- Top-down and bottom-up research are two approaches for narrowing the large universe of stocks to focus on for potential trading or investment. - Top-down starts with analyzing sectors and industries for relative strength compared to the overall market, then identifying leading stocks within those outperforming groups. - Bottom-up starts with an investor screening for stocks that meet specific criteria they deem attractive, such as valuation metrics or technical patterns. - Both approaches aim to efficiently filter the thousands of stocks down to a more manageable watchlist for further analysis of individual opportunities.

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Over the last 10+ years, the combination of heightened volatility and the advancement of
market access software have led much of the investing public to become more involved than
ever in the management of their financial portfolios. In past decades, most individuals
entrusted their asset management to mutual funds or other vehicles to navigate the markets
and achieve a return targeted to a relevant index such as the S&P 500 or the Lehman
Brothers Aggregate Bond Index. The average retail investor’s interest and involvement in
trading or managing their own portfolio was typically sparked right at the end of the 90’s
during the run up in the internet bubble and with the introduction of online discount brokerage
houses. The environment at that time was one of chaos and irrationality causing many people
to chase overhyped stocks or funds with little consideration for any downside risk possible in
the trade. Rather than worrying about whether or not their stock position was going to move
lower, the only consideration at that time seemed to be how much higher their stock was
going to run. As we all know with the bursting of the Internet bubble, most people learned the
lesson about the inherent risks of buying stocks as their positions sold off aggressively. After
all the smoke cleared, many once high flying stocks even ended up being completely
worthless.
The dramatic losses many people incurred after the market correction in the early ‘00s, forced
these investors to second guess the idea that they were able to trade and manage their
portfolios on their own. Additionally, many people shifted away from individual stocks entirely
and sought out the help of a “financial advisor” who would happily help guide these investors
toward a more “conservative” approach by “diversifying” their market exposure through
mutual funds. These advisors were quick to agree that the client should not be trading his or
herself and that trading in general was not the proper approach to investing. The advice
being given by financial representatives has been and continues to be that the client should
allocate their investment capital to a portfolio of stocks or mutual funds that will be “managed”
for them by the firm. The financial services industry as a whole has always promoted the
concept of ignoring the short/intermediate term volatility in the markets and provided
numerous explanations to back up the industry's mantra of "it's not about timing the market
but rather time in the market.” Coincidentally, having clients invest and stay invested in these
firm’s “managed products” happens to generate a very consistent and lucrative revenue
stream for the financial firm and it’s advisers.
In fact, profitability for many of these fee based financial firms exploded in the years after the

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dotcom collapse as these firms tapped into the anxiety of the general investing public and
assured them that the “modern portfolio theory” approach to investing was the answer. Under
modern portfolio theory, clients are encouraged to stay fully exposed to their risk/age
appropriate equity and fixed income allocations regardless of the market environment based
on the premise that any losses within the portfolio will either be offset by the other asset
classes in their portfolio or over time as the market “will always continue to rebound”. As a
result, clients were discouraged from reducing their market exposure as the recent financial
crisis began to unfold being assured all the while that it was normal to have market pullbacks
and that their portfolio will always rebound regardless of the short-term fluctuations.
As a result of the last two major market corrections, many investors have discovered the
negative impact large pullbacks have on their portfolio when they follow that mantra of "time in
the market" and retain full market exposure regardless of the market environment. It's now
common knowledge that after major market pullbacks, one's portfolio needs a return double
the amount of the loss just to break even (ex. if portfolio loses 50% of it's value, it needs a
subsequent return of 100% to be back to it's original value). With all of this turmoil and
volatility, and the psychological impact of seeing our money fluctuate wildly in value, investors
typically have one of two reactions: throw their hands up and move their money to cash or
build a strategy to identify trading opportunities and embrace the volatility.
For the latter group, which decides to embrace the volatility and seeks to profit from it, the
amount of information and technology available to navigate the markets has never been
better. The challenge is how to take full advantage of the information provided from websites
such as Yahoo Finance, Google Finance, and the brokers such as TD Ameritrade, Charles
Schwab, Etrade and Fidelity.
While the discount brokerage houses have gone through great lengths to enhance the
content and tools available through their websites/software many of the employees within
these firms are not fully versed on how to navigate them as they are still fundamentally in the
business of keeping customers fully invested in their products and discouraging them from
"timing the market". Regardless of the derivation of “financial planner” that these
representatives have as their title, they are all salesmen looking to pitch the firm’s fee based

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products to you and have little to no interest in any client that is going to be managing their
own portfolio (unless it means a large transfer of assets into the firm, then they’ll spend a little
time with you, until the assets show up).
To their credit, some of these firms have started to provide seminars in their branches that
provide a decent level of education on trading concepts but many clients leave these
seminars more confused than when they entered. Most of the presenters of these seminars
have little trading experience themselves and are essentially regurgitating a seminar they give
over and over with little worry as to whether the attendees leave the event more educated
than when they arrived. Their job is to give the seminar and they’re just trying to get through
the day just as many people do with their own jobs. Additionally, many of the firms that
provide these seminars provide them for the purpose of showing off the capabilities of their
software and website with the hopes that it will generate new business for the firm as people
transfer their assets from another broker that might be lacking the same functionality or has
never shown the client that they offer the same tools. When the main purpose of the seminar
is for the firm to show off the firm’s software, much of the seminar tends to focus on the
incredible technical analysis tools available and constantly focus on indicators and oscillators.
While these technical tools can be useful for traders they often prove confusing for beginner
traders and take them away from comprehending some of the most important fundamental
ideas one must master to become a successful trader, which are properly analyzing price and
volume levels.
As a result, retail clients are forced to educate themselves on how to fully utilize the research
content and analytics available to enable them to self manage their portfolios. By following
the steps in this guide, you will greatly expedite this learning process regardless of which firm
you conduct your trading with or which websites you use to identify market opportunities. This
guide will take you through the primary navigation steps and functionality available through
these websites and the many trading software programs available in the market and show
you how to fully leverage them to identify trading opportunities, analyze those opportunities,
and subsequently build a trading strategy around them.
The first step in trading is to identify which stock or stocks you'll be monitoring and potentially
trading, which can be a daunting task in the beginning as you start to realize that there are
over 9,000+ stocks to choose from. Professional money managers and traders have this

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same challenge and use one of two approaches to narrow the large universe of stocks that
exists in the market to a more manageable group that they will monitor closely. These two
approaches are: Top down research and bottom up research.
Top Down Research:
Top down research is used to identify a market sector that is generating relative strength or
weakness when compared to the market as a whole, then identifying the industry within that
sector generating relative strength or weakness within the sector itself, and lastly identifying
the top stocks (or bottom in the case of weakness) within that industry. Relative strength can
be defined as a sector showing resiliency to selling pressure during market pullbacks, or as a
sector that is outperforming the market in times of broad market gains. Relative weakness is
the exact opposite, a sector of the market that is generating lagging returns in relation to the
broader market during times of market appreciation and selling off harder than the broader
market during market pullbacks.
Take some time to read the table below, which provides an example of a sector/market
comparison:
Ultimately, top down analysis is used to identify how money is rotating around the sectors by
seeing which areas of the market are experiencing buying pressure and which areas of the

