Year: 2020

How to Value a Company And Find The Best To Invest?

For investors, company valuation is a crucial part of determining the potential return on investment. Start by looking at the value of the company’s assets.

One of the most confusing questions for all beginners in the market is how to value a company. The worth of the companies is important for every investor. And the question of how to value a company has a sense for any investor, entrepreneur, employee, and for any size company. Thus, you have to find the best way to determine the worth of the company. Do you need to ask to see the company’s books or you can value a company based on the existing customers or news? How much time will it take to learn how to value a company? When you notice some interesting companies where to go first? Yes, you can ask in many ways how to value a company.

The first comes first.

For every investor, the value of a company is a crucial part of determining the potential returns on investment. Every investor should know if the company is fair valued, undervalued, or overvalued because it has a great impact on a company’s stock or stock options.

For example, a higher valuation might indicate the options will grow in value.

So, if you want to know how to value a company, be prepared to take into consideration a lot of the company’s attributes. This includes revenue and profitability growth, stage of growth, operating experience, technology, commodity, business plans. Yes, but the list isn’t full without market sentiment, growth rate, overall economic circumstances, etc.
To understand how to value a company in a simple way, you can take a few factors into account.

What metrics to use to value the companies?

Here is how to value a company and basic metrics you can use for that. You can use the P/B ratio and P/E ratio. These two metrics are important when you want to evaluate the company’s stock. These basic metrics you can apply to almost all types of companies. But it is important to know the other and often unique factors that can affect the process of how to value a company.

One of the variables in the valuation of a company’s health is debt. But a company’s debt is not continually easy to measure or define. So this metric can make the company’s value difficult to value.

When you want to value a company or stock, it is smart to use the market approach that includes a comparative analysis of precedent transactions and the discounted cash flow which is a form of intrinsic valuation since it is a detailed approach, and also uses an income approach.

How to value a company’s stock?

There are several methods that may give you insight into the value of companies’ stocks.

They are the market approach, the cost approach, and the income approach. The cost approach means that a buyer will buy a share of stock for no more than a stock of equal value. The market approach is based on the belief that in free markets, supply and demand will push the price of a stock to a point where the number of buyers and sellers match. The income approach defines value as the net current value of a company’s future free cash flows.

Market value as a method on how to value a company

The market value is simple. It represents the shares trade for but tells us nothing about stock’s intrinsic value. Thus, we have to know the stock’s true worth. This is a key part of value investing.
The stock value is shown in stock price. The P/E ratio is helpful to understand this value. To calculate the P/E ratio just divide the price of a stock by its earnings per share

When the P/E ratio is high it is a signal for higher earnings for investors. This ratio is helpful to use if you want to know how to value a company. The P/E ratio shows the company’s possible future growth rate. But you should be careful when using the P/E ratio to compare similar companies in the same sector.
Investors connect value to stocks with P/E ratios. If the average P/E ratio is, for example, 20 – 23 times any P/E ratio above 23 times earnings is classified as a company that investors keep in high

Investors and traders use the P/B ratio to compare the book value of a stock to stock’s market value. To calculate the P/B ratio use the most recent book value per share and divide the current closing price of a stock by it. If the P/B ratio is low you can be sure the company is undervalued. This metric is very useful if you want to have accurate data on the intrinsic value of the company.

But be aware, there are several P/E ratios and numerous variations, thus you have to know which one is in play. For more about this READ HERE

Cost approach or book value

Book value is the amount of all of a company’s tangible assets (for example equipment) after you deduct depreciation. So, when we are talking about the company’s “net capital value” it means the book value, estimated by the company’s book of net tangible assets over its book of liabilities. To calculate the book value you have to divide the net capital value by the number of outstanding shares. The result is a per-share value. The book value never takes into account the brand, keep that in mind.

Income as a method on how to value a company

Use the capitalized cash flow to calculate a company’s worth when future income is expected to stay the same as it was in the past. But if you expect the income is going to vary, use the discounted cash flow method.

Calculations are simple, divide the result from capitalized cash flow or discounted cash flow by the number of shares outstanding and the figure you get is the price per share.

Bottom line

By understanding how to value a company you’ll be able to understand the essence of making investment decisions. No matter if you want to sell, or buy, or hold the shares of stock in some company. Warren Buffett, for example, uses a discounted cash-flow analysis.
Sometimes, the company valuation is held as the market capitalization. So, to know the value of the company you have to multiply all shares outstanding by the price per share. For instance, a company’s price per share is $10 and the number of outstanding shares is 4 million. If we multiply the price per share by the number of shares outstanding we will find this company is 40 million worth.

To be honest, it isn’t too hard to value the public company. But when it comes to private companies it can be a bit harder. You can be faced with a lack of information. For example startups. They don’t have a financial track record and you have to value these companies based on the expectation of future growth. To value an early-stage company can be a great challenge.

Before you invest in any company, you’ll need to determine its value. This is important because you need to know if it is worth your time and money. Think about the company’s value as its selling price. Maybe it is the simplest way.

27th March 2020
Stock Buyback: How Does It Impact investors?

A stock buyback decision may send a questionable signal to investors. Not all buybacks will show the management’s opinion that the stocks are undervalued.

By Guy Avtalyon

A stock buyback or a stock repurchase refers to a situation when a company buys its outstanding shares. The reason is simple, they want to decrease the number of available stocks on the market. Did you know this practice was illegal in the past? Oh, yes! It was illegal because it was seen as a type of stock manipulation. Today, a stock buyback is legal, of course.

When a company buys its stocks it can cancel them or hold them for re-issue later. To perform a buyback, a company can get its stocks in the market like any other investor. Also, there are two other ways to do so. The company may announce a proportional offer and buy equivalent parts from its shareholders. The other way is a tender offer. This means the company invites its shareholders to sell stocks by buying back a fixed number of its stocks at a specified price.

Tender offers are made publicly. The company invites shareholders to sell their stocks at a specified price and usually, they have a defined time frame to do that. The price specified is often at a premium to the market price. It can be conditional upon a minimum or a maximum number of sold shares.

The law demands public companies to buyback stocks from funds generated from profits or the gains of a current issue of stocks.

Buyback can be offered over a specific period. For example, a company announces its plan to buy back $70 million worth shares in the next 3 years.

What are the reasons behind a stock buyback

A stock buyback enables the company to invest in itself. When a company buys back its stocks it actually reduces the number of shares outstanding on the market. But at the same time, this increases the proportion of shares held by investors. A stock buyback is a business action. For example, the company sees its stock is undervalued, so it makes a buyback. This action is usually aimed to provide investors with a return. Such a company is bullish on its operations at that time, and stock buyback can significantly increase the earnings gained from shares allocation. The point is that the stock price will rise only if the P/E ratio is sustained. Also, when the company reduces the number of shares outstanding, it makes them worthier. That is the way to increase the stock’s EPS, stock price, and decrease the P/E ratio.

A stock buyback shows to investors that the company has enough cash deposited aside for unpredictable difficulties and a low chance of financial problems.

Also, a company can do that for the purpose of compensation when it wants to award employees or management with stock and stock options. That’s also the reason behind stock buyback, to avoid the dilution of existing stockholders.

How stock buyback is carried out?

