Table of Contents

Foreword
The Crash
Upward Trend
It was harder than I imagined!
Score: 1-0 for the Market
The Breakthrough
Success!
Who Is This Book For?
Introduction
The Stock Exchange Is for Pros
Stock Exchange or Casino?
Who Knows How the Market Will Move?
For Success, Advantage is Vital
Precise Knowledge or Art?
The Difference between Trade and Investment
What Will You Learn from This Book?
What’s Needed for Success?
How Much Can I Earn?
How Many of You Will Make It?
Chapter 1 - Allow Me to Introduce You… to the
Stock Exchange
Who Needs the Stock Exchange?
What is a Stock?
The Stock Exchange’s Early Days
The Netherlands
 London
The First Bubble
Wall Street – The Wall and the Money
Establishing the SEC – Securities and Exchange
Commission
Meet the Stock Exchanges
The New York Stock Exchange (NYSE)
The AMEX Stock Exchange
Founding NASDAQ
Crises
The Great Depression: Black Monday and Tuesday,
1929
Black Monday, 1987
The Dot-Com Crisis
The Credit Crunch (Sub-Prime)
Crises of the Past Decade (S&P 500 Index)
Crises and Traders
Who’s Selling to You?
“Market Makers”
Specialists
The ECN Revolution
Chapter 2 - Day Trading and How to Get Started
Eight Stages on Your Path to Success
Hardware, Software, and the Internet
The Advantage of the Group: Using Trading Rooms
Your Guide to Opening a Trading Account
How to Open an Account with a Broker
Can Your Bank Be Your Broker?
How to Choose a Broker
How to Choose a Trading Platform
With Which Brokers Should You Never Work?
Should You Trade on Margin?
How Much Should be Deposited in the Trading Account?
Chapter 3- Market Analysis Fundamentals
The Price Says it All!
The Market Is Always Right!
Market Forces: Bidders and Askers
“Go in! Go in!”… When Does the Public Buy?
The Role of the Professional
Science or Art?
Who’s Afraid of Technical Analysis?
So What Is Technical Analysis?
Fundamental Economic Analysis: What Does ItIncorporate?
Fundamental Economic Analysis Versus TechnicalAnalysis
Why Do I Never the less Use Fundamental EconomicAnalysis?
Chapter 4 - The Chart: Money’s Footprint
How to Read Millions of Peoples' Thoughts
Line Chart
Point and Figure Chart
Bar Chart
Japanese Candlestick Chart
Presentation of Candles over Varying Lengths of Time
Chapter 5 - Principles of Technical Analysis
The Basis
The Trend
Defining the Trend
Support and Resistance
When Support Turns into Resistance, and Vice Versa
High and Low Points
Analyzing Japanese Candles
Narrow Range Candle
Wide Range Candle
Candle Tail
Reversal Patterns
Common Reversal Patterns
When to Hit the Button
Breakout and Breakdown Patterns
Bull Flag
Bear Flag
Cup and Handle Formation
Inverse Cup and Handle
Head and Shoulders
Inverse Head and Shoulders
Pennant
Chapter 6 - Indices, Sectors and Crystal Balls
How to Predict Movement
The Most Important Market Index: S&P 500
SPY – The S&P 500 ETF
ES – The S&P 500 Futures
Should You Trade in Futures?
What is the ES Symbol?
Summary: SPX, SPY, ES
NASDAQ 100: The Second Most Important Index
NASDAQ 100 Symbol
NASDAQ 100 ETF: QQQ
NASDAQ 100 Futures Contract: NQ
The Forgotten Index: Dow Jones, DJI
The Dow Jones ETF: DIA
The Dow Jones Futures Contract: YM
Rebalance: How to Profit from Index Updates
Sectors and Industries
Chapter 7 - Indicators: The Trader’s Compass
Volume of Trade
Volume Precedes Price
Average Volume
What Volume Changes Mean
How to Interpret Volume Increase Prior to Daily Breakout
How to Interpret Volume Increase Prior to IntradayBreakout
How to Interpret Volume in an Uptrend
How to Interpret Volume in a Downtrend
How to Interpret Large Volume without Any PriceMovement
How to Interpret Large Volume at the Daily High
 How to Interpret Climactic Volume at the Intraday High
Moving Averages
“Fast” and “Slow” Averages
How to Apply the MA
The Unique Significance of the 200MA
Oscillators
The Relative Strength Index – RSI
The MACD Index
Fibonacci Sequence
Bollinger Bands
TRIN
TICK
The VWAP Indicator
PIVOT POINTS
Which Indicators Should You Use?
Chapter 8 - Shorts: Profit from Price Drops
Crises always provided the best opportunities.
The History of Shorts
Shorting: Why?
Shorts for Advanced Traders
Short Squeeze
Naked Shorts
Chapter 9 - The Trading Platform
Practical Steps to Choosing, Configuring, and Operating Your
Trading Platform
My Trading Platform
 Choosing a Trading Platform
First Activation and Screen Configuration
Screen Configuration
1 – The Main Stock Chart
2 – The Market Index Chart
3 – The Secondary Chart
4 – The Trade Window
5 – The T&S Window – Time & Sales
6 – The Account Manager Window
7 – The Trade Manager Window
The Trading Orders
Limit
Market order
Stop order
Complex Orders
Order Routing
Routing to Different Destinations
Automated Routing
Manual Routing
Adding and Removing Liquidity
The Trading Room
Chapter 10 - Winning Trades
It’s Time To Click the Button: Best Entry and Trade Management
Methods
How to be a Breakout Winner
Consolidation
Planning and Execution
What is the Stock Volume?
How and When to Click that Button
Buying Before Breakout
Pre-Breakout Volume
The Fear of Clicking the Button
When to Sell?
How Much to Buy? To Sell?
What Happens When a Breakout Fails?
How to Short at Breakdowns
Winner Reversals
When are Reversals Preferable to Breakouts andBreakdowns?
Entering a Reversal: Market Rules
The Entry Point
Trading Gaps
Gaps Almost Always Close
Why Do Gaps Form?
Why Do Gaps Close?
Never Chase Gaps
Gaps in Dual Stocks
Market Index Gaps
Trading the QQQ
Scalping
When are Scalps Executed?
The Scalping Technique
The One Cent Scalp
The Little Red Riding Hood Trap
Pre and Post-Market Trading
Using VWAP at Opening of Trade
Taking Advantage of Round Numbers
Trading Small Caps
How Can Small Caps Be Found?
The Russell 2000 – Market Index for Small Caps
Reciprocal Range Play
Trading at Financial Reports and Announcements
How to Take Advantage of Retest
The Top Down Analysis Method
Chapter 11 - Risk Management
Learning to Play Defense
Fundamental Risks
Risk Management and Loss Management
Fundamental Capital Risk
Psychological Risk
Leverage Risk
Technical Risk
Exposure-derived Risk
The “Stop Loss” Protective Order
Not All Stop Orders are Stop-loss Orders
How to Set the Stop Point
The Importance of the Stop
Time-based Stop
The Five-Minute Reversal Stop
 Hard Stop or Mental Stop
Risk Reward Ratio
Money Management
The 3x3 Method
Noise Cancelling
Points, Not Percentages – Quantity, Not Sums of Money
Learn from Your Experiences…Keep a Diary
Chapter 12 - Choosing a Winner Stock
From the Thousands of Stocks Traded, how Can We Choose the
Best?
Using Analysts’ Reports
Managing a Watch List
Following Up on “Stocks in the News”
Mergers & Acquisitions
Staying Loyal to a Stock
Intraday Search for Stocks
Using Special Stock Screening Platforms
Chapter 13 - How to Get Ready for Your First Day
of Trading
Important Tips Before You Click the Button for the First Time
Ever
Starting Slowly
Making Millions…with a Demo
Preparing for the Day of Trading, Step by Step
How Much Time Should You Devote to Preparation?
Will the Market Go Up or Down?
The Workday Components
Chapter 14 - The Demons are Coming!
Market Psychology
Behavioral Models
Are You Psychologically Suited to Trading?
Take Maximum Advantage of Your Tuition Fees
Succeeding…the Wrong Way
Handling Loss
Identifying Loss-Derived Behaviors
Know Thy External Foe
And Know, Too, Thy Home-Grown Foe!
The Rules of Psychological Conduct
The Top Ten: 10 Things Failing Traders Say
Chapter 15 - Special Occasions, Special Rules
Prepare for the Expectable
The Last Day of the Week
Options Expiration Days
Interest Rate Day
End of Quarter Window Dressing
The Market at Year’s End
Holidays
Chapter 16 - Preparedness and Empowerment
The Fear of Taking Risks
Self-confidence
Boosting Self-esteem through Internal Communication
External Communication
Aspiring to Be Powerful
Knowledge and Action
A Role Model
Believing in Success
Coping with Obstacles
Commitment to Success
Control Your Mood
Controlling Frustration
Accepting Responsibility
Do You Like Your Job?
Preparedness and Opportunity
Success is an Avalanche
So, Make a Decision!
Meir Barak

THE MARKET WHISPERER

A New Approach to Stock Trading

The Guide to Success and

Economic Empowerment

Contento de Semrik
Meir Barak
THE MARKET WHISPERER
A New Approach to Stock Trading

Senior Editors & Producers: Contento de Semrik

Senior editor: Seree Cohen Zohar

Editor: Melanie Rosenberg
Design: Silvia Ludmer-Cohen
Photographer: Peleg Alkalai
Copyright in English © 2014 by Contento de Semrik
and Meir Barak

All rights reserved. No part of this book may be translated, reproduced, stored
in a retrieval system or transmitted, in any form or by any means, electronic,
photocopying, recording or otherwise, without prior permission
in writing from the author and publisher.

ISBN: 978-965-550-310-4

International sole distributor:

Contento BestSellers Inc.
616 Corporate Way, Suite 2-4182
Valley Cottage, NY 10989
semrik10@gmail.com
www.semrik.com

Please Note: The information presented in this book is for learning purposes only. None of
the content is to be seen as recommendations to be followed precisely, but as general concepts
intended to expand your knowledge and personal abilities. The author is not responsible for
any direct and/or indirect damage that may be caused as a result of any topic detailed in this
book. None of the information in this book is to be seen as an investment recommendation or
as an alternative to individually adapted consultancy. Meir Barak does not offer investment or
profile consultancy, and may hold or activate stocks mentioned in this book. In any event, it is
recommended you contact a legal, financial, or professional qualified consultant. Stock
trading is not suited to everyone, and is considered a tough field.
Dedicated with love to my dear partner Carina and our gorgeous
girls Sharon, Adi and Arielle, who are always supportive and have
never doubted me, no matter what idea I came up with (and there
were many) or how crazy it sounded.

And also dedicated –

To all of you who are willing to turn your lives around in order to
succeed
Foreword

The Crash
In my thirty-sixth year, I became a penniless father of three little girls,
the youngest of whom was three months old. The business I’d
nurtured for thirteen years had just slipped between my fingers.
Identifying the brewing problems before I did, my business partner
had embezzled the last few thousands of dollars left in our bank
accounts. Our employees jumped ship. I was saddled with a debt of
some half-million dollars to banks and suppliers. What did I have in
abundance? Tears.
To fall so low is a situation I’d wish upon no one. Money pressures,
I quickly discovered, cause psycho-emotional pressures: depression
that manifests in loss of appetite, lack of motivation to work, and a
growing inability to sleep. I had no clue how to cope with these
problems. All the business management literature I’d been exposed to
dealt with “how to succeed” and “how to earn millions.” But when did
you ever see a book of tips for those owing millions? No doubt this is
because “losers” aren’t expected to write books and are not assumed to
have interesting life stories. And who would want to read a loser’s
story, anyhow…
Fascinatingly, all the business consultants who’d earned income
from me over the years evaporated as soon as the fountains of money
dried up. I’d hoped that at least the police would help in retrieving the
funds my partner had stolen; I hoped in vain. With very apparent
indifference, they completed the complaint forms, had me sign a
declaration, and sent me away to fend for myself. Three years later,
when I decided to lodge a complaint against the police department’s
handling of my file, an investigator called me in and threatened that if
I didn’t withdraw my objections, I’d be charged with submitting a false
claim. Clearly, all the taxes I’d paid over the years were also of no avail
in protecting me.
The downward spiral continued. Initially, banks sent me politely-
worded payment demands. Next, lawyers sent somewhat less polite
letters. They wanted their money, and they wanted it pronto. They,
too, began to air threats while foreclosing my accounts and
simultaneously adding fuel to the fire with more fines, commissions,
and interest at gray market rates. In less than a year, a half-million
dollars ballooned into one million. What does one do? How can the
debt be covered? What about the house and mortgage? How can
interest be repaid when it charges ahead at the speed of a red Ferrari
Turbo?
Most people who find themselves in this situation declare
bankruptcy, raise their hands in despair, and disappear from the
market. Today, I understand them. Very few of them ever return to
business activities. But I was never part of the majority crowd. Instead,
I took the advice of a lawyer who deftly gave me one of the best, most
effective pearls of wisdom I had ever heard: “Don’t seek the protection
of the courts of law. Don’t deny the debts. Admit they exist, speak to
the debtors, reach an arrangement, and pay them off!”
I did as he had suggested. The banks gave me some breathing
space, reduced the debts and interest, and left me some room to
maneuver, hoping that I’d repay the debts. That was all I needed.
Instead of weeping over my bitter plight, their flexibility was a huge
motivator to return to business activities and take my future in hand.

Upward Trend
It was 2000, the slowdown of the tempestuous hi-tech run-up to Y2K.
A short while before the dot-com bubble burst, I held rich business
experiences and numerous ideas for innovative Internet products that
would conquer the world during the period when millions of dollars
still flowed freely to Internet startups. Within just a few short months,
I established a fantastic startup, recruited partners, and raised several
million dollars. Money was flowing again.
 The hi-tech life was good to me. But like so many others in hi-tech,
especially after the bubble had burst, the market collapsed, and
investor funds ran dry, I felt as though I was stuck in one place. I was
bored with waking up early every morning, getting to work before
traffic started, returning home late after the traffic jams, and catching
up with my family pretty much only on weekends. I experienced a
mini-crisis one day when my wife asked me to take our little girl to
kindergarten, which I happily did. But when we arrived, my daughter
turned to me and said, “Daddy, that was my kindergarten two years
ago…”
I sought a way to leave the rat race, pay back my debts, and make
that one big hit. I also wanted to move into a lower gear and be closer
to my family. In short, I wanted to make millions without working too
hard.
There are very few legal ways to earn large sums quickly. I reviewed
the options, and chose an area I’d always loved: stock trading. From
short-term trading, so I’d heard, you could get rich quick.
I did very well. Within five years I was able to leave hi-tech, repay
all my debts, and become very comfortable. I went from a negative
balance of millions of dollars to a surplus of several million. I live the
American dream. The stock market made my dream come true. How
did it happen?

It was harder than I imagined!

It’s amazing how things are cyclical. Just thirteen years ago, I was still
a diligent hi-tech employee with no clue about the markets. The only
thing I did know was that loads of money shifted there, and I was
determined to get my hands on some of it.
My first problem, which everyone wishing to succeed must face,
was: should I give up my salary? Should I take the risk, leave my job,
and try a new direction? Only very few are prepared to do that. Most
of us are just too scared, and for good reason. I understood that if I
were to realize my dream, I’d have to take that risk.
Back then, I thought stock trading would be child’s play. I opened
an account with a broker (I’ll explain how and why later) and
innocently believed I’d succeed to buy cheap and sell high. How did
that first year end? With a loss, of course. Now, twelve years later, I
know I was clueless, lacked experience, and was somewhat arrogant.
In actuality, I was ripe prey for the pros. It took me a long time to
discover that behind every stock market deal are two sides: the pro
and the idiot. For the first year, I usually filled the role of the latter.
Score: 1-0 for the Market
There are moments in life that become etched in our memories until
the day we die. Do you remember where you were when the Twin
Towers came down? I certainly do. Similarly, I remember my very first
transaction.
On the day I opened my first trading account, I rushed to buy 1000
stocks of TEVA Pharmaceuticals. My very first trade! I was so excited. I
remember my pulse hammering away. The whole thing was a rush. I
didn’t see or hear anything else around me, I was so thrilled. The
outside world just seemed to disappear. There was a cone of silence,
inhabited only by me and my stocks.

SMART Behind every stock exchange transaction,

there are two
MONEY parties: the pro and the idiot. But
sometimes, the idiot
lucks out!

I was glued to the computer screen, counting anxiously, watching

every movement of every cent. Suddenly, when the stock went up ten
cents, I got scared it would drop down again, and I pressed the sell
button. Idiot! TEVA climbed $1.50 over several hours. A potential profit
of $1500 ended up being a mere $100. Never mind. Not so terrible for a
first transaction. I convinced myself that I was pleased as could be.
Then, suddenly, doubt rose in my mind: did the sell order really go
through? I knew I’d hit the sell button, so why did the trading
platform still show those 1000 stocks in my account? To be on the safe
side, I hit the sell button a second time. Whew! Now it indeed seemed
like I’d succeeded. My heart rate slowly returned to normal, and I took
a drink of cool water. Three minutes of effort, and a profit of $100.
What a financial genius I was! Not bad at all for my first effort as a
trader. Or so I thought…
I celebrated my success and opened the trading platform again an
hour later. To my horror, I discovered my account showing a loss of
$400 caused by a “short trade” of 1000 shares. What on earth was a
“short”? From the little I knew, a short was a method for profiting from
a dropping stock. What I couldn’t figure out was how the devil I got
into this, and how to get out of it. Meantime, TEVA continued to move
up like a rocket shooting for the moon, and for every cent it climbed,
$10 was being wiped from my account! Not a happy moment.
I did know that being in a short with a stock running up is not a
good idea at all. Pressure, sweat, a day’s salary gone in an hour, TEVA
not stopping to breathe for even a moment, and my trading account
evaporating before my eyes! What should I do next?
I phoned the broker’s client service center. After some nerve-
wracking Muzak-filled minutes, my answer came through. Apparently,
to exit a short of 1000 shares I needed to buy 1000 shares. I bought and
closed the platform. What a relief. Later I understood the sequence of
events: when I had sold the first time around, the trade platform had
not updated immediately, making me think the sale hadn’t gone
through. But it had; so that when I pressed the sale button again, I was
actually telling the system, “I’ve just sold 1000 shares I don’t have.”
That put my account into a “short.” But don’t worry, we’ll learn what
that is later in the book.
My first day of trade ended in burning failure. Score: 1-0 for the
market.

The Breakthrough
Call me persistent, call me stubborn, but I wouldn’t give in. I
continued buying, selling, and losing for almost an entire year. As time
passed, more and more questions surfaced, yet remained unanswered.
A year of losses taught me one certain thing: trading is a profession
like any other, and like all professions, you need to learn to become
successful. I set out looking for help.
To be a stock trader, you don’t need a diploma. Everyone can open
an account, trade, and make pointless moves, just like I did. That’s
also why most traders fail. I knew there were those who succeeded,
however, and I believed I could find ways to become part of that group.
I sought them. I found them.
Before the Internet, trading rooms could be found throughout the
United States. This is where traders met, working together as
professionals. In today’s Internet age, most trading rooms have closed
down, and activities have moved to chat rooms which any trader can
join for a monthly fee. These rooms are where you can hear
professional traders, whom we at Tradenet call “analysts,” discuss
trends, listen to their instructions, ask questions and basically trade
with them in real time without ever leaving your home. I was so happy
to join one of those trading rooms, and immediately felt like I’d come
to the right place.
What an amazing world I’d discovered. The analysts bought and
sold, in real time, successfully. Two analysts, Mark and Chris, are well
known and have become my friends. They are the people to whom I
owe most of my basic training. It seemed my path to success was
paved. All I needed to do now was to listen to the analysts and copy
their moves. So simple!So why was it so difficult?
What can be so difficult about copying a professional trader’s
actions? The answer is simple: because we all have our own level of
comprehension about what is unfolding before us, and we decide to
do things differently for our own reasons. Here’s an example: Chris
buys a stock that goes up 4% today, based on his feeling that it will
continue to rise, whereas I think, “Is he crazy? He’s going to lose. It’s
already gone up a lot!” Over time I saw that whenever I couldn’t
precisely understand Chris’s decision, I couldn’t accept it either.
During that period, my trades looked more or less like this: Chris
bought. I bought. I flee with my small profit, afraid to lose what I’d
already profited. Chris waits, and makes a handsome profit. In other
instances, when the stock was trending down, Chris would quickly get
out, while I would stay, hoping that it would come back to my cost.
Eventually, I’d be forced to exit with an unpleasant loss. In short, Chris
would profit and I’d lose. Yes. It was definitely time to start learning.
Statistics famously tout the figure that 90% of active traders lose
money. If you are among them, the solution is simple: do exactly the
opposite of what you think. At first I had trouble figuring the upside
down logic of the profession. I found that precisely those stock trades
I considered risky, if not downright dangerous, revealed themselves as
the biggest winners, whereas the ones I would choose and which
appeared to be less scary and more reliable, were less successful. Of
course, in my early trading history, I chose only those that failed.
But over time, I also discovered this tendency was not exclusive to
me. It’s very natural for an experienced trader to view the market
completely different than a beginner. To succeed, the beginner needs
to learn the basic principles, and slowly undergo a psychological
revolution. Because I’d skipped the stage of learning fundamentals and
jumped straight into the deep end, I concluded that I needed to
understand the market. It was time to “go back to the drawing board”
and learn the basics.
I knew what I had to do. I contacted Chris, the head analyst of the
trading room, presented myself as a member, and asked him to be my
personal mentor. I was very happy when he agreed, and we settled on
a fee. I packed a bag and took the first flight out to his home in
Phoenix, Arizona.
I remember our first meeting like it was yesterday. I was shocked to
meet a “boy” in his early thirties, who already had many years of Wall
Street experience under his belt serving as a “market maker” for a
well-known trading company, and later as an independent, successful
day trader. Two black cars, both Lexus models, were parked at his
luxurious home in a wealthy suburb of Phoenix, making it perfectly
clear with whom I was dealing. Chris came from an average family,
and had made most of his money as a day trader. Like so many others
I met over the years, Chris left an excellent job that brought him
hundreds of thousands of dollars each year, in order to earn his own
way as a day trader!
 SMART The market operates according to known
rules. There is no need to invent a new
MONEY method in order to earn money. Just adopt
the existing ones.

In Phoenix, the market opens at 6:30 in the morning. We started

our day of study at 6:00, and when trading was over at 1 PM, we were
off to play golf. I was dumbfounded at Chris’sworkday structure; I was
amazed at his self-control, and awed by his familiarity with the
market. I was completely bowled over by the inherent potential for
moneymaking through trading.
The stock market operates according to clear rules, I was surprised
to learn, and these are known chiefly to the professionals who make
their livelihood through trading. It would be too obvious to say that
from that day on, my life changed beyond recognition.

Success!
Within just a few months of my return home, I went from losing to
breaking even, and then from breaking even to profit. Some two years
after I made my first transaction, I succeeded in generating a monthly
income that allowed me to leave my job. Within just a few years, I
moved from hi-tech employment to the freedom of a home on the sea,
playing golf, swimming in my private pool--and no more than two to
three hours a day of pleasant trading. I had just achieved the
American dream.
I was proud of my achievements and loved trading, but more than
all else, I enjoyed teaching new traders. At first I taught several friends
at home, using the same method Chris had taught me. Friends I’d
taught for free brought their friends, who became paying members.
Some were from the hi-tech realm who wanted precisely what I had
done: to change the course of their lives.
They studied, they traded, and they joined the trading room
alongside Chris and Mark, until that remarkable moment when most
of the trading room’s members were… my students! At this stage I was
awarded a position as an analyst, together with Chris and Mark.

Simultaneously, wishing to divert the stream of students away from

my private home space, I established Tradenet, the school for day
trading. Over the years, Tradenet has become one of the largest in the
world, with branches in many states, trading rooms in diverse
languages, and the training experience of tens of thousands of
students. Throughout Tradenet’s existence I’ve continued, with only
rare exceptions, to trade daily from home. I’m not prepared to give up
on the comfort of working from home. Life is short, and every
moment should be enjoyed!
From an economic viewpoint, I’ve been“comfortable” for a long
while now. I don’t need to sell books, teach or even trade in order to
earn my living. But I’m writing this book nonetheless because I love
my profession, and I love to teach. Deep in my soul, I’m a true teacher.
That’s where my greatest satisfaction lies. Now that I’ve changed my
life and that of so many others, I consider it my obligation to write
this book, which can help change your life too.
I have reached the stage where I feel the time has come to share my
secrets and my experience in the hope that you, too, will take a small
step forward on the road to financial independence and live the good
life you were meant to lead. I know how to teach you to join the pros
and make big money, but I’m also offering this warning: if you’re not
determined and committed to success, you’ll lose money. You have to
want to become successful and be willing to learn and make mistakes
along the way.

Who Is This Book For?

This book is for all those who want to change their lives, improve their
incomes, and most importantly, enjoy the thrill and fun of trading
stocks.
This book is for all those who have zero knowledge, background or
experience in trading or in finance, which was my position just a little
over a decade ago. Even if you do have some experience with the
capital market, you’ll find the rules of professional trading different
from those with which you’re familiar.
This book is for you, especially, if you have a degree in Economics.
You’re in an even worse position than others, so forget the degree.
You’ll find that the stock exchange’s behavior is nothing like that
described in your textbooks!
Introduction

The Stock Exchange Is for Pros

Always remember that when you buy a share of stock, someone is
selling it to you. Some people seem to think that “the bank” or “the
broker” is selling it.
That’s not the case. The person selling the stock believes it is
valuable at precisely the same time as you’re thinking it’s cheap. In
other words, if you buy at a price that the seller feels is expensive,
what, in your opinion, is the seller thinking about you?
Correct. The seller is probably thinking you’re an idiot. When the
seller is a pro and you’re not, he’s almost always right.

SMART A pro trader once told me that a pro’s job is

to nd the idiots willing to buy from him…
MONEY

The stock exchange is my place of work. I am a pro. I make my

income from people who think they can take my money. The only way
the cash flow in my trading account will grow is if I make someone
else’s smaller. I profit from the money lost by investors, the public, or
the herd that doesn’t understand the rules of the game. Only a very
few lucky folks along the way have used their courage and
determination to profit and lead the rest of the herd.

