Internet Trader/Prelims 14/3/02 10:30 am Page i

Diary of an Internet Trader

Internet Trader/Prelims 14/3/02 10:30 am Page ii

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Internet Trader/Prelims 14/3/02 10:30 am Page iii

Diary of an Internet Trader

Practical insights
in investment wisdom

Alpesh B. Patel

London New York Toronto Sydney Tokyo Singapore Hong Kong

Cape Town New Delhi Madrid Paris Amsterdam Munich Milan Stockholm
Internet Trader/Prelims 14/3/02 10:30 am Page iv

PEARSON EDUCATION LIMITED

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First published in Great Britain in 2002

© Tradermind Ltd 2002

The right of Alpesh B. Patel to be identified as Author of this Work has been asserted
by him in accordance with the Copyright, Designs and Patents Act 1988.

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the service of a competent professional person should be sought.

The publisher and contributors make no representation, express or implied, with

regard to the accuracy of the information contained in this book and cannot
accept any responsibility or liability for any errors or omissions that it may contain.
Internet Trader/Prelims 14/3/02 10:30 am Page v

To my forefathers
for a proud heritage


When I read the Bhagavad Gita and reflect about how
God created this universe everything else seems so
superfluous. Albert Einstein

I am convinced that everything has come down to us

from the banks of the Ganges – astronomy, astrology,
metempsychosis. Voltaire

India was China’s teacher in religion and imaginative

literature, and the world’s teacher in trigonometry,
quadratic equations, grammar, phonetics, Arabian
Nights, animal fables, chess, as well as in philosophy, and
that she inspired Boccaccio, Goethe, Herder,
Schopenhauer, Emerson, and probably also old Aesop.
Lin Yutang, Chinese scholar and author of the book,
The Wisdom of China and India

Access to the Vedas is the greatest privilege this century

may claim over all previous centuries. The general
notions about human understanding … which are
illustrated by discoveries in atomic physics are not in the
nature of things wholly unfamiliar, wholly unheard of or
new. Even in our own culture they have a history, and in
Buddhist and Hindu thought a more considerable and
Internet Trader/Prelims 14/3/02 10:30 am Page vi

central place. What we shall find [in modern physics] is

an exemplification, an encouragement, and a refinement
of old wisdom. J. Robert Oppenheimer, (1904–1967),
theoretical physicist and the Supervising Scientist for the
Manhattan Project, the developer of the atomic bomb

The land where books were first written and from

where wisdom and knowledge sprang is India.
The Fourth Caliph, Ali bin Abi Talib (656–661 AD)

The Hindus are indisputably entitled to rank among the

most ancient of existing nations, as well as among those
most early and most rapidly civilized ... where yet the
Pyramids looked down upon the Valley of the Nile…
when Greece and Italy, those cradles of modern
civilization, housed only the tenants of the wilderness,
India was the seat of wealth and grandeur.
Thorton, History of British India

The genius of Hinduism, and the very reason of its

survival for so long, was that it does not stand up
and fight. Mark Tully, former BBC correspondent in India

It is already becoming clear that a chapter which had a

Western beginning will have to have an Indian ending if
it is not to end in self-destruction of the human race. At
this supremely dangerous moment in human history , the
only way of salvation is the ancient Hindu way. Here we
have the attitude and spirit that can make it possible for
the human race to grow together in to a single family.
Dr Arnold Joseph Toynbee (1889–1975), British historian
Internet Trader/Prelims 14/3/02 10:30 am Page vii

About the author

Alpesh B. Patel
LLB; MA (Oxon); AKC;
Visiting Fellow Corpus Christi
College, Oxford (2001–2),
Barrister-at-Law

Trading

Described by Channel 4 as the UK’s best known internet

trader, Alpesh started programming computers in BASIC
at the age of 10 and buying stocks 18 years ago at the
age of 12 (although he seems normal nowadays), moving
on from privatization stocks to penny shares. He left a
legal career to trade full time.
Today he concentrates on US and UK stocks as well as
futures and options trading, making extensive use of the
internet for research since he was a Congressional Intern
in 1994 and combining this with his own technical analy-
sis systems. On Channel 4’s latest Show Me The Money
series he was number 1 of 45 expert stock pickers.
Internet Trader/Prelims 14/3/02 10:30 am Page viii

viii

ABOUT THE AUTHOR

TV, radio and print

Alpesh writes the Diary of an Internet Trader for the week-

end Financial Times and for Bloomberg TV he appears
weekly in Bloomberg Money on the Net.

Books

Alpesh is the author of Internet Trading Course, Pocket

Guide to Trading Online, Net Trading, Trading Online and
The Mind of a Trader (all published by Pearson Education).
His books have been translated into Spanish, German,
French, Chinese and Polish. Trading Online was the num-
ber one best-selling investment book on Amazon UK, and
reached number two on the overall bestseller list.

Lectures
Alpesh regularly speaks on trading psychology, online
trading and technical analysis around the world from
Guatemala to Spain to Beijing.
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ix

Contents

Acknowledgements xii
Introduction xiii

Picking stocks 1

1 What are the different trading styles and which is

best for me? 3

2 How do I use online trading stock news to my

advantage? 11

3 Is long-term trading really ‘all that and a bag

of cash’? 41

4 What’s all this technical analysis and charting about

then? 47

5 Is it easier to trade a sector than a stock or a whole

index? 61

6 Inspire me that an online trader really can beat the

professionals 65

7 Where does past performance fit into stock

picking? 69
Internet Trader/Prelims 14/3/02 10:30 am Page x

CONTENTS
Picking brokers 73

8 Online brokers not for all 75

9 Just what type of broker is right for me? 81

10 Why do so many traders have the wrong broker? 89

Portfolio and risk management 93

11 What do I need to know about my portfolio that

the professionals know? 95

12 What is risk? How do I quickly and easily measure it

like a professional trader? 103

13 Why do I want to invest in bonds and what is the

best way for me? 119

Active trading 129

14 Should I trade actively? Which are the best tools

and what do the wrong ones cost me? 131

15 Why do so many people continue day trading? Is

there something in it or not? 141

16 I want to trade actively, so what about options

then? 147
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xi

CONTENTS
Foreign trading 167

17 I want to trade foreign stocks – am I mad or ahead

of the pack? 169

18 What about riskier foreign markets then? 183

19 How does foreign exchange affect my

portfolio? 189

Finale 199

20 Am I better off not trading online? Surely not? 201

Glossary 207
Further reading 227
Index 237
Internet Trader/Prelims 14/3/02 10:30 am Page xii

Acknowledgements

I t would be a mistake to think that, because this is one of

several books I have had published by Pearson Education,
acknowledgements are owed any the less than for the first
book.
I remain grateful as always to Jonathan Agbenyega, who
seized the idea and, like all the members of the Pearson
team, remained enthusiastic throughout.
As ever, I am sure in the eyes of reader I will receive all
credit for the hard work of Penelope Allport, Susan G. R.
Williams, and the wonderful, energetic team at Pearson.
But most of all I am grateful because each book is a joy
to my parents, and an ambition realized by me.

Alpesh B. Patel
2002
Internet Trader/Prelims 14/3/02 10:30 am Page xiii

Introduction

Why you need to read this book

Why are some people richer than others? They could both
have the same IQ and the same money to start with, the
same jobs paying equal salaries; each working as hard as
the other and paying the same household expenses. But
one of them will end up wealthier. How?
The answer lies in the differing knowledge each has
about finances. As JP Morgan recognized: ‘Private infor-
mation is the source of virtually all great wealth.’
The purpose of this book is to disseminate some of that
private information – what the rich know and the rest do
not. Its findings have been good enough to be published
in the Financial Times and read worldwide by millions of
readers, in the form of my column.

Why do I need to worry about trading online, if I am

just going to buy and hold for the long term?

The reason so many people trade online is precisely

because buy and hold takes so long to give you any
returns at all. Just see the diagram on page xiv.
Internet Trader/Prelims 14/3/02 10:30 am Page xiv

xiv

INTRODUCTION
S&P Composite 1966–1980
140

120

100

80

60
This 14-year bear market includes the
40 crash of 1973–74

20
1/66 10/67 7/69 4/71 1/73 10/74 7/76 4/78 1/80
Adjusted for inflation, the S&P 500 did not
return to its 1966 peak until 1991

Why you need to trade online

Consider the important calculations any sensible investor

needs to do before investing. Do you know how to
calculate the effect on your portfolio of a 10 per cent
market shock? Do you even know why you need to know
this? Do you know what type of stocks are most likely to
give you growth without volatility?
What if I told you the answer is easy to calculate in
seconds online, but with pen and paper would take
months. And do you know what the likely reaction of your
portfolio will be six months later – the answer is important
because otherwise the next time the market dumps 10
per cent how else do you know to sell or hold on?
Not only does this book tell you where to look, but it
also tells you why and what the rich online investors know.
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xv

CHAPTER TITLE
What the rich know

So what do rich investors know? Well, here’s a summary:

■ They know how important it is to have an investment

style suited to their needs and goals, and they know
how to find it.
■ They know how to look for investment opportunity
clues on online news stories.
■ They know when to switch to short-term investments
and when to have long-term ones.
■ They know how to save precious time by going
straight to the most valuable online sites that do the
hard work for you.
■ They know which financial securities to trade, not just
equities, but also new innovations which give them a
head-start advantage.
■ They know what not to do in selecting a broker and
in picking stocks.

This book takes you through all these findings and advice.

Alpesh B. Patel
Internet Trader/Prelims 14/3/02 10:30 am Page xvi
Internet Trader/chap 1 5/3/02 11:05 am Page 1

Picking stocks
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Internet Trader/chap 1 5/3/02 11:05 am Page 3

c h a p t e r o n e

What are the different

trading styles and which is
best for me?

Volatility: How do I buy in on the

ground floor and get out at the top?

What do you do if your stock

portfolio jumps from $30,000 to How do you
$500,000 in five months on ensure you get in
over-exuberance, but then falls for the upside
back to $30,000 three months and get out
later, perhaps on under-
before the
exuberance? How do you ensure
downside?
you get in for the upside and get
out before the downside?
Having a trading style is one way of avoiding the gut-
wrenching rollercoaster pain in the financial theme park.
A trading style protects profits and avoids losses as the
market falls. By adopting a style and understanding what
it entails, you develop discipline, avoid confusion and gain
fast relief from trading nausea.
Internet Trader/chap 1 5/3/02 11:05 am Page 4

4
DIARY OF AN INTERNET TRADER

Which are the major trading styles

used by market professionals?

Here we go…

Momentum
These investors look at the stock price to see whether it is
rising and at a rate stronger than its peers. They also look
to see whether earnings are exceeding expectations and
look for broker upgrades. The traders in this group tend to
be short term as they exit as soon as momentum
decreases. A momentum trader may have an exit rule such
as ‘sell half the holding if the stock falls 10 per cent from
its most recent high and sell the rest if it falls 15 per cent
off its most recent high price’.

Who is this style best suited to? The style is best

suited to those who have the time to monitor the markets
and are comfortable with a shorter-term outlook.

Some sites? Sites providing news about broker updates

and earnings estimates include those with AFX news and
RNS wires – RNS stands for regulatory news service; it will be
bland, basic news, with no interpretation. AFX are news
articles from the associated financial press and are therefore
opinionated, though the opinion may not be adequate.
Most online brokers such as E*Trade (www.etrade.com) and
Schwab (www.eschwab.com) provide this type of news.
Price charts are available on the free interactive charting tool
from Big Charts (www.bigcharts.com) and eCharts.com.
Internet Trader/chap 1 5/3/02 11:05 am Page 5

W H AT A R E T H E D I F F E R E N T T R A D I N G S T Y L E S A N D W H I C H I S B E S T F O R M E ?
Aggressive growth
These investors are often looking
for new companies which are Aggressive
growing very quickly. Such compa- growth investors
nies often have no earnings as they may calculate
are in the early stages of growth, they could lose
and tend to have limited trading at most their
history, so can be high risk. These initial investment
investors would have bought
but make many
QXL.com, ARM or BATM soon
more times that
after those stocks came on the
and therefore
market. Aggressive growth
investors may calculate they could find the risk-
lose at most their initial investment reward ratio
but make many more times that attractive.
and therefore find the risk-reward
ratio attractive.

What sort of trader do I have to be to go aggres-

sive? Aggressive growth traders tend to be short term,
exiting as growth prospects plateau and moving onto the
next aggressive growth stock. Many are found hunting
for internet and technology stocks before or shortly after
initial public offering (IPO). I don’t recommend this strat-
egy to those who are not willing to potentially lose sub-
stantial sums in short periods of time in the search for
potentially equally substantial gains.

Sites? Sites of particular interest to this breed include

www.eo.com, www.issuedirect.com, www.newissues-
ipo.com and ipo.com.
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DIARY OF AN INTERNET TRADER

Core growth
These investors will stick to large blue chip stocks that
have been the best performers on the Nasdaq, Dow Jones,
FTSE 100, etc. in terms of revenue and earnings growth.
They are willing to pay the extra in higher valuations that
such stocks often carry. Stocks like AstraZeneca, Cisco
Systems, GE, GlaxoWellcome and BP Amoco would
feature in their portfolios.

Where do I look? Fundamental stock data such as

earnings and valuation data is available for such investors
from the following excellent sources: Hoovers
(www.hoovers.co.uk), Hemscott (www.hemscott.net),
Wright Research Centre (http://profiles.wisi.com) and the
excellent www.quicken.com.

Core value
These traders look for historically low or below sector or
industry average price-to-earnings, price-to-book and
price-to-sales ratios. The stocks are typically below market
average profitability, but the investor expects a
turnaround and buys and holds until that occurs and the
market revalues the stocks. Energy and financial stocks
tend to be favoured by these investors.
Websites for the core value trader are the same as for
the core growth investor.

Deep value
These traders are a more aggressive version of core value
investing. They seek extremely low valuations and go for
Internet Trader/chap 1 5/3/02 11:05 am Page 7

W H AT A R E T H E D I F F E R E N T T R A D I N G S T Y L E S A N D W H I C H I S B E S T F O R M E ?
especially unfavoured sectors and stocks. They are
sometimes called ‘contrarians’ and often seek drastic
corporate changes such as takeovers, management buy
outs or sale of assets.

Growth
These traders are more aggressive than core growth
traders but less so than aggressive growth traders. They
will avoid relatively overvalued stocks even if they are blue
chip in the search for stocks likely to grow better than
average. They may look towards relatively undervalued
medium-cap stocks with better than sector average
revenue growth rates.

Sites? The medium to longer-term traders will find the

news sites and fundamental data sites mentioned above
the most useful.

Growth at a reasonable price (GARP)

These investors are looking for presently undervalued
stocks with the potential to outgrow the market. This
strategy is more conservative than a growth strategy and
tends to be medium to longer term in outlook. Sites pro-
viding company financial data, especially valuation data
mentioned above, are the most useful to this type of
online trader.
They would have steered clear of most internet stocks
since these were either loss-making or overvalued on
traditional valuation measures such as price-earnings (P/E)
ratios.
Internet Trader/chap 1 5/3/02 11:05 am Page 8

8
DIARY OF AN INTERNET TRADER

How do I choose the

best trading style?

Trading style selection should be based on your trading

experience, your aversion to risk and the sums of money
you are willing to risk, and your personality. For instance,
until a couple of years ago I was too impatient for ‘buy
and hold’ strategies, preferring the quick performance
feedback that comes from momentum trading. Equally, I
am not comfortable with aggressive growth investing as I
do not find the win-loss ratios attractive. Presently, I have
a momentum-based portfolio and a core growth portfolio.

Which type of traders have the

best performance record?

For the past few years momentum

If you are traders have outperformed value
comfortable with investors. However, that may now
different styles be changing. If you are comfortable
then, unlike a with different styles then, unlike a
fund manager, fund manager, you could take
advantage of the freedom you have
you could take
to switch styles.
advantage of the
The above classification is not
freedom you
exhaustive and you should also
have to switch remember that the likely returns
styles. from different trading styles vary
according to market conditions.
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W H AT A R E T H E D I F F E R E N T T R A D I N G S T Y L E S A N D W H I C H I S B E S T F O R M E ?
Figure 1.1MThe erratic performances of fund managers
suggest picking the right fund is more an
accident than a skill

Ten Mutual Fund Rankings

1988–97
100 *
*
80 *
Percentile Rank

60

40

20

0
1988

1989

1990

1991

1992

1993

1994

1995

1996

Year 1997

MSCI Emerging Market Index

MSCI Emerging Mkt. Mid, Latin American Index
MSCI AC Far East ex Japan Index
* Kaufman
SunAmerica Small Growth Co A
Columbia Special
Parnassus
American Cent-Ben Tar Mat 2015
Chase Vista Grow & Inc. A
Ariel Growth
Internet Trader/chap 2 14/3/02 2:41 pm Page 10
Internet Trader/chap 2 14/3/02 2:41 pm Page 11

c h a p t e r t w o

How do I use
online trading stock news
to my advantage?

There is so much online trading

share news – how do I use it?

News is important. It allows us to get a feel for why the

market is moving, then why a sector may be moving, and
downwards onto an industry then into a stock (see Fig
2.1). News has many functions for the trader.
Internet Trader/chap 2 14/3/02 2:41 pm Page 12

12

DIARY OF AN INTERNET TRADER

Figure 2.1MLayers of news

Company
news

Industry news

Sector news

Market news

What types of focus should

I give and what questions
should I be asking?

Look at Table 2.1. There is a lot of information on the web

and you have little time. Therefore you need to know where
to go to get the knowledge you require and how to use it
once you have it.
At the outset of your trading you must have a general
idea of what parts of the economy are doing well. Your
aim as an online trader is to invest in those projects that
will present you with the highest possible return relative to
the plethora of other available investment projects, over a
given period of time.
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13

H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
Table 2.1 Types of news and their uses for the
online trader

Type of news Uses

Market news ■ Is the market in trouble?

■ Is there much negative news that
will stop stocks soaring?
■ Are there economic problems in the
economy, such as high inflation, low
growth, strikes, political uncertainty,
low productivity, all of which will
impact stock price rises?

Sector ■ Which sectors are rising and which

are falling?
■ Is there sector rotation, i.e. some
sectors accelerate while others fall?
■ Is there growth in certain sectors,
e.g. technology, and trouble with
others, e.g. consumer goods?

Industry ■ More specifically, which industries in

a sector are enjoying good growth?
■ Is there news about positive
telecoms development or negative
tobacco issues?

Company ■ Is the company generating a sound,

positive stream of news?
■ Or is it warning of earnings
problems? Good news flows should
be reflected in strong upward price
moves. How is the price faring?
Internet Trader/chap 2 14/3/02 2:41 pm Page 14

14

DIARY OF AN INTERNET TRADER

But there are so many
areas to invest in

Therefore you need to have a starting point, otherwise

you will be swamped. A good starting point is to ask
general questions about the markets and stocks and then
proceed to answer those questions. As you work your way
through the chapter, answer the following questions:

■ Which markets am I interested in?

■ Is the general economy doing well?
■ Which sectors am I interested in?
■ Is the US telecoms sector (or other sector you may be
interested in) suffering?
■ Which telecoms stocks have been popular?

All this questioning – what

purpose does it serve?

Questioning is the first stage of analysis. It helps to focus

your thoughts so that you can create an efficient plan of
action. But it’s not enough to ask questions. Here is where
the general market news comes in. Financial and market
news is crucial because it answers your queries and
encourages further questioning.
And, of course, if you wish to trade on the market index,
e.g. the FTSE 100 or the Nasdaq, rather than any particular
company, general market news is directly important.
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15

H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
What types of news articles
should I look at?

Table 2.2 Different news styles

Type of news What it provides How to use it

Newswire A quick-fire Can give us

(also called summary of news advance warning
market pulse) items. Limited of impending price
(Fig 2.2) analysis. Mainly moves. Most
just describes what useful to short-
has happened. We term active trader
have to do most of because of its likely
our own analysis. impact on prices in
the short term.

Column A regular writer The columnist is

(commentary) offers a daily or usually taking the
(Fig 2.3) weekly piece on a recent newswires
particular issue and adding a bit
such as telecoms more analysis and
stocks or emerging opinion to them –
market stocks. explaining their
significance to us.
They give us a
clearer picture of
which stocks we
should investigate
further.
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DIARY OF AN INTERNET TRADER

Type of news What it provides How to use it

Feature An infrequent, For the longer-term

(Fig 2.4) very detailed trader as usually
special feature on identifying longer-
a sector. term prospects.
Often identifies
value stocks whose
present stock price
does not yet
accurately reflect
future prospects or
which will
gradually rise over
time as the
company ‘proves
itself’.

Figure 2.2 Newswire

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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
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2:41 pm

Special feature
14/3/02

Column
Internet Trader/chap 2

Figure 2.3

Figure 2.4
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DIARY OF AN INTERNET TRADER

All news is not the same, and each type of news has different
uses for the trader. We need to appreciate the different types
of news and how to use them – see Table 2.2.

Where should I look?

Here are some of the best news sites. The sites listed in the
next section on researching individual companies will also
be useful for general news.

411 Stocks ***

www.411stock.com

This is a simple megasite for finding information about a

stock. Provides price data, news, discussion groups,
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
charting, fundamental data and income statements. A lot
of information in one place.

Bloomberg ***

www.bloomberg.com

An abundance of news and commentary in a no-nonsense

format. Excellent reporting, sharp presentation and speed
for top-notch coverage of industry, markets, hi-tech stocks
and the global economy. The site is cleanly designed.
Valuable information delivered well.
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DIARY OF AN INTERNET TRADER

CBS MarketWatch ***

www.cbs.marketwatch.com

Front page packs essential breaking stories on the market

and companies. The information is well organized and
easy to navigate, with keyword searches. Links in articles
are well thought out. Free tools include company research,
charts and delayed quotes.

CNNfn ***
www.cnnfn.com

With its reporters worldwide the site is able to break news

and offer a very fast newswire service. Its writers also do
more in-depth thoughtful, analytical pieces which we as
traders can use too.
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
The Financial Times **
www.ft.com

The reliable pink pages online has full access to its leading
companies and markets news. It also has a searchable
archive and you can get news e-mailed to you.
Also see FTMarketWatch at www.ftmarketwatch.com –
decent market coverage and analysis. Offers an
assortment of model portfolios. Well-written articles. The
design is uncluttered.

LatinFocus ***

www.latin-focus.com

Sharp site for investors in select Central and South

American countries. Pull-up detailed economic profiles
packed with data. An excellent place for initial research.
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Money.net ***
www.moneynet.net

Free streaming real-time quotes. Recently added improved

market news and message boards. Very valuable.

MSNBC **
www.msnbc.com

Bill Gates foray into all things financial. Credible because it

is linked with NBC. Very user friendly.

Reuters Moneynet **
www.moneynet.com

Market commentary is very good. Breaking news.

Category news and companies prominent in the news
today will all be very helpful to get you started. However,
little visual variety makes it a bit monotonous.
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
Wall Street Journal **
www.wsj.com

The main problem with this site is the annoying regis-

tration aspect. Other than that the news content is best for
thoughtful pieces, not necessarily the newswire aspects.

WorldlyInvestor ***
www.worldlyinvestor.com

An excellent collection of columns and in-depth features

from industry practitioners, which means they are
especially insightful and helpful to the trader. The site is
well organized so you can focus on the sectors in which
you are most interested.

I want to see which sectors the

websites are picking up on.
Are there any sectors they think
are particularly interesting?

Well, I would click on the CBS MarketWatch site which

always has useful, insightful commentary – the type that
knows what is really happening in the markets and is
written for traders to profit from (Fig 2.5).
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Figure 2.5 CBS MarketWatch headlines

The headline which catches my attention is ‘Tobacco gets

a buzz’ – clearly, there has been some positive news
surrounding tobacco issues and I may want to investigate this
sector further. So I read on (Fig 2.6).

Figure 2.6 The news gets more detailed

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E X E R C I S E S – Y O U H AV E A G O

Visit four of the sites listed above and scan for two
major economy or sector stories that suggest fur-
ther investigation may lead to good stocks to
research.
Remember as you do this:

■ the clue is in the headlines;

■ it should not take time – the headlines should
jump out at you;
■ after the headline see which subtitle looks the
most promising;
■ print out the story for later cross-reference to
assist in your research and to keep in a folder so
that it can help with your trade planning (more
about this later) if you decide to buy the stock.

Jot down your findings here:

Potential stocks to
Site: Headline: investigate:
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Should I listen to the commentary?

But how do you know whether you should listen to that

one commentator on that one site? Easy:

1. Is it a well-respected site such as the ones I have

listed here? If it is not listed above, is it one whose
brand you have come across before?

2. Scan a few other sites. Do any of them pick up a

similar theme, e.g. tobacco stocks likely to rally?

3. Make a note of the stock names and the reasons the

site gives, then use them later when you do your
own research and confirm for yourself whether you
agree these stocks are a good buy or a goodbye. A
good trader doesn’t take anyone’s word for it but his
own.

But surely if the story is in the

headlines the stock price
will already have jumped?

This can sometimes be true for very immediate price

moves, but if you are a longer-term holder it need not be
a problem. We are looking for the types of news stories
that suggest the price has yet to move up, are forward
looking, for instance something headed:

Telecoms undervalued
Pharmaceuticals still further to ride
Housebuilders may end slide
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
I have heard about a company and
am interested in it as a potential
investment – how do I gauge whether
I should invest into this company?

The news is a starting point, but it’s time for you to decide
whether the company looks good enough for you.

What kind of things would I want to

know about a potential investment?

Here are a few suggestions:

■ What exactly is their business and how big is it?

■ Any major items of recent news about the company.
■ How much profit analysts think it will make in the
future; the firm’s business strategy.
■ What other investors have thought of it.
■ How its share price has performed in the last few
years.
■ How their accounts look – how profitable they are and
how profitable they can be.

For now let us focus on company-specific news.

What procedures should I follow?

To find out news about a specific company using any of the

excellent sites mentioned above is relatively easy as they all
follow a similar format.
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Ticker box
The first thing you need is the company’s ticker symbol.
The symbol lookup link under the ticker box will help you
find the ticker symbol for your stock. You then enter that
into any appropriate box – see Figs 2.7 and 2.8. You will
then be taken to more detailed information about the
stock, which usually includes the most recent news.