The company may present to its shareholders a tender offer. Shareholders have an opportunity to tender all their shares or part, a portion of them. The company limits the time for that. The price of a stock is at a premium price or the current market price. The premium price is compensation for stockholders that are willing more to offer their stocks, rather than hold them.

The company may buyback stocks on the open market, also. Some have buyback programs and from time to time you can see their offers. The share buybacks have a stimulative effect. Companies have more cash on hand to pay their debts or to provide cash for further operations. Also, some companies can extend share buybacks, which leads to a faster reduction of their shares float. Increasing the company’s important financial ratios also can be one of the reasons as much as undervaluation or ownership consolidation. For example, large, expanded buybacks may affect the share price to go up.

Generally speaking, buybacks are a sign of a company’s capacity to return value to its shareholders. One historical data is interesting. The companies that practice regular buybacks have outperformed the wide market.

The influence on investors

To the investors that own stock in the company that is doing buybacks, the stock buyback will boost the value per share. This action will give them more money and fast. But to really have any benefit from the company’s stock buyback you must hold enough stock. Otherwise, the buyback will not affect you significantly. To be honest, the greatest portion of the stock holds a small group of investors and they will have greater benefits from this gain.

That’s true, but also the truth is that the wealthiest 10% of investors hold 80% while almost 80% of shareholders hold just little as 8% of all stock shares.

A stock buyback isn’t cheap. Companies are spending a lot of money to exercise the buybacks. Some investors think that using extra cash for buying their shares in the open market is quite in contrast to what the companies have to do. They think they should reinvest that extra cash to support growth, to develop the company and provide more jobs or to expand the existing capacity.

Moreover, some investors claim that stock buybacks are synthetically pushing the per-share price higher. Also, they argue that this move is beneficial for management only. It isn’t secret that management’s capital is connected to stock ownership in their company.

The conclusion is – the stock buyback can drive the per-share price higher and the stock may look more attractive. The company will have the same earnings but the number of shares outstanding will be reduced.

Lately, companies like this practice, since the stock buyback is one way more to return value to shareholders. The others are dividends.

Buybacks vs dividends?

Both offers are all about how to return funds to investors. But which of these two programs investors like more? In case the financial markets are ideal, in the meaning of perfection, it shouldn’t matter.

For example, ABC company has one million shares in issue and excess cash of $2 million which it wants to distribute to investors. After this distribution, this ABC company expects profits of $1 million yearly and also expects a P/E ratio to be 8 times. So, this company can distribute this $2 million as a dividend of $2 per share or as a tender offer of 200,000 shares at $10 per share.

No matter which distribution they choose the total market value will be the same. Whichever method they choose the risks will be the same. But let’s do some math. So, we have to multiply the total market value by the P/E ratio.

In our example, it is:

total market value = $1 million x 8 = $8 million

But what we have here is if the company prefers to pay dividends, there will be a million shares in issue. Under the buyback, there will be 800,000 shares in issue. So, the value per share will be $8 (simple math: $8million/1 million) under the dividend option and $10 ($8 million/800,000) under the buyback option.

Let’s examine a case of a shareholder that holds 5.000 shares in both the dividend and the buyback situation. Such has a choice to hold or sell the shares.

As you can see this is the same for investors. Under both dividend and buyback options, shareholder’s wealth remains the same.
For dividend options, the shareholder has 5.000 shares worth $8 each plus $2 dividend per share. Which makes $50.000. While under the stock buyback option a shareholder will receive $10 per share, which is $50.000 also. Thus, for a shareholder both options are equally beneficial.
The above case is accurate only if the financial markets are perfect. But in the real world, they are not. So, shareholders may prefer buybacks.

26th March 2020
Price Action Strategies For Profitable Trading

Experienced traders use price action strategies in trading to make more profitable trades. Price action strategies are one of the most used in current financial markets.

Price action strategies in trading are present for quite some time. They are here for good reason. That’s why these strategies are frequently used in the financial market. Price action strategies are used by both long-term and short-term traders. The point is that analyzing the price of a security is maybe the simplest but at the same time the most powerful approach to getting an edge over the market. And that is crucial for any trader. Having an edge means that you’ll not be found out by the market.

Okay, you might think you are a great trader because you had several winnings. Do you really think that having luck is the most important part of trading?

Anyone can do the same if the lucky is a matter of importance.

Relying on luck is the danger because the wheel of fortune is turning around. And eventually, your winning trades will become great losses. All the profits you made during your winning streak will vanish like a soap bubble. That’s because you don’t have an edge. Actually, in this case, your edge is with the market which is too risky because at some point that edge will play out in favor of the market securing that trader loss.

If you don’t have an edge and the edge is in the favor of the market, it is a matter of time until the edge starts to play out and you’ll become a loser.

Think about this as a casino, for example. All tools and machines in the casino have odds adjusted in favor of the casino. In any case, the casino is the winner. Yes, from time to time someone will make a lot of money, but there are many losing players, more than winning. So, the casino will be the winner in any case.

That is the casino’s edge. The exact comes with your trading if you are only considering your next trade and never think about trading inside the market’s overall edge.

Stay focused on the price action

Price action is a trading method that enables a trader to understand the market and make trading decisions based on current and real price actions. So, in price action strategies you are not relying only on technical indicators. As you can see, the action price strategies are dependent on technical analysis. Some traders use price action strategies to generate a profit in a short time.

If you want to be a price action trader, you must be focused on price action. This sounds like nonsense, you may think. But if you want to evaluate deeper, you will find the majority of traders think the price action strategies are the same as pattern trading. And that is a great mistake.

While pattern trading requires just staring at the last candles of the chart and making a trade based on them, for price action trading you’ll need more. Yes, in pattern trading the last one or two candles can be an excellent entry signal, in price action strategies they are just candles among many many other candles on the chart.

Every successful price action trader knows how to read a price action chart as a whole and knows how to force them to tell the entire price action story. Price action traders have to interpret the real order flow, support and resistance, traders’ behavior and trends through the live price action.

What is price action trading?

Price action trading is trading in which traders base their decisions on the price movements of an asset which can be stock, forex, bonds, etc. There is no need to use other indicators, your trade is based on price action solely. Of course, you can use other methods but it will have a very small impact on your decisions.

The price action traders believe that the only valid source of data flows from the price itself. For example, when the stock prices go up, the price action traders know that investors or other traders are buying. Based on the aggressiveness of that buying, price action traders estimate will the prices continue to rise. These traders don’t care why something occurs. Their all concern is to find the best possible entry point with lower risks but with greater profits. For that to know, they are using real-time data, for example, volume, bids, offers, magnitude and similar. Also, historical charts are very important.

In trading – what is that?

First of all, price action trading is the method where you make all your decisions from the so-called “naked” price chart. That means there are no other indicators. All we have is price action. That’s a lot of data because all markets generate data about the price changes over different periods. And that data is displayed on the price chart. What can you read there? For example, everything about the beliefs and behavior of other traders and investors, no matter if they are humans or computers. Data is for a specific time frame and all opinions, beliefs, all financial data, news that affects price change, and behavior are visible on the chart as price action.

The most important part, with knowing the price movements, you’ll be able to develop a really profitable trading system. All signals from the price action chart have a general name – price action trading strategies. These strategies can give you a chance to predict future movements with a high level of accuracy so you can make a profitable strategy.

Price action trading strategies can be used on a broad variety of securities including stocks, bonds, derivatives, forex, commodities, etc.

