Category: How to Master in Trading – Advanced

The purpose of the category How to master in trading – advanced is to give experienced traders an insight into the new trading techniques. Very often they are very rarely used because they require advanced knowledge in many fields – from complex mathematical operations and calculations to the usage of high-level trading tools. Traders-Paradise’s goal is to inform about them. But not only that. The main intention is to make them familiar to all traders. No matter are they beginners or elite.

Traders-Paradise gives you an opportunity

In trading, just like it is in many fields, having advanced knowledge is an advantage per se. Thanks to our excellent analysts and experts, the most advanced techniques are available to the traders. Moreover, each of them is fully explained, with real trading examples. All complicated mathematical calculations are explained in detail. So, traders need to have on hand this valuable information and samples.

Traders-Paradise insists on quality

Concerning beginners’ already gathered knowledge, sometimes the explanation in the posts in the category How To Master Trading- Advanced will not be enough clear no matter how much we want that. Simply, to understand what our team writes here, the visitor will need to improve the skills. For them, Traders-Paradise has one simple piece of advice – visit one of our categories designed and written exclusively for the beginners.
This category – How to Master In Trading – Advanced is directed at elite traders. The impressive thing is that all posts and articles are very precise in explanation no matter how complicated the subject is. All advanced trading techniques, methods, strategies are understandable thanks to comprehensive and detailed explanations.

  • Gross Margin How To Calculate And Why It Is Important For Investors

    Gross Margin How To Calculate And Why It Is Important For Investors

    Gross Margin How To Calculate
    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.

  • How to Trade Stocks and Make Money?

    How to Trade Stocks and Make Money?

    How to Trade Stocks and Make Money?

    Everyone would like to know how to successfully trade stocks but only a few know how to do that. Here are some suggestions.

    There are not many people who know how to trade stocks and make money. Statistics confirm this. According to stats, only 5% of traders are successful. That means 95% of traders fail. Surprisingly, some stats show 80% of traders leave trading during their first two years. Moreover, almost half of all traders quit during the first month of trading. The other problem is that traders sell winners in a bigger percentage than losers.
    Profitable traders represent a tiny part of all traders with just 1.6% in the average year. Nevertheless, they are very active, the estimate is that they are accounting for 12% of all trading activities per day.

    Stock traders’ problems

    Maybe the biggest problem in the stock market is that traders don’t learn how to trade stocks and make money. They are gambling, to put it simply. Even when they are using some demo accounts or following elite traders, they use it to set up their trades automatically without a meaningful process or plan. We found an interesting thing, traders and investors usually overweight stocks in the industry in which they are working. That’s smart. That is the industry they know well, the companies are known to them too, so the probability of successful trades might enhance. But there can be some drawbacks too. The emotional approach to trade is one of them. Simply said, these traders may act as cheerleaders. That isn’t smart trading. Even if they have profitable trades, the percentage of such trades is small. Otherwise, there would be more efficient traders in the stock market. 

    Knowing these stats it’s understandable why traders fail. The trading decisions are not based on research or proven trading methods. They are based on emotions. Instead of learning how to trade stocks and make money, many traders view trading as a kind of game. Don’t hope to make millions with such an approach. It is more likely you will lose your shirt. Trading isn’t a game. On the contrary, it is a profession for which you’ll need skills, knowledge and continual education and development. It isn’t easy and no one should tell you it is. Hence, be careful of your trading decisions.

    How professional traders know how to trade stocks and make money?

    You might be questioning what professional traders know but you don’t. We are going to explain to you how to trade stocks and make money so you could act like a pro. It isn’t rocket science, actually, it is quite simple but we’ll need your full attention. 

    First of all, don’t think that becoming an elite trader is something you cannot achieve. You are just a few steps away from being that. All you need to unveil how to trade stocks and make money is just around the corner.

    So, let’s start!

    Successful traders usually don’t have any insider information that is unavailable to you. You can gather them also but the real question is why should you do that. In fact, all you need to have trading success is a small adjustment in how you think about trading. In simple words, it is all about your mindset. To become a successful trader you MUST change some of your trading practices if you want to know how to trade stocks and make money, of course.

    There is no secret recipe on how to trade stocks and make money

    Beginners in trading usually are looking for a secret and instant way to success. If you are not one of them, you probably don’t enjoy trading. It is possible you are looking for some tools that will guarantee the profit. Well, it isn’t wrong. There are so many tools out there. Many of them can make your life easier. But you have to love the trading process, even the charts reading and finding patterns. Yes, that isn’t the most exciting part of trading, some may say. But try to look at that from the other point of view. For example, finding just one good, steady, price pattern might enhance your trade and can be beneficial for a long time, maybe for your lifetime. 

    But let’s stay for a while on the subject of the joy of trading. The point is not to have fun (although you might have fun) but to understand what you are doing while trading and be ready to love it. There is no need to be an adrenaline addict but some dose of willingness to have excitement is necessary still. You have to understand the whole process, from the psychological perspectives, chart reading, to money management. And you have to love it. Otherwise, you will never succeed to become a really profitable trader. In other words, you need passion, knowledge, and tools.

    The importance of tools in trading

    When you start trading the stock market, you have to make three decisions: buy, sell, stay on the position. For that you need information. You have to know the stock historical performances. It is important to recognize the patterns. And that is exactly what one of the best books is giving to you. Let us introduce and recommend this particular one, the book The Two Formula: The Best Single Trading Pattern I Have Ever Used. This book doesn’t give you only theoretical knowledge. It is based on the personal experience of the author. That is the value per se. 