Stock Exchange or Casino?

A dictionary entry defines the stock exchange as “an organized market
in which businessmen meet in order to sell and buy stocks or
commodities such as diamonds, cotton, coffee and sugar.”
Such sweet talk! Such a lovely, respectable place to work that must
be! Businesspersons meet and earn profits. Every mother’s dream-
come-true for a successful child!
Now I will offer my definition. A more correct and precise one
cannot be found in any dictionary. “The stock exchange is a gambling
club in which the house members (pros, institutional traders, the
State) take advantage of the public’s greed in order to profit from their
mistakes.”
Yes, I said “take advantage,” no less! Words such as equities, stocks,
bonds, options, and futures hide a far greater truth known to the
professional players in the capital market: “Profit at the public’s
expense.” Call it “commissions,” or “management fees.” Call it “capital
gains tax” or whatever you will. Once the professionals and the
country have stripped you of these, you’re left with no money. Instead,
they’ve scooped it up. To the professionals’ amazement and sheer joy,
this truth remains concealed from the biggest player of all in the stock
exchange: the public. I have frequently said this, and will repeat it
once more: if you’re not a professional, do not go anywhere near the
stock exchange. The more I say it, the more people think I’m just
crazy. Conclusion: if the public’s compulsion to gamble cannot be
suppressed, there is only one thing left to do: profit from its money.

Who Knows How the Market Will Move?

The person able to constantly, correctly foresee how the market will
develop, or how a particular stock will move, has yet to be born.
Nonetheless, there exists a multitude of analysts and fund managers
who claim otherwise, attempting to justify an investment with
academic intellectualism, and thus preserve their source of income.
The well-oiled academic system and stock market requires self-
nurturing, justifying its “raison d’etre.” I have no reason to be angry
with the system, because it’s impossible to fight human nature. It is
quite reasonable that those involved would want to justify their
knowledge, and preserve their incomes. Most mature and smart folks
in the stock market would privately agree with methat in actuality
they know nothing at all of the future. But they would never admit as
much in public, as a public admission is tantamount to announcing
the failure of the entire enterprise. They are comfortable with
cooperating with the system and continuing to assure the public by
offering empty promises, which they hope will be realized with a good
bit of luck.
Trying to predict the future can be compared to traveling in a fog.
At a distance the fog looks thick, but seems to thin out as it gets
closer. So it is with the capital market. The shorter we make the
prediction framework, the clearer things become, even if there is still a
degree of fog preventing us from seeing things perfectly. If I ask you
where you will be in exactly six months, can you provide a precise
answer? If, on the other hand, I ask where you will be tomorrow
morning, it is more feasible that you will know and end up being
correct.
Nor am I any different in this respect. I, too, lack any knowledge of
how the market will play out. By contrast, sometimes when the fog
clears a little, I can, within reasonable bounds, successfully predict the
direction of the market or a specific stock for a span of several
minutes, several hours or even several days ahead. In those rare
instances when the fog entirely lifts, we can even see several weeks
ahead.

For Success, Advantage is Vital

Making a living requires an advantage. What’s your profession? Do
you have some kind of advantage? Of course you do! If you had no
advantage to offer, your client would go to your competitor. As with
every profession, the same is true for stock traders. You need an
advantage!
Trading is like managing your own business. As with any business,
if you fail you’ll need to close the business, fire the manager (that’s
yourself in this case), and find a new source of income.
Prior to investing in any business, you need to ask the following:
Who are your competitors? How can you beat them?
The owner of a business needs to understand his or her advantage.
Is the advantage in quality? In service? Location? Products? Without a
clear advantage, your business will fail.
 A stock is a commodity like any other commodity. Don’t buy stocks
if you have no clear advantage to offer. If you’ve decided to become a
stock trader, you must be able to identify the advantage and make the
best use of it, operating just as you would in any other business
activity.

Most of the public is defined as long-term investors. They believe in

their ability to identify companies which, over a long term of some
months or even years, will rise in value. The media is full of
calculations showing the millions you could have made had you
bought 1000 Microsoft stocks in 1980. Warren Buffett is known for
having made billions through long-term investments. Generations of
investors were nurtured on these tales of good fortune and attempts to
duplicate them.
Wake up! Just because a select few got lucky does not mean that
most people make money investing in the long term!
History ignores the greatest majority of investors. That’s the 90%
who lose their money. Many investors who made hundreds of percent
profit in the 1980s and 1990s lost everything in the decade between
2000 and 2010.

Example
Let’s examine what might have happened had you bought the ETF
(Exchange Traded Fund) of the S&P 500 known as SPY in January
1999, and sold it in August 2011:

In January 1999, you would have paid the identical amount for this
ETF as in August 2011, whereas in that same timeframe, you could have
received a risk-free yield from any bank of at least 50% based on
interest rates at the time.

The Long Term

Let’s assume you’re reading an article about a company with
wonderful prospects. Let’s assume that the analysts also like this
company. Do you have any advantage? You and another half-million
people have heard about this company and read the same article.
Where is your advantage over other readers? The public company’s
typist, who for a minimum wage typed up the quarterly report before
it was published, knows more than you. The typist has the advantage,
not you.
• No one can predict price movement over the long term. I can’t, you
can’t, nor can the best analyst in the world. Beware of anyone who
claims otherwise.
• Always remember: there is someone who will profit and someone
who will lose from every analyst recommendation.
• Remember that behind every stock transaction, there is a buyer or
seller who feels he or she is smarter than you.
• Remember: the big money is not where information is clearly
divulged to the public. If 90% of investors lose their money, then
they’re clearly doing something wrong!

The Mid-Term
A range of several weeks to months is the inherent advantage for
hedge funds. They operate with large sums, making it difficult for
them to maneuver in the short term, and they are justifiably fearful of
the long term. Due to the capital they hold, they can support stock
prices for periods of time, which increases their chance of profit. Their
advantage is in shifting large amounts of money and being somewhat
skilled at knowing where money is currently flowing. Although
sometimes they also lose.
The Short Range
The very short term, measured in seconds or minutes, is the market
makers’ and specialists’ advantage, which we will learn more about
later. They, in contrast to the rest of the general public, pay no
commissions. They receive the commissions! Because their role
involves coordinating real-time buy and sell commands, they know far
better than we do which direction the wind is blowing, and they take
advantage of the very short term. You will never find them buying a
stock because they believe in the company’s product or management!

An Example of “Advantage”
When long-term investors want to protect their investment in a stock,
they generally use a protective “stop order,” which will automatically
perform a sale if the stock price drops lower than a specific figure. The
stock exchange’s hours of activity overlap the working hours of the
average investor, making it difficult for such a person to constantly
follow the price movementin real time. The average investor relies on
the broker to carry out the automated stop order.
How does that help us? Average investors, whom we will call “retail
investors,” review their investments at the end of each week and place
protective stop orders into the system according to the price
movement during the week that passed. These stop orders await
automatic execution while the retail investors are at their day jobs.
The automated stop orders will be executed when the preset
conditions appear.

Our advantage:
• Looking at the stock’s graph, it’s easy to estimate the point where
automated stop orders will be executed. Can this information be
used to someone’s advantage? Of course it can!
• Let’s say that at a certain price, we see a strong chance for a heavy
concentration of stop orders.
• In other words, if the stock price drops to this figure, a large number
of stop orders will go live, which could likely push the stock price
down further.
• Can we profit from the expected drop? Of course! We can sell “short”
(which we’ll learn more about later) and profit from the price drop.
This is how making use of information can be an advantage.
I relate to stock trading just as any other business. I won’t trade
without an advantage. I know that competitors are operating against
me and want my money no less than I want theirs. I know that to
survive and profit, I must identify my advantage and maximize it. I
recommend that you, too, relate to your money with due respect and
conduct yourselves accordingly.

Precise Knowledge or Art?

Day trading stocks is an independent profession in which we buy
cheap and sell at a high price, taking advantage of other players. As
traders, our goal is to succeed in about 65% of the trades that we make
over time. Day trading is a simple profession to view, but difficult to
implement. It’s simple, because the rules are simple. It’s difficult
because of the psychological inhibitors that express both our fear and
greed.

SMART Day trading is an art integrated with

precision knowledge. The rules for the
MONEY precision knowledge can be learned, but
the art needs to be developed.

Day trading lies partway between relying on precise knowledge and

being an art. Day trading will not be successful if based on technical
analysis alone. If that’s all that was needed, it would be accounting. A
winning trader succeeds in merging knowledge and artistry. This book
sets out to provide you primarily with knowledge, and a touch of
artistry. The artistry is up to you to garner as you work hard and
accrue experience. You can teach someone to paint, but only a select
few will go on to make works of art that others appreciate and place a
value on. The same is true of trading.
The Difference between Trade and Investment
As you’ve surely realized, this book does not deal in stocks as an
investment, but rather in stock trading, which is actually no different
from any other field of business. An art dealer, for example, is very
different from an art collector. The art dealer will not buy famous
paintings and store them in the safe for decades, hoping their value
will rise. The art dealer buys a painting only if he or she estimates
there is a certain range of profit in a short-term sale. Like all of us, the
art dealer needs to pay a mortgage and cover food and other living
expenses.
The stock trader is just like the art dealer: both buy and sell in
order to create the profit that provides for their livelihood.
Professional traders buy stocks at a price they know is too low, with
the intent of selling at a price they know is too high. Stock traders also
make mistakes. But a stock trader who succeeds more often than errs
can make a living from the profession.
In contrast to the trader, investors do not try to earn their living
from the market. Investors turn their funds over to the management of
others, or manage their funds by themselves in the hope of positive
yields. Investors may improve or worsen their long-term financial
status, but cannot assure payment of their credit card bill at the end of
each month. A trader plans in advance how much money to risk with
each transaction, whereas the investor might, during tough times,
discover that most of his or her money has evaporated. Traders sleep
peacefully knowing that most of their money is in cash, whereas the
investor is exposed to market fluctuations.
Traders use “fast money.” Investors use “slow money.” Can $100 in
the hands of a trader be the same as $100 in the hands of the investor?
Not at all. When the stock exchange ends the year with increases at
6%, the investor’s funds have followed all trends over the year, and
therefore these funds are called “slow money.” By contrast, traders
enter and exit on each day of trade. An overall yearly change of 6%
comprises hundreds of trade days and tens of weeks during which the
market rises or drops several percentages. Traders follow these ups
and downs, and unlike the investor, traders use that same $100 many
times, sometimes thousands of times over. The trader’s money is “fast,”
as it enters and exits the market incessantly. We could say that a
trader’s money works harder. The investor’s money is “slow.” The
trader’s “fast money” piggy backs on the “slow money.”
Trading is my profession. Investment is not. I don’t negate the
validity of investment, especially if you’re good at it. But I do know
that investments will never lead to a monthly salary from the market. I
do believe that most of your free money should be invested, if not in
the stock exchange, perhaps in real estate. But that’s not my field of
expertise.

What Did I Know about the Stock Exchange

When I Started Out?
Nothing. A little more than a decade ago, I started from scratch. I
didn’t know how to buy or sell stocks, and I knew nothing about the
fundamental concepts. One important rule was clear to me, however:
money in the stock exchange, as in any business, is earned by buying
cheaply and selling for much more. In point of fact, there’s not much
difference between selling vegetables in an open air market and
trading stocks on Wall Street, apart from the fact that you’ll find more
books have been written about Wall Street. Add to stock trading the
comfort of working from your home, plus the potential for high
profits, and you have the best recipe for self-employment.
Stock trading is a simple profession. People tend to make simple
things complex. I believe that all any reasonable person needs for
success is the absolute determination to win. Even if you are clueless
and have no experience, don’t be deterred. You’re starting out at
exactly the same point I did.
This book is meant for you. It will lead you, step by step, at your
own pace, to a broader understanding. You need to make an
uncompromising decision to succeed. Now, to be absolutely certain
you’ll let no obstacle stand in your way to success, close the door to
your room, take a deep breath, and shout at the top of your lungs: I’m
going to make it!

What Will You Learn from This Book?

• Fundamentals of trading
• Choosing the right broker and trading platform
• How to choose winning stocks
• How to profit from rising or falling markets
• Technical analysis
• Basic and advanced trading methods
• Financial and risk management
• Trading psychology
• Self-empowerment
Having trained thousands of traders, I know just what tools you’ll
need to conquer the market. I know where to direct your focus, and
what to warn you about.
This is a practical and professional book written by an experienced
trader who trades daily with his own money.
This is the first, and last, book you’ll ever need in order to succeed
in day trading.

Who’s Afraid of Being Independent?

Stock trading is an independent business. When you trade in stocks,
you’re exposed to financial risk, as in any business. A salaried
employee who fails will never return his salary to his employer, even if
the employer incurred a loss. At the most, the salaried employee will
be fired. A self-employed person will pay for every error with his or
her own money. By contrast, a self-employed person who is successful
will earn far more than the wildest dreams of the average salaried
employee.
Do you have it in you to be self-employed? Are you prepared to
work without a salary and risk your money? Are you psychologically
ready for the risk? I encounter all kinds of students. Sometimes a new
student will ask, “Meir, I understand I won’t earn big money at the
outset, but can I be sure that within the first few months I’ll earn at
least as much as an average salary?” Oops! An employee-based
question. A self-employed person would never ask such a thing. Being
salaried is not bad, but to be independent, you need to be made of
something tougher. A self-employed trader can work less, enjoy more,
and profit ten times higher than a salaried employee, but must be
willing to take the risk. Be warned: without the willingness to risk
your money, you’ll get nowhere in trading.
Let’s now assume you’re ready to take the risk and are determined
to become independent. You can still have alternative business
interests other than stock trading. At this point, we need to draw up
some comparisons:

Commitment. Most businesses require a brick and mortar office,

usually rented. Rent is a long-term commitment: rent payments,
management fees, municipal taxes, electricity, water, maintenance and
more. By contrast, a stock trader works from home. Your current
expenditure might grow slightly, but there are no long-term
commitments.

Responsibility. A business requires employees, consultants, an

accounting staff, legal counsel….a great big headache and heavy
responsibility to provide for individuals who are dependent upon you.
Knowing that in the good old days I needed to be responsible for
paying my employees’ salaries caused me many a sleepless night over
the years. A stock trader doesn’t employ anyone. It’s the trader, the
computer, and the Internet. A huge advantage!

Investment. Every business demands investment: vehicles, office

machinery and supplies, advertising, printing, premise renovation and
more. In addition to a significant minimum investment, you’ll need
working capital to ensure ongoing activities until a positive flow
develops. The stock trader needs a good computer, several screens,
and working capital that allows opening the trading account and
having funds to trade. That’s it!
 The risks. It’s rare to see a business close without causing sorrow
and pain. Businesses close in hard times. Debts pile up, employees
pressure for raises, and banks suddenly cut off their lines of credit,
leaving the business without oxygen. Assets and stock, which under
regular circumstances are worth their purchase value, are thrown out
or sold for pennies. A stock trader can limit losses to a specific part of
his or her investment. Show me any other business where you can
limit your loss!

The possibilities. In most businesses, it’s hard to be creative. The

sorry fact is that most self-employed people make less than salaried
employees. The professional stock trader does not operate within a
competitive business reality that limits his or her possibilities. The
sky’s the limit!
Not everyone is suited to being a stock trader, just as not everyone’s
suited to being self-employed. Setting up a business requires
commitment, responsibility, investment, and risk. If I had to choose a
field to be self-employed in, undoubtedly my top choice would be one
with the lowest risk and highest possibilities.

From my experience, I’ve learned that the chances of success for a

beginning trader who must earn a livelihood from trading are far
lower than for those who simultaneously maintain their original
source of income. I want you to start out small and at the same time,
maintain another source of income. I want you to succeed slowly and
safely, knowing you have a secure amount of money coming in,
reducing the pressures to generate immediate income. If you’ve left
your job or are between jobs, don’t rely on trading profits. If you don’t
place all your hopes on trading profits, you’ll profit. If you feel
pressured to profit, you’ll end up losing.

What’s Needed for Success?

A successful trader needs three basic components:
• Thorough knowledge and follow-up at the beginner stage
• The proper trading environment: that is, a quality computer and a
hi-speed Internet connection
• An account with a professional broker who can provide fast, effective
charts and executions.
We will discuss all three elements throughout the book.
The chain is only as strong as its weakest link. Each of the
components below is important to your chain, which is your business.
If you want your business to do well, invest in each of them, from the
enrichment stage (learning) to the daily tools stage (trading system).

How Much Can I Earn?

After completing the training stage, you need to set income targets. A
realistic target for successful day traders is to double their money each
year, which means that a starting capital of $10,000 won’t allow you to
maintain a reasonable lifestyle unless you live in a Vietnamese village.
At the other end of the scale, a trader seeking a reasonable quality of
life will trade with $30,000 and more. As US citizens, the “day trading
margin rules” will require you to deposit no less than $25,000.
If your annual income depends on the amount of money in the
trading account, why not deposit more and profit more? Eventually
that might be the right move, but initially it is not, for two reasons.
First, not everyone has the required capital available, and secondly,
there are psychological limitations until you become proficient. To
trade with larger sums means being psychologically prepared for
larger fluctuations in profit and loss. The mental ability to cope with
these fluctuations is acquired only after years of trading. Do I display
emotion over large profits or losses? Rarely. Any of my days of trading
can end in large profits or large losses of thousands of dollars. I’m
accustomed to these fluctuations, and because the majority of my
trading ends in profits, I can psychologically cope with losses of a
scope that just ten years ago would have caused me sleepless nights.
Each of us has our own level of psychological limitation: therefore,
trading too early with sums that are too large may lead to losses. Every
trader must find the most suitable figure, based on the personality
aspect rather than financial abilities. As time passes and you gain
experience, your psychological resilience will strengthen, and you will
hopefully trade a larger account.

How Many of You Will Make It?

Sadly, very few. How many businesses make it? Statistics show that
only one in five businesses survives and become successful. Is that a
good reason not to open a business? Of course not! It’s a good reason
to open five businesses in the hope that one of them will succeed! If
you’re a reasonable person with a high level of determination,
persistence, self-control, willingness to learn, and reasonable capital,
you’ll succeed where most have failed. The ball is in your hands. Don’t
let statistics scare you. The human race would not have gotten far if no
one had ever been willing to take a risk.

So Why Did I Write This Book?

I believe that this book can improve the quality of life for many of its
readers, even if they aren’t involved in professional trading. I believe
that everyone should become familiar with, and take advantage of, the
stock exchange to the best of his or her ability. I believe that even if
you don’t trade, you’ll still be able to learn, and avoid the capital
market’s dangers that can easily ambush you. I believe that in our
current economic reality, every person must hold a second profession,
because you can never know when one of them will become useless. I
also believe it is our obligation to make the best use of our advantage
over the average investor attempting to profit from the stock exchange
without any knowledge or experience.
I believe we all deserve to enjoy this short life we have on earth. I
derive great pleasure from a successful day of trading and believe I can
help you get that feeling, too. It brings me great joy to hear a graduate
of my course tell me about his or her successes. That’s where my
realization and gratification lie, and that’s my proud signature on the
history of trading. My returns are the satisfaction and pleasure you get
from your success. Once you’ve become successful, email me and
make my day!

Welcome!
… to the fascinating world of stock trading. It’s the most realistic
virtual reality on earth, a reality in which every person with a
computer and Internet access can earn a living from any location in
the world. It’s the fairest profession in the world, in which everyone
has the chance to become a millionaire through his or her own
personal capabilities, without regard to race, gender, age, nationality,
or language. Best of luck!
Chapter 1 - Allow Me to Introduce
You… to the Stock Exchange
e Stock Exchange: My Place of Work

A Devoted Fan
We’re such strange creatures. We identify with our city, root for our
favorite football team, and even feel proud of our place of work, as
long as our salary keeps rolling in. The stock exchange is my place of
work, and it makes me feel proud. It’s because of traders like me that
it continues to exist and flourish. I contribute to its existence by
increasing trading volume, and in return, I get the chance to earn my
income. As future fans, here’s the history of your future place of work.

Who Needs the Stock Exchange?

Companies need money in order to develop their business. They can
recruit money from their stockholders or borrow from banks. The
disadvantage in bank loans, as we all know, is that unfortunately the
loan must be repaid. Not only must the initial sum be returned, but
banks also have this annoying habit of adding interest. In short, a
company requiring a bank loan burdens itself not only with the
repayment of the initial figure, but also the added amount of interest,
all of which slows down the company’s progress. But a brilliant bypass
action was invented: money that doesn’t need to be returned! It’s
called IPO – Initial Public Offering.

What is a Stock?
The IPO is an event in which a company sells shares of stock to the
public in return for the public’s money. What is a stock? It’s a
document that gives its owner the right to a part of the company.
When a company is formed, the company’s owners decide the number
of shares that comprise the company. If this is a new company, with no
performance, we can presume the value of its shares is zero. Once the
company begins operations, accumulating contracts, patents, income
and profit, its value rises. The value of its shares rises accordingly. But
the “value of a stock” is an abstract concept. A company’s transactions
fluctuate frequently, which makes it difficult to determine the true
value of its stock.
When a company offers shares to the public, it is selling part of its
stock. The sale is a recruitment of money by the company which the
company does not need to return. Buyers believe they are purchasing
cheaply, and hope that in the future they will sell for more. From this
point on, the shares are traded between buyers and sellers who for the
most part are not the company’s original owners. To protect the
interests of both buyers and sellers, and to improve reliability and
create greater fluidity, it was decided that stock trading would be
conducted within the controlled environment of the stock exchange.
Can any company offer shares to the public and become a
“public company?” No. A company wishing to recruit money through
the stock exchange must meet tough criteria related to sales turnover,
profits, and financial stability. Not every company needing money is
interested in going public, because after making the offering, it will
need to continue upholding tough regulatory standards which might
limit its progress; it will be required to become transparent, which
exposes its secrets to the public including its competitors. This is a
costly endeavor, and the company will also be required to include the
public that holds its shares in its decision-making processes. In short,
there are no free lunches.
The Stock Exchange’s Early Days

Stock trading is documented in ancient writings as early as 400 BC,

but the most significant, initial sale of stocks to the public occurred in
Amsterdam in 1602 with the establishment of the Dutch East India
Company as an international spice company.

The Netherlands
The essential difference in this case was the fact that from the outset,
the company’s stocks were meant to be sold to the public. In actuality
the public had little impact on the company’s management, which
remained in the managers’ control. The Dutch East India Company
was highly successful and for decades, from its inception through 1650,
paid its stockholders an average annual dividend of 16%. Over the
years, additional public companies were established in Amsterdam,
and stock trading took on an organizational nature. In 1688, the first
book in history dealing with stock trading was published. Its author,
Joseph de la Vega, was a successful Spanish-Jewish trader. He wrote
the book using a dialogue format between a stock holder, a trader, and
a philosopher. The book described in fine detail the relatively
ingenious conduct of the Amsterdam Bourse, and even offered
valuable tips to its readers.
London
Some few years later in London, 1693, the first bonds began to be
traded. Immediately afterwards, several British public companies
began trading. London’s first stock traders operated in coffee shops on
Change Street, adjacent to the Royal Exchange, the trading center they
were not allowed to enter because of their known “bad habits.” In
1698, one John Casting, whose preferred spot was in “Jonathan’s Coffee
House,” began hanging a list of stocks and their prices outside the
coffee house. This list is considered the first milestone in establishing
London’s stock exchange.

The First Bubble

Over the years to follow, several companies rose and fell, but the most
widely-known case was that of the South Sea Company, established in
1711 for the purpose of trade with South America. The company’s
shares were snapped up, their price rocketing upwards. Within a few
years, it became apparent that expectations of successful trading with
“The New World” were exaggerated, and in 1720 prices fell in one
sudden drop, creating the first bubble burst in history. In reaction, the
British Parliament created the “Bubble Act.” Enthusiasm for the stock
exchange dissipated for several decades. In 1789, stocks and bonds
began to be traded in the United States.More on that later.
Wall Street – The Wall and the Money

Wall Street has taken on many different semblances since its first
transaction. Most of the changes arose from the ongoing struggle
between two immensely powerful parties: the investment houses and
the government. The former has constantly sought to operate without
supervision, taking advantage of any and every opportunity for
stretching their long arms deep into the public’s pocket. They have
never been averse to any dirty trick: trading with insider knowledge,
disseminating misinformation or incorrect data through media
channels, or organizing raids on a specific stock are all examples of the
commonly-known methods of manipulation that have made Wall
Street professionals so loathsome to the public. More than two
centuries after Wall Street’s establishment, the 2008 financial crisis
shows us that nothing has changed.

SMART Wall Street has never been averse to any

dirty trick that deceives the public. The
MONEY tricks get smarter, and then so does their
regulation. It’s a never-ending game.

On the other side of the divide, the government has generally

sought to set the rules and regulations that restrain the insatiable
appetites of Wall Street traders for money. In short: government-set
regulations. Often, legal prohibitions don’t help at all, and prohibited
actions spread anyway. For example, instead of recruiting a newspaper
to publicize false information, companies were assisted by a grading
company that rates performance of other companies. This sways
public opinion because the public is told to view the grading
companies as legitimate. But the grading company often receives its
income from the reviewed company! The conflicts of interest
apparently didn’t bother anyone.
A turnaround in the relationship between Wall Street and the
government occurred as a result of the 1929 Crash, which critically
affected the entire United States financial system. The Crash led to a
serious economic slump of epic proportions that lasted several years,
known as “The Great Depression.”
Despite all these permutations, Wall Street has basically remained
the same. Jesse Livermore traded on Wall Street from the end of the
19th century to the early 20th century. His book How to Trade in
Stocks, and Lefèvre’s Reminiscences of a Stock Trader, a
biography of Livermore, show that Livermore would have had no
trouble trading successfully were he alive today.
Eighty years have passed since the 1929 Crash, and it seems that the
lessons learned from that devastating event have been forgotten.
Currently, at the time of this book’s writing, a new chapter is being
written in Wall Street’s history. The credit crunch, known as “The Sub-
Prime Crisis,” hit Wall Street like a bolt of lightning. Despite a fairly
quick recovery developing during the two years from the lowest point
of the slump, its lessons are still unclear. The crisis hit with full force
across the entire financial system of the US, and first and foremost on
Wall Street, so much so that some feel Wall Street is losing its top
billing in international finance markets. But before we mourn Wall
Street, it’s worth checking how it all began.