Price action strategies

Trendline strategy

One of them is the trendline strategy, very simple to use. The main point here is to know how to draw trendlines. This is an important part because only if you do it properly you’ll be able to predict where the price will bounce off the trendlines. Well, you’ll take a trade based on it so be consistent in how you draw trendlines.

Breakout strategy

The other price action strategy is a breakout. For example, a stock price is moving with a specific tendency. When it breaks the tendency, it is a signal for a new trading opportunity. To make this clearer, suppose a stock traded between $9 and $6 for the last two weeks. Suddenly, it moves above $9. So, the stock price changed the tendency. That is the signal for traders that the sideway moves are probably finished and the stock price is possible to go up to $10 or more.
Of course, you might be faced with a false breakout, but it is also an opportunity to trade in the opposite direction of the breakout.

Bars formation

Another price action strategies examine the price bars formation on a specific model of the chart. For example, candlestick charts. If traders use candlestick strategies, for example, the engulfing candle trend strategy. It is important to wait until the up candle engulfs a down candle during an uptrend. That should be your entry point, the moment when an up candle goes above the opening price of the down candle.

You can use price support and price resistance zones. That could give good trading chances. Support and resistance zones occur where the price has tended to reverse in the past and these points may be relevant in the future.

Bottom line

Price action strategies aren’t suitable for long term investments. They are aimed at short-term traders. So many traders don’t think that the markets never operate on consistent patterns. They believe the markets work randomly. The consequence is that they don’t think it isn’t possible to have a strategy that will work in any case. If you combine technical analysis with historical price data, price action strategies will allow you to make profitable trades.

These strategies are very popular today due to its advantages. They provide flexible trades, access to many asset classes, use of any software, apps or trading websites. Moreover, traders have a chance to backtest any strategy on historical data. Also, maybe the most important part of price action strategies is that the traders have an opportunity to choose their actions on their own. So, that creative approach to trading is important for many of them.

A lot of proponents on price action trading insist on high success rates. Trading has the potential for making great profits. Traders-Paradise suggests testing and acting after that. Just to be ready to meet your best possible profit chances.

25th March 2020
Shiller CAPE Ratio – The Measurement Of Market Valuation

The Shiller P/E or the cyclically-adjusted price-to-earnings (CAPE) ratio of a stock market is a market valuation metric that eliminates change of the ratio caused by the difference of profit margins during business cycles. It is the regular metric for evaluating whether a market is overvalued, undervalued, or fairly valued.

Shiller CAPE ratio or the cyclically-adjusted price-to-earnings ratio of a stock market is one of the regular metrics if you want to evaluate whether a market is overvalued, undervalued, or fairly valued.

Shiller CAPE ratio, developed by Robert Shiller, professor of Yale University and Nobel Prize Laureate in economics. This ratio usage increased during the Dotcom Bubble when he claimed the equities were extremely overvalued. And he was right, we know that now. Shiller P/E is actually a modification of the standard P/E ratio of a stock.

Investors use this Shiller CAPE ratio mostly for the S&P 500 index but it is suitable for any. What is so interesting about the Shiller CAPE ratio? First of all, it is one of several full metrics for the market valuation able to show investors how much of their portfolios should wisely be invested into equities.

The ratio is based on the current relationship among the price of equities you pay and the profit you get in return as your earnings.

For example, if the CAPE ratio is high it could indicate lower returns across the following couple of decades. And opposite, a lower CAPE ratio might be a sign of higher returns across the next couple of decades, as the ratio reverts back to the average.

Investors use it as a valuation metric to forecast future returns. The metric has become a popular method to get long-term stock market valuations. To be more precise, the Shiller CAPE ratio is the ratio of the S&P 500’s (or some other index) current price divided by the 10-year moving average of earnings adjusted for inflation.
The formula is:

CAPE ratio = share price / average earnings over 10 years, adjusted for inflation

That was the formula but let us explain a bit more how to calculate the Shiller CAPE or also called Shiller’s P/E ratio.
What you have to do is to use the annual earnings of the company in the last 10 years. Further, adjust the past earnings for inflation.

How the Shiller CAPE ratio works

As an investor, you know that the price is the amount you have to pay, and the value is the amount you get. That’s clear. We have to compare the price to the value and that’s why we have many metrics to do so. One of them is the P/E ratio, read more HERE.

It is legal that everyone wants to buy a healthy company when the shares are trading at a low P/E ratio. This means you can get lots of earnings for the price you paid. This is valuable for index too. Just take an aggregate price of the shares of the company from, for example, the S&P 500 index for one year and divide that number by the aggregate company’s earnings for that year. You will get an average P/E for the index.

But it isn’t quite true. For example, during the recession. At the time of the recession stock prices will fall as well as companies’ earnings (okay, they may fall significantly sharper). The problem is that the P/E ratio can rise temporarily. The investors want to buy when this ratio is low but temporary high P/E can send them a fake signal that the market is overpriced. And what is the consequence? Investors wouldn’t buy at the time when it is the best solution.

So, here is the Shiller CAPE ratio to fix that. Shiller invented a special version of the cyclically-adjusted price-to-earnings ratio to help fix this simple calculation. If we use his CAPE ratio we’ll have a more accurate understanding of the ratio between current price and earnings. This ratio employs the average earnings over the past business cycle, not just one year that may have bad or good earnings.

The importance of the ratio

Shiller himself explained this the best. He used 130 years of data and noticed that the returns of the S&P 500 over the next 20 years are fully inversely connected with the CAPE ratio at any observed period. How should we understand this? Well, when the CAPE ratio of the market is high, that means the stocks are overvalued. So, the returns in the next 20 years will be lower. Hence, if the CAPE ratio is low, we can be sure the next 20 years the returns will be satisfying.

This is natural and logical. Cheap stocks can increase in price no matter if it is from a growing company’s earnings or a rising P/E ratio. Contrarily, when stocks are expensive and have a high P/E ratio, they don’t have too much space to grow. It is more likely they have more chances to drop when market correction or recession comes.

How to use the Shiller CAPE ratio

Shiller warned against using CAPE in short-term trades. The CAPE is more helpful in predicting long-term returns. Siller said in an interview: “It’s not a timing mechanism, it doesn’t tell you – and I had the same mistake in my mind, to some extent — wait until it goes all the way down to a P/E of 7, or something.”

But really, you have to combine CAPE with a market diversification algo or some other tool for that. Maybe the most important part is that you never get fully in or fully out of stocks. As the CAPE is getting lower and lower, you are moving more and more in. We think the CAPE ratio for March this year is 21.12. Check the Shiller P/E ratio HERE

So, it isn’t super high. We, at Traders-Paradise, think the stocks should be an important part of your portfolio. Don’t get out of the stocks and go in cash because the CAPE is at 21. It is smarter to buy less and expect poorer returns in the next several years. Some experts noted that markets are most vulnerable when the Shiller P/E is above 26 like it was in February this year. Some stats show that investors respecting Shiller’s ratio are doing better.

Bottom line

Since Shiller showed that lower ratios signify higher returns for investors over time, his CAPE ratio becomes an important metric for predicting future earnings.

There are criticisms about the use of the CAPE ratio in predicting earnings. The main matter is that the ratio doesn’t take into account changes in the calculation of earnings. These kinds of changes may turn the ratio and give a negative view of future earnings.