Figure 2.7 Symbol lookup link and ticker box symbol

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Figure 2.8 Symbol lookup box for searching company
tickers

Story
Often, however, whenever a company is mentioned in a
story the company name is underlined, meaning if you
click on it you will be taken to more information about the
company, including news (see Fig 2.9). Some sites allow
you to search for news but the same principle applies (Fig
2.10). Fig 2.11 shows how CBS MarketWatch presents the
news.
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Figure 2.9 Clicking on highlighted stock names takes
you to more information about those companies,
including news

Figure 2.10 News search facility – this is not available

on most sites, but Ft.com and Moneynet.com have good
search facilities
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
Figure 2.11 All the news from Microsoft

EXERCISES

1. Find the ticker symbols for the following four

stocks:
■ Cisco (US).
■ Sun Microsystems (US).
■ Atlantic Telecom (UK).
■ France Telecom (French).
2. For each of these companies find both the
latest and historical news using one of the
websites mentioned above.
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What about news about
non-US stocks?

Simply go to a site that caters for this type of news. For

example, FTMarketWatch will give you stock symbols and
news for UK and European companies as well as US ones.

What should I be looking for

in a company newsflow?

Positive news items about the company include:

■ winning new orders;

■ increasing orders;
■ entry into new sectors;
■ new product developments;
■ good strategic alliances;
■ accelerations in the current business model.

We also want to know what the analysts are forecasting

for upcoming profits. This is worth knowing because
analysts receive regular private briefings from the company
on how things are going and so are usually on the mark
with their estimates.
Finding out what other investors have thought of the
company through ‘chat rooms’ and ‘share picks’ is inter-
esting since you can gauge other people’s opinion. If there
is some aspect of the company you are wondering about
or cannot understand, other people’s opinions will be
helpful. However, there are various warnings that are
stamped on these sorts of prescriptions, so beware.
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Remember: an investor’s opinion is just one estimation,
one outlook, not the last word.

How do I scan newsflow?

Since there are many news items and we want to be as

efficient as possible so that we can make our money and
actually have time to spend it instead of sitting in front of
the computer all the time, we need to know how to scan
these news headlines.
The general rule is that news companies try to tell as
much as possible in the headline. Consequently I tend to
focus on those headlines which common sense tells me are
likely to include some of the information I am looking for.
In the example below I have highlighted the ones I
consider in that category out of a series for Sun
Microsystems. However, I may also examine some of the
others if I think I need more information about a stock.
The following newsflow for Sun Microsystems shows
some headlines which merit further investigation.
headlines for: sunw

Friday, August 11, 2000

11:56 PM Startup Axient Bets On Private Fiber
Network — WITH A 60-CITY NETWORK,
AXIENT GETS DEAL FROM NBC TO
DELIVER BROADBAND OLYMPIC
COVERAGE – CMP Media
11:56 PM Vendors As VCs — Money And Influence
— As the biggest technology vendors
increasingly act as venture capitalists,
what are they getting in return? – CMP
Media
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11:56 PM Finding Components On The Web —
DEVELOPMENT PORTALS OFFER TESTED,
CERTIFIED, REUSABLE CODE THAT HELPS
SPEED PROJECTS – CMP Media
11:52 PM The New Developer Portals — BUYING,
SELLING, AND BUILDING COMPONENTS
ON THE WEB SPEEDS COMPANIES’ TIME
TO MARKET – CMP Media
11:51 PM Vendors Partner With Venture Capitalists
To Fund Startups – CMP Media
11:50 PM The Two Faces Of E-Biz Management –
CMP Media
11:50 PM Sun teams with vignette – CMP Media
11:50 PM Stealing Java’s Thunder — Microsoft’s
upcoming Visual Studio.net offers an
integrated development interface, a new
programming language, and programming
shortcuts that should result in more-
efficient Web development. A secondary,
unstated aim is to slow Java’s progress –
CMP Media
11:39 PM AMD, Intel draw 64-bit battle lines – CMP
Media
11:37 PM XML GAINS MOMENTUM — ebXML
emerging as EDI alternative for B2B
transactions – CMP Media
6:05 PM GSA Awards FirstGov Contract to GRC
International – PRNewswire
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H O W D O I U S E O N L I N E T R A D I N G S T O C K N E W S T O M Y A D V A N TA G E ?
4:14 PM WRAP: Dell shares fall 11% on concerns
about future sales growth (Update 1) –
Futures World News Select
3:46 PM LinuxWorld Conference & Expo Exhibitor
Profiles A to Z; Conference and Expo to
Start Next Week in San Jose, Calif. –
BusinessWire
2:47 PM Stock picks of the week: EMC, Pfizer, Sun,
Johnson & Johnson and H-P – Deborah
Adamson CBS MarketWatch.com
12:54 PM First Ecom.com Inc. Announces Second
Quarter Financial Results – BusinessWire
11:02 AM Robinson-Humphrey Analyst Interviews On
RadioWallStreet.com – BusinessWire
9:45 AM Planet City Software Teams With CRD
Capital – PRNewswire
Thursday, August 10, 2000
11:01 PM Sun, Microsoft Java Battle Delayed –
Unknown (cmtx-pc)
8:23 PM James J. Whitney Named Forsythe
Solutions Group’s E-Business Solutions
Technologist – BusinessWire
8:13 PM PVI, Sportvision, Inc. Named Winners
Success Story Receives Recognition from
Sun Microsystems, Computerworld
Competition – PRNewswire
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EXERCISE

Find and then highlight the most important news

items for the Indian technology company Satyam
which is listed in the US under ticker code SIFY.

■ Did you learn anything about US corporate

investment in India?
■ Did you find out the names of major US
companies investing in India?
■ Did you discover Indian economic conditions?
■ Has Satyam entered into recent alliances?
■ What other interesting stock moving news was
there for the stock?

Can you give a quick

summary of key terms?

Technical analysis – methods used to forecast future

prices using the price data alone (for example by plotting
it as a chart and noting direction) or using the price as an
input in mathematical formulae and plotting the results.
Contrast this with fundamental analysis.

Fundamental analysis – forecasting prices by using

economic or accounting data. For example one might base
a decision to buy a stock on its yield.

Market capitalization – this is the product of the number

of shares outstanding and the current price.

Director dealings – whether the directors have been

buying or selling shares in their company.
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Should I also look
using a search engine?

Of course. The internet is a huge expanse of information

and if you want to navigate it and find the information you
want, you will have to search. A search engine is simply a
site that ‘searches’ other sites depending on keywords
entered by a user. Search engines are therefore of general
use, not just for the online trader.

How should I search?

Simple: type in the keyword and press enter. If you want to
be technical, most search engines will have options which
allow you to specify whether the engine is to provide
results that contain the keywords as a phrase or any one of
the keywords.
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■ Since pages on the internet change quickly, a search
engine is unlikely to be up to the minute and some
results may be out of date.
■ Just because an engine does not find a site does not
mean it does not exist.
■ Because of the different ways search engines work,
each will return different results.
■ If you are not satisfied with the results, try a different
engine.
■ Results are ranked according to the closeness of the
match to your request and not according to the best
available site in terms of content.

Which are the top search engine sites?

Use these sites yourself to search for information on

specific areas of trading:

■ Altavista www.altavista.com
■ Excite www.excite.com
■ Lycos www.lycos.com
■ Yahoo! www.yahoo.com

SELF-ASSESSMENT

1. Which one of these is not something you

would find a useful piece of market news?
a. Inflation projections.
b. Last year’s inflation figures.
c. Expected growth rates.
d. Possible foreign armed conflict.
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2. What is sector rotation?
3. What is another name for a newswire service?
a. Market wire.
b. Market rotation.
c. Market pulse.
d. Market beat.
4. To what type of trader is a newswire most
useful?
a. Active short-term traders.
b. Medium-term traders.
c. Long-term traders.
5. Which has the least analysis?
a. Market pulse.
b. Column.
c. Special feature.
6. Does stock price always react to news?
7. Name a site that provides news on non-US
securities by allowing you to enter their ticker
symbols.

Answers:

1. b – because they are backward looking.

While they are relevant in shaping this
year’s expectations, they are too far in the
past to have market influence.

2. Where sectors that were not increasing in

price start growing as money rotates into
them and out of previously leading
sectors.
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3. Market pulse (used for instance by
FTMarketWatch.com).

4. Active short-term traders as such news is

purely factual and tends to influence the
immediate price, although it can often have
longer ramifications, depending on how it
is interpreted.

5. Market pulse – it tends to be factual

reporting, not with opinion.

6. No – that is one reason why trading is so

difficult.

7. www.ftmarketwatch.com, for example.

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c h a p t e r t h r e e

Is long-term trading
really ‘all that and
a bag of cash’?

What are long-term online

investors to do when markets
head for the floor?

Not to fear, there is much to help

you keep your nerve through However, based
such turbulent times. Consider on the same
that since 1950 US investors index, the
have experienced more than 29 average bull
market corrections (when the market lasts 47
market declines by 10 per cent months, with an
or more) and 11 bear markets (a
increase of 123
20 per cent decline) based on
per cent – well
the S&P 500. The average length
worth waiting for
of these bear markets has merely
been around seven months, if you are a buy
with an average decline of 28 and hold investor
per cent.
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However, based on the same index, the average bull

market lasts 47 months, with an increase of 123 per cent
– well worth waiting for if you are a buy and hold investor.

What if I lose my nerve and exit,

hoping to re-enter once things
appear more bullish?

According to Fidelity, one of the world’s largest fund

managers, if in 1980 you invested $10,000 tracking the
S&P 500, by 2000 your investment would have been worth
$185,000. If, however, in an attempt to ‘time’ your entry
and exit you missed the best 1 per cent of days in the past
20 years, you would have had a mere $34,000.
Of course, Fidelity fails to tell us what would happen if
in attempting to time the market you missed the worst 1
per cent of days.

What strategies might the buy and

hold investor adopt in these difficult
conditions to shore up his nerves?

Dollar cost averaging is one way to ensure falling markets

are not all bad news.

Huh?

Here the online investor makes periodic purchases

regardless of market movements. It reduces your cost per
share because you are buying more shares when prices are
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I S L O N G - T E R M T R A D I N G R E A L LY ‘ A L L T H AT A N D A B A G O F C A S H ’ ?
down and fewer shares when prices are high. For instance,
say you intended to buy $12,000 of IBM stock on the first
trading day of January 2002. Instead of making the whole
investment, you may reason that
since you do not know the best
time to buy you will cost average Cost averaging
and invest $1,000 monthly in the yields impressive
stock instead. results even if in
Such cost averaging yields the short term
impressive results even if in the markets fall as
short term markets fall as long as in long as in the
the long term they rise. The sum of long term they
$2,000 invested in the S&P 500 rise
annually since 1975 even on the
worst possible day each year (the
market high) would turn to more than $500,000 in profits
by 2000, according to Micropal, the special fund
monitoring and research company.

Any more strategies?

Yep. Another way for buy and hold online investors to

reinforce their nerves as the turbulent market dents their
portfolios is to remember that stock returns become less
volatile over longer periods.
Take the S&P 500 during 1926–1995. Returns over a
rolling one-year period fluctuated from +50 per cent to
–50 per cent. Over a rolling ten-year period that drops to
+20 per cent to –1 per cent. Longer holding periods reduce
risk of loss. Of course, the downside is that it reduces
spectacular gains, too.
Try www.hemscott.net and bigcharts.com for free long-
term online share charts.
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Is the long-term view

the best way to go?

Well, of course the best reason for buy and hold investors to
hold their nerve is the billionaire investor Warren Buffett.
Berkshire Hathaway, his investment company, has produced
a 24 per cent growth per share in book value for the past 35
years.
Unfortunately, my impatience prevents me from ever
becoming a long-term buy and holder. Even Warren
Buffett missed the TMT (technology, media and telecoms
stocks) mania gains of 1999. He
didn’t buy technology stocks
Even Warren because he correctly reasoned that
Buffett missed overvalued stocks are not a good
long-term buy. However, those who
the TMT
profited from the rise in TMT shares
(technology,
in 1999 and (because of their short-
media and
term perspective) exited as the
telecoms stocks) market fell in 2000 will over the two
mania gains of years 1999–2000 have outper-
1999. formed Buffett. (If you’re a tech
head, check out www.herring.com
and www.interstocks.com.)

So it depends then?

The trick for the short-term trader is to be able to maintain

that outperformance and not get caught in the slump.
And that really does require some nerve.
Figs 3.1, 3.2 and 3.3 make the point that if you are
thinking of being a long-term investor, then you really
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I S L O N G - T E R M T R A D I N G R E A L LY ‘ A L L T H AT A N D A B A G O F C A S H ’ ?
need to be very long term because in the short term
portfolio returns are all over the place; only over
decades do they rise consistently. Portfolio numbers
refer to differing levels of risk, from 10 the lowest to 90
the greatest.

Figure 3.1MAnnual returns over 27 years

1975 1985
45
1991

30 1995
Annual Return (%)

1999
15

–15
1974 1990
–30
1973 1976 1979 1982 1985 1988 1991 1994 1997

Portfolio 10 Portfolio 30 Portfolio 50 Portfolio 70 Portfolio 90

Figure 3.2MEvery 3-year returns over 27 years

110
85–87
100 76–79
90 91–93
80
70
60
Return (%)

50
40
30
88–90
20
10
0 73–75
–10
73–75 76–79 79–81 82–84 85–87 88–90 91–93 94–96 97–99

Portfolio 10 Portfolio 30 Portfolio 50 Portfolio 70 Portfolio 90

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Figure 3.3MEvery 9-year returns over 27 years

450
400 1982–1990

350
1991–1999
Return (%)

300
250
1973–1981
200
150
100
50
0
1973–1981 1982–1990 1991–1999

Portfolio 10 Portfolio 30 Portfolio 50 Portfolio 70 Portfolio 90

Internet Trader/chap 4 5/3/02 11:15 am Page 47

c h a p t e r f o u r

What’s all this

technical analysis and
charting about then?

How can I predict which way a

stock is going to go?

This question is at the heart of any choice about a stock –

all other questions flow from this one. One way of evalu-
ating whether a stock price will rise is to analyze how the
price has moved in the past. Technical analysis (or TA to its
friends) is a basis for forecasting future prices using
(recent) past price data.

So, is there any more to TA?

Technical analysis is a method of determining opportune

buying and selling points. It involves methods used to
forecast future prices using the price data alone (for
example by plotting it as a chart and noting direction) or
using the price as an input in mathematical formulae and
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plotting the results. Contrast this with fundamental

analysis, which looks at a company’s accounts, reports, etc.
in order to evaluate price moves.
Whenever we use TA, or any other form of analysis, we
are, in fact, looking for points where there is an increased
probability of a price move. We look for areas into which
it is highly probable that the price will move.

When is TA a better tool

than fundamentals?

Well, TA tends to work best over a time frame of a few

days to a few months, so it is ideal for short-term to
medium-term trading. Many of the indicators and
methods of analysis we will examine are trying to
determine when traders may have overreacted and
therefore have sold too much stock too quickly or vice
versa, and therefore afford us the opportunity to enter or
exit the market at the best time to maximize profits.
However, TA does not always work. It cannot explain
everything in the market, since the market does not
behave in a necessarily consistent manner.

What are the basic tools and

strategies?

I am not going to go through every single analytic method

known to man and beast. I am going to focus on the
techniques I use, that are the most popular and that the
major institutions use. At the end of this chapter you won’t
have a PhD in TA, but that doesn’t matter – you’re going
to use TA, not lecture on it.
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Let us start from the top. The first thing all technical
analysts will do is put up a price chart, of which there are
many types.
Bar charts (Fig 4.1) are the most popular way of
depicting prices. The extremities of the price high and the
low determine the length. The horizontal line on the left of
each vertical line represents the opening price, and the
horizontal line on the right represents the close.

Figure 4.1 Bar chart

In the Japanese candlestick (Fig 4.2) there is a ‘body’

and a line (like a wick). The body is a rectangle drawn
between the open and close of the day. It is shaded black
if the close is lower than the open, and white if the close
is above the open. The wick is added to join the high and
low of the day. Of course, if there is no price movement
after the open, there will be no body or wick, just a
horizontal line.
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Figure 4.2 Japanese candlestick

There are many more, including the straightforward line

chart (Fig 4.3), but you get the point.

Figure 4.3 Line chart

What do I do with these charts?

What am I looking for?

In a word, trends. A trendline simply joins a series of higher

lows and lower highs.
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W H AT ’ S A L L T H I S T E C H N I C A L A N A LY S I S A N D C H A R T I N G A B O U T T H E N ?
Uh?

Look at Fig 4.4. We see the line joining higher and higher
lows. Drawing trendlines is an art and you should not look
for exact points but a feel of where prices are hitting the
approximate narrow area around the line and then moving
back up. What trendlines try to represent are areas where
there is a relatively increased probability of a price move off
the trendline. You would not trade off the trendline, but
rather use it as one piece of evidence when determining
likely price moves.

Figure 4.4 The trend is your friend

Is there any more to trendlines?

By drawing support and resistance levels we are again

trying to determine areas where prices are probably, but
not certainly, going to behave in a particular way (see Fig
4.5). This shows support and resistance levels, the lower
line being the support. So for instance, when the price
approaches the resistance area, it has greater difficulty
getting past that area and you may decide you want to exit
your position (if you are holding one) at that point.
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Figure 4.5 Support and resistance levels

Like trendlines, support and resistance levels are not set

in stone. They are liable to move and can be penetrated
intra-day or over a couple of days. They are zones of
probable price action.
With trendlines and supports and resistances, the
probability of a price move in a particular direction
increases the longer the trendline has been in ‘force’, i.e.
not been significantly penetrated. For example, if the price
has hit the trendline on five occasions and then moved up,
it should do the same the sixth time it hits the trend.

So what is the explanation of price

movements along a trendline?

With supports and resistances what we are seeing is a

battle between buyers and sellers. For instance, at a
resistance level sellers may have decided they will start
selling a security at that level because it is overpriced, and
buyers are too few to do much about it. So the price has
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W H AT ’ S A L L T H I S T E C H N I C A L A N A LY S I S A N D C H A R T I N G A B O U T T H E N ?
to retreat as selling increases. If buyers increase in number
and size at the crucial point then the price may break
through with the force of a broken dam, marauding
buyers thus pushing the price higher and higher. This is
one reason why price often jumps at breakouts with a
sharp rise, a gap in price and large volume.

What should I look for?

Look for penetration or breakthrough of the resistance – if

there is one it should be followed by a big move. An alter-
native method of trading is to wait and see if the trendline
or support is not broken, and then trade in the direction of
the rebound.

What counts as penetration

of the trendline?

Given market volatility you could get price piercing a

trendline or support or resistance but then closing back
above. For this reason, some analysts only draw trendlines
and supports based on closing prices, because intra-day
prices are too erratic. Others say the price must close for
two or three days in the penetration position.

■ When a support or resistance level is broken it tends

then to reverse its role and become a resistance level
or a support level respectively (see Fig 4.6). This is a
common occurrence known as a ‘reversal pattern’ and
the same rules apply as before.
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■ After a breakthrough of a support or resistance the

price will often ‘pull back’ to the trendline it has just
broken through. You have to be careful of this as you
may think the move has just ended, in which case you
may exit an otherwise profitable trade prematurely.

What patterns suggest a turning

point in the share price – hopefully
indicating an up-turn?

Reversal patterns
These are chart patterns which historically have tended to
precede a reversal in prices. Again, they are added to our
overall evidence of what the price may do, which gives a
better idea of whether we should exit a position or enter
one.

Head and shoulders strategies

An anatomical pattern this. Take a look at Fig 4.6. It is not
always as clear-cut. This is a common pattern on bar charts
and fairly reliable. The horizontal line represents the
‘neckline’ and you always wait for it to be broken for it to
be a head and a shoulder position. The pattern can occur
on a slope. The position can also occur as a bullish (rising
share price) pattern if it appears as an opposite or mirror
reflection.
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W H AT ’ S A L L T H I S T E C H N I C A L A N A LY S I S A N D C H A R T I N G A B O U T T H E N ?
Figure 4.6 Head and shoulders

Triangle strategies
Figure 4.7 shows a triangle. For a price reversal on the
upside the horizontal line appears above the ascending
diagonal line. We are then looking for a breakout of the
horizontal line. To trade the pattern you can treat it very
much like a breakout pattern from a resistance level.
Volume should be decreasing to the apex and then
increase on breakout as the marauding purchasing
invaders breach the sellers’ line of defence. Below is an
ascending triangle; the descending triangle is an exact
mirror reflection and would represent a price breakout on
the downside.
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Figure 4.7 Triangle

Saucer strategies
The pattern for this is shown in Fig 4.8. It represents a gradual
change in opinion about a stock. Although a saucer is rare, if
you can spot them as the price is rising they can be an
additional confirmatory indicator of a trend change. There
are no price targets for this pattern so exit needs to be
determined more by rising percentage stop-losses or exit
points determined by other technical methods.

Figure 4.8 Saucer

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W H AT ’ S A L L T H I S T E C H N I C A L A N A LY S I S A N D C H A R T I N G A B O U T T H E N ?
What patterns suggest that share
prices will continue to move in the
current direction?

Continuation patterns
These patterns confirm that the current direction of price
movement will continue. They can represent a pause in
price and so can be used as a good point to step on before
the escalator starts moving up again.

Rectangles
The rectangle is simply where the price action moves
sideways between a support and resistance level after a
rise. It can be thought of as a resting place where buying
and selling troops stop to reconsider the price levels.
A strategy for this is to trade it in the same way you
would any other breakout of a resistance. Unlike a normal
breakout, the fact that price has risen up to the rectangle
formation adds to the likelihood of the breakout.

Flag strategies
A flag can appear in an uptrend or downtrend (see Fig
4.9). The flag looks like a rectangle rotated diagonally
upwards and is preceded by a downtrend. The flag is
where, instead of a sideways move after a downturn,
buyers for a while outgun sellers and cause prices to rise,
as they believe prices have oversold, but the sellers soon
return as price rises. The flag is important only after the
bottom of the flag is pierced – so wait for that. If it is not
pierced, you simply have a reversal.
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Figure 4.9 Flag

Pennant strategy
The pennant shows a rising trend followed by a price move
where low boundary lines converge, representing the
battle between buyers and sellers. Volume should decrease
to the apex and increase on the breakout of the upper
boundary. You can treat the breakout of the upper
boundary in the same way for trading as we discussed
before about trading breakouts generally (see Fig 4.10).

Figure 4.10 Pennant

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W H AT ’ S A L L T H I S T E C H N I C A L A N A LY S I S A N D C H A R T I N G A B O U T T H E N ?
What general lessons
should I note when looking for
the above TA patterns?

Before moving on we should make a general point about

how the TA tools examined are to be used as part of your
overall trading strategy. Remember:

■ Any single tool is not sufficient as the basis of a

trading decision.
■ The tools must be used in conjunction, each providing
further confrmation or not. Find out which tools are
best for you.
■ The TA tools must also be used to precisely time your
entry or exit from a position. Timing your entry or exit
is critical, since it is not enough to think the price will
rise or fall in the next couple of weeks. TA is a fine-
tuner.
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c h a p t e r f i v e

Is it easier to trade a
sector than a stock or
a whole index?

Is picking the right sector easier

than picking the right stock?

Of course it is. It is easier to predict how a sector will go

than a specific stock in a sector. Moreover, volatility either
reclaims stock gains or results in downright losses.

What about an index?

Contrast indices and individual stocks with sectors and

your chances of a return seem to improve.

So why don’t all online traders invest

in sectors and not just stocks?

Because until recently it was far easier to buy a stock. But

no more. Exchange traded funds (ETFs) are one way to
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invest in sectors – see www.morningstar. com;

www.indesfunds.com/ETFzone.htm ETFs represent a
portfolio of stocks and are available on European sectors,
for example, as ‘iShares’ (www.ishares.net) such as the
iBloomberg European Resources. Unfortunately the
iShares are available on only a limited number of sectors
and all are pan-European. US sectors, by contrast, are well
covered by other ETFs called ‘holders’ (www.holders.com).
You can trade ETFs just like a stock through online
brokers such as www.dljdatek.com, www.ameritrade.com,
www.fastrade.co.uk and www.fimatex.co.uk.

How are they different to trusts?

Unlike trusts, you can trade them any time during market
hours on real-time prices. And unlike a sector investment
trust, such as those listed on www.moneyextra.com, you
would know exactly the composition of the portfolio of
stocks throughout the day.

Does this mean I can trade actively?

Yes, such characteristics make active trading easier too,

allowing easy and quick exits should sector sentiment
change rapidly.

But how do you anticipate

a rising sector?

By examining sector rotation – the movement of cash from

some sectors into others. I look for signs of rotation by
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IS IT EASIER TO TRADE A SECTOR THAN A STOCK OR A WHOLE INDEX?

examining weekly sector gains and losses covering
fortnightly and monthly periods. Sectors with consecutive
periods of increasing gains are clearly the ones money is
entering. Comdirect.co.uk and my own creation,
www.pathburner.com/sectors.asp, have useful sector
charts.

What other ways can

I anticipate rotation?

Another way to anticipate sector rotation is to examine their

price charts for period-on-period growth on software. Finally,
look at newsflow and analysts’ reports covered by sites such
as www.digitallook.co.uk and www.ftmarketwatch.com.

How should online traders

interpret strong sector growth?

Any sector that rises strongly will evoke two types of

reaction from online traders. First, it’s gone up so much so
soon, it must be ready for profit taking and therefore too
late to enter. The opposing view is, what’s been working
for the past three months is hardly about to stop working
without some sector-wide bad news, and so the trend
should continue.

So who’s right?

I follow the second view: wait for price improvement

following newsflow and positive analyst comment, even
risking getting in a little bit late, then stay in for the rise
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until the price (not necessarily poor newsflow) shows

weakness by making new, say five or six-day, lows.

Of course, there is a price to pay

for picking sectors, surely?