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market are experiencing selling pressure. As you probably know and if not, will learn soon,
the market is very dynamic and constantly changing which means that we, as investors and
traders, have to constantly adapt to it. By conducting top down research and looking at
different times frames (short, intermediate, long) we'll ideally be able to identify signals
indicating that money flow is shifting from one sector to another and follow that shift ourselves
rather than staying in the old favorable sector and trying to force trading opportunities that are
no longer there. Much of a stock’s performance can be dictated by the general market trend
as well as the trend of the company’s sector/industry. Some percentages often referenced to
illustrate this are that 80% of stocks follow the market up during an uptrend and 91% follow
the market down during a correction (downtrend). As we discuss trend later, you’ll see why
it’s important to be able to identify the trending behavior of your stock to help you increase
your likelihood of a successful trade.
Aside from gauging current levels of relative strength or weakness that a sector is showing in
relation to the broader market, we also want to gauge the general trend that a particular
sector is showing over different time periods to try to identify signals of increasing strength or
weakness. For example, if over the last 6 months a particular sector has been
underperforming the broader market (ex. S&P 500 is up 2% while the sector is down .5% over
a 6 month time frame) but over the last 3 months has been outperforming the broader market
(ex. S&P 500 is up 1% while the sector is up 2%) this could be a signal that money is shifting
into that sector and we may want to put some of the top stocks within that sector on our radar
for possible trading opportunities.
Once you’ve identified a sector that appears to be exhibiting relative strength or positive
momentum, the next step would be to look closer at the industries that comprise that sector.
Each sector has industry groups that make up the broader sector. By conducting a
comparative analysis of the industries within the sector, we’ll be able to identify the particular
area(s) of strength that are contributing most to the overall sector’s performance. In the table
below you’ll be able to see the industries that comprise the Information Technology group
sorted on a one month return basis with the industries generating the strongest results
starting at the top:

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In the table above, you’ll see that when sorted over a one month return basis at the time this
guide was written, Information Technology had outperformed the S&P 500 by just about 4%
on a total return perspective (8.42% vs. 4.51%). Within the Information Technology sector we
can further identify that the Internet Software and Services Industry out performed both the
broader market and it’s broader sector while contributing greatly to the overall sector’s
performance (17.68% vs. 8.42% vs. 4.51%). Our next step is to dig even deeper and look
within the Internet Software and Services industry to identify stocks that might be breaking out
and exhibiting good trading signals for us.
In the table below, you’ll be able to see some of the top stocks from a one month return
perspective within the Internet Software and Services industry which we identified by noticing
relative strength in the Information Technology sector:

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So, what do we do with this information? Well, we wouldn’t automatically buy these stocks for
sure but we would start looking at each company’s chart to determine whether the current
trend and price level offer us a good trading opportunity. Later in this guide, I will clarify what
I mean by a good trading opportunity. For the time being, I want to ensure that you now see
the power of using Top Down research to narrow an unmanageable universe of over 9000+
stocks to a more manageable group that we can start to spend some time researching and
conducting more in depth research on. Additionally, we should constantly be building and
updating our watchlists of stocks to monitor because these lists will be our go-to resource for
potential trading opportunities.
How to conduct top down research:
Most of the retail brokers offer this type of research on their websites under a tab labeled
"research" or something similar to that. Normally, once you click on the firm's research tab,
you'll have a sub-tab that will allow you to navigate to different types of research (stocks,
options, mutual funds, etc.). Comparative sector analysis is normally found under the
"market" research tab. Additionally, certain information relevant to sector/industry
performance data can be accessed via both Google Finance (Sector Summary, as well as
proprietary search activity measurements through “Google Domestic Trends”) and Yahoo
Finance (Investing => Industries).

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Bottom Up Research:
The other approach taken to identify stocks one might want to trade is bottom up research. In
the section above we discussed top down research where the investor starts by gauging the
overall market’s strength, seeks to identify a sector/industry exhibiting relative strength to the
overall market, and finally seeks the leading companies in that group to take a position in.
With bottom up research, the investor is looking for specific criteria attributable to a company
that he/she feels will make that company’s stock a compelling investment opportunity or at
least an opportunity to exploit a missed valuation by the market and make a trade.
What we find most investor’s doing in the beginning is relying on the media to provide them
with stock ideas. They may hear about a company on CNBC or when Jin Cramer is yelling at
them when they get home at night. Once they hear about this new company, they
subsequently start researching the company/stock (hopefully) to see if it meets their criteria
for a good investment/trade prior to buying it for their portfolio. They may look to see if it
trades within a certain P/E ratio range, exhibits a certain EPS growth, or maybe whether it is
meeting certain technical criteria in it’s chart pattern or regarding it’s indicators/oscillators.
Rather than waiting for the media to spoon feed us with a trading idea that happens to meet
our specific criteria, bottom up research allows the investor to scan the market to identify only
the stocks that meet the criteria they already use to judge an investment prior to making a
trade. By leveraging a stock screener, the investor is able to select the P/E range they are
looking for, the EPS growth number, etc run a scan on the market and be able to identify a list
of stocks that meet those criteria, effectively reducing the universe of 9,000+ stocks to choose
from down to a much more manageable list for more intense research.
For example, we may leverage a stock screener to identify stocks that have low PE ratios,
high EPS growth, increasing price performance, and a chart pattern indicative of a positive
trend/sign of support. Many of these terms may be foreign to investors that are new to
managing their own portfolio or trading. To learn the definition of these types of ratios or
indicators be sure to ask your Adam Mesh trading coach which of these criteria may be useful
as you build your trading strategy.
For those of you that have been through the Adam Mesh coaching program and have learned
the style of trading that is taught, you know that students of the program tend not to look at

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fundamental ratios like those referenced above (PE ratios, EPS growth etc) even though they
are often referenced by the talking heads on the financial news shows. Those fundamental
ratios, as discussed in more detail below are more relevant to people that are looking to make
a long term investment in a company and are concerned about the way that company’s
finances are managed and how that translates in that company’s stock valuation (price).
Students of the Adam Mesh program are taught to simplify their process of analysis to avoid
being overwhelmed by the amount of information out there and just focus on where the stock
price is trading in relation to itself over short, intermediate, and long periods of time. Adam
Mesh coaching students are taught to screen the market for trading opportunities rather than
long-term investment opportunities.
How to conduct bottom up research:
This type of research is also found under the "research" tab of most brokers’ websites and is
usually accessed through the "stocks" sub tab on that under the research tab. Once you're
on the stock research page, bottom up research is conducted by using the firm's stock
screener. This will allow you to identify the specific criteria (fundamental, technical, price
action based, etc) that you want to use to scan the broader market and identify the stocks that
meet your credentials. In addition, both Yahoo Finance and Google Finance also offer stock
screeners on their website.
To give you a sense of what a stock screener may look like, below is a screen shot of the
Yahoo! Stock screener, which offers a fairly robust list of criteria useful for identifying potential
stocks that may warrant additional analysis and attention:

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Again, the example above exhibits a bottom up search seeking stocks that fall within
particular fundamental ratio ranges, which would not be the type of criteria utilized by students
of the Adam Mesh trading group. A much different approach is taught to our students to
identify great trading opportunities in the market, which will be covered during your one on
one sessions with your coach.
Building a trading plan:
Finding a stock that is interesting to us as a trading opportunity is the easy part. Once we’ve
identified a potential opportunity, this is where the real work comes in. As human beings we
are emotional by nature, whether we’d like to admit it or not. Emotions are incredibly
dangerous when it comes to trading, as they will cloud your judgment and cause you to make
poor decisions over and over again. This is often seen when it comes to selling your stock
position.
Most people find it easy to buy a stock but struggle greatly with when to sell. For example, an
investor may buy a stock for $50 per share and be ecstatic when it very quickly rallies to $58
per share. Rather than recognizing the fact that they’ve rapidly experienced a 16% gain in a
short period of time and taking the profit, one of the most dangerous emotions of all (greed)
tells them to hold on to the stock because they’re certain it will go to $60 per share and they
want those last $2 of profit. Sure enough rather than continuing higher, the stock just as
quickly retreats from it’s rally, all the way back down to $52. Now the investor says, “I’m not
going to sell it here, I’ll wait for it to get back to $58”. What does the stock do? It pulls back
even further to $48 per share, putting the investor at a loss. Does the investor sell then?
Absolutely not. They end up riding the ups and downs on the stock, with all of the emotions
involved with them, until they can’t even bear to look at their brokerage statements anymore
without getting heartburn. There is a better way and it is by removing emotions. One of the
first things we all must acknowledge to ourselves is that we will never buy a bottom and
never sell a top. Pursuing tops and bottoms can end up being extremely costly to our
portfolio. There is plenty of real estate in between that we can take advantage of and
make great trades.
One thing I have always told clients, is that before you buy a stock you should have three