    What will you find in the book The Two Formula: The Best Single Trading Pattern I Have Ever Used?

    According to the author, Michael Swanson, the first time he used this trading pattern was in 1999. And how good this price pattern shows the fact he is using it for even more than 20 years. He reveals that just one single price pattern is quite enough for successful trading whatever you want stocks, funds, futures, commodities. Basically, you can use this price pattern for anything that you can draft on the technical charts. We have been reading a lot of books about trading. Also, we examined a lot of patterns but this particular one is extremely interesting. This trading strategy is completely unique. 

    Few words about trading strategies

    Essentially, a trading strategy is a method of buying and selling in the stock markets or some other markets. The trading strategy is based on rules that deem to end up with success in trading and in profit. So, most traders are guessing and trying to notice the bottom and the level where the price starts to go up in order to buy an asset in the hope it will rise further. The point is they are often wrong. Go back to the beginning of this article and you’ll see the stats. What do the majority of traders do? They are hunting price movement. But it very often turns into chaos. Why is that? They are not trading, instead, they are gambling, they place trades without a meaningful process. 

    When they see how big mistakes they have, traders use charts to figure out what is wrong and try to fix it. Sometimes they are spending hours, days even weeks, staring at the charts to predict how the price will go in the future by using technical indicators, a lot of them. And they are confused more and more. These complicated images can fry their brain but their trades will not become more successful.

    The simplicity of The Two Formula pattern

    For any trader, the simplicity of the pattern is extremely important. If you have too many indicators added to the chart you will have a blurred picture. The essence of profitable trading is to have a steady plan, something that really works when setting the position. You must have confidence in what you are doing and you have to know how your trade will end up. This “Two Fold Formula” book can help to achieve all of that.

    Where is the catch?

    This book shows how with a one price pattern setup you can make a profit while trading. Basically, it is a simple strategy and that’s why it is an effective one. Easy to understand, easy to use, without misunderstanding. Everything is explained clearly and smoothly and, what is most important, based on personal experience and proven. 

    Some traders have to lose, but you would have a chance to make a profit with this method. Any trade has only two ends: loss or profit. Why shouldn’t you profit? This may help you to trade like a pro. 

    Bottom line

    People are afraid of the risk, but these two formula pattern seems to be using some good indicators and a more “tuned” strategy. 

    Pro tip: use it with our preferred trading platform virtual trading system to see if it’s working before trying on real funds (68% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money)

  • A Bottom fishing As An Investment Strategy

    A Bottom fishing As An Investment Strategy

    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.

  • MACD Indicator – Moving Average Convergence Divergence

    MACD Indicator – Moving Average Convergence Divergence

    MACD Indicator
    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.

  • Falling Knife Stocks – How To Profit From Falling Knife

    Falling Knife Stocks – How To Profit From Falling Knife

    (Updated October 2021)

    Falling Knife Stocks
    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.

  • Calculate Portfolio Performance

    Calculate Portfolio Performance

    Calculate Portfolio Performance
    Don’t base the success of your investment portfolio on returns alone. Use these three sets of measurement tools to calculate portfolio performance.

    The main goal to calculate portfolio performance is to measure the value created by the investor’s risk management. The majority of investors will judge the success of their portfolios based on returns. But it isn’t enough. To have a sense of how our investment portfolio is well-diversified and how much risk we take we need to calculate portfolio performance. In other words, we need a measure of both risk and return in the portfolio to judge its success. Until the 1960s no one paid attention to the risks involved in obtaining returns. But today we have several ways to calculate portfolio performance and measure it. 

    Our aim is to present you with these valuable tools. 

    Sharpe, Jensen and Treynor ratios pair risk and return performances, and unite them into unique value. Well, each of them operates a bit differently so we can choose one to calculate portfolio performance or mix all three ratios.

    Calculate Portfolio Performance Using Sharpe Ratio

    Sharpe ratio is the measure of risk-adjusted return of an investment portfolio. Or in other words, by calculating it we can find a measure of excess return over the risk-free rate relative to its standard deviation. It is common to use the 90-day Treasury bill rate as the representative for the risk-free rate. This ratio is named after William F Sharpe. He is a Nobel laureate and professor of finance, emeritus at Stanford University.

    The formula is:

    ​Sharpe ratio= (PR−RFR) / SD

    ​In this formula, PR represents the expected portfolio return, RFR is the risk-free rate, while SD represents a portfolio’s standard deviation which is a measure for risk. Standard deviation reveals the variation of returns from the average return. So we can say that if the standard deviation is great, the risk involved is also great. 

    So, you can see how the Sharpe ratio is simple to calculate since it has only 3 variables. 

    But let’s calculate portfolio performance more realistic. For example, our portfolio has a 20% rate return. The whole market scored 15%. So, we may think that our portfolio is greater than the market, right? But it isn’t a proper opinion. How is that? Well, we didn’t calculate the risk we had to take to earn such a great rate return. What if we took much more risk than we thought. That would mean that our portfolio isn’t optimal. Let’s go further in this analysis. Imagine that our portfolio has a standard deviation of 15% and the overall market has 8%, and the risk-free rate is 3%. This is just a random example. Let’s calculate portfolio performance now using the Sharp ratio formula.

    Sharp ratio for our portfolio: (20 – 3) / 15 = 1.13

    and

    Sharp ratio for the market: (15 – 3) / 8 = 1.5

    Can you see now?

