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Trading Trading Presentation Transcript

  • Trading & Investing in Stocks & Options Department of Social Science & Policy Studies Worcester Polytechnic Institute Michael J. Radzicki, Ph.D. [email_address] http:// www.michaeljosephradzicki.com /
  • Outline Of My Talk
    • Hierarchy of Stock & Options Price Movement
    • Some Basic Macroeconomics
    • Inter-Market Analysis
    • Sector Rotation
    • Market Breadth
    • Trading & Investing
    • Options
  • Hierarchy of Stock & Options Price Movement
    • Economy
      • Actions of central bank(s)
      • Fiscal policy
    • Markets
      • Currency Markets
      • Commodity Markets
      • Bond Market
      • Stock Market
    • Sectors
    • Industry Groups
    • Individual Stock Prices
    • Individual Stock Option Prices
  • Some Basic Macroeconomics
    • Gurus: John Maynard Keynes, Hyman Minsky, Abba Lerner, Warren Mosler & L. Randall Wray
    • Capitalist economies have a trend & a cycle(s)
    Some Basic Macroeconomics
    • Trend due to self-reinforcing processes:
      • Supply Side
        • Population Growth
        • Technological Innovation & Ideas
        • Capital Accumulation
      • Demand Side
        • Fiscal Policy
    Some Basic Macroeconomics
    • Cycle (primarily) due to:
      • Consumption Spending
        • Since 1980, due to consumer credit
      • Investment and the dynamics of its financing
        • Which includes speculation (a self-reinforcing process)
      • Countercyclical Government Spending
    Some Basic Macroeconomics
    • Inflation/deflation and involuntary unemployment are the traditional evils that policymakers try to combat
      • Other evils exist too
    • Capitalist economies are often “demand constrained”
      • Which results in unused production capacity
      • In both the long and short runs
    Some Basic Macroeconomics
    • Minsky’s Theory of the Cycle
      • Investment spending & its financing is the key
      • Hedge Firms/Sectors
      • Speculative Firms/Sectors
      • Ponzi Firms/Sectors
    Some Basic Macroeconomics
    • Central banks in capitalist economies are said to (implicitly) follow a Taylor Rule:
    • I t = Inf t * + r t * + a*(Inf t - Inf t *) + b*(y t – y t *)
    • I t = Target Federal Funds Rate
    • Inf t = Rate of inflation (measured by GDP deflator)
    • Inf t * = Desired rate of inflation
    • r t * = Real interest rate consistent with full employment (usually thought to be 2%)
    • y t = Real GDP
    • y t * = Potential real GDP
    Some Basic Macroeconomics
  • Some Basic Macroeconomics Economy of the Rest of the World U.S. Economy Private Sector Balance Gov’t Budget Current Account Federal Reserve System Open Market Committee Fed Funds Target Rate; Bond Purchases & Sales Taylor Rule, Current Account & Exchange Rates
    • During the expansion phase of the cycle (fearing inflation) the Fed starts to raise the Federal Funds rate target
      • The term structure of interest rates responds
    • Generally speaking, rising interest rates & fear of inflation:
      • Drives bond yields up and thus bond prices down
      • Slows the housing market & thus household sector spending
      • Slows the economy (and thus slows earnings growth) [maybe]
      • Drives stock prices down
      • Drives commodity prices up
      • Can strengthen (or weaken) the dollar
    Some Basic Macroeconomics
  • S&P 500 PE Ratio Moves Opposite of the Federal Funds Rate
    • But fiscal policy cannot be ignored!