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numbers in your head: “what is your entry price, where will your protective stop loss
be, and what is your profit target?”. If you have not quantified all three of these numbers,
not only have you not done enough analysis on the stock but you are likely buying on emotion
which 9 times out of 10 will lead to a losing trade (even if it's initially in your favor). There
are many tools you can use to help quantify where your stop loss should be and where your
initial profit target order should be. In addition, many of the brokerage firms offer order types
such as conditional orders that will allow you to put in both of these exit orders at once and
not worry about missing your prices while still protecting you from leaving an open sell order
once one of the orders is executed. So how do we pick the three levels we’re going to use for
our entry/exits? This is where technical analysis comes in to play.
Essentially, by studying the stock’s price chart and it’s trading behavior, technical analysis
attempts to identify and answer some very important questions that will guide us in our
trading. The questions we are attempting to answer are: “What is the stock’s current trend?
Where are it’s levels of support? Where are it’s levels of resistance?”. The first question, and
many would argue the most important question to answer, is regarding the stock’s current
trend. As trader’s we need to acknowledge and respect the direction the market is taking the
stock and attempt to move with it. We don’t want to be betting that we’re smarter the market
and fighting the momentum of the stocks direction. There is a very well known saying that
captures this concept: “The trend is your friend until it ends”. Most people have heard
this saying and often chuckle when they first hear it due to it’s novelty but it is a very important
saying to follow. If you really break it down, it is providing a number of important messages.
Firstly, identify the stocks current trend, secondly do not fight that trend, and thirdly watch for
conditions signaling that the trend may be weakening or coming to an end.
As you’ve probably heard a number of times, a stock can only trend in three directions:
up, down or sideways. During an uptrend, the stock is seen to make new highs on each
rally and when it begins to pullback from the rally period, pulls back to a higher low. This
signals strong demand for the stock as buyers are coming in to acquire it at higher and higher
levels. As we look to trade a stock in an uptrend and to identify where our entry and exit
parameters are, we’ll need to do a little drawing on the stock’s chart to identify the trend line.
The way to draw an uptrend line is by taking the trend drawing pen in the chart software and
connecting two of the low points seen during pullbacks in the uptrend. Once those two points
have been connected, the software should forecast out the rest of the trend for us. This trend
line will help us build our trade.. Our entry point for the trade will be during the next pullback

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to the trend line, our protective stop loss will be below the trend line by a reasonable amount
in case we happen to buy on the pullback that breaks the trend (trend is our friend until it
ends) and our profit target is a new high as the stock continues it’s trend. Once we put on the
trade, we let the stock do whatever it’s going to do knowing we are positioned for whichever
outcome plays out. The uptrend might end and we get stopped out for our predetermined
loss or it will continue in its trend, positioning us for a profitable trade.
In the following image, an example is shown of a stock that is clearly exhibiting an uptrend
pattern. Notice that when the stock pulls back in price, it does so at higher and higher levels
and when it rallies in price, it reaches higher and higher prices. We use the trend line to guide
us for our entry and exit prices for this trade.
What’s important to note is that if the uptrend ends by the stock breaking down through it’s
trend line and being unable to rally back above it, the stock will likely then begin exhibiting
one of the other two trends, a downtrend or a sideways range bound trend. We will then wait
to see which of those two trends it is showing characteristics of and then attempt a trade
according to that trend.
A downtrend is the complete opposite of an uptrend in that it is a period where selling
pressure in the stock is driving the stock down to lower lows and even when there are price
rallies in the stock, they bring it to lower highs as the sellers come right back in to the market.
We do not want to be buying stocks during a downtrend (don’t fight the trend) but rather

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shorting stocks (if you’re comfortable with shorting) during the rallies to the stock’s downtrend
line. We’ll draw the stock’s downtrend line the exact opposite way we drew it’s uptrend line,
by connecting two lower high points rather than two higher low points. From an entry and exit
perspective, we’ll sell short when the stock rallies to it’s downtrend line, put in a protective buy
stop somewhere above the trend line in case the stock rallies through and then look for a
profitable buy limit at a new low in the event the downtrend continues in our favor.
The third trend a stock can be in is a sideways, range bound trend. This trend is a
consolidation period where the stock is channeling between two points, an upper level and a
lower level, for an extended period of time. The approach we will take when trading a stock in
this type of trend is to buy it as it appears to touch and reverse off its lower price level, put in a
stop loss at a reasonable distance below that level and then have our profit target order at the
upper price level. We will continue to make this trade over and over until the stock does one
of two things, breaks out through the upper price level and begins an uptrend or breaks down
through the lower price level and exhibits the beginnings of a downtrend.
In the following image, there is clearly a level of upper resistance where the stock has
difficulty trading above a certain value and a clear level of lower support where we see the
stock constantly holding a certain value and not breaking below in price:

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The second part of our saying “The trend is our friend until it ends” is also very important to
keep in mind as we need to be aware of signals that the trend we are trading could be
meeting it’s end. While trading with an uptrend stock, we must keep an eye out for past
resistance levels at these can potentially put an end to our uptrend (preventing the stock from
making new highs) and for stocks in a downtrend we need to be aware of past support levels
as these can put an end to our downtrend (preventing the stock from making new lows). So
what are support and resistance levels?
Resistance is a historical stock price that the stock has had difficulty trading above in the past
and will likely present difficulty again as the stock approaches it and attempts to trade higher.
As an analogy, many people refer to resistance as your ceiling.
The following chart exhibits a stock that has difficulty breaking up above a resistance level.

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Support is the opposite, from an analogy perspective it is your floor. Support is a stock price
where historically, buying pressure has come in to prevent the stock from trading much lower
than that level.
The following image highlights a stocks support level where even in the midst of heavy selling
pressure, buyers consistently return and prevent the stock from trading much lower.
As traders, we need to be very cognizant of these levels so we are not caught off guard by

17. 16
these levels while in a trade. This means that even if we typically make short-term trades, we
need to be looking at longer-term charts at points during our analysis to ensure we’re aware
of the stocks support/resistance levels. For example, we don’t want to be trading a stock that
on a 3 month chart appears to be in an uptrend with the sky being the limit without first
pulling up a 6 month or 1 year chart to ensure there isn’t a historical resistance level quickly
approaching. The same would go for us shorting a stock that appears to be in a downtrend
on a short-term chart but when we expand to a longer term chart we recognize it is
approaching a strong historical support level.
Another important aspect of support and resistance levels are what happens when they have
been broken. When a stock “breaks out” through a past resistance level, the level will often
become a new support level for the stock and at some point, to confirm the breakout, the
stock will pullback during it’s up move to test that new support level. An analogy for this
occurrence is someone bouncing on a pogo-stick and constantly slamming up against the
ceiling on the first floor of their home. All of a sudden, they bounce so hard that they break
through the ceiling and land up on the second floor of their house. As a result, what had been
their ceiling (resistance) is now their floor (support). The opposite would be true with support.
In the following chart, you can see that once a resistance level has been broken through and
the stock begins to trade in a new range, the price level that had initially been resistance
subsequently becomes a support level.