Wall Street is in New York’s Lower Manhattan. It was so named

because in 1653, a wall was built there by Peter Stuyvesant, the Dutch
governor of the city then known as New Amsterdam, to protect the
city’s residents from the “Indians” as they were known at the time, and
from a possible British invasion. The wall itself was never put to the
test, but lent its existence to the name of the street running alongside
it.

SMART Regulation, like the stock market, develops

as a result of crises that lead to bubbles. But
 MONEY unlike a bubble, it never bursts. By nature, it
always progresses and never regresses.

In 1789, to cover debts of the government and its colonies, the first
United States Congress, via its central bank, issued what were known
as Treasury Bonds to the value of $80 million. These were sold to the
general public. In those days, Manhattan’s population numbered
around 34,000 and Wall Street was still an unpaved dirt road. Along its
sides, trading houses stood and transacted international commodity
sales. Very quickly, Wall Street’s trading houses also began selling
lottery tickets, stocks, and bonds. The hottest items during that
period, and in fact the item around which speculative trading began,
were bonds. In those days, a person wishing to buy or sell stocks or
bonds had to issue a public notice or sell to friends. As demand
developed, two renowned trading houses of the time, Leonard
Bleecker at 16 Wall Street, and Sutton & Harry at 20 Wall Street, began
holding supplies of bonds and stocks.
Stock trading began to develop. Investors assisted in setting up and
developing companies by investing their money in return for a Deed
of Shares confirming their investment in writing and providing them
with a holding in part of the company. These deeds served as security
and proof of ownership, and assured the investor’s stock in the
company. This led to several synonyms that would come into use over
time, among them Securities (signifying they were securely held by
their owner) and Equities (indicating entitlement to part of the
capital).
In March of 1792, a New York trader named William Duer, who also
served as the US Assistant Secretary of the Treasury at the time, was
investing in a scheme to buy up the US debt to France at a discount.
The plan failed and Duer lost his entire wealth and more, but the
ramifications of his failed investments contributed to the Panic of
1792, where he fell into bankruptcy. The term “crash” was applied to
these events. It was one of many that would take their place in Wall
Street’s history. Following this crash, traders decided to
institutionalize their activities and establish one place where it would
be possible to control and document all transactions. In May of 1792,
the traders and market makers signed the “Buttonwood Agreement,”
named such because it took place beneath the sycamore (buttonwood)
tree that stood outside 68 Wall Street. The agreement saw the formal
establishment of the New York Stock Exchange and the setting of
standardized trade commissions.
The famous NYSE (New York Stock Exchange) edifice was built in
1827 on the corner of Wall Street and Hannover Street. In 1842, a
competing stock exchange was established known as AMEX, the
American Stock Exchange. Simultaneous to the worldwide economic
prosperity, Wall Street developed its role as the most important
international financial center.
In the late 1890s and early 1900s, a new phenomenon began to pick
up steam. Throughout the United States, “stock shops,” also known as
“bucket shops,” sprouted up. The term was imported from Britain,
where it had clear connotations of illegal activities. Clients of these
shops traded in stocks for speculative purposes without actually
making a stock exchange transaction: in actuality, gambling. A trader
“played” on the stock price without actually buying the stock. When
the trader profited, the shop lost, and vice versa: a casino for all
intents and purposes. The stock rates were continually telegraphed in
from New York throughout the entire trading day. They were called
out by one clerk and simultaneously written down by another on a
large board facing the public. Because the shop’s interests were
diametrically opposed to those of the trader, swindling was endless,
and these shops were perceived as unreliable. A detailed description of
these activities is found in Edwin Lefèvre’s Reminiscences of a
Stock Operator, mentioned earlier as a biography of one of the
biggest traders, Jesse Livermore. In 1930, during the Great Depression,
these shops were made illegal, and the fun and games came to an end.

Establishing the SEC –  Securities and Exchange

Commission
As part of the lessons learned from the Great Depression, and seeking
to prevent a future repetition of the processes that contributed to the
1929 Crash, the Congress established the first regulatory body to
supervise the United States capital markets. It was set up in 1934 and
called the SEC, the Securities and Exchange Commission. The SEC
determined standards geared to preventing the development of those
factors that led to the Crash, particularly manipulation of prices and
use of insider information. Over the years, the SEC instituted many
regulatory changes which continue to contribute to enhancing trust in
the capital market.
When the public shows greater trust in the capital market, the
market’s activities expand and crash risks such as those of 1929
decrease. Regulatory ordinances that seem obvious to us now were not
in place in the past. Currently, for example, a public company is
obligated to convey significant notifications to the public via
conference calls, before conveying them to insiders. Sound natural?
That’s one of the regulations set by the SEC only a few years ago. The
SEC’s task has yet to be completed. In fact, it seems it will never be
completed. Insider information is still the most normal way to make
small capital gains in the market. It is Illegal and stinky, but whenever
there’s been a lot of money on the table, there are those looking for
the get-rich-quick shortcuts. Even today, only a small percentage of
those taking advantage of insider information are held accountable.

Meet the Stock Exchanges

The stock markets are comprised of several stock exchanges. A stock

exchange is a business like any other. It makes a profit from
commissions and services. The stock exchanges compete among
themselves, appealing to different business niches. Each stock
exchange has its own uniqueness, technology, advantages, and of
course, its typical disadvantages.
The New York Stock Exchange (NYSE)
The NYSE (www.nyse.com) is located on the corner of Wall and Broad
Streets. It is the largest in the world as far as the market value of the
companies traded on it. The market value, known as market
capitalization or “market cap,” multiplies the number of shares of
stocks held by the public by their stock exchange-traded price. If you
calculate the market cap of stocks traded in the NYSE, you will reach a
peak period combined value of more than ten trillion dollars! More
than 3000 companies comprise the NYSE trading list.
Prior to the terror attacks of September 11, 2001, it used to be
possible to stand at the stock exchange’s gallery window and watch it
in action. Now, to enter the gallery, you need to get a special entrance
license, or become a photographer for CNBC, Bloomberg or others, or
know someone with a key function who can request a permit for you.
But once in the gallery, you’ll see something amazing that is part of a
disappearing world. Traders scurry among dozens of work stations,
broadcasting commands with odd hand signals, and navigating their
way through mountains of notes transferred from buyer to seller and
carelessly let to fall on the trading floor.
Because I was acquainted with the well-known television
commentator who goes by the name “Dr. J,” I was lucky enough to
receive the amazing chance to join a CNBC photo shoot of S&P 500
options traders in the Chicago Stock Exchange. I stood, fascinated,
surrounded by dozens of traders shouting and pushing as though in a
football game. Later I learned from Dr. J, a former pro-football player,
that one of the conditions of acceptance for work on the trading floor
known as “pit” is the height, weight, and physical ability to push aside
competing traders!
The unavoidable is happening to the biggest stock exchange in the
world, too. Computers are slowly taking over all processes, despite
strong opposition by the traders. Computerized trading brings greater
competition, fewer commissions, greater transparency for the public,
and higher execution speed: exactly what the public wants, and
precisely what the companies that employ floor traders don’t want. It
started small. NASDAQ, the United States’ first computerized stock
exchange, became the model. The NYSE was then forced to respond to
public pressure and incorporate automatic systems which initially
managed only a small part of the turnover of high-volume stock
trading. Over the years, this was used to silence the public. Political
pressures were handled on the quiet through phone calls between
CEOs of the mega-corporations and the appropriate politician.
Despite the opposition, the revolution was actually completed over the
past few years, and currently most of the NYSE operations are
computerized. Now, when I buy or sell a stock at the speed of a
nanosecond, I remember a distant bad dream of just a few years ago,
when I taught Tradenet students that the execution time of a NYSE
transaction could take up to two minutes from the time the button is
pressed!

The AMEX Stock Exchange

The American Stock Exchange (www.amex.com) was established in
New York in 1842. AMEX is the third-largest stock exchange in the US,
after the NYSE and NASDAQ. Trade there focuses mainly on stocks of
small to mid-size companies and a range of ETFs, Exchange Traded
Funds, about which we will learn more later. AMEX operates similarly
to the NYSE, using the tender method of their market makers (we’ll
learn more about them later, too). AMEX belongs to NASDAQ and its
volume of activities is relatively low. AMEX, like NYSE, has also moved
most of its processes to quick, effective computerized execution.

Founding NASDAQ
1971 saw an important change take place. The NASDAQ stock
exchange was established, and unlike the NYSE, NASDAQ
computerized all its trade processes. The NASDAQ computers are in
Connecticut and link to more than 500 market makers’ computers,
allowing electronic trade in one click. From that point on, market
makers no longer needed to compete over each other’s shouts on the
trading floor. Everything was push-button. The result: commissions
slowly dropped, the quality of service improved, competition grew,
and companies of a new type issued stocks and raised trillions of
dollars. Within two decades, and with the proliferation of the
Internet, NASDAQ was accessible in the home of every trader. For the
first time, the road to private trading was opened. We can, in fact, say
that the profession of day trading as we know it now was born with
NASDAQ’s founding.

Crises

If you run a statistical check of the average period between each crisis
throughout market history, you’ll discover that during your own adult
lifetime, at least three crises will occur. In other words, if you’re a
short-term investor, there’s a reasonable chance that sooner or later
you’ll lose a sizeable portion of your capital. That’s one of the risks of
the market for investors. For someone with the good luck to
experience a first crisis around the age of forty, there’s a good chance
of survival, but if it catches you when you’re sixty-five, I’m not certain
you’ll manage to save your pension. An exception is the last decade,
2000-2010, during which two of biggest crises in market history
occurred in close proximity: the Dot-Com Crash and the Sub-Prime
Crash.

The Great Depression:  Black Monday and Tuesday,

1929
The crash of Black Monday, October 28, 1929, with its 12.8% drop,
followed the next day by Black Tuesday with its 11.73% drop, are
known as “The Great Crash,” which led to a ten-year economic slump
known worldwide as “The Great Depression.” The crisis occurred on
the heels of the era known as “The Roaring Twenties,” a contrasting
period of some ten years during which America wildly celebrated the
victory of the First World War, living on endless credit, with real estate
prices going through the roof.
Unlike other crashes, the Great Depression lasted several years,
dipping to an all-time low in July 1932, which marked the lowest slump
of the entire twentieth century’s capital market. The market only
recovered to its pre-slump level in November 1954. In actuality, young
adults who held stocks prior to the slump spent the bulk of their adult
lives waiting for the recovery.

Black Monday, 1987

As in other crashes, herd panic swayed the game on October 19, 1987.
In 1929, the “herd” flooded the streets and swamped brokers’ offices.
In 1987, the “herd” blocked the brokers’ telephone lines. Hysterical
“sell at any price” and “get me out” orders arrived from the entire
United States. At some point, the brokers and market makers stopped
answering the calls, and the market collapsed, out of control. The
crisis commenced in Hong Kong, spread to Europe, hit the United
States and caused an index drop in just one day of 22.8%, marking the
greatest ever single-day drop. Despite this event, and somewhat
surprisingly, 1987 ended in net gains for the year!
As always following a bubble’s burst, someone needs to earn a
living from creating new regulations and setting new standards.
Within the bubble’s craziness, the SEC put forward new rules meant
to protect the private investor and prevent a repeat of this event. The
newly-instigated changes focused on the market makers’ role. The SEC
decided that in order to guard the market from panic crashes and
prevent a “sellers only” situation, market makers would be obligated to
buy a certain amount of shares from the public during rate drops. The
new law was passed shortly after the crash, and calmed the regulators’
consciences for another brief period.

The Dot-Com Crisis

The dot-com bubble burst on Monday, March 13, 2000, following five
years of sharp rises. On that Monday, the start of the trading week, the
market opened with a gap of 4% down on the NASDAQ index as a
result of the miserable timing of several parties which simultaneously
sold shares in Cisco, IBM and Dell at a value of billions of dollars. The
drop ignited a wave of sellers, leading eventually to a loss of 9% over
the next six trading days.

SMART Crises are good for traders! High

uctuation, public panic, and the ability to
MONEY execute shorts are important tools in the
hand of an experienced trader.

The bubble was structured around the euphoria which peaked with
the invention of new, unprecedented economic models based on
“market penetration” instead of profits and on “unadvertised costs”
and other innovations that matched the spirit of the times. For as long
as money flowed into the hi-tech industry, especially in light of the
low interest rates of 1998 and 1999, the boom kept growing. In 1999
and the start of 2000, when the government increased the interest
rates six times in succession, money was made more expensive, and
the new economic models began to collapse like a house of cards.
At the peak of the crisis, the NASDAQ index representing the
technological stocks lost some 80% of its value, and the S&P 500 lost
46%. I personally experienced this crash as a hi-tech entrepreneur and
beginning trader. I recruited millions of dollars from investors for
startups I established, and rode the peaks and valleys of that period
from every angle possible. These were also my initial years as a trainee
trader. In fact, I owe the positive change in my life to the Dot-Com
Crisis, which left me, as so many others like me, unemployed, and
forced me to seek an alternative in the world of stock trading.

The Credit Crunch (Sub-Prime)

The credit crunch, more commonly known as the “Sub-Prime Crisis,”
burst onto the American market in the summer of 2007 and developed
into an overall worldwide economic crisis. Its opening shot was in
September 2008, with the collapse of Lehman Brothers Investment
Bank and the nationalization of AIG Insurance Company. The panic
peaked in October and November 2008, during which the market lost
some 30% of its value (yes, October once again…). Prices continued
dropping until they reached their low in March 2009. In the final run,
in just eighteen months from the October 2007 peak, the market lost
57.4% of its value.
The source of the crisis, as with the 1929 Crash, is in the decade of
almost unlimited credit at low interest rates given to anyone who
asked for it, as well as in the real estate market which developed into a
boom, then burst and dragged worldwide lending banks down with it.

Crises of the Past Decade (S&P 500 Index)

 The Dot-Com Crash began in [1] March 2000, dropped until [2]
September 2002, and lost a total of 46% value. From this point the
market rose to a peak [3] in October 2007. The Sub-Prime Crash [4]
began in October-November 2008, reaching its lowest point [5] in
March 2009.

Crises and Traders

During crises, market fluctuation and trade volume increase, and
therefore we, the traders, flourish at such times! Unlike the majority of
the public, we also know how to profit from drops: further on we will
study the principles of shorting. The first crisis I experienced as a
trader was the Dot-Com Crash of 2000 to 2002. Unfortunately, as a
novice trader, I was insufficiently experienced to benefit from the
events, but I did benefit from the rises that followed. The Sub-Prime
Crisis, by comparison, was a real celebration. In October 2008, I
tripled my trading account in one month alone!
Who’s Selling to You?

When you buy or sell a stock, someone is on the other side, selling to
you or buying from you. Who is that person, what’s his or her role,
and what’s guiding him or her?

“Market Makers”
When you want to buy or sell a stock, you need someone with whom
to make that transaction. Have you ever thought about what might
happen if you want to sell, but there’s no buyer? At what price would
the sale order be executed? Can you and several more sellers cause the
crash of a stock because, for a short period, there was no buyer on the
other side? Market makers are the people always willing to fulfill the
role of “the other party,” even if they don’t buy and sell the way you do.
The role of market makers is to constantly stand behind the stock.
They set buy and sell orders in advance, with fixed spreads, and hence,
they “make the market” for that stock.
How do market makers profit? Their profit derives from the spread
(the difference) between the sale and purchase prices. For a company
with a volume of millions of stocks per day, a profit of one cent can
amount to $10,000 per day for every million shares traded. Not a bad
income at all!
It’s not always that simple in the market makers’ world. They take
no small amount of risks in that the stock moves in the opposite
direction from the actions they execute. On the NASDAQ exchange, to
ensure that the market will remain competitive and that the spreads
set by the market makers will remain as limited as possible, the stock
exchange encourages activity by a large number of market makers for
the same stock. When a specific stock is being handled by dozens of
market makers, the individual investor is assured of high volume and
competitive spreads.
Specialists
Specialists are the NYSE’s version of NASDAQ’s market makers. In
contrast to the NASDAQ, in the NYSE each stock is allocated to only
one specialist. The specialist may be allocated several stocks to trade
simultaneously, but each stock will be traded by only that single
specialist.
Specialists hold a dual role. Firstly, they must provide reasonable
liquidity when there are no buyers or sellers for the stock, by buying
and selling to their own accounts. This prevents fluctuation during
periods when there are no other buyers or sellers. Secondly, they serve
as brokers for the brokers, by setting buy and sell orders and carrying
them out at the best price possible, known as “best execution.” For
example: when a certain broker is interested in executing a sell order
for a client for a stock priced at $50, but the client’s order is to buy at
$49 in the hope that the stock will drop to this level, the specialist
keeps the order on his or her book, called “booking the order,” and
executes it when the price reaches the client’s preference. The law
requires that specialists must respect the client’s interests over their
own at all times. Until just a few years ago, prior to computerization,
every buy and sell order went through a specialist. Currently, most
NYSE executions take place via automated trading, similar to the
NASDAQ format.

The ECN Revolution

The role of market makers and specialists is important, but it’s not as
though they work for free. The fact is that they make their profits from
the spread between the bid and ask, which means that we pay their
price.
An ECN (Electronic Communication Network) allows us to forego
their intermediate services. The ECN is a network of computers that
allows buyers and sellers to connect and set buy and sell orders
without the “mediation” of market makers. ECNs began operations in
1969 with the very first system known as “Instinet,” which initially was
used only by the market makers for transactions between one another.

Due to the lack of liquidity that led to the 1987 collapse, laws were
passed forcing market makers to respect electronic orders. These laws
saw the first usage of ECN systems by the public. Currently, the
majority of orders we execute are placed through ECNs.

Stock traders, in contrast to investors, use “Direct Access” trading

programs, which we’ll study later on. Through direct access programs,
we can choose to send buy or sell orders directly to market makers, or
to the range of ECN systems. Another popular option is to use the
services of a broker who will automatically choose the most suitable
direct access channel for you in terms of execution speed and cost.

So How is All This Connected to You?

At the basic level, none of this needs to interest you. You can open an
account with a broker, deposit your money, and learn how to buy and
sell stocks. As long as you’re trading only in small quantities of several
hundred shares per click, you can use your broker’s auto-routing and
ignore all the background activity. When you develop into a more
serious trader and increase your quantities, known as positions, to
thousands of shares per click, you’ll come across instances where you’ll
receive only part of the quantities you require (partial executions) and
often at prices higher than you wished. For large positions, it’s worth
routing your orders to different destinations in order to gain speed
and liquidity. But it will take some time to get to that stage, and by
then you will be more familiar with and better understand additional
routing options and their significance.
Chapter 2 - Day Trading and How
to Get Started
Stage by Stage on the Road to Fame
Are You Disciplined?
This is the stage where you need to maintain self-discipline. The rules
of stock trading are simple, but because of our personality quirks,
everyone still tends to behave differently. The average person’s
psychological behavior does not match the behavior of the market.
Greed, on one hand, and fear on the other cause us to react in
precisely the opposite manner than is required. From now on, you’ll
need to accept and respect these rules undisputedly.

Eight Stages on Your Path to Success

1. Don’t read too much instructional material. This book will be all
you need. Information-overload will take you out of focus and
confuse you. After some months of trading, once you’ve gained
experience and internalized the basic principles, then read more.
2. Find an experienced personal mentor who can walk you through
your initial steps, or join a course. Self-study is not a sufficient
solution. Just as driving can’t be learned only by reading a textbook,
so it is with trading.
3. Before trading with real money, ask your broker for a demo system
that will let you practice. Be diligent about using the demo
for no more than a few days. Using it for longer creates the
dangerous illusion that you’re immune to any kind of psychological
effects resulting from the pressures of trading in real money. Believe
me, you’re far from immune!
4. Open an account with a broker and deposit a sum suited to your
financial abilities. You should absolutely not deposit a sum of
money that will endanger your financial status. A too-large amount
 will cause you tremendous psychological pressure and lead you to
break discipline, with dreadful results.
5. Don’t trade alone. You’re still far from ready! Make sure you have
ongoing, real time follow-up. Join an online trading room and listen
to what experienced traders have to say. Then try to emulate their
actions.
6. Trade in small quantities. You’re not safe from errors. Your initial
goal is to successfully conquer the market while trading in small
quantities and creating minimal profits or losses, all for the sake of
your learning curve and not for getting rich quick. Only when you
have greater control and stable profitability should you increase the
amount.
7. Keep a trading diary in which you list every action you take, with
notes and conclusions (to be discussed further). When we don’t
write the details down, we forget them.
8. Read this book a second time once you have some experience.
Only in the second reading and having traded with real money will
you understand the significance of the assistance this book offers.
Read the book a third time one year later.

Don’t try to learn alone. It never ends happily…

What’s your profession? Engineering? Law? Computer technician? No
matter what it is, I’m sure you invested serious study time, whether it
was a technical course for computer repair or long years in academic
institutions. I’m sure you never thought you could be a successful
professional without studying and then devoting more time to
internship. It always amazes me that people think they can succeed in
stock trading without investing in their studies!
It’s amazing to discover that most of the independent traders never
bothered to study in any formal framework. In one of the most
complex professions around, most of the people active in the capital
markets rely on their gut feeling and luck.

SMART When we manage other people’s money, we

 MONEY feel obligated to study. When it comes to
managing our own, we behave recklessly
and even negligently.

When we handle someone else’s money, we feel the need to study,

but when it comes to our own, we behave irrationally and rely on a
“third sense” to get it right. How strange it is that we lose our faith in
education when it comes to our own funds. This must be one of the
oddest phenomena in human behavior. Stock trading is a profession
like any other. It is also one of the few professions that can bring you
sweet, swift financial success. But when it comes to your own money,
you shouldn’t be thinking about the opportunities, but rather the
risks! Remember, every time you buy a stock, someone else is selling it
to you. Sometimes I’m the seller. Are inexperienced buyers on the
other side of the transaction so certain they can beat me and take my
money and that of other pros like me? Professional traders like me
have all paid seriously with our time and money for this education and
experience. I have news for you: we have no intention of letting
anyone beat us!

Have you heard the claim that ninety percent of traders lose? It’s
one hundred percent correct! In fact, I’m sure the number is even
higher. The greater majority of those losing traders are people who
think they can trade without learning the trade! There’s no need for a
license or diploma to become a day trader. The conditions for joining
the profession are simple, and anyone without the slightest previous
experience can learn to uphold them: open a trading account, deposit
funds, buy, and sell. Anyone filling these criteria can be defined as a
“day trader.” Is it any wonder, then, that the probability of success is so
low? I was there too, and made the same mistake. I faced failure any
number of times. It would have placed me squarely in the sad statistic
of losers. I survived, but no more than ten percent of new traders will
be stubborn enough to survive. The ones that do, accruing experience
and knowledge, are the ones that will profit from the funds of those
who don’t invest in knowledge. My job is to ensure that you learn, and
that you join the winners. The more you learn, the greater your
chances of success.

You can acquire theory from books, but you need more than that.
You need to take a course. Courses cost money, but they save you more
than you spend. Sometimes, a tip from an experienced instructor is
worth far more than the cost of the course. Even if you feel that you
already have that basic knowledge and fairly broad experience in the
capital markets, the additional information you will learn in a course
is worth the effort of joining one. Without an optimal education,
you’ll be forced to rely on your good luck. And if that’s the case, you
might as well forget trading and just take a joy ride to Las Vegas.
There, at least, you’ll lose with a smile as you sip drinks on the house
.
Hardware, Software, and the Internet
Reliable hardware is an essential link. It is very worthwhile making a
clear distinction between the old home-use computer containing tens
of programs and possibly even dormant viruses, and your trading
computer, though that’s not a necessity at the outset.

SMART An effective computer and screens are the

most important tools in trading.
MONEY

Initially, it’s enough to use a home computer with a single screen.

As you progress, it is recommended that you switch to a high-quality
computer linked to four screens, each a minimum of 21 inches, but
preferably a 23 inch size. Further on, I will show you my work station
and detail the function of each screen.
Hi-speed Internet is vital for the execution speed of orders. Internet
connection reliability is crucial. Remember, though, that
communications breakdowns are part and parcel of day trading, but
they can be greatly reduced if hi-speed, reliable connections are
secured.

The Advantage of the Group: Using Trading Rooms

Stock trading is easier to perform when you’re part of a group. A
novice trader will find it difficult to go it alone in locating suitable
stocks, making the best decisions, and maintaining high level self-
discipline. In an online trading room in which many others are also
active, the novice trader finds solutions for all these problems.
Trading rooms are not a new invention, even if the online versions
are. Professional literature has been discussing them for at least the
past 150 years. They were always the places where traders swapped
views, got help or instruction, and tips on hot stocks. Joining a trading
room helps overcome one of the biggest issues faced by the day trader:
self-discipline. When a large group makes a joint decision, it will
usually be far more correct than the decision of the lone novice trader.
I joined an online trading room in my first year of trading. I
remember listening to the analyst, as the trading room’s instructors
are known, and thirstily absorbing every word he said. As the years
passed, I too became an analyst of that very same trading room, and
later the head analyst of the Tradenet room.
Have I already mentioned that you don’t need to leave the house in
order to join the trading room? In the distant past, trading rooms were
crowded physical places: noisy, filled with the smoke of umpteen
cigars and cigarettes. Over time, they became crowded computer
rooms, just as noisy and just as smoke-filled. Now they exist on the
Internet, where you can join a large group of traders in the comfort of
your own home environment. You gain all the advantages of a real
time trading room without the smoke and the noise. Actually, several
years ago when I described the wonders of the Internet trading room
to a group of traders, one turned to me and expressed his interest in
joining, provided I could promise him “they don’t smoke there!”
And what’s the role of the novice trader in the online trader room?
Very simple: to listen, learn, and copy the pros as much as possible.
Clear and easy. The novice will encounter experienced traders, listen
to their discussions as they trade, learn from their actions, and receive
real time support as needed. Even experienced pros have trouble
trading without a trading room. About half of the actions I take on any
given day derive from ideas expressed by other traders in the room.
Even if they’re relatively new traders, they can still raise some effective
ideas.

SMART The online trading room is a chat room that

links other stock traders’ homes. In the
MONEY online trading room, you will listen, learn,
and execute transactions together with the
pros.