Well, you’re not going to get

the huge returns a stock can
provide. By definition a sector Sectors are more
cannot outperform its best forgiving than
performing stock. However,
stocks and that
you won’t have the kinds of
can make them
losses you could have with a
more rewarding,
stock either. In essence,
too
sectors are more forgiving
than stocks and that can
make them more rewarding,
too.
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c h a p t e r s i x

Inspire me that an online

trader really can beat
the professionals

And the prize for best fund manager goes to…you – the
online investor. In second place is the professional full-time
fund manager.
The top 100 online investors on Marketocracy.com not
only outperformed 99.8 per cent of all US professional
fund managers during the second quarter of 2001, they
also outperformed all the main market indices, too.

Surely these online investors are

outperforming professionals by
taking excessive risks?
Well, Marketocracy.com requires them to abide by strict
rules which all online investors should consider.
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How?

First, no position can exceed 25 per cent of your total

portfolio value. Second, half your portfolio must be
comprised of positions under 5 per cent each. Third, you
must classify whether your investment style is growth,
value or a blend of the two. This last rule ensures an added
professionalism and discipline.

Am I outperforming professional
fund managers too? How do I
measure my online portfolio?

Measuring your portfolio performance is not straight-

forward. Investors tend to overstate their performance
because of mathematical or psychological errors. Mathe-
matical errors can include simple things like including the
cash inflows as part of their returns. Psychological errors
involve revising history: ‘Oh, I had an off day when I
picked those two stocks, I’ll leave those out of my calcu-
lations.’

How about some maths?

The maths is a little tricky. Imagine your $1,000 investment

grows to $1,500 after three months (i.e. R1 = a 50 per cent
gain). You then add another $1,000. The $2,500 then
appreciates to $4,000 over the next nine months (R2 = 60
per cent gain). What is your total return?
Total return = R1 + R2 + R1xR2 or 0.5+0.6 + 0.5x0.6 =
140%
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I N S P I R E M E T H AT A N O N L I N E T R A D E R R E A L LY C A N B E AT T H E P R O F E S S I O N A L S
The total return is not simply the profit/capital, i.e.
2000/2000 (100 per cent) because your profit was earned
on different amounts of capital. For instance, if you
produced a 100 per cent return on $1,000 and then intro-
duced $10,000 into your account on the last day of the
year, your return is still virtually 100 per cent.

Having calculated my performance,

how do I beat the fund managers?

Exploit the advantages of being small, explains Peter Siris in

Guerilla Investing (1998, Longstreet Press). That often means
small cap investments. See specialist site www.itruffle.com or
www.smallcapcenter.com for small cap picks and news.
With billions to invest, many funds can’t invest even 0.5
per cent of their capital without owning the company
outright. If a fund’s minimum investment is $300 million
and the fund does not want to own more than 50 per cent
of a company, then there’s only 200 large cap public
companies to choose from.

Which stocks produce higher returns?

Large or small companies?

Small cap stocks produce higher returns than large ones

over a long time frame, according to research by Nobel
prize winners Merton Miller and Myron Scholes. Moreover,
Ben Warwick in In Search of Alpha (2000, John Wiley &
Sons) confirms that with more money under management,
pension funds confined to large caps find it increasingly
difficult to generate alpha: market-beating returns.
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As well as investing in small caps,

how else can I beat the fund
managers?

By adjusting the number of

stocks in your portfolio.
Buffett goes for
Robert Hagstrom’s The
the latter
Warren Buffett Portfolio
(2000, John Wiley & Sons)
approach: ‘Put all
explains that a portfolio with your eggs in one
250 stocks is less likely to basket and
beat the market than one watch the basket
with 15 stocks. But the like a hawk’
fewer the stocks, the more
volatile the returns (the
beta) – i.e. the greater chance you will trail the market too.
Hagstrom suggests Buffett goes for the latter
approach: ‘Put all your eggs in one basket and watch the
basket like a hawk.’

What if I cannot deal with alphas

and betas, etc.?

If alpha and beta is all Greek to you, then of course

consider investing through a fund manager, as should
those who simply do not have the time or inclination to do
their own stock picking. But don’t be surprised if your civil
engineer neighbour comes home from work in a Ferrari.
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c h a p t e r s e v e n

Where does past

performance fit into
stock picking?

All things being equal, should an

online trader buy a stock that has
doubled over the past year, or halved
in value over that time frame?

I was asked this at a lecture, and it became clear that the

answer is not as obvious to some as it is to me. Of course,
all things are seldom equal, but it is a common dilemma
among traders whether to focus on the shooting star
stocks that just keep going up, or the dogs that just keep
on drowning. It annoys me how many get the answer
wrong. Equally interesting is what it reveals about them as
traders and people.
The dilemma often starts like this: our first trader, let us
call him Richard Traderman, is always on the look-out for
stocks which are at their lows. His reasoning for buying
into such stocks often falls into three fallacies.
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The three fallacies if you will?

■ The first fallacy is the ‘if you burn it, they will come’
fallacy. It goes like this: ‘The stock cannot keep falling for
ever, the sellers are likely to sell too much and their
overreaction will see buyers flood in and the price rise.’
■ The second fallacy is the ‘white knight’ fallacy, and the
reasoning is thus: ‘If the stock price does keep falling
and the company gets cheaper, then someone is
bound to come in and take the company over or
institutional investors and shareholders will force a
management restructure which will see the company
share price rocket.’
■ The final fallacy is the ‘human infallibility’ fallacy,
which runs like this: ‘I have an insight into the
management and prospects of this company that the
rest of the market has yet to see. Soon, clouds of
ignorance will be removed from before the eyes of
market makers and traders, and they too will see the
light and the promised value this company surely
deserves – according to me.’

So what would a smart trader do?

Our second trader, Alec Smart, always examines the share

price trend first before even considering a stock purchase. He
wants to see it rise smoothly upwards, with the stock
becoming progressively more expensive in absolute terms
each month.
Both Richard Traderman and Alec Smart want the same
thing from their trading – they want to make money.
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W H E R E D O E S PA S T P E R F O R M A N C E F I T I N T O S T O C K P I C K I N G ?
Who is more likely to be
successful and why?

You may have guessed whose side I am on. In my view, it

will almost always be Alec who will be the more successful.
First, while occasionally manage-
ment overhauls occur and white
knights appear, the timing is unpre- The ‘human
dictable. A stock can languish at infallibility’
depressingly low values for months, fallacy, which
if not years, and companies do go
runs like this: ‘I
bust. A tax write-off is not a legit-
have an insight
imate investment strategy.
into the
Second, you would sensibly
want to diversify your holdings so management
that you are looking at maybe 10, and prospects of
possibly even 15 stocks to invest in. this company
Any more than 15 stocks to that the rest of
monitor and it is unlikely you would the market has
have the time to keep an eye on yet to see.’
them.

What else can I learn from

Traderman’s poor strategy?

Another reason Traderman’s strategy will fail him is that he

is ignoring the singularly most important piece of infor-
mation the market has about a stock: its price. And
remember, the market is never wrong. To Richard
Traderman, if the stock was worth buying at 100c, then if
it halves to 50c, it is all the more cheaper, indeed attractive.
If it should halve again he will buy some more at 25c – after
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all, now his average cost of purchase, and therefore his

break-even point, is even lower.
What Traderman does not realize is that if the price is
falling, stock holders are having to sell the stock at lower
prices to find buyers. People just are not willing to pay any
more. That should tell you something about what others
think about the company. On the other hand, if the price
of a stock is rising consistently, it indicates people are
willing to pay more for it. There is likely to be market confi-
dence in the company, and it is a good place to start
further research into the stock, its earnings, newsflow,
cashflow, market and sector.

What do I do when the

stock plummets?

A good ‘trailing stop’ should limit that. So, for instance,

you may have a rule that if the stock falls 20 per cent from
its current level you will exit. There will be more about such
risk and money management strategies later.
Richard Traderman is not real, but you will find his spirit
in online chat rooms throughout the web. The poor souls
are in share purgatory. To me it seems as if they may even
get some perverse joy about worrying over their stock
performance. Maybe they are punishing themselves? Or
maybe they are congenital optimists. To these poor
helpless souls I can give the advice of businessman Elbert
Hubbard: ‘The safest way to double your money is to fold
it over once and put it in your pocket.’
Internet Trader/chap 8 5/3/02 11:22 am Page 73

Picking brokers
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c h a p t e r e i g h t

Online brokers
not for all

Is online broking for everyone?

Too many investors are

blindly opening online
For those with
execution-only brokerage
little investment
accounts when they would
experience,
be better off with different
forms of brokerage. Online execution-only
execution-only brokers are brokers offer
ill-suited for many different little support for
types of investors. So while making sound
online brokers may seem as trading decisions
if they are trying to convince
everyone that online trading
is for them, you better read this chapter to see if you’re one
of the many for whom it is not suited.
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What if I am a market novice with

some money set aside for investing?

For those with little investment experience, execution-only

brokers offer little support for making sound trading
decisions. No amount of market news, stock quotes,
online portfolios and journalistic comment can replace the
advice of a good, experienced broker for those unsure
about investing.

What about an advisory broker?

Advisory brokers require minimum

Although the account sizes of typically at least
advisory broker is $10,000 and their commissions
nearly ten times tend to be substantially greater
more expensive, than those of execution-only bro-
the market losses kers because they are offering
due to investor a personal added-value advisory
service.
inexperience can
The commission costs of using
be far greater
a typical advisory broker such as
Killik (www.killik.com), Pathburner
(www.pathburner.com), or Durlacher
(www.durlacher.com) on five $10,000 trades could be $825,
compared with $87.50 in total with an execution-only broker
such as Sharepeople (www.sharepeople.com).
However, consider the cost of losing 40 per cent of a
$50,000 portfolio a market sell-off, compared with losing
perhaps only 20 per cent because you used an experienced
advisory broker. The saving in market losses would be
$10,000. Therefore, although the advisory broker is nearly
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ONLINE BROKERS NOT FOR ALL

ten times more expensive, the market losses due to
investor inexperience can be far greater. The cheaper DIY
service of the deep-discount e-broker can be a false
economy in a volatile or bearish
market and an advisory broker can
be a sound investment in itself for Relatively lower-
this type of investor.
risk pooled
financial
products such as
What if I am relatively investment and
experienced and unit trusts would
cash-rich? allow them to
tap into
Even the more experienced cash-
professional
rich investor may wish to have a
management at
second opinion from an advisory
broker before committing a large
low cost
sum of money to a stock decision
based solely on his own research. Would it not make sense
to pay an extra couple of hundred pounds for professional
financial advice before committing, say, $50,000 of
investment funds?

What to do for the cash-poor

novice then?

Those who aren’t confident about making their own

trading decisions, and for whom the steep minimum
account sizes and commission charges of advisory brokers
don’t make economic sense, should be considering longer-
term investments, not short-term trading which requires
them to rely frequently on their limited market knowledge.
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Alternatively, relatively lower-risk pooled financial

products such as investment and unit trusts would allow
them to tap into professional management at low cost. 1-
800-MUTUALS (www.mutualfundworld.com) bills itself as
‘America’s mutual fund superstore’ and offers more
than 7,000 funds as well as managed accounts; Brill’s Mutual
Funds Interactive (www.brill.com) offers news for all levels of
investor and especially beginners; Morning Star (www.
morningstar.com) offers top-notch research; Funds Direct
(www.fundsdirect.co.uk), TrustNet (www.trustnet.co.uk),
and MoneyExtra (www.moneyextra.co.uk) are good places
to start.

But I am a sophisticated,
highly active trader!

For those who are semi-professional in their trading,

spending several hours each day monitoring the markets and
looking to make several quick short trades daily, the services
of an execution-only broker are likely to be inadequate. Such
traders will require more than the low commission costs that
e-brokers provide. They need lightning-fast execution that
takes seconds, not minutes, and streaming real-time quotes.
They need to consider dedicated trading platform software
free from brokers such as Deal4Free (www.deal4free.com)
and MyBroker (www.mybroker.co.uk) rather than purely a
web-based service which executes orders through a glorified
e-mail service, as seems to be the case with the tardy execu-
tions of e-brokers.
Such highly sophisticated traders who view stocks as
just another short-term trading vehicle for profits will also
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ONLINE BROKERS NOT FOR ALL

want the choice of financial products that most e-brokers
do not provide – forex trading, options and futures trading
online. Again MyBroker and Deal4Free would be appro-
priate.

So for what type of investor is

an online execution-only broker
most suitable?

Ideally you would have market experience, be comfortable

with making your own investment decisions, and be
relatively active, making, say, at least two trades a month.
You would be looking to hold your positions for at least
several weeks and tend to have trade sizes of less than
$7,000. Little wonder that market leaders Schwab and
E*Trade are offering advisory services in the US because
they can charge more for advice than execution only.

Figure 8.1MS&P composite, 1966–80

140
120
100
80
60
This 14-year bear market includes the
40 crash of 1973–74
20
1/66 10/67 7/69 4/71 1/73 10/74 7/76 4/78 1/80

Adjusted for inflation, the S&P 500 did not

return to its 1966 peak until 1991
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Figure 8.2MS&P composite, 1906–24

12

10

6
After 18 years, the
4
Roaring ’20s bull market
2 finally broke through the
1906 peak
0
9/06 6/08 3/10 12/11 0/13 6/15 3/17 12/18 9/20 6/22 3/24
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c h a p t e r n i n e

Just what type

of broker
is right for me?

So, since it feels as though there are

almost as many online brokers as
online traders, how does a wily
online trader decide which broker
to open an account with?

The factors to consider often enter the equation only after

bitter experience. These are my conclusions. Of course,
price is of primary concern. Online trading is popular partly
because it offers discount commissions for investors who
do not want to pay a full-fee broker for advice they could
have discovered themselves on the internet, or for trades
where they do not want advice.
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But even among online brokers

the commissions must vary?
So which do I choose?

Well, commissions do vary greatly, but comparison is near

impossible with each calculating commissions on a
different basis – some using the value of your trade, others
the number of shares bought, and others the frequency
with which you trade. The best advice is to calculate what
size trades you expect to make normally and then visit the
various websites to work out who would offer you the
cheapest commission.

Is there more to online

trading than price?

Yes, there is certainly more to online broker selection than

price – if there wasn’t then Schwab in the US, which is one
of the most expensive online
brokers, would not have the
There is certainly largest market share. According
more to online to a study by JD Power and
broker selection Associates, the most important
than price. factor in selecting an online
broker is customer service. The
same study, based on US brokers
and traders only, found that Schwab topped the list for
offering greatest customer satisfaction.
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J U S T W H AT T Y P E O F B R O K E R I S R I G H T F O R M E ?
Reliability?

Reliability in service is an essential prerequisite for any

online trader. There is no point saving $20 in commission
on buying a stock, only to find you can’t sell it because
your online broker has broken down. Such ‘downtime’ by
online brokers is becoming increasingly frequent in the US,
and in 2000 even the mighty Schwab had one full hour
where trades could not be placed. In a survey by
TheStreet.com (again a survey of US brokers by US clients),
DLJ Direct came top in the category of reliability. They are
now owned by TDWaterhouse.com

So execution is
important then?

Poor execution can also override price as a concern for an

online trader. The price at which your trade is ‘executed’
should be as close as possible to the real-time price quote you
see on the screen before you trade. Poor execution can often
end up swamping any commission savings. In the
TheStreet.com survey, Schwab came above DLJ Direct, which
in turn narrowly beat E*Trade on the issue of execution
prices.
If you like such almost-scientific surveys of online
brokers, see www.gomez.com. The website’s internet
broker ‘overall score’ rankings placed E*Trade in pole
position, with DLJ Direct and Schwab in second and third
place respectively.
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What about the look of the site?

Site design is an important consideration for me. There is

nothing worse when you are trying to find a quote, do
some research or quickly place a trade than to find
navigation around the site as
difficult as travelling up the
Online trading is Amazon (the river, not the site).
about more than I want my online broker easy
placing a trade and intuitive to use. There is
through an only one way to see what suits
online broker you and that is to visit the sites
instead of themselves. I am sorry to report
phoning a that I find the purely UK online
brokers, unlike US brokers with
traditional
UK sites, seem too often to be
broker. Trading
competing for the title of most
online profitably
offputting site, and that’s when
still requires they are not racing to see who
research to arrive can be the most expensive. Did
at stock picks, and these site designers speak to a
the internet is an single online trader?
excellent resource Online trading is about
to offer this more than placing a trade
through an online broker
instead of phoning a traditional
broker. Trading online profitably still requires research to
arrive at stock picks, and the internet is an excellent
resource to offer this. I always check to see what research
the online brokers offer.
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J U S T W H AT T Y P E O F B R O K E R I S R I G H T F O R M E ?
Do they provide free portfolio
monitoring, charting, news from
major wires, research from renowned
institutions and commentary, or are
they just a website appended to a
traditional brokerage?

All in all I much prefer the big US brokers’ UK sites to the

sites of purely UK brokers because of site design,
commission and available research. When it comes to
choosing between the US brokers themselves, I prefer the
biggest players like the ones mentioned above (and for
that matter below) because it is they, with their leverage
and clout, who can offer quality research and the security
of knowing they have the money to spend on resources.

Sites?

Try the following: www.etrade.com (in addition to the broker

service, it offers a load of free tools to the public such as real-
time quotes, customizable portfolios, personalized market
views and e-mail), www.eschwab.com, www.datek.com and
www.scottrade.com.
For Latin American trading check out Patagon at
www.patagon.com and Latin Stocks at
www.latinstocks.com.ar (Argentina),
www.latinstocks.com.br (Brazil) and
www.latinstocks.com.mx (Mexico).
Note how analysts can get it wrong, recommending
buying a stock as it keeps falling (Fig 9.1)
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Figure 9.1MMorgan Stanley’s early call helped it nab

the best Amazon return
12/13 MDI
$120 issues “buy” 2/2 MS reiterates “outperform”
Top Two Banks* Return JP reiterates “buy”
Morgan Stanley (MS) +400.21% MDI upgrades to “strong buy”
$100 Deutsche Banc (DB) +121.39% 12/8 JP 3/13 DB reiterates
issues “buy” “market perform”
4/20 DB
$80 Bottom Two Banks Return upgrade
9/3 JP
J.P. Morgan (JP) –82.29% reiterates “buy” to “buy”
$60 McDonald Invest (MDI) –52.42%
1/5 DB
10/22 DB 12/8 MS
Amazon Share Price

issues “market downgrades reiterates

$40 outperform” to “market “outperform”
perform”
9/18 MS issues 3/16 MDI
reiterates
$20 “outperform”
“strong buy” 9/19 JP
1/25 JP
reiterates “buy” reiterates “buy”
0
1997 1998 1999 2000 2001

Source: Multex

It seems analysts have a bias towards saying ‘buy’. So

be warned if you follow them and not your own
research (Fig 9.2).

Figure 9.2MDistribution of outstanding analyst stock

recommendations
100%
Strong buy

Buy

Hold
80% 38.5% 38.6%
Underperform
or sell
Percent of Ratings

60%

33.8% 35.4%
40%

20%
27.0% 25.3%

0.7% 0.7%
0
March 2000 May 2001

Based on an analysis of total outstanding analyst recommendations on

March 24 2000 and May 4 2001
Source: Industry Standard June 2001

Fig 9.3 shows how, even as the market falls, analysts

continue giving the buy recommendation.
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J U S T W H AT T Y P E O F B R O K E R I S R I G H T F O R M E ?
Figure 9.3MNew tech stock analyst ratings vs
Nasdaq performance

5000 1,500

Number of Recommendations
4000 1,200
Nasdaq Index

3000 900

2000 600

1000 300

0 0
Jan Mar May Jul Sept Nov Jan Mar May

2000 2001

Source: Industry Standard

Even the 19 largest brokerages have issued money-losing

stock advice, according to investment research firm
Investars.com. Even the bank with the best overall credit
rating – Credit Suisse First Boston – had returns below 7
percent for traders following its advice precisely. Another
reason to pick your own stocks?

Figure 9.4MHypothetical investment return based on

analyst recommendations
All Stocks Technology Hardware Stocks

Top 5 Investment Bank or Research Firm Stocks Rated Return Top 5 Investment Bank or Research Firm Stocks Rated Return

1 Credit Suisse First Boston 1.558 +6.9% 1 Merrill Lynch 143 –13.59%
2 A.G. Edwards 600 +4.4% 2 Bear Stearns 100 –18.3%
3 Salomon Smith Barney 1.348 +0.9% 3 A.G.Edwards 55 –18.7%
4 Merrill Lynch 1.491 –1.5% 4 Salomon Smith Barney 149 –18.8%
5 Morgan Stanley 1.184 –2.7% 5 Goldman Sachs 11 –18.3%

Bottom 5 Bottom 5
1 Robertson Stephens 693 –48.3% 1 Robertson Stephens 153 –54.9%
2 USB Piper Jaffray 617 –22.7% 2 Dain Rauscher 96 –54.4%
3 Dain Rauscher 627 –21.5% 3 Deutsche Banc 90 –51.4%
4 CBC World Markets 804 –14.7% 4 USB Piper Jaffray 82 –50.9%
5 Deutsche Banc 804 –14.7% 5 USB PaineWebber 85 –47.1%

Source: Industry Standard

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c h a p t e r t e n

Why do so many
traders have the
wrong broker?

Can online discount

brokers offer advice?

Remember too that online

discount brokers cannot offer For truly detailed
advice because by law they are analysis and the
restricted to being execution highest quality
only. While they may offer news investment ideas
feeds, which can include broker nothing can beat
recommendations, for truly the analysis of
detailed analysis and the highest ‘the best on the
quality investment ideas nothing
street’, as long as
can beat the analysis of ‘the best
you can get it for
on the street’, as long as you can
free
get it for free.
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What are full-service brokers offering

now that online discount brokers are
offering free research?

In response to the growth in discount online brokers,

Merrill Lynch has been the highest-profile traditional full-
fee broker to offer online trading and open its gates to its
highly prized research, which is still available for free from
http://askmerrill.com/international.

Name some more names then.

Another full-service broker forced by the competition from

online brokers to offer its research to the public is Paine
Webber, which has an excellent service at
www.painewebber.com, offering equity, market, industry
and thematic research.
Then there’s the mighty Salomon Smith Barney at
www.salomonsmithbarney.com offering worldwide
research from a macroeconomic to individual equity level,
plus my favourite, special reports on internet and
technology stocks generally. And none of this is second-
rate findings from a trainee that the company deigns
worthy of giving away for free just before binning it – it is
good quality stuff I would gladly scour the bins outside
their offices for.
Lehman Brothers also cuts to the chase and lists its ten
‘uncommon value’ stock picks at www.lehman.com.
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W H Y D O S O M A N Y T R A D E R S H AV E T H E W R O N G B R O K E R ?
Who’s really good?

When it comes to top-quality internet and technology

stocks research available free on the web, no one beats
Morgan Stanley Dean Witter in my opinion. You can find
excellent and hefty reports at www.ms.com. The downside
is that the download will take for ever and a good few
trees as there are hundreds of pages in each report. Try
saving them to hard disk and save the forests. You should
also try Merrill Lynch HSBC (MLHSBC.com) who provide
free reports to clients.

What if I want the top full-service

brokers – how much will it cost me?

Of course there are many people who do not want to do

their own research or to trade through a discount online
broker and prefer relying on a full-service broker for advice,
not just free research; so much so that Merrill’s web
account attracts about $3 billion in new assets each
quarter, while the execution-only broker Charles Schwab
(www.eschwab.com) attracts $30 billion per quarter
according to industry sources.
If you are tempted to use a top full-service broker such
as Merrill Lynch, you will find fees as a retail customer of
more than $50 per trade, and sometimes as high as $200
– far higher than the $5 to $30 charged by discount online
brokers. Merrill combines broker advice and online trading
in an account charging $1,500 minimum p.a. For that you
get not only research but advice.
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What are clever online traders doing?

Given that John Steffens, head of

Keep a regular Merrill’s retail business, estimates
watch on the sites that the average customer has
of the full-service between $350,000 and $450,000
brokers in their new full-service web
mentioned trading accounts, whereas a survey
above. Use the by TheStreet.Com reveals that
free research they most online discount broker
account holders trade with less
provide to place
than $5,000, it may be that wily
trades ‘on the
traders make the big decisions with
cheap’ through
the advice of the big brokers and
execution-only rely on their own judgements with
brokers small amounts.

So what’s your advice then?

Keep a regular watch on the sites of the full-service brokers

mentioned above. Use the free research they provide to
place trades ‘on the cheap’ through execution-only
brokers.
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Portfolio and
risk management
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c h a p t e r e l e v e n

What do I need to know

about my portfolio that
the professionals know?

How do I find out how likely

it is that my portfolio will drop a
stomach-churning amount?

A stock portfolio is possibly your

second largest investment, after A stock portfolio
your home. Even a single stock is possibly your
investment of $6,000 is perhaps second largest
the largest single purchase a net investment, after
trader makes all year. But we
your home.
don’t know our portfolios,
beyond the names of the stocks
within them, their share prices and maybe a few news
stories about the companies.
Some net traders use online portfolio trackers, such as
that on www.etrade.com or www.datek.com, to track
their profits and losses, receiving daily e-mail updates of
their holdings and all news relating to their holdings that
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day. Frankly, we don’t know the likelihood of our portfolio

dropping a stomach-churning amount. We need to know.
This chapter tells us how.

Should I use software to monitor

my portfolio?

Traditionalists will use portfolio monitoring software such

as Quicken (www.quicken.com), Microsoft Money or a
spreadsheet program such as Excel to keep tabs on their
holdings, or go to a portal such as the excellent
Yahoo!Finance (www.yahoo.com). But this is basic.

So what is better?

Newer online tools mean we should have far greater

technical knowledge on a par with professional money
managers about how our portfolios behave.

What should I know?

How much money could you lose because of extreme

market movements, say where price fluctuations exceed
95 per cent of the typical daily price changes? Before the
internet such calculations would have been outside the
competency of most net traders. After all, you would need
to look at the daily performance of the stock on each
business day of the previous year (on average, 252
business days), then rank the daily returns from lowest to
highest. Next you would need to calculate the average of
the worst 5 per cent of the daily returns (or, approximately,
the worst 13 of the 252 return values).
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W H AT D O I N E E D T O K N O W A B O U T M Y P O R T F O L I O T H AT T H E P R O F E S S I O N A L S K N O W ?
Why is this important?

