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Absolute High (or Absolute Low) - the highest (or
lowest) price of a security during a specific period of time.
The term "absolute" indicates that the comparison is purely against the
price history of the stock. Is the current price higher than
the last peak in price? If so, the stock has made a higher Absolute
High. If the stock is lower than the previous peak in price, it has
made a lower Absolute High. (Compare with Relative High or Low). back
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Accumulation - technical analysis use the term
"accumulation" to describe the activities of institutional investors and
large traders as they slowly build a position in a stock. Because
institutions buy so many shares, one large order would drive the price
higher and frustrate their attempt to buy the stock cheaply. So they
"scale" into the stock by spreading their purchase activity over a
number of days or weeks. Indicators like Accumulation-Distribution and
On Balance Volume are used to detect accumulation and enable the trader
to follow along with the institutional buying. back
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Accumulation-Distribution Line - The A-D Line is a
secondary indicator that is based on both volume and price data, and is
similar to On Balance Volume (OBV) in what it is designed to do. The
A-D line is a closed indicator that sums the new data along with
existing data, making it a relatively slow moving indicator. It is
designed to detect early money flow into or out of a stock. Volume
reflects activity, while the direction of the close indicates what's
actually being done. The key difference between the A-D Line and On
Balance Volume (OBV) is in how the line is calculated. OBV parses the
data according to whether the current close is above or below the
previous close. The A-D Line parses the data according to the location
of the closing price relative to its intra-period range. Another term
for the location of the closing price is "Closing Location Value." back
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Action Timeframe - The shorter timeframe that a
trader uses to act on the decision made within the Decision Timeframe.
Traders should work in at least two timeframes - a longer-term timeframe
to detect the direction of the trend. Because we want to always be in
phase with the trend (long during an uptrend, and either short or out of
the stock during a downtrend), we zoom out to a longer timeframe (the
"Decision Timeframe") for trend analysis and for making the decision
whether or not to buy or sell. The second timeframe is used to act
on that decision. Assuming we decide to buy, it is now time to
take action - to buy the stock at the most favorable price. So we zoom
in to a shorter term timeframe - the Action Timeframe. We then work in
the action timeframe to find the counter trend - the short-term
downtrend within the longer-term uptrend.
Once the action is taken, we must zoom back out to the Decision
Timeframe. Why? Because there is no more action to take until another
decision is made - and decisions are made within longer-term timeframe.
By selectively using timeframes, you increase your chances of making
favorable entries…and then allowing those positions to run until the
trend changes. And trends last longer than we think they do. This dual
timeframe method will reduce your activity, and will likely increase
your profitability. back
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Aggressive Buyers - Describes a condition wherein
Buyers are so determined to own the stock that they will meet the asking
price of the Seller. In other words, they are willing to pay retail
prices-even marked up prices-for the stock. They will "take the offer"
rather than being selective in what they pay. The Aggressiveness of
Buyers is relative to the Aggressiveness or passivity of Sellers.
Aggressive buying can result from many things - a positive fundamental
development that has not been anticipated by the market; a negative
fundamental development that has been anticipated by the market; a
short squeeze where those who are short the stock are compelled to buy
the stock back. Their buying attracts momentum-oriented traders and
creates a feeding frenzy of buying activity. (Aggressive Buyers create
Buying Pressure) back
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Aggressive Sellers - Describes a condition wherein
Sellers are so determined to exchange their stock for cash that they
will meet the bid of the Buyer. In other words, they are willing to
sell at a discount to get rid of the stock. They will "hit the bid"
rather than remaining selective in their sales price. The
Aggressiveness of Sellers is relative to the Aggressiveness or passivity
of Buyers. Aggressive selling can result from many things - a positive
fundamental development that has already been anticipated by the market;
a negative fundamental development that has not been
anticipated by the market; a breakdown below key support that turns
winners into losers and prompts traders to take their losses before they
get too big. Their selling attracts momentum-oriented traders who will
sell the stock short ("lean on the stock") and thereby shake out more
shareholders. (Aggressive Sellers create Selling Pressure)
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Ascending Triangle - a chart pattern defined by
horizontal resistance and rising support. The ascending triangle is
created by steady supply of stock at one level. Each time the stock
price rises to that level, selling pressure halts the advance at that
level. The result is a horizontal line of resistance. And each decline
is met by increasingly Aggressive Buyers who are unwilling to wait for
the stock to fall to the previous low. This series of higher lows
creates a rising line of support. The resolution of the Ascending
Triangle is usually out of the top - a breakout. But if the stock
remains too long in this pattern so that the price actually reaches the
apex (i.e., that point where the support and resistance lines meet), the
resolution will often be a weak trickle out of the pattern. Why?
Because an ascending triangle will only be fully completed when Buyers
and Sellers are at a standoff. When there is no differential between
the relative Aggressiveness of Buyers and Sellers, there is no catalyst
for the dynamic breakout for which ascending triangles are known. back
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Average True Range (ATR) - this indicator is a
measure of volatility. It was created and developed by J. Welles
Wilder-the originator of Relative Strength Index (RSI). The ATR takes
an average of the "True Range" of a stock which is the greatest of: (1)
the current high minus the current low; (2) the absolute value of the
current high minus the previous close; and (3) the absolute value of the
current low minus the previous close. The True Range is a good measure
of volatility because it takes gaps into account by including the
greatest of the above three values. You'll notice that options (2)
and (3) both compare the absolute value of the previous
close versus the current high and current low. The Average
True Range is the 14-day moving average of the True Range. The ATR
is the basis for the Chandelier Exit trailing stop methodology. back
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Base - a technical analysis term that referring to
that period of time in which a stock, index, or entire market trades
within a general price zone for an extended period of time. The longer
the time period, the stronger the base becomes. A strong base serves as
the platform that provides the support for the beginning of a new
advance, and also serves as support on any pullback. (Related Terms:
An extended period of Churning produces a base. Heavy financial
commitment and emotional commitment exist within a base. Also,
breakouts have a better chance of being sustained if the base).
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Bear - an investor or trader who thinks the price of
a stock will fall. back
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Be Careful Out There - a quote from Hill Street
Blues, in which Sergeant Esterhaus reminds the police force to be
cautious when they are out on the street. Since I began writing for
TheStreet and RealMoney, I have concluded each article with this quote.
It is meant to remind readers that trading is not the same as winning,
and that trading without caution is dangerous. It is not to be confused
with bearish sentiment. Risk management through prudent position sizes
and consistent use of stop losses equate to "being careful out there."
Thus, it is certainly possible (and sometimes very profitable) to be
aggressive while still "being careful out there." back
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Bear Market - a prolonged period in which stock
prices fall in an environment of pessimism. Often times, corrections
are confused with Bear Markets. Bear Markets tend to occur during a
recession, rising unemployment, or dramatic increases in inflation.