Trading rooms also have their disadvantages. The diversity of

trading methods and the professional jargon that dominates the
discussions can set a novice’s head spinning. When you join the
trading room, you will first need to learn that jargon, and only then try
to focus on the methods best suited to you. Over time, you should be
able to adopt the most appropriate method and stick with it. If you try
to imitate too many methods as used by various analysts, you’ll get
nowhere fast. Bottom line, you’ll need to find the niche that matches
your nature, focus on it, and ignore the “white noise”of traders and
analysts that you feel are not a good match.
That’s also exactly how you should relate to the diverse information
you’ll find in this book. If you try to utilize it all simultaneously, you’ll
end up using none of it. Focusing is an important trait. Expanding
your knowledge can be done over the long term as you accumulate
experience and confidence. Highlight that sentence and come back to
it in a year’s time. Right now, it means little. In a year, you’ll
understand.
Tradenet runs online trading rooms at various levels, suited to
beginners and advanced traders, and in various languages. These serve
traders in different countries. The trading rooms are a service, and
carry a fee. For the professional trader earning his or her living from
the market, the service is vital and its cost marginal, but for the
beginner, the cost seems high. Think of it as part of your tuition.
Your Guide to Opening a Trading
Account

When you buy a stock, for both technological and regulatory reasons,
you need the services of an agent known as the broker. The broker
mediates between you and the stock exchange. When you deposit
your money with your chosen brokerage company, you receive (usually
free of charge) trading software that connects your buy and sell orders
to the various stock exchange computers.
The broker might be the bank that enables buying and selling
stocks along with additional banking services, or it may be an
independent company specializing solely in providing brokerage
services. Usually a specialized broker will be cheaper and more
effective than the bank.
In the not too distant past, people wishing to buy or sell stocks had
to take themselves off to the broker’s offices, wait in a queue, and pay
a hefty commission. In short, a loss of no small amount of money even
before the stock rose by just one cent. Active traders bought and sold
stocks at cheaper prices through phone calls with the broker’s
transaction room, and highly active traders set up expensive
communications systems connecting them directly with the various
brokers. Those days are well over. The Internet revolution brought the
stock exchange directly into the personal computer of every single
person in the world who wishes to buy and sell stocks. In fact, the
public now has access to the most advanced trading systems which,
not so long ago, served only the professionals. Data that once could be
accessed by only the privileged few is now open to public use.
As the Internet continued to develop, trading programs developed,
procedures were totally computerized, and commissions dropped. The
minimum commission when I started out as trader stood at $15, and
it’s now $1.50 with ample room for it to drop further. The more the
commission fees dropped, the more useless brokers’ phone-in
transaction rooms became. Rooms that were populated by tens if not
hundreds of employees turned into a desert of screens and computers,
serving only a small number of traders who still have not internalized
the Internet revolution, and are willing to pay exorbitant commissions
for an unnecessary phone call. Commission markdowns and Internet
penetration, together with new technological developments such as
mobile phone applications that allow buying and selling, have led the
trading world to the portals of additional population strata.

How to Open an Account with a Broker

Opening a stock trading account is a simple procedure. All you need is
to complete several forms and add a color scan of your current valid
passport, and a utility bill such as from the electricity company or a
bank statement proving your current address. Every broker will be
happy to help you complete the process in one brief phone call. When
the forms are certified after the broker has checked the data, the
broker will provide you with details of the bank account to which you
transfer money. Usually 24 to 48 hours later, your account with the
broker will be credited. The broker will then send you an email with
installation instructions for the trading platform and an initial
password which you can later change. When you first operate the
trading platform through your dedicated password, you will be able to
see your deposit in your account, awaiting your order. If you surf to
the broker’s site, you can then use the same password to view your
execution history. The entire process should take between one to five
days to complete.

Can Your Bank Be Your Broker?

Theoretically, yes. Practically, no. Yes, because every bank is a broker
that also enables you to buy stocks in every stock exchange. Yes,
because your money is already held by the bank, and you therefore
have no need to transfer it to a separate broker’s account. Nonetheless,
several problems arise. Banks will generally collect commissions from
you that are from five to fifty times higher than those collected by
specialist brokers. Banks will generally provide a limited, cumbersome
trading platform that does not display real time data and is usually
suited only to long-term investors, and definitely not suited to day
traders. Later we will review the requirements of trading platforms.
Finally, I have yet to come upon a bank able to provide you with the
necessary tools.

How to Choose a Broker

Many brokers would be happy to provide you with a trading platform,
but not all of them are suited to a professional trader. You need to
distinguish between brokers who designate their services to the public
of long-term investors, the category where most brokers fall, and those
who provide web-based platforms. They are known as Online
Brokers. Professional brokers supplying direct access platforms allow
fast navigation of direct orders to any target. Professional brokers
provide trading platforms which are not web-based, but which usually
require downloading and installing software and allow the trader to
send orders directly to the stock exchange computer without using a
slow, costly method. These are called Direct Access Brokers. To be a
successful day trader, you must work only with Direct Access
Brokers.

How to Choose a Trading Platform

The trading platform is the most important link in the system
connecting trader and broker. I know traders whose trading volume is
so large that they could significantly decrease the commissions they
pay if they’d move to a competing broker, but may prefer to stay with a
more expensive broker because of their satisfaction with the broker’s
trading platform.
The trading platform lets the trader route buy and sell orders
directly to the stock exchange computer. The trading platform you will
use must include charting which will help you follow stock rates in
real time.
 SMART Commissions aren’t the main consideration
when choosing a trading platform.
MONEY Execution speed and reliability are far more
important to the trader than the
commission charged.

Just as a skilled carpenter will not compromise on the quality of the

saw, so a professional day trader will never compromise on the quality
of the trading platform, as any such compromise will end up being
very costly. Think for a moment about what might happen if a trader
wanted to buy a stock at the breakout point, but the order is delayed
and the transaction is missed because the stock has risen higher than
the requested price. The trader’s frustration will be immense.So will
the long-term financial damage.
The direct access system lets the trader buy and sell stocks direct
from any destination with liquidity at the moment of execution. If the
trader wishes to do so, the order can be routed directly to an ECN
which provides the stock exchange’s liquidity. Alternately, the trader
can direct the transaction directly to the market makers. There are
advantages and disadvantages with direct routing to any destination
according to the quantity of shares needed and the speed of execution,
but the direct access system leaves that choice in the trader’s domain,
which is how it should be. For the most part, the trader will prefer
executions of up to several thousand shares, considered a large
amount, routing the orders via the broker’s automated routing system.
The system will automatically find the cheapest and most rapid route
much faster than the trader can. For a professional trader, a delay of
one or two seconds can in some cases mark the difference between
profit and loss. In other instances where the quantities are large or the
commission is more significant than the execution speed (a method
we’ll learn about later), the trader may want to route the order direct
to the market makers.
 It is very clear that a trading system supporting direct access is far
better and more effective. If so, why is it that most brokers don’t allow
direct access? More on that later.

With Which Brokers Should You Never Work?

The online broker, unlike the direct access broker, is interested in
delaying the execution of transactions. If a transaction is delayed, it
could lodge even greater profit in the broker’s pocket beyond the
regular commission: for example, imagine a situation in which a client
sells 1000 Microsoft stocks and simultaneously another client with the
same broker wants to buy 1000 Microsoft stocks. The broker will prefer
to execute the order between the two clients without needing to relay
it to the stock exchange computer. Closing the transaction internally
saves the broker costs, and sometimes even makes the broker
additional profit from the spread (difference) between the bid
(purchase) and ask (sale) prices. A spread of one cent over 1000
stocks means $10 more profit beyond the regular commission that the
broker collects from both of the clients making the transaction. To
create opportunities where the broker can execute orders in-house,
the broker may be tempted to delay execution for several seconds.
This is insignificant for the long-term investor, but intolerable for the
day trader. In addition, when online brokers relay your order to the
market, they will choose the destination cheapest for themselves.
Usually these are market makers who will share their profits with
brokers. The cheapest destination is not necessarily bad for you and
can sometimes be a faster route, but your preferences as a trader are
different from those of the broker. You want speed and liquidity;
brokers want profit.

SMART Online brokers collect rebates for execution,

therefore pro t more if they delay execution
MONEY and route orders to destinations that are
cheaper for the broker.
Should You Trade on Margin?
A margin is a loan that brokers provide to traders. As with every loan,
margin bears interest, unless the trader makes use of it only during
the course of the trading day, in which case no interest is paid.
When a client opens an account with a broker, the client can
choose a margin account or a cash account. A margin account
allows you to buy stocks at a multiple of four times your money: for
example, if you deposited $30,000 in your account, you will be able to
buy intraday (in one day’s trading) stocks valued at $120,000. In other
words, the margin carries a 4:1 ratio.
By contrast, if you want to hold stocks overnight, perhaps fearing
that the stock price may change in the course of two days’ trading, you
will need to be satisfied with a 2:1 margin. This sets your buying power
at $60,000. If you use this doubled buying power between two trading
days, you will be charged interest. Clearly it is worthwhile using the
intraday margin during one trading day, as you will pay no interest. I
support using margin beyond one day of trading, despite the interest
charged, because the trading method that holds for several days is
based on aggressive profit goals of several percent, which means the
annual interest charged allows a higher expected profit. Margin allows
you to work with higher sums than your regular cash balances allow.

SMART Margins are dangerous if you don’t know

how to use them, but a real gift when you
MONEY manage them correctly.

Margin also has its disadvantages. Let’s say you deposited $10,000 in
your account and bought 1000 shares at $10 each, using all your
deposit. In other words, you’ve used your own deposit without using
any margin. A drop of 25% in a stock price from $10 to $7.5 will cause
you a loss of $2500, or 25% of your money. On the other hand, if you
use a 4:1 margin, buying 4000 shares for $40,000 followed by a drop of
25% in price will cause $10,000 worth of damage and wipe out your
account! And what would have happened if you’d slept on Lehman
Bros stocks after the Sub-Prime Crisis when they plummeted to $3 and
the next day were worth mere cents? When you sleep on a margin of
2:1 and the stock price drops more than 50%, this is the stage in which
you are losing not only your own money but that of the broker too.
The broker’s job, of course, is to prevent risks of this kind. This is why
brokers maintain a risk department whose job it is to keep tabs on
your account and warn of potentially hazardous situations. In
actuality, it rarely happens that a client loses more than the amount in
his or her account.
Does margin sound risky? To experienced professionals, not at all.
They will never endanger more than a pre-defined sum of money. This
sum, which they are willing to risk, will have nothing to do with
margin. As we will learn further on, they use stop orders as
protection, and plan in advance the maximum dollar loss they are
willing to absorb. They never absorb losses of tens of percent, and
never endanger their trading account. If you remain disciplined and
operate according to the rules, you will learn as we progress, and
margin will become a gift at your service when wisely used. By
contrast, if you are not sufficiently self-disciplined and have a
tendency to gamble, beware!
Brokers are at risk and do not share in the profits you can make
from margin: so why would they bother to provide you with margin?
There are two main reasons. The first is the fact that interest is profit.
When you buy on margin beyond the trading day on which you
purchased the stock, you pay interest, from which the brokers make a
profit. The second reason is that the greater the sum of money
accessible to you, the more probable it is that you will execute more
transactions with greater volume. Why would you be happy with
buying just 200 shares if you can profit from buying 800? In short,
margin benefits both sides: the trader can put in just one quarter of
the amount needed and enhance his or her potential on each trade by
double or quadruple, while the brokers benefit from greater volume of
activity which creates more commissions.
 As a day trader, I’m very active within the day’s trading hours and
often use the entire margin capability available to me. I tend not to
use the full margin available for purchasing one stock, but for several
stocks simultaneously purchased: for example, I might buy stock A
without any margin, identify a good opportunity, and buy stock B with
margin, and possibly even stock C and D until my money’s full margin
is maximized.
When I sleep on a stock for a range of several days, it will usually be
after successfully taking a partial profit of at least 75% of the shares I
bought. The same would apply, too, if I slept on four different stocks: I
would use almost no margin.
Summarizing: the disadvantage of margin is the interest it bears
beyond one day’s trading and the risk of losing four times more than
you might have lost if trading without the margin. In actuality, the risk
is no higher, as we will learn later, as there is little significance to the
sum with which you’re trading as long as you use stop orders that limit
the amount any transaction can lose. The advantage of margin is that
you don’t need to make a much larger deposit in order to trade with
higher sums. In light of the dangers inherent to using margin, day
trading rules prevent brokers supervised by American regulations to
provide margin greater than a 4:1 ratio on any single trading day and a
2:1 ratio for more than one day. In fact, the condition for being allowed
to use margin is that you are required to deposit a minimum of
$25,000 in your account. In any case, even if you do find a way to reach
higher margin, as new traders I would advise you to make do with the
4:1 ratio. A too-high margin might go out of control in risky situations
where you feel you absolutely “must have” a certain stock. That’s
precisely when it’s best to take a deep breath and minimize the risk. A
reasonable margin prevents mishaps of this kind. In short, be satisfied
with a little less and you will save a great deal.

How Much Should be Deposited in the Trading

Account?
As noted, United States regulations prevent day trading to people with
less than $25,000 in their accounts. Day trading is defined as making
more than four transactions over five successive trading days. US
citizens wishing to operate as day traders must deposit that minimum
figure. In actuality, the day trader must deposit more, because the very
first loss that brings the total below $25,000 will limit the trader to no
more than four transactions over five successive days. This rule does
not apply, however, to citizens of other countries on condition that
they operate via brokers whose center of activities is not within the
US, and on condition that the broker is regulated outside the US.
US brokers offer their services mainly to US clients, and therefore
do not match the attitudes of citizens from other countries. In other
words, even if you aren’t a US resident, you will still suffer the
limitations placed on US citizens and will need to deposit a minimum
of $25,000 to trade daily. With this in mind, I would recommend that
if you choose to open an account with a US broker, you deposit at least
$30,000 so that any losses you may absorb will not limit your activities.

SMART The more money you deposit in your

trading account, the more you increase
MONEY your chances of success. “More money” is a
relative value based on your changing
nancial abilities and the risk level you
acclimate to.

Trading CFD’s
What is a CFD? A CFD (Contract for Difference) is a contract between
a “buyer” and a “seller” certifying that the seller will pay the buyer the
difference between the stock price at time of purchase and its price at
time of sale. In other words, buying a CFD allows the buyer to profit
(or lose) from the difference in stock price without actually buying the
stock itself.
 Under certain conditions, as described below, and if your broker
allows you to choose between stock or CFD trading, choose CFD
without a moment’s hesitation! CFD is executed in exactly the same
way as stock trading. In fact, if your broker does not expressly state
what you’re trading in, I’m prepared to vouch for the fact that you
wouldn’t even sense the difference.
So how does CFD trading differ from stock trading? When you buy
stocks, you buy them through the stock exchange from a person
interested in selling them at the exact same time you’ve decided to
buy. One of the biggest issues with the stock exchange is the scope of
supply and demand. But we don’t always find the buyer or seller with
the required amount, and we often need to “chase the stock.” Chasing
stock generally costs us both money and health. But when you buy
CFD, you’re not buying stock at the exchange; you’re buying a contract
identical to the stock from your broker.
The advantage of this method is that your broker can allow you to
buy or sell any quantity without linking it to stock exchange liquidity.
Think of it this way: Let’s say you want to buy 1000 shares, but
sellers are currently only offering 100. You would have to wait for
additional sellers, or possibly pay a higher price for additional stock.
When you trade in CFDs you are not limited by quantity, and
therefore the instant you hit BUY, you receive the full amount you
wanted even if that supply of shares is not currently available in the
stock exchange. Similarly, when you wish to sell 1000 shares, you will
not have to wait for buyers to take the full quantity. You just sell by
hitting the SELL button. If you have experience in the market, as I
have, you must agree that it’s impossible to tag this method with any
description other than “amazing!”
Have you ever heard the claim that students in trading courses who
use the “demo” (which allows practicing how to trade without actually
involving money) almost always profit? That’s a true claim. One of the
main reasons explaining their success is the fact that training
programs, like CFD trading platforms, do not limit the trader to
market liquidity. You press the button – you’ve bought! You press the
button – you’ve sold! Any quantity, and at lightning speed. Traders in
the real market can only dream of such immediacy. Ask any
experienced trader what his or her biggest problem is, and probably
the complaint topping the list will be speed of execution and liquidity.

More Bene ts of CFD Trading

No limit on shorts – In the stock market, some stocks carry limits on
shorts. That’s not true for CFDs. Nor is there any uptick limit which,
in the real market, limits the broker’s ability to execute shorts unless
the stock rises by one cent.
High execution speed – Buy and sell orders of regular stock go
through a long process where the order is sent to the broker, who
sends it to the stock exchange, and back. CFD trading is between you
and your broker alone, making execution super-fast.
High level margin – CFD brokers are not limited to the usual scope
of leverage on stock and can therefore let you margin up to 20:1. How
does that translate? If you deposit a sum of $10,000 in your trading
account, you can execute trades up to a total of $200,000. A word of
warning: high leverage is a blessing to very experienced traders, but
can be extremely dangerous for new traders.

What to Check before Choosing Your CFD Broker

Buy/sell spread – You need to check if you broker allows you to trade
in regular market spreads. In other words, check that he does not
“open” the spread between the seller and buyer price beyond what is
shown in the stock exchange where the real share is being traded. I
know of CFD brokers who, instead of taking execution commissions,
open the spreads by three to ten cents and even more. In this regard I
can say that the broker I use, COLMEX, allows me to trade in real
market spreads.
Diversity of Stock – Some 10,000 stocks are traded on the American
stock exchanges. Of these, for a variety of reasons such as volume of
activity, only about 2000 are suited to CFD trading. Check with your
broker how many can be CFD traded. Some brokers only offer a small
range, some offer dozens or a few hundred, and some, like COLMEX,
offer a few thousand, which is all that’s needed for trading.
 Summing up, I note the interesting fact that CFD trading is legal,
accepted, and supervised by the regulatory authorities in most
countries in the world except the USA. If CFD trading is so good for
traders, why is it blocked to USA traders? Simply, as I explained above,
a CFD doesn’t trade the stock itself. If all market activity focused on
CFDs instead of trading in stock, the stock exchange would lose its
main raison d’etre: recruiting capital for companies.
In short, if you live outside of the USA, you might prefer to open a
CFD account after checking with your broker that they offer real
market spread, a reasonable commission and a broad supply of stock.
If you live in the USA, the only way to trade in CFD is by joining a
group of proprietary traders operating outside America, who may be
looking for traders, including Americans, to broaden their trading
base.

A Word of Warning
For good reason, the United States has set day trade regulations
requiring a minimum of $25,000. In the past, when this standard was
determined, commissions were far higher. When the minimum
commission stood at tens of dollars per transaction, the trader had no
choice but to operate in large amounts of money to offset the impact
of these commissions. If a trader did not have a serious deposit in the
account, the commissions would gobble up all the trader’s profits.
Now, with commissions far lower and the minimum currently at about
$1.50, the trader can buy and sell small quantities without lessening
his or her chances of success. In some countries where Tradenet is
active, such as areas of Eastern Europe, the monthly profit target is
$1000, which equates to twice the average monthly salary. In short:
America is not the whole world, nor is the entire world American.
Nonetheless, relative to the profit levels and your cost of living,
years of experience have taught me that the higher the initial deposit,
the greater your survivability and reaching success.

Are You Personally Acquainted with Your Broker?

It’s completely natural to be wary over depositing your money into the
bank account of a broker you don’t know. If you want to sleep better at
night, knowing your money is safe, check whether the broker you’ve
chosen operates within the framework of regulations. This means your
money, like that of others, is supervised, separated from the broker’s
own ongoing activities, and insured. The insurance provided should
not be that of the broker, but of a reliable, external organization.
Clients of US brokers are meant to be insured by federal insurance up
to a framework of $100,000 in their accounts, while clients of European
Union brokers enjoy the automatic cover of the ICF (Investor
Compensation Fund) for up to a €20,000 deposit. The ICF covers all of
Europe and insures every deposit up to this figure, in every European
financial organization.

Broker Support: What You’ll Get, and What You Won’t

Imagine this: the US Federal Reserve Bank publicizes an important
economic notice creating a financial turmoil. Traders, investors,
institutions and market makers stream multiple orders into the stock
exchange’s computers. The outcome: system failure and immense
difficulty in getting orders executed. This kind of situation shouldn’t
bother you in any way, unless you’re a day trader holding a particular
stock and your only interest is fleeing from it as early as possible.
But bad luck strikes: all systems are stuck and you need to call the
broker’s client service. Due to the crash, you probably aren’t the only
ones phoning your broker at that very moment: that means you’ll be
spending long Muzak minutes until call is finally picked up. Sounds
like a nightmare? Experienced traders know these and similar
scenarios well.
Admittedly, systems these days are highly reliable. Such situations
are rare, but breakdowns can happen. Remember that breakdowns
and glitches are part and parcel of the life of a day trader. Try to
choose a broker who will respond quickly for no more than the cost of
a local call. That’s the kind of broker who can save you a lot of money,
and help give you peace of mind.
Summary
Whittle down your list of potential brokers according to points you
assign each one based on the following:
1. Is the broker well-known and with long-term experience,
operating according to the regulations?
2. Do the regulations under which the broker operates provide for
insurance of your money? If so, up to what amount is covered?
3. What is the minimum execution cost?
4. How much will you pay beyond the minimum? (usually a fixed
price per stock)
5. Does your broker allow you to deposit less than $25,000 and still
allow you to day trade?
6. Does your broker allow you to trade on margin?
7. Does the broker collect a fixed monthly fee for providing a trading
platform? If so, how much?
8. Does the broker collect a fixed monthly fee for providing
information of any kind?
9. Does the broker’s trading platform allow you to observe real time
charts?
10. Does the broker’s trading platform allow direct access to stock
exchanges?
11. Is the broker’s trading platform a downloaded, installed, dedicated
application, or is it only web-based?
12. Will your broker let you “paper trade”, known as practicing on a
“demo platform”?

Once you’ve found a broker of your liking, check his website for
where to begin the process of opening your trading account. Once
that’s completed, deposit your money, receive the trading platform,
and continue with the learning process described in this book, while
learning the platform you’ve chosen.
Chapter 3- Market Analysis
Fundamentals
Prices move in only three directions: up,
down & sideways.
The Price Says it All!
The stock market is like a huge giant that constantly changes its
appearance. Every trading day is different from the preceding one,and
every trading hour is different from the hour before. As the ancient
Greek philosopher Heraclitus once said, “You cannot step in the same
river twice.”
The stock market is the outcome of the sum of all persons
operating on and in it. Each has an individual opinion and thoughts,
and individually, each pushes the market in the direction he or she is
able, whether as a buyer or seller.
Can we nonetheless know what the sum total of persons operating
in the market is thinking? Of course we can. A quick glance at that
most important piece of information gives us the answer: the price.
A dynamic market which constantly changes is inherently
challenging. Our human thinking processes are very standardized.
Most people wish to demarcate concepts within boundaries, and sort
and catalog things, whereas the market is highly dynamic. To cope
with this challenge, you will need to become closely familiar with the
market, the principles of stock trading, and how markets behave. This
will enable you to establish your own work program, your own rules
and limitations, and apply them when you join the market.

The Market Is Always Right!

The stock market’s conduct as described has given rise to two similar
statements: “the market is always right” and “the price is always right.”
At any given moment, the market and the price consistently embody
all relevant information. Don’t try to argue with the market. Many
before you have tried and failed. Any attempt to force your opinion or
hopes on the market is predestined to failure. Even large players in the
stock market, who truly have the ability to slightly shift the market,
are aware of the market’s forces and consider their moves with due
gravity.
Over time, I also learned the purposelessness of disputing the
market. For example, one of my rules (which we’ll discuss further) is
that on any day that I make three consecutive losses, I stop trading.
My experience has taught me that if I continue, I just keep losing,
since the psychological impact of three losses at a time makes me try
to force my will on the market.In that battle, I can assure you, the
market will always come out on top.

Market Forces: Bidders and Askers

Understanding the market means first understanding the forces

controlling it: in other words, gaining a deeper understanding of the
interests of buyers (bidders) and sellers (askers) and the impact of
their interests. It is customary to say that if bidders control the
market, the price of a stock rises, and if sellers are controlling, the
stock price will drop. This is true in general, but too simplified and
appropriate to a novice trader or amateur investor. We know that
bidders want to buy cheaply, and sellers want to sell for the highest
price they can get. For investment banks, who buy and sell for
institutional clients and are remunerated according to the bid and ask
prices they procure for the clients, buying cheaply and selling at
higher prices gets translated into action. We, the small traders, can do
nothing but follow in their footsteps.
Let’s take a look at the following: one fine morning, a trader in a
large investment house on Wall Street is instructed to buy 500,000
stocks of Company X. In anyone’s view, that’s a lot of stocks… Will
Company X’s stocks open on that same day with a rise or a drop in
rate? The answer depends on multiple factors, but because the bidder
wants to buy a huge amount of stocks at the cheapest price possible,
the bidder will first try to make the stock price drop. The bidder may
start the day by selling a large quantity of stocks as soon as trading
opens, igniting a wave of sales. When the stock drops to a price that is
sufficiently low in the bidder’s view, the bidder will then start buying.
Simply put, the buyer’s control over the stock caused it to drop instead
of rise. A trader following the stock’s movement may accidentally
think the stock is facing a day of downward-spiraling prices, when in
actuality that was only at the start, followed by rising prices for the
rest of the day.

“Go in! Go in!”… When Does the Public Buy?

Sunrays are peeping through the window of Average Investor’s

home. Good morning! Mr. Average heads for the kitchen, makes
coffee, and pulls a few cookies from the box. Heading toward the
family room, Average detours to pick up the newspaper tossed at his
doorstep earlier and eyes the headline: “Hot Stock Exchange: The Five
Top Stocks.” Actually, that’s a good reason to move away from the
stocks, but we’ll explain that later. For now, Average is sipping his
coffee, turns on the television and watches a morning show. The word
from the sponsors ends, and the emcee asks, “And how did our money
do this week?” We’re shown an investment house. The presenter sums
up the week’s events, ending with the statement: “The stock market is
boiling. The public is streaming in.” That’s actually another good
reason to take caution, but more on that later.

SMART The public buys stocks at their peak price.

Sometimes the stocks continue to rise, but
MONEY mostly the public holds onto them long
enough for them to begin dropping, and
the public absorbs the loss.