It could mean the difference between a portfolio whose

risk appetite you can stomach and one that leaves you
taking risks far greater than you anticipated. If you can
anticipate the types of losses your individual holdings and
overall portfolio may typically incur,
you can decide whether to reduce
or rebalance your holdings. It could mean
the difference
between a
So how healthy is portfolio whose
your portfolio? risk appetite you
can stomach and
Apologies from CEOs for poor one that leaves
shareholder returns is common- you taking risks
place, but not when the CEO is far greater than
Warren Buffett. The closure of you anticipated
hedge funds is common, but not
the flagship funds of George Soros.
Trading losses too are no surprise, but not from the
personal portfolio of the head of a trading firm (Track
Data) and amounting to $45 million!
So what chance do I, a private investor, stand of making
good returns in turbulent markets if even the most experi-
enced are suffering poor investment performance?
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Is my portfolio underperforming
relative to key benchmarks such as
the S&P 500 or the FTSE 100 and
indeed which benchmarks
should I be targeting?

Other questions that crop up along the same lines include,

Do I have the optimal mix of stocks, cash and other
financial assets for my risk profile and financial goals? and
How do I know if I own too few or too many stocks for the
risk/reward I am targeting?
It’s not surprising that such questions arise given that
existing financial portals have hardly developed innovative
portfolio tools in the past several years despite an increase
in competition between sites.
Sure, simple online portfolio tracking, which updates
stock prices but little else, offered by sites such as E*Trade
(www.etrade.com) or Stocktrade (www.stocktrade.co.uk)
is useful in allowing online traders to more quickly and
easily monitor their holdings, but as with the display of
quantitative financial information, online portfolio tools
reveal a lack of understanding of customer needs and of
creativity. We don’t even have pie charts to show the
relative weightings of our holdings or bar charts to depict
their relative performances.
For an answer to these questions, two of the best sites
and tools can be found at www.quicken.com and
www.riskgrades.com.
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W H AT D O I N E E D T O K N O W A B O U T M Y P O R T F O L I O T H AT T H E P R O F E S S I O N A L S K N O W ?
What do I need?

Asset allocation tools are one major category of online

portfolio tools that are important but often lacking, yet
they are relatively easy and inexpensive to provide. Asset
allocation analysis involves determining the financial goals,
time horizon, risk tolerance, tax status and investing
experience of an individual and suggesting asset classes
that the investor should hold, e.g. large, mid and small cap
stock holdings, cash, fixed income and international
securities .

What else?

Tax analysis providing running income and capital gains tax

liability reports (and allowing for indexation allowances) is
another service that is easy to provide but often missing on
financial portals.

How do I know how

well my portfolio is doing?

Another aspect of portfolio analysis missing from online

portfolios is performance analysis. While online portfolios
of brokers like Ameritrade (www.ameritrade.com) and
Stocktrade (www.stocktrade.com) and portals such as
ADVFN (www.advfn.com) provide some useful portfolio
performance information such as total gross profit or
loss and individual percentage gains since purchase, they
lack further analytical tools. For those I suggest
www.quicken.com.
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In analyzing performance
what should I look for?

The following would be useful:

■ the ratio of winning to losing trades;

■ the average holding periods for each, so for instance
one could determine whether losing stocks are being
held for too short a time and losses could therefore be
minimized by exiting trades later;
■ annualized returns based on current performance;
■ commission paid, including the average amount per
trade (there may be an opportunity to maintain return
but reduce commissions by altering the size or number
of trades);
■ the maximum favourable and adverse excursion, i.e.
the highest and lowest value the overall portfolio
reaches as well as individual stocks so that one can
gauge the reward-to-risk prospects of the portfolio
and stocks;
■ a measure of the correlation between individual stocks
to help gauge the extent of diversification.

Even without online portfolio tools offering the above, the

serious investor should monitor the above information
manually or on a spread-sheet.

But this is too difficult, isn’t

there anything else I can do?

What the lack of detailed valuable analytical tools

combined with recent market losses reveals is that some
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W H AT D O I N E E D T O K N O W A B O U T M Y P O R T F O L I O T H AT T H E P R O F E S S I O N A L S K N O W ?
individuals would be far better with advisory brokers rather
than execution-only ones. Realizing this, discount brokers
in the US, led by E*Trade and
Schwab, are offering advisory
Even without
services which also allow the online
brokers to break out of the low
online portfolio
margin and high marketing cost tools offering
execution-only segment of the the above the
market and enter the more serious investor
lucrative higher margin advisory should monitor
brokerage market. information
Although it is unlikely that their manually or on a
offering of advisory services is spread-sheet
motivated by customer care, and is
in fact rather a concern for the
‘bottom line’, if e-brokers offered some of those portfolio
tools as part of their execution-only services they would
improve customer investment performance and ultimately
keep more of them – thereby improving their own and
their customers’ profitability. Of course, lessons from
Buffett and Soros suggest any improvements are not
guaranteed to be easy or indefinite.
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c h a p t e r t w e l v e

What is risk?
How do I quickly and
easily measure it like a
professional trader?

I don’t want to maximize my

returns from trading online. If
at the start of the tech boom in I want to
1999 I had invested, say, maximize my
$10,000 equally between the reward-to-risk
five best performing TMTs, I ratio
would probably have well over
$30,000. But I am not losing
sleep over having missed them.

Why?

I want to maximize my reward-to-risk ratio and buying

those stocks would not have done that.
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How can I measure

the risk I am exposed to?

Even those who have some idea about risk use outdated,
unsophisticated or discredited measures. Beta is a popular
yet incomplete measure of risk. Beta measures how much
an individual stock is likely to move with the general
market. A beta of 1 means that a stock will tend to move
lock step with the general market, while a beta of 2 means
that the stock will rise 2 per cent for any 1 per cent rise in
the stock market, and fall 2 per cent with any 1 per cent
fall in the stock market, on average.

What’s wrong with beta?

Beta can be misleading. For instance, two stocks with the

same beta generally have a different level of risk. Standard
deviation is another common measure of risk and it too has
deficiencies. For example, it fails to weight historical share
prices to give more significance to the most recent prices.

What other risk management

tools are there then?

Newer online tools remove traditional problems with risk

measurement because the internet tools do the complicated
calculations for you real-time. This will potentially result in
greater online trading returns. JP Morgan has taken its inter-
nationally and institutionally acclaimed RiskMetrics risk calcu-
lations and converted them for the private investor through
RiskGrades (www.riskgrades.com).
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This is a very powerful tool. It reveals, for instance, that
two stocks can be equally risky (in very simple terms they
have been equally volatile in the past six months), yet the
one-year returns can be very different.

What else can RiskGrades do?

RiskGrades also suggests online
traders have riskier stock portfolios Inconsistencies
than they realize. Consequently their can exist in many
returns are often lower than they portfolios, even
expect – losses greater than antici- brokers’ model
pated or profits lower than they
portfolios
should be. The problem is so great
that even model portfolios on
reputable websites misjudge the level of risk they advocate.
Inconsistencies can exist in many portfolios, even
brokers’ model portfolios. The fault is not theirs. It is due
to a general lack of understanding of the nature of risk and
an unnecessarily intuitive not quantative approach to risk.

If inconsistencies in how I handle

risk can arise in my portfolio,
what should I do to correct them?

I suggest the serious private investor should know the

following about their stock portfolios:

■ which stocks contribute the greatest risk to their

portfolio;
■ how well diversified their portfolio is;
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DIARY OF AN INTERNET TRADER

■ what you should expect to see as an average worst

case one-day trading loss;
■ whether replacing any stocks reduces risk without
impacting return, or even improving it.
■ how to use RiskGrades to evaluate the above for your
portfolio.

Since risk and diversification go hand

in hand, how many stocks should a
well-diversified portfolio contain?

As few as a dozen stocks can yield good diversification. A

diversified portfolio is one where the negative impact on a
portfolio of an event due solely to a specific stock is
minimized.

What about the type

of stocks I choose?

All important in diversification are

All important in the stocks you select. Again, too
diversification many private investors have stocks
are the stocks closely correlated to each other.
you select Simply buying a stock from
different sectors is not the answer
because sectors can be linked in
their movements too. RiskGrades allows quick assessment
of how diversified your portfolio is.
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So, if I’m not maximizing my returns
per se, what am I maximizing?

The trick with a portfolio is to

maximize reward for any level of I would rather
risk through asset allocation. underperform
According to RiskGrades an and have a better
aggressive portfolio can produce an risk-to-reward
expected annual return of 30 per ratio than be a
cent, but that is only if the assets star performer
are allocated to minimize risk.
taking great risks.
I would rather underperform
Trading is not a
and have a better risk-to-reward
one-shot game
ratio than be a star performer
taking great risks. Trading is not a and in the long
one-shot game and in the long term I would be
term I would be the outperformer. the outperformer

But what if I am tempted

by those risky tech stocks?

Unfortunately many traders first select risky ‘growth’

internet stocks, reasoning that if they are risky then growth
will follow. Such fallacious reasoning is equivalent to
saying ‘if producing high-grade steel results in pollution,
therefore if I pollute I will produce high-grade steel’.
Consequently they have all the risk but little of the return
because of the assets selected. Once again the online tools
of RiskGrade assist in resolving that problem.
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The bottom line?

Too few private investor websites understand online trading.

If they did they would provide as many statistics about risk as
they do about P/E ratios.
Doubtless brokers will provide
E-traders need to such information with the
beware the risk motive of encouraging greater
of overtrading trades as investors rejig their
portfolios in pursuit of the ideal
portfolio. E-traders need to be
aware that the risk of overtrading and incurring commission
costs from doing so that is not measured by RiskGrades.

How much risk can I take?

Know thyself. It is essential that as an investor you know

how much risk you can tolerate. If you are quite conser-
vative, you may be averse to the probability that the
market may fall 5 per cent. An aggressive investor,
however, may take a 5 per cent drop with a pinch of salt
since he thinks there is a good probability of a 5 or 10 per
cent rise. The exercise below will help you know yourself.

EXERCISE – RISK TOLERANCE TEST

An investor’s risk tolerance in making investment

decisions can depend on investment goals as well as
the investor’s personality. The following exercise will
measure your reaction to market risk, weight the
relative importance of your goals and uncover your
personal investment preferences.
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Give yourself the points in the brackets for your
answer.

1. The degree to which the value of an investment

moves up and down is referred to as ‘volatility’.
In general, more volatile investments tend to
grow faster than more stable investments – they
have a larger potential upside. However, volatile
investments are more risky since there is no
guarantee that the ‘upturns’ will be larger than
the ‘downturns’. How much volatility are you
willing to accept?

A Slight. I do not want to lose money, even if

it means my returns are small. (1)

B Some. I am willing to accept the occasional

loss as long as my money is in sound, high-
quality investments that can be expected to
grow over time. (3)

C Considerable. I am willing to take

substantial risk in pursuit of significantly
higher returns. (5)

TOTAL POINTS ––––––––––

2. Suppose your investment portfolio contains a

significant portion of large company stocks in
addition to several other assets. Large
company stocks have averaged a compound
annual return of 11 per cent over the past 72
years. However, if large company stocks had
lost 18 per cent of their value in the past year,
what would you do?
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A Sell the large company stock portion of my

investment portfolio and realize the loss. (1)

B Sell some, but not all, of the large company

stock portion. (2)

C Continue to hold the large company stock

portion of my investment portfolio,
following a consistent long-term strategy.
(3)

D Buy more large company stocks. (4)

TOTAL POINTS ––––––––––

3. Please provide your response to the following

statement.

Given my investment time horizon, I am

willing to accept significant fluctuations in the
value of my investments to achieve potentially
higher long-term returns.

A Strongly disagree. (0)

B Disagree. (1)

C Agree. (2)

D Strongly agree. (5)

TOTAL POINTS ––––––––––

4. Which of the following statements is most

true about your risk tolerance and the way
you wish to invest to achieve your goal(s)?
My investment should…
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A be completely safe; I do not wish to run the
risk of losing any principal at any time. (1)

B generate regular income that I can spend.

(2)

C generate some current income and also

grow in value over time. (3)

D grow over time, but I would also like to

generate some current income. (4)

E grow substantially in value over time.

I do not need to generate current
income. (5)

TOTAL POINTS ––––––––––

5. An investor must be prepared to expose

his/her investments to increased chances of
loss in attempting to achieve higher expected
returns. The following statements represent
possible outcomes for three hypothetical
portfolios at the end of one year. Which
investment portfolio would you be most
comfortable holding?

A Portfolio A has a likely return of 6 per cent,

and there is a 10 per cent chance of loss at
the end of the year. (2)

B Portfolio B has a likely return of 10 per cent,

and there is an 18 per cent chance of loss at
the end of the year. (3)
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C Portfolio C has a likely return of 14 per

cent, and there is a 25 per cent chance of
loss at the end of the year. (4)

TOTAL POINTS ––––––––––

6. I understand the value of my portfolio will

fluctuate over time. However, the maximum
loss in any one-year period that I am prepared
to accept is:

A 0 per cent. (1)

B –5 per cent. (2)
C –10 per cent. (3)
D –20 per cent.
E –30 per cent+. (5)

TOTAL POINTS ––––––––––

7. Investments in which the principal is ‘100 per

cent safe’ sometimes earn less than the
inflation rate. This means that, while no
money is lost, there is a loss of purchasing
power. With respect to your goal(s), which of
the following is most true?

A My money should be ‘100 per cent safe’

even if it means my returns do not keep up
with inflation. (0)

B It is important that the value of my

investments keeps pace with inflation. I am
willing to risk an occasional loss in principal
so that my investments may grow at about
the same rate as inflation over time. (3)
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C It is important that my investments grow
faster than inflation. I am willing to accept
a fair amount of risk to try to achieve this.
(5)

TOTAL POINTS ––––––––––

8. Which statement best describes your main

concern when selecting an investment?

A The potential for loss. (1)

B Mostly the potential for loss, but also the

potential for gain. (2)

C Mostly the potential for gain, but I am still

concerned about the potential for loss. (3)

D The potential for gain. (4)

TOTAL POINTS______

9. Consider the following two investments, A

and B. Investment A provides an average
annual return of 7 per cent with minimal risk
of loss of principal. Investment B provides an
average annual return of 10 per cent but
carries a potential loss of principal of 20 per
cent or more in any one year. If I could
choose between Investment A and
Investment B to meet my goal(s), I would
invest my money:

A 100 per cent in A and 0 per cent in B. (1)

B 75 per cent in A and 25 per cent in B. (2)

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C 50 per cent in A and 50 per cent in B. (3)

D 25 per cent in A and 75 per cent in B. (4)

E 0 per cent in A and 100 per cent in B. (5)

TOTAL POINTS ––––––––––

If you tended to go for the first options in the above

questions, you are quite averse to risk. So, if you
scored between

■ 8 and 20 you tend to be particularly risk-

averse;
■ 21 and 35 you tend to be neutral towards risk
and volatility;
■ 36 and 50 you like market volatility, regarding
it as the best opportunity to make money.

Does investing online lessen the

risk of losing money?
Investing online can lessen risk but only to the extent
that it puts all the tools and resources in your hands to
conveniently make your own investing decisions.
When you’re online, you can easily scan the market
indicators and price-track movements, thus reducing
the risk of error of judgement.
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Interest rate risk
When the cost of borrowing money goes up, it erodes the
value of certain investments since it reduces the relative
return on the investments. This is especially vigorous for long-
term fixed securities like bonds. For example, if you bought a
bond with the ‘fantastic’ rate of 8 per cent and five years later
interest rates move above 8 per cent, you will have a lower
relative return compared to, say, savings accounts.

Investor psychology
Panicky investors’ overreaction to fluctuating interest rates
and inflation fears prompts a market sell-off that affects
the value of investments, even among those who kept
their heads. Herding behaviour can create exceptionally
volatile markets.

Market conditions
Stock prices can soar to such highs per dollar invested that
the market and your individual investments become more
vulnerable in the event of a decline. This is also referred to
as market indices.

Liquidity
A liquidity risk is the inability to convert an investment
quickly and easily to cash, which is purely liquid, without
incurring a significant loss in the value of the investment.
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Any tips for trading in Latin America?

■ ZonaFinanciera (www.zonafinanciera.com) gives you a

good picture of the economic climate in Latin America
and an idea of general market risk. What makes this
site particularly useful is that it is very broad in terms
of the number of countries it covers. The site offers
separate, detailed information for all the major Latin
American markets: Argentina, Bolivia, Brazil, Chile,
Colombia, Costa Rica, Ecuador, El Salvador, Spain,
Guatemala, Honduras, Mexico, Nicaragua, Panama,
Paraguay, Peru, Puerto Rico, the Dominican Republic,
Uruguay and Venezuela.
Under the stocks section there is a complete review of
the main developments in the markets and you can
trade online in stocks and mutual funds. Market
commentary is knowledgeable.
Alongside key indicators such as quick quotes, indices,
currency and news reports, there is an interesting
section, ‘Investor School’, that provides information on
the basics as well as on strategic investing and risk
assessment.
■ Bloomberg Latin America (www.bloomberg.com/sa) is
quite general and offers only basic information about
the major Latin American indices and financial news.
■ LatinInvestor (www.latininvestor.com) has a wide
range of authoritative reports from brokers and
consulting firms on the major Latin American
economies, companies and industries. Key market
information is available on Argentina, Brazil, Chile,
Mexico, Peru and Venezuela. However, only a small
number of these reports are free.
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Figure 12.1MSome good news: here’s a list of significant
events and how they have affected the markets. As you can
see, one year later the markets had returned to positive
returns, except for 1981–82.

First Trading Session Subsequent Market

Response to Event Behaviour

DJIA DJIA DJIA DJIA % One Six One

Date Event Close Close Change Change Month Month Year
Previous Change Change Change
Day
1. 1/17/91 US launches
bombing
attack on 2,509 2,624 114.6 4.6% 11.8% 15.0% 24.5%
Iraq
2. 8/2/90 Iraq invades 2,899 2,865 –34.7 –1.2% –8.8% –3.2% 5.0%
Kuwait
President 995 992 –2.6 –0.3% 0.6% –14.3% –16.9%
3. 3/30/81
Reagan shot
President
4. 8/9/74 Nixon 785 777 –7.6 –0.97% –14.7% –8.9% 6.0%
resigns
President
5. 11/22/63 Kennedy 733 711 –21.2 –2.9% 6.6% 15.4% 25.0%
assassinated
6. 10/22/62 Cuban 569 558 –10.5 –1.9% 15.6% 27.4% 34.0%
Missile Crisis
7. 9/26/55 President
Eisenhower 487 456 –31.9 –6.5% 0.04% 12.5% 5.7%
heart attack
8. 6/25/50 North Korea
invades 224 214 –10.4 –4.7% –4.5% 7.4% 15.1%
South Korea
9. 12/7/41 Japan
attacks Pearl 117 113 –4.1 –3.5% –0.9% –6.2% 2.9%
Harbor,
Hawaii

Source: dowjones.com
Past performance is not a guarantee of future performance.
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Why do I want to invest

in bonds and what is the
best way for me?

What is a bond?

A bond is a loan to a govern-

ment, corporation or other The safe-haven,
entity known as the issuer. In low-risk,
return for the loan, the issuer guaranteed
promises to pay you a specified returns offered
rate of interest during the life of by government
the bond and to repay the face bonds are
value of the bond (the princi-
overlooked by
pal) when it ‘matures’.
too many online
Among the types of bonds
investors
you can choose from are gov-
ernment securities, municipal
bonds, corporate bonds and foreign government bonds.
The safe-haven, low-risk, guaranteed returns offered by
government bonds are overlooked by too many online
investors.
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An example, please?

The $100 Treasury 6 per cent

Bonds should 2002 bond may trade in the mar-
ket at $98. It will pay two interest
form an essential
payments during the year of $3
part of a
each (6 per cent of $100). The
balanced planned
government guarantees this and
portfolio. You
a payment of $100 on maturity in
would alter the 2002 – a $2 return above today’s
mix of cash, purchase price.
bonds and stock But you can also buy and sell
to fit the desired gilts in the open market during
goal and risk the period between the issue and
tolerance redemption date. If you do this,
you may make a capital gain or
loss.

Why should you consider the lowest

risk bonds – government/Treasury
bonds or gilts – as part of your
online trading portfolio?
Guaranteed returns is a key attraction – sacrificing the
possibly greater reward of holding equities for the
certainty of a positive return and the guarantee of no loss.
In a volatile climate would you prefer a guaranteed 10 per
cent return from bonds or an uncertain return from a tech
stock?
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So, how should bonds fit into my
overall investment portfolio?

Bonds should form an essential part of a balanced planned

portfolio. You would alter the mix of cash, bonds and stock
to fit the desired goal and risk tolerance.

How should I divide my portfolio in

terms of bonds, shares and cash?

That will depend on your particular preferences to risk (see

Chapter 12). A Wall Street Journal survey of portfolio
strategists at 13 top brokerage firms showed they recom-
mended a portfolio blend of assets that includes 31 per
cent bonds, 61 per cent stocks and 6 per cent cash.

But what if I am quite conservative?

If you are rather risk-averse then you will go for a higher

proportion of bond (and cash) vis-a-vis shares (Fig 13.1). A
conservative plan, with income from stock dividends and
portfolio value stability exchanged for potential upside,
would probably involve 25 per cent in cash, 20 per cent in
stocks and 55 per cent in bonds, according to Charles
Schwab (www.eschwab.com).
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Figure 13.1MA conservative plan

25%
Cash
55%
Bonds

20%
Stocks

15% Large Company

5% International

Return (1970–2000)
• Average annual return: 9.32%
• Best year: 21.81%
• Worst year: –1.25%

How would a conservative

portfolio perform?

The conservative portfolio averaged 9.32 per cent annu-

ally between 1970 and 1999, with 22 per cent in its best
year and a mere –1.25 per cent in the worst year. Your
choice of portfolio is determined by your financial goals
and risk tolerance. Figure 13.2 shows a moderately con-
servative plan.
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Figure 13.2MA moderately conservative plan

15%
Cash

45%
Bonds
40%
Stocks

20% Large Company

10% Small Company
10% International

Return (1970–2000)
• Average annual return: 10.52%
• Best year: 25.56%
• Worst year: –6.55%

What about an aggressive,

risk-preferring portfolio?

An aggressive portfolio would hold 95 per cent in stocks,

according to Schwab (probably 30 per cent in international
stocks, 25 per cent small companies and 40 per cent large
companies), and the remainder in cash (Fig 13.3).
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Figure 13.3MAn aggressive plan

5%
Cash

95% Stocks

40% Large Company

25% Small Company
30% International

Return (1970–2000)
• Average annual return: 12.80%
• Best year: 42.25%
• Worst year: –23.83%

And how would it perform?

According to Schwab, between 1970 and 1999 such a plan

would typically yield 12.80 per cent annually, the best year
producing 42 per cent and the worst a loss of 24 per cent.
This plan is for long-term investors who want high growth
and don’t need current income. Substantial year-to-year
volatility in value is exchanged for potentially high long-term
returns. Figure 13.4 shows a moderately aggressive plan.
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Figure 13.4MA moderately aggressive plan

5%
Cash
15%
Bonds

80% Stocks

35% Large Company

20% Small Company
25% International

Return (1970–2000)
• Average annual return: 12.32%
• Best year: 36.52%
• Worst year: –19.14%

I still don’t know what the

mix of stock to bonds to cash
should be. Any other methods
of allocating a portfolio?

This one is not very scientifically rigorous, but here goes…

one method for allocating a retirement portfolio suggests
that you subtract your age from 100. The resulting number
is how much of your portfolio should be invested in stocks.
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For example, if you are 35 years old, 100 – 35 = 65, so 65

per cent of your portfolio could be allocated to stocks, 25
per cent to bonds and a constant 10 per cent to cash.

Are there any other

benefits to bonds?

Aside from the risk/reward enhancement to a portfolio,

another benefit of investing in bonds is the active
secondary market for gilts which means they can be readily
traded before maturity if you need cash unexpectedly.
Such liquidity offers a flexibility you won’t get from high-
yielding bank accounts.

Are bonds complicated

investment tools?

Financial and tax planning with bonds requires professional

advice for most people. There is a lack of financial planning
tools that actually ask your financial goals – the amount you
want to raise, your risk tolerance, how much you have in
savings – then suggest the optimal combination of bonds,
stocks and cash based on past market performance. In the
meantime, visit MoneyExtra’s (www.moneyextra.co.uk) IFA
search to find an Independent Financial Advisor near you.
However, there are loads of educational resources…

Websites?

To invest in US Treasuries visit www.investinginbonds.com.

This provides very good practical and educational
tools with in-depth explanations of different types of
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bonds, as well as a seven-step educational programme.
www.bondsonline.com includes data on federal, munici-
pal and corporate bonds. Many US brokers, such as
www.Ameritrade.com, offer online bond trading, as do
some US brokers in the UK such as www.schwab-
europe.com. However, such brokers do not offer online
trading of UK gilts.

Are there any other ways I could

access the bond market?

Bond funds are another way to

access the bond market. They offer Bond funds are
the added diversification of a pooled another way to
investment. Visit Interactive Investor access the bond
International (www.iii.co.uk) for past market. They
performance of funds. The site also offer the added
covers the higher risk corporate diversification of
bond market. Truly the name is a pooled
bond, government bond.
investment

Any more sites?

Of course. www.taxfreebond.com provides online bond

brokerage and offers free research tools, including
municipal bond primer and taxable equivalent yield calcu-
lators.
Others include:

■ www.bondtrac.com – offers handy free search tools.

■ www.bradynet.com – the site for getting info about
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Brady bonds, the Third World debt instruments issued

by the US government.
■ www.publicdebt.treas.gov – the Bureau of the Public
Debt.
■ www.moodys.com is the Moody’s Investor Services
that pours forth masses of research on companies and
publishes a lot of it on the web for free.

What about Latin America?