They typically end in a series of gut-wrenching sell-offs that shake out
the most patient investors. They are also rare - the mega trend of the
stock market is up. back
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Beta - a measure of the volatility of a given
security (it can be a stock, mutual fund, or portfolio) relative to an
established benchmark - usually the S&P 500. For example, if the S&P
advances 1% and XYZ advances 1.5%, XYZ has a beta of 1.50. If the S&P
advances 1% but the stock falls by .5%, then it has a negative
beta of 0.5. High Beta describes a stock that is much more volatile
than the S&P, though not necessarily in the same direction. back
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Bollinger Bands - a secondary indicator in which two
lines are plotted two standard deviations above and below a moving
average (typically, the 20-period moving average). The 20-period moving
average is the Middle Band. The upper Band is the line plotted two
standard deviations above the Middle Band; while the Lower Band
is the line plotted two standard deviations below the Middle
Band. Because the standard deviation formula is very sensitive to small
movements, Bollinger Bands provide an excellent indication of the
volatility of a stock. As volatility increases, the width of the Bands
increases. As volatility decreases, the Bands become very narrow.
Bollinger Bands create an independent frame of reference within which to
gauge the current location of price within the Bollinger Bands in
relation to its prior location within the Bollinger Bands.
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Bollinger Band Complex - my term for the area
confined by the upper and lower Bollinger Bands. The upper Bollinger
Band defines the top of the Bollinger Band Complex, while the lower
Bollinger Band defines the bottom of the Bollinger Band Complex. (See
Relative High and Relative Low).
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Bollinger Band Width - the distance between the
upper and lower Bollinger Bands. Narrow Bandwidth indicates a low
volatility condition, while wide Bandwidth indicates a high volatility
condition. The formula for BandWidth is (Upper Band - Lower
Band)/Middle Band. Narrow BandWidth defines a Volatility Squeeze,
and typically exists at the beginning of meaningful trends. back
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Bottom - the lowest point of a stock or index within
a given period of time. A bottom is followed by a steady increase in
price. A bottom is the level at which demand soaks up all the supply.
Bottoms are formed at support.
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Bottom Up Approach - an investment approach that
considers companies on their own merit, without regard for industry
groups, sectors, economic climate or business cycles. This approach
focuses on company fundamentals, management, its business model and
certainly its growth prospects. The bottom up approach is based on the
theory that a good company is a good company - and will outperform
irrespective of outside influences. In essence, the bottom-up approach
sees the financial market not as a stock market, but as a market of
stocks. back
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Breadth - that portion of the overall market that is
participating in the market's price action. A market advance on
"healthy breadth" means that most stocks are also advancing. A market
advance on "poor breadth" means that a smaller number of stocks were
participating in the rally. Market breadth is important for
understanding whether a market advance has serious power behind it with
strong money inflows…or whether the market is advancing only on the
strength of a narrow list of stocks that are enjoying dramatic gains
sufficient to push their indexes higher. There are various measures of
breadth, including the Advance-Decline line, the number of net 52-week
highs versus 52-week lows, and the McClellan Oscillator and McClellan
Summation Index. back
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Break Even Stop - the second stop in a series of
multiple stop loss methods. The Break Even Stop is placed at or near
the entry level to ensure that a profitable trade will not become a
losing trade because of an adverse price move soon after the trade has
been initiated. back
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Breakdown - a price decline below established
Support.
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Breakout - a price advance above established
Resistance. This is important: Not all breakouts are created equal!
You will find that breakouts in stocks that are in out-of-favor sectors
do not perform as well as breakouts in stocks that are in strong
sectors.
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Broken Pattern - the resolution of a Chart Pattern
that is opposite the usual resolution. Broken Bullish Patterns resolve
downward; Broken Bearish Patterns resolve upward. back
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Bull - an investor or trader who thinks the price of
a stock or market will move higher. back
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Bull Market - a prolonged period in which the
broader market rises faster than its historical average. Bull Markets
typically start after a prolonged market decline, and occur within a
positive economic and fiscal environment. Also, Bull Markets can last
much longer than people expect due to a dynamic known as a "feedback
loop", wherein rising prices reinforce the Crowd's prevalent feelings of
optimism to an extent that the Crowd feels confident enough to buy more
- which causes additional gains in the market and again reinforce the
Crowd's optimism. back
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Chandelier Exit - a stop loss methodology based on
the Average True Range (ATR) of a stock. The Chandelier Exit "hangs"
from the top of the intra-period trading range (e.g., in a daily chart,
the Chandelier Exit hangs from the intraday high). This stop can only
move in the direction of the trend and never lower. It is an excellent
methodology for setting trailing stops on trending stocks.
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Chart Pattern - a series of price movements that
form identifiable patterns when drawing lines along the tops and bottoms
of the price action within the chart. Common price patterns include
ascending triangles, descending triangles, head-and-shoulders, etc. The
usefulness of chart patterns is based on the theory that the Crowd
behaves similarly each time a specific set of conditions exists. A
chart pattern represents the presence of those conditions (e.g.,
aggressive buyers versus passive sellers; widespread boredom and
indifference, etc.); the pattern does not create those
conditions. Moreover, the best we can get from a pattern is an
approximation or estimate of what the Crowd is feeling,
and how it is likely to react in response to new events. Many
traders mistakenly believe that identifying a chart pattern entitles
them to a profitable trade because the pattern must resolve in
a predetermined direction. All patterns do not resolve as anticipated -
and those Broken Patterns often yield as much or more useful information
then Completed Patterns.
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Churning - a condition wherein a stock trades within
a relatively narrow range as a result of an even balance of
aggressiveness among buyers and sellers. When the aggressiveness of
buyers and sellers is equally matched, the volatility of the stock is
low because neither side feels strongly enough to control the price of
the stock. Churning is healthy when it occurs after a dramatic price
move because it gives traders the opportunity change positions - stock
is sold for cash, and cash is paid for stock. (See Congestion) back
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Closed Indicator - an indicator that is based on a
set amount of data. For example, a 10-day moving average is the average
of the last 10 days of data. As each day creates new data, the oldest
data within the 10-day period drops off. Moving averages, Bollinger
Bands, RSI, Money Flow, and MACD are examples of Closed Indicators.
Closed indicators are oscillators with a set range such as 0 - 100.
(Compare this with an Open Indicator) back
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Completed Pattern - the resolution of a Chart
Pattern in the usual and anticipated direction. Completed Bullish (Bearish)
Patterns resolve upward (downward). back
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Confirming - a signal from a Secondary Indicator or
other source that is consistent with the price action. It validates the
underlying thesis of the trade. (E.g., an RSI oscillator that is making
higher highs "confirms" an uptrend in price; while an RSI
oscillator that is making lower highs does not confirm
the uptrend in price.) Traders like to find confirmation signals to
reinforce their position.
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Congestion - a trading range; a period of
non-trending price movement. The price is not trending higher or lower,
but is trading within a loose price range. The range of congestion is a
function of volatility. A wide area of congestion indicates
high volatility (emotional trading environment where neither bulls nor
bears are dominant), while a narrow area of congestion defines
low volatility (an area of indifference where neither bulls nor bears
feel strongly enough about their position to push the stock out of the
narrow trading range). Congestion may develop into a reversal of an
established trend (a Top or Bottom), or it may merely be a period of
Consolidation within an existing trend, after which the price moves in
the original direction. An example of congestion is a Rectangle
Pattern. The rectangle is typically a Continuation pattern that
resolves in the direction of the existing trend (a Completed Pattern).