18. 17
If a stock breaks down through it’s support level, meaning the buyers retreat from supporting
the stock at that price, that price level will likely become a new resistance level when the
stock attempts to rally again. Just like the breakout through resistance, the stock will likely
come back to test this level to confirm the breakdown. To continue with the pogo-stick
analogy, if instead of bouncing so hard the person breaks through their ceiling, they land so
hard that the floor gives out under them they will land in the basement of their home and what
had been their floor (support) will now have become their ceiling (resistance).
In the following image, you can clearly see that when this stock finally breaks down through
its support level, that level becomes a new resistance level that it has difficulty trading above.
Charting tools to help identify your trading levels:
Every discount brokerage firm at this point offers some type of advance trading platform for
their “active” trading clients. One of the primary components of these software packages is
the robust charting window which allows the uses to take advantage of a number of drawing
tools to overlay uptrend lines, downtrend lines, support lines, and resistance lines to help the
investor visualize these levels for their trades. At least one of the platforms out there, TD
Ameritrade/Think or Swim actually shows the investors entry and exit orders on the chart with

19. 18
a line so they can get a sense of where their orders are positioned. The investor is then able
to drag their orders up or down on the chart in the event trading conditions call from
adjustments in their prices.
Chart Patterns
As discussed above, the application of technical analysis allows a trader to identify the trend
his/her security is exhibiting and determine advantageous entry and exit points to construct a
trade that offers a good risk reward with that trend in mind. Aside from just generally looking
for uptrend, downtrend, and range bound characteristics in their stocks, technical traders also
look for specific chart formations that may give them a signal that their stock is about to move
in one direction or the other. To continue with the saying “The trend is your friend until it
ends”, traders look for chart patterns that could indicate that their stock is either going to
continue it's current trend, which are referred to as continuation patterns, or indicate that the
current trend the stock is exhibiting may be coming to an end and reversing direction, which
are referred to as reversal patterns.
It is important to understand and be able to spot some of the more basic and recognizable
chart patterns as they can provide a trader with great signals for a potential trading
opportunity. To give you a quick example of one of the more basic chart patterns that may
signal a trading opportunity, we'll start with a reversal pattern known as Double Bottom
pattern. In the section on trend, we discussed that a downtrend was characterized as a stock
consistently making lower highs and lower lows. A double bottom pattern can be one of your
first signals that the current downtrend that a stock is experiencing could be coming to an
end.
So how do you spot a double bottom? Well, let's imagine a stock has been in a downtrend
and has dropped from $30 per share to $20 per share over a certain period of time. During
this downtrend there have been some rallies in the stock's price but every time the stock
rallies, the sellers come back in at lower levels and push the stock to a new low within the
trend. For this example let's imagine that the stock just hit a new low of $20 per share and
has rallied a bit up to $21.50. As expected, we start seeing selling pressure come right back
in and start pushing the stock down again. However, this time the stock does not break down
to a new low below $20 but rather holds the $20 level again indicating a potential level of

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support at that price and a potential sign that the downtrend could be coming to an end.
In the following image, a stock that is in a continuing downtrend exhibits a double bottom
signaling a possible reversal of the current trend and subsequently leading to the stock
rallying back up through it’s trend line:
As we know, when a trend ends it will become one of the other two trends, an uptrend or a
sideways range bound trend. So while it is called a reversal pattern, a double bottom does
not necessarily mean that the stock will immediately cease it's downtrend and reverse into an
uptrend (although it does happen often) as it is possible that the stock could begin a sideways
range bound pattern from there. However, this pattern will potentially clue us in to a possible
change in trend and an emergence of new price levels that can aid us as we look to identify
our entry and exit parameters.
The opposite of a double bottom is a double top pattern and it is also a reversal pattern that
we should keep our eyes out for. Just like the double bottom pattern signals us that the
current downtrend in a stock may be coming to an end, the double top pattern signals to us
that our stocks uptrend may be running out of steam. Let's imagine we purchased a stock at
$35 per share and have seen a nice upward trend in it's price for a few months since we
purchased it. During this period that the stock has been trending in our favor, we have
consistently seen the stock rally to higher and higher prices and during brief pullbacks in
price, hold higher and higher lows. When the stock hits a price of $50 per share, we start to
see a pullback as some selling pressure appears and the stock pulls back to $48.75. As we

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know, there are periods of pullbacks during an uptrend so we are not alarmed by this period
of selling. However, as the stock begins to advance again, it fails to break above $50 during
it's advance as we see the selling pressure return at the $50 price level. By looking at a chart
of this stock we would be able to visually see our “double top” at the $50 price level.
The following image provides a good example of a stock that had been in an uptrend, hit a
double top and subsequently began to reverse direction:
Identifying this chart pattern during our stock's uptrend could be a signal that the trend is
running out of steam and may be a good time for us to tighten our stop losses or start
considering some profit taking at the current levels. As mentioned in the description of a
double bottom below, seeing a double top does not guarantee that our stock is going to
reverse immediately into a downtrend but rather that the current trend may have hit a
significant price level we should acknowledge and formulate a new strategy around.
Double tops and double bottoms are only two of many different chart patterns that can be
used to identify a potential price movement in a stock that you are trading or monitoring. As
mentioned above, some of these chart formations indicate the continuation of a particular
trend while some indicate that the current trend the stock is in may be ending and potentially
reversing. To learn more about other chart patterns, including the pattern that historically
produces the most explosive returns, be sure to speak with your Adam Mesh trading coach.
A question you might ask yourself at this point is, how can I find a stock that is exhibiting a

22. 21
double bottom or some other type of advantageous chart pattern? Most of the retail brokers
offer the ability to screen the market for technical criteria of a stock including chart patterns,
giving traders like yourself another tool to identify potential trading opportunities out of the sea
of stocks that exist out there.
A quick point about momentum
Beginner traders often make mistakes in the beginning for a number of reasons. Many of the
reasons have much to do with their emotions and the way they react to their money being at
risk but one reason I believe people get into trouble in the beginning is that they are greatly
influenced by the “conventional wisdom” they hear out there about investing and trading. One
of the most repeated and well known mantras about the stock market is the old adage of “buy
low, sell high” and I think many people interpret this incorrectly which leads to problems in
their trading. The actual application of this saying tends to be most relevant for long term
investors that intend on purchasing a stock and holding it for years so they are willing to step
in and purchase it during a period of instability and weakness.
From a trading perspective, the only reason that you should be buying a stock is because you
believe you'll be able to sell it a greater price in the future based on your analysis. Since that
is your belief going into the trade, then you are conceptually “buying low, with the intention to
sell high”. Most people however, interpret this saying to mean they should be buying a stock
as it is selling off and declining in price with the anticipation that it will turn around in the near
term and start appreciating in price, leading to a profitable trade. This is the wrong mindset to
be in as we've discussed in the section on trend. A stock can remain in a downtrend for an
extended period of time and greatly depreciate in value during that period of time. If you buy
during this period, you are fighting the momentum on the stock and putting yourself in a risky
situation. We want to buy when the stock has been appreciating in price and the momentum
is in our favor, which runs counter to many people's understanding of how to trade.
Indicators/Oscillators
Another major aspect of technical analysis is the use of indicators and oscillators such as
moving averages, RSI, MACD, Bollinger Bands, etc. Indicators and oscillators are
mathematical formulas used to measure activity in the stock’s trading price and applied to
help gauge volume activity, momentum, continuation of trend, reversal of trend or other