The CAPE ratio was proved as important for identifying potential bubbles and market crashes. The average of the ratio for the S&P 500 Index was between 15 -16. The highest levels of the ratio have exceeded 31( February 2020). For now, the Shiller CAPE ratio announced market crashes three times during history: Great Depression in 1929, Dotcom crash in 1990, and Financial Crisis 2007 – 2008.

Opponents of the CAPE ratio claim that it is not quite helpful since it is essentially backward-looking, more than it is forward-looking. Another problem is that the ratio relies on GAAP earnings, which have been changed in recent years.

The proponents claim the Shiller P/E ratio is good guidance for investors in determining their investment strategies at various market valuations.

Historical data show that when the market is fair or overvalued, it is good to be defensive. When the market is cheap, companies with strong balance sheets can produce great returns in the long run.

24th March 2020
Gross Margin How To Calculate And Why It Is Important For Investors

The gross margin helps investors to examine a company’s potential for profitability. But investors shouldn’t rely on it as the only metric.

Gross margin represents the companies’ net sales revenue minus the cost of goods sold or shorter COGS. Why is this so important? Gross margin is the sales revenue companies keep. To put it simply, that is the money the companies left over when they pay all cost, fixed and variable related to their production but subtracted from their net sales. Fixed and variable costs are purchasing the materials needed for production, plant overhead, labor. So, the higher gross margin means that a company retains more capital. That money company usually uses for debt payments or some other costs.

To calculate it we need to know two figures: net sales and cost of goods sold. Net sales is calculated if subtract returns, discounts, and allowances from the gross revenue.

So the formula to calculate the gross margin is expressed as

gross margin = net sales − COGS

This is is an important metric. It enables companies to fund investments during periods of growth and be profitable when the growth declines. Many factors add to a company’s capability to keep a high gross margin. That can be products that deliver high ROI, pricing discipline, etc. It reveals how much a company is able to invest in further development, sales, or marketing and consequently, can it be the winner in the market.

The importance of gross margin in investing

Every single investor would like to discover the next big player in the market and invest in the company in its early days and ride those stocks to enormous gains. For example, some of them did it in the early days of Apple, Microsoft or similar.

Though, finding these stocks is the tricky part. Early-stage growth companies don’t have obvious and constant earnings. Some investors who invested in such companies usually end up in loss. Since there is no earnings yet, what do you have to look at? Simple, look at the gross margin and cash flow. For early-stage companies, but not for them only, these two metrics are most important. Well, you have to understand one important thing. Some companies will heavily spend to develop some products or expand their business during some period. So, it might be some losses over those periods that can last even a few years. But every investor is expecting that, right? Hence, the most important for you as an investor is to determine if the company is able to be profitable after all.

For example, you are examining a fresh company in the market. It has fantastic revenue growth. Always ask yourself how capable is the management in turning sales into profits? Here is this important metric on the scene to help us. It is the best tool we have to examine a company’s potential for profitability. Use the formula above and calculate it before deciding to buy any stock. Never overlook the importance of gross margin.

A real-life example

Let’s assume a company you are estimating has $10 million in sales. The costs of purchasing materials and labor amount to $6 million. What will be its gross margin? Let’s use the formula.

$10.000.000 – $6.000.000 = $4.000.000

That is a 40% gross margin rate. This figure is important but you’ll need to estimate if a company is on the way to profitability. So, watch for increasing gross profit margins. The increasing gross profit margin will show if there is an uptrend.
Also, increasing gross margin is connected to research and development. For example, biotech and technology companies need money to invest in these sectors. Companies with increasing gross margins always invest more cash in future operations.

What does the gross margin tell investors?

The gross margin is the part of the revenue that the company retains as gross profit. For instance, when a company’s quarterly gross margin is 40%, that means it retains $0.40 from each dollar of revenue produced. You can use any currency, of course. Since COGS has been already subtracted, the rest of the fund can be used for interest fees, debts, dividends payment, etc. Gross margin is very important for companies, not for investors only. By using this tool they can compare the expense of production with revenues. For instance, a company has a problem with falling gross margin. What can management do?

They may try to cut labor costs or to find a cheaper supplier. The other solution is to increase the price of the products to increase revenue. But this isn’t always the best solution since the sales may drop due to increasing prices. Gross profit margins can be useful for investors to estimate company efficiency. Also, this measure can help investors to compare the companies with different market caps.

How gross margin influence the profitability

To explain the influence gross margin has on profitability, let’s examine an easy example. For example, two companies are the same, but their gross margins are different. They have the same revenue, distribution, operating costs, almost everything is the same. But, company ABC is generating double the operating profit of company XYZ. If we want to value these companies, we can conclude that company ABC should be valued more than twice the value of company XYZ.

But what if company XYZ has a temporary hard time making gross margin below, for example, 10%? What is this company is investing in research and development, and thus has an expense for that of about 30%? Does this make it less efficient and favorable? Maybe this company is doing something on the go-to-market side to get more customers? So, this part has to be examined also. What we want to say is that one metric isn’t good enough, you have to use several to get the full picture of the company’s performances. Even companies with low gross margins can be profitable in a long haul.

Is it important in stock picking and investment?

Some investors misunderstand the gross margin also called gross profit margin with profitability ratio operating margin.

Remember, different companies have different gross margins and that depends on the essence of business. That is the reason why you should never try to compare the gross margins of companies from different industries. Do it in the same industry. Of course, you can make comparisons for companies with different market caps.

When you are estimating the gross margin willing to pick a stock to buy, remember that the majority of the companies are following the market cycles. When the market is booming the demand is very high, while in the dropping market the demand is low. During the bull market, period companies with a high gross margin will be a favorable investment. Hence, when the bear market starts such a company will suffer more. Well, how is that possible? The company with a high gross margin tends to grow faster, its profit and EPS grow faster, and higher EPS means higher returns for shareholders. But when the bear market occurs the profit of such a company will usually fall faster.

Of course, the management has the possibility to reduce the costs and limit the operating margin decline.

Bottom line

Investors can use this metric while deciding to invest in some company but shouldn’t be relied on it as solely one. They have to use it along with other metrics to pick a stock they want to add to the portfolio. Companies with high gross margin can deliver strong returns but the other parameters should be included also. Keep in mind that some early-stage companies can be a good choice too, also if the other metrics show that.

20th March 2020
How to Invest When the Coronavirus Pandemic Sends the Stock Market Down

The markets entered the bear territory but it isn’t the reason to stop investing. Actually, despite the coronavirus pandemic and oil wars, it is the opposite.

By Gorica Gligorijevic

When the market comes into this situation the logical question that smart investors ask is how to invest when the coronavirus pandemic sends all markets down.

Should we stay away and wait for market consolidation or to act and profit? Let’s change our positions for a sec. Instead of being investors, let’s try to assume how managers of the companies are acting now. Yes, some closed up. But we don’t want to talk about them, we would like to discuss serious, responsible managers with the ability to project future actions related to their business and the companies. Like them who are investigating and planning how to beat the competition, or how to become more competitive after all, the investors should do the same thing. Investing should be a game without ending, renewed all the time. Investors may move their assets from one industry to others but should never stop investing.

So, the question of how to invest when the coronavirus pandemic sends all markets down sounds logical for amateurs. Professionals are looking even now for new and better opportunities.