If the resolution of the rectangle is in the opposite direction of the
existing trend, it is a Broken Pattern. back
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Consolidation - An area of Congestion within an
established trend that resolves in the direction of the trend. (Also
known as Continuation) back
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Continuation - An area of Congestion within an
established trend that resolves in the direction of the trend. (Also
known as Consolidation) back
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Converging - two trendlines that are moving toward
each other. Converging trendlines create many Chart Patterns such as
triangles and wedges. back
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Correction -describes a reversal of the prevailing
trend (a "countertrend move"). Corrections are healthy for the
prevailing uptrend because they are caused by profit-takers who are
selling to new buyers. Once the stock is in the hands of these new
buyers, the average cost basis of the stockholders approximates the
current price level. This indicates two things - that these buyers are
committed to the stock moving higher; and that the risk of additional
profit-taking at only slightly higher price levels is minimal. After
all, the temptation to take profits only becomes prevalent after a
significant price increase from the average cost basis of stockholders.
More substantial corrections that end the prevailing trend and create a
new trend in the opposite direction are known as Reversals). back
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CRB Index - an unweighted average of 17 key
commodities. These 17 commodities can be organized within 6 different
groups - energy, grains, industrials, livestock, precious metals, and
agriculturals. The CRB is seen as an indication of inflation. When the
price of commodities is rising, the increased cost of these raw
materials will ultimately work its way through the industry cycle and
result in higher costs for finished goods as manufacturers pass on their
costs to the consumer.
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Crowd - The Crowd is…the Mob. The "Crowd" refers to
that faction of the market (which consists of Buyers, Sellers, and
Spectators) that has the most influence on price movement.
When the Crowd is Bullish, the buying pressure exceeds selling
pressure. Prolonged bullishness or optimism within the Crowd
creates an uptrend. Prolonged bearishness or pessimism
within the Crowd creates a downtrend. The important thing to
understand is that "the Crowd" is never wrong! Because stocks move in
response to the strongest force, and the Crowd-by definition-is
the strongest force, then it pays to run with the Crowd. During a given
trend, the Crowd is only wrong once - when the trend ends. But until
the trend does come to an end, any countertrend move is simply a healthy
pullback within the dominant trend that is controlled by the Crowd. back
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Cyclical Stocks - Certain industries are directly
impacted by the strength or weakness of the economy. Stocks of
companies within those industries outperform in a growing economy and
underperform in a contracting, or weakening, economy. Examples of
cyclical industries are automobiles, chemicals, paper and
transportation. In a growing economy, we want to be heavily weighted in
cyclical stocks. In a stagnant or weakening economy, we want to avoid
cyclical stocks. Remember that the market discounts the future, so the
direction of cyclical stocks reveals the market's outlook on the health
of the economy. An excellent vehicle for tracking the cyclical stocks
is the Morgan Stanley Cyclical Index (CYC), a dollar-weighted index
which comprises 30 stocks from more than 25 industries, including autos,
metals, papers, machinery, chemicals, and transportation. (Compare
Non-Cyclical Stocks) back
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Decision Timeframe - The longer timeframe that a
trader uses to detect the prevailing trend and decide what to do. After
the decision is made, the trader zooms in on the shorter term Action
Timeframe. Traders should work in at least two timeframes - this
longer-term Decision Timeframe within which to detect the trend and
decide whether to become involved. The second timeframe is the
reference for acting on that decision. After the action is
taken, we return to the Decision Timeframe so that we eliminate the
possibility that we will be shaken out of the trade by those same minor
fluctuations that enabled us to get a favorable entry. We have taken
action - the next step is to decide when to sell by using the prevailing
trend as the basis for setting stop loss levels and profit targets.
This dual "Decision/Action" timeframe gives us the best of both
worlds and promotes following the most basic rule of trading - "Cut your
losses short and let your profits run." First, through the Decision
Timeframe we remain in phase with the trend and "let our profits run."
Conversely, through the Action Timeframe we obtain more favorable
entries, thereby allowing us to set prudent stops and "cut our losses
short." back
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Descending Triangle - a chart pattern defined by
horizontal support and falling resistance. The descending triangle is
created by steady demand for stock at one level. Each time the stock
price falls to that level, buying pressure halts the decline at that
level. The result is a horizontal line of support. And each advance is
met by increasingly Aggressive Sellers who are unwilling to wait for the
stock to rise to the previous peak. This series of lower highs creates
a falling line of resistance. The resolution of the Descending Triangle
is usually out of the bottom - a breakdown (or "downside breakout").
But if the stock remains too long in this pattern so that the price
actually reaches the apex (i.e., that point where the support and
resistance lines meet), the resolution will often be a weak trickle out
of the pattern. Why? Because a Descending Triangle will only be
fully completed when Buyers and Sellers are at a standoff. When
there is no differential between the relative Aggressiveness of Buyers
and Sellers, there is no catalyst for the dynamic breakdown for which
Descending Triangles are known.
Distribution - a term used by technical analysts to
describe the dynamic where trading volume is higher, yet the price does
not advance. An increase in trading volume without a corresponding
price increase indicates that the stock is being sold. These
"distribution days" often occur during Phase 3. back
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Diverging - two trendlines that are moving away from
each other. Diverging trendlines create Chart Patterns such as
Broadening Tops. Signals that are inconsistent are known as
Divergences. An example is a downtrending series of highs in the price
accompanied by an uptrending series of lows in RSI. RSI is said to be
Diverging from the price pattern. (Note: An indicator that is
showing strength in relation to the price action is a positive
divergence; while an indicator that is showing weakness in relation to
the price action is a negative divergence.)
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Emotional Commitment -
my term for the tendency of traders to maintain a vested interest in the
price at which they took action - where they made a financial commitment
to the stock. Trading volume is a critical component of emotional
commitment. If a large number of shares have traded at a particular
level, the emotional commitment at that level is high. So a return to
that same level is likely to elicit a meaningful reaction from the
Crowd. On the other hand, when a stock price returns to a level at
which very few shares have traded, few traders are committed to that
level. As such, the low level of emotional commitment is unlikely to
impact the trading action of the stock.
Support and resistance levels are directly tied to the level of
emotional commitment. The higher the level of emotional commitment at a
particular price, the more formidable that price level will be as
support or resistance. (People become emotional when money is involved,
so Emotional Commitment can be used interchangeably with Financial
Commitment. They are synonymous). back
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Exponential Moving Average (EMA) - the type of
moving average where more weight is given to the most recent data. It
is "front-end weighted", resulting in the most recent price changes
having the greatest impact on its movement. As such, it is more
reactive and faster moving than a Simple Moving Average. The 12- and
26-day EMAs are the most commonly used EMAs for the MACD (Moving Average
Convergence-Divergence). The 50- and 200-day EMAs are commonly used
signals for establishing the direction of long-term trends. back
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Focus Stocks - those stocks that are tracked for by
the Stock Market Mentor. The list of Focus Stocks is dynamic and
changes according to fundamental and technical developments, as well as
overall market conditions. back
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Industry Group - a group of stocks whose companies
are in a distinct business or industry within a specific sector. For
example, Intel (INTC) is in the Semiconductor Industry Group and the
Semiconductor Industry Group is one of several groups within the
Technology Sector. (Examples of other Industry Groups within the
Technology Sector are Software, Electronics, Computers, Data Storage,
etc.) The Industry Group is the 3rd step in the 4-step Top
Down Approach, where in we focus first on the strength of the broader
market indexes like the S&P 500 or Nasdaq Composite, and between Value
and Growth themes. Within the broader Market, we look for the strongest
Sectors; and within the strongest Sectors we focus on the strongest
Industry Groups. Finally, we look for the strongest Stocks within the
selected Industry Groups. The result is that we've found the strongest
Stocks within the strongest Industry Groups within the strongest Sector
within the strongest Market Index. back
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Intermarket Analysis - the study of the relationships between the four major financial
markets of Currencies, Commodities, Fixed-Income Securities (Bonds and
Notes), and Stocks. The sequence of influence is as follows: The US
Dollar impacts Commodity prices which in turn impact Bond prices which
in turn impact Stock prices. The relationships are as follows:
(1) The
US Dollar has an inverse relationship with Commodities.
