How Do You View Money?
Stockscores.com Perspectives for the week ending June 5, 2005
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Stockscores Club Meeting - Calgary and Vancouver
Our last Stockscores Club Meetings before the Summer break will happen this week.
Calgary - Wednesday June 8 at 7:00 pm
University of Calgary
Murray Fraser Hall Room 160
Vancouver - Thursday June 9 at 6:30 pm
Best Western Abercorn Inn
Richmond
Anyone is welcome to attend these meetings, so don't be shy and come out and join us. The first meeting you attend is free, after that they are $10 each time. I look forward to seeing many of you this week!
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In this week's issue:
On money, the Bible tells us:
"For the love of money is a root of all kinds of evil." 1 Timothy 6:10
Ayn Rand, in her book Atlas Shrugged, seemed to respond to this assertion in the following passage:
"So you think that money is the root of all evil?" said Francisco d'Anconia. "Have you ever asked what is the root of money? Money is a tool of exchange, which can't exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value. Money is not the tool of the moochers, who claim your product by tears, or of the looters, who take it from you by force. Money is made possible only by the men who produce. Is this what you consider evil?"
So what does this have to do with trading the stock market?
What is noticeably different between these two passages is the word love. The Bible does not tell us that money is the root of all evil, instead it is the love of money that is destructive. Rand simply argues that money in itself is not the root of evil.
What is important is the emotional link to money that leads to destruction, and nothing could be more true for investing and trading.
The best traders are those who don't love their money. They consider the money invested in positions in the same way as a 12 year old considers his or her score on a Playstation game. Money is a means of accounting, and not as a means to pursue material things.
The more you care about your money, the more your decisions will be governed by emotion, the greatest enemy of the trader.
Do you make a decision differently if you are making a trade right after suffering a loss? It is easy to want to "make back" the loss on the next trade, and as a result, not follow a disciplined approach. A trade may be working well, and then give an exit signal. However, the trader who has just suffered a loss may not heed the exit signal if the position has not made enough to pay for the initial loser. Emotion has taken a role in the decision to hold the position longer.
Perhaps you have trouble selling your losers. It is common to want to hold on to your worst stocks and avoid the pain of locking in a paper loss. The fear of suffering a loss stems from a love for money.
Instead, we should love the reward afforded by hard work in the stock market. Discipline and emotionless trading will produce money, so avoiding the love for money should be our pursuit.
The stock market is the ultimate arbiter of truth in the economic world. To beat the stock market, you must make better decisions than the masses, for the masses will regress to mediocrity. Another passage from Altas Shrugged is fitting:
"To trade by means of money is the code of the men of good will. Money rests on the axiom that every man is the owner of his mind and his effort. Money allows no power to prescribe the value of your effort except the voluntary choice of the man who is willing to trade you his effort in return. Money permits you to obtain for your goods and your labor that which they are worth to the men who buy them, but no more. Money permits no deals except those to mutual benefit by the unforced judgment of the traders. Money demands of you the recognition that men must work for their own benefit, not for their own injury, for their gain, not their loss-the recognition that they are not beasts of burden, born to carry the weight of your misery-that you must offer them values, not wounds-that the common bond among men is not the exchange of suffering, but the exchange of goods. Money demands that you sell, not your weakness to men's stupidity, but your talent to their reason; it demands that you buy, not the shoddiest they offer, but the best that your money can find. And when men live by trade-with reason, not force, as their final arbiter-it is the best product that wins, the best performance, the man of best judgment and highest ability-and the degree of a man's productiveness is the degree of his reward."
Ask yourself, do you make the best judgments you can? Are you at the mercy of someone more rational and less emotional than you? It is the best decision that wins, and the wonderful thing about the stock market is that you are told every day whether you have earned the reward of good decision making. Lose your emotional attachment to money and find success.
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The most important factor affecting stock price is information. As information about the earnings potential of a company is made public, prices move to reflect the new knowledge. Often, stocks move in advance of the public release of information because there are market participants who have access to the information early. In other words, the process of information dissemination is gradual and not always fair.