    • Actually, the quantity of money in the economy is determined by fiscal policy
    • “ Monetary policy” simply consists of setting the federal funds rate
    • Lerner-Mosler-Wray story
    Some Basic Macroeconomics
    • Levy-Kalecki Profits Equation:
    • Gross After Tax Profits (Includes Interest, Rent & Dividends) =
    • Investment Spending + Consumption Out of Profits - Saving Out of Wages +
    • [Gov’t Spending – Gov’t Tax Revenue] +
    • [Exports - Imports]
    Some Basic Macroeconomics
    • Thus:
    • [Gross After Tax Profits – Investment Spending – Consumption Out of Profits + Saving Out of Wages] -
    • [Gov’t Spending – Gov’t Tax Revenue] -
    • [Exports - Imports] = 0
    Some Basic Macroeconomics
    • That is:
    • [Saving Out of Profits + Saving Out of Wages] -
    • [Budget Deficit/Surplus] -
    • [Trade Deficit/Surplus] = 0
    Some Basic Macroeconomics
    • That is:
    • [Private Sector Balance] -
    • [Current Account Balance] =
    • [Government Sector Balance]
    Some Basic Macroeconomics
    • Currently:
    • Private Sector Balance (+2% of DPI) -
    • Current Account Balance (-6% of DPI) =
    • Government Sector Balance (4% of DPI)
    Some Basic Macroeconomics
    • Other Levy-Kalecki Profits Equation Relationships :
      • The Unemployment Rate closely tracks the Private Sector Balance
        • When the private sector goes into deficit it reduces the unemployment rate but also accumulates debt
      • The Value of the Dollar closely tracks the Government Sector Balance
        • As the budget deficit increases, the value of the dollar falls
    Some Basic Macroeconomics
    • Thus, any private sector surplus (i.e., any accumulation of wealth by the private sector) coupled with any current account deficit must be offset by a government sector deficit and vice versa!
    • So, how loud should we applaud the federal budget surpluses during the late 1990s?
    • Government surpluses are deflationary and directly associated with the loss of private sector wealth
      • Which is bad for stock prices
      • Which decouples the relationship between stock & bond prices
    Some Basic Macroeconomics
  • Inter-Market Analysis
    • Guru is John Murphy
      • http:// stockcharts.com/charts/performance/Intermarket.html
      • 2004. Intermarket Analysis: Profiting from Global Market Relationships . Hoboken, NJ: John Wiley & Sons, Inc.
      • 1991. Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity, and Currency Markets . Hoboken, NJ: John Wiley & Sons, Inc.
  • Inter-Market Analysis
    • Three key relationships:
      • U.S. Dollar & Commodities => Negative
      • Commodities & Bonds => Negative
      • Bonds & Stocks => Positive (Unless Deflation)
        • Bond market typically leads stock market by 6-8 months
  • Inter-Market Analysis Source: StockCharts.com
  • Inter-Market Analysis Source: StockCharts.com
  • Inter-Market Analysis Source: StockCharts.com
  • Inter-Market Analysis Source: StockCharts.com
  • Inter-Market Analysis
    • Main idea:
      • If you’re going to successfully trade stocks and stock options, you have to pay attention to the bond, commodities and currency markets
      • Therefore, you also have to pay attention to the economy, fiscal & monetary policy, and to world events
  • Sector Rotation
    • Guru is Sam Stovall of Standard & Poor’s
      • http://www.businessweek.com/investor/list/stovall_toc01.htm
      • 1996. Sector Investing . McGraw-Hill.
      • 1995. Standard & Poor’s Guide to Sector Investing . McGraw-Hill.
    • Murphy & Cramer are into it too!
  • Sector Rotation Source: StockCharts.com
  • Sector Rotation
    • Over the macroeconomic cycle, institutions move money out of certain sectors and into other sectors
    • Thus, a good investing/trading strategy is to follow the institutional money to the hot sectors
    • http:// stockcharts.com /charts/Carpet/
  • Sector Rotation – Relative Strength Source: StockCharts.com
  • Sector Rotation – Relative Strength Source: StockCharts.com
    • Gurus are Greg Morris & John Murphy
    • Morris, Gregory L. 2006. The Complete Guide to Market Breadth Indicators . New York: The McGraw-Hill Companies.
    Market Breadth
    • Advance/Decline Indicators
    • New High/New Low Indicators
    • Up Volume/Down Volume Indicators
    • McClellan Indicators
    • Vix
    • Technical analysis applied to the main indices
    Market Breadth
    • Not every close of the S&P 500 below its 200 day EMA signals a bear market, however every bear market starts with a close of the S&P 500 below its 200 day EMA.