    While our portfolio scored more than the overall market, our Sharpe Ratio was notably less. So, our portfolio with a lower Sharpe Ratio was a less optimal portfolio even though the return was higher. This means we took an excess risk without extra bonus. But it isn’t the same case when it comes to the overall market, it is actually the opposite. When the market has a higher Sharpe ratio, it has a higher risk-adjusted return. The best portfolio is not the portfolio with the highest return. Rather, an excellent portfolio has a higher risk-adjusted return.

    Sharpe ratio is more suitable for well-diversified portfolios because it more correctly considers the risks of the portfolio. 

    Jensen ratio

    The Jensen ratio gauges how much of the portfolio’s rate of return is attributable to our capability to produce returns above average, and adjusted for market risk. 

    The Jensen ratio measures the excess return that a portfolio produces over the expected return. This figure of return is also recognized as alpha. Let’s say that our portfolio has positive excess returns, so it has a positive alpha. On the other hand, a portfolio with a negative excess return has a negative alpha.

    The formula is:

    Jenson’s alpha = PR−CAPM

    Here, PR stands for portfolio return and CAPM is risk-free rate+β( beta). We know that beta is the return of the market risk-free rate of return.

    ​By using Jensen’s alpha formula we can calculate an investment’s risk-adjusted value. It is also known as Jensen’s Performance Index or ex-post alpha. Jensen’s alpha tries to determine the unusual return of a portfolio no matter what assets it consists of. This formula was first introduced by the economist Michael Jensen. Investors use this formula to calculate portfolio performance by enabling them to discover if an asset’s average return is adequate to its risks.

    Regularly, the higher the risk, the greater the expected return. So, that’s why evaluating risk-adjusted performance is especially important for making investment decisions. It will allow doing this. 

    This Jensen’s alpha also can be expressed as 

    Jensen’s alpha = Portfolio return – ((Risk-Free Rate + Portfolio Beta x (Market Return – Risk-Free Rate))

    The alpha figure can be positive or negative. When it is higher positive values that suggest better performance in comparison to expectations while negative rates showed that the assets perform below expectations. Jensen’s alpha is expressed in percentages. 

    Let’s take the example of a stock with a return per day based on CAPM. And we see that it is 0.20% but the real stock return is 0.25%. So, Jensen’s alpha is 0.05%. Is it a good indicator? Yes, you can be sure.

    The purpose of this measure is to help investors to go for assets that grant maximum returns but with minimum risks.

    For example, you found two stocks that are offering similar returns. But one with less risk would be more profitable for investors than the one with greater risk. When calculating Jensen’s alpha you would like to see a positive alpha since that indicates an abnormal return.

    Treynor ratio

    The Treynor ratio is very useful to calculate portfolio performance. It is a measure that uses portfolio beta,  a measure of systematic risk. That is different from the Sharpe Ratio that adjusts return with the standard deviation. 

    This ratio represents a quotient of return divided by risk. The Treynor Ratio is named after Jack Treynor, the economist, and developer of the Capital Asset Pricing Model.

    The formula is expressed as:

    Treynor ratio = (PR−RFR) / β

    The symbols are well-known, PR stands for portfolio return, RFR refers to the risk-free rate and β is portfolio beta.

    We can see that this ratio takes into account both the return of the portfolio and the portfolio’s systematic risk. From a mathematical viewpoint, this formula expresses the quantity of excess return from the risk-free rate per unit of systematic risk. And just like the Sharpe ratio, it is a return/risk ratio.

    Let’s assume we would like to compare two portfolios. One is the equity portfolio and the other is the fixed-income portfolio. How can we decide which is a better investment? Treynor Ratio will help us pick the better one.

    To put this simply, assume for the purpose of this article only, the equity portfolio has a total return of 9%, while the fixed-income portfolio has a return of 7%. Also, the proxy for the risk-free rate is 3%. Further, let’s suppose that the beta of the equity portfolio is 1.5, while the fixed-income portfolio has a beta of 1.25

    Let’s calculate for each portfolio!

    Treynor ratio for a equity portfolio = (9% – 3%) / 1.5 = 0.040 

    Treynor ratio for a fixed-income portfolio = (7% – 3%) / 1.25 = 0.032

    So, the Treynor ratio of the equity portfolio is higher which means a more favorable risk/return option. Since the Treynor ratio is based on past performance it is possible not to be repeated in the future. But you will not rely on just one ratio when making an investment decision. You have to use other metrics too.

    For the Treynor ratio, it is important to know that the negative value of beta will not give exact figures. Also, while comparing two portfolios this ratio will not show the importance of the difference of the values. For instance, if the Treynor ratio of one portfolio is 0.4 and for the other 0.2, the first isn’t surely double better.

    Bottom line

    To calculate portfolio performance we have to determine how our portfolio has performed relative to some benchmark. Performance calculation and evaluation methods fall into two categories, conventional and risk-adjusted. The most popular conventional methods combine benchmark and style comparison. The risk-adjusted methods are focused on returns. They count the differences in risk levels between our portfolio and the benchmark portfolio. The main methods are the Sharpe ratio, Treynor ratio, Jensen’s alpha. But there are many other methods too.

    But one is sure, portfolio performance calculations are a key part of the investment decision. Keep in mind, portfolio returns are just a part of the whole process. If we never evaluate the risk-adjusted returns, we will never have the whole picture. That could lead to wrong decisions and losses, literally.