For example, as the Dollar falls in price, commodity prices rise because
they are denominated in Dollars. It will take more weak Dollars to buy
the same amount of commodities. Conversely, a stronger Dollar results
in lower commodity prices because it takes fewer strong Dollars to buy
the same amount of commodities.
(2) Commodities
run inversely to Fixed-Income Securities (Bonds and Notes).
When commodity prices are rising, fixed-income investors anticipate an
inflationary environment and demand a higher rate-of-return (yield) on
their loans. Why? Because by the time they are repaid the principal
loan amount, the buying power of that principal is diminished - rising
commodity prices have caused an increase in the cost of finished goods.
So if fixed-income investors believe that commodities are going to
become more expensive, they will require higher interest payments to
offset the declining purchasing power of their principal
(3) Fixed-Income
Securities run in tandem with Stock prices.
As bond yields fall (which results from rising bond
prices), stock prices
rise. This relationship is based on the cost of money. When money is
cheap (bond yields are low), businesses can take advantage of the cheap
money and expand. Their expansion activity creates jobs (good for the
economy) and enables them to grow their business (good for their
earnings…and for the stock price). Rising bond yields (falling bond
prices) have the opposite effect. Expensive money hampers the ability
of businesses to grow. In particular, expensive money hurts smaller
businesses which have greater dependency on borrowing than do larger
companies. This is why small cap stocks struggle in an inflationary
environment - the high cost of money has a greater adverse effect on
them than it does large companies with greater resources.
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Investor - the term for someone that exchanges
assets. In simplest terms, we exchange stock for cash, and cash for
stock. We "trade." Much is made of the distinction between the trader
and the investor. The difference usually concerns time horizon,
methodology or both. Traders are seen as being short-term oriented with
a focus on the movement of stock price. Investors are seen as being
long-term oriented with a focus on the underlying fundamentals of the
company. However, the lack of clear-cut criteria renders the
distinction meaningless. In the final analysis, we are all traders - we
trade our cash for stock, and we trade our stock for cash. I this
forum, there is no distinction between trader and investor. If you have
a brokerage account, you are a trader!
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"Let's Talk Trading" - a section in The Stock Market
Mentor newsletter that discusses effective approaches to trading, money
management, risk management, time-efficient research and the trading
mindset. Let's Talk Trading is also the forum for answering Member's
questions and sharing ideas. Let's Talk Trading is the first step in
creating an interactive Member Blog. back
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Long - to own a security. (E.g., If you own Google
(GOOG), you are long GOOG.) (See Short). back
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Low Risk - a trade is a low risk trade when the
entry is sufficiently close to the logical stop level that only a small
amount of money is risked in the trade. A "low risk" trade is not the
same as a high-probability trade. The only distinguishing
characteristic of a low risk trade is the ability to place a tight
stop. For example, when we are able to buy a stock extremely close to
support, we are taking a low risk trade. The stock only need fall a
short distance before breaking support and hitting our stop.
Conversely, a stock bought too far away from support is a high risk
trade. Why? Because the stock can fall an unacceptable distance before
we know whether the stock will indeed bounce off support and save our
trade, or whether it will break down through support and force us to
sell at a large loss. Look for low risk trades; be patient and avoid
high risk trades. There is always another trading opportunity right
around the corner. back
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MACD (Moving Average Convergence Divergence) - a
technical indicator originated by Gerald Appel based on the price
difference between a long-term and a short-term exponential moving
average (EMA). Used correctly, MACD can be both a trend-following tool
as well as a momentum indicator. The common MACD setting includes the
12-period EMA and the 26-period EMA. The "MACD" is the 9-period
exponential moving average of the difference between the 12- and
26-period EMAs. A more accurate and timely setting for detecting buy
signals involves using shorter term EMAs. Buy signals are detected with
the 8-period EMA and the 17-period EMA, with the "MACD" remaining the
9-period exponential moving average of the difference between the 8- and
17-period EMAs. (Note: the MACD is based on the absolute (price)
difference between the two EMAs and not the percentage difference. As
such, divergences in MACD can be misleading in a stock that has
substantially changed prices. Why? Because there is a big difference
between a $3 difference in the moving averages of a $10 stock versus a
$3 difference in the moving averages of a $60 stock). back
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Market - a reference to the major market indexes
such as the S&P 500, the Dow Jones Industrial Average, the Nasdaq
Composite, and the Russell 2000. back
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McClellan Oscillator - the "McOscillator" is a
momentum indicator that is based on advance/decline statistics. It is a
closed indicator that measures market breadth from the relationship
between each day's net advances (i.e., advancing issues - declining
issues = net advances). The McOscillator is similar to the MACD in that
the relationship between two moving averages creates the McOscillator.
The McOscillator attempts to anticipate positive and negative changes in
the Advance/Decline statistics, and is useful for short-term market
timing. back
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McClellan Summation Index - the Summation Index is
an open indicator derived from adding up the daily values of the
McOscillator. The Summation Index is used for more intermediate and
long-term interpretation of the market's power and direction. The
Summation Index generally ranges between 0 and +2000. A reading of
+1000 is neutral, and readings outside the normal range indicate unusual
market conditions. Bear markets typically end with the Summation Index
below -1200. A strong rise from such a low level can signal the
beginning of a new bull market. This signal is confirmed when the
Summation Index rises above +2000. In the past, such a confirmation has
resulted in bull markets lasting at least 13 months, with the average
ones lasting 22-24 months. back
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Momentum - an closed indicator that measures the
rate of change of the stock price. A momentum indicator is a leading
indicator that moves above and below 100, and creates buying and selling
signals through divergences from the price trend, extreme readings, and
crosses above and below the 100 centerline. back
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Money Flow - a term used to describe the dynamic of
whether money is flowing into or out of a security. Various closed
indicators are used to analyze money flow, including Chaikin Money Flow,
Money Flow Index and Money Stream. The calculations of each indicator
are different, but they all take into account volume, direction and
amplitude of price, and intraday time frame. The typical calculation
uses a 14-day period. An alternative time frame that can be used in
conjunction with Bollinger Bands is a 10-day period, which is ˝ the
period of the Bollinger Bands and provides a better frame of reference
for relative highs and lows within the Bollinger Bands. back
to top
Moving Average - a statistical technique to analyze
a specific set of prices. The moving average smoothes out short-term
fluctuations in price by summing them and dividing by n data
points. For example, a 10-day moving average sums the last 10 days of
prices, and then divides by 10. As new data is added to the front end,
the oldest data is dropped from the back end. Two types of moving
averages are the Simple Moving Average (SMA) and Exponential Moving
Average (EMA). The SMA is unweighted, and assigns the same weight to
each data point. The EMA assigns more weight to the most current data,
thereby making it faster and more responsive to recent data. The slower
SMA is used as the reference for Bollinger Bands. This is because the
standard deviation calculation that creates Bollinger Bands is extremely
sensitive to small fluctuations. As such, the use of an EMA as the
basis for calculating Bollinger Bands would create a too much volatility
and hamper the usefulness of the Bands. back
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Non-Correlating Stocks - the old adage is that "a
rising tide lifts all boats." In other words, in a strong market, most
stocks will be strong. Conversely, in a weak market, most stocks will
be weak. Stocks that move in sync with the market have a positive
correlation to the market. Stocks that do not move in sync with the
market are non-correlating stocks. These stocks can create trading
opportunities in a weak market environment. back
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Noncyclical Stocks - Cyclical stocks are in those
industries directly impacted by the strength or weakness of the economy
(see Cyclical Stocks). Noncyclical stocks are stocks that remain stable
even in a weak economy because they produce essential products.