    • If the 50 day EMA of the S&P 500 crosses below its 200 day EMA the odds of a bear market increases
      • Called a “death cross”
      • Opposite is called a “golden cross”
    Market Breadth
  • Market Breadth 50 Day EMA 200 Day EMA
    • Weekly Moving Average Cross-Over System (from John Murphy)
    • 13 Week EMA & 34 Week EMA
    • Works best on S&P 500
      • S&P crossed briefly & then recovered
      • NASDAQ has crossed
    Market Breadth
  • Market Breadth False Signal (Quickly Corrected) Bull Bear 13 Week EMA 34 Week EMA See Next Slide
  • Market Breadth Convergence But No Cross Small Cross & Recovery
    • S&P 500 100 Day (20 Week) & 400 Day (20 Month) Exponential Moving Averages
      • Closing below the 100 Day EMA is a minor sell signal (bearish)
      • Closing below the 400 Day EMA is a major sell signal (bearish)
      • 400 Day EMA is major area of support
    Market Breadth
  • Market Breadth Minor Bearish Bullish Major Bearish 100 Day EMA 400 Day EMA 400 Day EMA ProvidesSupport
  • Market Breadth Bullish Bullish Bearish 400 Day EMA Bollinger Bands +-2
    • Generally speaking, it’s better not to trade against the market
    • Bull market: Buy stocks & call options
    • Bear market: Sell stocks short & buy put options
    Trading & Investing
    • Select Your Style:
      • Scalping
      • Day Trading
      • Swing Trading
      • Intermediate Position Trading
      • Long Term Position Trading
      • Investing
    Trading Vs Investing As you move from micro scalping to investing, you hold your positions longer (thus tying-up your capital longer) & can earn more $ on each trade. But you must also know more about why a stock is moving [ Financial Economy (news, earnings, splits, fundamentals, etc.) & Real Economy (FDA approval, new products, mergers & acquisitions, etc.)]. Pattern Day Trading Rule Applies
    • Three Tools Required for Trading & Investing:
      • A method for finding stocks & options to buy & sell
      • A trading platform for timing entries to, and exits from, trades
      • A method & strategy for executing trades
        • Broker
        • Trading Plan
    Trading & Investing
    • Stock Shepherding
    • Stock Screeners
      • Business Week (Free)
        • http://prosearch.businessweek.com/businessweek/general_free_search.html?mode =advanced
      • Short Term Stock Selector (Free & Cost)
        • http://home.flash.net/~hesler/
        • Neural net picks stocks to swing trade
      • HotScans (Cost)
        • http:// www.marketgauge.com /
    • Market Carpets & Heat Maps
      • http://www.smartmoney.com/MARKETMAP/
      • http://screening.nasdaq.com/heatmaps/heatmap_pmi.asp
      • http:// www.spdrindex.com/sectortracker /
    • Top Ten Lists
    • News: e.g., CNBC & Bloomberg
    • Pundits: e.g., Cramer (Boo-Yah)
    • Value & Growth Investing
    Finding Stocks & Options to Trade
    • Technical trading is nothing more than support & resistance!