One reason is to overcome this market down and the other is to find market players that can produce a bigger profit. The market is here and it will never stop working. So, why would we do the opposite?

What can generate gains during the pandemic?

This pandemic influences markets all over the world. Coronavirus outbreak hits almost all countries on the globe and as well their economies.

Global markets had been beaten almost overnight. The main problem, according to some analysts, is investors getting panic in the downturn markets. The events are accelerating sharply, faster than spreadsheets and charts could predict them. Advanced investors shift into funds, options, or some commodities to hedge their investment portfolios. The others with a lack of experience, haven’t time to do that. Also, badly timed and wrongly settled hedges may produce big losses. Moreover, put protection is becoming incredibly expensive. Market makers avoid the opposite side of the trade.

But maybe it is even worse for those who shifted into cash to find a better buying opportunity after the outbreak. Yes, cash is the position too, but if you stay too long in that position might cause the earning of zero. Yet, it is better than losing capital but you’ll miss the opportunity to profit. Yes, even now while markets are down you can still earn. There are some industries and sectors where you can invest especially now. Of course, no one can guarantee that stocks will rise forever, but why don’t we call stats as help.

How to Invest in Biotech stocks

Here are some ideas on how to invest when the coronavirus pandemic causes all markets to drop.

So, according to data biotech stocks are a good choice right now. Also, health care. Maybe more than ever both sectors are active these days. The virus COVID-19 is still greatly new and the subject of many scientific types of research. They are all looking for COVID-19 treatments. The companies involved can be a great opportunity. For example, large and mid-cap companies from that sector. According to data, closed near 52-week highs at the end of last week. On the last trading day, they played very well. For example, MASI which is a large seller of pulse oximetry to hospitals. Or CNC, and some others like QDEL, just take a look at its historical data.

Or maybe Roche Holding AG ROG, which gained 3.7% in premarket trading today (Thursday, March, 19) just after they announced its plans to work on Phase 3 clinical testing Acterma. It is a drug used in rheumatoid arthritis treatments but showed good results in treating patients with COVID-19 with severe pneumonia.

Roche announced it is in consultations with the FDA. This company needs the authorities’ approval to start research with the Biomedical Advanced Research and Development Authority. It is expected that about 330 patients from all over the world will take part in that. Recently, Roche got FDA’s approval for manufacturing COVID-19 tests for the U.S.

Roche’s stock fell 7.7% in the last 12 months.

Small-cap companies from the same sector are not such a good choice because there are too many speculations around them and it is possible for investors to end up with losses faster since those companies could disappear overnight.

How to Invest in Safe-haven stocks

Do you know how important soup is important today? What do you think, can some producers of soup be a safe-haven investment? The example of Campbell Soup Company shows us it can.

Popular safe havens are running a bit better than their growth equals. They are paying high dividends reducing the losses caused by lower prices. For example, Campbell Soup Company is paying a 2.84% forward dividend yield. Moreover, the company is trading near a 52-week high after its earnings report.

Also, Mondelez International traded at $46.55 and with a dividend yield of 2.45%. This sweets producer is a super-force: Toblerone, Oreo, Cadbury, Belviva, TUC. The company produces pre-packaged goods. And that kind of producer is among the most desired safe-haven stocks right now since its goods can be used at consumers’ homes. There is no need for visiting restaurants and being in the crowd.

MDLZ stock is outperforming the S&P 500 by more than 10%. For some investors, the problem with this company can be its exposure to China, and store shelves are less stocked now. But the company’s branch in China is very close to setting the situation to normal.

Maybe Johnson & Johnson a 134 old company? It is one of the largest healthcare companies in the world. The company covers pharmaceuticals, medical materials, and devices, surgical and orthopedic robotics, etc. It has well-known products Band-Aid and Tylenol. The analysts are optimistic about the company’s long-term growth prospects.

How to invest during the coronavirus pandemic?

This can be an ethical and financial question. Both are inappropriate. Money has to work.

It is true, in just several weeks, the Coronavirus pandemic hit almost a third of the world market cap. The Sensex is 20% below from its highest highs reached just two months ago. The Indian equity market bounced back last Friday. The other markets have fallen even more.
The coronavirus spreading caused panic all over the world and lessened the confidence of investors.

The other unpleasant events happened also. For example, the crude oil war between Russia and Saudi Arabia has added volatility to the markets. But something has changed. It isn’t all about the coronavirus outbreak, the other things influence the markets also.
The commodities and currency market are in turbulence because of the crude oil war. This is a crash of huge magnitude. It will take time for confidence to come back but that doesn’t mean we have to sit aside. This can be a great opportunity to invest.

The stock market condition today

Stock market volatility is normal, and also discouraging but doesn’t have to be. For some investors, it is almost impossible to avoid panic and sell-off, we know that.
One of Wall Street’s main stock benchmarks, the Dow Jones, dropped and entered bear market territory on Wednesday, March 11. Dow Jones has been in a bull market since the financial crisis in 2008-09. Also, the big volatility is present, partially due to the oil price war but also, due to the fears of the coronavirus. Of course, that is stressful for investors. But they know, as much as we know, that stopping investing is the worst scenario ever.

So, how to invest when the coronavirus pandemic sends all markets down sounds illogical for professionals. Investing must continue. And we show you where and how. Stay invested! Maybe this can help.

19th March 2020
A Bottom fishing As An Investment Strategy

The most popular bottom fishing strategy is value investing but traders also use technical analysis to identify oversold stocks that may be winning bottom fishing possibilities.

Bottom fishing as an investment strategy refers to the situation when investors are looking for securities whose prices have lately dropped. Also, that are assets considered undervalued.

Bottom fishing as an investment strategy means that investors are buying low-cost shares but they must have prospects of recovery. This strategy also refers to investing in stocks or other securities that dropped due to the overall market decline. But they are not randomly picked stocks, they have to be able to make a profit in the future. Well, it is general hope.

Buy low, sell high

We are sure you have had to hear about the old market saying “buy low, sell high” as the most pragmatic and most profitable strategy in the stock market. But, also, it isn’t as easy as many like to say. You have to take into consideration several things while implementing bottom fishing as an investing strategy. Firstly, you’ll be faced with some traders claiming that it is an insignificant strategy. The reason behind their opinion is if you are buying the stocks that are bottoming you do that near its lowest value.

The point is that almost every stock is a losing one. Usually, some momentum traders and trend followers will support this opinion. Where are they finding confirmation for this? Well, traders tend to sell to breakeven after they have been keeping a losing stock for a short time. They want to cut losses and that’s why they are selling, to take their money back and buy some other stock. Traders are moving on.

Overhead resistance will affect the way a stock trades but it is expected when using this strategy. Moreover, overhead resistance isn’t as inflexible as some investors believe.

Bottom fishing is an investment strategy that suggests finding bargains among low-priced stocks in the hope of making a profit later.

What to think about while creating this strategy

The most important thing is to know that you are not buying the stock just because it is low-cost. Lower than ever. The point is to recognize the stocks that have the best possibility for continued upsides.

Keep in mind that buying at the absolute low isn’t always the best time to do so. Your strategy has to be to buy stocks that have a chance of continued movement. Stock price change may occur on the news or a technical advancement like a higher high. A new all-time low can cause a sharp bounce if traders assume the selling is overdone. But it is different from bottom fishing. Bottom fishing as an investment strategy has to take you to bigger returns.