  • What Is Alpha In Investing – How to Beat the Market

    What Is Alpha In Investing – How to Beat the Market

    What Is Alpha In Investing
    Alpha represents a measure of an asset’s return on investment compared to the risk-adjusted expected return.
    Beta represents a measure of volatility. Beta measures how an asset moves versus a benchmark.

    What is Alpha? Alpha is a measure of the performance of an investment in comparison to a fitting market index, for example, the S&P 500. The base value is zero. And when you see the number one in Alpha that means that the return on the investment outperformed the overall market average by 1%. A negative alpha number shows that the return on the investment is underperforming in comparison to the market average. This measure is applicable over a strictly defined time frame.

    What is Alpha more? It is one of the performance ratios that investors use to evaluate both individual stocks and portfolio as a whole. Alpha is shown as a single number, for example, 1, 2, 5 but expressed as a percentage. It shows us how an investment performed related to a benchmark index. For example, a positive alpha of 4 (+4) suggests that the portfolio’s return outperformed the benchmark index’s performance by 4%.  But the alpha of negative 4 (-4) means that the portfolio underperformed the index by 4%. When alpha is zero that means that your investment had a return that met the overall market return.

    What is Alpha of a portfolio?

    It is the excess return the portfolio yields related to the index. When you are investing in some ETF or mutual funds you should look if they have high alpha because you will have better ROI (Return on Investment).

    But you cannot use this ratio solely, you have to use it together with a beta. Beta is a measure of investment volatility. The beta will show you how volatile one investment is compared to the volatility of, for example, the S&P 500 index.

    These two ratios are used to analyze a portfolio of investments and assess their theoretical performance.

    How to calculate?

    First, you have to calculate the expected rate of return of your portfolio. But you have to do that based on the risk-free rate of return, market risk premium, and a beta of the portfolio. The final step is to deduct this result from the actual rate of return of your portfolio.

    Here is the formula

    Expected rate of return = Risk-free rate of return – β x (Market return – Risk-free rate of return)

     and

    Alpha of the portfolio = Actual rate of return of the portfolio – Expected Rate of Return on Portfolio

    The risk-free rate can be discovered from the average annual return of security, over a longer period of time.

    You will find the market return by tracking the average annual return of a benchmark index, for example, S&P500. The market risk premium is calculated by deducting the risk-free rate of return from the market return.

    Market risk premium = Market return – Risk rate of return

    The next step is to find a beta of a portfolio. It is determined by estimating the movement of the portfolio in comparison to the benchmark index. 

    So, now when we have this result, expected rate of return, we can calculate further. We have to find the actual rate of return. It is calculated based on its current value and the prior value.

    And here we are, we have the formula for calculation of alpha of the portfolio. All we have to do is to deduct the expected rate of return of the portfolio from the actual rate of return of the portfolio.

    That was a step by step guide for this calculation.

    Becoming an Alpha investor

    There is a great discussion about should the average investor look for alpha results of a portfolio. But we can hear that investors mention alpha. This is nothing more than the amount by which they have beaten or underperformed the benchmark index. It can be the S&P 500 index if you are investing in the US stock market. In such a case, that would be your benchmark.

    For example, if the benchmark index is up 4% over the period, and your portfolio is up 6%, your alpha is +2. But if your portfolio is up 2%, your alpha is -2.

    Of course, everyone would like to beat the benchmark index all the time. 

    What is the Alpha investing strategy?

    We know that Alpha is a measure of returns after the risk is estimated. Risk is determined as beta, a measure of how volatile one investment is related to the volatility of the benchmark index.

    Alpha strategies cover equity funds with stock selection. Also, hedge fund strategies are a popular addition in alpha portfolios.

    Something called “pure alpha” covers hedge funds and risk premia strategies. The point is that by adding an alpha strategy to your overall portfolio you can boost returns of the other investment strategies that are not in correlation.

    Alpha is the active return on investment, measures the performance of an investment against a market index. The investment alpha is the excess return of investment relative to the return of an index.

    You can generate alpha if you diversify your portfolio in a way to eliminate disorganized risks. By adding and subtracting you are managing the risk and the risk becomes organized not spontaneously. When alpha is zero that means the portfolio is in line with an index. That indicates that you didn’t add or lose any value in your portfolio.

    When an investor wants to pick a potential investment, she or he considers beta. But also the fund manager’s capacity to generate alpha. For example, a fund has a beta of 1 which means it is volatile as much as the S&P index. To generate alpha, a fund manager has to generate a return greater than the S&P 500 index.

    For example, a fund returns 12% per year. That fund has a beta of 1. If we know that the S&P 500 index returns 10%, it is said the fund manager generated alpha returns.

    If we consider the risks, we’ll see the fund and the S&P index have the same risk. So, the fund manager generated better returns, so such managers generated alpha. 

    Alpha in use

    You can use alpha to outperform the market by taking more risks but after the risk is considered. Well, you know that risk and reward are in tight relation. If you take more risks, the potential reward will go up. Hence, limited risks, limited rewards.

    For example, hedge funds use the concept of alpha. They use beta too, but we will write later about the beta. The nature of hedge funds is to seek to generate returns despite what the market does. Some hedge funds can be hedged completely by investing 50% in long positions and 50% in short positions. The managers will increase the value of long positions and decrease the value of their short positions to generate positive returns. But such a manager should be a ninja to provide gains not from high risk but from smart investment selection. If you find a manager that can give you at least a 4% annual return without a correlation to the market, you can even borrow the money and invest. But it is so rare.

