Wiser Trader Stock and Options Newsletter

http://www.WiserTrader.com

 

Issue No. 1 – November 22, 2004

Systems@WiserTrader.com

James Andrews

 

1.0 Introduction

 

       The Wiser Trader Newsletter is the result of trading experiences from just before the height of the dot-com craze and the bursting of the internet bubble up to the present.  The newsletter will share insights on stock and options trading from the common sense perspective of a small investor.   As much as possible, this will be done in a concise manner partly due to habits accumulated from the editor’s 25 year background in electronics technology research and development.  Hopefully, comments will not be too cryptic.

 

      The small investor comes to the stock market from a variety of disciplines and is forced to make earthmoving adjustments in how he views the market environment.  If he comes from a highly structured logical background, as I have, he should consider it a major handicap.  The markets operate on the two E’s, earnings and emotions.  Make that read emotions to the second power, namely greed and fear.  He typically lacks the resources of brokers and large fund managers to develop trading and investment information.  It is challenging for him to gauge his expectation of results in view of the limited availability of time, funds and information versus the enormous number of possibilities.

 

      This newsletter attempts to lend structure to this emotional maze.  With one eye on using tools to make his market decisions more objective and the other on market conditions, the small investor can scale his trading strategy to match his funds while continually expanding his sources of timely, low cost information, tools and techniques.  The number of stock choices for the small investor is not necessarily smaller than for the large investor.  But the choices are different indeed. 

 

      It is our expectation that these selective opportunities can be recognized, evaluated and acted upon in a systematic, objective manner.  We will try not to portray ourselves as experts because we are not.  Our goal is simply to help make smaller investors more successful.  In this spirit, we accept constructive input wherever we can find it.  In the coming months, stock investing and trading systems will be discussed and evaluated for how well they lend themselves to the resources of a small investor.  Stock picking provided here is neither purely value-based nor growth-based but a blend of both. 

 

      The normal organization of this newsletter is to provide an analysis of the past week’s market behavior that results in a watch list of stocks that are, for now, posted on the web site.  This is normally followed by a brief summary of a published investment strategy or trading system that we contrast with our own procedures in terms of the availability of information needed to put it to use. These systems are usually embodied in one or more tools found at the web site page http://www.wisertrader.com/resources.php.  The http://www.WiserTrader.com/portfolio.php page displays a model portfolio of stocks traded on the American Stock Exchange, the New York Stock Exchange and the NASDAQ.  The time period for trades ranges from a few days to a few months.  For a brief time, while the site's track record is being demonstrated, the information is available for free without a password.  During this free period, we will display our losing stock picks, as well as, our winners.  The cumulative profit/loss summary is based on the assumption that all buys are of equal value.

 

2.0 Analysis - Week ending 11/19/04

 

  Week ending 11/19/04:

  Gold for past 30 days:

  USD   +4.33%

  CAD   +0.14%

  CHF   -0.20%

  GBP   +1.90%

  EUR   +0.62%

  JPY   +0.55%

  Indices for the week:

  Dow Jones    -1.0%

  NASDAQ 100   -0.1%

  S&P500 Index -1.2%

  Russel 2000  -1.1%

  Leaders for the week:

  Sector:      Energy

  Industry:    Coal

 

 

      The core PPI (excluding energy and food) was up 0.3% for the second month in a row, reflecting a modest increase in pricing trends.  Inflation is on the radar screen as a potential problem for the financial markets.  This can be seen above in the increased gold price in relation to the US dollar.  Gold itself has not yet really begun a bull market in its own right against most major currencies.  Alan Greenspan said investors should be prepared for rising interest rates and expressed concern about the large trade deficit and budget deficits.  Even though the bond market sold off on Friday, the yield on the 10-year dropped to 4.19% from 4.22% at the end of the previous week.  The sell-off on Friday probably hasn't eliminated the underlying bullish sentiment in the stock market.  It certainly gave bears a reason to take some profits.  But the Thanksgiving week is often an up week for the market and there is widespread confidence that there will be a good holiday season for retailers.

 

The energy sector has risen steadily all week.  While oil and gas have pulled back from their recent highs, the growing upsurge in energy demand from India and China implies that prices will continue to rise.  According to oil giant BP, world coal consumption rose 6.9 percent last year, more than three times the rate of growth in oil demand.

 

2.1 Watch list

 

      We are looking for optionable stocks whose percentage relative strength over the past 6 months is greater than 95%, EPS Growth over the past 12 months is greater than 80% and are within 5% of their 52 week high. If we can find such stocks that fall within a leading sector and industry based on the above information, we consider that a plus.  See Table 1.