For Latin America, Patagon www.patagon.com offers

bond trading and funds for all the major markets. Also,
BradyNet www.bradynet.com provides specific infor-
mation on Brady bonds for Mexico, Ecuador, Argentina,
Venezuela and Brazil. There are market commentaries, a
research library, and individual company profiles. Charting
and technical analysis is informative, but available only
once registered.
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Active trading
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c h a p t e r f o u r t e e n

Should I trade actively?

Which are the best tools
and what do the wrong
ones cost me?

I am an active trader, trading

around three times a day. Can
use a normal online broker like, say,
E*Trade or Schwab?

For a serious active internet

trader the services of the most
popular online brokers will not If you need fast
do. These browser-based bro- trade executions
kers cannot compare to special- a browser-based
ist brokers. Recent innovations broker will prove
are the by-product of the day- frustratingly
trading craze, yet should be inadequate
considered a necessity to a far
wider audience.
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Why do I need a ‘special broker’?

If you need fast trade executions in seconds not minutes,

detailed price quotes – telling you who is in the queue to
buy or sell your stock and at what prices – speedy order
entry, real-time balance adjustments, institutional quality
trading screens and analytical information, then a browser-
based broker will prove frustratingly inadequate.

What is the difference then

between a browser-based broker
and an active broker?

Browser-based brokers such as the market leaders – Schwab

(www.eschwab.com or www.schwab-europe.com), E*Trade
(www.etrade.com or www.etrade.co.uk), TD Waterhouse
(www.tdwaterhouse.co.uk), Datek (www.datek.com) and
Pathburner (www.pathburner.com) – differ from active
trader brokers in significant ways. Each of these makes
browser-based brokerage inadequate for the active net trad-
er. Essentially, browser-based brokers are slower and less
streamlined than active brokers in providing such services as
quote updates, execution and order entry.

Why are active brokers faster in

providing quote updates?
When you seek an update intra-day price chart from a
browser-based broker your request passes from your PC,
via the internet, to the broker’s server. The server finds the
quote, rebuilds the web page on which to display the
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chart, and passes it back to your PC via the net. Delays
often occur with the server or on the internet due to the
amount of traffic.
However, active trader brokers offer a faster service.
They provide software that resides on your PC and does
calculations, such as constructing charts and your portfolio
value, that would otherwise be done on your broker’s
server. That is significantly quicker than a traffic-laden
overworked broker server doing the calculations then
sending you the results by rebuilding a web page.
Consequently the active trader has instant price and
chart data, thus avoiding costly decisions based on
outdated information.

Why are active browsers faster in

execution? And why does it matter?

The speed of trade execution is a second advantage of an

active trader broker over a browser-based broker. With a
browser-based broker your order goes via the internet to
the server to be executed usually via third-party intermedi-
aries. All this adds delays, sometimes more than 20
minutes, during which the price at which you buy or sell
the stock can be far worse than you saw on screen origi-
nally. The difference between buying 1,000 shares at
$100.00 and $100.50 is $500. If that net effect occurs only
once a week it can represent more than $26,000 in annual
hidden costs.
Active trader brokers save time and money by avoiding
routing orders via third-party intermediaries and instead
provide direct market access or electronic direct access
trading (E-DAT).
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What about streamlined order entry?

Many active trader brokers cater for the active internet

trader by providing streamlined order entry. Browser-based
brokers often ask for confirmation of your order. That adds
valuable seconds to order execution and can be annoying
when trading intensively throughout the day. The active
trader broker removes such (cautionary) hurdles.

Do active browsers provide any

significant advantages in the
provision of market information?

Yes. A richer source of market information is a fourth

advantage of the active trader broker. For instance, level II
quotes not only give you the
best bid-ask prices of a stock
A richer source of but also all the prices at
market information which others are queuing to
is a fourth advantage buy or sell the stock. Such
of the active trader information allows you to
broker see the depth of interest in a
stock and to formulate
trading strategies accordingly – should you sell now before
those 40,000 shares in a TMT are sold by Lehman
Brothers?
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Do active brokers provide
any advanced features over
browser-based brokers, apart
from speed and accuracy?

Yes. Yet another advantage of the active trader broker is

that they usually permit margin trading – lending money
based on your portfolio holdings with which you can trade
and hence leverage your position. Of course that can
accentuate the downside, but such facilities are offered
only to the experienced trader.

So what are the practicalities involved

in opening an active broker account?

Active trader brokers include Carlin (www.carlingroup.

com), Direct Access Traders (www.directaccesstrader.
co.uk), Interactive Brokers (www.interactivebrokers.com),
CyBerCorp (www.cybercorp.com) and Tradecast (www.
tradecast.com).
The closest equivalent in the UK to the above US trading
sites is MyBroker (www.mybroker.com) and trading using
contracts for differences via GNI (www.gni.co.uk) and
Deal4Free (www.deal4free.com).
Not all offer the same service and a visit to each site is
essential. Some, such as Direct Access Traders, charge a
monthly licence for the software, although there is often a
100 per cent refund if you do a minimum number of trades
per month. Direct Access Traders refunds the $268 charge
in months where you do more than 50 trades.
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If I want to trade more actively,

what other things should
I be thinking about?

1. Infrastructure is an essential expense for the active

trader. I occasionally trade intra-day – in futures –
and find a dual flat-screen workstation with dual
Pentium processors running on fault-tolerant
Windows NT essential to avoid system crashes from
data overload. Visit Dell (www.dell.com) for prices.

2. Beware, however, short-term trading can be very

unprofitable, time-consuming and addictive.
Consider Michael Hensley who lost $180,000 day
trading and filed for bankruptcy only to comment in
the Chicago Tribune that he planned to invest the
$14,000 from the sale of his home in the markets!

3. Clearly, great skill and learning of strategies is

required to actively trade. At one extreme is day
trading – buying and selling stocks
within the day through high-value
Education is key quick trades. Education is key to
to success as an success as an active trader. In the
active trader UK, courses on day trading and
short-term trading are offered by
Direct Access Traders
(www.directaccesstrader.co.uk), providing five days’
training for £995. Good educational sites giving
details of strategies include
(www.careerdaytrader.com), www.daytraders.com,
www.activetraders.net and www.tradehard.com.
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S H O U L D I T R A D E A C T I V E LY ? W H I C H A R E T H E B E S T T O O L S A N D W H AT D O T H E W R O N G O N E S C O S T M E ?
What if I don’t want
to trade more actively?

You should still consider active broker accounts. While

features such as speed of execution and level II quotes are
less relevant for infrequent investors, commissions can be
significantly lower than browser-based brokers. For
instance, Interactive Brokers charges $0.01 per share with
a $1 minimum. There are no other fees or charges, effec-
tively making it commission-free trading. Fig 14.1 shows
that there are very few days that make big returns, which
is why Fig 14.2 shows few traders doing it well.

Figure 14.1MDistribution of daily S&P 500 returns,

1998–2000
300

250

200
# Days

150

100

50

0
–6% –5% –4% –3% –2% –1% 0% 1% 2% 3% 4% 5% 6%

Variation from mean

Source: DFA and Yahoo Finance

Since the big gains occur on only a few days, the

argument goes that trying to time the market and be in
the market on those days is like throwing dice and so one
should not try to time the market. Of course we self-
directed investors believe we can time the market, or can
at least avoid some of the worst days.
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Figure 14.2MA warning to equity investors – it isn’t

easy beating the market

Avg. Equity Fund Investors vs T-Bill & S&P 500

Gain on $100,000 after Inflation (3.23%)
17 yrs – 1984–2000

$705,84

16.8 x

$83,338
$42,139

Avg. Equity 1 Yr Treasury S&P 500 Index

Investor Bill (6.86%)
(5.32%yr)

Source: Dalbar, Inc., 2001, DFA

And Latin America sites?

Patagon
www.patagon.com

Patagon is a very comprehensive financial site. The site is

widely used for expert opinions and real-time quotes on
Latin American markets, essential for active traders. The
site can be categorized as follows:
Its educational content has everything you need to
know about the financial world explained in an instructive,
easy and thorough manner. There are quote prices, official
reports, and balances. Mergers, acquisition and takeover
announcements, launching of new Latin American services
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S H O U L D I T R A D E A C T I V E LY ? W H I C H A R E T H E B E S T T O O L S A N D W H AT D O T H E W R O N G O N E S C O S T M E ?
and companies are included with data for the whole
region. There is global news coverage with more than 400
daily wires and constant updates; in-depth market analysis
with weekly guest speakers and individual company infor-
mation; real-time discussion forums and an investment
simulation game.

Latin Stocks
www.latinstocks.com

The Latin Stocks website is extremely extensive and broad

since it covers breaking news from all the Latin American
markets, focusing particularly on Argentina, Brazil and
Mexico. In fact, there are separate country-specific set-ups
of the basic Latin Stocks site:
www.latinstocks.com.ar (Argentina)
www.latinstocks.com.br (Brazil)
www.latinstocks.com.mx (Mexico)

All the Latin Stocks sites include various standard tools

such as quick quotes, market indices, currency rates,
interest rate, individual company snapshots, financial
guides, S&P’s analysis and mutual funds.
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c h a p t e r f i f t e e n

Why do so many people

continue day trading?
Is there something
in it or not?

What is day trading?

When I buy shares, like most people I usually pay the offer
price to buy them and the bid price to sell. The spread –
that is the difference between the bid and offer prices – is
pocketed by the market maker – the institutional individual
on the other end of the deal.
A day trader tries to put himself in the position of the
market maker by trying to buy stock at the (lower) bid price
and sell it at the (higher) offer price through direct access
to the market without using a broker but using special
software and hardware from home or a trading booth at a
day-trading firm. The day trader makes his money from
this spread, although sometimes from any share price
move as well.
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Are there any problems

with day trading?

The main problem with day

The main trading is that you are trying to
problem with make a profit from small price
day trading is differences. Take day-trading
that you are Amex stock standing at 1725 bid
trying to make a and 1728 ask. With $10,000 the
profit from small day trader would buy 579 shares
at 1725. Selling those at 1728
price differences
would realize merely $17.37
profit before costs.
Day traders require capital
and time in abundance to make the activity worthwhile.
First, they need a lot of capital to plough into the trade so
that multiplied by the small price it results in an acceptable
profit. Second, they need to trade a lot so that those small
profits become something respectable, and that takes a lot
of time.

Is it time-consuming?

Well, day traders have to be analyzing the market from

open to close for those profitable opportunities. If you
leave the screen for a few seconds the price could quickly
move against you and since you are relying on small price
moves from which to profit, it could easily result in a very
large loss. Few people have the inclination to sit in front of
a trading screen each day. You may be finished around 5
or 6 p.m., but what about the day job?
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This is UK specific, but
commissions are important. What
are the commissions like?

Commissions are another excellent reason I do not day

trade and why it will not be popular in the UK. A single
£10,000 day trade (buying and selling) would cost £79.98
in commission. In the above example, even trading
£40,000 worth of Barclay’s stock would not overcome the
commission, let alone provide enough money to live on or
to compensate you for the time spent on the activity, and
you would be buying at offer and selling at bid in any
event, because online brokers do not provide direct market
access.
Relatively high commissions in the UK compared with
the US, where the above trade could cost $8 with Ameri-
trade (www.ameritrade.com), make the activity a good
way to pay the brokers’ wages and little else. Add 0.5 per
cent stamp duty and that makes day trading in the UK
even more unattractive.

Will I need any special

technology to day trade?

Yes, and here lieth another dilemma. The unavailability of

inexpensive technology makes day trading for private
individuals very difficult. Day traders need level II quotes to
trade effectively. Such quotes not only display the bid and
the ask (level I) but also which firms have other orders at
various prices. Such quotes are available in the US,
but through software for your home PC or through
specialist day-trading firms. And it is rare to find either
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available in the UK for the private investor. Reuters

(www.reuters.com), Bloomberg (www.bloomberg.com)
and Topic 3 (www.primark.com) screens are designed for
and marketed to market professionals, not private traders
– their lease costs run to more than $10,000 per annum.

Surely an ISDN connection is fast

enough for day trading?

The internet is too slow for day

The internet is trading. A dedicated high-speed
too slow for day line (ISDN is too slow) is recom-
trading mended by most advocates of
the activity since day trading
requires speed of reflex to
capture small price moves, and to exit quickly in case larger
price moves occur, thus magnifying losses. Such technology
in the home does not come cheap and specialist day-trading
firms providing it to private clients are not readily available.

Is day trading particularly a more

difficult skill to acquire?
The skills required to be a day trader are yet another reason
I dislike the activity. Looking for those small price moves,
and knowing where and when to find them, while all the
time the well-trained boys and girls from institutional
banks like Lehman Brothers are also chasing them with
state-of-the-art technology, places the odds definitely
against the amateur, untrained individual.
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What do the stats look like for
day trading? Have investors
been doing well day trading?

The North American Securities Association concluded a

seven-month study recently and found that the high
number of trades involved meant on average you needed
to produce a 56 per cent annual return just to break even.
The same study found 70 per cent of day traders lose
money. The Securities and Exchange Commission (SEC) in
the US found that in one firm 67 out of 68 day traders
were losing money. These are definitely not my kind of
odds. The SEC also estimates there are in any event only
5,000 day traders at most in the US. A lot of hoopla by a
few over very little in my view.
The good thing about day trading is that, rather like
poor gamblers at the roulette wheel, day traders remove
themselves from the market anyway.

I’m still interested. Where can I find

out more about day trading?
If you are still curious and want to find out more, visit
Daypicks (www.daypicks.com), Trading Tactics (www.
tradingtactics.com) or Elite Trader (www.elitetrader.com)
for online chat about day trading and see Active Traders
Network (www.activetraders.net) for more educational
materials. For a UK perspective try www.daytrader.co.uk.
Latin American Sites for day trading are, unfortunately,
lacking.
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Fig 15.1 illustrates that a few days account for greatest

gains. This leads many to argue that the only sure way to
capture those days is to always be in the market. Of course
that also means capturing the bad days.
Others, most online traders included, try to capture the
good days, accept that they will get a few mediocre days,
and aim to exit quickly when it becomes clear they are in
on a bad day.

Figure 15.1MS&P 500 index – distribution of monthly

returns, January 1926 to June 2001
100

90

80

70
# of Months

60

50

40

30

20

10

0
–31.00 –30.00
–29.00 –28.00
–27.00 –26.00
–25.00 –24.00
–23.00 –22.00
–21.00 –20.00
–19.00 –18.00
–17.00 –16.00
–15.00 –14.00
–13.00 –12.00
–11.00 –10.00
–9.00 –8.00
–7.00 –6.00
–5.00 –4.00
–3.00 –2.00
–1.00 0.00
1.00 2.00
3.00 4.00
5.00 6.00
7.00 8.00
9.00 10.00
11.00 12.00
13.00 14.00
15.00 16.00
17.00 18.00
19.00 20.00
21.00 22.00
23.00 24.00
25.00 26.00
27.00 28.00
29.00 30.00
31.00 32.00
33.00 34.00
35.00 36.00
37.00 38.00
39.00 40.00
41.00 42.00
43.00 44.00

Monthly % change
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c h a p t e r s i x t e e n

I want to trade actively,

so what about
options then?

A third of US online traders trade in options as well as

stocks, according to a 1999 survey by TheStreet.com.

What are the advantages of

options trading?

US options trading has many advantages – it makes more

sense in terms of returns, it offers commissions savings,
choice of securities, ease of market access, removes other
hidden costs, quality options websites, and even free
educational material.

Can you give me a

definition of options?

In the complex version, an option is the right but not the

obligation to buy or sell a given product at a fixed price (the
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exercise or strike price) before a predetermined date (the

expiry date). The price at which that option trades (premium)
depends on market supply and demand and theoretical
pricing models incorporating variables such as the volatility
of the product, time until the option expires, interest rates
and other factors we need not worry about yet.

Aren’t the mechanics of options

trading quite complicated?

Yes, but simply stated, call options rise in value and put
options fall in value if the underlying share price rises, all
other things being equal. The reverse is true if the price falls.

So what are options used for?

While there are sophisticated uses of

options, many online options traders
While there are will use them as leveraged instru-
sophisticated ments for relatively short-term trades
uses of options, lasting at most a few months.
many online Let’s take a UK example,
options traders although the same principle applies
will use them as in the US. You may buy the HSBC
leveraged October 1600 option costing
£2,360 per options contract. That
instruments for
would give you the right to buy
relatively short-
1000 HSBC shares at 1600p each
term trades
by mid-October should you wish to
lasting at most a exercise the right. If the share price
few months rose 10 per cent in three weeks the
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option may then trade at 357p, i.e. if you sold the option
you would make £3,570 – £2,360 = £1,210. A return of
over 50 per cent on the option on a mere 10 per cent rise
in the share price.

So why are such trades attractive?

There are many optionable securities, giving you lots of
choice in selecting opportunities. If starved of choice, one
has to either make second-best trades or simply not trade
for prolonged periods. Inevitably trading performance
improves.

What about Education is

commissions? essential for both
the novice and
Typical big-name, reliable US e-bro- intermediate-
kers such as Ameritade (www. level options
ameritrade.com) and Accutrade trader since the
(www.accutrade. com) may charge risks can be
around $25 for a single options substantial
contract.

Should I trade index options?

Index options trade on the performance of a stock market

index rather than a particular share. It can be a lot easier to
have a view on a major index than a particular stock. After
all, there is no shortage of analysis about the Nasdaq, Dow
Jones, FTSE, etc. and their projected levels. How many
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commentators write as frequently about Pacific Media or

Tadpole? Simplicity also stems from not having to analyze
company reports, earnings estimates and accounts –
although arguably predicting the Dow Jones direction is
not made any easier despite the volume of commentary
about it.

Ok, how do they work?

In the same way as share options. A ‘call’ option on the

Dow Jones increases in price, all things being equal, as the
Dow Jones rises. A ‘put’ option rises in price as the Dow
Jones falls. Obviously a Dow Jones put option is a useful
product in bear markets.

Can you give me an example?

As an example, let’s take the FTSE 100. If the index stands

at 6100, you feel that the market is going to rise and
decide to buy two July 6200 call option contracts. The
premium is quoted at 250 index points such that your
outlay for two contracts is £5,000 (2 x 250 x £10)
excluding dealing costs.
The index rises and stands at 6300 at the end of May.
The July 6200 call option may then be quoted at 350 index
points. Feeling that the stock market has peaked, you
make a closing sale, realizing a profit of £2,000, excluding
dealing costs.
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Can I profit in a bear market?

Yes, index options are seen as

attractive in that it is possible to Yes, index
profit from a falling market, thereby options are seen
allowing – in theory at least – as attractive in
superior returns in a bear market or that it is possible
just having an insurance policy to profit from a
against the falling value of a stock falling market
portfolio.

I hear options also provide

greater leverage?

Options also provide leverage whereby limited capital can

produce significantly greater gains than a similar amount
invested in a single stock. For instance, a 5 per cent move
in an index could mean more than 100 per cent return on
the option.

Yes, but what are the difficulties

of options trading?
Despite the benefits of trading index options, there are
significant pitfalls because of their complexity. The
leverage that options trading provides can produce a
sharp loss as quickly as a profit. Because they are complex,
investors often start trading them before they are fully
qualified, not knowing which options provide the optimal
performance, and consequently they often make basic,
avoidable mistakes (such as buying the ‘cheaper’ options,
which generally, however, expire worthless, or buying
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stock options – which will be discussed separately – in low

volatility stocks).

How do I find out more

about options?

Many more complexities are involved than the above

examples reveal and the key to options success is
intensive investor education – both for novice and inter-
mediate-level traders since the risks can be substantial.
I recommend using the educational tools of web,
software, books and training courses to fully understand
the nomenclature of options, including essential terms
such as in-the-money, butterfly spreads, delta, vega,
gamma, and which trading strategies are the best for
your particular risk profile.
The 1999 TheStreet.com survey revealed that already
nearly one in three US online investors trade options. In my
experience, options are misunderstood, perceived as
highly risky and inaccessible for the private investor, partly
because of a lack of awareness about the abundance of
excellent educational material.

Which sources do you recommend?

The best books on options trading include Peter Temple’s
Traded Options and Michael Thomsett’s Getting Started in
Options. Remember to look for discounts on online
bookstores such as www.amazon.com.
Exchanges provide a very good resource for learning
about the operation of options. Visit www.liffe.com and
the Chicago Board Options Exchange, www.cboe.com.
Although the latter is American, the principles are the
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same. More usefully both exchanges provide ample free
material on options and trading strategies, including
software demonstrations of options principles. If in
Chicago, the CBOE is worth a visit now that London does
not have floor traders. Other excellent educational sites
include Options Industry Counciil (www.optionscentral.
com), Chicago Board of Trade (www.cbot.com) and Matrix
Options (www.matrixoptions.com).
Option courses are offered by Training for Profit
(www.trainingforprofit.co.uk), Stour Concepts (www.
stourconcepts.com) and The Investors’ Club (www.
investorsclub.co.uk).
Useful US options sites providing quotes, strategies,
commentary, discussion boards and hot options tips
include the diverse INO Global Markets (www.ino.com),
MoneyNet (www.moneynet.com) and the easy-to-use
Financial Web (www.financialweb.com).

OK, this is complicated, so give me a

textbook round-up for reference.

An option is a contract between the holder and the

grantor (called writer of the option). A holder pays the
writer a premium for entering into the contract. There are
basically two types: call options and put options.

KEY TERMS

Writer
Strike price or exercise price
Exercise period or expiry date
Premium
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Figure 16.1MLong call

PROFIT
+ LONG CALL

BREAK-EVEN PRICE

Strike
Price
0

STOCK PRICE
– Lower Higher
LOSS

The X-axis represents the price level of an underlying stock.

The Y-axis represents profit and loss, above and below the
X-axis intersection respectively.

Figure 16.2MLong put

PROFIT
+ LONG PUT

BREAK-EVEN PRICE

Strike
Price
0

STOCK PRICE
– Lower Higher
LOSS

The X-axis represents the price level of an underlying stock.

The Y-axis represents profit and loss, above and below the
X-axis intersection respectively.
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A call gives the holder the right, but not the obligation,
to buy from the writer:

1. within a fixed period of time (the exercise period);

2. a fixed quantity of the underlying security;

3. at a fixed price (being the exercise price or strike

price).

Example
In the UK, ‘one contract of the Barclays July 1100 calls
priced at 67p’ would give the holder the right to buy, any
time before a fixed date in July, from the writer 1,000
shares in Barclays Bank at a price of 1100 pence (or £11)
each. To purchase the option in the first place the holder
would have to pay the writer £670 (1,000 x 67 pence) as
premium.

N O TA B E N E

In the US equity options relate to the right to buy or

sell 100 shares, and in the UK to 1000 shares.

Example
ABC Corp. July 80 calls entitle the holder to purchase 100
shares of ABC Corp. common stock at $80 per share at
any time prior to the option’s expiry in July.
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What’s the big idea ’ere?

The general idea is of course to

Call holders make money! The flexibility of
therefore want options (see below) provides many
the underlying ways in which this can be done.
share price to One of the simplest ideas is (in the
rise case of a call option holder) to buy
shares in the future from the option
writer at the fixed exercise price and
then immediately sell them in the market at a profit,
assuming the market price is greater than the exercise
price. In the Barclays example, if the underlying price of the
stock was 1200 at expiry in July, the holder would call for
his 1,000 shares (at a cost of £11 each) and then sell them
immediately in the market at £12 each. Call holders
therefore want the underlying share price to rise.

N O TA B E N E

Whether or not the option is exercised the writer

keeps the premium

From the point of view of the writer or seller of the

option, he is obliged if ‘called’ upon to sell the 1000
shares in Barclays Bank and would receive the £11 per
share in return. The writer wants to profit from receiving
his premium and not being forced to sell the holder any
shares in the future. The call writer therefore does not
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generally want the market price to

rise above the strike price, Call writers
otherwise he will have to sell to the therefore do not
call holder at a lower price than he want the
could get in the market. In the underlying share
above example a call writer would price to rise
have to sell at £11 under the
option, when in the market he

I W A N T T O T R A D E A C T I V E LY, S O W H AT A B O U T O P T I O N S T H E N ?
could otherwise have received £12. Call writers therefore
do not want the underlying share price to rise.
Similarly, a put option gives the holder the right, but not
the obligation, for a fixed period of time to sell to the writer
a fixed quantity of the underlying security at a fixed price.
Most people trade in traded options. That means
they can sell the option contract itself to someone else if
they so wish, without ever exercising it.

What about the strike price?

Each common stock will have numerous options with

differing strike prices. The strike price for an option is
initially set at a price which is reasonably close to the
current share price. The exchange introduces other strike
prices at fixed intervals from that initial strike price.

Read the press

Premiums for exchange traded options are often printed
in major financial newspapers. Typically the listing may
look as follows (only calls have been shown):
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Option &
closing price Strike price May June July

ABC 105 7 1/2 9 1/4 10 1/8

112 3/8 110 3 4 3/4 6 1/4
112 3/8 115 13/16 2 1/8 3 1/2
112 3/8 120 13/16 7/8 1 3/4
112 3/8 125 1/16 no option 13/16

In the above illustration, ABC May 115 calls are trading

at 13/16 or $81.25.

How is the option price calculated

and how can I profit?

The price at which an option is bought and sold is called

the premium. In the Barclays example the option premium
was 67p. This is a little like a margin payment.
An option’s premium has two components, the
intrinsic value and the time value.

Intrinsic value
A call option has intrinsic value if the underlying security
price is greater than the option’s strike price. A put option
has intrinsic value if the underlying security price is less
than the strike price.

KEY TERMS

Intrinsic value
(Share Price) < (Strike Price) = Put option has
intrinsic value
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(Share Price) > (Strike Price) = Call option has
intrinsic value

In-the-money option (An option with intrinsic

value)

Out-of-the-money option (An option without

intrinsic value)

So in our above example, if the

price of Barclays’ shares was 1110p, If an option has
then the option’s intrinsic value intrinsic value it is
would be 10p. That is, if you in-the-money. If
exercised the call you could buy an option has no
Barclays’ shares from the writer at intrinsic value it is
1100p (strike price) and sell them in out-of-the-money
the market at 1110p (underlying
security price). That is also why an
option can never be worth less than its intrinsic value.
A call option would have no intrinsic value, and so only
time value, if the underlying price was lower than the strike
price. If an option has intrinsic value it is in-the-money. If an
option has no intrinsic value it is out-of-the-money. An
option whose strike price is nearest to the underlying price is
at-the-money.