    Alpha Described

    What is alpha more? It is often called the Jensen index. It is related to the capital asset pricing model which is used to estimate the required return of an investment. Also, it is used to estimate realized achievement for a diversified portfolio. Alpha serves to discover how much the achieved return of the portfolio differs from the required return.

    Alpha will show you how good the performance of your investment is in comparison to return that has to be earned for the risk you took. To put this simply, was your performance adequate to the risk you took to get a return.

    A positive alpha means that you performed better than was expected based on the risk. A negative alpha indicates that you performed worse than the required return of the portfolio. 

    The Jensen index allows comparing your performances as a portfolio manager or relative to the market itself. When using alpha, it’s important to compare funds inside the same asset class. Comparing funds from one asset class, otherwise, it is meaningless. How can you compare frogs and apples?

    What is beta?

    When stock fluctuates more than the market has a beta greater than 1.0. If stock runs less than the market, the beta is less than 1.0. High-beta stocks are riskier but give higher potential returns. Vice versa, stocks with lower beta carries less risk but yield lower returns.

    Beta is usually used as a risk-reward measure. It helps you determine how much risk you are willing to take to reach the return for taking on that risk. 

    To calculate the beta of security, you have to know the covariance between the return of the security and the return of the market. Also, you will need to know the variance of the market returns. The formula to calculate beta is

    Beta = Covariance/Variance

    ​Covariance shows how two stocks move together. If it is positive that means the stocks are moving together in both cases, when their prices go up or down. But if it is negative, that means the stocks move opposite to each other. You would use it to measure the similarity in price moves of two different stocks.

    Variance indicates how far a stock moves relative to its average. You would use variance to measure the volatility of stock’s price over time.  

    The formula for calculating beta is as shown above.

    Beta is very useful and simple to describe quantitative measure since it uses regression analysis to gauge the volatility. There are many ways in which beta can be read. For example, the stock has a beta of 1.8 which means that for every 1% correction in the market return there will be a 1.8% shift in return of that stock. But we also can say that this stock is 80% riskier than the market as a whole. 

    Limitations of Alpha

    Alpha has limitations that investors should count when using it. One is related to different types of funds. If you try to use this ratio to analyze portfolios that invest in different asset classes, it can produce incorrect results. The different essence of the various funds will change the results of the measure. Alpha is the most suitable if you use it strictly for stock market investments. Also,  you can use it as a fund matching tool or evaluating comparable funds. For example, two large-cap growth funds. You cannot compare a mid-cap value fund with a large-cap growth fund.

    The other important point is to choose a benchmark index. 

    Since the alpha is calculated and compared to a benchmark that is thought suitable for the portfolio, you should choose a proper benchmark. The most used is the S&P 500 stock index. But, you might need some other if you have an investment portfolio of sector funds, for example. if you want to evaluate a portfolio of stocks invested in the tech sector, a more relevant index benchmark would be the Dow technology index. But what if there is no relevant benchmark index? Well, if you are an analyst you have to use algorithms to mimic an index for this purpose.

    Limitations of beta

    The beta is good only for frequently traded stocks. Beta shows the volatility of an asset compared to the market. But it doesn’t have to be a rule.  Some assets can be risky in nature without correlation with market returns. You see, beta can be zero. You should be cautious when using a beta.

    Also, beta cannot give you a full view of the company’s risk outlook. For short-term volatility it is helpful but when it comes to estimating long-term volatility it isn’t.

    Bottom line

    What is alpha? It began with the intro of weighted index funds. Primarily, investors started to demand portfolio managers to produce returns that beat returns by investing in a passive index fund. Alpha is designed as a metric to compare active investments with index investing. 

    What is the difference between alpha and beta?

    You can use both ratios to compare and predict returns. Alpha and beta both use benchmark indexes to compare toward distinct securities or portfolios.

    Alpha is risk-adjusted. It is a measure that shows how funds perform compared to the overall market average return. The loss or profit produced relative to the benchmark describes the alpha. 

    On the other hand, beta measures the relative volatility of assets compared to the average volatility of the entire market. Volatility is an important part of the risk. The baseline figure for beta is 1. A security with a beta of 1 means that it performs almost the same level of volatility as the related index. If the beta is under 1, the stock price is less volatile than the market average. And vice versa, if the beta is over 1, the stock price is more volatile. There is some tricky part with beta value. If it is negative, it doesn’t necessarily mean less volatility. 

    A negative beta means that the stock tends to move inversely to the direction of the overall market.

  • How To Read Stock Charts?

    How To Read Stock Charts?

    How To Read Stock Charts?
    Stock charts will provide you the information about the stock’s past trading prices and volumes. This is a remarkable advantage when it comes to technical analysis.

    By Guy Avtalyon

    How to read stock charts and what they are trying to tell you? How can you use them in making your investment decisions? So let’s see the importance of price action and technical analysis. Because that’s it.

    We are 100% sure you’ve already had the opportunity to see the stock charts, for example, Yahoo Finance is one of those places. If you want to get some experience with outlook and parameters, it is the right place. Also, you could see the stock charts when you examine the company’s stock you wanted to buy.

    And what can you see? 

    There are two types of charts: line and candlestick. It looks so simple and a small graph but contains a lot of very important data. For example, you can see the opening and closing price, the lowest and the highest price of the stock, and plenty of other information set in that small image.

