Moving Average (SMA)

The upper band generally shows a resistance level while the lower band generally shows a support level. If you take a close look at your Bollinger band, you will discover that the price generally bounces off the band whenever it touches the upper or lower band.

With this observation, you can employ the upper and lower bands as support and resistance when planning your trade.

Besides using the upper and lower bands as the support or resistance, you can also employ of Bollinger bands to aid you in measuring the volatility of the market.

When the upper and lower bands are tapered, you are in fact in a period of consolidation and when the bands are widely apart, you are in a period of strong price movement

Trading Forex with Strategy- Part 2

TradingIn the previous article, we looked at some crucial points that you must keep in mind when looking to trade foreign exchange. We now continue with some more important things that you should remember when trading.

If in doubt, stay out:
If you’re not sure about a trade and find you’re hesitating, stay on the sidelines.

Trade logical transaction sizes:
Margin trading permits the fx trader a very large amount of leverage, trading at full margin capacity can make for some very large profits or losses on an account. Scaling your trades so that you may re-enter the market or make transactions on other currencies is usually wiser. In short, don’t trade amounts that can possibly wipe you out and don’t put all your eggs in one basket.

Determine market sentiment:
Market outlook is what most of the market is supposed to be feeling about the market and therefore what it is doing or will do. This is essentially about trend. You may have heard the term ‘the trend is your friend’; this essentially means that if you’re on the right track with a strong trend you will make successful trades. This of course is very basic; a trend is capable of reversal at any time. Technical and fundamental data can point out however if the trend has commenced long ago and if it is strong or weak.

Market expectation:
Market expectation communicates to what most people are anticipating as far as upcoming news is concerned. If people are anticipating interest rate to rise and it does, then there generally will not be much of a movement because the information will already have been ‘discounted’ by the market, on the other hand if the adverse happens, markets will generally react violently.

Use what other traders use:
In an ideal world, every trader would be looking at a 14 day RSI and making trading choices based on that. If that was the case, when RSI would go under the 30 level, everyone would buy and by effect the price would rise. Needless to say, the world is not an ideal place and not all market participants pursue the same technical indicators, draw the same trend lines and recognize the same support & resistance levels. The great diversity of opinions and techniques employed translates directly into price diversity. Traders however have a penchant to use a limited variety of technical tools. The most common are 9 and 14 day RSI, clear trend lines and support levels, Fibonacci retracement, MACD and 9, 20 & 40 day exponential moving averages. The nearer you get to what most traders are looking at, the more accurate your estimations will be. The basis for this is simple arithmetic, larger numbers of buyers than sellers at a certain price will move the market up from that price and vice-versa.

Trade Forex with a Strategy-Part 1

Trading successfully is by no means an easy matter. It necessitates time, market information and market understanding and a large amount of self control. Anyone who says you can time after time make money in foreign exchange markets is being dishonest.

Foreign exchange by nature is a volatile market. The practice of trading it by way of margin raises that volatility exponentially. We are therefore talking about a very ‘fast market’ which is logically incoherent. Following that principle, it is reasonable to say that in order to make a successful trade, a trader has to take into account technical and fundamental data and make a learned decision based on his insight of market sentiment and market expectation. Timing a trade correctly is almost certainly the most vital variable in trading successfully but regularly there will be times where a trader’s timing will be off. Don’t expect to produce returns on every trade.

Let’s spell out what a trader needs to do in order to put the best chances for money-making trades on his side:

Trade with money you can afford to lose:
Trading fx markets is speculative and can effect in loss, it is also exciting, lifting and can be addictive. The more you are ‘involved with your money’ the more difficult it is to make a clear-headed decision. Money you have made is precious, but money you need to live on should never be traded.

Identify the state of the market:
What is the market doing? Is it trending upwards, downwards, is it in a trading series. Is the trend strong or weak, did it start long ago or does it look like a new trend that’s forming. Getting a clear image of the market condition is laying the groundwork for a winning trade.

Establish what time frame you’re trading on:
A lot of traders get in the market without viewing when they would like to get out, after all the goal is to show a profit. This is true but when trading, one must extrapolate in his mind’s eye the movement that one anticipates to occur. Within this extrapolation, lives a price development during a certain period of time. Attached to this is the idea of exit price. The significance of this is to mentally put your trade in view and although it is clearly not possible to know precisely when you will exit the market, it is vital to define from the beginning if you’ll be ‘scalping’ (trying to get a few points off the market) trading intra-day, or going longer term.

This will also resolve what chart period you’re looking at. If you trade many times a day, there’s no point basing your technical analysis on a daily graph, you’ll most likely want to analyze 30 minute or hour graphs. In addition it is vital to know the different time periods when various financial centers enter and exit the market as this creates more or less volatility and liquidity and can control market movements.

Time your trade:
You can be right about a possible market movement but don’t be too early or too late when you enter the trade. Timing considerations are twofold; a predictable market figure like CPI, retail sales or a Federal Reserve decision can combine a movement that’s already underway. Timing your move means knowing what’s anticipated and taking into account all thoughts before trading. Technical analysis can help you recognize when and at what price a move may occur.

Time for Investors to Look East

In the time of fragile global economic recovery, one market which stood out is Asia. If you are looking to invest in new markets then Asia is a promising destination as it offers lot of opportunities. The financial market in this region is also robust with trillions of dollars under the financial system. The Asian market can be distinguished under two categories: developed and developing economies. The developed economies include Japan, Hong Kong, Singapore and South Korea. The developing economies include economies like India, China, Malaysia and Thailand.