An hour passes. The insufferable thought runs through Average’s

mind: everyone’s in and making millions in profit and he’s the only
sucker still on the outside. That’s when the decision comes: “It’s about
time my money worked for me, too!” says Average to himself, and
decides to buy. He puts the cookies back in the box and calls his
investment consultant.
Why is Mr. Average Investor buying? Is it because someone
recommended that action, or because it’s “in the media?” Does Mr.
Average know what to buy? When to sell? Which stocks to be wary of?
Would you buy a refrigerator or car in the same frivolous way? Perhaps
your investment advisor knows what and when to buy? From my
acquaintanceship with investment advisors, I’d say that 99% of them
have no idea what to buy. In fact, the person has yet to be born who
knows with certainty whether a stock will go up or down in the
longterm. I don’t know, either.
The public tends to buy because of social pressure: others are
buying, or a friend suggested it, or for fear of being the only one left
out. The public will never be the first one in to buy a stock that has
only just begun going up. A stock’s potential to rise in the short term
is usually identified only by the professionals. The public observes the
stock which has already risen and promises to buy if it “proves” itself
as strong, and continues rising. Usually the public is only convinced
when the stock has already risen too far, proclaiming it a “winner.”
Then they step in and buy. Who, in your opinion, is selling to the
public at the high price? That’s right: the professionals. Even if the
stock does continue rising, the public will tend to overstay, the stock
will start to drop, and the public will absorb the losses.

The Role of the Professional

The pros have a clear role: they take the public’s money. And they have
plenty of creative ways to do that. Their biggest advantage is the fact
that they’re pros. That’s their profession. The public generally arrives
at work in the morning, answers phones, writes e-mails, and believes
its money is hard at work. The public receives a salary at the end of
the month, because each member of the public has a profession. Each
person earns his or her income because of an advantage that has no
connection to the capital market.
 As with the public, so too with the professional: the pro knows that
the public will behave in a certain way. The public feels pressured and
sells hysterically when the market comes close to a low, and buys
enthusiastically when the market’s upward movement is already too
tense and about to correct.
Stock exchange trading is my profession. It’s a profession that does
not require knowledge of economics, but rather of psychology alone.
In fact, the less you know about economics, the better off you are. As
an amateur psychologist, I know how to predict the public’s behavior.
The simple outcome is that if both of us invest in the market, the
probability is higher than in most cases I will come out the winner.
Just as I cannot replace a professional in some other field, there is no
reason to assume that such a professional can replace me in my sphere
and take my money.
The professionals are not mere stock traders. They are also fund
managers and investment bankers and anyone who makes a living
from the capital markets. They also have creative ways of taking the
public’s money. They manage it in return for management fees,
commissions, and other kinds of income without ever promising any
results! Based on the past, we can see that over the last twenty years,
80% of the world’s managed funds earned their clients less than
market index yields: in other words, fund managers know they are
taking the public’s funds in vain, but with every advertisement they
continue to promise: “Give us your money and everything will be fine.”
One simple and valid conclusion can be drawn in respect to every
profession in the world: amateurism costs money, professional brings
money in. The dream of money working for you is not realistic, and in
best-case scenarios, works solely during occasional periods that can be
pinpointed only in retrospect.
In short: no one is prepared to work on your behalf! If you want to
earn profits, you need to press those buttons yourself. Learning is the
key to success. This book is just one part of the process.

Science or Art?
There are four ways to reach a decision on transacting in stocks:
• Technical analysis, which is how traders operate
• Fundamental economic analysis, the method for long-term investors
• Random walk, the mode of operation for those who claim there is
no method
• Gambling, the method used by the public which thinks it’s found
“the formula” for turning a profit
Stock trading is not an exact science. If it were, it would be handled
by accountants. No method is complete in and of itself. Even if you
learn a 300-page manual on technical analysis by heart, I can assure
you that you’ll still lose money. The winning recipe is a combination of
winning components. The question then becomes: how do I
proportion the components? That differs from one execution to
another, from one stock to another, from one set of market conditions
to the next. Getting the proportions right is, in fact, the art of trading.
Stock trading is midway between an exact science and art.

Who’s Afraid of  Technical Analysis?

Sometimes the very title of a specific field causes people to fear it and
feel alienated from it without even knowing that field’s content. Too
often this is the case with the phrase “technical analysis.”

SMART Technical analysis is based on observing

past behavior for the sake of predicting the
MONEY future. Technical analysis is based on
outcomes and not on reasons.

The word “analysis” indicates a review process that closely studies

the details, and often conjures up someone deeply engrossed in
meticulously examining mounds of books, articles and papers. The
word “technical” generally indicates a practical, mechanical sphere,
conjuring up images of engineers in white lab coats bent over
blueprints or a complex piece of equipment. Both words merged into
one phrase seem to cause strong trepidation.
In fact, the field of technical analysis is far from these images. Yes,
it has to be learned, just as any profession must be. Technical analysis,
in fact, is simple to understand and easy to apply, especially in the area
of day trading which requires only the fundamental tool that technical
analysis offers. More importantly, technical analysis does not only
relate to dry analysis and comprehension, but actually offers a
practical method for stock trading.

So What Is Technical Analysis?

• Technical analysis is a review of graphs showing the behavior of a

financial product for the purpose of forecasting future price trends
• Technical analysis focuses on price: i.e., the outcome of the totality
of insights of all factors operating in the market
• Technical analysis takes no interest in the reasons for any given price

The technical trader’s three basic premises are:

1. The change in price embodies all market forces. In
other words, the stock price expresses everything that can impact
the price as far as economics, psychology, politics, etc. Therefore, all
that is needed is to follow the price, which reflects changes in
supply and demand.
2. Prices move in trends. Trends are cyclical and therefore
generally allow predicting their direction.
3. History repeats itself. For more than a century, technical
analysts have been assisted by graphs plotting stock trends. Accrued
information allows identifying recurring behavior patterns.
Technical analysts believe that in certain situations the public’s
emotional reaction can be expected, and therefore the analysts
presume that based on past history, future movements can be
predicted.
 Technical analysis alone will lead you to certain failure. Even if you
study all the books ever written on the subject and can quote them by
heart, and were you to write software that operates according to their
doctrines, you’d still fail.
At the most, 10% of technical analysis components actually work,
but not in a vacuum. If you know which of those components to
isolate from all those available, and how to integrate them with other
components unrelated to technical analysis, you have a good chance of
succeeding. But remember, the recipe for success merges experience
and art.

Fundamental Economic Analysis: What Does It

Incorporate?

A fundamental investor is one who buys a company’s stocks in the

belief that the main source of price change will be the company’s
performance, which covers changes in sales turnover, profitability,
demand for the company’s products, management, cash flows, and
more. The main tools these analysts use are the company’s balance
sheet, analysts’ recommendations, information gleaned from the
media, and hearsay. A fundamental analyst is also interested in the
economic status and the status of the sector to which the stock
belongs, such as software developers, semiconductors, and the like.
Fundamental investors review market interest rates and try to predict
their direction and their scope of change. All this data is weighed, and
conclusions are reached.
These are usually long-term investors who do not expect to see
their predictions realized in the short term. They therefore keep their
positions in the hope of seeing them turn fruitful in the long term.
I use fundamental analysis at the level of media headlines. I don’t
believe in this type of analysis, but I do believe that the public, and
funds, believe in it, therefore I relate to it with due respect and give it
some weight in my decision-making processes. For example: let’s say
the public believes that the stocks of a certain biotechnology company
will strengthen due to a diverse set of components. This is good
enough information for me to realize I need to focus on technical
trading opportunities with biotechnology stocks. In actuality, I’m
merging the technical analysis with the fundamental economic
analysis.

Random Walk

The theory of roaming negates all types of analysis, whether

technical or economic. This theory, developed in academia, sees price
change as completely random and unpredictable, and that nothing
can be learned from the stock’s history towards predicting its future
trend. The theory is based on another called “The Efficient Market
Hypothesis,” according to which prices embody all information
available in the market. There are no expensive or cheap stocks
because the market calculates all risks and opportunities as an
embodied price. The “Random Walk Hypothesis” claims that because
markets are random, one should “walk” through them “randomly”
[from this point on], and that the best way to profit from a stock is
through a “buy and hold” action.
There is indeed a degree of randomness in the market, but to say
that all price trends are random is unthinkable. Random walk theory
claims that it is impossible to overcome market indices and that one
would be hard-pressed to explain the success of famous investors such
as Warren Buffet and Peter Lynch. Their claim, therefore, includes me
and my successful trading colleagues. A well-known standing joke
concerning “efficient market” theories charmingly points to its
inherent Achilles’ heel:
Two lecturers on economics see a $100 bill lying on the sidewalk.
One bends down to pick it up, while the other says, “That’s ridiculous.
There’s no way a $100 bill is just lying there. After all, someone else
would have picked it up long ago!”
According to the Efficient Market Hypothesis, someone else
certainly would have picked it up long ago, but there it is! Keep in
mind that at the basis of both theories, random walk and technical
analysis, is the premise that the market manifests all market factors.
The difference between these two approaches is that proponents of
the random walk see the market as embodying all information at high
speed, therefore no one has any advantage in the market, whereas
technical analysis claims that important information manifests in the
market far earlier than is known to the general public.

Gambling, Anyone?

Well, this isn’t actually a method. It is actually the mode of conduct

of the public, which rushes to the stock exchange at its peak and flees
at its slump. It is the behavioral norm of the public that generally loses
money on the stock exchange. It is also sometimes the approach of
inexperienced traders who do not operate according to the most basic
trading rules, and do not believe in the principles they have set for
themselves. Watching such traders from a distance, the observer may
think they are real pros, but the dwindling account of such traders
tells the true story. Even as a novice trader, be a trader, not a gambler.
A sheep dressed in wolf’s clothing is still a sheep inside.

Fundamental  Economic Analysis  Versus  Technical

Analysis

This long-standing dispute began when the first analyst drew a line
between two points representing a stock’s price changes over the axis
of time, thereby creating the very first price graph.
The essence of the dispute is whether to buy a stock based on
company and market performance, such as the company’s balance
sheet, or based on the stock’s behavior as illustrated by graph alone.
Both methods attempt to predict price trends. As already noted,
the fundamental economic investor examines the stock’s value relative
to company performance and market performance, and concludes
whether its price is above or below its true value. If, in the long-term
investor’s opinion, the price is currently below its true value, he or she
will buy, and vice versa. The technical trader does not ask “why,” but
tries to predict price trends according to graphs, that is, results in the
real-time field.

SMART Integrating fundamental economic

analysis with technical analysis is a
MONEY winning combination. No method can
operate alone, while ignoring the existence
and logic of the alternative method.

At this point, I will cease being objective and say outright that I do
not believe in the sole credibility of one or another method. I believe
that their integration is the winning method. In reality, I choose to be
80% technical and 20% fundamental. Most technical analysts arrived
at this preference through fundamental economic analysis. I can
promise you that if you try to earn profits by reading financial reports
in newspapers and watching them on television programs, you will
discover sooner or later that you’re wasting your time.
Why do most people believe in fundamental economic analysis?
Because we’re educated to invest in the long term. And why is that?
Very likely because someone has to make a living from teaching
economics in universities, because funds must find legitimate
justifications for erroneous purchases, because stock market colleges
want to continue existing, because we as humans must peg everything
into some kind of mathematical, organized framework, and because
none of the educators are willing to admit that basically, they know
just about nothing even when history indisputably proves that they’ve
erred throughout the long term! Teaching methods and attitudes have
not changed over decades, and sometimes even over centuries.
Most of those involved in the stock market define themselves as
purely fundamental or purely technical. In reality, there is no small
amount of overlap between the two methods. The problem arises
when the two methods oppose each other. History has proven that the
technical method has always preceded the economic analysis. Most of
the largest market trends occurring throughout history were ascribed
no significant explanation according to economic data, yet most could
be predicted based on technical conduct. Experienced technical
traders learn over time to trust their own considerations, which will
often stand in direct opposition to those proposed by fundamental
economic analysts. Technical traders will be enjoying the benefits of
changes when fundamental investors have long since missed the train.
Would you like an example? Was it possible to profit from hi-tech
companies’ stocks at the end of the 1990s? Of course, and abundantly!
Could even one fundamental investor be found able to justify buying
stocks in technology companies that have no income, only
expenditures and dreams? Of course not! Technical traders knew
where the public’s emotions would lead the market, whereas
fundamental investors chose to ignore the expected change.
At some point, they nonetheless found justification for joining.
Remember the phrase “profit without advertising costs”? Several more
illustrious economic concepts came into being along the duration of
the hi-tech bubble, meant to justify late-entry into a teeming market.
Funds simply could not tell their clients they were not buying when all
competitors presented astronomical profits, therefore they invented a
financial justification, and happily bought in. Those who wasted their
time with analyses of hi-tech companies’ financial reports prior to and
during the rush, left opportunities wide open for technical analysts to
enjoy alone. Those who continued justifying their erroneous
fundamental holdings when the stock exchange changed direction
and crashed, lost out.
Over time, once the market had absorbed these large shifts, the two
methods caught up with each other and once again presented a united
front. We ask: must some compromise be found between them? As a
novice, I thought the answer was no. Now, with years of experience
under my belt, I believe I was wrong. As noted, I’m currently operating
on an 80% technical and 20% fundamental mix. I’ve moved a little to
the other side because I found that when sticking with only one
approach, the market seems in many cases to operate as though it has
a mind of its own. I found that relying on technical data alone did not
provide me the advantage I sought. By contrast, it’s completely clear to
me that relying on economic data alone is nothing more than a
gamble. If you’ve ever tried to watch how a stock behaves after its
financial reports are publicized, whether good or bad, you’ll
understand exactly to what I refer.
Note that I used the very specific terms “fundamental investor” and
“technical trader.” In the past, when the world was chiefly industrial, it
was possible to rely on economic data for the long term. In the past, it
wasn’t possible to change the rules of the game overnight. When a
mega-corporation like General Motors or IBM presented good balance
sheets, it was clear that no competitor could surface overnight and
take their top status from them. Therefore, these economic data
points were reliable for the long term. To compete with GM or IBM, an
unimaginable investment would be needed, therefore in the short
term, no change could be expected that would endanger the investor
too greatly.
In today’s technological reality, every young entrepreneur living in
student dorms can topple a conglomerate like IBM from the top of the
pyramid. Remember when IBM preferred to develop hardware, and
some young guy named Bill Gates developed DOS for them? Just
check Microsoft’s market cap against IBM’s to understand how the
world can change. And who used technological innovation to topple
Microsoft from its top position as the company with the largest
market value? Apple, which was dormant for years but reached new
peaks with the iPhone and iPad, leaving Microsoft behind at the
curve. And what of Google, sprinting ahead? Will Facebook, breathing
hard down Google’s neck, overtake the lead? In the current business
world, any technological or biological innovation can change market
structure overnight. The days when our parents would buy a stock
such as IBM, place the paper deed (yes, once upon a time a written
deed was issued to the stock owner) beneath their pillow and go to
sleep knowing all would be fine, have long since disappeared. Nor
have we yet begun to discuss the impact of wars and terror attacks…
I believe that long-term investment is dead, together with the
world of absolute control and the fundamental economic analysis
method. The short term is what to watch, which is why technical
analysis is currently the controlling method. We live in a time when
we need to trade with fast changes and remain wary of dangerous
long-term investments. The technical trader who buys stocks that
unfortunately move in the wrong direction (yes, that can happen, too)
realizes he or she has erred, sells them and moves on to the next
stock. When fundamental investors buy a stock, they hold onto them
for as long as it has yet to be proven that the fundamental economic
data have altered. Such investors believe that the stock’s value is
actually higher than its market value, and therefore when it drops in
price, it can actually increase their holdings. It’s true that not so many
years ago, the method did work. Remember the dot-com bubble that
burst in 2000? That’s where the method stopped working. That’s
where the technical trader profited from shorts and the fundamental
investor crashed in a market which, to date, has yet to fully recover. It
was the trader’s opportunity, not the gambler’s.
If you need further persuasion, let me present another question: is
there any link between a company’s balance sheet and reality? Older
readers may well recall Enron, one of the largest energy corporations
in the world. Enron collapsed when its CEO chose to present the
balance sheet in a “creative” manner, and made sure he found an
accountant who would not stand in his way. Even if we allow that the
balance was legitimate, it nonetheless reflected the company’s status
in the previous quarter, which commenced just three months earlier.
Who is interested in it today? I’m sure that most balance sheets
presented to us are legitimate and correct, but should we gamble on
them with our money?
As traders, we rely chiefly on clear technical data. In the past, we
have come across a stock that rose multiple percentages in one trade
day, and only the next day the economic data causing the rise become
clarified. This does not imply we have no trust in economic data. We
just feel that they are already incorporated into the stock’s chart.
As if all that is not enough, there’s another important difference.
Technical analysis can be applied to every stock, sector, and market.
Give me a yearly graph for Japan’s Nikkei index, and within seconds I
can analyze the Japanese market. Show me the yearly graph for the
DAX index and in the blink of an eye, I will analyze the German
market. Can fundamental analysts, who need to read mountains of
material before buying any stock, do that? No! They cannot specialize
in every market, sector, and stock. They are limited to a specific sector
and even a specific company in some cases, and will never review the
entire market, but only a slim segment of it.

Why Do I Never the less Use Fundamental Economic

Analysis?

First and foremost, because most of the public uses it. Whether
there is any meaning to fundamental analysis or not is as pointless as
asking whether there is meaning to technical analysis. As soon as a
large enough number of people believe so, and operate on the basis of
economic data with predictable outcomes, the experienced trader will
know how to take advantage of the predicted movement and earn a
livelihood from it. Over the years, I have learned to appreciate the
power of the fundamental herd and rein it in for my own purposes. I
take no small number of technical decisions based on economic
factors alone. For example: I focus a lot on stocks influenced by
extreme economic analysis, such as an analyst’s upgrade, but then I
choose a technical entry and exit point. Using fundamental economic
analysis does not in any way indicate that I believe in that method, but
I’m definitely a firm believer in the predictable behavioral outcomes of
those who do use them. I have no need to deny any kind of prediction.
Rather, I need to evaluate whether it will be self-fulfilling.

Technical  Analyst or  Coffee-Grounds  Reader

Is technical analysis an exact science or an art? I think the truth is

somewhere in between the two. Senior analysts in Tradenet’s trading
room often ask me whether it’s worth buying this or that stock, and
my answer could very well be that it’s actually worth selling the stock.
If technical analysis were an exact science, there’d be no room for two
differing opinions on the same stock. By the way, even within the
science of economics, disputes are abundant, and what one economist
considers a solid company will be viewed unstable by another.
 If that is how things operate, you will surely be asking yourself
what function technical analysis holds. At the start of this chapter, I
noted that the market is like a giant of tremendous proportions, in a
constant state of change. Technical analysis helps create order in the
chaos and allows the trader to read the market through stock prices
and chart action. Moreover, from the moment traders learn how to
read the market, they no longer need to examine it constantly from
the technical perspective in order to understand what they see; they
simply understand (rather than ”read”) the market. Technical analysis
is therefore a tool that ripens in the trader’s awareness: we use it to
learn how to read the market, and once we know that, we no longer
need it except in instances when reading is difficult. Traders who
understand the market can identify market directions at early stages,
long before the regular technical signals, and trade accordingly.
Obviously, once the technical picture is completely clear, it’s clear to
everyone, and at that point you no longer have any advantage.
While technical analysis is not an exact science, there are technical
analysts, many of whom are well-known, that frequently fail in their
analyses. Young traders seeking to coerce technical methods onto the
market will fail time after time. When the market is collapsing, there
is no significance to technical support levels; when it is euphoric,
technical resistance levels are broken without a fight.
Some technical analysts have given a bad name to the field, and
threaten the livelihood of astrologers and coffee-grounds readers.
Among such analysts you will find charts with so many indices, lines,
and figures that you no longer know whether you’re looking at a graph
or a map of the constellations. Technical analysts who provide
forecasts for several months ahead are not professionals, but
charlatans.

Leave the Box

The laws of technical trading are known to all trading parties. The
specialists and market makers in the New York Stock Exchange know
your stop loss order point and your entry orders points, and will often
take advantage of this information for their own benefit. Take this into
account when you’re trading. The resistance line is not a solid wall,
and the support line is not stable ground. This is why we first talk
about “support levels” and “resistance levels” rather than precise
science. Young traders in the trading room often tell me they have sold
a stock because it broke the support level, while experienced traders
and I have held the stock and in the end, profited. Don’t let your hand
be too easy with the mouse. Remember that trading is a battle of the
minds and always involves two parties: buyer and seller.
This is also why I guide my traders not to place a stop order, but to
wait for that moment when the stock reaches the stop and then exit
manually. The specialists and market makers know where most
traders’ stop orders are, and use them to their own advantage.

The Guru of All Gurus!

The world of finance is liberally peppered with gurus. Jim Rogers is

one example. He believed with all his heart that China was the next
big thing, to the point that he moved to Singapore and his little
daughter learned to speak fluent Mandarin, leaving Chinese listeners
dumbfounded. And how many gurus predicted the 2008 Sub-Prime
Crash? Not long before that collapse, I was invited to participate in a
panel of economists at a well-known university.

SMART No one can predict the future of the market

or any stock. For every opinion presented by
MONEY a renowned analyst, we can nd a
contradicting opinion by an even more
renowned analyst.

First, the chief economist of a large bank spoke, followed by the

CFO of another bank. Both offered solid forecasts: the housing crisis is
no more than a simple passing episode, the economy is strong, there is
no danger of crisis in the capital market. In short, a message of “Don’t
worry, all is well.”
I’m used to the idea that someone receiving a salary from the bank
would not try to frighten the public or drive investors away, but this
was over the top. When it was my turn to address the audience, I said
very simply, “I don’t know what will happen.” The moderator persisted,
admonition coloring his voice, “We brought you here to tell those
present what they should do.” So I told the truth, and one which will
surely mean that that university will never invite me again to lecture
there. This is what I said: “Don’t listen to analysts, because they have
no idea about the future.”
From the reaction of the moderator and the public, I had clearly
touched a sensitive spot. The public likes to be told what to do. It likes
to be taken by the hand and led, whether to slaughter or splendor, but
it does not want to be burdened with the commitment of having to
make its own decisions. At this stage of a clearly-explosive
atmosphere, I added, “Don’t let bankers and funds manage your
money, take management fees and commissions, and then tell you ‘it
will be okay.’ The truth is that just like me, they have no idea what will
happen in the future.”
No matter whom the guru is, or whether he or she takes the form
of an investment advisor or analyst, when you read or hear any kind of
recommendation in the media, don’t lap up those words with thirsty
love. Consider them critically, and recognize the fact that even if they
are correct, they are known to millions of people, leaving you no
advantage.

The Archimedean Point

The Greek philosopher Archimedes is known chiefly for his famous

shout, “Eureka!” meaning, “I have found it!” This was his reaction on
discovering that the volume of objects can be measured by sinking
them into water. Another Archimedean phrase, though less well-
known, is “Punctum Archimedis,” the Archimedean Point. Archimedes
claimed that were he able to grasp the world at a certain point, he
could move it.
Some traders seek their Archimedean Point in books. They search
for the book or method that will let them “conquer the market.” They
want someone to take them by the hand until they succeed. I’m sorry
to disappoint you, but there is no winning recipe or magical word that
lets you profit from every single transaction. The tool closest to the
Archimedean Point is the trend, which we will look at more closely in
Chapter 5. To identify and take advantage of trends, we first need to
learn, in Chapter 4, how to use the graph.
Chapter 4 - The Chart: Money’s
Footprint
A stock’s chart incorporates all its
history and points to its future.
How to Read Millions of Peoples' Thoughts

The trader’s main working tool is the chart or graph. A chart’s

function is to present stock price history and indicate its future
direction via conclusions based on the past: a kind of financial crystal
ball where there is no present, and only the past exists. A nanosecond
beforehand is already the past, a second forward is the future. When
deciding whether to buy or sell a stock, we cannot be satisfied with
only the current price. We must review where that price came from
and conclude which direction it is heading. We need to investigate
when sellers stopped its rise in the past (resistance lines) and when
buyers saved it from crashing (lines of support). Using this and other
information, we need to determine how it will behave in the future
and at what prices certain actions may occur. We will use as many
charts as our computer screens allow to follow the various stocks,
sectors and important market indices. Currently, I use nine screens
and am considering adding another, but that is mostly to watch the
amazed looks on faces of people walking into my work room.

SMART A stock’s chart is an integration of

fundamental knowledge with the addition
MONEY of a healthy dollop of human psychology.

Charts can be weekly, presenting information over several weeks;

daily, presenting several days; or intraday, presenting data for the same
day at different intervals such as on a one-minute or fifteen-minute
basis. These charts provide the trader a look deep inside the market
and trace the price changes, which are the outcomes of the constant
tug-of-war between buyers and sellers. Stock prices do not rise or drop
coincidentally. As a trader, I derive a great deal of pleasure from
observing charts showing real-time shifts, imagining all the people
seated behind their desks all around the world, buying, selling, and
impacting on the price at the very moment I am watching. This is a
“war” of control over money and power, with victory going to the
person that makes the best decisions based on the information at his
or her disposal. I enjoy following the traps that buyers and sellers set
for each other. I see the errors and the successes and try to think what
I would do in their stead. Even a person with vast experience in the
capital market, but none in intraday trading, will find it difficult to
understand the logic behind intraday stock trading. Those with
insufficient experience might be satisfied with just attempting to
understand and analyze the weekly or daily chart. But in fact, intraday
trading does have its logic, and plenty of it. The more screen-time
experience you gain, the better you will understand what drives the
bears and bulls influencing the stock, the more you will become
acquainted with the intraday logic, and the greater your self-
confidence will increase--to the point where you too will join the war.
Every move the day trader makes, whether buying or selling, is based
on chart patterns that we will learn, and on outcomes that represent
the trader’s evaluation of the war’s outcomes as plotted on the chart.

Using charts now seems to me the most natural and obvious thing.
How can we possibly manage without them? But that is not how
things were in the past. Up until one hundred years ago, almost no
charts were used. Quotes of stock prices reached the trading room by
telegraph, a designated clerk wrote them down on a large board, and
the previous price was erased. Successful traders were those blessed
with excellent memories. Over time, it became understood that a
connection exists between the past and future behavior of a stock
price.Some traders began charting the information, seeking recurring
outcomes. The use of charts began to make greater headway as famous
chart-based theories began developing, such as the Dow Theory and
the Elliot Waves. In the 1960s, charts became increasingly prevalent
with the advent of the first industrialized computers.