    What trading charts can tell?

    You must know, a chart is a visual illustration of changes in stock price and trading volume. They are not magical or scary. In essence, the charts do one easy job: They want to tell you a story about the stock. Stock charts will give you an objective picture without hypes and rumors. They will neglect even news and tell you the truth and what is really going on with your stock. 

    For example, when you learn how to read stock charts you’ll be able to notice if institutional investors are heavily selling. That will quickly provide you valuable info on what you have to do. The charts literally tell you that. If you see in the graph the investors are massively buying, what are you going to do? What do the charts want to tell you? They want to tell you: buy too. Or if you see they are selling: sell too. Those investors are heading the exits.

    The institutional investors’  buying or selling will shift your stock up or down. And the charts will tell you that on time. So you’ll be ready for action. That is extremely important in the stock markets that are volatile and stock price can change in a second.

    How to read stock charts

    Reading charts is one of the most important investing skills. Stock charts will tell you if the stock is depreciating or appreciating because they are recording the stock price and volume history. Well, when you grow your skill in chart reading, you’ll be able to find more. You will notice some small, often indirect signs in the stock actions such as whether the particular stock showed some unusual activities. 

    You choose the type of chart that best suits you, a line chart or a candlestick. But the charts will show you the price of daily changes in its price area. 

    Let’s breakdown all these bars and lines

    You will notice the vertical bars. They record the share price span for the chosen period. The horizontal dash that intersects within the price bar shows the current price. Also, it shows where a stock closed at the end of the day. If the color of the price bar is blue that means the stock closed up but if it is red the stock closed down.

    In the volume area, below the horizontal line, you will also see bars but volume bars that represent the number of shares traded in some period, day, week, month, etc. The color of the bars tells us the same as price bars. Also, there you will see the average volume for some stock over the last 50 days.

    Charts will tell you all about the average share price over the last 50 days and the last 200 days of trading. But by reading stock charts you will have the info about how the stock price moved compared to the market. It is a so-called relative strength line. When this line is trending up, we can say the particular stock is outperforming the market, the opposite means the stock is lagging the market.

    Changing the time period

    You can do that and have a look at the daily, weekly, monthly charts. 

    Daily stock charts will help you to measure the current strength or weakness of a stock. These charts are very useful for identifying the precise buy points and creating a short-term trading strategy.

    Weekly stock charts will help you to recognize longer-term trends and patterns in stock prices. The weekly charts use logarithmic price scaling. So, you can easily make comparisons between stocks or the major market indexes.

    Indicators in the stock charts

    All the charts will come with them. Indicators are tools that provide visual representations of mathematical calculations on price and volume. Well, they will tell you where it is possible for the price to go further. The major types of indicators are a trend, volume, momentum, and volatility. Trend indicators show the direction of the market moving. They are also known as oscillators because they are moving like a wave from low value up to the high and back to low and high again as the market is changing.

    Volume indicators will show you how volume is developing over time, how many stocks are being bought and sold over time. 

    Momentum indicators show strong the trend is. They can also reveal if a reversal will happen. They are useful for picking out price tops and bottoms. 

    Volatility indicators reveal how much the price is changing in a particular period. So, volatility isn’t a dangerous part of the markets, you have to know that. Without it, traders would never be able to make money! In other words, how is it possible to make a profit if the price never changes? High volatility means the stock price is changing very fast. Low volatility symbolizes small price moves.

    Some traders don’t use indicators because they think the indicators can smudge the clear message that the market is telling. Well, that’s obviously an individual approach.

    What are Support and Resistance Levels

    Stock charts will help you to identify support and resistance levels for stocks. Support levels are price levels where you can see increased buying as support to stock’s price that will direct it back to the upside. Resistance levels, as the opposite, shows prices at which a stock has presented a trend to fall while trying to move higher, and switched to the downside.

    Recognizing support and resistance levels is extremely important in stock trading. The point is to buy a stock at a support level and sell it at a resistance level. That’s how you can make money. If some stock has clear support and resistance levels, the breakout beyond them is an indicator of future stock price movement.

    For example, you have in front of you the chart and you notice that the stock didn’t succeed to break above, let’s say $100 per share. And suddenly, it makes it. Well, in such a case you have a sign that the stock price will go up. You might see, as an example, that some stock traded in a tight range for a long time but once when it broke the support level, it will continue to fall until a new support level is established.  

    Bottom line

    Knowing how to read stock charts will give you a powerful tool while trading. But you have to know that charts are not perfect tools. Even for the most experienced analysts. If they are, every stock trader and investor would be a billionaire.

    Nevertheless, knowing how to read stock charts will surely help you. That may increase your chances of trading stocks. But you will need a lot of practice. The good news is that everyone who spends time and gives an effort to learn how to read stock charts can become a good chart analyst. Moreover, good enough to enhance the success in stock market trading. 

    Try to learn this. It can be valuable. We’re doing smart trading.

  • 80/20 Investing Rule – Pareto principle

    80/20 Investing Rule – Pareto principle

    80/20 Investing Rule - Pareto principle
    80/20 investing rule or Pareto principle is great for individual investors who don’t like conventional rules. It isn’t difficult but could increase the chances of your profit. 

    Let’s see first what is behind the 80/20 investing rule or Pareto principle. 

    It’s a saying, which claims that 80% of both outcomes or outputs is a consequence of 20% of all inputs for some event. The 80/20 investing rule is frequently used in many fields not in investing only.