23. 22
potential signals for the stock’s behavior.
There are a vast number of indicators and oscillators in existence out there and for each, a
trader that will swear it is the best tool to identify good trading opportunities. Rather than
overwhelm yourself trying to follow too many parameters during your analysis, it is best to not
try to rely on too many sources for signals or interpretations on a stock's potential direction.
However, with that said, using some of these indicators and oscillators can assist you in both
identifying new trading opportunities that may be unfolding as well further analyzing
opportunities that you may already be involved with.
While they are very useful to help confirm or disprove your analysis of the stock, it is
important to not become too reliant on them for your trading decisions especially in the
beginning stages of your trading. Price is always the most important factor to consider as
these are derivations and measurement of price activity. In general when it comes to
technical analysis, think T-S-R-I: “What is the Trend? Are we approaching Support or
Resistance? Then, you can gauge what are my Indicators suggesting?”
Using indicators/Oscillators in your analysis:
In addition to providing trend/support/resistance drawing abilities, the charting windows found
in the “active” trading software offered by the brokerage houses also allows the user to add in
the various indicators and oscillators they’ll use for their analysis. Most brokerage houses
also provide definitions for each of the formulas as well as how to apply them to your chart
studies. You may also discuss these formulas with your Adam Mesh trading coach to
determine which can provide you with the most useful signals.
Risk Management
Technical analysis can help us remove emotions from our trading by enabling us to quantify
where we should be buying a stock (near support or on a pullback during an uptrend) and
where we should be exiting our trades (near resistance for profit, below support line/trend line
during uptrend). In addition to applying technical analysis to our trading strategy, it is
important that we also apply overarching risk management rules that will govern which trades
we will make and what position size we will use to ensure we are managing our portfolio
correctly. Protecting principal is our first and up most concern since if our principal is lost we
will be unable to make additional trades. While technical analysis will allow us to build a

24. 23
trading plan, if our plan does not include the proper risk/reward approach and the proper
position sizing we could expose our capital to having one or a few bad trades greatly offset
our future trading principal. Like Mike Tyson says “everyone has a plan until they get
punched in the face.”
So what position size should we take and what type of risk/reward should we apply to our
trading? By waiting until we identify at least 2:1 risk/reward opportunities and initially applying
some derivation of the 1% rule, we can easily identify which trades to make, quantify what
size to trade them in, and put the odds in our favor so that even when we have losing trades,
the winners will offset those losses plus generate additional return. To illustrate 2:1 risk
reward and the 1% rule, let’s consider a stock trading in the $25 range. After studying it’s
chart pattern, we identify $25 being a historical support level and the stock is pulling back to
that level as we’re watching it. We also see that in the past when the stock has broken
through the $25 level on the down side, it has traded as low as $18 and we don’t want to be
along for that ride down. To protect our capital and manage our potential loss, we will put in a
stop loss at $24 per share. The entire premise of our trade is that $25 is support so if that
support is broken and the stock starts breaking down, we don’t want to be along for the ride.
A stop loss at $24 will protect us from this breakdown but also give us enough room that we
shouldn’t get shaken out of the stock by a quick trading anomaly that temporarily takes the
stock under it’s $25 support. Being that we are risking $1 on this trade (buying at $25 and
having a stop loss at $24) we should be fairly comfortable that the stock could rally to $27 or
above for us to be willing to make this trade. If we are confident we can achieve $2 in profit,
we will be willing to risk $1 of loss in pursuit of that $2 profit. By maintaining a 2:1 or 3:1 risk
reward, this positions us so that if 50 percent of our trades are losing trades and 50 percent of
our trades are wining trades we’ll still come out ahead in the end as our winners will out earn
the losers. What we don’t want to do is risk $1 in pursuit of $1 or risk $1 in pursuit of $.50.
So, now that we’ve identified our entry parameters for the trade we now need to figure out
how many shares of stock we should buy or in other words what our position size should be.
A rule that is often taught to new traders is the 1% rule (or 2%, or 3%, 1% being the most
conservative). This rule states that we should only be willing to risk 1% of our trading capital
on any one given trade. For example, if we have a $100,000 trading account, we are willing
to risk $1000 on any one trade. This not only helps us arrive at the proper position sizing but
means we could be wrong on 100 trades before we’re out of money. Many traders in the
beginning allow one loss to knock out 15-20% of their trading capital which is a position that’s
very hard to rebound from. So how does the 1% rule help us determine our position size?

25. 24
Well, to back into our correct position sizing we divide our risk per trade ($1000) by our risk
per share ($1 in this instance since we are buying the stock for $25 and have our stop loss at
$24). By dividing $1000 by $1, we arrive at a position size of 1000 shares. What you’ll notice
is that 1000 shares of a $25 stock is equal to $25,000 or 25% of our entire $100,000 trading
account. However, even though a full quarter of our portfolio is allocated to this trade, we are
only risking 1% of our capital by having our stop loss in at $25.
This math will work whether you are trading with a $10,000 portfolio or a $1,000,000 portfolio
and you can choose how aggressive or conservative you’d like to be be with this rule.
Obviously, the 1% rule is the most conservative approach so you may decide to apply a 2%
rule or a 3% rule. What’s most important is that you do have some form of risk management
approach in place for your trades. This is your money you’re trading in the market, that you
worked hard to earn and made decisions in life that allowed you to save it, so be sure you
don’t allow yourself to burn it all up with a few bad trades.
Traditional Order Types
Once we’ve completed our stock analysis and built our trade strategy we’ll need to enter our
orders through either our discount broker’s website or through their “active” trading platform.
When we enter our orders, it is important that we enter the appropriate order types and
understand the mechanics of each. The most basic type of order available is a market order
and usually executes immediately at the stock’s offer price (in the case of buying) or it’s bid
price (in the case of selling). In case you are new to trading, I’ll clarify what the bid price and
the offer price are. The market price for a stock is achieved when buyers and sellers come
together and agree on a price. Buyers identify the price they are willing to pay for the stock
by submitting a bid, let’s say 50.00. Sellers identify the price they are willing to sell their stock
for through an offer (or what’s often referred to as the ask price), let’s say $50.01. If you as
an investor were interested in immediately buying the stock, whoever’s on the offer at $50.01
will sell it to you at the price. This means you would be paying a penny higher than the bid
($50.00) or paying what is called the spread (the difference between where buyers are
bidding and sellers are offering). This is what would happen if you were to enter a market
order. On the flip side, if you entered a market order to sell, you would be able to sell your

26. 25
stock on the bid.
Sometimes the difference can be much greater than one penny and you may not be willing to
pay the spread or your entry point on your trade is not where the current market for the stock
is and you only want to buy or sell when the stock gets to a certain price. To accomplish this,
you can use a limit order. When entering a limit order, you actually identify a stock price that
you would be willing to execute your trade at and by definition your order can only be filled at
that price or better. For example, if the stock is trading around $50 per share but you’re target
entry price is roughly $48 per share, you would put in a limit order for $48. You can only be
filled at $48 or lower on a buy limit order assuming the market trades back down to that level
and your order is in fact executed while the stock is trading around that price area. With a
limit order, there is a chance your order to buy may never be executed if either the market
never pulls back to that level or if it does pull back but your order is behind others and isn’t
executed prior the stock rallying back from the $48 level. However, if you are executed on
your order you know you’ll be filled at $48 per share or better. So, with a limit order you are
guaranteed price but not guaranteed execution. With a market order, as discussed above,
you are guaranteed execution but not price.
A sell limit order would be used for your profit target order typically when you’re long stock (or
as an entry sell order when getting short). For example, if you bought 1,000 shares of stock
at $25 and your profit target is $27 you could place a sell limit order for $27 knowing you will
not be sold out of your order for less than $27 if the stock rallies up to and through that level.
As mentioned during the example for a buy limit order, you can guarantee price with limit
order but not execution. Just like with the buy limit, if the market price of the stock never
reaches that level or it does but only for a short period and you are not executed than you’ll
still be holding that position and will have to adjust for that.
The other traditional order type you’ll likely be utilizing to implement your strategies will be
stop orders. Stop orders come in two forms, stop loss orders and stop limit orders. Stop loss
orders are placed below the stock’s current trading price and are used as an order of
protection when you currently own the stock and want to manage the amount of loss you’re
willing to take if the position moves against you. Still using the example of purchasing a stock
at $25 per share and wanting to protect our downside, we could put in a stop loss at $24 per
share. If the stock were to sell down to the $24 level, our trigger price would be hit and a
market order to sell would be triggered as a result. As discussed above, market orders will fill