Several accepted norms exist for presenting prices on charts.

Different traders choose different methods, but most of them,
especially day traders, almost exclusively use the “Japanese
Candlesticks” method which will later be elaborated. Several of the
methods are described briefly below, by way of initial introduction

Line Chart

This is the simplest chart, commonly recognized by the public and

used most often in financial media. A line chart is created by
connecting all the closing prices (the last trade price at the end of
the day) over a certain period. These are plotted onto the chart, and a
line is drawn connecting them. This is the simplest way to present
prices, but as we will see later on, it is insufficient, as the information
it provides is relevant only to the stock’s closing price. For a trader, it
lacks the important data such as open price, intraday high price (the
peak price for each day) and the intraday low price. This is
information that the trader cannot be without.

AAPL – 6-Month Line Chart

The line chart is useful and most frequently used in the media. It is
especially convenient for comparing the prices of several stocks in one
chart, or comparing a stock and its sector index. If, for example, we
wish to check a stock’s Apple (AAPL) chart and compare the AAPL
behavior to the hi-tech sector stocks, a line chart makes the job easier
and allows determining whether a specific stock is stronger or weaker
than its sector.

Summary:
A nice chart, but completely useless to the trader. I use this kind of
chart only when I write articles for newspapers or when television
program producers request a simple chart prior to going on air that
viewers can understand. You’ve seen it, you’ve made this chart’s
acquaintance, and now you should forget it altogether.

Point and Figure Chart

The X and O chart is a very old method first written about in 1898.
Its popularity rose in the 1940s with the publication of A. W. Cohen’s
1947 guidebook on point and figure stock market timing. By contrast
with other price presentation methods where price is dependent on
time, the point and figure method marks a rising price as X and a
dropping price as O. This method chiefly serves long-term investors,
since it presents prices over just one timeframe (for example, the
closing prices of a period of trading days).Therefore it sifts out
intraday trading fluctuations, based on the premise that intraday
changes are no more than distracting noises that cause the investor to
implement unnecessary actions. Here is an example of a point and
figure chart:

Summary:
 If you really want to anger me, read Cohen’s 1947 book, which can
be ordered online, and try to use this method on intraday trading.
There’s a good chance that instead of making money, you’ll end up in
tears. If you’re interested in long-term investment, there might be
something to gain from reading the book, but long term does not
interest me and is not the field we’re dealing with here, so it will not
be discussed further.

Bar Chart

Now we’re moving up a level! Unlike the line chart, the bar chart
displays a good amount of useful information and is the most
common chart in use by investors. Note that I used the term
“investors” and not “traders.” On a bar chart, every vertical bar
represents price behavior for a specific timeframe, as follows: the
uppermost extreme of the vertical bar indicates the highest price for
the specific time unit (HIGH), and the bottom point indicates the
lowest price (LOW). The small horizontal mark on the left shows the
start price (OPEN) and the horizontal on the right shows the (CLOSE)
price

Let’s say that the bar chart above indicates price changes of a stock
over one day: its opening, highest, lowest, and closing price for one
day. Because the closing price is higher than the opening price, we
understand that we are looking at a chart showing a day in which the
price rose.

How do you think a chart showing an overall drop in price would

look? This is how:
 A day in which no change occurred would look like this:

AAPL Chart for 16 Trading Days

[1] shows the stock price on July 29 starting at its high (peak),
dropping, then ending slightly above the low
[2] shows the AAPL price on July 7 opening slightly above its lowest
point, dropping, then ending at a high
[3] shows AAPL on July 12 showing no change. The open and
closing prices are identical.
A bar can indicate any length of time, from a single day as in the
chart above, to a week, a month, and of course much shorter intraday
trading periods from five minutes, fifteen, a half hour or full hour.
Intraday traders will choose bar charts illustrating from two to thirty
minutes. By contrast, an investor wanting to examine a stock’s long-
term behavior will likely choose bars showing daily or weekly periods.
Note the disparity between the open and closing prices on the
AAPL bar chart shown above. Note also that from one day to the next,
the opening price is different from the closing price of the previous
day; for example, on the day marked [1] you can see that the opening
price is lower than the closing price of the previous day.

How is that possible? We call this phenomenon the “price gap,” or

more commonly just “gap.” It is wellknown and important to traders,
and will be discussed further. Note that one of the disadvantages of
the line chart, unlike the bar chart, is that it does not contain this
information!
Why don’t traders use the bar chart? On one hand, it is clear and
detailed; on the other hand, it is difficult to read. The small
horizontals on the left and right eventually drove me crazy, and I’m
sure they speed up that inevitable day when you’ll visit the optician
for reading glasses (I’m not there yet…). Bar charts are generally for
older investors who are not willing to learn “new tricks.” Bar charts
just aren’t “cool” enough for young folk like me.

Japanese Candlestick Chart

At last we reach our goal. Up until now, I fulfilled my professional

obligation and presented you with several methods aimed at the
general public or veteran investors. But they are unnecessary for our
purposes, and now we arrive on the shores of the Promised Land. Get
ready for a surprise, because it is precisely this Japanese candlestick
method which is really retro and amazing, and started in…the 18th
century!
The method was developed by Munehisa Homma, a Japanese rice
trader (1724-1803) who was one of the first to make use of past rice
prices to predict future prices. And the method really worked!
Munehisa became very wealthy from the rice trade, and was bestowed
the title of “Honorary Samurai.” Someone calculated his annual
trading profits in modern terms and reached the figure of $10 billion,
with a cumulative capital of $100 billion! The principles of this method
were studied in the 1970s by several technical analysts, and primarily
by Steve Nison who also wrote a bestseller on the method. The result
is that the Japanese candlestick method now serves us well.
Munehisa Homma’s method allows me to understand the changing
prices across an axis of time. Note that I used the word “understand”
rather than merely “observe” or “see.” Over the years, I experienced an
amazing phenomenon. If you, like me, spend several years observing
the Japanese candlestick method, perhaps you too will undergo a
similar transformation. At some point, though I cannot define exactly
when it happened, I managed to comprehend the candle “matrix” (you
saw the movie, right?). Now when I look at a complex Japanese
candlestick chart, I start talking fluent Japanese. I “understand” the
stock without needing to analyze the chart. I can look at it just as a
surgeon looks at a brain scan, or as a musician hears music when he or
she sees notes. I am in the world of support, resistance, breakouts and
breakdowns, and bears and bulls. This virtual world of rising and
falling prices is where some of them “respond,” too: “Buy me, sell me…
I’m willing to keep rising up to the price of…”

You’re probably thinking that after so many years of Japanese

candlesticks, I’ve lost my mind. There could be a bit of truth in that.
But for those of you who know how to play a musical instrument and
who succeeded (unlike me, who was forced to learn piano and is left
with nothing to show for it but “Do Re Mi”) in moving from just
reading the notes to hearing them, you know exactly what I mean. For
a musician, this is the stage in which he or she lives within the “body”
of the notes. For the stock trader, it is the stage in which he or she
feels the stock, senses the fear and greed of sellers and buyers, and
knows how to take advantage of this for his or her own benefit. As a
novice trader, I needed some ten minutes to analyze a chart comprised
of Japanese candlesticks. Now that takes me no more than several
seconds.
 Below is a typical Japanese candlestick chart showing daily price
changes over a period of sixteen trading days. Each candlestick
represents one day of trade. Does the chart look familiar? That’s
because it provides the same information as the bar chart from a
couple of pages back. At first glance, it appears a little more
complicated, but as I explained above, I promise it’ll get easier.

16-Day AAPL Japanese Candlestick Chart

Here, too, each candlestick represents one day of trade: [1] a day of
falling prices, [2] a day of rising prices, [3] a day of no change. Take a
couple of minutes and compare this chart with the bar chart. Try to
understand the way prices are presented in this chart, as compared to
the bar chart. I promise you that within a short time, you will
understand the concept without having read any explanation. This is
important. Please stop reading and make that comparison.
Did you continue reading without stopping? If so, you’ve just failed
the most important test for any trader: self-discipline. This time I’ll
forgive it, but let’s agree that this will be the last time you breach
discipline. Without strong discipline, you will pay a costly price.
So how do we read a Japanese candle? As with bars, Japanese
candlesticks indicate the movement of prices over a specific period
chosen by the trader, which can be a minute, a month, and even a
year. But instead of a vertical line with two horizontal bars, the candle
has a “‘body.”

• The top and bottom parts of the body show the opening and closing
prices.
• When the candle is a light color, usually green, white or transparent
(but other possibilities exist), the closing price was higher than the
opening price. In other words, the price for the represented period
rose.
• When the candle body is red, black or any other dark color, it means
the closing price was lower than the opening price. In other words,
the price dropped.
Most of the candles have a tail, sometimes also called a shadow.
• At the upper end, it is called the topping tail, and indicates the
highest price for the period represented by the candle (for example,
the day’s high).
• A tail at the lower end is called the bottoming tail, and indicates the
lowest price for the specific period.
Later we will learn that the length of the tail is very important for
analyzing the expected stock price movement.

Japanese Candle Showing Price Rise:

Let’s assume this is the candle representing one day of trading. On

the left you see a simple line chart describing the stock’s behavior over
one day. The stock opens trade at a price of $20, drops to a low of
$19.5, rises to a day high of $21.2, and ends the day of trading with a
close of $21.
To the right of the chart we see a clear candle: that means the price
rose. The opening price is the base of the body of the candle, the close
is the upper peak of the candle body, and the bottoming and topping
tails indicate the day’s high and low. Simple, right?

Japanese Candle Showing Price Drop:

 Let’s say that this Japanese candle also represents one day of
trading. Notice that it is in a dark color. Looking at the bar chart, you
can immediately understand that this chart shows a day of dropping
prices. To the left of the candle you see the simple line chart
describing the stock’s behavior over the entire day. The stock opens
the day trading at $21, peaks with the day’s high of $21.2, drops to the
day’s low of $19.5, and closes the day of trade at $20.

To the right of the bar chart you see a dark candle, meaning
dropping prices. Because the candle is dark, you immediately
understand that the opening price is the top of the candle’s body, the
closing price is the bottom of the body, and the two tails, topping and
bottoming, show the day’s high and low.

SMART Remember that for a light-colored candle,

the opening price will be at the bottom, and
MONEY for a dark-colored candle the opening price
is at the top.

You might want to claim that the Japanese candle provides the
exact same information as the bar chart: the opening price, closing
price, highest and lowest prices. This is true, nonetheless there are two
differences:
• Because of the different colors, in a split second we can identify
whether the stock rose or fell. Compare again with the AAPL chart
and see which makes identifying stock price movement easier.
• The second and more essential difference is that Japanese candles
developed over time with additional techniques that add a further
dimension to the method.
 A third reason exists for using Japanese candles: Because most
professionals have shifted to using this method, it is very worthwhile
that you look at the market exactly the way they do, so that you can
operate in exactly the same way they do. If you operate before them,
they will not be buying together with you, and your risks increase. If
you buy after them, you will be buying at too high a price.
Without a doubt, Japanese candles light the way for traders who
know how to use them effectively. Here is another example:
Japanese Candle Showing No Change in Price

When a stock’s open and closing prices are identical, the candle
will not be green or red or any other light or dark color, and its “body”
will shrink, as you see, to no more than a horizontal line. This candle
is called a “doji,” and indicates indecision: a perfect balance of power
between buyers and sellers. In the chart above, you see that the
opening and closing prices are the same: $20. The stock did move
around, from a low of $19.5 to a high of $20.2, but in the end, closed
with no change.
Presentation of Candles over Varying
Lengths of Time

Traders operate within different timeframes than those used by

investors, but nonetheless they check every stock chart over the long
term and short term, as I will explain. When I want a total picture of
the stock I’m interested in trading, I alter the presentation to show
different timeframes and change the candles to show different
timeframes, as explained further.
One of the stocks I am currently analyzing for potential purchase is
“Altria,” symbol MO. Altria is the number one cigarette manufacturer
in the world, known for Marlboro, Parliament, Virginia, and many
other brands. The trade opportunity can be identified easily according
to a daily chart, where every candle represents one day of trade:

Altria, MO – Daily Japanese Candle Chart for Three Months

As noted, in this chart each candle represents one day of trading.

The size of the chart in relation to the size of this book’s page is what
prevents me from showing a longer period. However, when I spread
the trading platform across my computer screen, the chart is spread
across a larger surface and allows me to clearly discern the candles for
at least nine months, which is precisely what I would like you to do
when you examine a stock. With Altria, I noticed a sharp increase in
price lasting for eight days of trading [1] and several days of
consolidation [2] around this peak area.
This is one of the technical formations that traders love, and is
called the “bull flag.” The term derives from the rise in price [1] that
looks like the flagpole, and then the stable holding of this price, the
consolidation, which looks like the flag itself. The term “bull” means it
will charge forward. When people are “bullish” on a stock, they expect
it to go up.
In this case, we will want to buy Altria if it goes higher than the top
part of the bull flag: this increase is known as a “breakout.” In other
words, we will buy Altria if its price goes over $21.50. The accepted way
of presenting this planned trade is as follows:
MO>$21.5
One of the reasons that Altria’s formation appeals to me is the fact
that in yesterday’s trading, the market dropped sharply by 3%, whereas
Altria, as you can see by the consolidation around the flag [2], held up
well for its higher range of prices and was not drawn down with most
of the market.
Before making my final decision on whether to buy, I want to know
a little more of Altria’s history. To do that, I will change the chart
display to “weekly.” Each candle will now represent one week of
trading, and I will observe the stock’s behavior over a two-year period:

Altria, MO – Weekly Japanese Candle Chart for Two Years

 Here, too, if your screen allows it, display an even longer period,
preferably of five years. What do we see? Without doubt, Altria has
maintained a nice upward trend over the past two years. Yes, I’m still
interested!
Now that I like what I see over two timeframes, the daily and the
weekly, I want to check its behavior at a closer level. For that, I move
to a display of the last ten days of trade and candles showing thirty-
minute timeframes:

Altria, MO – Ten-day Japanese Candle Chart at Thirty-Minute

Timeframes

When we look closely, we clearly see the consolidation at the top of

the flag. Now imagine a situation where the stock breaks out at the
flag’s peak and rises higher than $21.50. That could be very interesting!
To complete my inspection, I check Altria’s behavior over the last
day of trading with candles of five minutes. To get an even clearer
view, I always prefer to see the last two days of trading:

Altria, MO – Two-Day Japanese Candle Chart at Intervals of Five

Minutes
 Had I checked only the last two days of trading, I’m not sure I
would want to buy this stock. But, having already looked at the past
ten days, the past two days fit better within the broader timeframe.
Additionally, I keep in mind that the last day of trading ended with a
sharp drop in prices in the overall markets, which also affected Altria a
bit. I am now very interested. When taking into account the candles
for day, week and longer periods, I see clearly that I really like Altria’s
history and can predict that its future looks good, although not until it
moves above $21.50.

SMART Before deciding to buy a stock, you need to

check its behavior over periods of ve
MONEY minutes, thirty minutes, daily, and weekly.

Summary:
When making your decision to buy a stock, and also determining the
best entry point (professionally known as a “trigger”), it is vital to
switch between different timeframes, examine the stock’s behavior
using Japanese candles of different intervals, and even elaborate on
market activity during the same timeframes. In weekly candles, I see
less “noise” than in daily candles, and in daily candles I see less “noise”
than in intraday thirty-minute candles, and so on. As an intraday
trader, I will make my trade decision within the day’s trading
according to candles of five-minute intervals, and occasionally
according to candles of two-minute intervals.
 Swing traders buy stocks for ranges of several days up to several
weeks. They will make their decision based on daily charts. Long-term
investors, known as core traders, who hold stocks for months and even
years, will base their decisions on weekly charts.

The Result
I couldn’t resist. Almost three months have passed since I wrote
this section, and now, as I make my final editorial adjustment, I
decided to complete the picture with the results. Of course, you would
not have gotten to see them if I had failed…

Altria, MO – 13% above the Bull Flag

Chapter 5 - Principles of Technical
Analysis
Chart Formations: Mirrors of Fear and
Greed
The Basis
Technical analysis is a simple technique as long we don’t try to make it
complicated. Technical analysis, unlike fundamental analysis, ignores
a company’s value and focuses wholly and solely on the movement of
its price, which is an outcome of supply and demand. The main
influences on supply and demand are the human emotions of fear and
greed, and market players take advantage of both.
Human emotions can be analyzed psychologically. Technical
analysis is nothing more than a mirror of human psychology. Using
technical analysis cleverly lets the trader predict buyers’ and sellers’
moves and take an educated guess at price direction on the basis of its
past behavior.

The Trend
We have already mentioned that prices move in three directions: up,
down, or forward. The market does not move backwards, because time
does not move backwards. The market’s directional movement is
called its “trend.” When the market rises over a period of time, we call
this the uptrend; dropping over a period of time is called downtrend,
and when it “moves sideways” with insignificant deviations, it is called
a trendless market. It is easy to profit when there is a trend, and very
difficult when the market has no trend. Generally, those who make
money in a trendless market are the brokers who profit from
commissions.

Famous Clichés and Trading with the Trend

Several famous clichés are tied to the capital market: “When it rains,
everyone gets wet,” and “Only when the tide goes out do you discover
who’s been swimming naked,” and “Buy the rumor, sell the news.”
But one important cliché describes the most important rule in
trading: The Trend is Your Friend.
What does this mean? Trade in the direction of the trend, and only
in the direction of the trend. Accompany it and actualize it as long as
there are no signs of its ending. The more careful you are about
integrating trends, as will be explained later, the better off you will be.
The perfect trade occurs when I buy a stock with a clear trend, the
sector in which the company operates shows an identical trend, and
the overall market shows the same trend.

SMART In actuality, you will try to convince

yourselves that “just this once” you will buy
MONEY contrary to the trend. After all, it “has
dropped far enough” and “must” go up…

Even though I always teach my students to trade in the direction of

the trend, it happens that new traders in our trading room suggest
buying or shorting against the trend. The basis of their suggestion
seems logical: “the stock has dropped enough and therefore must
make an upside correction” or “the stock has gone up and must make
a downside correction.” Yet, other than in very unique cases, this
thinking is fundamentally flawed.
Buying a stock on a downward trend, or vice versa, is like
swimming against the current of a surging river: there’s very little
chance you will reach your target, and even if you do, you’ll be
exhausted. Occasionally, a trader who suggested shorting an upward
trending stock later draws my attention to the fact that the stock did
indeed drop by so many dollars. I am happy to congratulate his or her
success, but also add my generic response, “I guarantee that if you do
this ten times, you will fail in at least seven of them.” I have spent
sufficient years and gained enough experience to guess when a stock is
changing its trend, and now am able to relate how I failed in the
majority of instances. Don’t try it. It’s a waste of your time and money.
Trading with the trend allows me to long (buy) strong stocks that
are rising and short weak stocks that are dropping. In this way, I
preserve the advantage of the trend, and increase my chances of
success. Trading against the trend reduces chances of success and
misses opportunities in other stocks which are moving in the trend
direction.
In Memories of a Wall Street Analyst, the book’s
protagonist Larry Livingstone talks about an old man named
Partridge, who had years of stock trading experience. When untrained
traders asked his advice about specific stocks, he would authoritatively
repeat the exact same answer, “You know, we’re in a bull market!” Old
Partridge understood and internalized something that even veteran,
let alone young traders have trouble understanding: full advantage
should be taken of trading with the trend. As long as the market is
rising and the stock you bought maintains its upward trend, or as I
often say in the trading room, “has done nothing wrong,” don’t sell it!
The same is true when shorting stocks when the market is trending
down.
At the start of the school year, I attended a parents’ meeting at my
daughter’s school. Before leaving home, I traded and joined up with
my trading colleagues in the trading room. When it came time to
leave, I placed protective stop orders into the trading platform. On
returning some three hours later, I noticed that the balance in my
trading account had risen considerably. The trend did its work and the
stocks continued moving. The conclusion is obvious: as long as a stock
“does nothing wrong,” don’t touch it. Go out wherever you plan to go,
and don’t stay glued to the computer screen. Then you won’t be
tempted to sell. By the way, my experience has shown that
interminably watching those screens does not help a stock’s price go
up or down.
A new trader might believe that “professional traders” tend to trade
throughout the trading day. If that is true, it does not mean that they
are constantly buying and selling. Not at all! What it means is that
these traders let the stocks do their job quietly, uninterrupted. Trading
a whole day does not mean staring at screens the whole day. In
actuality, I tend to sit at my computer system for no more than two
hours a day, but do come back for brief visits during the trading day
just to keep an eye on developments, and chiefly to ascertain no
changes in the trend.
In my early days as a trader, I understood that stock trading success
lies in increasing opportunities and decreasing risks. To increase my
chances, I generally join the majority as far as market trend. How do I
know which way the majority is headed? I watch two things:
• the stock’s trend (up or down), and
• the stock’s volume, which is the number of shares executed between
buyers and sellers
Professional traders always prefer volatile stocks which crash or
frequently break out, as such stocks behave according to hysteria or
greed. These are two states in trading that can bring a lot of money
into your pocket if you know how to identify them on time and enter
and exit at the right points.

De ning the Trend

The trend is the direction that the market is taking. Because the
market, like a snake, never moves in a straight line but always zigzags,
the trend is structured from a series of highs and lows.
• A series of highs and lows, where each low is nonetheless higher
than the previous one, and each high is higher than the previous
one, creates an upward trend. This series is defined by higher highs
and higher lows.
• A series of highs and lows where each new low is lower than the
previous one, and each new high is also lower than the previous
one, creates a downward trend. This series is defined by lower
highs and lower lows.
The public generally hears only about rises and drops in the
market, but according to conservative estimates, about one-third of
the time the market is neither moving up or down, but rather staying
the same. A series of similar highs and similar lows creates this
movement. In the trading room, we often describe this situation as
moving sideways or moving in the range.

SMART When the market is moving sideways, it is

difficult to pro t. We can never know in
MONEY advance if the market will move with the
trend or not. Once we notice that the
market is trendless, we avoid taking new
trades.

When a series forms of two rising highs and two rising lows, it
defines the uptrend. In the chart above, we see three rising lows and
four rising highs, which is a very clear upward movement. Notice that
the fifth high is lower than the fourth. Does this indicate that the
uptrend has stopped? No, but it is definitely gives cause to watch for
changes.

UpwardTrend:

Is there any importance to the time intervals between each high

and low? No. The interval during which you trade is the determining
factor. If you entered for several days, as a swing trade, because you
identified an uptrend on the daily chart (where each candle represents
one day), that is the trend you need to “ride.” Long-term investors will
generally ride trends based on weekly charts (where each candle
represents one week), and intraday traders will identify and buy stocks
over intraday trends based on five-minute candles.
When should you buy? If you’re willing to take risks, buy after the
first low. If you tend to be more cautious and are willing to take a little
less profit, buy after the second low. We will discuss this in detail later.

Downtrend

When a series forms of two dropping lows and two dropping highs,
this defines a downtrend. In the chart above, we see a series of four
dropping lows and three dropping highs: a very clear downtrend.
Notice that the fifth low is higher than the fourth low. Does this mean
that the downtrend has ended? No, but there is definitely room to
suspect an upcoming change.

Joy Global, JOYG – Uptrend

Joy Global maintained an uptrend for almost three months, rising

from a price of $44 to a peak of $64. Notice the four rising lows and
the three rising highs before the stock changed direction, broke the
previous low and dropped to a new low. If you had been holding the
stock, where in your view should your exit point have been? The
correct answer is the trend’s break point: that is, the drop below the
last high’s low, beneath the $58 mark.
Until now, I’ve explained why it is so very important to trade with
the trend, and so important to utilize it fully. (Never forget that!) I also
explained the three market trends, but I have not explained what
these mean from the trader’s viewpoint.

Think for a moment: what does the trader always wish to know?
• A trader always wants to know the ratio of buyers to sellers: in other
words, which of these two opposing groups is winning the endless
tug-of-war.
• When buyers are winning, we see uptrends.
• When sellers are winning, we see downtrends.
• When there is balance between buyers and sellers, the stock will
move sideways, with slight upward and downward movements but
no real trend.

What do professional traders do with this information?

• They will want to buy (long) when the buyers are winning: that is,
when the stock is rising.
• Thy will want to sell short when the sellers are winning: that is,
when the stock price is dropping.
• Sideways movement is dangerous: on one hand, the stock is moving
in a range that does not allow for making any profit.On the other
hand, a small pull on the rope in favor of one of the sides can lead to
losses.
This is why pro traders do not trade during sideways movement,
but wait for a clear up or downtrend. Avoiding any action is
sometimes the best step to take. Over time, you’ll discover that during
sideways markets, you will do better when you do nothing! If market
conditions do not allow joining a clear trend, don’t join. In other
words, not joining means not losing money. This will be discussed
further.
Support and Resistance

When technical analysts talk about support and resistance, they are
usually referring to “lines of support and resistance,” but, as is
presented further on, support and resistance can also be found at high
and low points, in moving averages, and in round numbers. Support
and resistance are also linked to another phrase: breakouts and
breakdowns.
• A sharp drop in price can be a support breakdown
• A sharp rise in price can be a resistance breakout

Areas of Support and Resistance

In the early 20th century, many stock traders began to acknowledge

that a stock needs to break out from, or break down “even the smallest
resistance” in order for it to be traded. In those days, traders were not
assisted by charts or other technical tools, and only used support and
resistance. They remembered and wrote down the highs and lows, and
related to them as points of future support and resistance. Even
traders on the NYSE trading floor, who in the past had traded using
hand signals, did not use any kind of chart. Instead, they used areas of
support and resistance. These traders can hardly be suspected of
unprofessionalism.
Identifying areas of support and resistance in a stock, then, is vital
to traders when analyzing the trend and determining their entry and
exit points. As already noted, professional traders are always interested
in knowing the balance of power between buyers and sellers, and
these areas indicate turning points in the balance.

SMART Who supports a dropping stock? Buyers

who believe that it will go up, and “heavy”
MONEY shorters who realize pro t (i.e. are buying
 back their short positions) during the
downtrend

• The area of support is the price where the stock stops on its way
down: in other words, the point at which buyers outnumber sellers.
• The area of resistance is the price where the stock has stopped on
its way up: in other words, the point at which sellers outnumber
buyers.