    But our subject is investing, where the 80/20 rule means that 20% of the holdings in a portfolio are in control for 80% of the portfolio’s growth. Well, this 20% can be in charge of 80% of the portfolio’s losses. 

    For example, you can build a portfolio of 20% growth stocks and 80% bonds which are less volatile investments. The 80% will provide you a nice and stable return since the bonds are low-risk, while the 20% in stocks that are considered as the higher-risk investment could give greater growth and higher profit.

    Also, you can add to your portfolio 20% stocks in the extended market that cover 80% of the market’s returns. But this can be too risky because the stocks are unpredictable and volatile.

    Okay, you wouldn’t believe that the market rises 80% of the time, right? But it is true. But does the market drop 20% of the time? The best way to check this is to check it by yourselves and you will be surprised as well as we were. Advanced traders and investors use this 80/20 investing rule as a great advantage. 

    How to use the 80/20 investing rule?

    Examine your investment portfolio and think which of your investments result in 80% of the returns. What can you see? The stocks are what generates most of the returns. 

    If it is needed, don’t hesitate to cut off a stock if it looks like it falls into your 80% of your overall investment portfolio in terms of returns. Anyway, we want to give some ideas on how to use the 80/20 investing rule and become a better trader.

    First of all, you have to finish some tasks such as evaluating how strong your earning power is and to know the inventory of your assets in the portfolio. What are your best assets in terms of investing? You must know that your portfolio is your financial house and you have to keep it in order. You can do that only if you measure and estimate from time to time but actually frequently. Be reasonable, not too frequently. You don’t need the stress. All you want is to avoid unnecessary risks. Okay, you did this task and periodically just go over these figures to check if they follow your investment plan. It is vital for investing to check the current and potential earning power from time to time and keep an eye on your outgoings.

    Let’s follow the 80/20 investing rule.

    Investing success depends on a few resolutions. For example, the simplicity of your investment strategy and portfolios.

    The main aim of investing: Never lose money. That is the rule No1. This means never bet on price changes and rising markets. You need to build an investment portfolio able to follow this rule. Well, we have to be honest, there is no trader or investor that came into the safe zone and comfortable position with speculating and risking in the stock market. Too many risks will more likely lead you to large losses, not to the profits.

    Benjamin Graham said:

    “Investment is most intelligent when it is most businesslike.”

    What is the right meaning of this saying? Managing the investments is like you are running your own business, your company. So, you have to respect some principles that could lead you to success.

    The 80/20 investing strategy

    The 80/20 investing strategy is all about increasing the chances of your investment success. Actually, it is all about how to unite your portfolio strength and its resources. But, the 80/20 rule has nothing to do with asset allocation. It is wider than that. The goal is to achieve the highest returns possible.

    80/20 rule investing means intelligent investing.  

    At its essence, the 80/20 rule requires you to recognize the best assets and by using to achieve maximum returns. To do that you don’t need complex math, it’s just a rule.

    When the markets are overvalued, why do you have to buy? The risk of loss exceeds the potential return, right?

    The 80/20 investing strategy will reduce levels of volatility as we described and reduce the drawdowns. Your assets will really “compound” over the long-term. One of the easiest ways to manage this strategy is to use a moving average crossover. The principal is quite simple. Stay in stocks when the S&P 500 index is above the 12-month moving average, and you change to bonds when the S&P 500 falls below the 12-month average.

    Pareto principle

    Let’s say your portfolio has many holdings. But it doesn’t matter how many holdings you have, the 80/20 rule or Pareto Principle applies. To win by using the 80/20 rule, you have to keep in mind a few things.

    Firstly, 80% of your profit depends on 20% of your activities. You can spend a lot of time choosing some great stock, evaluate it, estimate, try to figure out where to set a stop-loss, basically, you have just a few tasks that should be in your focus. Yes, few but they will generate you a profit.

    So what do you have to be considered about? What steps do you have to take? You should know your ideal allocation based on your risk tolerance. Also, you have to rebalance it periodically. Can you see? Just two steps, but important though. With these two simple things, you will have success more often.

    And you will see that 80% of your returns come from 20% of your holdings. How to choose the winners? Well, you know, they are companies built to succeed for a long time.

    Bottom line

    80/20 investing is excellent for individual investors who don’t like to follow conventional rules. It isn’t complicated but could easily increase the odds of your success. Just remember that 80% of your returns arrive from 20% of your holdings. Try to find the winners in your portfolio, play on them and look at how your portfolio will become worth and rise in value. 

    This 80/20 investing rule or Pareto principle is visible in almost all areas of our lives. The 80/20 rule was developed by Vilfredo Pareto in Italy in 1906. He was an economist and he saw that 20% of the pea pods in his garden produced 80% of the peas. After that, he revealed that 20% of citizens in Italy hold 80% of the land. Well, did the 80/20 investing rule grow in Pareto’s garden? According to the legend, yes.

    You can find little scientific analysis that either proves or disproves the 80/20 rule’s validity. But the fact is that many financial advisors and consultants have the 80/20 investing strategy as an offer. Moreover, they have extremely good results.

  • P/E Ratio An Quick Method to Value a Stock

    P/E Ratio An Quick Method to Value a Stock

    P/E Ratio An Quick Method to Value a Stock
    Investors use the P/E ratio to unveil the relative value of a company’s stock. Also, the P/E ratio can be used to compare a company’s historical data or to compare markets as a whole over time.