27. 26
at the highest bid price (when selling) which means we may not actually get out right at $24
but maybe around $23.95 or so. The actual price we get out at will be dictated by how
aggressively the stock is selling off at that moment. If it’s dropping very aggressively there
may not be bids until a much lower price. So as you can see, similar to a market order, a stop
loss will guarantee execution but not price. Another risk with a stop loss is that if the market
gaps down between the close of one day and the open of the next and the stock opens at a
price lower than your stop trigger price your sell order will be executed around that level.
Even with these risks, it is imperative to have a protective sell order in to manage your risk on
the downside as it is preferable to being fully exposed to an outright collapse of the stock’s
price and your trading capital with it.
The second type of stop order is a stop limit order. When entering a stop limit order as a
protective sell order you would also set a trigger price somewhere below the stock’s current
market price in an effort to manage the amount of downside you are willing to expose yourself
to. Once your trigger price is hit, let’s say $24 to stay with our current example, a limit order
to sell the stock will be triggered rather than a market order, which was the case with a stop
loss order. As discussed above, a limit order will sell only at your limit price or better which
provides both benefits and potential problems. The benefit will be that we’ll know that if our
order to sell is executed we’ll be out of the stock at $24 or better however if the stock is selling
off aggressively and trades right down through the $24 level, our sell order will not be
executed, we’ll still own the stock and will be along for the ride down. So, just like a limit
order we’re guaranteed price with a stop limit order but not guaranteed execution as the
market may trade through our level.
Modern Order Types
As the various brokerage houses and market websites have been increasing the amount and
sophistication of technology, information and analytical tools available to retail investors such
as ourselves, the industry has also modernized the types or orders their clients can enter to
implement their trading strategies. Examples of some of these more recent order styles are
trailing stop losses, contingent orders, and conditional orders.
The first of these orders that we’ll review are trailing stop orders. These orders come in both
trailing stop loss format and trailing stop limit format which embody the same pros and cons of
the traditional stop loss and stop limit orders discussed above. The difference between the

28. 27
new trailing version of these orders is that instead of setting a stagnant trigger price that the
order will remain stationary at, their trigger price will follow the stock’s price up with a pre-
determined distance (either dollar based or percentage based) during favorable market
conditions to offer more dynamic order management while still ensuring you’re positioned for
a pullback in the stock’s price. The order will only trail the stock during favorable market
movement but will not move down when the stock pulls back so at some point the two will
meet and your sell order will be executed.
Let’s continue with our example from above but instead of putting our sell stop loss order at
$24, we’ll put in a trailing stop loss order with a $1 trail price. If at the time we enter this
order, the stock is trading at $25 then our stop loss will initially be place at $24 ($25-$1 trail).
If the stock were to immediately sell off and trade down through $24 we would be executed
around $24 just like our traditional stop loss since the trailing stop loss would only follow the
stock up in favorable market movement. So let’s look at what could happen with favorable
market movement. Let’s say we put in our trailing stop loss and the stock quickly rallies to
$26.50. Shortly after the rally, bad news hits the wire about the company and it sells off in an
orderly fashion to a level of $23.50. Where would we be out of our position? Well, with the
trailing stop loss we would have been executed out of our position somewhere around $25.50
as the sell order would have moved up with the stock’s price during the rally with a $1 trail
and will not move down when the stock sells off. If we’d had our traditional stop loss in place
in this scenario we would have sold for $1,50 less as the stock pulled back to below our $24
trigger price.
These orders also come in trailing stop limit format which means that the sell order triggered
would be a limit rather than a market order (in the case of a stop loss) bringing along the
same issue of guaranteed price but not execution as reviewed with traditional stop limits
(guaranteed execution but not price with stop losses). Additionally, these orders also come in
percentage based or dollar based trails between the stock’s price and the order. In the
example used above we assumed a dollar based trail but could have used a percentage
based trail. The only caveat or I should say difference between the two is that the distance
between the order and the stock’s price will expand in the case of a percentage trail as the
stock appreciates in value (ex. If we have a 10% trail and the stock is initially priced at $50
per share than there will be a $5 difference between the order and the stock, that $5
difference will expand to $7 if the stock appreciates to $70 per share).

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Conditional and Contingent Order Types
The most recent and by far most effective and exciting addition to the world of order types
have been the conditional and contingent orders now available through most retail brokerage
firms. Conditional orders essentially expand on the ability for client’s to receive alerts if a
particular condition occurs in their stock or on an index. As has been the case for the past 10
years or so, client’s are able to sign up for alerts on their account and receive an email, text,
or notification through their trading software if, let’s say SPY breaks through a price of $125
per share. What conditional orders offer is the ability to turn that condition into an executable
order for a stock or option trade. In the past, trader’s would receive their alert notification and
if they were in the position to (near the computer/phone), would place a trade based upon the
alert. Now, trader’s are able to select conditional orders through their broker’s website or
trading software and construct and “if-then” trading scenario. As an example if a trader felt
the SPY was starting to exhibit strength and looked as if it was poised to break through it’s
resistance at $125 within the next few days/weeks, the trader could construct a conditional
order that would say :”If SPY has a last trade price of greater than $125 per share, then place
a buy limit order for 100 shares of SPY in my account at a limit price of $125.05.” This order
types means you no longer have to be worried about being away from your computer or
otherwise unable to act if a condition occurs in the market that could present an opportunity
for you to make a trade. Most brokerage firms offer conditional orders where the condition
can be based on the stock’s last trading price, bid, ask, volume, etc. Many also offer the
condition to be based on an index such as the S&P 500 with the resulting trade being on a
stock or option.
While conditional trades are very useful and exciting, the contingent order types really offer
the most utility for the average retail trader to be able to manager their trades effectively.
Contingent orders require the actual execution of a primary trade occur, and once that has
happened, enter one or more additional orders in some relation to that trade. These orders
come in a number of forms such as OTO which stands for One Triggers the Other, OCO,
which stands for One Cancels the Other, and one of the most recent and most effective which
is currently offered through TD Ameritrade, One Triggers Two. To explain how these orders
work, I will focus on the the One Triggers Two order as it is most useful for our risk managed
trading approach.
One of my earlier statements was that before you buy a stock you should have three numbers

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in your head, what is my entry price, where will my protective stop loss order be, and what is
my profit target for the trade. I continued to walk through how we would identify these three
levels using technical analysis and understanding the stock’s trend, support, resistance, etc.
From there, we wanted to only implement trades that offered us a 2:1+ risk reward
opportunity. The One Triggers Two order type allows the trader to all at once build in their full
execution strategy. For example, if we’ve been following XYZ stock and have determined that
it is pulling back near it’s $25 support level and we think it will bounce off that level and rally,
we can easily build our entire strategy with this order type. We would start with our first order,
a buy limit for 1,000 shares of XYZ at $25.10. We would then fill in our subsequent orders
which will be triggered only if our initial buy limit order is filled. These orders will be a sell
order in the form of a stop loss for 1,000 shares of XYZ at $24 and then a sell limit order for
1,000 shares of XYZ at $27. With the One Triggers Two order type, we can walk away from
the computer knowing we have effectively positioned ourselves for a sound trade based upon
our research and analysis and will now let the market determine the outcome.
With the amount of research, analytical tools, and order types available to the average
investor, there has never been a better time to trade. With that said, if this is your first foray
into trading stocks in your Brokerage account or IRA, it is important to understand industry
rules around trading activity in your account.
Cash Account vs. Margin
The type of account you’re trading in and whether or not you are trading with margin will
impact the logistics of your trading which I will explain in more detail below. When
establishing a brokerage account, you will often see an option to add a margin feature to your
account. Margin is basically a line of credit granted to you by the brokerage firm that will
allow you to purchase securities with borrowed funds. The leverage granted to a client
through margin borrowing offers the potential to profit from borrowed funds but also carries an
elevated risk of loss should the market move out of favor of their positions. As with any line of
credit, if the client borrows funds from their brokerage house they will be paying interest on
that loan. Having margin on the account also serves the purpose of creating a cushion for
trading with unsettled funds since the brokerage firm has extended a line of credit that the
trader has access to. If a client does not add the margin feature to their brokerage account, it
is defined as a cash account which means the client will be limited to the amount of cash that