Summary:
In the support area, the majority think that the stock’s price is cheap.
In the resistance area, the majority feel that the stock’s price is
expensive.
Professional traders seek to buy a stock on the way up after it
breaks through the area of resistance, and will seek to short (sell)
when a stock breaks through the area of support.
I want to emphasize that these are areas, not lines, of support and
resistance. The term “line” represents a rigid, unfeasible reality. Is it
reasonable that all people active in the market will constantly buy at
the same support price and always sell at the same resistance price? Of
course not. This is even truer for a large market. Additionally, as
noted, the principles of technical analysis are known to all people
active in the market, and frequently “lines” will be broken out
purposely in order to execute automatic buy and sell orders fed into
computers, or to tempt innocent traders into buying and selling a
stock.

When Support  Turns into Resistance, and Vice Versa

• When an area of resistance breaks out, it turns into an area of
support.
• When an area of support breaks down, it turns into an area of
resistance.
Let’s examine this rule using the following charts and try to
understand how the rule operates:
Resistance – Turning into Support

SMART When a stock breaks out of resistance [1],

rises [2], and then returns to its breakout
MONEY price [3], we call the phenomenon a
“retest” – in other words, the stock “tests”
and certi es the resistance that has now
turned into support.

Why does resistance become support? For three reasons:

1. Traders like buying stocks that break out through resistance. When
a stock breaks out through resistance [1], they buy it, hoping it will
go up. When to their joy it does rise and creates a new high [2],
they’re sorry they didn’t buy a larger quantity at the outset… Now
the stock is too expensive to make it worth buying more, but they
would love to increase the amount they hold if the stock price
would drop to its breakout figure [3]. When it does, they buy,
establishing support [3].
2. Other traders who missed the breakout see that the stock is rising,
and are sorry they missed joining the festivities. They won’t buy the
stock at its peak [2] because it is too costly, but they’re happy to buy
it when it returns to the breakout price [3]. When it does, they buy.
Buying indicates that they support that price: in other words, they
establish support [3].
3. The last ones in on the support list are the “short sellers,” who
hoped that the stock would not rise, but were caught with a stock
that hit new highs [1] and were sorry they did not close the shorts
before the breakout. They lose money, but psychologically they have
 trouble admitting their error and closing the short all the way to the
high [2]. Of course they would be delighted if they were given a
chance to exit their short position at the pre-breakout price, that is,
buy at that price (we will explain later how a short is closed by
buying). When the stock does drop down, they will wipe the sweat
from their brow, buy, and also be among those establishing [3]
support.

Summary:
If a stock drops back down to its “retest” point [3], then all the
traders have a common interest: to buy. This shared interest is what
turns resistance into support.

Support – Turning into Resistance

Why does support turn into resistance? For the exact reverse
reasons to those detailed above:

1. Traders love to sell short stocks that break down through support.
When a stock breaks down through support [1], they execute a
short, that is, they sell the stock (more on this later) and hope that
it will go down. When, to their joy, it does, and reaches a new low
[2], they’re sorry they didn’t short at the outset with a greater
quantity… But now it has gone down too low for them to sell
another amount. However, they’d be happy to increase the amount
of their short if the price returns to its breakdown point [3]. If it
does return, they will increase the quantity of shorts, that is, sell
more, and be among those creating resistance [3].
2. Other traders who missed the breakdown [1] see that the stock is
dropping and are sorry they didn’t join the shorting festivities. They
won’t execute a short when the price is at its lowest [2] because it
has already “dropped down too much,” but they would be happy to
execute a short (i.e. to sell) if the price returns to its breakdown
point [3]. If it does go back up, they will short and be among those
establishing resistance [3].
3. The last group establishing resistance is the “long traders” (in
contrast with “short traders”). Long traders are those who believed
in the stock and bought it before its breakdown, believing it would
go up. Long traders are currently caught with a losing stock: they
watch it reach a new low and are sorry they didn’t sell it before the
breakdown. They are sustaining large losses and have difficulty in
admitting their mistake and selling when the stock price is low [2].
They pray that it will go back up to its breakdown point [3] when
they will happily sell. When it does, they will also be among the
sellers establishing resistance [3].

Summary:
If a stock rises to its retest point [3], it will usually encounter
resistance originating in the common interest of all those operating in
the market at the time: sellers. This shared interest turns support into
resistance.

High and Low Points

The high and low points also serve as areas of support and resistance,
both on intraday charts and daily charts.

High – Turning into Resistance

 Why does a high [1] create resistance when the price returns to the
same [2] point?
To understand this, we need to penetrate the thoughts of buyers
more deeply.
Every point on the chart represents both buyers and sellers. The
same is true for when the stock reaches its high [1]. Of course, buyers
at that point still do not know they have reached the peak price, and
in a show of enthusiasm over a strong stock, they buy at this high,
hoping the stock will go up. In actuality, when they discover that it is
dropping, they are disappointed. They are losing money, and sorry
that they were tempted and bought at a high price. They do not want
to sell at a loss, so they promise themselves that if the stock returns to
the price at which they bought [1], they will correct their mistake and
get rid of the stocks at the same price they bought them.
They are not the only disappointed buyers who bought; there are
many others who are also waiting to sell at their entry price. If the
stock does go back to that first high [2], it will encounter all those
waiting sellers.
Can the stock price overcome the sellers’ resistance and rise to a
new high? Sometimes yes, sometimes, no. The question revolves
around the balance of forces between sellers and buyers. In the chart
above, we can see that the stock continued rising [3]. In other words,
in this case the buyers won.
The retreat from the second high [2] is called “double top.” When
a stock rises to the double top, in most cases it will retreat due to
resistance, and drop. In such situations, if you bought a stock that is
about to reach its double top, it would be wise to realize some of the
profits a little before the anticipated resistance point.
SMART When a stock drops from its high and tries
to get back up, it encounters the resistance
MONEY created by all the disappointed buyers who
bought as it rose previously and now wish
to sell at their purchase price.

Low – Turning into Support

Why does the last low create support?

Here, too, we need to understand the psychological perspective of
buyers and sellers. At every point on the chart we will find both buyers
and sellers, but in this case, we call the sellers “short sellers.”
At the stock’s low [1], short sellers cannot yet identify this point as
the low. In a burst of enthusiasm over a weak stock price, they execute
a short, hoping that it will continue dropping.
In actuality, they discover that the stock is rising against their
hopes and they are losing, which disappoints them. They promise
themselves that if the stock returns to its pre-short price (that is, the
same price as the previous low), they will correct their mistake and
close the short (that is, they will buy).
If the stock does drop to the same low [2], it will encounter all
those disappointed short sellers who are thrilled that the stock
returned to their entry position.
Can the stock overcome the support of buyers and drop to a new
low? Maybe yes, maybe no… The answer depends on the balance of
forces between sellers and buyers.
 In the chart above, we see that the stock continued dropping [3]. In
other words, in this case, sellers won. The rise at point [2] from the
low is called a “double bottom.” When the stock drops to a double
bottom, in most cases it rises again because of the support created by
buyers.

How Does a Drunken Snake Crawl?

In a straight line!
Just as a snake will never crawl in a straight line, a stock will never
move in a straight line, but always in ups and downs and in highs and
lows.
Remember this when a stock is moving in the opposite direction to
what you want. Usually a stock moves “against” your wishes because
that is its nature, which does not necessarily imply that the trend has
changed.
Differentiate between episodic noise in a stock’s movement and
real change in trend. We will discuss “noise” regarding stock prices
later.
Analyzing Japanese Candles
So far, we have seen how prices are presented using Japanese candles.
Now we will discuss the components of the candle: the candle body,
and the tail. Each candle contains information about the balance of
power between buyers and sellers.

Narrow Range Candle

The narrow range candle shows a relatively short distance between

the opening and closing price.
Relatively … compared to what? To the common behavior of the
stock being examined.
Every stock has its own “personality.” A candle can only be defined
as short (narrow) or long (wide) if you observe the stock’s behavior
over a representative timeframe in which you can see the conduct of
many candles.
For a stock such as AAPL, a narrow range intraday candle of five
minutes might be from ten to thirty cents, although by contrast, for
most stocks, it would be considered long range.
• A narrow range candle indicates low volatility.
• A relatively small change in the balance between buyers and sellers
indicates, in many cases, sharp movement anticipated in the near
future in one or the other direction.
• A narrow range candle also indicates that buyers and sellers hold
close to equal force, as occurs with the candle called a “doji.” It is not
a perfect balance, as represented by the doji, but does have clear
significance.

A candle has little meaning in and of itself, but becomes more

important when we observe its position in the formation of several
candles. For example, a narrow range candle has one meaning if it
follows several more narrow range candles, and a different meaning
following several wide range candles. This will be detailed later. We
will also discuss trend reversals. As with the doji, a narrow range
candle also hints at an imminent trend reversal, and provides greater
reliability to the reversal pattern.

Wide Range Candle

Here are examples of what candle colors and lengths mean:

• When it is light-colored, the buyers are in clear control
• When it is dark-colored, the sellers are in clear control
• The longer it is, relative to the other candles, the clearer and
stronger the control

Narrow and Wide Range Candle in AAPL with Five-Minute

Candles

In the narrow range candle [1], the distance between the opening
and closing price is very small and almost insignificant. The narrow
range, as noted, is a relative term. For AAPL, a range of five cents
between opening and closing prices, as we see in this candle, is a
miniscule range, but in other stocks such as Microsoft (MSFT), it may
indicate a relatively wide range.
When we compare the narrow range candle [1] with the wide
range candle [2], the narrow and wide ranges become clear
specifically for AAPL. In the wide range candle [2], the range between
opening and closing prices is 50 cents. Observing this candle relative
to adjacent candles, we have no doubt that in that five-minute
timeframe, sellers strongly controlled the stock. The very fact that
after five minutes of seller control a balance was reached between
sellers and buyers, as expressed by the narrow range candle [1],
indicates that the battle for control is peaking and could shift to the
opposite group. In this case, we can see immediately following the
narrow range candle that the buyers did take over. Very often, a
narrow range candle does indicate a change of direction, known as
“price reversal.”

What is the stock’s trend?

From the chart above, we cannot see sufficient candles to ascertain
the trend. But let us assume for now that since the start of trading,
AAPL is trending up. Because, statistically speaking, the chances of the
trend’s continuing upward movement are stronger than the chances of
it changing, the narrow range candle [1] has a strong chance of being
followed by an uptrend and control would return to buyers, which is
what did happen.
The formation of changing direction comprised of a wide range
downward candle [2] followed by a narrow range candle [1] and then
another rising candle is called “reversal,” which we will learn more
about later.

SMART We never make trading decisions based on

only one candle. Every candle is signi cant
MONEY and reliable only within a formation
comprised of several candles around it.

Candle Tail

The tail, also known as the shadow, indicates a change in the

power balance between buyers and sellers. To understand how the tail
is formed, let’s look at the chart below, showing a day of AAPL
intraday behavior.
AAPL Fifteen-Minute Candles

Based on its light color, candle [1] indicates a rise in price: in other
words, the stock’s closing price is higher than its opening price. But a
price rise does not disclose the full story. This candle has more to tell
us: it also has a long topping tail.

What does the tail signify? As already noted, the tail indicates the
stock’s peak price in the fifteen-minute timeframe represented by the
candle. At some point during those fifteen minutes, the stock price
reached the high of the tail, and buyers were in full control. The tail
also indicates that buyers did not manage to maintain that high price.
In fact, the tail actually shows that sellers took over control of the
stock! We see that the length of the tail is almost the full length of the
entire candle. Conclusion: there is a high probability of price reversal,
i.e. a drop in price, as indicated in the candles that follow [1].

Now, to understand the meaning of the tail even better, let’s spread
that fifteen-minute interval between 15:15 and 15:30 into candles of
one-minute long, and examine what really happened more closely.

AAPL One-Minute Candles

 Here the power struggle is more clearly seen. We see a constant,
strong increase of clear candles indicating buyer control, and then a
sequence of black candles indicating that sellers have taken control.
Although at the end of the fifteen-minute interval the stock price rose,
the tail’s formation shows a shift in control, and therefore an
anticipated change in direction of the stock’s price. In the previous
chart, you can see that this is exactly what happened.

SMART A topping tail indicates that sellers take

control, and a bottoming tail indicates that
MONEY buyers have taken control. Tails are an
excellent tool for predicting price reversal.

Does the color of the candle have meaning relative to the tail? In
the fifteen-minute AAPL chart, the candle is clear: this indicates a rise
in price. If it were dark, indicating a drop in price, then the tail would
even more strongly imply change of control.

A topping tail indicates that sellers have taken control. The longer
the tail, the stronger and clearer the control. The candle color makes
no difference.
A bottoming tail indicates an expected upward reversal. Here, too,
the position of the candle with the tail within the formation of candles
provides the tail with its significance. A long tail pointing down
reminds us that there used to be complete seller control, but control
has now been taken by the buyers.

Reversal Patterns
Candles very loyally tell us of the battles between buyers and sellers
for any given timeframe, but these are just a small part of the total
picture of patterns they create.
To understand where a stock originates and to try and predict
where it is going, we must look at much more than a single candle
within a group of candles, and try to make our decisions based on
patterns comprised of several candles. When we learn to identify
patterns, we can “understand” a stock with just a glance, and take
decisions accordingly.

• Reversal patterns are chart formations of a group of candles that

help us identify high and low points.
• We use reversal patterns to understand when we should buy or sell
stocks which are about to change (reverse) direction. For example: if
we bought a stock, we would want to sell as close as possible to its
high, but if we were holding a stock short, we would want to buy it
back as close as possible to its low, right at the point where it just
begins to go up.
• If we want to profit when shorting a stock, we would do that before
its price goes up.
• If we wish to sell short, we would want to short when the stock has
finished a pullback and is about to execute another drop.

Reversal patterns are usually formed after a significant rise or fall in

price. Patterns are subdivided into bullish, implying an upward
direction, or bearish, implying a downward direction.
The patterns I will explain further are common and accepted by
professional traders. All these patterns are valid for any timeframe or
period. They can be implemented for a group of weekly candles, daily
candles or intraday candles, depending on your purposes and the
range over which you plan to hold the stock.
Common Reversal Patterns
Summary
Patterns are mirrors that reflect the war between buyers and sellers.
Patterns help predict the outcomes of this war and allow the trader to
choose the winning side.
Try to examine each pattern, and imagine the war. Once you’ve
learned these patterns, your next move is to join the real game. Open
a volatile stock price chart, such as that of AAPL, and try to guess, in
real time, according to patterns of five-minute candles, what the
stock’s next step could conceivably be. I believe you’ll be presently
surprised by your ability to predict the pattern.

Homework
 Below is a day of trading in AAPL stock, represented in five-minute
candles. Name each of the patterns marked on the chart:

It’s not so very difficult, right? So what’s the problem? You can
make millions this way! But… unfortunately, it’s not quite that simple.
The question is not only whether you can identify pattern reversal, but
how long that reversal will last. For example: if you correctly identify
the reversal pattern [1] and execute a short there but do not turn a fast
profit, you will find yourself losing when the stock reverses direction
toward [2]. Identifying the pattern is the basis, but it is not the entire
picture. Later we will also learn that the pattern must be integrating in
the stock’s trend. In other words, we would not short at [1] because at
the start of the day, the stock was running up and therefore the
probability is high that the downward reversal would be relatively
short compared to the next upward reversal (with the trend)
immediately following [1] and before [2].
In fact, the example I chose is a dreadful sampling of a stock that
traded most of the day without a trend. If you try to make a profit
from the outcomes of these reversals on a day like that, you are
destined to failure! In short, don’t let me catch you trying to make
“fast money.” Believe me, I was there, I tried it, I lost enough until I
eventually learned that I must never get involved in a trendless stock.
Success requires that you identify the outcomes of reversal patterns
in stocks with a clear trend. One good yield from a stock with a clear
up or down trend may be enough to provide your daily profits.
Intraday Pattern Reversal for Sears, SHLD

On the day that AAPL went nowhere, Sears began its first hour of
trade with a clear upward trend. The day actually began with two dark
candles, but experienced traders know that during the first ten
minutes of trade (the first two candles), a stock’s trend is still
undetermined and derives chiefly from automated orders given by the
public to brokers before the day’s trading begins. When the third
candle rises higher than the high of the two dark candles, we can
assume that from here on, the stock will go up.
Has an uptrend been established yet? Absolutely not. We will wait.
After the first up trending candle are two dark “corrective” candles.
These are then followed by a new high, and we now have two higher
highs. Now we can see the trend. Now we await the trend correction,
and buy on the first reversal which appears at [1]. At this point the
stock is showing the classic reversal pattern with a long bottoming tail
and is simply begging us to buy. SHLD closes the day’s trading with a
high of 4.4% above the open!

Summary:
One trade with the trend is worth a thousand failed intraday
attempts at finding the reversal pattern of a trendless stock.

SMART A reversal pattern should be looked for only

within the stock’s trend. In an up-trending
MONEY stock, we will look for the bullish pattern,
 and in a downward trending stock, we will
look for the bearish pattern

Later in the book, we will apply the more common name for these
pattern changes: reversals.
• A reversal that brings the stock back to trending up is called a roll-
up
• A reversal that bring stock back to trending down is called a roll-
over

Homework
Traders will often look at fifteen-minute candles in order to reduce
the influence of “noise” on their decisions. On a clean page, sketch a
fifteen-minute candle that replaces Sear’s first three 5-minute candles.
Get the picture?

When to Hit the Button

There is little point in learning patterns if you do not know when to

hit the button. In the chart below, I have marked the long and short
entries in the accepted reversal formations.

Of course, you need to remember that this is not an exact science.

The entry point is more a feeling comprised of many facets tied,
among other things, to the general market direction, the trend’s
strength, the stock’s behavior, and a great number of additional factors
we will learn about later. At the moment you need to press the button,
you will need to assess several factors that may cause you to press
early or late, relative to what you see and sense.
As you note in the chart, in most cases I have tried to precede the
entry point even before the point where the classic pattern actualizes.
When I see a reversal being structured right before my eyes, I try to
keep focused on the thought, “What is the probability that the pattern
will reach completion?” If I answer “90%,” then I’ll press the button
even before the pattern is fully developed. When I decide to press at
this early stage, I base my decision on a lot of experience, but your
current status is not the same as mine. My suggestion to the novice
trader is to wait until a clear reversal develops. Only later will you
acquire the “artistic” component in trading.
The entry points shown on this chart are slightly before the final
development of the pattern, but I do think that you can already begin
to implement them as shown.
One of the greatest advantages of the online trading room where I
trade daily with hundreds of other traders is that I can be heard in real
time executing my early entries. If you hear me applying this strategy
50 times, it’s highly probable that on the 51st, you’ll be able to do it
yourself.
Note that so far we have learned when to enter, but not when to
exit. In a later chapter discussing trade methods, reversals will be
discussed further and we will round out information on money
management, aka when to sell.

Breakout and Breakdown Patterns

The function of breakout patterns, like reversal patterns, is to

identify the entry point on a stock which is about to make a sharp
upward price change. In contrast to reversal patterns, the breakout
pattern is not meant to identify the point of reversal, but
continuation.
 Breakout patterns operate better when the market is stronger and
volume is high. It is possible to trade in breakout patterns throughout
the trading day, but the best time to do so is during the first ninety
minutes of the trading session. Later, we will trade in intraday
breakouts providing they look particularly good or are based on the
daily chart, and their purpose is for a swing of several days’ length.
The reverse of breakout patterns is known as breakdown
patterns. Everything that has been said relative to stocks breaking out
with an upward movement is true for stocks breaking down in a
downward movement.
Breakout and breakdown patterns are based on psychological
formations of buyers and sellers, on fear and on greed. Every time you
identify a pattern, imagine the people currently holding the stock, or
about to exit it. Think about the mindset of long traders, short traders,
and the disappointment of those who did not succeed in buying or
shorting, or those who are currently, like you, trying to enter. By the
time you reach the stage where you “understand” the stock, the
patterns will be well assimilated in your mind.

Bull Flag

A bull flag is a bullish pattern comprised of one or more strong

candles that form the “pole” of the flag, and several candles (usually
three to five) that consolidate around the head of the pattern, and
comprise the flag itself. The long entry will be executed when the
price goes over the top of the flag. The pattern’s strength derives from
the stock price quickly rising to its top, but instead of correcting at its
peak as would be anticipated of a stock that has completed a sharp
rise, the stock consolidates around the peak and within a short time
breaks out beyond that, continuing to move up “without looking
back.” The significance of rising to a new high is an unequivocal
victory of buyers over sellers. Buyers are not waiting for a reversal and
are willing to buy at any price. On the other hand, the short sellers,
disappointed by the stock’s rise and hoping it will correct downwards
after the high, are forced to close their shorts when the stock reaches a
higher high (i.e. to buy), thus causing further highs.
A bull flag is a strong formation that usually allows us to execute a
scalp. The term “to scalp” relates to a trading method where the
trader executes a speedy entry and exit from a stock. It usually lasts
between several seconds and several minutes. We buy at the breakout,
sell three-quarters of the quantity at the first signal of weakness, and
then hold the remaining piece in the hopes that the final quarter will
continue rising. We scalp quickly, since the stock price prior to the
breakout was already extended upwards and we fear that the
breakout will fail.

A Bull Flag Formation for Philip Morris – PM

In this intraday chart showing two days of trade, we see Philip Morris
rising strongly at the start of trade from $49.7 to $50.5, which is a
sharp rise of some 2% lasting for just fifteen minutes. This is the area
that forms the flagpole. Now it consolidates around the high and
completes the bull flag formation. Note that in this case, we can
clearly see over time how the candles around the consolidation
become increasingly shorter, i.e. the price is consolidating towards a
possible breakout. This is the area of the flag.
 Another interesting point is that the stock consolidates beneath the
price of $50.5, which we call a semi-round number. As we will learn
later, at round numbers as well as sometimes semi-round numbers,
many sellers inhibit the stock’s further rise. The stock breaks out of [1]
the bull flag’s head (resistance) and rises a little more than 1% [2]
“without looking back.”

Bear Flag

A bear flag is the reverse pattern of the bull flag. The pattern
comprises one or more downward trending candles representing the
flagpole, and several candles (usually three to five) consolidating
around the bottom of the pattern to create the flag shape. A stock will
be shorted when the price drops below the flag’s low. The pattern’s
strength derives from the stock price dropping below the low, but
instead of correcting upwards, as would be expected of a stock that
has completed a sharp series of drops, the stock breaks down under
the low. The significance of a new low is an unequivocal victory of
sellers over buyers. Buyers are very pressured, do not wait for the
correction, and are willing to sell at any price. On the other hand,
buyers who prayed for a correction to save them are disappointed by
the stock’s further drop to a lower low, and sell under pressure, which
causes the stock to drop further. The bear flag formation allows us to
short scalp (speedy entry and exit), because the stock price is
stretched downwards even before the breakdown, and we are afraid
that the stock will drop to a new low but then immediately correct
itself upwards.

Bear Flag Breakdown, Genzyme – GENZ

 In the above example, the stock price of the bio-tech company
Genzyme drops at the start of the day’s trading, and with one five-
minute candle forms the bear flagpole [1]. For the next five candles, it
solidifies around the intraday low, hinting that despite the price drop,
it has no intention of correcting upwards as would normally occur
with a sharply dropping stock. Consolidation around the bottom of
the flagpole creates the flag itself. Breaking down the base of the flag
leads, as expected, to continued lows.

Cup and Handle Formation

The cup & handle formation is a bullish pattern that suggests the
shape of a cup and handle. The pattern is comprised of a stock
reaching its high, encountering resistance and correcting downwards.
The stock returns to the high, and in this way forms the cup. At the
high, the stock once again encounters resistance (remember when we
learned the term “double top”?) and corrects downward again while
creating the shape of the handle. This time, when it returns to a high
for the third time, it breaks through the resistance and rises to a new
high. The breakout point is the point where we should buy the stock.
 What have we learned about the stock prior to its breakout? The
stock reached a high, so we realize it is strong. It corrected downwards
but returned to the same high, from which we learn that buyers are
still in control. The stock drops again, but this time drops less than
the previous time and for a shorter period. The stock returns to its
high a third time.

Conclusion: Buyers are in control and are even become more

aggressive: they are buying after the smallest correction, and they are
buying faster. Buyers have begun overtaking the sellers. We conclude
that the stock is strengthening and may break out the resistance soon.

Cup and Handle Formation, United States Steel – X

In the intraday chart for X, we can see that the stock is rising
strongly at the start of trading and meets resistance at the price of
$54.49. It retreats, drops [1] but returns again to the resistance point,
and in this way forms the cup. Now it drops to a new low [1], which
shapes the handle, but this time the low is higher than the previous
low, since buyers are becoming more aggressive. It returns again to its
high within a shorter timeframe than when forming the cup. The
stock breaks through the resistance [2] and climbs to a new high.

Interestingly, if you track back slightly into the previous trading

day, you can see that the area of resistance was formed on that day.
You can also see that if you connect the previous trading day’s
formation to that of the breakout day, you will find a more complex
formation called head and shoulder formation, which we will study
later. Note that the formation does not need to be perfect from the
graphical perspective. For example, the line of resistance does not
have to pass exactly through the same previous high points.

SMART Patterns do not have to be “pretty” or

“perfect” from the graphical perspective. A
MONEY pattern is valid even with deviations from
the precise areas of support or resistance.

Inverse Cup and Handle

The inverse cup and handle is a bearish formation, the reverse of

the “cup and handle” described above. The pattern shows a stock
dropping to a low, finding support, then correcting upwards. The stock
then returns to a low, creating the shape of an inverse cup. It is then
supported again at the low point, and corrects once more upwards
while forming the shape of an inverted handle. The small handle’s
shape and the amount of time taken to form it are shorter than the
time in which the cup took shape, i.e. sellers are more aggressive. Now
it returns to a low for the third time, breaks down through support
and continues lower. The breakdown point is where we should sell
short.
What have we learned prior to the breakdown? The stock dropped,
and therefore we see it is weak. The stock corrected upward but
dropped again, from which we learn that sellers are still in control.
The stock rises again, but only less than the previous high (this is the
handle) and then returns to a low in a shorter timeframe than it took
to reach the previous low.
 Conclusion: Sellers remain in control and are beginning to sell
earlier and lower than at the previous high (the cup shape). The fact
that the stock returns to a low faster, and from a lower price, indicates
to us that the stock is weakening and that it will probably soon break
down through the support line.