Noncyclical stocks are defensive stocks because they defend against
economic downturns. Examples of noncyclical industries include
household nondurable goods (soap, toothpaste, and household cleaners),
utilities (water, gas and electricity) and basic food items (milk, meat,
bread, etc). Companies such as Procter & Gamble, Altria Group,
Coca-Cola and General Mills are noncyclical companies. In a declining
market, it pays to lean towards noncyclical stocks. Most noncyclical
stocks pay dividends, thereby adding to their attractiveness during
times of economic weakness. One trading vehicle for trading noncyclical
stocks is the iShares Consumer Non-Cyclical Sector Index Fund (IYK). back
to top
On Balance Volume (OBV) - a secondary indicator
developed by Joseph Granville to detect the accumulation or distribution
of shares by large institutions. The calculation relates volume with
price changes by providing a running total of volume. OBV assigns a
positive value to volume that occurs during a day that closes higher
than the preceding day, and assigns a negative value to volume that
occurs during a day with a closing price lower than the preceding day. back
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Open Indicator - an indicator that sums all
available data. New data is added or subtracted from all existing data,
creating a slower indicator that can be used to detect more subtle
market trends such as steady accumulation or distribution that is not
really reflected in the price action. Two such open indicators are
Accumulation-Distribution and On Balance Volume. (Compare Closed
Indicator). back
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Options Trading - Trading options is very different
from trading stocks. An option is a leverage vehicle enabling the
option holder to control rather than own a stock. Understanding the
time element of options trading is critical to success, and failure to
understand the time element of options trading will inevitably lead to
failure. Because of the leverage provided by options, market timing is
much more important than when trading stocks. A small adverse move in
the underlying stock price can produce a large loss in the value of the
option. Conversely, a small favorable move in the underlying stock
price can produce exorbitant gains in the value of the option. Options
trading is not for the inexperienced or the faint of heart. back
to top
Overbought - the term used by technical analysts to
describe a situation where the stock price has advanced to such a degree
that an oscillator such as RSI, stochastics or money flow has reached
its upper range. Depending on the specific situation, an overbought
condition can be bullish (indicating the high likelihood of higher
prices) or bearish (indicating the high likelihood of lower prices).
The term can also refer to a stock from a fundamental standpoint, where
strong demand pushes the stock price to levels that are not supported by
the fundamentals of the underlying business. back
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Oversold - the term used by technical analysts to
describe a situation where the stock price has fallen to such a degree
that an oscillator such as RSI, stochastics or money flow has reached
its lower range. Depending on the specific situation, an oversold
condition can be bearish (indicating the high likelihood of lower
prices) or bullish (indicating the high likelihood of higher prices).
When a stock becomes deeply oversold, the stock can become attractive to
value-oriented investors who believe that the fundamentals warrant a
higher stock price. back
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Passive Buyers - when those who wish to own the
stock are particular and discriminating about their purchase price.
When buyers are passive, they use limit orders whereby they will only
purchase the stock at a low price. Relative to sellers, they are
passive - they would like to exchange their cash for the stock…but
only if they can buy it on sale. When buyers are passive, the stock
price will decline because sellers are more anxious to sell their stock
than buyers are to buy it. back
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Passive Sellers - when those who wish to sell the
stock are only willing to sell if their asking price is met. They are
willing to exchange their stock for cash, but only if they can make the
sale at a marked up price. When sellers are passive, the stock price
will rise because buyers are more anxious to buy their stock than
sellers are to sell it. back
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Price by Volume (PBV) - a horizontal histogram
parsing trading volume according to price. The PBV bars extend from the
left side of the price chart. The length of the bars at different price
levels corresponds to the amount of trading volume that has occurred at
those price levels. For example, a long PBV bar at $23 indicates heavy
trading volume at $23. The length of a PBV bar corresponds to the level
of emotional commitment or financial commitment at that level. If
the price is above the long PBV bar, then that bar should act as
support on a pullback in price. Why? Because many traders
regret their prior sale and are hoping for a second chance to buy.
So a retracement to their sale price presents a second bite at the
apple. Similarly, if the price is below the long PBV bar,
that bar should act as resistance on a price advance. This
resistance is created by the large number of traders who's buying
created the long PBV bar. They regret having bought the stock that
is now below their purchase price. So if the price rallies back to
their entry point, they will eagerly sell their losing position for a
"break even" trade. This selling puts pressure on the stock and
can cap any price rally. (Note: The more accurate name for
this is "Volume by Price". However, this term was inadvertently
reversed in my first article for RealMoney where I discussed this
term...and it stuck! As such, I seek to avoid confusion by
sticking with the errant term "Price by Volume". But irrespective
of what you call it, this histogram is quite helpful in determining
support and resistance levels. back
to top
Phase 1 - The first of three identifiable
phases in an uptrend. Uptrends often occur over three phases or waves.
The first phase (Phase 1) describes the initial trend that begins at the
breakout from a base. After a series of higher highs and higher lows,
the slope of the trend is established. That is Phase 1. Phase 1 is
created by institutional allocation of capital into the market. The
asset (which could be a stock, sector or the market) has become cheap;
so professional money managers begin buying the asset.
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top
Phase 2 - The second of three identifiable
phases in an uptrend. At some point within the initial uptrend (Phase
1) the angle of the slope either steepens or begins to flatten out.