Not all low-cost stocks are good opportunities.

Some are low with reason, simply they are bad players. For example, some stock might look good at first glance but you noticed one small problem. Don’t buy! When there is one problem it is more likely that stock has numerous hidden problems. There is no guarantee that low stock will not drop further.

Further, for bottom fishing strategy, you will need more time to spend than it is the case with position trading, for example. You have to be patient with this strategy. You are buying a weak stock, and they became weak due to the lack of investors’ interest. Do you know when they will be interested again? Of course, you cannot know that nor anyone else can. When you want to use a bottom fishing as an investment strategy you must be patient and have a time frame of months, often years to see the stock is bouncing back

If you aren’t psychologically ready to stay with these trades for a long time you shouldn’t start them at all.

The bottom fishing strategy requires discipline

If you want to practice bottom fishing as an investment strategy you will need discipline. It requires extra effort. It isn’t easy for some aggressive traders to hold a stock for months and without any action. We know some of them that made a great mistake by cutting such stock just because they were bored. If you notice you are sitting in stocks that are dropping lower on the small volume you still can exit the position. The losses might add up quickly, so you’ll need to set a strong stop loss to avoid it. Even if you hold a stock paid $1. It can produce big losses over time if you don’t have at least basic risk management. Stop-loss and exit points are very important in this strategy.

The two main types of bottom fishing

There is the overreaction and the value. For example, the news of some company’s problems may cause a lot of traders eager to enter for a sharp recovery. The stock suddenly had a sharp decline but they may think the market overreacted and the stock will bounce quickly. That could be faulty thinking but what if the long-term bottom fishers start to buy that stock too? The company’s problems are temporary and as times go by, could be forgotten.

The point is that the bottom fishing on the news or even earnings is a good opportunity to trade a bit of volatility. But you have to be an aggressive trader and able to play the big fluctuations. These short term trades can easily become investments if you don’t pay attention to it. Before you enter the position you must have a solid trading plan with defined entry point, stop-loss, and exit point. Optimize your strategy before you jump in. There is one tricky part with cheap stocks – they can become cheaper.

The essence of bottom fishing as an investment strategy

Bottom fishing is when you try to find the bottom of a stock that has a higher price. Let’s say a stock was at $200 and now it is at $20. When you try to bottom the fish stock you’re actually trying to catch its bottom and buy it and provide it to go to the upside. In simple words, you want to get a good deal, to obtain the lowest possible price or bargain on the stock. But, if you want a good bottom fishing you must understand how it works. There are too many fresh traders starting bottom fishing but ending up with stock lower or never getting out from that low level. They are spending years stacking in bad investments. Also, their money becomes locked in such bad investments.

A real-life example

Nowadays, we have a big selloff in the stock market. It is a great opportunity to buy some stocks that were very expensive since they are much lower now. A high priced stock has the drawback. Everyone would like to buy but have insufficient capital. That’s why the trading volume of such stock can be small. And suddenly due to some unfortunate event, the price is going down. Buying these stocks is a very good opportunity because they have the chance to go back up to the top. But it is hard to catch the bottom for these stocks. So many investors push up the price in the hope to get out at a higher price.

Are they right or wrong? It is obvious they’ll have to sell these stocks when they start to come back up to reduce their losses. That is the main disadvantage of bottom fishing if you don’t do it accurately.

Bottom line

If you want a proper approach to the bottom fishing, you’ll have to watch for higher highs and higher lows. When you notice in the chart that a trend line is moving up off of a bounce you’ll see the real bottom. Well, you might not catch it at the lowest point, but you’ll catch it in a range of 5% or 10% which is a good deal for long-term investment. That can be a good strategy for investors willing to hold a stock for several years.

For example, the stock price had a sharp decline and fell from $300 to $100 per share over three days. You could determine it was due to market conditions. So, you are buying 10 shares for $1.000. Next week, the price returned to $300 per share. What are you going to do? Sell, of course. You can sell the share of stock that you purchased for $1.000 at $3.000 (10 shares at $300 each) and make a profit of $2.000. Really not bad.

Bottom fishing as an investment strategy is attractive for boosting portfolio value. Also, it is good for fast making profit while the volatility in the market is present. But, keep in mind, it can be risky because you can’t be 100% sure how the stock or market will go, how the price will run as a result of investors’ behavior, or how the particular company will survive the problems in the global economy.

16th March 2020
The Average Daily Trading Volume How to Calculate

(Updated October 2021)

A stock’s daily trading volume shows the number of shares that are traded per day. Traders have to calculate if the volume is high or low.

The average daily trading volume represents an average number of stocks or other assets and securities traded in one single day. Also, it is an average number of stocks traded over a particular time frame.

To calculate this you will need to know the number of shares traded over a particular time, for example, 20 days. The calculation is quite simple, just divide the number of shares by the number of trading in a specified period. Daily volume is the total number of shares traded in one day.

Trading activity is connected to a stock’s liquidity. When we say the average daily trading volume of a stock is high, that means the stock is easy to trade and has very high liquidity. Hence, the average daily trading volume has a great impact on the stock price. For example, if trading volume is low, the stock is cheaper because there are not too many traders or investors ready to buy it. Some traders and investors favor higher average daily trading volume because the higher volume provides them to easily enter the position. When the stock has a low average trading volume it is more difficult to enter or exit the position at the price you want.

How to calculate the average daily trading volume

As you expected, it is quite simple. All you have to do is to add up trading volumes during the past days for a particular period and divide that number by the number of days you observe. It is usual to calculate ADTV (Average Daily Trading Volume) for 20 or 30 days but you can calculate it for any period if you like. For example, sum the average daily trading volumes for the last 30 days and divide it by 30. The number you will get is a 30-day average daily trading volume.

Since the average daily trading volume has a great impact on the stock price it is important to know how many transactions were on a particular share. The same share can be traded many times, back and forth and the volume is counted on each trade, each transaction. For example, let’s say that 100 shares of a hypothetical company were purchased, and sold after a while, and re-purchased, and re-sold. What is the volume? We had 4 transactions on 100 shares, right? So, the volume in this particular case would be expressed as 400 shares, not 800 or 100. This is just a hypothetical example even though the same 100 shares could be traded many more times.

How to find the volume on a chart?

Thanks to existing trading platforms it is easy since each will display it. Just look at the bottom of the price chart and you’ll notice a vertical bar. That bar indicates a positive or negative change in quantity over the charting time period. That is the trading volume.
For example (if you don’t like too much noise in your charts), you will use 10-minutes charts. Hence, the vertical bar will display you the trading volume for every 10-minutes interval.

Also, you will notice that these bars are displayed in two colors, red and green. Red will show you net selling volume, and green bars will let you know the net buying volume.
You can measure the volume with a moving average, also. It will show you when the volume is approximately thin or heavy.

What is an average daily trading volume for a great stock?

Are you looking for the $2 stock with an average daily volume of 90,000 shares per day? It won’t be easy. Sorry!

The stocks that traded thinly are very risky and changeable. To put this simple, we have a limited number of shares in the market. Any large buying might influence the stock price skyrocketing. The same happens when traders and investors start to sell, the stock price will fall. Both scenarios are not beneficial for investors. So, you must be extremely careful when trading stocks with daily trading volume below 400.000 shares. You can be sure it is a thinly traded stock even if it is cheap as much as $2. The stocks with low prices carry higher risks. For example, penny stocks.