 

 

Table 1

Watch List as of 11/19/04

 

 

      Trades can apply to either options or the underlying stock, depending on available resources, investment time frame and money management rules as discussed below.  Options are chosen to be mildly or deeply in the money so as to have a reasonably high delta. Delta, which ranges from zero to one, is equal to the probability that an option will be in the money on its expiration date.  More near term it equals the dollar amount that the option premium changes for every dollar amount that the underlying stock price changes.  Expiration dates are picked as far as possible into the future not exceeding one year.  It’s perfectly OK to exceed one year but it’s just easier to remain under one year for the trading platform that I personally use.  The value of the time premium decays less rapidly the farther out one goes and one does not need to panic to get out of a trade as the expiration date approaches.  Using this method, one tries to exit any trade that expires within the next one or two months. 

 

3.0 Procedures

 

In this first issue, we need to focus on preliminary details of how trades can be executed with objectivity.  Conditions that trigger entering a trade for the above watch list selection criteria apply to both options and the underlying stock.  For long positions, a buy trigger occurs in an up trending market defined by both MACD moving averages being consistently above the zero reference.  The actual trigger occurs when the slow stochastic indicator reaches an over-sold condition (below about 20) and the fast %K line crosses above the slow %D line, as WCC did, for example,  in mid October and appears to be about to do in the chart in Figure 1.  Notice the volume in relation to the rising average volume curve.  Recent falling prices are accompanied by falling volume while rising prices are accompanied by rising volume.   This is bullish and we can afford to wait for the price to rise before entering a trade. 

 

 

bigcharts.marketwatch.com

Figure 1

 

      Other trigger indicators can be used in an up trending market besides the slow stochastic indicator.  The Williams %R is one such indicator that is favored by one of my mentors, Dr. Stephen Cooper.  The scales of the slow stochastic and the Williams %R are inverted about the zero reference with respect to one another but their behaviors are otherwise similar.  The Williams %R in Figure 2 replaces the volume chart in the previous figure for comparison with the slow stochastic.  Both indicators are in agreement about the October over-sold condition (below -80 for Williams %R) but agree less well for current conditions.  So we might take the more conservative route and wait for both to agree.

 

 

bigcharts.marketwatch.com

Figure 2

 

3.1 Money Management

 

      Extensive reading in my early trading career lead me to the image of a free wheeling entrepreneur who instinctively does what is needed at the right time.  I quickly learned that this is only true if one has already taken the time to instill certain habits and self disciplines.   Any experienced trader will tell us that the most important self discipline is money management.  One must avoid situations where a single trade can cause a large draw-down in one’s total funds.  In order to continue trading one must never get wiped out.  One has to survive in order to trade.  The details vary but for underlying stocks it can be summed up simply by saying that: (1) no single trade or idea should consume more than about 4% of one’s investment capital or portfolio and (2) no single trade should be allowed to decline in value by more than 25% before it is considered a loss and exited.  If one uses this set of ratios, then the maximum loss on a single trade will never be more than 1% of one’s portfolio.  One can accept a series of such losses without getting hurt too badly.

 

      For very small portfolios the maximum trade size might be extended to up to 10% of one’s portfolio with the maximum loss for a single trade being reduced.  Remember, there is nothing wrong with buying a single share of a stock except for the potentially large premium one pays in transaction fees as a percentage of the trade.  No one knows except the trader and his broker.  This is where the anonymity of a discount online brokerage comes in handy.  There is no one looking over his shoulder to make him feel uncomfortable about the size of his trades. 

 

      But whatever set of numbers one chooses, he should work to deeply ingrain the appropriate trade size to the point where it becomes a reflex.  The test will come in the form of what size trade he makes when he sees a great trade opportunity that excites him.  As for getting excited in the first place, we as small traders must remember that there are more great trades out there than we can possibly act upon. 

 

4.0 Results - Model Portfolio

 

      For the week ending 11/19/04, the portfolio performance of the first two stocks actually purchased is shown in Table 2. 

 

Table 2

Portfolio as of 11/19/04

Symbol	Company	Buy Date	Buy Price	Week’s Close	Action	P/L(%)
CREE	Cree, Inc	11/12/04	$37.10	$37.76	long	+1.7
UPL	Ultra Petroleum	11/12/04	$50.80	$50.20	long	-1.2

 

 

5.0 Conclusions – P/L

 

      The cumulative or average portfolio P/L is +0.3%.  Checking the buy dates against plots of the slow stochastic and Williams %R reveals that these two trades were made using something other than the criteria described above.  The more disciplined approach outlined above will likely improve performance over the coming weeks.