    By Guy Avtalyon

    The  P/E ratio or price to earnings ratio calculates the market value of a stock in relation to its earnings and do it by comparing the market price per share by the earnings per share. To put this simple, the P/E ratio indicates how much the market wants to pay for a particular stock based on its current earnings.

    Investors often use the P/E ratio to assess a stock’s fair market value by predicting future earnings per share.

    It is one of the most broadly used methods for determining a stock value. It can show if a company’s stock price is overvalued or undervalued. But the P/E ratio can reveal a stock’s value in comparison with other stocks from the same industry. This ratio is also called a “multiple” because it shows how much an investor is willing to pay for one dollar of earnings

    That is why the P/E ratio is also called a price multiple or earnings multiple. Investors use this ratio to determine how many times earnings they are willing to pay.

    Calculate the P/E ratio

    The formula is simple. Just divide the market value price per share by the company’s earnings per share.

    P/E ratio = share price/earnings per share

    Earnings per share or EPS is the volume of a company’s profit for each outstanding share of a company’s common stock. It is a kind of indicator of financial health. Earnings per share present the part of a company’s net income that would be gained per share if all the profits is paid out to its shareholders. If traders and investors want to discover the financial health of a company they use EPS.
    In P/E calculation, the amount of “earnings” or “E” is provided by EPS.

    P/E = EPS/Saher Price

    Where the symbols show:

    P/E = Price-to-earnings ratio
    Share Price = Market value per share
    EPS = Earnings per share

    ​ For example, at the end of the year, ABC company reported basic or diluted earnings per share of $3 and the stock is selling for $30 per share. Let’s find the P/E ratio:

    EPS = $4
    Share Price = $30 

    This ABC company P/E ratio was: 

    P/E = $30/$4 = $7.50

    So, the company was trading at ten times earnings. So what? This indicator isn’t helpful without comparison to something. As we said, this figure has to be compared to the historical P/E scale of this company stock, or to peers from the same industry.

    For example, this P/E ratio was lower than the S&P 500 (the S&P 500 average is about 15 times earnings) but we can compare this P/E ratio to peers. And we noticed that the company XYZ had the P/E ratio of 11 at the end of the same year. What can we conclude? Well, ABC’s stock is undervalued. It is lower than, for example, the S&P 500 and for the same period, had lower P/E than its peers.

    You can calculate this ratio for each quarter also but it is common to calculate it at the end of the year.

    Use the P/E ratio to calculate earnings yield

    This is particularly useful. The formula is actually inverted P/E ratio and looks like this:

    Stock’s Earnings Yield = (EPS / Share Price) x 100

    or in our ABC company case:

    earnings yield = (4/30) x 100 = 13.33

    Can you see, to calculate the stock’s earnings yield you have to divide EPS by share price and multiply by 100 to turn it into percentages.

    The earnings yield of a stock is the percentage of each dollar invested in company stocky. It is calculated by dividing earnings per share of the company to its share price. 

    And as you can see, our ABC company has a low P/E ratio but high earnings yield. That will always be like this, the stock with a lower P/E ratio has a higher earnings yield, and the stock with a higher P/E ratio has a lower earnings yield. 

    This lets you easily compare the return you are earning from the underlying company’s business to other investments. Also, this will provide you to avoid to get in bubbles, panics, and fears. It gives you an insight into the stock market and directs on the underlying economic facts.

    Of course, you don’t need to perform all these math even if it is totally simple. This is especially important for beginners in the market. 

    The majority of stock market sites will automatically figure the P/E ratio and you can see it immediately. With help of this number, you can understand the difference between a stock that is selling at a high price because it suddenly became an analysts’ darling and a stable company that is out of analysts’ kindness and investors are selling it for a part of what it truly deserves.

    The two types of EPS metrics 

    Forward P/E ratio

    The most common types of P/E ratios are the forward (also known as leading) P/E and the trailing P/E.
    The forward P/E uses expected earnings guidance instead of trailing figures. It is useful when you want to compare the current earnings to the future.
    While it is helpful it also can lead you to some confusion. The main problem is that companies often underestimate earnings. The reason behind this is they want to beat the estimated P/E when they announce the next quarterly earnings. Also, some companies will declare too strong and enthusiastic the estimation but later adapt it in the next earnings report. Of course, there are always analysts to provide estimates but can confuse too.

    Trailing P/E ratio

    The trailing P/E the most popular P/E metric. It takes into account past performances. To calculate the trailing P/E you have to divide the current share price by the EPS earnings for the last 12 months. Investors mostly like trailing P/E because it is more objective.
    But this ratio also has weaknesses since the past performances don’t guarantee future performances. It is always better to invest money based on future earnings chances. 

    The other problem is the EPS figure is constant. You know the stock price is changing. If some company event pushes the stock price higher or lower, the trailing P/E will not reflective of those changes in full. The trailing P/E will alter as the price of a company’s stock moves because earnings are published each quarter. On the other side, stocks trade every day.  That’s why investors favor forward P/E. When the forward P/E ratio is lower than the trailing P/E, you can be sure the analysts are expecting earnings to increase. And vice versa.

    What are the limitations of P/E?

    The P/E ratio has some limitations. When it is low you may think the stock is good but the stock isn’t good just because it is cheap. You have to know the growth rate, free cash flow yield, dividend yield, and many other metrics also, to make a qualified decision when buying a stock.

    Build a diversified portfolio that not only holds assets that were handsome but also reduces risk.