Irrespective of direction, the change in trend is noticeable. This new
trendline is Phase 2. The angle might become steeper or shallower, but
the change in trend is made evident by a series of highs and lows that
departs from the established pattern of Phase 1. What are the
underlying dynamics that create Phase 2? In Phase 2, a significant
amount of institutional money has already been put to work. Because
that money is already in the market, it is no longer a force of buying
pressure. Instead, the buying pressure that comprises the Phase 2 trend
originates from the public as it recognizes that the price is moving
higher. A flatter Phase 2 indicates more orderly buying within a
certain degree of doubt among the Bulls - the Wall of Worry is alive and
well. A steeper Phase 2 indicates more undisciplined, confident buying
by the public. In this environment, the Wall of Worry is less of a
factor as investors worry more about missing out on the rally. But at
some point, Phase 2 transitions into the final phase of the uptrend -
Phase 3. back
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Phase 3 - The third of three identifiable
phases in an uptrend. At some point within the progression of Phase 2,
the angle of the slope again changes in a series of higher highs and
lows that depart from the trendline that characterizes Phase 2. The
resulting trendline marks Phase 3 of the uptrend. The underlying
dynamics of Phase 3 are dictated by the characteristics of the preceding
phases - Phase 1 and Phase 2. As professional money managers recognize
that the asset has become fairly valued (or perhaps overvalued), they
begin the process of distribution of the asset - they are taking profits
so that they can reallocate that cash to some other undervalued asset
(and thus start the Phase 1-3 progression all over again - in that new
asset). The slope of Phase 3 relative to Phase 2 can tell us a lot
about the underlying dynamics of the market. A steeper slope indicates
an overconfident public that is buying without exercising discipline.
The market is being controlled by Aggressive Buyers. The eventual
outcome of a steep Phase 3 is an exhaustion of buying. The public's
enthusiasm for the asset is greater than its ability to keep buying.
When the last of the buying is done, Phase 3 ends with a steep
correction. Conversely, a shallower slop in Phase 3 indicates more
persistent distribution - the market is "heavy". The public is more
cautious and buying interest is more passive. A shallower Phase 3
ultimately leads to either a downtrend or a resumption of the uptrend.
If a new downtrend is the outcome of Phase 3, then we label Phase 3 as a
Top. If Phase 3 instead leads to a resumption of the uptrend, then we
label Phase 3 as Consolidation. back
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Primary Indicators - There is only one primary
indicator - price. Price movement as reflected in trends and chart
patterns takes precedence over all other technical indicators. Why?
Because we can only make or lose money by the price action. Secondary
indicators provide valuable insight into the quality of the price trend
- they impact our bias towards the sustainability of the price action.
But secondary indicators should never take precedence over price. back
to top
Relative High (or Relative Low) - the highest (or
lowest) price of a stock as it relates to an independent frame of
reference. The predominant use of this term in the Stock Market Mentor
is describing the relationship of price to the Bollinger Band Complex.
A current price peak that is higher within the Bollinger Band Complex
than the prior price peak is at a higher relative high, even if
that current price is at a lower Absolute High.
Bollinger Bands are a function of volatility, so assessing the relative
highs and lows of price patterns within the Bollinger Band Complex
provides essential information on the strength of upward volatility
compared to downward volatility. back
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For example, a reliable indication of a meaningful bottom is when a
price pattern forms a lower absolute low (i.e., lower
current price than the previous low in price), but a higher relative
low (i.e., the current price is higher within the Bollinger
Band Complex relative to the previous low in price, even though
the current price is actually lower in price than the previous
low). This combination of lower absolute low and higher relative low
indicate that, while the price is still falling, the downward volatility
is waning. And the only reason downward volatility will decline is when
selling pressure is starting to give way to buying pressure. (Compare
with Absolute High or Absolute Low). back
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Relative Strength - The term "relative strength"
refers to the relationship between the performance of two stocks or
indexes. If one stock or index is moving higher than the other, then
its "relative strength" is greater - it is performing better and is
where we want to be. Relative Strength is a key component of the Top
Down Approach. back
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Relative Strength Index (RSI) - J. Welles Wilder
originated the Relative Strength Index (RSI) as a method of comparing
the strength of an asset on up days against weakness on down days. This
closed indicator is a gauge of momentum and works differently in
trending versus non-trending markets. It is in the same category of
secondary indicators as stochastics. back
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Resistance - That price level where a stock can
trade up to…but not exceed…for a certain period of time. Resistance is
that level at which the aggressiveness of sellers overcomes the
aggressiveness of buyers; where supply exceeds demand. We can identify
probable areas of resistance of an asset by studying its prior trading
history. The more trading that occurs at a particular price level, the
greater the Financial Commitment is at that level. And when a stock
trades up to a price level with heavy financial commitment, the supply
of stock at that level is likely to overcome the demand for the stock as
committed sellers do what they've been waiting to do - sell the stock!
(Compare Support; See PBV Bars) back
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Reversal - a change in the direction of price
movement to such an extent that the prevailing trend ends. (Compare to
Correction, which is a healthy countertrend move resulting from
profit-taking being met by sustained demand, followed by a resumption of
the prevailing trend) back
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Robot Portfolio - A theoretical long-term 10-stock
portfolio originated by John Dorfman, president of Thunderstorm
Capital. The Robot Portfolio consists of out-of-favor stocks that meet
specific criteria with respect to market capitalization, debt-to-equity,
earnings and price/earnings ratio. Since 1999, "the Robot" has
outperformed the S&P 500 7 out of 8 years, with an average return of 34%
compared to an average return of 5% for the S&P 500.
back to
top
Scaled Entry - Building a position in a stock
through a series of small purchases at different price levels rather
than in a single transaction. By "scaling into a position", the trader
puts less money at risk at the initiation of the trade. If the trade is
profitable, the trader then adds to the position. If the trade is
unprofitable, the trade is closed for a very small dollar loss. The use
of scaled entries addresses the inherent risks of trading by sacrificing
the potential profit from a larger initial position in favor of a
reduction in risk through a series of smaller positions. Scaled entries
dramatically reduces the possibility of a big loss. The scaled entry
technique enables the trader to more easily cut his losses short. back
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Scaled Exit - Closing a position in a stock through
a series of smaller sales at different price levels rather then simply
dumping the entire position at one time. By "scaling out of a
position", the trader is able to take partial profits on a good trade
without sacrificing further upside. The hallmark of good trading is to
let profits run for as long as possible, and a scaled exit leaves a
portion of the position intact to enjoy additional gains while freeing
up money to capitalize on other opportunities. As a position increases
in profitability, it increases in size relative to the size of a
trader's portfolio. The scaled exit enables the trader to bring the
portfolio back in balance and avoid being overweight in one profitable
position.
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Secondary Indicators - all technical indicators
other than price movement (as seen in chart patterns). Secondary
Indicators provide very useful information on the quality of the price
movement. Is momentum increasing or decreasing? Is volatility
increasing or decreasing? Is the stock under distribution or is it
still being accumulated. Is there an increase or decrease in the number
of traders participating in the current trend? We use secondary
indicators to help answer these questions. Simply put - secondary
indicators provide insight into the quality and sustainability of the
current price action.
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Sector - an area of the economy in which business
share the same general product or service. A general list of sectors
includes Consumer Discretionary, Consumer Staples, Energy, Financial,
Healthcare, Industrial, Materials, Utilities, Technology,
Transportation, and Services. Each Sector is comprised of several
Industry Groups. The Sector is the 2nd step in the 4-step
Top-Down Approach, where in we focus first on the strength of the
broader market averages like the S&P 500 and the Nasdaq Composite.