31. 30
is available in his/her account when purchasing stocks. Having a cash account requires the
trader to very closely monitor the amount of cash available for trades. Being that IRA
accounts do not allow trader’s to have margin, they are defined as cash accounts.
If you have placed any trades in your accounts in the past, you’ve likely already encountered
SEC trade settlement rules which dictate that stock trades settle in your account three
business days after the trade date. Essentially, what this means is that when you buy a stock
in your account you actually don’t pay for that purchase until the trade settles three business
days later. For example, if you were to purchase 100 shares of XYZ stock on Monday you
wouldn’t actually be charged for that trade until Thursday when it settles. As a client of a
brokerage firm, when you place a trade, you are stating that you have sufficient funds to pay
for that trade. If you were to buy a stock in a cash account without sufficiently cleared funds
to pay for the trade, you will put yourself in a position of potentially violating industry rules
which could lead to your account being frozen for 90 days. The types of violations you run
the risk of triggering are good faith violations, freeriding violations, and liquidation violations
and to save yourself future frustration, it is very important you understand the mechanics of
how they could be triggered and how to avoid them.
These violations occur when a customer places a trade in a cash account without having
sufficient funds to pay for that trade. Since there is a 3 day settlement period between the
trade date and settlement, the client could conceptually deposit funds to cover that trade prior
to or on the settlement date. In the interim, carrying that position during the three day period
between the two dates is seen as an extension of credit from the broker to the client.
Extending a line of credit up to industry limits in a margin account is not an issue but when
clients trade with unsettled funds in a cash account or above their margin credit limit, they can
trigger these violations. In my former job at a large brokerage firm I constantly saw people
that were new to trading trigger these violations in their accounts, but even seasoned traders
run the risk of triggering them if they are trading very actively in their accounts without being
cognizant of when each trade is settling.
I most often saw trader’s trigger freeriding violations in their account when they were trading
actively intraday and using all of the cash available in the account to buy and sell. The SEC
requires that you pay for the purchase of a stock before you sell it or in other words prohibits
you from selling a stock before paying for the purchase. When a trader triggers a freeriding
violation, the SEC requires that the brokerage firm institute a 90 day cash-up front restriction

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on their account. This restriction allows you to trade in your account but you can no longer
purchase stocks with unsettled sale proceeds. There are a number of scenarios that could
lead to a freeriding restriction but let’s look at the following for an illustration. Let’s say a client
has $1000 of settled funds in his account and buys 100 shares of ABC stock which is trading
at $50 per share, this trade would cost the client $5000 (plus commission). The client has
$1000 settled in his account and would need to cover the extra $4000 for the cost of the trade
with settled funds by the settlement date of the trade (3 business days after the trade).
Instead of holding the trade until settlement and covering it’s cost with settled funds, the
traders sells the stock the next day for $54 per share. Since this client sold his stock prior to
paying for it, he has triggered a violation. Depending on whether the client has funds
available to settle the trade on settlement date will determine whether they have triggered a
good faith violation or a freeriding violation. If the client does not cover the funds necessary
to pay for the trade by settlement date, a freeriding violation will be triggered and the account
will be subject to the 90 day restriction referenced above. If the client does have sufficient
funds settled in the account by settlement date for the trade, a good faith violation would have
occurred. Brokers are required to monitor good faith violations in a customer’s account and
after three violations (typically) within a year’s time occur, institute the 90 day account
restriction.
Liquidation violations can also occur when new traders are not fully familiar with the
mechanics of trade settlement rules and similar to good faith violations can lead to account
restrictions after a number of violations have been recorded. These violations occur when a
trader sells a stock after the purchase date of a new trade with the intentions of using the sale
proceeds to cover the new trade. For example, a client has $1000 of settled funds in their
account and a position of 100 shares of ABC stock which is trading for $50 per share. The
client buys 200 shares of XYZ stock which is trading for $15 per share and would cost the
client $3000 plus commission. The day after the XYZ purchase, the client sells his ABC stock
with the intention to use the proceeds from that sale to pay for XYZ purchase. However,
since the trade to purchase XYZ stock will settle the day before the sale of the ABC position
the client has triggered a liquidation violation.
Just to reiterate, it is very important that you constantly monitor the cash activity in your
account and where you stand from a trade settlement perspective to prevent yourself from

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triggering one of these violations. This becomes especially important when trading in a cash
account such as an IRA or a brokerage account with no margin added. It is also imperative
that the firm you are trading through have real time accounts balances so you are sure the
system is capturing and reflecting your proper account values on an intraday basis.
Surprisingly, some of the biggest brokerage firms in the industry still do not offer real time
intraday balances so be sure to ask when you are shopping around to determine which firm
you’ll be trading with.
As mentioned above, adding the margin feature to your brokerage account will provide a bit of
a cushion that will allow the trader to use unsettled funds to trade with up to a certain dollar
value as dictated by the SEC’s Regulation T rules. Being that margin is a form of credit
extension from the broker to the client, it is regulated by the SEC in regards to the amount of
credit that can be extended to a client as well as the type of collateral eligible for the margin
loan to generated off of. If you are brand new to margin, it is essentially buying stocks,
options, futures or other securities in your account with money borrowed from your broker
while using your own cash or security positions as collateral for the loan. Most brokerage
firms will allow you to open a margin account with as little as $2000 although some may
require a larger starting balance than that.
Buying a security on margin magnifies both the risk and reward potential of your trading since
you will now be able to purchase more stock in your account than you would have been able
to by just using your own cash. For example, let’s say you think ABC, stock which is trading
at $20 per share, is starting to breakout and you want to buy 500 shares in your cash
account. You would pay $10,000 plus commission to purchase the stock. Sure enough ABC
starts rallying and your limit order to sell your position at your profit target is filled at the $24
level. You would received $12,000 minus commission in proceeds from the sale of your 500
shares booking a roughly 20% return on your initial investment amount of $10,000 (ignoring
commissions). However had you used your margin account, you could have used the
$10,000 of your cash as collateral to buy $20,000 worth of as industry rules allow an initial
margin requirement of 50%. What this means is that the cash or securities you deposit as
collateral for the loan you will take from the broker must initially be valued at 50% of the loan
amount. This builds in a buffer to protect the brokerage firm from being in a margin call as
soon as the trade occurs. We will talk about the margin call a little later. To stay very high
level and conceptual with how margin works at this point, we’ll continue with the trading
example of ABC stock. So, instead of buying 500 shares of ABC with our cash, we borrow an

