Notes to self ...

Doing more reading while I wait for my account to be funded. These are just some notes for myself, so they may not make much sense.

1) I do not have to trade.
This is not my job. I do NOT have any real need to trade. I will only enter a trade because I have determined it to be a 'good' trade. My broker doesn't care if I win or lose on a trade as long as entered the trade.

2) Stop-loss orders are my only friend.
Just like poker every dollar I lose is someone elses gain, every dollar I gain is someone elses loss. Nobody is looking out for me but me. Many people have volunteered their experiences in the stock market when they find I'm doing this. Without fail their stories fall into 2 categories. Winning stories; where they tell me about some stock they bought at the "ground floor" to see it rise (most of these people are the 'buy and hold' types, and the increase took place over many years). Losing stories; where they tell me about all the times they lost money, from not being able to "watch" the market or from hoping it would turn around. Nobody who shares a story with me ever mentions where their stop-loss points or take-profit points were, they had no plan if the market turned against them, not the winners or the losers.

3) My goal is to find good trades, not massive profits.
Similar to #1. In poker my winnings took place over thousands of hands. On average I only bothered playing with 30% of those hands. By only entering with good hands I could average 3-5 big bets in profit every 100 hands (including rake). There my be thousands of trade opportunities every year, I will only enter the good ones.

4) Volume, Volume, Volume!
Price is a "meeting of the minds" between buyers and sellers at a specific point in time. Price may fluctuate wildly as different people with different goals and different mindsets come together at certain points. Volume gives indication that the particular "meeting of the minds" is backed by the 'crowd' of the market. A price move has different meanings depending on the relative move in volume.

5) Herd mentality
Trends gain strength because of the herd mentality of crowds. If everyone and their mother is in on a trend, it's probably about to end.

6) Amatuers open, pros close
The opening price of a given day (and more so on the first day of the week or month), is influenced by 'amateurs' placing orders after market hours and those orders being filled at the market opening. When placing a stop order to enter a position, delay the order for an hour or two to avoid the rush and correction.

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Current Trades

What is it? BlahBlah

Ticker: XXXX

Cost: $X.XX

Value: $X.XX

Exit Point: $X.XX

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Trading Account Summary

Current Balance: $X.XX

Current Value: $X.XX

Highest Value: $X.XX

Lowest Value: $X.XX

Highest Drawdown: XX%

Rules, rules, rules (part 2) ...

The other set of rules I need to create is my trading system. There are a TON of technical indicators available, no really. The key is building a select few into a trading system. There is no "golden bullet" indicator, they all have flaws, they are all wrong at times (hopefully different times). The more I read about the various indicators the more it appears they are very similar to one another.

As I see it there are three main groups: (search investopedia for descriptions I'm not going to link each one)

• Chart patterns ("Head and shoulders", triangles, flags, sushi rolls, doji stars, fibonacci fans / retracements, etc.)
• Trend indicators (MACD, DMI, Bollinger / Keltner Bands, etc.)
• Supply / Demand oscillators (CMO, Stochastics, RSI, MFI, etc.)

Chart patterns are shapes or patterns that can be seen by examining historical price data. Usually the pattern or shape itself isn't an indicator, but the price data breaking the boundries of the patter or shape is the indication of future movement in a particular direcion. For example, if a previous point of support is broken (price hit a certain low then rebounded on several occasions until finally falling below the "rebound" point), then that penetration is an indication that prices will continue to move lower in the future. I included fibonacci fans / retracements here because they to point to "decision" levels for price, if a stock retraces 33% of it's gain / loss you need to examine if it will change direction or continue.

Trend indicators show the direction of a trend, the strength of a trend, and sometimes both. They tend to "lag" behind current price data. So while a chart pattern may indicate a reversal of direction the trend indicator will verify it a few data points later, in general.

Oscillators generally indicate where the stock price is in terms of supply and demand. A high value usually indicates the stock is "overbought", lots of people buying the stock have driven up the price. A low value indicates the reverse, lots of sellers creating oversupply and driving down he price.

Dr. Alexander Elder put together a "Triple screen Trading System" in his book Trading for a Living (very good book). I like the system, as it combines various indicators to compensate for each others weaknesses. The first step is to determine my "trade horizon", or how long I intend to be in each trade. Day traders have horizons in terms of hours, buy and hold types have horizons in terms of years; I'm looking at days or a few weeks (only 5 days in a trading week). Once I have my horizon (measured in days), this will become the data grouping to examine intermediate trends. So when looking for intermediate trends I will use charts showing daily price data. Long trends will be an order of magnitude larger, so I will use charts with weekly data to determine long trends. Short trends will be an order of magnitude smaller, so I will use charts with hourly data to determine short trends. An analogy Dr. Elder uses is Tides, Waves, and Ripples.