Here we came to the dollar volume. While the daily trading volume shows how many shares traded per day, the dollar volume shows the value of the shares traded. To calculate this you have to multiply the daily trading volume by the price per share.

For example, if our hypothetical company has a total trading volume of 300.000 shares at $2, what would be the dollar volume? The dollar volume would be $600.000. This is a good metric to uncover if some stock has sufficient liquidity to support a position.

To decrease the risks, it is better to trade stocks with a minimum dollar volume in the range from $20 million to $25 million. Look at the institutional traders, they prefer a stock with daily dollar volume in the millions.

Understanding Average Daily Trading Volume

Average daily trading volume can rise or drop enormously. These changes explain how traders value the stock. When the average daily trading is low you have to look at that stock as extremely volatile. But, the opposite is with higher volume. Such stock is better to trade because it has smaller spreads and it is less volatile. To repeat, the stock with higher trading volume is less volatile because traders have to make many and many trades to influence the price. Also, when the average trading volume is high, trades are executed easily.

This is a helpful tool if you want to analyze the price movement of any liquid stock. Increasing volume can verify the breakout. Hence, a decrease in volume means the breakout is going to fail.

The trading volume is a very important measure.

It will rise along with the stock price’s rise. So, you can use it to confirm the stock price changes, no matter if it goes up or down. When we notice that some stock is rising in volume but there are not enough traders to support that rise and push it more, the price will pullback.

Pullback with low volume may support the price finally move in the trend direction. How does it work? Let’s say the stock price is in the uptrend. So, it is normal the volume to rise along with a strong rising price. But if traders are not interested in that stock, the volume is low and the stock will pullback. In case the price begins to rise again, the volume will follow that rise. For smart traders, it is a good time to enter the position because they have confirmation of the uptrend from the price and the volume both. But be careful and do smart trading. If the volume goes a lot over average, that can unveil the maximum of the price progress. That usually means there will be no further rise in price. All interested in that stock already made as many trades as they wanted and there is no one more willing to push the stock price to go up further. That often causes price reversal.

Bottom line

The average daily trading volume shows the entire amount of stocks that change hands during one trading day. This can be applied to shares, options contracts, indexes or the whole stock market. Daily volume is related to the period of time. It is very important to understand that when counting volume per day or any other period each transaction has to be counted once, meaning each buy/sell execution. To clarify this, if we have a situation in which one trader is selling 500 shares and the other one is buying them, we cannot say the volume is 1.000, it is 500. Anyway, this is an important metric that will show you if some stock is easy or difficult to trade.

13th March 2020
MACD Indicator – Moving Average Convergence Divergence

MACD is one of the most popular indicators used among traders. It helps identify the trends direction, its speed, and its velocity of change.

MACD is short for “Moving Average Convergence Divergence.” It is a valuable tool. Traders know how important it is to use MACD as an indicator. Also, how reliable is using this tool in trading strategies. But that can wait for a while, firstly, let’s explain what is Moving Average Convergence Divergence or shorter MACD.

It is a trend-following momentum indicator that presents the correlation between two moving averages of a stocks’ price or in some other assets. We can calculate the MACD, it is quite simple.

Just subtract the 26-period EMA from the 12-period EMA. EMA is an Exponential moving average.

Here is the formula:

MACD = 12-period EMA − 26-period EMA

The 26-period EMA is a long-term EMA, while 12-period EMA is a short-term EMA.

If you need more explanation about EMA, let’s say that the exponential moving average or EMA is a type of MA, moving average. EMA puts more weight and importance on the most recent or current data points. That’s why the EMA is also referred to as the exponentially weighted moving average.

The result we get by using the calculation is the MACD line.

The MACD is useful to identify MAs that are showing a new trend, no matter if it is bullish or bearish. But it’s the priority in trading, right? Finding the trends has a great impact on your account since that is the place where you can earn money.

To recognize the trend you will need to calculate MACD as we show you, but you will need the MACD signal line, which is a 9-period EMA of the MACD and MACD histogram that is calculated:

MACD histogram = MACD – MACD signal line

The main method of reading the MACD is with moving average crossovers. When the 12-period EMA crosses over the longer-term 26-period EMA pay attention since the possible buy signal is generated.

You can buy the stocks or other assets when the MACD crosses above its signal line.

The selling signal is when the MACD crosses below this line.

MACD indicators are interpreted in many ways, but the general methods are divergences, crossovers, and rapid rises/falls.

How the MACD indicator works

When MACD is above zero is recognized as bullish, but when it is below zero it is bearish. If MACD returns up from below zero it is bullish. Consequently, when it goes down from above zero it is bearish. When the MACD line crosses more below the zero lines the signal is stronger. Also, when the MACD line passes more above the zero lines the signal is stronger.

The MACD can go zig-zag, it will whipsaw, the line will cross back and forward over the signal line. Traders who use this indicator don’t trade in these circumstances because the risk is too high. To avoid losses they usually don’t enter the positions or close them. The point is to reduce volatility inside the portfolio.

The divergence between the MACD and the price movement is a more powerful signal when it verifies the crossover signals.

Is it reliable in trading strategies?

MACD is one of the most-used technical indicators. It is a leading and lagging indicator at the same time. So it is versatile and multifunctional, so being that it is very useful for traders. But one feature of this indicator is maybe more important. The indicator has the ability to identify price trends and direction, and forecast momentum, but it isn’t complex. It is pretty simple, so it is suitable for beginners and elite traders to easily come to the result of the analysis. That is the reason why many traders view MACD as one of the most reliable technical tools.

Well, this tool isn’t quite helpful for intraday trading but can be used to daily, weekly or monthly charts.

There are many trading strategies based on MACD but basic strategy employs a two-moving-averages method. One 12-period and one 26-period, along with a 9-day EMA that assists to deliver clear trading signals.

Operating the MACD

As we said, it is a versatile trading tool and the indicator is strong enough to stand alone. But traders cannot rely on this single indicator for predictions. They have to use some other indicators along with MACD to ramp-up success in forecasting. It works great when traders need to identify trend strength or stock’s direction.

If you need to identify the strength of the trends or stocks direction, overlapping their moving averages lines onto the MACD histogram is really helpful. MACD can be observed as a histogram alone, also.

How to Trade Forex Using MACD Indicator

If we know there are 2 moving averages with diverse speeds, we can understand the more active one or faster will react quicker to price change than the slower MA.

So, what will happen when a new trend occurs?

The faster lines will act first and ultimately cross the slower ones and continue to diverge from the slower ones. Simply, they will move away. When you see that in the charts, you can be pretty sure the new trend is formed.

When you see that the fast line passed under the slow line, that is a new downtrend. Don’t think something is wrong if you cannot see the histogram when the lines crossed. It is absolutely normal since the difference between the lines at the moment of the cross is zero.

The histogram will appear bigger as the downtrend starts and the faster line moves away from the slower line. That is an indication of a strong trend

For example, you trade EUR/USD pairs and the faster line crossed above the slower and the histogram isn’t visible. This hints that the downtrend could reverse. So, EUR/USD starts to go up because the new uptrend is created.

But be careful, MACD moving averages are lagging behind price since it is just an average of historical prices. But there is just a bit of a lag. It is not enough for MACD not to be one of the favorites for many traders.