Within the broader market, we look for the strongest sectors; and within
the strongest sectors we focus on the strongest Industry Groups.
Finally, we look for the strongest Stocks within the selected Industry
Groups. back
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Sector Rotation - an investment strategy where we
rotate stock holdings from one sector to the next, depending on the
state of the business cycle. The idea is to be involved in the sector
or sectors that stand to benefit the most in the economic climate.
Successful sector rotation gives the trader a better chance of beating
the market. However, it is tougher than it seems because of the
forward-looking nature of the market. Oftentimes, the time to sell
stocks within a particular sector is when they are benefiting the most
from the business cycle. By combining technical analysis and
fundamental analysis, traders are better able to utilize the Sector
Rotation methodology.
back to top
Selling into Strength - to sell a stock in an
environment where buyers are aggressively taking the stock. Selling
into strength is a good idea when it appears as if the current uptrend
is not sustainable. Selling into strength is a common scaled exit
technique. back
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Sentiment - the prevailing psychology of the crowd.
Prices rise in an environment of optimism (bullish sentiment), and they
fall in an environment of pessimism (bearish sentiment). Numerous
technical indicators can be used to quantify the relative levels of
optimism and pessimism within the market, including a comparison of long
and short positions, market volatility, the ratio of put options versus
call options, and the inflow or outflow of cash. Sentiment is a key
indicator in assessing the sustainability of the current market
environment. An excellent source for sentiment is SentimenTrader.com. back
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Short - to sell a stock that you don't own. The
shares of the stock are borrowed by your broker ("getting a borrow") and
then sold in the open market. The proceeds of the "short sale" are
deposited into your account, and you are counting on being able to buy
the shorted shares back (to "cover your short") at a lower price and
return them to the rightful owner (the lending source of the borrowed
shares) and keep the difference. Rather than "buying low; selling high"
the short seller "sells high and buys low." Shorting can be quite
profitable, but is also a risky strategy because of the risk of a Short
Squeeze. back
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Short Interest - the total number of shares of a
stock that have been sold short and not yet repurchased. When the short
interest is high enough, a bullish situation exists because of the
increasing possibility of a Short Squeeze. back
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Short Squeeze - a short squeeze results from a
sudden demand (i.e. buying) in a stock which has a large amount of
shares outstanding on the short side. If the buying persists to an
extent that short sellers must cover their short positions, the result
can be brutal to the short sellers. The buying increases the share
price, which in turn creates additional fear (and short covering) among
short sellers. As people rush to buy stock and cover their positions,
the price runs to extreme price levels until a normal supply/demand
situation returns. The aftermath of a short squeeze is a significant
retracement in price as the urgent short covering finally exhausts
itself and leaves a pool of devastated short sellers. back
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Simple Moving
Average (SMA) - an unweighted moving
average wherein the same weight is assigned to each data point,
irrespective of its place in the data series (compare the SMA with an
EMA (exponential moving average), wherein greater weight is assigned to
the most recent data). Because all data is assigned the same weight,
the SMA is slower than the EMA, and is used as the reference for
Bollinger Bands. (The slower SMA is used because the standard deviation
calculation that creates Bollinger Bands is quite sensitive to small
fluctuations. As such, the slower, steadier SMA provides a more stable
frame of reference for the ultra-responsive Bollinger Bands.)
back to
top
Slope of Hope - the term that describes the
declining price trend of a former high-flier. One common dynamic within
the stock market is the tendency of the crowd to become overly
enthusiastic about a stock. This extreme bullish sentiment pushes a
stock to unsustainable levels where even the most optimistic earnings
estimates justify significantly lower stock prices. But because the
crowd believes, any dip in price is met by weak buying that is
sufficient to stop the immediate price decline, but insufficient to
reverse the downtrend. The bulls hope that the market is wrong, and
they stubbornly cling to the belief that the stock will return to its
former glory. But the downtrend continues until the last of the
stubborn bulls has given up. Only then does the Slope of Hope hit
bottom and begin the process of building a base for the next advance. back
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Snapback - a sharp counter-trend move. A snapback
can occur in any direction, though it usually describes the
counter-trend advance at the end of an extreme sell off - a "snapback
rally". Snapbacks can lead to profitable short-term trades because
they capitalize on market extremes by participating in the inevitable
correction of the extreme. back
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Standard Deviation - a measure of the dispersion of
a set of data from its mean. The more spread apart the data is, the
higher the deviation. A volatile stock has a high standard deviation.
Because standard deviation is calculated by the square root of
the variance, it is extremely sensitive to changes in the variance.
Bollinger Bands are constructed by calculating the standard deviation
the 20-period simple moving average. The most common setting for the
upper Bollinger Band is 2 standard deviations above the
20-period moving average. The lower Bollinger Band is usually 2
standard deviations below the 20-period moving average. back
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Stochastics - a momentum oscillator originated by
George Lane. Stochastics are similar to RSI in that both indicators
measure momentum. But a key difference is that RSI parses the data by
comparing the current close with prior closes within a set
period (usually 14 periods), while stochastics are based on the current
location of price relative to the price range of a set period
of time. back
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Stop Loss - a predetermined price level at which a
position will be closed. A "stop loss order" is essential to protecting
trading capital as well as profits. The location of the stop loss order
relative to our entry price defines the risk of the trade. The closer
the stop loss is to the entry point, the lower the risk; however,
excessively tight stops often result in being "stopped out" of a trade
by normal volatility. Stop loss placement is as much an art as a
science, but it is an essential component of responsible money
management. One characteristic that differentiates professional traders
from amateur traders is the use of stop losses. The vast majority of
professional traders define their risk by placing stop losses, while
many amateur traders fail to use stop losses because they assume that
they will make money on the trade. (Also known as a Protective Stop).
back
to top
Support - That price level where a stock can trade
down to…but not exceed…for a certain period of time. Support is that
level at which the aggressiveness of buyers overcomes the aggressiveness
of sellers; where demand exceeds supply. We can identify probable areas
of support of an asset by studying its prior trading history. The more
trading that occurs at a particular price level, the greater the
Financial Commitment is at that level. And when a stock trades down to
a price level with heavy financial commitment, the demand for stock at
that level is likely to overcome the supply of the stock as committed
buyers do what they've been waiting to do - buy the stock! (Compare
Resistance; See PBV Bars) back
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Three Day Rule - The stock market consists of
several groups of traders, and it pays to run with the smartest group.