EXERCISES

(Share Price) < (Strike Price) = In-the-money put /

Out-of-the-money call

(Share Price) > (Strike Price) = Out-of-the-money put

/ In-the-money call
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Time value
The second component of option premium is time value. It
is the difference between the option premium and its
intrinsic value.
So in our previous example time value would total 57p.
Time value essentially represents the price the holder pays
the writer for the uncertainty. It is the cost of risk which the
writer faces. Time value erodes as expiry approaches.
Therefore an option is a wasting asset in the hands of the
holder.
Time value can be calculated using complex mathe-
matical option pricing models such as the Cox-Rubenstein
Model. The variables are risk-free interest rates, strike
price, underlying security volatility, underlying security
price and any dividends which would be paid if the under-
lying security were held.

Figure 16.3 Time value = premium – intrinsic value

5 time value
intrinsic value
4
Market value $

0
1 2 3 4 5 6 7 8 9 10

Time
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What are the factors
affecting time value?

■ Interest rates – higher interest rates tend to result in

higher call premiums and lower put premiums
■ Dividends – higher cash dividends imply lower call
premiums and higher put premiums
■ Volatility – volatility of the underlying stock places a
greater risk on the writer that the stock will expire
in-the-money and so volatility raises premium

From the above it follows that at expiry (when time value

equals zero) an out-of-the money option is worthless and
an in-the-money option is worth its intrinsic value. Note
that since an option cannot have negative intrinsic or time
value, the most an option holder can lose (and the most a
writer can make) is the premium, no matter how much the
underlying price changes.

What is the relationship between

the option price and the price
of the underlying security?

The most important thing to remember is that the price of

a call tends to rise as the underlying security price rises and
the price of a call tends to fall as the underlying security
price falls. The price of a put tends to rise as the underlying
security price falls and the price of a put tends to fall as the
underlying security price rises.
So why buy an option and not the security? Because an
option is leveraged. That means that for a given
percentage change in the underlying price the option price
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can change by a greater percentage. You get a bigger

bang for your buck.
Going back to our previous example, if the price of
Barclays moved from 1110p to 1150p, the option price
may move from 67p to 97p. That means there would have
been a 3.6 per cent change in the underlying price and a
44.7 per cent change in the option price. You could then
decide to sell the option or exercise it as before. There
would be more money to be made from selling it.
The price of an option rarely has a 1:1 correlation with
the underlying security price. The delta is the rate of
change of the option price to the rate of change of the
underlying price. So, for example, a delta of 0.5 means
that if the underlying price rises by, say, 10 cents, then the
option price will change by 5 cents. Obviously the greater
the delta, the greater the bang for your buck. However,
the delta is greatest for in-the-money options, i.e. those
with the most intrinsic value and therefore the most costly
options. Consequently, when calculating potential returns
you have to draw a balance between the delta and the
price of the option.
An example will clarify the situation. Barclays shares are
trading at 1110p. July 1100 calls are 51p; July 1200 calls
are 16p. If tomorrow the price of Barclays shares were to
be 1200p then it may be that the July 1100 calls trade at
123p (average delta of 0.8) and the July 1200 calls trade
at 22.5p (average delta of 0.25).
The return from the July 1100s is 141 per cent and only
41 per cent from the cheaper 1200s. Of course, in this
example we have only estimated deltas and have ignored
costs and bid-ask spreads. Nevertheless it gives you some
idea of the balances that need to be drawn. For modest
moves one is likely to profit most from just in-the-money
options.
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Can you give an example of leverage?

To own 100 shares of a stock trading at $30 per share

would cost $3000. On the other hand, to own a $5 option
with a strike price of $30 would give you the right to buy
100 shares for $30 at any time up to expiry. The option
would cost only $500 ($5 x 100 shares).
If one month after the option is purchased the stock
price has risen to $33, then the gain on the stock
investment is $300, or 10 per cent. However, for the same
stock increase the option may have increased to $7, for a
return of $200 or 40 per cent.
Leverage of course has parallel downside implications.
If in the above example the stock fell to $27, the loss on
the stock investment would be $300 or 10%. For this $3
fall the option may now be worth $3 itself, i.e. a 40% loss.

Vive la différence
Options are in many respects similar to shares for the
purposes of trading for profit.

Similarities Differences
■ Orders to buy and ■ Options have a
sell are handled by limited life
brokers ■ There are fewer
■ Trading is conducted options than stocks
on regulated exchanges ■ Option owners
■ Pricing mechanisms have no rights over a
are open and transparent company; they are not
■ Investors have the shareholders
opportunity to follow ■ Option holders receive
price movements second no dividends
by second if they wish
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Where are the strategies?

Although there are only two types of option, calls and

puts, there are a lot of option strategies. With options you
can protect your stock holdings from a price decline, you
can prepare to buy a stock at a lower price, you can
increase income on your current stock holdings, you can
participate in a large market move even if you are unsure
beforehand which way the market is going to move, and
of course you can participate in a stock rise or fall.

Kids’ stuff
The simplest strategy is to go long a call or a put. That
means you buy to open a call or put. If you go short
(write the option) then you sell to open a call or put. In
the latter case you have to post margin since your losses
are potentially unlimited. It is a lot safer for the lay investor
to be long puts than short calls even though on both you
profit from falling prices. A common options strategy
already discussed above is to purchase calls to participate
in an upward price movement.

Locking in a price
Another popular use of calls is to lock in an attractive stock
purchase price. Imagine that ABC is trading at $55 and you
believe they are about to increase in value but you do not
have the funds to buy 100 shares. You know you will have
the funds in six months, but you are afraid that if you wait
that long the shares will increase in value.
You see that the option expiring eight months hence at
the strike price of $55 costs $3, i.e. $300. If you buy one
contract and then in six months the price of the stock is
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$70, you could exercise your option and buy the stock for
$5,500 + $300. Whereas if you did not have the option
and had to buy the option in the open market, it would
have cost you $7,000. So you just made a saving of $1200.

Puts to protect unrealized

profit in a stock position
Imagine you bought ABC stock at $50 and it is now
trading at $70. You fear there may be a short-term fall in
the price but do not want to sell your holding on the
hunch. By buying an ABC put option with a strike of $70
for $2 you are assured of being able to sell your stock at
$70 no matter what happens to the stock price. If the price
does not collapse, you will have lost the premium $2 x 100
= $200. Consider it an insurance premium.
But if the stock had fallen to, say, $55, you could have
sold it at $70 per share, less $2 per share for the option
premium. That means you would have earned an extra
$13 per share with the option than if you had not taken
out the insurance policy.
Option strategies are beyond the scope of this book but
I will mention a few to give you some idea of what the
professionals and the experienced non-professional can do
with options.

■ Hedge: a hedge is a position where one position

profits if the other position loses. So a hedge can be
thought of as an insurance against being wrong. For
example, a hedge against a long call, one could sell
short a different call or go long a put.
■ Straddle: buy to open an at-the-money call and buy to
open an at-the-money put. You profit by increased
volatility in the underlying price irrespective of
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direction. The strategy is a guts if the options are both

in-the-money and a strangle if they are both out-of-
the-money.
■ Bull call spread: long in-the-money call and short out-
of-the-money call. Profit from upward price
movement. This becomes a bull call calendar spread
if the short call is nearer month than the long call.
■ Bear put spread: long in-the-money put and short out-
of-the-money put. Profit from downward price
movement. This becomes a bear put calendar
spread if the short put is nearer month than the long
put.

Various other strategies exist depending on your views as

to volatility and direction, and the extent of risk you wish
to take. These strategies have some unusual names, such
as butterfly, condor, iron butterfly (buy a straddle and sell
a strangle because you expect a limited size move), combo,
ladder, box, conversion and reversal.
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Foreign trading
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c h a p t e r s e v e n t e e n

I want to trade
foreign stocks – am I mad
or ahead of the pack?

I am interested in foreign stocks.

What do you recommend I do?

Why should we miss out on

owning some world-beating
Online trading
stocks producing exceptional
allows us to
returns just because we do not
have the tens of thousands of
trade foreign
pounds often needed for a pri- stocks cheaply,
vate client account with a major efficiently,
investment bank that would quickly and easily
allow us to access global mar-
kets? Online trading allows us
to trade foreign stocks cheaply, efficiently, quickly and eas-
ily through American depositary receipts (ADRs).
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What are ADRs?

ADRs are dollar-denominated US securities backed by and

related to the underlying company stock, which may, for
instance, be UK-listed shares. The price of the ADR and the
underlying stock will generally move in tandem. A
complete list of ADRs is available on the excellent
www.global-investor.com.

Why are ADRs more advantageous

than direct trading?

Of course, in place of trading ADRs we could always open

multiple foreign online trading accounts with different
brokers, holding them in different
currencies (facing conversion costs)
The efficient and of course learn the language of
solution then each country since their e-broking
becomes ADRs sites often are not in English. Try
E*Trade Korea (www.etrade.co.kr)
for a taster of the difficulties.

What about tax – urghhhhh?

We can also face the problems of double taxation on our

gains in those companies. For instance, the Korean
government has rules about how much currency you can
convert from sterling to local currency and how long you
have to keep it in the country. In any event, do you know
of a cheap online broker through which you can buy
Telecomunicacoes Brasileiras 100 per cent in the past 18
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weeks? The efficient solution then becomes ADRs, which
avoid all of these difficulties.

Why should I trade

in foreign stocks at all?

The reasons for trading in foreign stocks are compelling.

■ First, other global regions may be experiencing superior
growth rates to our own economy. Trading their stocks
could significantly improve our performance. When the
recession comes we may be able to avoid a downturn in
our own performance by tapping into the economic
cycle of a country or region going through a growth
phase of its economic cycle. As one Salomon Smith
Barney analyst commented about Latin America: ‘The
region enjoys unique
characteristics that could turn it
into the hottest internet market
ADRs are a
in the world.’ Now, through ADRs
compelling
I can act and profit from that
proposition that
analysis.
provides me with
■ Second, I can have a more
a wider selection
diversified portfolio exposed to a
of companies
whole industry group I may find
exciting but which is global
from which to
rather than local. For instance, if choose the very
I am interested in the telecoms best
sector, and in particular the
telecoms equipment and wireless telephony industries,
ADRs allow me to take advantage of better growth
affecting the whole industry by not being restricted to
only US companies in the field.
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■ The third reason I find ADRs a compelling proposition

is that they provide me with a wider selection of
companies from which to choose the very best. The
wider the choice, the greater the chance I will pick
winners assuming my research remains diligent.

Are there any more

advantages to ADRs?

A further advantage of trading

You pay US online ADRs is that they are traded like
trading commissions, any other US security. You are only
which can be very holding dollars, not numerous
low, even compared other currencies. You pay US online
with those of trading commissions, which can be
brokers in other very low, even compared with
developed markets those of brokers in other developed
markets like the UK.

Is there any special risk

to trading in ADRs?

If you are residing in the UK, for example, trading UK

stocks only, investing in ADRs for emerging markets will of
course mean that you need to open an account offering
US stock trading (with a UK or US broker). And here, with
the ADR you have the currency risk of holding dollars and
the conversion costs involved. But if you intend to put
away for several months a pool of money for trading in
dollar stocks and don’t intend to convert back and forth,
those costs and risks can be minimized.
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What are the practicalities
of trading ADRs?

Trading ADRs is straightforward. It is just like trading any

US security. You would use a US e-broking account as you
would for trading in, say, Microsoft or Intel. Which online
broker should you use for trading ADRs? The same you use
for your US stock trading, and if you don’t have one yet
then I usually recommend Ameritrade (www.ameritrade.
com) or Datek (www.datek.com) because of positive
personal experience and good feedback about them from
others.
For the Brits, UK-based brokers also offer US stock trad-
ing. Popular ones include Schwab (www.schwab-
europe.com). For a list of UK-based brokers offering US stock
trading, visit the quaint but useful and informative GoShare
site (www. goshare.fsnet. co.uk).

Any other sites for ADR investors?

Sites for the ADR investor include Global Investor

(www.global-investor.com), and the content-rich Worldly
Investor (www.worldlyinvestor.com), which offers a gob-
smacking site with excellent columns to get the best ideas
for the various regions you are interested in. Use the ADR
stock screener to generate ideas of ADRs, although it is a
bit basic. Sign up for the various free e-mail newsletters
according to sector and region, e.g. Internet Europe. There
is also the professional www.adr.com by J.P. Morgan as
well as the Yahoo!Finance sites for each region, although
these are not always in English (www.yahoo.com).
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Latin America

If Latin America is of special interest to you, all of the

following should be very useful.

Bescos **
www.bescos.com

A well-designed site with news, a summary of how the

major indices are performing, news, commentary, a chat
site plus excellent educational material. The size is clear,
crisp and friendly to use.

Bloomberg Latin America **

www.bloomberg.com/sa

This site is quite general and offers only basic information

about the major Latin American indices and financial
news. Not as focused as some of the other sites.

Bloomberg TV ***
www.bloomberg.com

Watch live financial TV in Spanish from Bloomberg TV via

the internet – excellent.

BradyNet **
www.bradynet.com

This site provides specific information on Mexico, Ecuador,

Argentina, Venezuela and Brazil. There are market
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commentaries, a research library and individual company
profiles. Charting and technical analysis is informative, but
available only once you have registered.

Elpais **
www.elpais.es

This website for the popular paper is a good source of

Spanish-specific content, as you would expect.

Expansion directo ***

www.expansion.recoletos.es

This site is very well designed. Use it for financial news and
analysis and to stay on top of what is happening in the
markets. It also has a useful archives section and online
chat. The site includes news about companies, markets,
finance, technology and Latin America.

Expansion Financiera *
www.expansion-financiera.com

The site is too bare. Should contain lots more information

rather than one or two video clips.

Ganar.com **
www.ganar.com

Use this one for market news, as well as analytical

commentary on technology and finance.
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Latin Focus ***

www.latin-focus.com

Sharp, top-notch site. Just click on a nation and pull up a

detailed economic profile. It is an excellent place for initial
research.

LatinInvestor ***
www.latinvestor.com

The site has a wide range of authoritative reports from

brokers and consulting firms on the major Latin American
economies, companies and industries. Key market infor-
mation is available on Argentina, Brazil, Chile, Mexico,
Peru and Venezuela. However, only a small number of
these reports are free.

Latin Stocks ***

www.latinstocks.com

The Latin Stocks website is extremely extensive and broad

since it covers breaking news from all the Latin American
markets, focusing particularly on Argentina, Brazil and
Mexico. In fact, there are separate country-specific set-ups
of the basic Latin Stocks site:

■ www.latinstocks.com.ar (Argentina)
■ www.latinstocks.com.br (Brazil)
■ www.latinstocks.com.mx (Mexico)

All the Latin Stocks sites include various standard tools

such as quick quotes, market indices, currency rates,
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interest rates, individual company snapshots, financial
guides, S&P’s analysis and mutual funds. The sites also
include further excellent items: a free newsletter, a
discussion forum and market chat. Analysis, assessment
and standpoints are insightful. The sites have clear menus
and are easy to navigate. Overall, these are well-designed
and comprehensive sites.

MegaBolsa **
www.megabolsa.com

Use the site’s educational material for an introduction to

technical analysis. It has a host of news links, and analysis
of the major Latin and Spanish markets.

Patagon ***
www.patagon.com

Patagon is a comprehensive financial site, widely used for

expert opinions and real-time quotes on Latin American
markets. The site can be categorized as follows:

■ home page – gain access to a wide array of financial

options, bank services and products;
■ education – everything you need to know about the
financial world explained in an instructive, easy and
thorough manner;
■ quotes, graphs and info – quote prices, official
reports, balances. Mergers, acquisition and
takeover announcements, launching of new Latin
American services and companies. Data for the
whole region;
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■ trading – buy and sell stocks, bonds and funds;

■ news – global coverage with more than 400 daily
wires. Constant updates;
■ market analysis – in-depth analysis with weekly guest
speakers and individual company information;
■ community – real-time discussion forums. There is an
investment simulation game.

Patagon is very broad. It provides a good starting point for

newcomers through the educational and community
section. Yet there is enough coverage of the major markets
and sophistication in the analysis for the more experienced
investor.

Senda Financiera *
www.sendafinanciera.com

Use this one to find the detailed technical analysis on the

Ibex plus some stocks, market commentary and stock
charts.

Yahoo!Finanzas Espana ***

http://es.finance.yahoo.com

Yahoo’s own financial portal is useful for quotes on major

European indices as well as news wires. Use it to get stock
quotes, too. The news sources are quite exhaustive,
including Reuters. A good one-stop shop.

ZonaFinanciera.com ***
www.zonafinanciera.com
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What makes this site particularly useful is that it is very
broad in terms of the number of countries it covers. The
site offers separate, detailed information for all the major
Latin American markets: Argentina, Bolivia, Brazil, Chile,
Colombia, Costa Rica, Ecuador, El Salvador, Spain,
Guatemala, Honduras, Mexico, Nicaragua, Panama,
Paraguay, Peru, Puerto Rico, the Dominican Republic,
Uruguay and Venezuela.
For each country, it is easy to find the most data on the
markets, banks, insurance and real estate. Under the
stocks section there is a complete review of the main
developments in the markets and you can trade online in
stocks and mutual funds. Market commentary is knowl-
edgeable.
Alongside key indicators such as quick quotes, indices,
currency and news reports, there is an interesting section,
‘Investor School’, that provides information on the basics
as well as on strategic investing.

Any other relevant financial sites

Argentina

■ Mercantil Valores – stockbroker daily closing Buenos

Aires SE stock prices and index levels
(www.totalnet.com.ar/Mercval).
■ Ministry of Economy and Public Works and Services –
quarterly economic report, etc. (www.mecon.ar).
■ National Statistics Institute – Spanish
(weww.index.mecon.ar).
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Brazil

■ Jornal do Brasil – (Portuguese) daily general/economic

news (www.jp.com.br).
■ Agencia Estado – (Portuguese) daily financial news
(www.agestado.com.br).
■ O Estado de S. Paulo – (Portuguese and English digest)
daily news (www.estado.com.br).
■ Banco da Bahia – (investment bank) daily reports with
updated charts from the IBOVESPA and interest rates,
inflation indices, future prices, daily stock report with
closing prices (www.bahiabank.com.br).
■ Sao Paulo SE – BOVSPA daily market reports, closing
share prices (www.bovespa.com.br).

Chile

■ Chip News – daily news (www.chip.cl).

■ Santiago SE – daily market summary: share indices,
volume, major price movers (www.bolsantiago.co).
■ Bolsa Electronica de Chile – (Spanish) real-time index
charts (www.bolchile.cl).
■ Chilean Govt Network (www.presidencia.cl).
■ Banco Central de Chile – Spanish (www.bcentral.cl).

Portugal

■ Publico Online – (Portuguese) full text of daily

newspaper (www.publico.pt/publico/hoje).
■ The News – English (www.nexus-pt.com).
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■ Lisbon SE – BVL30 stock index updated every five
minutes (www.bvl.pt).
■ ICEP – brief economic overview (www.portugal.org).

Spain

■ Banesto – weekly market comment, analysis on stocks

(www.banesto.es).
■ Fincorp – daily exchange rates, money and bond rates,
stock indices, brief market news
(www.servicom.es/fincorp).
■ Madrid SE – (www.bolsamadrid.es).
■ Stock Research – (Spanish) technical analysis
newsletter (www.meff.es).
■ BBV – monthly economic report (www.bbv.es).
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c h a p t e r e i g h t e e n

What about
riskier foreign markets
then?

How can I be truly global

in my trading?

Well, thanks to the internet it is easier to trade stocks in

emerging markets, from Eastern Europe to Israel, South
Africa to Asia, and Latin America. A wave of online brokers
and websites is available to help research, buy and monitor
such stocks.

Do emerging markets perform well?

Advocates of emerging markets argue the performances
of some of the national stock indices speak for themselves.
After all, the world’s best performing stock market last
year was an emerging market, the Shanghai B Index,
which rose 136 per cent.
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But those types of gains in your portfolio are elusive. To

start with, historic performance is a poor indicator of
future returns whatever the market. India’s Sensex rose
around 80 per cent in 1999,
only to fall 25 per cent during
Emerging the next 12 months.
markets have no Emerging markets have no
monopoly on monopoly on strong gains,
strong gains, either. And if you do pick a
either country whose stock exchange
rises over the year, you’ll still
need to choose the right
stocks. Mexico’s Inmex index could be up 15 per cent this
year, but within that index Telefonos de Mexico could be
down 33 per cent.

How can I find out about

the performance of emerging
markets myself?

Try excellent emerging markets sites like www.worldly

investor.com, www.mfinance.com, www.latinfocus.com
and www.global-investor.com.

So if the past performance of

emerging markets isn’t a good
enough reason to invest,
maybe their potential is?

The advocates argue that these regions have so much

growth potential that their companies should grow far
faster than companies in more mature western economies.
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Take China’s telecoms sector,
which is often portrayed as the These regions have
perfect example of why you so much growth
should invest in emerging mar- potential that their
kets. Every month, there are two companies should
million new telephone lines being grow far faster
installed and over two million than companies in
mobile phone subscriptions
more mature
bought. The potential for further
western economies
growth is huge because 75 per
cent of China’s population have
never made a phone call.

So, if the potential reward is

so huge, should I invest in
China Mobile, the world’s third
largest mobile phone company,
or China Unicom, the country’s only
fully integrated telecoms company?

The answer is neither. Just because an emerging market

has potential doesn’t mean its own stocks are the best
investment to reap that potential. Nor does it mean that
stocks in developed markets lack potential and if the
potential argument does not work for Chinese telecoms, it
seems even more unconvincing for other sectors, let alone
emerging markets with a smaller population to exploit for
growth.
I would far rather tap into the potential of emerging mar-
kets through investing in long-established Western multi-
nationals that are doing deals in the region. For instance, in
2000 Vodafone paid £648 million for a stake in the Mexican
mobile company Grupo Iusacell. If the region delivers
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extraordinary growth, Voda-

I would far rather fone’s share price will reflect
tap into the that; if not, then at least
potential of Vodafone’s European and US
emerging markets businesses (which yield the bulk
through investing of its £1.3 billion profits) will
in long-established cushion any blow to the share
Western multi- price. Besides, can the local
emerging markets companies
nationals that are
claim to be successful in the
doing deals in the
fierce developed markets and
region
use that knowledge and power
locally?

How do I buy stocks

in emerging markets?

If you still wish to buy stocks in emerging markets, the

internet offers three approaches:

■ First, through online brokers such as the

comprehensive Brunswick Direct
(www.brunswickdirect.com) which provides access to
26 emerging markets.
■ Second, there is the depository receipts route (ADRs
and GDRs – global depository receipts). These are
tradable securities (denominated in dollars) based on
the underlying shares of non-US companies. They are
traded through the same brokers used to trade US
stocks, for instance www.eschwab.com.
■ Third, there are pooled investments. To find which unit
trusts and investment trusts invest in emerging
markets and their historic performance, visit
www.trustnet.com.
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W H AT A B O U T R I S K I E R F O R E I G N M A R K E T S T H E N ?
As with much on the internet, just because the oppor-
tunity is there doesn’t mean you should take it. And more
so with emerging markets, which always seem to be
emerging but never quite arriving.

Figure 18.1MSignificant events, 1941–91

Date Event
1/17/91 US launches bombing attack on Iraq
8/2/90 Iraq invades Kuwait
3/30/81 President Reagan shot
8/9/74 President Nixon resigns
11/22/63 President Kennedy assassinated
10/22/62 Cuban Missile Crisis
9/26/55 President Eisenhower heart attack
6/25/50 North Korea invades South Korea
12/7/41 Japan attacks Pearl Harbor, Hawaii

Figure 18.2MGrowth of a dollar, August 1926 to July 2001

Growth of a Dollar (log plot) Aug 1926 to July 2001
Center for Research on Security Prices, Total Market Index
events are numbered from table above

ending value = $1,763

10,000

1,000
2 1
3
value of a dollar

100 4
5
6
7
10 8

9
1

0
1927
1930
1933
1936
1939
1942
1945
1948
1951
1954
1957
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999

year

Source: www.ifa.tv
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Even through crisis, the dollar keeps getting stronger – a

good argument for holding dollar-denominated shares
and not foreign ones in the long term.
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c h a p t e r n i n e t e e n

How does foreign

exchange affect my
portfolio?

How do exchange rates

affect my foreign stock?

Calculate!
The value of the exchange rate will obviously affect the
value of your foreign stock. As the exchange rate of the
dollar appreciates (depreciates), the price of foreign stock
in dollars will fall (rise), before taxes and fees and not
accounting for dividends.

Fill in the template below for a share of your choice.

Exchange rate to $1 at purchase ___________ (A)

Exchange rate to $1 now ___________ (B)

Share price at purchase $__________ (C)

Shares purchased ___________ (D)

Share price today $__________ (E)

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The stock price now unadjusted for the exchange rate is

(E). The stock price now adjusted for the exchange rate
variation that took place over the period between
purchase of the stock and now is:

E * {1 – [(B – A) / A]} = _____________ = G

Call the above figure G. The gain per share will therefore
be:
G  C = _____________

At the original exchange rate of A, your return would be:

(E  C) / C =______________

Given the new rate of exchange of B, your return would

be:
(G  C)/C =______________

Explanation?
When the amount of the foreign currency required to be
exchanged for $1 increases (the dollar appreciates), your
profits on an investment decrease if you sell. If the
amount required decreases, your profits increase. In
other words, when the dollar becomes more valuable,
your return decreases. If the dollar weakens in relation to
the foreign currency, your return increases (Figs 19.1 and
19.2).
If the dollar weakens and the foreign currency becomes
more valuable, the value of your foreign stock increases.

The lesson
If you want to invest in companies traded on foreign stock
exchanges, you’ll need to consider foreign exchange rates.
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HOW DOES FOREIGN EXCHANGE AFFECT MY PORTFOLIO?