How to invest in or enter this market

Asia’s spectacular growth rate strengthened by cross border flow of global capital has made this place offering plenty of growth opportunities. Asia is an exciting place to invest. If you are looking to invest in this region then there are plenty of mutual funds and exchange traded funds (ETF). These funds are much diversified as they vary from region to region (south Asia/ south East Asia/ Asia Pacific) or are country specific or, sector specific. If you are delegating your research work for investments then fund managers and professional managers can easily guide you about above mentioned funds.

However, if you like to invest on your own then buying ADR’s (American depository Receipts) are the easiest way. Investing in ADR’s provides great opportunity to earn dividends and capital gains in the US dollars ADR’s are issued by the US bank which are negotiable certificates representing specific number of foreign shares under foreign stocks traded on US stock exchange.

Structural difference in Asian markets

Just like the Asian economy which is still growing its markets too particularly in developing economies are not yet mature. The bonds and equity markets are less regulated compared to Europe or America. When it comes to regulatory reforms then Asian stock markets are way behind their western counterparts. Political influence has a huge role to play particularly in developing Asian markets where government interventions are not uncommon.

This structural dissimilarities, mainly under regulatory affairs, demand investors to conduct an in-depth research and give thoughtful consideration to any investment in Asia mainly developing economies before adding it to their portfolios.

Booming Asian market and your portfolio:

Even though global markets and major economies are reeling under fragile recovery, Asian powerhouses are growing at phenomenal rate. Countries like China, Malaysia, South Korea, Malaysia and Thailand are export powerhouses. India is witnessing almost 8-9% GDP growth mainly through internal demand, which is growing very quickly. All these countries are witnessing consistent and positive GDP growth. Therefore, missing out this golden opportunity to invest will be a big mistake. Investors should allocate some part of their investment portfolio in Asia.

Terms of a Futures Contract

futuresA futures contract contains the specifications of the transactions. The specific of all contracts in a given commodity on a given exchange are identical, apart from the expiration dates. This standardization is an important feature of futures markets as it makes contracts interchangeable, freeing traders and investors from the need to worry about unusual provisions. The specifications cover the following.

Contract Size; This specifies how much of the asset must be delivered under one contract. Size for commodity futures is usually specified by weight or quantity. For financial futures, the value of the underlying asset is specified is monetary terms.

Quality; Contracts for commodity futures specify in the physical quality of the product the seller has promised to supply. They often use industry-standard product grades. Some contracts allow the seller to substitute substandard product at a reduced price. Of course, quality standards are not relevant for most financial futures contracts, such as currencies.

Delivery Date; Every Contract is available with a choice of delivery dates; the dates on which the parties are obliged to complete the terms of the contract. Contracts are typically identified by month, with delivery on a specified day or days of the month. Trading in a contract ceases on or before the delivery date.

Price Limits; To facilitate smooth trading, each contract specifies the smallest allowable price movement, known as tick or a point. Many contracts also specify daily limits for price changes to avoid large day-to-day swings. Chicago spring wheat futures may not rise or fall by more than $0.20 per bushel on any day.

Position Limits; The exchange imposes a limit on the number of contracts a speculator may hold for a particular delivery month and a particular commodity. The purpose of position limits is to prevent a speculator from cornering the market by owning a large proportion of open contracts and thus being able to manipulate price. Position limits do not usually apply to investors who can prove to the exchange that they are hedgers.

Settlement; Most future transactions do not lead to the actual delivery of the underlying products. However, the contract specifies when and where delivery must be made and may provide for the alternative of cash settlement, in which the parties fulfill their obligations by making or receiving cash payments rather than exchange goods.

Stock Picking Strategies- Part 5

Income Investing

Probably the easiest of all stock picking strategies is the income investing method, which involves identifying and investing in those companies that provide steady stream of income in the long run. Generally, steady stream of income is associated with government bonds; but stocks can also provide steady stream in the form of strong dividends.

Typically, income investors invest on mature, established companies that have reached a saturation point and growing beyond that point is not sustainable. Companies in utilities industry are the perfect example. As these companies are not rapidly expanding, earnings are not reinvested in the company resulting into stable streams of dividends for shareholders.

However, income investing does not mean that investors should look out for companies that provide highest dividend. Investors should look out for dividend yields, a ratio which is found out after calculating dividend earned on each share divided by the total number of shares outstanding. This method is an accurate form of dividend earnings rather than former method.

Usually, income investors demand a dividend yield of 5-6%. This means, if you are investing R$1 million in share capital of the company then you are expecting a dividend income of R$50,000 to R$60,000. In order to provide yourself a steady stream of income, your investing strategy should be very clear: choose those companies which provide sustainable strong yields in the future.

One more aspect where income investors need to be careful is company’s past dividend paying policy. Suppose, a company has been providing dividend yields of 2.5% in the past; now, all of sudden it decides to pay an annual dividend of 6% then investors should watch out whether this is sustainable or not. As a rule of thumb, longer a company is providing good dividends to its shareholders; more likely is that they will provide it in the long run. Investors should see that companies do not show over- optimism while increasing the dividend yields.

However, never invest money solely on high dividend yielding companies. Such companies are able to pay high dividends because they are not retaining substantial part of the income in the form of retained earnings. So if there is any scope for further growth such companies are unable to invest in new projects due to lack of retained earnings. Conversely, if such companies increase their retained earnings, then they can grow by investing in new projects which in turn might result into higher dividend yields.