The first screen employs a trend following indicator to determine the direction of the long term trend (Tide). I will be using weekly price data represented with a Heikin-Ashi Candlestick representation, this helps smooth out "noise" and make the prevailing trend more obvious. A MACD indicator will be my primary indicator of trend direction, and an ADX indicator will help me confirm the strength of the trend. Chart analysis techniques (Candlestick patterns, Fiboniacci fans / retracements) will be used as additional confirmation for trend diretion changes.

The second screen uses oscillators to identify consolidations (Waves) during the prevailing trend (Tide), a temporary fall or sideways action during an uptrend signals a good point to enter the trend ("buy low" afterall). I will use daily price data in both Candlestick and Bar representations. An EFI (Elder Force Index) oscillator will be my primary indicator, with a CMO (Chande Momentum Oscillator) providing confirmation of "over bought / sold" conditions. Again chart patterns will provide additional confirmation. Since oscillators can give false signals during longer trends (ie. A long uptrend will have an oscillator showing "overbought" conditions for some time as buyers continue to drive the price up over a longer period.), employing them as a second screen after determining the longer trend allows me to identify which signals to ignore. Continuing the example, if the long term trend is up only oscillator signals saying "buy" will be used; the "sell" signals will only be used if the long term trend changes.

The third screen doesn't need many analytical tools. Once an entry point has been confirmed in the second screen, an order is entered just outside the previous day's boundaries. Continuing the example; the long term trend is up, the mid-term trend identifies a temporay pull back, the third sceen looks at the previous day's hourly action and a stop-buy order is placed above the previous day's high. On the next trading day, if the price rises (as predicted by the first screen) the buy order is executed and we got into the up trend at a low point. If the price decreases (as predicted by the second screen) then the stop-buy is adjusted to just above that day's high, as long as the primary long term trend has not changed this will ensure we enter the uptrend at the lowest point.

This covers when to enter a trade, equally (some would say more) important is when to exit the trade. After the position is acquired a stop-loss order is placed on the opposite side of the day's boundaries. Finishing the example, yesterday the stock was purchased; a stop-sell order is placed just below yesterday's low. If the trend changes rapidly, we are spared the minimum loss. If the trend continues as we predicted in the first screen, then the stop-sell order can be increased steadily to lock in profits.

I'll have to use a small change to the Dr. Elder's system. Since my money management rules preculde my from buying sizeable amounts of the stocks I'll be screening (DJIA members); I'll be buying options instead. The frist two screens will be unchanged, but the third screen will examine the daily price movement of the related stock option. Stop-buy and stop-sell orders will be applied in the same fashion.

Up next, an example of the Triple Screen System in action ...

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Current Trades

What is it? BlahBlah

Ticker: XXXX

Cost: $X.XX

Value: $X.XX

Exit Point: $X.XX

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Trading Account Summary

Current Balance: $X.XX

Current Value: $X.XX

Highest Value: $X.XX

Lowest Value: $X.XX

Highest Drawdown: XX%

Rules, rules, rules (part 1) ...

Before I start putting my money at risk there are two sets of rules I have to create. The first set of rules cover money management, how much money to risk and how often. Investopedia has a good article on this. In limit poker part of the rules were defined for me. I could only risk bets in set increments defined by the table stakes.

The other two limit poker rules were:

1. Have a bankroll of 300 times the size of the "big blind". (So at $0.50/$1 tables, have a $300 bankroll)
2. Start each table session with 30 times the size of the "big blind". (Assuming same stakes, $30)
3. If you exhaust your funds for the session; stop, "cool off", and examine the table situation and your performance before deciding to call it a day or continue playing.
   
4. Fold when you KNOW you are beat. (This is the hardest to learn.)
   

These rules helped weather the inevitable losses, or drawdowns.

For my stock market project the rules will be:

1. Each trade will only be 2% of my total account value.
2. Total money at risk (over all current trades) will be less that 20% of total account value.
3. Use REAL stop-loss / take profit orders, not "mental" stops.
   