Figure 19.1MPrice vs future exchange rate

42

40

38
Price per share ($)

36

34

32

30

28
168 178 188 198 208 218 228 238 248

Exchange rate to $1

Figure 19.2MRate of return vs exchange rate

11

10
Price of return ($)

7
168 178 188 198 208 218 228 238 248

Foreign currency exchanged for $1

Foreign exchange refers to the conversion of money of one

country into its equivalent in the currency of another country.
Exchange rates fluctuate daily, making your investment in,
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DIARY OF AN INTERNET TRADER

say, a France or India-based stock worth more or less,

depending on the relative values of the French franc or the
Indian rupee versus the US dollar.

How much do fees affect

my rate of return?
Calculate!
Note: here we are excluding dividends and taxes, which
would have an effect on the result.

Share price at purchase $___________ (A)

Shares purchased $___________ (B)

Share price today $___________ (C)

Fees at Fees at
purchase sale

As fixed dollar amount $_______% (D) $_______% (E)

As % of total amount $_______% (F) $_______% (G)

As dollar amount
per share $_______% (H) $_______% (I)

Your total gain without fees would be

(A*B) – (C*B) = _________________

Your total gain with fees would be:

[{(B * [A + H]) * [(F / 100) + 1]} + D] – [{( B * [C  I]) *

[1 – (G / 100)]} – E]

= __________________

(Don’t let the formula intimidate you; a lot of the entries will
be zero because you will not be assaulted with a fee at every
stage.)
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HOW DOES FOREIGN EXCHANGE AFFECT MY PORTFOLIO?

Explanation?
When you pay a fee may be as important as the amount
you pay. The chart below gives you a rough idea of the
number of percentage points your rate of return drops due
to the amount and type of fees you may pay.
Fees can be more damaging, all things being equal,
when they are placed upfront on your principal, rather
than in arrears (Fig. 19.3).

Figure 19.3MComparison of fees paid upfront against

fees paid at sale
Decrease in r ate of return (%)

1
Fees at sale
Fees upfront

0
1 2 3 4 5 6 7 8 9 10

Fees as per cent of total amount (%)

The lesson
Transaction fees, mostly in the form of brokerage commis-
sions, lower your rate of return on a stock investment.
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What is my current yield

from dividends?

Calculate!

Share price today $_________ (A)

Shares owned $_________ (B)

Average quarterly dividend $_________ (C)

The current yield on your dividend as a percentage is

(before tax):

{[C * 4] / [A * B]} * 100 = ___________

Explanation?
Dividend yield is simply the dollar amount of dividends you
receive in a 12-month period from an investment, divided
by the current market value of the investment.

The lesson
Dividend yields for most large-cap stocks have diminished
to well below 3 per cent. Note also that the dividend
income is taxed as ordinary income, which lowers your
after-tax return.

Which are better: income or growth

stocks?

Calculation has not been included in this section because

the question is quite general and the calculation would be
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HOW DOES FOREIGN EXCHANGE AFFECT MY PORTFOLIO?

too complicated to work out on paper … lucky for you!
Nevertheless, here’s an explanation.

Explanation?
Growth stocks are those stocks that pay little or no
dividends in exchange for a larger expected appreciation in
share price. Income stocks, on the other hand, pay steady
and growing dividends in exchange for a smaller expected
appreciation in share price.
The annualized rate of return on a stock investment is
calculated using the following two methods:

■ Internal rate of return (IRR). With IRR, any cash

dividends are assumed to be reinvested in additional
shares of the stock.
■ Financial management rate of return (FMRR). FMRR
assumes that dividends are invested in a money
market account.

The lesson
When comparing growth and income stock, the return on
a growth stock will rise much faster with a rise in the
selling price per share than it would for an income stock
(because most of the return on an income stock is accrued
from dividend and earnings).
Figure 19.4 below gives you a rough idea that as the
share price increases, growth stocks would be more advan-
tageous. The problem, however, is knowing whether the
share price will rise. In a bear market, income stocks would
look like a better investment if held for a while. As the
figure suggests, higher price volatility would mean that the
return on growth stocks would fluctuate more markedly
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than income stock (which would receive more stable

dividends earnings). Therefore if you are quite risk averse
or the market particularly volatile, you may be better off in
income stocks.

Figure 19.4MComparison of growth and income stocks

based on price changes

16
15
Your return after taxes (%)

14
13
12
11 Growth stock
Income stock
10
9
8
7
24 26 28 30 32 34 36

Selling price per share ($)

EXERCISES

1. What is an exchange rate?

2. What is the relationship between the

exchange rate of the dollar to price per share
and to the rate of return of foreign stock?

3. What are dividends?

4. What is current dividend yield?

5. What is an income stock?

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HOW DOES FOREIGN EXCHANGE AFFECT MY PORTFOLIO?

Suggested answers
1. Basically, it is the amount of foreign currency
required to buy one unit of home currency
(let’s assume the US is home). It is the value of
home currency (dollar) in terms of foreign
currency. If more foreign currency is required
to buy $1, the exchange rate has appreciated
and the value of the dollar has risen.

2. As the value of the dollar exchange rate

appreciates relative to, say, sterling, the price of
stock in UK firms and so the return on that stock
must fall. A strong dollar can mean investment
in stock abroad has become less attractive.

3. Dividends are the distributions of cash or

securities to a company’s shareholders that
have been declared by a company’s board of
directors. They are usually expressed as ‘per
share’. US companies that pay dividends
usually do so four times a year. For example,
100 shares of a stock paying a dividend of
$2.75 per share generate $275 in dividends.

4. The annual dollar interest paid by a share or

bond divided by its market price. Current yield
is a measure of part of the rate of return on
the investment.

5. An income stock is a stock that has very low

share price volatility and the share price tends
to have a low expected appreciation (as
opposed to a growth stock); rather, income
stocks have larger dividend payments.
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Finale
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c h a p t e r t w e n t y

Am I better off
not trading online?
Surely not?

Is there anyone left in the US who

does not have an e-brokerage
account or at least know
someone who has one?

Online trading looks set to become as mainstream as

having a mortgage, but far more fun, of course. However,
dangers lurk for the converts from offline trading which
hitherto have hardly been mentioned. An academic study
by Brad Barber, author of stock research from the
University of California at Santa Barbara, reveals some
intriguing findings no online trader can afford to ignore.

So, what are the dangers?

Commissions would appear to be a good reason to trade

online. It seems obvious that if commissions on the whole
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DIARY OF AN INTERNET TRADER

are lower online, then one would definitely be better off

online.

How are low commissions a danger?

Well, according to the Barber study it appears that those

trading offline tend to beat the market by about 2 per cent
per annum, yet when they go online they suffer in their
returns – lagging the market by 3 per cent annually. This
despite lower commission costs.

So what is the cause?

One major cause of the fall-off in performance is that in

going online, traders tend to trade more actively. It is easy
to see why that would be so.

■ First, lower costs remove the obstacle of concern

about whether ‘the trade is really justified’.
■ Second, with faster execution speeds and ease of
access to one’s account through the internet at any
time, and especially the real-time update of one’s
portfolio, it is not difficult to see why people would
want to ‘fiddle’ with the stocks owned, buy the next
hot thing, or just chase the market.

How do I remedy the

problem of overtrading?

The advice I would give to online traders in such a position

is to clearly plan why a particular trade is worth placing,
what they expect the stock to do and why, over what time
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A M I B E T T E R O F F N O T T R A D I N G O N L I N E ? S U R E LY N O T ?
frame, and to set exit levels. In the words of Bill Lipschutz,
former global head of foreign exchange at Salomon
Brothers, taken from The Mind of a Trader: ‘In a year you
might place 250 trades. In the end it comes down to five.
On three you lose a fortune and on two you make more of
a fortune.’ The point is to be patient and to pick your
trades with good reason.
But there is more to poor online trading performance
than simple overtrading due to low costs. The source of
the overtrading is apparently psychological and rooted in
overconfidence.

What causes this sudden burst of self-

confidence, and what can we online
traders do to protect against it and so
also protect our returns?

According to psychologists, humans

have a tendency to be overconfident ‘Don’t mistake a
in their own abilities and their
bull market for
knowledge. They tend to attribute
skill.’
any success to their own abilities
even when that is not warranted.
Remember the old market saying: ‘Don’t mistake a bull mar-
ket for skill.’

But there is so much information on

the net, surely I can’t go wrong?

The availability of information, of which there is an

abundance online, also leads to overconfidence. Consider
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DIARY OF AN INTERNET TRADER

the quantity and quality of information on sites such as

www.ft.com, www.bloomberg.co.uk and http://finance.
uk.yahoo.com.
The more information you
give someone, the more over-
They have the confident they are likely to
illusion of become. They have the illusion
knowledge of knowledge. The illusion of
knowledge leads to the illusion
of control for the online trader.
Overconfidence leads to more speculative trading without
proper detailed analysis and that leads to greater losses and
worse online trading performance.
Would-be and existing online traders therefore need to
be aware of this problem and to find ways of challenging
it to improve their performance.

So some tips then?

■ Risk management: on a detailed analysis of the stock

you plan to trade in, is the upside potential greater
than the downside risk by a ratio of at least 2:1? If for
instance you bought 100 shares of XYZ at $50,
expecting a rise to $60, it would not be wise to say
you will stay with the trade even if the stock hits $25.
In other words, how high do you expect it to go, and
how low could it go before you knew it was not going
to turn around and you had better exit?
■ Objectivity: maintaining an objective view about a
trade is essential to being able to exit without
‘psychological’ difficulties. Do not become attached to
a stock. The key issue is one of probability – is the
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A M I B E T T E R O F F N O T T R A D I N G O N L I N E ? S U R E LY N O T ?
expected gain on the upside greater than that on the
downside?
■ Stop-losses: have you set an exact price level at
which you are not willing to
accept further losses and will
exit? This stop-loss cannot be Having formed a
too close to the price where you trading plan,
entered your position, stick to it!
otherwise even a small down
move may trigger your stop-loss
and cause you to exit. On the other hand, it cannot be
too far from your entry price level otherwise you may
lose all your investment before deciding to exit.
■ Discipline: having formed a trading plan, stick to it! It
is surprising how many traders ignore their exit levels
when the time comes to pull the trigger because their
mind comes up with a hundred reasons not to exit.

There is another reason not to assume online trading is

without downside. In Germany, online trading comes with
a spiritual health warning. Evangelical churches there are
concerned about the massive growth in online trading in
search of quick profits. In my experience there is no conflict
between online trading and spirituality – most online
traders pray like crazy.
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Glossary

Abandoned option Where an option is neither sold nor

exercised but allowed to lapse at expiry.

Accumulation A technical analysis term describing a

stock whose price is moving sideways.

Acid test ratio A measure of financial strength. Also

known as the quick ratio. Cash plus short-term invest-
ments plus accounts receivable divided by current liabil-
ities for the same period. All other things being equal,
a relatively high figure may indicate a healthy company.

Active channels A feature of Internet Explorer 4. Internet

sites that are selected as channels provide special IE4
content. Bill Gates wants to lead internet TV, hence the
term channels.

Active market Securities trading with a relatively high

degree of liquidity, the major benefit of which is narrow
spreads. A term of art rather then precision.

Aftermarket Also known as ‘secondary market’,

referring to the trading in a security after its initial
public offering.

All or none Order instructing the broker to buy or sell the

entire amount of the order in one transaction or not at all.
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GLOSSARY

American depositary receipt (ADR) Effectively like

owning in dollars stocks of US-listed companies. A
popular form of owning shares of foreign companies.

American option An option that is exercisable at any time

within its life. Can be traded outside Europe and are.

American Stock Exchange (AMEX) Located in New

York, this is the third-largest US stock exchange. Shares
trade in the same ‘auction’ manner used by the larger
New York Stock Exchange unlike the Nasdaq’s ‘market-
making’ methods.

Arbitrage The purchase in one market of an instrument

and the sale in another market of it or a closely linked
instrument in order to profit from the small price differ-
entials between the products in the two markets.
Arbitrage profits usually exist only for a short time
because someone usually swoops on them since they
are ‘locked in’.

Arbitrageur A trader engaged in arbitrage. They seek to

make a lot of small, quick profits.

Ask The lowest price at which a dealer or market maker

will sell a security (also, ‘bid’, ‘offer’).

Assign To oblige a call option writer to sell shares to the

option holder, or to oblige a put option writer to buy
shares from a put option holder.

At the close Order instructing to be filled as close as

possible to the market close.

At the market An order to buy or sell at the best price

obtainable in the market.
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GLOSSARY
At the open Order instructing the transaction to be filled
in one of the first trades for a particular security, or to
be cancelled otherwise.

Averaging Where a price moves against a trader and he

trades more of the stock to enlarge his position but to
lower his overall entry price. It will mean he will have a
lower exit price at which he can make a profit.

Away from the market Trade orders that cannot be

executed because they are above or below the current
bid or ask. For example, a limit order to buy 50 shares
of AOL at $105 when the best offer is $109 will not be
filled and is said to be ‘away from the market’.

Backbone A high-speed connection within a network that

connects all the other circuits. Another name for a
‘hub’. A central connection from which ‘spokes’ or
connections radiate.

Bandwidth The capacity of a network to carry data. If

your pipes are clogged (low bandwidth) then things
take for ever to load. It’s an issue not of length but of
width.

Basis point Used to calculate differences in interest rate

yields, e.g. the difference between 5.25 per cent and
6.00 per cent is 75 basis points.

BBS A bulletin board system. A little like an electronic

notice board. You ‘post’ messages to the board and
everyone who subscribes to the board can view them.

Bear(ish) An individual who thinks prices will fall.

Bear market A market in which prices are falling.

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GLOSSARY

Bear spread An option position where it is intended to

profit from a falling market. Usually the position
involves the purchase of a put at one strike price and
the sale of a put at a lower strike price.

Beta This measures the stock’s volatility to the market as a

whole. A beta value greater than 1.0 represents greater
volatility than the general market; less than 1.0 repre-
sents less volatility than the general market.

Bid An offer to purchase at a specific price.

Big Board Nickname for the New York Stock Exchange.

Greatly adds to your smugability if you only ever refer to
the NYSE as the Big Board. The ignorant will instantly
fall admiringly at your feet. That a person of flesh and
blood could know so much!?

Black-Scholes Pricing Modelability A mathematical

model used to calculate the price in theory of an option.
The main input variables are: the risk-free interest rate,
volatility, dividends, time to expiry, the strike price,
underlying price.

Block As in ‘the sale of a block of shares’. A transaction

involving a large number of shares or other security.
Often blocks are bought or sold at a discount to the
current market as an accepted cost of trading a large
number of shares.

Boiler room Derogatory term to describe a brokerage firm

where investors are aggressively solicited over the
telephone with high-pressure telephone sales tactics.
Smug traders, stay well clear.

Bounce What happens to mail which for some reason

(e.g. wrong e-mail address) cannot be delivered.
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GLOSSARY
Breadth Comparison of issues traded on a stock exchange
on a given day to the total number of issues listed for
trading. The broader a market move the more significant
it is.

Break A sudden fall in price.

Breakout When the price moves out of its recent range.

Sometimes signals further moves in the direction of the
breakout.

Broker An individual who executes customers’ orders.

Bucket shop Slang term for a disreputable brokerage firm

that regularly engages in illegal practices, such as selling
customers’ stock at a higher than market price without
disclosing the fact.

Bull(ish) An individual who believes prices will rise.

Bull market A market in which prices are rising.

Bull spread An option position where it is intended to

profit from a rising market. Usually the position involves
the purchase of a call at one strike price and the sale of
a call at a higher strike price.

Buy in A person having to buy a security because of an

inability to deliver the shares from a previous sale of said
shares. Often associated with short sellers.

Call option (calls) The right, but not the obligation,

existing only for a fixed period of time, to purchase a
fixed quantity of stock at a fixed price.

Cash flow per share The trailing 12-month cash flow

divided by the 12-month average shares outstanding.
All other things being equal, a relatively high figure,
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GLOSSARY

growing steadily, is a sign of a growing and healthy

company and may indicate a rising share price.

Churning Illegal practice by a broker to cause excessive

transactions in a client’s account to benefit the broker
through increased transaction fees.

Clerk An employee of an exchange’s member firm, who is

registered to work on the exchange floor.

Closed When referring to a position this means one has

made an equal and opposite trade to one already held
and so has no more exposure to the market on that trade.

Co-mingling Illegal act of combining client assets with

those of the brokerage to boost the fiduciary’s financial
standing.

Contrarian An individual who generally believes it is

usually better not to do what the majority is doing,
because the majority does not make money.

Cookie According to conspiracy theorists, a cookie is a

small piece of software that is downloaded from a
website to your computer’s hard drive that tells the web
master all your hidden and deepest secrets. According
to everyone else, a cookie is a small piece of software
that is downloaded from a website to your computer’s
hard drive that tells the web master your user name,
password, viewing preference and one or two other
things. It means you do not have to enter the same
information over and over again.

Crossed market The highest bid is greater than the lowest

offer due to buyer and seller imbalance. Usually only
lasts a few seconds until the market ‘sorts itself out’.

Current ratio The ratio of total current assets divided by

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GLOSSARY
the total current liabilities for the same period. A
measure of financial strength. All other things being
equal, a relatively high figure would indicate a healthy
company.

Cyberspace William Gibson’s name in his fantasy novel

Neuromancer (William Gibson, 1994) to describe what
is now known as the internet.

Daisy chain Creating the illusion of trading activity in a

stock through collusion of a number of brokers. Yes, it
is illegal.

Day trade(r) A position that is closed the same day it was

opened.

Deep discount Often, internet brokers that charge

commissions far less than full service or discount
brokers; as cheap as you can get.

Delta The change of the options price for a change in the

underlying price. A delta of 0.5 means a 10-point move
in the underlying price causes a five-point move in the
option.

Depreciation An accounting measure used to reduce the

value of capital expenditure for the purposes of
reclaiming tax.

Diversification Reducing risk by spreading investments

among different investments. Not putting all your eggs
in a few baskets.

Dividend ex-date This is the date from which a purchaser

of the stock will not be entitled to receive the last
announced dividend. Appropriately, when a stock goes
ex-dividend its price falls by approximately the value of
the dividend.
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GLOSSARY

Dividend growth rate A measure of corporate growth.

The annual positive change in dividend paid to stock-
holders. All other things being equal, an increase
should indicate a growing company and should be
reflected in rising share price.

Dividend rate This is the total expected dividends for the

forthcoming 12 months. It is usually the value of the
most recent dividend figure multiplied by the number of
times dividends are paid in a year, plus any extra
dividend payments.

Dividend yield This is calculated by dividing the annual

dividend by the current price and expressing the figure
as a percentage.

Domain Part of a web or e-mail address. Separated from

the rest of the address by dots.

Dotted quad A set of four numbers separated by dots

that constitutes an internet address, e.g.
123.32.433.234.

Down tick A trade in a security that was executed at a lower

price than the previous trade; same as ‘minus tick’.

EPS Earnings per share. A measure of corporate growth.

The value of corporate earning divided by the number
of shares outstanding. All other things being equal, a
growing figure reflects a healthy growing company and
should be reflected in the share price.

European option An option that is only exercisable at

expiry.

Exercise Where the holder of an option uses his right to

buy or sell the underlying security. Also means to work
out.
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GLOSSARY
Expiry The date up to which a trader can exercise his
option.

Flame An e-mail that is abusive or argumentative. Usually

includes the words ‘You are a …’ somewhere in the
message.

Flamefest The same as a flame orgy.

Flat (1) A market where the price of a stock and/or its

volume have not changed significantly over a period of
time; (2) to no longer hold a position in a particular
security or account.

Floor broker A member who executes orders for clearing

members.

Floor trader An individual who trades on the floor of an

exchange either for himself or for a company.

Free speech An issue relating to the internet about which

the US Congress spends inordinate quantities of time.
Essentially, the concern is to give rights to those who
would deny them to others, including those who
granted them.

Freeriding Rapid buying and selling of a security by a

broker without putting up funds for the purchase. Yup,
it is illegal.

Front running Buying or selling securities ahead of a large

order so as to benefit from the subsequent price move.

FTP (file transfer protocol) The protocol for sending files

through the internet.

Fundamental analysis Forecasting prices by using

economic or accounting data. For example, one might
base a decision to buy a stock on its yield.
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GLOSSARY

Futures A standardized contract for the future delivery of

goods, at a pre-arranged date, location, price.

Gap Where a price opens and trades higher than its

previous close.

Geek Also known as a net nerd. They were the kids

everyone hated at school, who wore thick black-
rimmed spectacles and were extremely uncool. They
would also get sand kicked in their faces and were so
unpopular no one would be seen dead with them –
sometimes not even their parents. Now the sand has
settled, and it has become clear that because they were
unpopular they spent all their time studying, and can
now be considered some of the wealthiest people on
the planet, with the fastest, flashiest cars. They
definitely had the last laugh.

Gross margin A measure of company profitability. The

previous 12-month total revenue less cost of goods sold
divided by the total revenue. All other things being
equal, a decrease in gross margins could indicate
troubled times ahead.
Hedge Protection against current or anticipated risk
exposure, usually through the purchase of a derivative.
For example, if you hold euros and fear that the price
will decline in relation to the dollar you may go long
dollar. You would then make some profit on your long
position to offset your losses in holding euros.
Hit the bid When a seller places market orders with the
intention of selling to the highest bidder, regardless of
price.
Implied volatility Future price volatility as calculated from
actual, not theoretical, options prices. The volatility is
implied in the prices.
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GLOSSARY
In and out Term for day trading in a security.
Income per employee The income after taxes divided by
the number of employees. A measure of corporate
efficiency. All other things being equal, the greater the
figure, or a growing figure, indicates a more efficient
company and should be reflected in a rising share price.
Initial margin requirement Amount of cash and
securities a customer must have in his/her account
before trading on margin.
Initial public offering (IPO) First sale of stock by a
company to the public.
Insider Person such as a corporate officer or director with
access to privileged company information.
Insider share purchases The number of shares in the
company purchased by its insiders – officers and
directors – over a stated period of time. All other things
being equal, a relatively large move may indicate a
forthcoming upward move in the stock price.

INSTINET A ‘fourth stock market’ allowing members to

display bid and ask quotes and bypass brokers in
securities transactions. Owned by Reuters.

Institutional net shares purchased This is the difference

between institutional share purchases less institutional
share sales in the company over a stated period of time.
All other things being equal, a relatively large move may
indicate a forthcoming upward move in the stock price.

Institutional per cent owned This is the percentage of

shares owned by all the institutions taken together. It is
a percentage of the total shares outstanding. All other
things being equal, a relatively large move may indicate
a forthcoming upward move in the stock price.
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Intranet This is a collection of computers connected to

one another and usually located in a company or other
organization. Unlike the internet, the network is private
and not principally intended for the public.

Java An island or a coffee bean or a programming

language developed by Sun Microsystems. It allows
users to do lots of clever things with web pages.

LAN (local area network) A network of computers

operating up to a few thousand meters from each
other.

Level I quotes Basic service of the Nasdaq stock market

that displays current bid and ask quotes.

Level II quotes Service of the Nasdaq stock market that

displays current bid and ask quotes and the bids and
asks from all market makers in a particular stock.

Level III quotes Service of the Nasdaq stock market that

allows a market maker or registered broker–dealer to
enter a bid or ask on the electronic trading system.

Limit The maximum permitted price-move up or down for

any given day, under exchange rules.

Liquid market A market which permits relatively easy

entry and exit of large orders because there are so many
buyers and sellers. Usually a characteristic of a popular
market.

Long A position, opened but not yet closed, with a buy

order.

Long-term debt to total equity A measure of financial

strength. The long-term debt of the company divided
by the total shareholder equity for the same period. All
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GLOSSARY
other things being equal, a relatively high figure may
indicate an unhealthy company.

Margin A sum placed with a broker by a trader to cover

against possible losses.

Margin call A demand for cash to maintain margin

requirements.

Mark to market Daily calculation of paper gains and

losses using closing market prices. Also used to
calculate any necessary margin that may be payable.

Market capitalization This is the product of the number

of shares outstanding and the current price.

Market order See At the market.

MIME Multi-purpose internet mail extensions. This

enables you to attach files to e-mail.

Momentum An indicator used by traders to buy or sell. It

is based on the theory that the faster and further prices
move in a particular direction, the more likely they are
to slow and turn.

Moving average A system used by traders to determine

when to buy and sell. An average (simple, exponential,
or other) is taken of the closing (or opening, or other)
prices over a specific number of previous days. A plot is
made based on the average. As each day progresses,
the moving average has to be recalculated to take
account of the latest data and remove the oldest data.

Net After expenses, or short for the internet.

Net profit margin A measure of profitability. Income after

taxes divided by the total revenue for the same period.
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GLOSSARY

All other things being equal, downward pressure on the

net profit margin could provide advance warning of
impending share price decline.

Netiquette Proper net behaviour. For instance, swearing

is neither appropriate etiquette nor is it netiquette.

Network A group of computers connected to each other

so that their users can access each others’ machines.

Offer A price at which a seller is willing to sell.

Off-line browser A browser that permits viewing of sites

previously downloaded without being connected to the
net.

Open position A position that has not yet been closed

and therefore the trader is exposed to market
movements.

Overbought/oversold A term used to mean, broadly,

that a stock is likely not to advance further and may
decline (overbought) or advance (oversold).

Position Trades which result in exposure to market

movements.

Price, 52-week high This is the highest price the stock

traded in the last 52 weeks. It may not necessarily be a
closing high, it could be an intra-day high.

Price, 52-week low This is the lowest price the stock

traded in the past 52 weeks. Could be an intra-day low
price.

Price to book ratio The current price divided by the latest

quarterly book value per share. All other things being
equal, a relatively low figure may indicate the stock is
undervalued.
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GLOSSARY
Price to cash flow ratio The current price divided by the
cash flow per share for the trailing 12 months. All other
things being equal, a relatively low figure may indicate
the stock is undervalued.

Price to earnings ratio The current share price divided by

earnings per share before extraordinary items, usually
taken over the previous 12 months. All other things
being equal, a relatively low figure may indicate the
stock is undervalued.

Protocols A set of rules with which two computers must

comply in order to communicate.