      • http://www.stockconsultant.com/
    • Need a charting program to identify support & resistance levels & thus to time entries & exits
      • http://www.marketbrowser.com/mbzzzq2.asp (Free)
      • http://www.bigcharts.com/ (Free)
      • http://www.tradestation.com/ (My Personal Choice)
    Trading Platforms
    • Like the economy, individual stock prices have a trend & a cycle
    • Up-Trend: Higher highs & higher lows
      • Bullish: Buy stocks; Buy call options
    • Down-Trend: Lower highs & lower lows
      • Bearish: Sell stocks short, Buy put options
    • No Trend: Price just oscillates
      • Neutral: Sell call options on stocks you own
    Trading Platforms
    • Must identify up-trend, down-trend, or no trend
    • Plotting stock price data
      • Line plots
      • Western bar plots
      • Japanese candle sticks
    Trading Platforms
    • Apply Well-Known Technical Indicators to the Stock Price Data
      • Moving Averages & Trend Lines
        • Shows changes in trends
      • ADX – Average Directional Index
        • Shows the strength of a trend
      • Oscillators
        • E.g., RSI & Fast & Slow Stochastics
        • Shows over-bought & over-sold conditions – i.e., when a stock price will reverse
      • An Indicator that Utilizes Elements of Both the Trend & the Cycle
        • MACD – Moving Average Convergence Divergence
    Trading Platforms
  • Fundamental Investing
    • Growth Investing
      • Guru is Cramer (among many others)
      • http://www.thestreet.com/
      • http:// www.cramerwatch.org /
      • Main Idea:
      • P/E = [Price ($/Share) / Earnings ($/Share)]
  • Fundamental Investing
    • P/E = “Multiple” = M
    • M * E = P
    • Find stocks that have a lower M and a higher historical growth rate of E than the average firm in the S&P 500
    • PEG useful
  • Fundamental Investing
    • But:
    • M * Expected Future (E) = Expected Future (P)
    • So, should try to predict future earnings growth too
      • Conference calls
      • Analysts
      • New product introductions
      • Small debt
      • Better sales & margins, & lower costs than rivals
      • Secular or cyclical stock?
  • Fundamental Investing
    • Value Investing
      • Guru is Warren Buffet
      • http://www.coattailinvestor.com/
      • Main Idea: Analyze a company & determine its intrinsic value. When its share price drops below that value => buy.
      • Bible is Security Analysis by Graham & Dodd
      • Must know basic accounting
  • Method & Strategy for Executing Trades
    • Broker
      • Keys to selecting a good broker
      • Cash & margin accounts
    • Trading Plan
      • Money management
        • Risk-Reward Ratios
        • Order entry & exit strategies
          • Order types
          • Setting stops
  • Example
    • http://scansstaging.marketgauge.com/login.asp?reason=denied_empty&script_name=/Scans/OpeningRange.asp&path_info=/Scans/OpeningRange.asp&fid=8969
    • Paper Trading:
      • http:// simulator.investopedia.com /
  • Options
    • Derivative markets are exploding!
    • Options provide leverage (a small percentage move in the underlying asset means a large percentage move in the value of the corresponding option) & a way to manage risk
    • Options require a smaller outlay of capital
    • Many options strategies are quite simple; some are complex
  • Options
    • Some options strategies only work if the underlying asset moves in a particular direction
    • Some options strategies only work if the underlying asset moves in either direction
    • Some options strategies only work if the underlying asset doesn’t move
  • Options
    • An option is a contract that gives the owner the right , but not the obligation , to buy/sell an underlying asset (e.g., 100 shares of stock) at a particular price (the strike price) by a particular date (the expiration date).
      • It’s an asset
    • Two types of option contracts:
      • Calls & Puts
    • Two styles of options contracts:
      • American style & European style
  • Options
    • The writer of an option has the obligation (a liability ) to buy/sell an underlying asset (e.g., 100 shares of stock) at a particular price (the strike price) by a particular date (the expiration date).
      • This obligation will not need to be fulfilled unless the strike price is passed
  • Options
    • A contract has two parties: a buyer & a seller
    • Bullish
    • Max reward limited to premium received
    • Max risk = strike price – premium received
    • Bearish
    • Max reward limited to premium received
    • Max risk unlimited
    Write
    • Bearish
    • Max risk limited to premium paid
    • Max reward = strike price – premium paid
    • Bullish
    • Max risk limited to premium paid
    • Max reward unlimited
    Buy Put Call
  • Options
    • Time decay
      • Ice cube melting on a sidewalk
    • Options Valuation
      • Time value
      • Intrinsic value
        • ITM, ATM, OTM
        • Volatility
        • Other factors
  • Options
    • Simple strategies
      • Buy a call instead of the underlying stock
      • Buy a put instead of shorting the underlying stock
      • Buy/Write or Rent Your Stock
      • Write a (naked) put to purchase a stock you feel is currently over valued
  • Options
    • Free information on options:
      • http://www.888options.com/
      • http:// biz.yahoo.com/opt/education.html