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additional $10,000 from our broker and buy 1000 shares of ABC stock in our account at $20
per share. We pay $20,000 plus commission for the trade. For the entire time we are holding
this position, our broker is charging us interest on the $10,000 we have borrowed just like any
other loan we have taken in our lives. With this interest charge being taken into
consideration, margin is often used by traders on a short term basis as the longer you hold
the position, the more interest you pay, and therefore the greater the return you need to
achieve from your stock trade.
Just like in our first trade of 500 shares, let’s say ABC stock quickly rallies up to our profit
target of $24 and our limit order to sell our position is executed. This time, instead of having
500 shares of stock we have 1000 shares because we borrowed money from our broker. The
gross proceeds of this sell order will generate a $24,000 credit to our account. As soon as a
sale takes place and proceeds come into the account, they are immediately applied to the
outstanding loan balance on your account. As you can imagine, the brokerage firm wants to
ensure they are paid back the money they lent you. Right away, $10,000 will go back to pay
off the loan leaving you with $14,000 in proceeds from the sale of your ABC stock. This time,
with the benefit of borrowing funds from the broker to take a larger position in ABC stock we
have achieved a 40% return by earning $4,000 ($14,000 -$10,000) on our initial investment
amount of our $10,000 in cash (again ignoring commissions and this time interest on the
margin loan as well.) This should illustrate the primary benefit of utilizing margin in your
account. An additional benefit was referenced earlier on during the content on trading
violations, which is that the amount of credit extended to you can help build a buffer in your
account when funds are in their settlement period and there are additional trades you’d like to
implement in your account.
So far we’ve only addressed the benefits of buying a position on margin, but like we’ve heard
our whole lives, there’s no such thing as free lunch. Buying a position on margin also comes
with added risk while you are holding your stock position and it is fluctuating in value. Let’s
work through our ABC trade again but this time look at a different outcome. Initially, we only
traded with our own cash and bought 500 shares of the stock of $20 per share. If instead of
the stock immediately rallying to our profit target of $24, let’s imagine it immediately breaks
down through what we thought was the support level at $20. Ideally, you followed the 2:1 risk
reward section above and had a stop loss in at roughly $18 (risked $2 on the down side in
pursuit of $4 on the up side). If our stop loss is executed at $18 per share, we’ll have sold our
500 share position and received $9000 in sale proceeds for a loss of 10% (again ignoring

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commissions). Now, if we take this exact trade but instead of just using our own cash we had
borrowed $10,000 from the broker to buy 1000 shares of the stock, we would have doubled
our loss to a 20% loss (at least, that again is ignoring commission and margin interest). Let’s
work through the math. We buy 1000 shares of ABC stock at $20 per shares for an
investment amount of $20,000 ($10,000 is ours, $10,000 is our broker’s). The stock breaks
down through our support level and our stop loss order to sell is executed at $18 per share.
This sale of 1,000 shares at $18 per share will generate sale proceeds in the account of
$18,000. As mentioned above, any sale proceeds that enter the account immediately go
back to pay the loan of $10,000. After we’ve paid back the loan, we’re left with $8,000 which
means we’ve lost $2,000 of our $10,000 for a 20% loss (not taking into account commissions
and interest paid on the loan). So you see that margin is not all sugar and spice and
everything nice. There is additional risk involved whenever there is additional return possible.
The example above is a very clean and simplistic example of two trade scenarios on margin
and how they would impact our account. Holding a position on margin is a much more
dynamic situation than described above because of maintenance margin requirements on the
account and the impact market fluctuation can have on our position values. Maintenance
margin is the amount of equity you must maintain in the account without the broker issuing a
margin call. The SEC’s Regulation T sets initial margin requirements at 50% as we discussed
above which means that to generate a $20,000 trade we would need to have 50% or $10,000
in cash or securities available in our account as collateral for the loan. Certain securities such
as penny stocks, pink sheet stocks, IPO’s, etc are not allowable as collateral typically (just an
FYI). Once we’ve covered our initial margin requirement and the trade to purchase our
position on margin has been cleared we’re now subject to maintenance margin requirements.
Regulation T sets maintenance margin levels at 25% although many brokerage firms set
theirs higher at 30%, 40% or so.
Maintenance margin means that as the market and our positions are fluctuating in value, we
must be meeting a minimum equity of 25% or 30% (or whatever your broker sets mm at) of
our loan balance. If we fall below that threshold, a margin call will be issued and we will either
need to deposit more cash to cover that loan, sell securities and the proceeds from the sale
will go toward the loan, or the broker will sell the securities for us to pay down the loan. If we
find ourself in this situation, it probably means the market/our stock has depreciated in value
pretty aggressively and it might not be ideal for us to sell our position at such a low level.
Sometimes, if we have the cash and we trigger a margin call, it could force us to purchase

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more stock at a time when we normally would not have due to fear from the market selling off
At times this may work in our favor by acquiring additional shares at a lower level and if the
market begins to rally or bounce from these low levels we would now be along for the ride
back up with a larger position than we normally would have. This situation would obviously
be reserved for stocks we have a very strong fundamental belief in. Many times, we may not
have the cash available to cover a margin call and may be forced to sell our stock at
depreciated levels and book losses on our trades or we may have changed our outlook for the
stock and decide to cover the position. Either way, it is important to understand the risk
associated with margin from the perspective of general market volatility and how it can force
us to make decisions on our account we may not have had to if we were not carrying a
margin debit balance. What magnifies this risk is that many brokerage firms are not required
to wait for you to meet the call or to even notify you that they’ll be selling your securities to
meet the call so be sure to fully read the margin agreement when you’re filling it out at the firm
you’ll be dealing with or make this one of your questions as you’re shopping around for the
firm you’ll be trading with.
To illustrate how you might find yourself in a call, let’s work through the math on a trade. Let’s
say you’ve purchased $20,000 worth of a stock by taking out a $10,000 margin loan and
putting $10,000 of your own cash into the trade as collateral. You’ve clearly met the initial
margin requirement of 50% which allowed the trade to take place. After carrying the position
for a while the stock starts to break down and your position’s market value is now $15,000.
Your brokerage firm has a maintenance margin requirement at 40%, which means that your
equity requirement would be $6000 ($15,000 x 40%). Your current equity would only be
$5,000 since you have a $10,000 loan and the value of the position is currently $15,000. This
would put you in a call of $1000 that would have to be met with either a deposit (of cash or
securities sufficient to cover call amount) or by selling some shares to reduce the loan.
Pattern Day Trader Status
In a nutshell, margin comes down to leverage and all of the risks and rewards associated with
it. Buy borrowing money, we’re able to buy twice the amount of stock we would normally be
able to acquire with our own funds. For a confident trader who is managing risk correctly this
can be a very beneficial proposition but is obviously not without it’s caveats. Depending on

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your style of trading, exchange rules have also been adjusted over the past few years to
provide even greater leverage to trader’s who frequently trade intraday and meet the
definition of the industry’s “pattern day trader status”. From the regulatory body FINRA’s
perspective, if a trader has a margin account, generates four or more day trades during a five
day rolling period and these day trades account for more than 6% of the trading activity, this
trader will be labeled a pattern day trader. If you do not meet both of these criteria, that status
will not be relevant. From FINRA’s perspective, a day trade is the buying and selling of the
same stock intraday.
This designation will be removed from the account if after it’s been assigned, the trader does
not conduct one day trade over a retroactive 90 day period.
Under current pattern day trader status rules, the client must maintain a $25,000 equity
amount in their account at all times. If the equity falls below the $25,000 equity required they
will trigger a day trade minimum equity call and be required to deposit additional cash or
securities necessary to meet the shortfall. This $25,000 minimum equity requirement is
designed to cover any potential losses and manage the additional leverage made available to
the client with this pattern day trader designation. By having this definition, the client is
granted leveraged purchasing power equal to 4 times their NYSE margin excess for day
trades. This means instead of 2:1 leverage, the client is able to access 4:1 leverage for day
trades only. Any positions held overnight will be subjected to traditional exchange
requirements of 2:1. So as you can see, by being granted pattern day trader status and
maintaining sufficient equity in the account to meet industry requirements, clients are able to
a larger credit line from their broker to take positions up to 4 times the normal size they would
be able to purchase within their cash account.
At the end of the day, this guide has been designed to provide you with a road map on how to
navigate the vast amount of information and technology available in the market to find stock
ideas, analyze those stock ideas and subsequently implement a trading strategy around
them. Ideally, you now feel more comfortable with the mechanics of opening a brokerage
account and understanding the criteria important to decide which firm to trade through.
Additionally, you also now understand the various types of orders you can execute through
your broker to build your trades and have a clear understanding of how cash management
rules in the industry govern your trading frequency and leverage abilities. Good luck in your
trading.