4. Stop, "cool off", and re-examine if I reach 30% drawdown.

Which brings us to the new footer below. The "Current Trades" portion will show each of my open trades. What I'm trading (1 July Call Option on Citigroup, Strike price $50), the Ticker symbol, how much it cost me (less than 2%, not counting commission), how much it's currently worth, and at what value my stop-loss (or take profit) order is set to. The "Account Summary" portion will show my current available balance, the current value (including holdings at risk in 'current trades'), the highest value my account has reached, the lowest value my account has reached, and the previous two entries in terms of drawdown percentage.

Right now they are all just place holders, until I fund my account later this week.

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Current Trades

What is it? BlahBlah

Ticker: XXXX

Cost: $X.XX

Value: $X.XX

Exit Point: $X.XX

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Trading Account Summary

Current Balance: $X.XX

Current Value: $X.XX

Highest Value: $X.XX

Lowest Value: $X.XX

Highest Drawdown: XX%

And now the DJIA ....

Above you'll see a 6 month chart for the Dow Jones industrial Average, the chart has the same components as the S&P500 chart. One notable exception is the orange line indicating a support line. You can see that prior to February this line acted as resistance; this is not uncommon.

The end of this chart (showing market close on Friday May 26th), shows a brief up-trend just like the S&P500. In the case of the DJIA this up-trend reached it's 20 EMA; however, just like the S&P500 it did so on comparatively low volume. This is not surprising as the DJIA and he S&P500 have high correlation. The outlook is similar to the S&P500, since the latest trend reached the EMA on low volume we'll have to see if the DJIA moves back into the trend channel or continues to fall, the trading volume is again an important indicator of the strength of these possible moves.

Why should I care?

Per my "game plan" I'll be looking for entry and exit points for the 30 stocks that make up the DJIA. Discerning the general trend of the overall average helps indicate where the underlying stocks may be heading. In this case if the indications are not clear the stock in the DJIA will most likely trend "sideways" or down in the short-term.

Next week prediction: DJIA will revert to a slight down-trend. The previous down-turn was related to people turning to other investments on the news of rising interest rates. Despite the up-turn (on weak volume) there will continue to be downward pressure as "slower" investors shuffle where they put their money.

Next up, getting back on schedule with Money Management ...

S&P 500 General Analysis

Slight change in programming, I'll start with the general market trends.


The above chart covers the past 6 months. The top portion shows the price of the index, followed by the trading volume, then the Average Directional Index, lastly the Relative Strength index. The blue line on the price chart is a 20 day Exponential moving average, the red line a 50 day exponential moving average, the green line is hand-drawn to show the previous general up-trend and lower trading channel of the index.

So what does it all mean?

As the green line demonstrates there is a gentle long term uptrend. If we plotted price data on a weekly basis instead of daily this would be more obvious, and it would also be indicated in an ADX value rising steadily towards 40. This is further supported by noticing that the price will increase then fall back to the 50 day moving average. Since this uptrend is a very gentle slope, the market can be considered trending "sideways" in the near term (weeks, instead of several months).

But what about the recent downturn?

As you can see the recent downturn took prices below the green trendline, as well as below the moving averages. The downturn found support near the 1265 price mark, this value also provided support back in January and February. In the very near term (days, maybe 2 weeks) I expect the price to return to the moving averages and perhaps touch the green trend line again. Where it goes from there depends a lot on the trading volume during the coming days. If the "return move" is conducted on high volume this will indicate a strong short term uptrend. If the return is accompanied by low trading volume then it is likely the market will continue it's downwards fall (the next question then becomes, will it find support at 1265 again?). Since the most recent minor uptrend has been on decreasing volume, I predict the later option.

So why should I know this?

The general 'wisdom' is "don't fight the trend", if the market as a whole is in a down trend so will a majority of the stocks I'm going to examine; those stocks that appear to be moving against the general trend will have to have strong indications that the move will take place.


Prediction for next week: The S&P500 index will continue it's slight rise until it meets it's moving average values. After that it depends largely on next weeks' trading volume.


Up next, the Dow Jones Industrial Average ...

Account Opened

So I opened an account with MB Trading. They offer $0.01/share stock trades (minimum $1 per order), and $1/contract Options trades. No account minimums or transaction minimums for these commission rates. The Options ability comes with a catch, for Options quote data feed it's $10 per month, this fees does get waved with 10 options contract trades per month. Even with the $10 it's still cheaper than most other brokerages. As I get better at this I might not even be paying that $10. This is a real deep discount brokerage, no frills, just raw data and fast efficient order execution. I'm not paying for advice or research or stock screening, that's what "hands on approach" is all about.