Fortunately, this process often shows up in market activity. If significant new information is available, those with access to that information at an early stage may buy or sell in the market. In doing so, they can cause abnormal market activity.
For example, if an individual learns that Company A is likely to announce an alliance with Company B that will have significant impact on Company A's bottom line, that individual may decide to purchase shares in Company A. If there are enough people with enough buying power doing this, they can cause the price of Company A to move significantly, and trade an abnormal amount of volume.
Mathematically, we can define what a normal price move for a stock is based on its past trading history. A stock like Microsoft may move up or down 3% on average in a day. A smaller, more speculative stock may have a greater range of price movement. Based on their specific trading history, it is possible to extrapolate an expected range of price movement for the next trading session. If that stock moves outside of that range, it is deemed to have made an abnormal price change.
We can apply the same reasoning to the quantity of stock traded on a particular day as well. If a stock trades far beyond the average number of shares that it has traded historically then, statistically, it has traded an abnormal number of shares. Identifying stocks that make statistically significant abnormal price movements while trading an abnormal quantity of shares provides clues that the stock is trading on significant new information. That information may have been made public, market participants may be making an educated guess on future information, or privileged market participants are trading on private information. In certain situations, stocks that behave abnormally are often telegraphing future price trends.
Identifying stocks that have made statistically significant abnormal price gains is an excellent way to find stocks that may continue into up trends. However, using only this filter is insufficient as you will simply find too many candidates and a success rate for finding winners that is too low.
Recognizing that price volatility defines uncertainty, we also want to focus on stocks that have recently been in a period of low volatility, relative to the past trading history of the stock. Market participants are confident about the value of a company that shows little volatility. In other words, the market is confident about the price it has given to all available information. Therefore, if a stock breaks from this period of low volatility with an abnormal gain, we hypothesize that the move was motivated by new information. This new information will take the stock higher as more people learn about it. If the stock makes this abnormal break out of a period of low volatility with strong volume support, we have even more evidence that there is new information causing some investors to get excited.
The concepts of support and resistance is very important to this strategy. When looking at a stock chart, it is relatively easy to see that there are price ceilings and floors that seem to prevent a stock from moving up or down. These lines of resistance are really just a boundary above which the market is unwilling to pay or sell. Based on all the information that the market has about a company, the market is unwilling to pay more than the resistance price and unwilling to sell for less than the support price.
I ran the Abnormal Activity Up and Abnormal Activity Down scans to find some stocks that swing traders could focus on for some relatively short hold period plays. For swing trading, it is important to also look at intraday charts to watch for breaks of the trend or moves that require a loss be taken. After doing these scans, two stocks stood out as good short term swing trading opportunities.
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1. MSFT
MSFT made a strong move to the downside on Friday, and it looks like it will fall some more in the next week or two, setting up a swing trading opportunity for those willing to short the stock or buy a put option. A stop at $25.85 should protect against losses and we may see pull back some more over the next few days.
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2. SINA
SINA has an abnormal day to the upside and broke out from a long term pennant pattern on Friday. There is lots of overhead resistance that SINA will have to work through, but I think that swing traders may want to keep an eye on it. The Internet sector was quite strong last week, so it seems investors are focusing on these stocks as a group as well. Support is at
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References
Get the Stockscore on any of over 20,000 North American stocks.
Background on the theories used by Stockscores.
Strategies that can help you find new opportunities.
Scan the market using extensive filter criteria.
Build a portfolio of stocks and view a slide show of their charts.
See which sectors are leading the market, and their components.
Disclaimer
This is not an investment advisory, and should not be used to make
investment decisions. Information in Stockscores Perspectives is often
opinionated and should be considered for information purposes only. No
stock exchange anywhere has approved or disapproved of the information
contained herein. There is no express or implied solicitation to buy or
sell securities. The writers and editors of Perspectives may have positions
in the stocks discussed above and may trade in the stocks mentioned. Don't
consider buying or selling any stock without conducting your own due diligence.
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