The Three Day Rule is a short-term trading rule based on the theory that
significant moves are started by the smartest, most well-capitalized
traders. These traders buy on the first day. The second day of a move
is caused by the "semi-smart" traders who notice that a move is
occurring and are quick to seize the opportunity to profit from the
move. By the third day, only the slower, poorly capitalized traders are
left to buy. This last group may have seen the move, but were not
aggressive enough to buy during the first or second day. By the third
day, they are ready to buy the stock, even at an extreme price. And who
are they buying from? They are buying from the first group - from the
smart, well-capitalized traders who are taking profits and are moving
onto greener pastures. Look at any daily chart and you will find very
few significant moves that last for more than three consecutive days
without a correction. So, under the Three Day Rule, avoid buying a
stock on the third day of an advance. Chances are that you will have a
better buying opportunity within a very short period of time. Following
the Three Day Rule may result in missing out on an occasional dynamic
move; but over time, the Three Day Rule will keep you out of trouble. back
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Tick Index - a very short term indicator based on
the number of stocks trading on an uptick (a trade above the previous
trade price) minus the number of stocks trading on a downtick (a trade
below the previous trade price). A positive Tick Index indicates that
more stocks are being bought than sold, and vice versa. The higher the
tick index, the more powerful the market. back
to top
Top - the point or process where an uptrend exhausts
itself and is followed by a meaningful decline. Tops tend to be more
gradual process-driven formations as the natural bullish bias of the
market is gradually overcome by an increase in selling pressure. Hope
is one of the emotions that characterizes tops, and can take a while to
dissipate. Because hope is such a persistent emotion, tops often take
much longer to form than most traders and analysts think. Also, what is
believed to be a top can often turn out to be consolidation. As such,
anticipating tops is very difficult because it involves going against
the trend.
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Top-Down Approach - an investment approach that
focuses first on the best sectors to be involved in given the current
economic climate and business cycle. From the best sectors, the top
down approach then selects those industry groups within those sectors
that are more compelling. Finally, the companies within the selected
industry groups (which are, in turn, within the selected sectors) are
examined. Only in this final step are the company's fundamentals and
price history of the stock analyzed. back
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Trader - the term for someone that exchanges
assets. In simplest terms, we exchange stock for cash, and cash for
stock. We "trade." Much is made of the distinction between the trader
and the Investor. The difference usually concerns time horizon,
methodology or both. Traders are seen as being short-term oriented with
a focus on the movement of stock price. Investors are seen as being
long-term oriented with a focus on the underlying fundamentals of the
company. However, the lack of clear-cut criteria renders the
distinction meaningless. In the final analysis, we are all traders - we
trade our cash for stock, and we trade our stock for cash. I this
forum, there is no distinction between trader and investor. If you have
a brokerage account, you are a trader!
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Trailing Stop - a stop loss order that adjusts in
accordance to fluctuations in the market price of the asset. Using a
trailing stop enables you to let profits run with the assurance that the
stop loss will cut your losses short. The trailing stop takes emotions
out of the decision-making process because it is based solely on the
movement of the asset, and leaves no room for discretion. Various
trailing stop techniques exist, including Chandelier Exits, Volatility
Stops and Parabolic Stop and Reverse (SAR). Each has its own place
within a trading methodology. back
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Triangle - a general category of chart patterns
created by drawing trendlines along the peaks and valleys of a price
chart. A series of lower highs and higher lows cause the trendlines to
converge, thereby creating a triangle. Variations of the triangle are
the ascending triangle (bullish), descending triangle (bearish) and
symmetrical triangle (a continuation pattern). Triangles are similar to
wedges (reversal patterns) and pennants (continuation patterns). back
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TRIN - The TRIN was developed by Richard Arms to
measure the health of the market, or market breadth. It is a
volume-based indicator designed to indicate whether more volume is
moving into advancing stocks or declining stocks. The calculation for
TRIN is: back
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(Advancing Issues/Declining Issues) / (Volume of Advancing
Issues/Volume of Declining Issues)
VIX (CBOE Volatility Index) - The Chicago Board
Options Exchange (CBOE) Volatility Index, or, "the VIX" shows the
market's expectation of 30-day volatility. It is constructed using the
implied volatilities of the S&P 500 index call and put options to derive
the implied volatility of a hypothetical 30-day at-the-money option.
Because options are estimates of future prices, the VIX is
meant to be forward looking and is used as a measure of market risk.
The VIX is seen as a gauge of investor complacency or fear. A low VIX
represents complacency and often signals a market top; while a high VIX
represents excessive fear and is often indicative of a market bottom.
As a general rule, VIX readings below 20 equate to less stressful and
complacent markets. VIX readings above 30 reflect fear and uncertainty
in the market.
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VXN(CBOE Nasdaq Volatility Index) - The Chicago
Board Options Exchange (CBOE) Nasdaq Volatility Index, or "the Vixen" is
a measure of implied volatility for the Nasdaq 100 (NDX). The VXN is
calculated using the same methodology as the VIX. The VXN represents the
implied volatility of a hypothetical 30-day option that is at the
money. back
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Volatility - in statistical terms, volatility is the
measure of the dispersion of returns for a given asset. But in layman's
terms, volatility refers to the amount of price fluctuation of the
asset. Rapid or wide ranging price changes equate to high volatility,
and small or slow price changes equate to low volatility. Volatility is
a measure of risk and uncertainty. The measure of the volatility of a
stock relative to the S&P 500 is the beta of a stock. For example, a
stock with a 1.2 beta value has moved 120% for every 100% move in the
S&P. Volatility is cyclical, and periods of low volatility lead to
high volatility, which in turn leads to low volatility. Understanding
the cyclical nature of volatility is essential to trading success. back
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Volatility Squeeze - a prolonged period of low
volatility characterized by a narrow trading range. Because of the
cyclical nature of volatility, a period of low volatility will
inevitably lead to a volatility expansion, where the price becomes
highly volatile. A volatility expansion tends to be directional in
nature - that is, the volatility will increase in an upward direction
(breakout) or downward direction (breakdown). Trading volatility
squeezes can be exceedingly profitable because of the nature of the
trade. By delaying our trade until the squeeze breaks either upward or
downward, we enter the trade right at the infancy of the volatility
expansion. As such, the trade begins working immediately and does not
require much patience. The volatility squeeze should be profitable
almost immediately. If it is not, then the trade is suspect and should
be closed out. One method of detecting a Volatility Squeeze setup is by
studying Bollinger Bands. An extremely narrow Bollinger BandWidth is
only possible during conditions of low volatility. The Volatility
Squeeze is a major focus of the Stock Market Mentor. back
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Volatility Stop - a Trailing Stop methodology that
incorporates into the calculation the volatility of the stock's
volatility. Volatility Stops are useful in protecting gains on strongly
trending stocks that are so far above the last level of support that a
pullback to support sacrifices too much of the profit. Volatility stops
are used when more traditional stop methods are impractical.
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Wall of Worry
- The Wall of Worry describes the dynamic wherein the stock market
continues to rise in the face of uncertainty and negativity. It is
said that “a Bull Market climbs a Wall of Worry.” Stop and
consider the dynamics within an uptrending market and the basis for this
Wall of Worry will become apparent. Worried money is usually on
the sidelines. It is not invested. But as traders worry
about political or economic uncertainties, they might also notice that
the market is moving higher without them. So they start to put
money to work. They remain worried about the market, but they hold their
nose and buy anyway. Who are they buying from? They are
buying stock from other traders who fear a market decline. These
worried sellers are happy to exchange their stock for cash because they
are uncomfortable remaining in the market. But after they have
sold, they realize that the market continues to move higher without
them. So they in turn put their money back into the market,
driving it even higher. See how the pervasive uncertainty can
actually be the impetus for higher prices? So the next time you
find yourself feeling uncertain and worried during a strong uptrend,
remind yourself that you are climbing the Wall of Worry. The use
of trailing stops and scaled entries and exits is an effective way to
climb the Wall of Worry without taking on undue risk.
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