I called their customer support to ask some questions and was connected with a live human. They also provide an online chat service to talk to customer service reps as well, which also provided prompt attention. One form I need to sign and mail to them and then I can fund my account directly with a single ACH transfer from my savings account.

Next up Money Management, and maybe some general market analysis ...

We have the technology ...

So, I have my game plan. What's next? The tools to do the job.

I've downloaded the Medved QuoteTracker software. There are a myriad of third party tools that help analyze stocks. Most (including QuoteTracker) seem to be geared to the more active (day) trader. QuoteTracker is free though, and I'm a cheap bastard. I don't pay for a service to provide "real-time" stock quotes. I don't need it, I'm not doing intraday trading (buy and sell within the same day). The software offers a variety of technical analysis tools, and integrates itself with a variety of online brokerages. This isn't supposed to be an ad, just why I chose it.

There are also two very good chart analysis tools available online, Prophet.net and BigCharts.

With the software and charting tools out of the way it's time to choose a broker. Currently MB Trading looks the most appealing to me. They have some of the lowest commission rates, but I need to call them and find out what sort of strings their "0.01 per share" plan has. Usually plans like this require a certain number of trades per month, or a monthly fee. While they didn't list any such requirements on the website, they didn't specify that these requirements don't exist. In addition they support the free software I have, allowing me to do analysis and trade orders all in one place and 'offline' (aside from data input). I also looked them up at the NASD website, and they are properly registered (and located in the US as opposed to the Cayman Islands).


Next up, opening an account ....

Pre-game warmup.

Theory: "I turned $50 into $300, playing on-line poker. I can do this too!"

Reality: Honestly I think there is a correlation. Poker has taught me about analyzing risk vs. reward (pot odds), money management (choosing table limits, when a front running hand becomes worthless), and about taking smaller more regular winnings over homeruns. Those 3 things are often overlooked by "novice" stock market investors like myself.

On the other hand, I had a strict mathematically proven game plan to follow with limit poker. Much like blackjack, there is a proven chart of starting Texas Hold-'em starting hands, when they are worth calling / raising / etc. From there it's more math about pot odds, and the odds your hand will improve. Playing limit poker takes out a large part of the 'guesswork' involved with bluffing as seen in 'No Limit' Hold-'em. For stocks, there's not really a proven game plan to follow. There are a dizzying array of strategies and systems but it's tough to separate the scams from the real deal. Not to mention I could be spending my $5,000 on the trading system alone.


So what's MY game plan in the stock market?

I'm going to split the middle. On one side there are "buy and hold" investors. These folks see purchasing stock as buying part ownership in companies, as a result they put considerable effort into selecting profitable companies. They can be considered Fundamental analysts. On the other side are the "(day) traders". These folks see stock as a commodity to trade, as a result they put considerable effort into determining the best time to buy or sell a stock. They can be considered Technical analysts.

Technical analysis interests me more, but I can't deny the track record of "buy and hold", so I'm splitting the difference. I'm going to "time the market" with stocks that have a proven fundamental track record. For example, the stocks that make up the Dow Jones industrial Average, or are found in Warren Buffet's Berkshire Hathaway portfolio. I see this as similar to the online poker game plan, smaller more regular wins by "properly" playing proven starting hands.

The flaw with this plan is that with only $5,000 I can't buy very many shares of big name stock. More to the point money management rules suggest limiting any individual trade to 2% of your capital, or $100 in my case. The solution at the moment is to invest using Options. There is added risk in the sense of time value (options expire at a certain time), and leverage (movement of the stock is magnified by the lower initial investment), but there is also reduced risk in the form of set maximum losses (the premium on the option).

I'll no doubt be altering my game plan as I learn more but that's where I'm starting for now.


Let's see how things go.

How did we get here?

1) I got a ~$5,000 tax refund this year (YAY! homeownership).

2) I want to take a more hands on approach to investing.

3) I did a lot of reading (for me) on item #2.

4) I discovered $5,000 isn't very much when it comes to hands-on investing. With the exception of the infamous and nefarious stock market.

5) More reading on item #4 as well as the futures market (not enough money again).

6) Jenny started her finance centered blog.

7) I recalled that when I was dipping my toes into online poker I ran across several blogs that reviewed the authors progress. Often complete with thoughts at the time, after the fact analysis, etc.

8) Dusted off my geocities and blogspot accounts, et voila!

So with the stated mission of turning $5,000 into $25,000 (lofty goal? of course), let's begin.