Push technology The internet can be quite a passive

experience, needing the user to log on to a site to
determine if changes have occurred, or to download
information. With push technology, the browser can be
set to download data automatically from a set site.

Put option A right, but not the obligation, existing for a

specified period of time, to sell a specific quantity of
stock or other instrument at a specified price.

Pyramiding The increase in size of an existing position by

opening further positions, usually in decreasing incre-
ments.

Quick ratio A measure of financial strength. Cash plus

short-term investments plus accounts receivable divided
by current liabilities for the same period. All other things
being equal, a relatively high figure may indicate a
healthy company. See also Acid test ratio.

Return on assets A measure of management effec-

tiveness. Income after taxes divided by the total assets.
All other things being equal, a relatively high or
growing figure may indicate a company doing well.
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GLOSSARY

Return on equity A measure of management effec-

tiveness. Income available to shareholders divided by
the total common equity. All other things being equal,
a relatively high or growing figure may indicate a
company doing well.

Return on investments A measure of management

effectiveness. Income after taxes divided by the average
total assets and long-term debt. All other things being
equal, a relatively high or growing figure may indicate a
company doing well.

Revenue per cent change year on year A measure of

growth. The revenue of the most recent period less the
revenue of the previous period divided by the revenue
of the previous period. All other things being equal, a
growing figure indicates a growing company and
should be reflected in a rising share price.

Sales change (as a percentage) A measure of corporate

growth. The value of sales for the current period less
the value of sales for the preceding period divided by
the value of sales for the preceding period, expressed as
a percentage. All other things being equal, a growing
figure indicates a growing company and should be
reflected in a rising share price.

Sales per employee A measure of company efficiency.

The total sales divided by the total number of full-time
employees. All other things being equal, the greater
this figure the more efficient the company.

Scalper A trader who seeks to enter and exit the market

very quickly and thereby make a lot of small profits.

Seat Exchange membership that permits floor trading.

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GLOSSARY
Server A computer that shares its resources with others.
The resources may be disk space, or files, or something
else.

Shares outstanding The number of shares issued less

those held in treasury.

Short An open position created by a sell order, in the expec-

tation of a price decline and so the opportunity to profit
by purchasing the instrument (so ‘closing out’) at a lower
price.

Short-term debt The value of debt due in the next 12

months.

SMTP (simple mail transfer protocol) The standard set

of rules for transferring e-mail messages from one
computer to another.

Speculator An individual who purchases financial instru-

ments in order to profit. Often used to refer to a non-
professional. Sometimes used derogatorily.

Spread The simultaneous purchase of one contract and

the sale of a similar, but not identical, contract.
Depending on the exact combination, a profit can be
made from either a rising or falling market.

Stop order (stop-loss orders) An order left with a broker

instructing him to close out an existing position if the
market price reaches a certain level. Can be used to
take profits or stop losses.
TCP/IP (transmission control protocol/internet protocol)
A set of rules used to connect to other computers.
Technical analysis Method used to forecast future prices
using the price data alone (for example, by plotting
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GLOSSARY

them on a chart and noting direction) or using the price

as an input in mathematical formulae and plotting the
results. See also Fundamental analysis.
Technical rally or decline A price movement resulting
from factors unrelated to fundamentals or supply and
demand.
Tick The smallest possible price move.
Total debt to equity ratio A measure of financial
strength. The total debt divided by total shareholder
equity for the same period. All other things being equal,
a relatively low figure is a sign of a healthy company.
Total operating expenses A measure of the cost of
running the company. All other things being equal, a
lower figure is preferable to a higher one.
Trendline A line on a price chart indicating market price
direction. The line connects at least three price points
which touch the line, with no prices breaking the line.
Volatility A statistical indication of probable future price
movement size (but not direction) within a period of
time. For example 66 per cent probability of a 15 pence
move in three months.
Webcasting This is the internet trying to be older – like TV
or radio. Instead of viewing pages, you view a stream of
data in the form of radio or video. Unfortunately, the
infrastructure is lacking to make this a popular alter-
native to TV and radio.
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GLOSSARY
Whipsaw A price move first in one direction, and, shortly
thereafter, in another direction thereby catching traders
wrong-footed. Such markets may be termed ‘choppy’.
Such effects often give rise to false buy and sell signals,
leading to losses.
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Further reading

H Abell, The Day Trader’s Advantage, Dearborn

Financial 1996. A little dated from the ubiquitous Abell,
who seems to be a full-time author producing what
feels like one book per month. Focuses on the trading
psychology aspects of day trading.
Carroll Aby, Point and Figure Charting, Traders Press
1996. Both a beginners’ guide and a reference book
for this method of plotting prices.
Steven B Achelis, Technical Analysis from A to Z, Probus
1995. A good introductory guide which is compre-
hensive. Lots of pics of indicators.
Gerald Appel, The Moving Average Convergence-
Divergence Method, Signalert 1979. Appel is the
creator of this highly popular trading method, and this
book explains it straight from the source’s mouth.
Useful if you plan to place large weight on this
indicator in your own trading.
Gerald Appel and Fred Hitschler, Stock Market Trading
Systems, Dow Jones Irwin 1980. This is a classic and
discusses the price ROC and moving average trading
systems among others. It is always best to go to the
original source to gain insights which later secondary
texts are likely to miss.
Richard Arms, Volume Cycles in the Stock Market,
Equis 1994. Arms is a well-known technical analyst and
this book delves in depth into volume. If volume
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FURTHER READING

analysis is something you intend using then this a very

good source of information.
Robert Barnes, High Impact Day Trading, Irwin 1996.
This book highlights the author’s Mountain Valley
system, going for longer moves and ignoring shorter
ones. It has proved a very popular title.
J Bernstein, The Compleat Day Trader, McGraw-Hill
1999. A very good seller, with an unusual title. Covers
not only day trading but also risk management.
The Bhagavad Gita, Trading psychology. Various
editions. Although written more than 2,000 years ago,
and not directly about trading, I found it to be one of
the most useful ‘trading’ books I have ever read. It
largely discusses discipline – how and why – and the
benefits of discipline. Since a lack of mental discipline is
one of the major downfalls of traders, this is likely to be
a very profitable read.
William Blau, Momentum Direction and Divergence,
Wiley 1995. Definitely for the advanced user. If, after
learning about oscillators, you want to take things
further and uncover some mathematics to better
understand their weaknesses then this is a good book.
Philip L Carret, The Art of Speculation, Wiley 1997.
Apparently highly regarded by Victor Nieder-hoffer.
However, in spite of that, I would recommend it as a
good read.
AW Cohen, How to Use the Three-Point Reversal
Method of Point and Figure Stock Market Trading,
Chartcraft 1984. Despite the cumbersome title this is a
useful book on this popular method of drawing charts.
R Colby and T Meyers, Encyclopedia of Technical
Market Indicators, Business One Irwin 1988. As one
would expect of a book claiming to be an encyclopedia
this is an exhaustive study. It will be most useful if you
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want a good overview before settling down on a few
chosen indicators.
John Cox and Mark Rubinstein, The Options Markets,
Prentice Hall 1985. This is a classic text on options. The
book is about valuing options – these authors, of course,
created the famous Cox–Rubinstein option pricing model.
Robert Daigler, Advanced Options Trading, Probus
1993. This book moves beyond basics and discusses
some strategies generally used only by the profes-
sionals. That does not mean a private investor using
them will have hit upon some sector – so beware. But if
you are interested in knowing more than just the basics,
this book is better than most.
David DeRosa, Options on Foreign Exchanges, Probus
1992. Not to leave out the currency-option boys and
girls, this market specialist covers valuation of options
and pricing of currencies, as well as how the various
markets work. Probably useful for the beginner and
intermediate-level trader in forex options.
Edward Dobson, Understanding Fibonacci Numbers,
Traders Press 1984. Not too difficult to understand if
Fibonacci fascinates.
Mark Douglas, The Disciplined Trader, Prentice Hall
1990. An extremely good book. Written in a very intel-
ligent fashion and gets away from ‘Mickey Mouse’-
fashion psychology. Deserves a far higher profile than it
has to date received.
S Eckett, Investing Online, FT Pitman 1997.
Encyclopaedic in coverage and an excellent reference
tool with a focus on global investing.
William Eng, Trading Rules, FT Pitman 1995. While some
of the rules will be familiar, others provide valuable
enough information to justify buying this easy-to-
understand book.
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FURTHER READING

C Farrell, Day Trade Online, Wiley 1999. Farrell is a young

man who trades for a living. Some good content in
here, but lay-out, design and substance lacking in other
respects.
Robert Fischer, Fibonacci Applications and Strategies
for Traders, Wiley 1993. Take Fibonacci study further
with this book. While you do not necessarily need such
detailed knowledge, if you are going to use it, you may
as well know all there is.
Kenneth Fisher, 100 Minds that Made the Market,
Business Classics 1991. Biographical in nature and the
profiles are somewhat short, but nevertheless a good
bedtime or holiday read.
M Friedfertig and G West, Electronic Day Traders’
Secrets, McGraw-Hill 1999. This book has a series of
interviews with day traders from Friedfertig’s own
brokerage company. A lot of trading psychology here,
but light on strategies.
D Gerlach, The Complete Idiot’s Guide to Online
Investing, Que 1999. Que are known for their
computer books and this venture appears to be a
bandwagon thing. But the Complete Idiot’s guides can
be clear and more comprehensible if you are, um, well,
a complete idiot.
Elli Gifford, The Investor’s Guide to Technical
Analysis, FT Pitman 1995. While the book uses UK
companies to illustrate points, it is nevertheless useful
to traders in any country. Thorough, comprehensive,
and easy to read and understand. Good as a starter
and for more advanced study; however, it is not
mathematical.
William Grandmill, Soybean Trading and Hedging,
Wheat Trading and Hedging, Corn Trading and
Hedging, Investing in Wheat, Soybeans, Corn,
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Irwin Professional 1988, 1989, 1990, 1991 (respec-
tively). A series of books by the appropriately named
Grandmill for commodity traders. Grandmill provides
details of the commodities, and his own systems for
picking entry and exit points. If you think it is best to
become an expert in one area of commodity trading
then books such as these should be a good starting
point to developing your skills and understanding.
William Grandmill, Make Money with S&P Options,
How to Make Money with Corn Options, Make
Money with Soybean Options, Irwin 1989, 1990,
1990 (respectively). If you are concentrating on one of
these areas and feeling you need something specifically
addressing your trading needs, then these books were
written with you in mind. Grandmill is a prolific writer
and knows what he is talking about.
Joseph Granville, New Strategy of Daily Stock Market
Timing for Maximum Profit, Prentice Hall 1976.
Another one of the technical analysis gods. This book
discusses on-balance volume in particular. Granville
created that indicator, so who better to learn more
about it from?
Alvin D Hall, Getting Started in Stocks, Wiley 1997 (3rd
edition). A very good primer for stocks. Hall has a clear
style and injects humour now and again to alleviate the
rigour.
Charles Kindleberger, Manias, Panics and Crashes, Wiley
1996. Why do the economists, statisticians and
government nerds always get it wrong? This book does
not provide any answers, but it does provide some
insights.
George Kleinman, Mastering Commodity Futures and
Options, FT Pitman 1997. This book is very well-
presented indeed. A little like a textbook in style, but
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covers the ground very well for both beginner and inter-
mediate user.
Knight-Ridder, The CRB Commodity Yearbook, Knight-
Ridder annual. A very useful reference guide to
commodities. Filled with data, charts, tables and articles
on trends and strategies. If you are serious about
commodities you should have this.
Robert Koppel and Howard Abell, The Inner Game of
Trading, Irwin Professional 1997. Includes interviews
with some leading traders, but its value comes from the
analysis of psychological difficulties traders are likely to
encounter. Definitely recommended.
John Labuszewski, Trading Options on Futures, Wiley
1998. This covers treasuries, currencies and
commodities. I think if you are trading options on
futures there is more to it than understanding options
and understanding futures. The whole is greater than
the sum of the parts, and therefore a book such as this
is added value in being exclusively written for one
trading sector.
Edwin Le Fevre, Reminiscences of a Stock Operator,
Wiley 1994 (reprint edition). An undoubted classic. The
fictionalized trading biography of Jesse Livermore, one
of the greatest speculators ever seen. While dated (it
was written in 1923), it nevertheless provides some
insight into the difficulties encountered by traders. A
very enjoyable read.
Todd Lofton, Getting Started in Futures, Wiley 1997
(3rd edition). Very clear and easy to understand as well
as giving lots of information for delving deeper.
Charles Mackay and Joseph de la Vega, Extraordinary
Popular Delusions and the Madness of Crowds
and Confusion de Confusiones, Wiley 1995. Explores
crowd psychology and how that affects market
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movement. While its examinations are 300 years old, it
is highly relevant today. Short and interesting.
Lawrence McMillan, McMillan on Options, Wiley 1996.
Brands itself as the ‘Bible’ of the options markets. Why
do publishers refer to their books as the ‘Bible’ of
something? I wonder if they mean only a minority of
people will ever read the book but more are supposed
to and it competes with equivalent books for the rest.
Anyway, that aside, McMillan goes beyond explaining
the basics about options and actually applies a degree
of critique. Should consider if you are a beginner.
John Murphy, The Visual Investor, Wiley 1996. Former
CNBC presenter provides a good primer on technical
analysis. He draws on one of the key aspects of
technical analysis – it is visual.
David S Nassar, How to Get Started in Electronic Day
Trading, McGraw-Hill 1999. Nassar owns a day-trading
firm, and this book is written from the perspective of a
man who knows his business.
David S Nassar, The 22 Rules of Day Trading Online,
McGraw-Hill 1999. After the success of his earlier day-
trading book, David Nassar returns with a different
format.
Sheldon Natenberg, Option Volatility & Pricing
Strategies, Probus 1994. Natenberg is a leader in this
field. This book is definitely for the more advanced
trader wanting to dig into option mechanics.
Steven Nison, Japanese Candlestick Charting
Techniques, New York Institute of Finance 1991. Steve
Nison is regarded as the expert on Japanese candle-
sticks. This book is very clear and very easy to under-
stand. Nison uses actual charts and not stylized fictional
ones. He also focuses on how and when the chart
indications fail. The book helps an understanding of the
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rationale behind technical analysis, why it works, and

why it does not. Excellent.
Grant Noble, The Trader’s Edge, Probus 1995. Some very
useful insights into what they do on the floor. A good
insider’s view and useful pointers on some of the advan-
tages.
Alpesh B Patel, Trading Online, FT Prentice Hall 2000.
New and revised version of the best-seller covering all
the steps to trading from getting set up to monitoring
positions.
Alpesh B Patel, The Mind of a Trader, FT Pitman 1997.
Advice on becoming a better trader from the world’s
leading traders, including Pat Arbor, former Chairman
of the Chicago Board of Trade, and Bill Lipschutz,
former Global Head of Forex at Salomon Brothers, who
made on average $250,000 each and every trading day
he was there, for eight years!
Martin Pring, Technical analysis, Technical Analysis
Explained, McGraw-Hill 1991. The first half of this
book is more relevant than the second. While a little
disappointing, nevertheless provides insights not
available elsewhere.
Martin Pring, Martin Pring on Market Momentum,
McGraw-Hill 1993. Aimed at the user who has chosen
momentum as one technical indicator from his arsenal
and wants to learn more, this book is typical Pring; clear
and useful. Unfortunately Pring maintains his habit of
stylized artificial charts instead of giving more real
market illustrations to make his points.
Alan Rubenfeld, The Super Traders, Irwin 1992. Nine
profiles of traders from diverse backgrounds. While a
little bit too biographical, nevertheless makes for a
good read.
Jack Schwager, A Complete Guide to the Futures
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Markets, Wiley 1984. This book covers fundamental
analysis and technical analysis as well as spreads and
options. Characteristic of Schwager’s books, it is very
thorough.
Jack Schwager, Market Wizards, New Market Wizards,
Harper Business 1993, Wiley 1995 (respectively). An
absolute must. Fascinating, although since it’s in a
question and answer format you are left to draw many
of your own conclusions.
Kenneth Shaleen, Volume and Open Interest, Irwin
1996. A good starter to investigating these two popular
statistics in technical analysis. Probably unavoidable if
you are trading futures.
Larry Spears, Commodity Options, Marketplace Books
1985. This one is for beginners who may not have settled
on a particular commodity and want an overview.
Peter Temple, Traded Options, 3rd edn, Pearson
Education 2001. For those trading options on LIFFE.
Thorough and explains all the basics, from what options
are to buying software.
Michael Thomsett, Getting Started in Options, Wiley
1993. Again, very clear and easy to understand. An
excellent start for beginners.
Russell Wasendorf and Thomas McCafferty, All About
Options, Probus 1993. The good thing about this book
is that it covers both strategies and some of the
background mechanics behind options, such as what
happens on the trading floor.
Neal Weintraub, Tricks of the Floor Trader, Irwin 1996.
One of the few books of its kind. Gives the outsider a
view of what the insider does. Provides knowledge
which is useful to know.
Welles J Wilder, New Concepts in Technical Trading
Systems, Trend Research 1978. Wilder is very highly
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236
FURTHER READING

regarded in the technical analysis world. Here he

explains and interprets numerous indicators, including
RSI.
L Williams, Long-term Secrets to Short-term Trading,
Wiley 1999. Larry Williams is a proven trader. An
excellent book, because he clearly knows his stuff and
trades off it.
M Anthony Wong, Trading and Investing in Bond
Options, Wiley 1991. This title covers strategies and
pricing models and details the peculiarities of trading
this market using options.
Martin Zweig, Winning on Wall Street, Warner Books
1997 (revised edition). Zweig is famous for his market
reports and for being one of Schwager’s market
wizards. I found a copy of this book for $11.99 – you
can’t go wrong.
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Index

1-800-MUTUALS 78 bondtrac.com 127

411stock.com 18 BradyNet 127, 128, 174–5
Brazil, financial websites 180
Accutrade 149 Brill 78
active brokers 132–5, 137 brokers
Active Traders Network 136, 145 choosing 81–7
ADRs see American depository online 131–7
receipts recommendations 86–7
ADVFN 99 surveys 82–3
advisory brokers 76–7, 79 types 75–80, 89–92
aggressive growth trading 5 websites 84
alpha 67 browser-based brokers 131–4
Altavista 38 Brunswick Direct 186
American depository receipts Buffett, Warren 44, 97
(ADRs) bull markets 41–2
definition 170 Bureau of the Public Debt 128
pros and cons 170–2
trading in 173, 186 call options 150, 153–4,
websites 173–81 156–7, 158–9, 164
Ameritrade 62, 99, 127, 143, careerdaytrader.com 136
149, 173 Carlin 135
Argentina, financial websites 179 CBOE see Chicago Board
asset allocation analysis 99 Options Exchange
CBS MarketWatch 20, 23–4,
Barber, Brad 201, 202 29, 31
bear markets 41 chat rooms 32
Berkshire Hathaway 44 Chicago Board of Trade 153
Bescos 174 Chicago Board Options Exchange
beta 104 (CBOE) 152–3
Big Charts 4, 43 Chile, financial websites 180
Bloomberg 19, 144, 204 China, telecoms sector 185–6
Bloomberg Latin America 116, CNNfn 20
174 comdirect.co.uk 63
Bloomberg TV 174 companies
bonds news 27–36
definition 119–20 small cap stocks 67–8
investing in 121–6 continuation patterns 57
websites 126–8 core-growth trading 6
bondsonline.com 127 core-value trading 6
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cost averaging 42–3 Financial Times, website 21, 30,
Cox-Rubenstein Model 160 204
Credit Suisse First Boston 87 Financial Web 153
CyberCorp 135 flag strategies 57–8
FTMarketWatch 21, 32, 40, 63
datek.com 85, 95, 132, 173 full-service brokers 90–2
day trading fund managers, performance 9,
definition 141 65–8
pros and cons 142–6 fundamental analysis 36, 48
Daypicks 145 see also technical analysis
daytrader.co.uk 145 Funds Direct 78
daytraders.com 136
Deal4Free 78, 79, 135 ganar.com 175
deep-value trading 6–7 GDRs see global depository
delta (options) 162 receipts
digitallook.co.uk 63 Getting Started in Options
Direct Access Traders 135, 136 (Thomsett) 152
director dealings 36 gilts 120, 126
dividend yield 194 global depository receipts (GDRs)
DLJ Direct 83 186
dljdatek.com 62 Global Investor 170, 173, 184
dollar growth 187–8 GNI 135
Durlacher 76 gomez.com 83
GoShare 173
E*Trade 4, 79, 83, 98, 101, growth at a reasonable price
131, 132 (GARP) trading 7
E*Trade Korea 170 growth stocks 194–6
eCharts.com 4 growth trading 7
electronic direct access trading Grupo Iusacell 185
(E-DAT) 133 Guerilla Investing (Siris) 67
Elite Trader 145
Elpais 175 Hagstrom, Robert 68
emerging markets, investing in head and shoulders strategies
183–8 54–5
eo.com 5 hemscott.net 6, 43
eschwab.com 85, 91, 121, Hensley, Michael 136
132, 186 herring.com 44
ETFs see exchange traded funds holders.com 62
etrade.com 85, 95, 132 hoovers.co.uk 6
Excel 96 Hubbard, Elbert 72
exchange rates, foreign stocks and
189–92 In Search of Alpha (Warwick) 67
exchange traded funds (ETFs) income stocks 194–6
61–2 indesfunds.com 62
Excite 38 initial public offering (IPO) 5
execution-only brokers 75–6, 78, INO Global Markets 153
79 Interactive Brokers 135, 137
Expansion directo 175 Interactive Investor International 127
Expansion Financiera 175 interest rates, risk 115
internet connections, day trading
fastrade.co.uk 62 and 144
fimatex.co.uk 62 interstocks.com 44
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investars.com 87 analysing 26
investinginbonds.com 126 commentary 23–6
investment psychology 115, company news 27–31
203–4 non-US stocks 32
investment trusts 78 types 12–18
Investors’ Club 153 websites 18–24
IPO see initial public offering North American Securities
ipo.com 5 Association 145
ISDN 144
iShares 62 online trading
issuedirect.com 5 active trading 136–9
itruffle.com 67 dividend yield 194
emerging markets 183–8
J.P. Morgan 173 foreign stocks 169–81,
189–92
Killik 76 fund managers and 65–8
long-term 41–6, 77
Latin America, investing in 116, news 11–40
128, 138–9, 174–80 pros and cons 201–5
Latin Focus 21, 176, 184 risk 114–15
Latin Stocks 139, 176–7 rules 66
LatinInvestor 116, 176 in sectors 61–4
Lehman Brothers 90, 144 strategies 3–9, 42–3
leverage 151, 161–3 technical analysis and 47–59
liffe.com 152 tips 204–5
Lipschutz, Bill 203 tools xviii–xix
liquidity 115 transaction fees 192–3
Lycos 37–8 options
definition 147–8
market capitalization 36 intrinsic value 158–9
marketocracy.com 65 jargon 153
Matrix Options 153 share prices and 161–2
MegaBolsa 177 strike price 157–8
Merrill Lynch 90, 91, 92 time value 158, 160–1
mfinance.com 184 trading 147–52, 164–6
Microsoft Money 96 see also call options; put
Miller, Merton 67 options; traded options
The Mind of a Trader 203 Options Industry Council 153
momentum trading 4, 8
MoneyExtra 62, 78, 126 Paine Webber 90
MoneyNet 22, 30, 153 Patagon 85, 128, 138–9,
Moody’s Investor Services 128 177–8
Morgan, J.P. xvii pathburner.com 63, 76, 132
Morgan Stanley Dean Witter 91 pennant strategies 58
morningstar.com 62, 78 performance analysis 99–100
MSNBC 22 portfolio management
mutual funds 78 diversification 106
mutualfundworld.com 78 tools 96, 98–101
MyBroker 78, 79, 135 trackers 95–6
Portugal, financial websites
newissues-ipo.com 5 180–1
news price charts 49–59
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price-earnings (P/E) ratios 7 support and resistance levels
put options 150, 153–4, 157, 51–4
158, 164
taxfreebond.com 127
quicken.com 6, 96, 98, 99 TD Waterhouse 132
technical analysis 36, 47–8
rectangle patterns 57 patterns 54–8
Reuters Moneynet 22 price charts 49–59
reuters.com 144 trendlines 50–4
reversal patterns 54 see also fundamental analysis
risk management technology, media and telecoms
beta 104 (TMT) 44
diversification 106 Temple, Peter 152
online investing and 114–15 Thomsett, Michael 152
reward-to-risk ratio 103, 107, ticker symbols 28–9
204 TMT see technology, media and
risk tolerance 108–14 telecoms
tools 104–5 Topic 3 144
RiskGrades 98, 104–5, 106, Tradecast 135
107, 108 traded options 157
see also options
Salomon Smith Barney 90 Traded Options (Temple) 152
saucer strategies 56 tradehard.com 136
Scholes, Myron 67 trading see day trading; online
Schwab 4, 79, 82, 83, 101, 131 trading; options: trading
schwab-europe.com 127, 132, Trading Tactics 145
173 Training for Profit 153
scottrade.com 85 Treasury bonds 120
search engines 37–8 trendlines 50–4
sectors, investment in 61–4 triangle strategies 55–6
Securities and Exchange TrustNet 78, 186
Commission (SEC) 145 trusts 62
Senda Financiera 178
share picks 32 unit trusts 78
Sharepeople 76
Siris, Peter 67 Vodafone 185–6
smallcapcenter.com 67 volatility 3, 43
Soros, George 97
Spain, financial websites 181 Wall Street Journal, website 23
spread (options) 141 The Warren Buffett Portfolio
Steffens, John 92 (Hagstrom) 68
stocks Warwick, Ben 67
income vs growth stocks 194–6 WorldlyInvestor 23, 173, 184
past performance 117 Wright Research Centre 6
price forecasting 47–59,
69–72 Yahoo! 38
small cap 67–8 Yahoo!Finance 96, 173, 204
Stocktrade 98, 99 Yahoo!Finanzas Espana 178
Stour Concepts 153
Sun Microsystems 33–5 ZonaFinanciera 116, 178–9