More about MACD

As you can see, the MACD is all concerning the convergence and divergence of the two moving averages. Convergence happens when the moving averages go towards each other. Divergence happens when the moving averages go away from each other. The 12-day moving average is faster and affects the most of MACD movements. The 26-day moving average is slower and less active on price changes.

MACD was developed by Gerald Appel in the late ’70s. It is one of the simplest and most useful momentum indicators that you could find. The MACD utilizes two trend-following indicators, moving averages, turning them into a momentum oscillator. So it provides traders to follow trend and momentum. But the MACD is not especially useful for recognizing overbought and oversold levels.

Bottom line

The MACD indicator is unique because it takes together momentum and trend in one indicator. This special combination can be used to daily, weekly or monthly charts. The usual setting for MACD is the difference between the 12-period and 26-period EMAs. You can try a shorter short-term moving average and a longer long-term moving average to have more sensitivity and more frequent signal line crossovers.

The drawback of MACD is that it isn’t able to identify overbought and oversold levels since it does not have an upper or lower limit to connect these movements. For example, over sharp moves, the MACD can continue to over-extend exceeding its historical heights. Moreover, always keep in mind how the MACD is calculated. We are using the current difference among two moving averages, meaning the MACD values depend on the price of the underlying asset.

So, it isn’t possible to relate MACD values for a group of securities with differing prices.

Some traders will use only on the acceleration part of MACD, some will prefer to have both parts in order.

The one is sure, MACD is a versatile indicator and every trader should have it as part of the tool kit.

9th March 2020
Falling Knife Stocks – How To Profit From Falling Knife

(Updated October 2021)

Falling knife stocks represent a high opportunity to make a lot of money, but they have a tremendous potential to hurt the traders’ portfolio.

The falling knife stocks represent the stocks that have felt a speedy decline in the price and it happened in a short time. A ‘falling knife’ is a metaphor for the quickly sinking in the price of stocks. Also, it could happen with other assets too. We are sure you have heard numerous times “don’t try to catch a falling knife,” but what does that really mean?

That means be prepared but wait for the price to bottom out before you buy it. Why is this so important, why to wait for the stock price to bottom out? Well, the falling knife can rebound quickly. That is called a whipsaw. But also, the stocks may fail totally, for example, if the company goes bankrupt.

Even if you know nothing about investing, you know the phrase “buy low sell high.” But it is good in theory. In practice…

Okay, let’s see! Suppose we have a stock with price drops. Firstly it was just 10%. No problem, we could survive that, we can cover that loss in our portfolio with gains on other assets. Oh, wait! Our stock continues to fall more and more, by 30%, an additional 40%, 60% even 90%. All this happened in a few months, for instance. That is the so-called “falling knife.”

The falling knife definition

Falling knife quotes to a sharp fall, but no one can tell what is the precise magnitude or how long this dropping will last until it becomes a falling knife. But certainly, there is some data we can use to determine if there is a falling knife at all. So let’s say that the stock that dropped 50% in one month or 70% in five months are both recognized as a falling knife. They are both falling knife stocks.

The general advice from experts is “don’t try to catch the falling knife” and it is even more valuable for the beginners. In any case, anyone who wants to continue to invest in that stocks or wants to trade them should be extremely cautious. This kind of stock could be very dangerous since you may end up in a sharp loss if you enter your position at the wrong time. So try not to jump into stock during a drop. Of course, traders trade on this dropping. But traders don’t want to stay in position for a long time, they want to be in a short position, so they will examine all indicators to time the trades. For beginners, this is still dangerous.

How do these stocks work?

They work very simply. At first, you will read or hear some bad news about the company. When bad news appears the stock price can drop. And it isn’t something unusual in the stock market. Yet, if this degradation continues we can see investors selling in a panic. That can decrease the price further. So we have two possible scenarios. For example, after bad news, some good news may appear. Let’s say the company’s management is trained for damage control and we are sure that the stock will rebound. This situation is greatly profitable for the investors who purchased this stock at a cheaper price before it bounced back.

But what is a possible scenario if the company continues to weaken?

Even bankruptcy is possible. Well, in such a case the investors could have enormous losses.

So, the precise conclusion is that falling knife stocks can generate huge gains but also, a great loss. That depends on when you enter the position. Well, you know, some stocks never rebound. Even more, they didn’t reach the original price for years since they began to drop.

To have a real chance to make a profit from falling knife stocks you must have a firm plan. What do you want to achieve? If you want a short trade, maybe it is better to wait until the stock ends its dropping.

Falling knife as an opportunity

But you might think this “falling knife situation” is a great opportunity to buy the cheap stocks that will grow in the future. That’s legitimate, of course. But instead of investing all the money you have at once, try to buy that stock in portions. One bunch this week, the same can be bought in the next week, etc. There is another way too. Let’s assume you want to invest in this stock $10.000. The original price before dropping was $500 per share, now it is $200, so buy that $500 for $200 and wait for a while until the price drops more, to $100, for example. Then you can buy another $500 for $100, etc.

The point here is that you have a plan in place and stick to it since you will not have time to make a proper decision during the regular market hours because this kind of dropping in stock price is moving too fast. For your plan to be successful, it is MUST have an exit strategy. That is particularly important for traders that are waiting for the quick bounce. The exit strategy will provide you to protect your trade to not become an investment. The essence of knife catching isn’t to buy low and sell lower.

Make big money when the stock prices go down

There are some rules if you want to profit from a falling knife and traders should follow them.

Buying a stock that is falling sharply is a bad idea for beginners, to make this clear. Picking the bottom can generate massive gains, that’s true but only if you buy at the right time. If you miss it, it is more likely you will end up in huge losses. And that happens remarkably frequently.

But at some point, when the falling knife is so close to the bottom and when the risk of additional loss is at a minimum. So the potential gains can be enormous. So, reach it out and take it. Yes, we know it is easy to say but how to do that?

The first rule for profiting from the falling knife is: Don’t buy a stock on the first drop. You see, when the first bad news comes, it is more likely that there will be more bad news that will cause the stock price to drop further. Even if there is some good news for a short time, the more bad news will come in most cases. So, wait for that and after that happens, you can start to buy but be sure that technical requirements support the bottom. That is extremely important if you want to generate massive gains.

Use MACD

The moving average convergence divergence momentum indicator is helpful to reveal where a stock is going to head next. For example, if the stock is hitting the new lows and the MACD indicator also hits the new lows, you have a strong downtrend that is very possible to continue. But if the MACD is rising the trend is going to reverse. That means that the risk of catching a falling knife is reduced. So, we have a stock that dropped at least twice but the rising MACD shows the trend is going to reverse. Don’t wait anymore, buy it! This is a low-risk point, so traders should buy that stock since its price will rise.

That’s how you can make money from a falling knife and with low risk.

Bottom line

The falling knife stocks can be a great opportunity, but they can hurt your portfolio, also. For experienced traders, yes. But if you are a beginner, it is better to stay away from these stocks until you learn more. Even not all experienced traders are not able to handle the “falling knife” stocks and catch the falling knife and recognize the whipsaw. Sometimes, you’ll have to wait for a long time until you make any gains from this trade. Don’t expect the stocks can bounce back over the next day or week. It is more possible to wait for months after you enter the trade to see the gains. But it can be worth it. Anyway, it is worth knowing how this thing works.

8th March 2020