Breakdown of Cup and Handle, Myriad Genetics – MYGN

Myriad Genetics begins its trading day with fifteen minutes of

sharp lows, finds support, corrects upwards, returns to a low and
creates the inverse cup [1]. The stock rises again, drops to a low and
forms the inverse handle [2]. The stock breaks down support [3] and
continues to drop. Later it reverses direction upwards. The fact that
the stock rises after the breakdown formation is of no importance to
us. The breakdown succeeded, and with correct money management,
as we will learn later, we can profit nicely from that, too.

SMART The success of a pattern in leading to

breakdown or breakout is measured in the
MONEY distance the price moved after the
breakout. There is no guarantee that the
 pattern’s success in the short range will lead
to a continuation of the trend.

Head and Shoulders

The head and shoulders formation is considered one of the

strongest bearish formations. As with the inverted cup and handle,
here, too, the structure involves candles consolidating above the line
of support in expectation of its breakdown.
The head and shoulders formation, being so powerful, is a favorite
of traders and therefore draws the attention of sellers and short sellers
more than other formations.
The formation is comprised of a left shoulder indicating the first
low price, a head indicating the upward correction and a return to the
low, and a right shoulder indicating an additional correction followed
by the return of the stock to a low at the support point. The low’s
breakdown is where support breaks, and also where the short enters.

The tractor manufacturer AGCO drops immediately when the

trading session opens, corrects a little upwards, and forms the left
shoulder [1], corrects and forms the head [2], returns to the support
line, corrects again and forms the right shoulder [3], and finally breaks
the line of support.

Head and Shoulders Formation - AGCO

Inverse Head and Shoulders

The inverse head and shoulders is a bullish formation, and the

opposite of the head and shoulders. Similar to the cup and handle,
here, too, the structure shows candles consolidating beneath the line
of resistance in anticipation of its breakout.
The inverse head and shoulders, also a strong formation, is a favorite
among traders and draws more buyers than other formations.
The structure is comprised of a left shoulder indicating a high
price, a head indicating the downward correction and a return
upwards to the line of resistance, then a right shoulder indicating a
further correction, and a return of the price back to the line of
resistance. The breakout through resistance is also the point of long
entry.

SMART Head and shoulders formations are “long

range” formations structured on multiple
MONEY
 candles, and are therefore valid even if they
operate against the stock’s original trend.

Inverse Head and Shoulders, the Fuel Company – ATPG

ATPG drops sharply when the trading session opens, corrects

upwards and forms the left shoulder [1]. It then drops to a new low,
but returns to the area of resistance of the left shoulder, and in this
way forms the inverted head [2]. It corrects again and forms the right
shoulder [3]. It should now be fairly clear that the price is reversing
direction. The right shoulder [3] indicates that buyers are no longer
panicked, compared to the head [2], and that a breakout of the
resistance line should lead to a high.

Pennant

A pennant formation can be bearish or bullish. In the pennant

formation, the price consolidates while moving in the form of a
pennant, as seen in the chart. You need to sketch the pennant in your
imagination and then wait for the exit beyond its boundaries, as we
see in the chart.
The technical premise is that at the end of consolidation, at
approximately 80% of the pennant’s expected range, a sharp shift in
movement should be executed. Usually the exit from the pennant
follows the original trend, in other words: if the stock showed an
uptrend before its consolidation in the pennant formation, it is
reasonable to assume that the price will break out upward in
accordance with the original trend, similar to a bull flag, but without
the flagpole. By contrast, if the price consolidates into a pennant while
trending down, it is reasonable to assume that a breakdown will occur
with a downward movement, similar to a bear flag, but without the
flagpole.

Pennant Breakout, SanDisk – SNDK

SanDisk rises immediately when the trading session opens [1],

encounters resistance, and consolidates in the pennant form. The
pennant breaks out [2] and SanDisk continues rising. The buy position
can be at the exit from the pennant, or in the transition above the
“flag” area. As you see, this breakout formation is very similar to that
of the bull flag, but instead of consolidating beneath the upper
resistance line, the price consolidates in the shape of a pennant.
Personally, I prefer to trade the bull flag formation. It is clearer and
simpler to identify entry positions.
Chapter 6 - Indices, Sectors and
Crystal Balls
Most stock trends can be anticipated
according to the movement of the
market and sector to which a company
belongs.
How to Predict Movement
Market performance is measured with market indices. Every index
represents a different group of companies and is comprised of
different market sectors. Indices can be represented on a chart, and we
observe the movement of the index through candles. Every index and
every sector has a different meaning. Some are more important, some
less so, but all are important. A market index does not serve only to
show us what the market has “done,” but above all else, to predict
which way the market is trending. Because the market and sectors are
responsible for 90% of price movement for the stocks we trade, it
follows that if you know how to predict index movement, you will also
be able to predict the price movement of the stocks in which you are
interested. Stop for a moment and think about that. Do you really
understand the significance of what you’ve just read? Okay, let’s move
forward.

SMART The market index is no less than the trader’s

crystal ball. A full 90% of the price
MONEY movement begins and ends with advance
movement of the market index

We need to recognize the indices in their order of importance and

learn how to use them. In addition, and to expand our knowledge, we
will relate to some less useful indices, simply because as future
professional colleagues, I don’t want you to feel ashamed that you’re
not familiar with them.
As a rule, we monitor several indices. We don’t believe in just one
index, but rather try to combine information from several of them.
Once we get to know the main indices, we will also learn about the
sectors comprising each index. Because of the high importance of
movement of the indices for the stocks in which I trade, I devote one
full screen to indices and sectors and watch them even more, time
wise, than I watch the stock prices I am trading.
The Most Important Market Index:
S&P 500
The S&P 500 index (symbol: SPX) is the most important index in the
world.Without doubt, for traders it is the focal index, the king, the
trader’s crown and scepter. It was developed by the financial services
company Standard & Poor’s, giving rise to its initials. This index
displays the prices of the 500 largest-traded US companies via a
formula that calculates the importance and influence of these top 500
companies according to S&P specialists’ considerations. Standard and
Poor’s is considered of highest quality due to its broad range, and it
serves as the benchmark for measuring the entire market
performance. Of course, the S&P serves managers of portfolios,
investment funds, hedge funds, and more in every stock exchange
throughout the world.
For example: an investment fund that succeeds in providing its
investors with a positive yield of 8% when the S&P rose only 6% will
proudly declare that it has “beaten the market.” On that matter, let
me state that research consistently shows the horrific fact that 80% of
the world’s investment funds do not succeed in beating the market.
Therefore, next time you receive your investment fund’s annual report,
proudly flashing its positive annual return, discover the truth by
comparing the results to the market outcomes. In most cases, you will
be sorely disappointed. In fact, I have never found a fund that is able
to beat the market over the long term.

SMART Do you want to beat 80% of the funds? Buy

market basket ETFs. Research over a twenty-
MONEY year period shows that 80% of funds
worldwide do not succeed in beating the
market index.
Note: from this point on, whenever I refer to “the market” or
“the market index,” I will be referring to the S&P 500 index.
The rise and fall of indices are measured in percentages, but stock
market specialists on TV channels such as CNBC or Bloomberg will
usually be heard saying something like,
“The S&P rose today by 18 points.”
These specialists expect you to know at any given moment the
index point value. Currently, for example, the market is around 1,800
points, so you will need to understand that a day’s rise of 18 points is
an increase of 1.0%. The index’s value in points is the normalized price
of 500 different stocks, but it is not a tradable index. In other words,
you cannot buy and sell that index itself. To trade in index-linked
values, the “Exchange Traded Fund” (ETF) was invented, and will be
explained further.
Previously, I noted that the S&P 500 is the most important index
for the intraday trader. Why? Because 60% of a stock’s movement will
be dictated by index movement. In other words, the stock you have
bought will rise or fall after the S&P 500 has risen or fallen, and you
will profit or lose chiefly by being dependent on market direction.
Would you like proof? Observe the index in the chart below, where
you can see the connection between the S&P and the stock:

Comparing the Intraday Behavior of Apple (AAPL) and S&P 500

(SPX)

In the chart above, you can see Apple’s intraday movement in five-
minute candles. If you thought Apple had a life of its own…you were
wrong! All intraday movement is determined at the outset by the
market movement. The market moves first, and individual companies’
shares follow. Certainly an important stock such as Apple carries
serious weight in the market index, but its weight is still relative to
499 other companies comprising the index. In other words, Apple
does not have the power to move the index on its own. This is not true
for the NASDAQ 100 index in which Apple is currently a 20%
component.
I can well imagine how you are taking a deep breath and saying,
“Just WHAT does he mean? Am I supposed to know in advance when
a stock is about to rise even before it has?”
The answer is: Yes!
Is it easy to make money this way?
The answer is: No!
Apple should move in the direction that the market is trending, but
you can never know how much the market will move, how far behind
it Apple will move, and when the market will reverse.
How can we nonetheless take advantage of this information? In
several ways:

Buying
Let’s assume Apple is about ready to break out through intraday
resistance and you are weighing the risk of buying at the breakout.
Now let’s assume that just before Apple breaks out, the market also
broke out to a new high. Does the market breakout help you decide
whether to buy Apple in the breakout? Of course! Let’s also assume
that the market showed a strong breakout. Would you now consider
buying a larger quantity than what you might have initially intended?
Yes! You would have considered entering Apple because of a nice
technical formation, but you reached that decision and the quantity
you chose because of the market’s “support.” Think about the reverse
case: You are considering buying Apple at the breakout, but just before
Apple’s breakout, the market breaks down. What would you do? Yes,
you must forego entering.
Turning a Pro t
Let’s assume that simultaneous to the market rising, you bought
Apple, the stock rose, reached the area of profit you set, and now
you’re trying to “squeeze” a fraction more profit from the uptrend.
Your finger is poised on the mouse, and you wonder whether you
should press that sell button. The market stops moving up, and
suddenly begins to correct down. This will usually occur just before
Apple will also correct. Is this the time to sell and turn a profit? Of
course it is. Because we have already learned that 60% of Apple
movement is tied to market movement, so Apple will almost certainly
drop following the market’s drop. It is true that stocks do very
occasionally “have a life of their own” and Apple could go up even if
the market is dropping, but the risk in trading will be much higher.

SMART Don’t ght the market. Don’t buy stocks

moving opposite to the market direction,
MONEY because you will almost always lose money.
Go with the market direction. Going
against the market direction is tough and
lies in terrain where only extremely
experienced traders dare to trade-- and
even then, very rarely with success.

Sideways Movement
Let’s assume that you’re interested in buying a stock that is about to
break out, when the market starts moving sideways. Should you buy
when the stock breaks out? I have no perfect answer, but if there is no
market support, the breakout will be much weaker, and the risk high
to very high. The wisest decision in such cases is to buy smaller
quantities.

Trend
Let’s assume you wish to buy a stock which is up trending when the
market is downtrending. Should you buy? Most likely, you should not.
The most feasible eventuality is that the market will continue trending
down, and sooner or later your stock will follow the market direction.
Institutional investors buy only in accordance with market direction,
and if they don’t help you, it is better that you don’t buy.

Exceptions
Sometimes I break my rules on purpose. If, for example, I believe
something special is happening to a stock and its chances of rising are
particularly high, I might buy it even when the market is down
trending. Of course there is high risk when I buy against market
direction, and therefore my stop order, which is my protective
backstop, will be closer to the buy price, and of course I will buy a
smaller quantity.

Independent Stocks
There are very few stocks which have what is known in professional
jargon as “a life of their own,” meaning that they are not influenced
by the market direction. They are usually stocks with low volume in
which institutional funds do not invest, and are therefore less sensitive
to the moods of institutional traders as these moods manifest in
market direction. Usually these are stocks priced at less than $10,
which we will learn more about later. Be wary of these stocks unless
you have gained a lot of experience.
Sometimes a stock will have “a life of its own” when special
announcements are made. An example would be the publicizing of an
important announcement concerning a stock, when an analyst’s
recommendation goes live or is changed, when quarterly reports are
made public, and so on. In such cases, the stock may move
irrespective of market direction, though it will still be affected by
market direction. For example, the market may drop while a specific
stock rises. Nonetheless, if you compare the stock’s movement relative
to that of the market, you will see that every time the stock executed
an intraday reversal, it was closely synchronized with the market’s
intraday reversal. In other words, when the market corrects down
during a downtrend, the independent stock will correct down even
though it is showing an uptrend. This means that even if you are
trading in a stock that is moving against the market trend, you still
need to examine every move in the market’s trend.

Note:
All the principles noted above are also relevant in reverse for stocks
that are in a downtrend, i.e. for shorts instead of longs. If, for example,
the market is rising and on that same day, a certain stock in which we
wish to execute a short is dropping, it is still moving according to
market direction. While it is dropping, despite its direction being
the opposite of the market direction, it will correct up each time that
the market index goes up, and will go back to dropping each time that
the market index drops. By the end of the day, the market could end
with highs and the stock with lows, but the intraday movement will be
strongly influenced by market direction.

Index Symbol
Different trading platforms may present the same index under
different names, but with the same basis. If you wish to find the SPX
index, you may need to search for an identical or closely similar
symbol: SPX, $SPX or SPX$ - the same symbol with a dollar sign before
or after it. If none of these symbols matches your graph software, use
the symbol search field to look for the term: S&P 500.

Summary

The market index known as the S&P 500 represents not only the
market direction but also the mood of private and institutional
investors, and of traders. Institutional traders do not buy stocks when
the market index drops, but wait patiently until the index downtrend
causes the stock they are waiting for to drop, allowing them to buy it
at a cheaper price after the correction. When you buy a stock, you
should look for support from the institutional investors. You want
their mood to be as happy as possible, and you want their money to
enter the stock you have just purchased. Don’t expect that to happen
when the market index is dropping. Don’t fight the direction of the
market!

SPY – The S&P 500 ETF

As noted, the S&P 500 market index, symbol SPX, is not a tradable
index but denotes in points the state of the stocks that comprise it.
Because many investors, especially those disappointed by funds, are
interested in finding a simple way to link their money to market
yields, i.e. to “buy the market,” the solution for them is to buy the S&P
500 ETF (Exchange Traded Funds) that follow the market and are
known as SPYDERS, bearing the recognized symbol SPY.

ETFs are financial instruments traded exactly like stocks, and are
therefore given symbols just like stocks. The SPY price is very similar
to its value in points with the deletion of one zero. In other words, if
the SPX stands at 1500 points, the SPY price will be in the vicinity of
$150. ETFs are more sensitive to supply and demand fluctuations.
Unlike the SPX, the SPY can be graphed to show volume, which
does not exist for an index.

ES – The S&P 500 Futures

If I haven’t yet confused you with the difference between the non-
traded index represented by SPX and the tradable ETFs represented
by SPY, I will likely succeed in confusing you now when I present the
most important variation of the S&P 500, represented by ES.
The ES is the S&P 500’s futures contract, or as it is professionally
known: E-mini S&P 500 Futures.
Without going into a detailed explanation at this point of “future
contracts,” I do wish to differentiate between a stock and a futures
contract: a futures contract is a “financial product” which can be
bought and sold just like stocks, but with one difference: its expiration
date is at the end of each quarter.
The price of the futures contract represents the “anticipated future”
of the S&P 500. In other words, the ES represents the anticipated
market direction. In actuality, the ES is a tradable contract, traded by a
crazy bunch of experts in the CME – Chicago Mercantile Exchange.
These traders operate in transactions with a volume of billions of
dollars daily. It’s commonly accepted on Wall Street that futures
traders know better than anyone else on the face of the earth whether
the market will go up or down. If you check the ES at the end of a
day’s trading, you will see that it precedes the SPX or SPY by several
seconds, and therefore allows you to note market direction earlier, too.
Since we have already understood that the S&P 500 is THE most
important index for the day trader and determines 60% of the
direction of stocks you are trading, if you also use the ES, you will
definitely know before others which way the market is moving. In
short, it’s worth money.
Not every broker or chart provider allows display of the ES, since
they need to pay for the information coming from the Chicago Futures
Exchange. If your broker does supply this information, you will likely
be charged some $50 per month for it.
Another advantage of the ES is the fact that it is electronically
traded almost 24 hours a day (it closes for 15 minutes at 4:15 pm EST)
except on weekends, which goes far beyond normal trading times of
stock exchanges, operating between 9.30 am to 4 pm EST. This means
that the ES is traded before other trading sessions open. Therefore, if
you look at the pre-market chart about one hour before the start of
trade, which is what I do, you will know whether the market will open
positively or negatively as compared to the prior day’s close. But of
course, you are not the only ones able to check the pre-market chart:
every decent financial site or television channel, such as CNBC, will
keep you updated prior to the trade session opening as to what kind of
opening the futures are “signaling,” adding a warning statement such
as: “Futures do not always represent market direction.”
Should You Trade in Futures?

Futures trading is not for everyone. Futures contracts behave like

stocks, but with heavy leverage of 1 to 20. This means that you get a lot
more bang for your buck trading futures contracts. Even if the price of
futures shows no volatility, the movement of money in the accounts
creates the illusion of real volatility. This illusion, accompanied by the
thrill it arouses of seeing money in the account, attracts “gamblers”
who usually very quickly lose their money. Veteran traders like me also
trade (but not exclusively) in futures. I would recommend that novice
traders with less than three years’ experience do not even try.
Everything in its own good time, and patience pays off.

What is the ES Symbol?

Futures expire every three months, at the end of the third Friday of
any quarter. Simultaneous to their expiration, new futures contracts
are being formed and traded: their expiration date will be at the end of
the third Friday of the next quarter. Unlike a stock which carries a
fixed symbol, each future has its own symbol. Your broker can help
you find the current symbol of a future, but you can also do that
yourself, as will be explained.
An example of a futures symbol with an expiration date of the first
quarter of 2013 would be /ESH3.
Explanation of the Symbol
The slash always precedes the letters “ES,” which are the two letters
in the symbol that will never vary. The “H” represents the quarter,
which in this case is the first quarter of the year, i.e. this future expires
at the end of March. The digit indicates the year, i.e. 2013. The digit
will always be single: 3 is 2013, 4 will be 2014, 5 will be 2015, etc.
The quarters are represented as follows:
H – futures contracts expiring at the end of March
M – futures contracts expiring at the end of June
U – futures contracts expiring at the end of September
 Z – futures contracts expiring at the end of December
I taught myself to remember which letter represents which quarter
by linking it with the name of a much loved food, “hummus,” as well
as the fact that the letters are in alphabetic order.
Question: It is currently September 2, 2013, and you wish to view
the relevant futures charts. What symbol will it carry?
Answer: You can already view futures expiring in December 2013,
but they will show lower liquidity than those expiring in September,
and therefore you will choose futures expiring in September. After the
third Friday in September, all trading volume will be on the December
contract, although most professionals “roll” to the new contract more
than a week before expiration.
The symbols will be:
Futures expiring in September: /ESU3
Futures expiring in December: /ESZ3

Summary: SPX, SPY, ES

The market index is the most important index for intraday traders. If
I’m on holiday in Thailand and forced to forego my entire array of
screens in my trading room and make do with my 12-inch laptop, the
only index I will display, other than the chart for the stock I’m trading,
is the five-minute intraday SPY chart or the five-minute intraday ES
chart. Every market index movement will be important in helping me
decide whether I need to buy or sell a stock. I will use the SPX only
when I need to quote a change in the market for a professional article
I am preparing for the media.
I choose not to waste expensive paper on samples of the SPY or ES
charts, since they will look identical to those of the SPX, and you will
only see differences when you starting tracking them in real time.
NASDAQ 100: The Second Most
Important Index
The NASDAQ stock exchange also receives a good share of display
space on my computer screens. The NASDAQ 100 index, with its NDX
symbol, is the second most important index for day traders. The index
was developed by the NASD, National Association of Securities
Dealers, which established the NASDAQ stock exchange. This index
represents the price of the leading 100 NASDAQ companies. Since the
NASDAQ stock exchange contains a very high proportion of
technology companies, the index closely reflects the state of affairs in
these companies. A unique phenomenon for our times, in light of the
sharp rise in price of Apple’s stock [AAPL], developed when Apple
covered some 20% of the index’s movement. We often joke that if you
buy NASDAQ 100 ETFs, you get Apple, plus a bonus of some 99 other
stocks…
At this point it is not necessary to list the entire 100 important
companies represented by the index, which you can find easily on any
financial site, but you surely realize that in addition to Apple, the
NASDAQ 100 includes other well-known companies such as Microsoft
[MSFT], Intel [INTC], and Google [GOOG]. As with the S&P 500, here,
too, each stock carries a different weight. If Apple goes up some 3%, it
will have stronger influence on index performance than a similar rise
by a less important stock.
Since the S&P 500 contains the 500 most important stocks in the
market, clearly a significant proportion of NASDAQ 100 stocks will be
among the S&P 500. This explains why the S&P is considered more
important and reliable than the NASDAQ 100. Why, then, do I give
this index a central position on my trading screens? Is the S&P 500 not
sufficient?
The answer relates to the volatility of the NASDAQ 100. It is
comprised chiefly of stocks from technology companies. It is well
known that these stocks show high volatility relative to the lack of
volatility typical of most of the “solid” stocks in the broader S&P
market index. Technology stocks are more volatile because the “dream
element” embodied in their price is higher than the same“dream
element” in a company unrelated to the sphere of technology. For
example, the impact of a new electronic gadget on Apple’s stock price
will be more significant than on shares of Ford [F] when it announces
a new model. A volatile index cannot necessarily be relied upon,
therefore the NASDAQ 100 is given second place in the list of
important indices, but its second place is by virtue of its volatility.
As noted, 60% of market movement is dictated chiefly by the S&P
500. Therefore, it is important for me to analyze index direction. Since
the NASDAQ 100 is more volatile than the S&P 500, the NASDAQ
index will often indicate the expected direction before the S&P. As an
example, let’s assume that the NASDAQ 100 breaks out first to a new
high. Does that mean the stock I bought will also reach a new high?
No. As we learned, it will move chiefly according to the S&P 500 rather
than the NASDAQ 100, but the NASDAQ breakout may certainly hint
at the direction that the S&P 500 will take. To summarize: an early
NASDAQ 100 breakout causes me to suspect that the S&P 500 will
follow suit. The NASDAQ 100 early breakout is often like an advance
warning system of what will happen with the S&P 500.

NASDAQ 100 Symbol

The NASDAQ 100 symbol is NDX. As with the SPX, it may appear on
your charts with a $ sign before, after, or absent from the symbol:
NDX$, NDX, or $NDX. If one of these symbols does not match your
trading platform, use the symbol search field to find the symbol by
entering this term: NASDAQ 100.
The NDX, like the SPX, is not a traded index, which means you
cannot see its volume. It moves only during trading hours, as it is
computed based on the price of the 100 stocks that comprise it and are
traded in real time.

NASDAQ 100 ETF: QQQ

The NASDAQ 100 NDX index is not a tradable index, but many
individuals are interested in linking their money to NASDAQ 100
yields (which is very dangerous!). As a result, the ETF (Exchange
Traded Fund) came into being. It tracks the NASDAQ 100 and is
known as “the Q’s” or by its familiar symbol, QQQ.
As with the ETFs for SPY, which track the S&P 500, the QQQ is also
traded as though it were a stock. It has its own symbol, buyers and
sellers. Being a traded ETF, many traders prefer tracking the Qs than
the NDX, because with ETFs, “money talks.” ETFs are more sensitive to
changes in supply and demand, and a displayable volume is created.

NASDAQ 100 Futures Contract: NQ

The NQ is the NASDAQ 100 futures contract. It is professionally

known as the E-mini NASDAQ 100 Futures contract. Just as the ES
represents the S&P 500’s expected future, so the NQ represents the
NASDAQ 100’s expected future.
The NQ is a contract traded on Chicago’s CME. If you watch the
NQ during the trading session, you will see that in actuality, it
precedes the NDX or QQQ. Paying your broker for the ES package
should automatically include all E-mini indices, thus the NQ will be in
that package too. It is electronically traded almost 24 hours a day.
Checking its chart just before the trading session opens will show you
whether the NASDAQ will open up or down, long before many others
know.

The NQ Symbol
As with the ES, NQ contracts expire every three months on the third
Friday at the end of each quarter.
An example of the symbol for futures expiring at the end of the
second quarter would be /NQM3. The slash and the letters “NQ” will
always remain part of the symbol. The rest decodes precisely the same
way as for the ES: “M” represents contracts expiring at the end of the
second quarter, and “3” represents the year 2013.
The Forgotten Index: Dow Jones, DJI
The Dow Jones Industrial Average [symbol: DJI], also known
simply as the “Dow,” was developed by Dow Jones & Company. It is
the most veteran and famous of indices on Wall Street. The index is
comprised of thirty of America’s larger companies over a variety of
sectors and is meant to act as a “bell weather” index for the economy.
Large numbers of investors worldwide view the Dow as the main tool
for following the US market’s mood. It is most often quoted in
financial media, but the Dow is the last index that needs to interest
you as traders. Stock exchange traders are often smug when they come
across investors who mention the Dow, which these traders often call
“the forgotten index.” The only reason it ranks in the third (yet still
highly respectable) position is not because you are meant to use it, but
because you will hear it abundantly quoted.
Keep in mind that Dow Jones & Company publicizes hundreds of
different indices relating to diverse sectors and various states. The DJI
is indeed the most famous of them all, but it remains only one of the
many indices.
Why do we not use the DJI? Firstly, because it is comprised of only
30 stocks, therefore is not truly representative of the market. Secondly,
the thirty stocks comprising the index are often the most “tired”
stocks of mega-companies which are highly lethargic. As traders, we
need volatile indices representing future expectations and not old
histories of mega-corporations. The Dow simply does not deliver the
goods.

How is the Index Represented?

The DJI may appear in your trading platform without the $ symbol, or
preceded by or following the letter symbol: $DJI, DJI$ or DJI. If one of
these symbols does not match your trading platform, use the symbol
search field to find the symbol by entering this term: Dow Jones
Industrial Average.
The DJI, like the SPX and the NDX, is not a tradable index, so you
cannot see any trade volume. None exists. The index moves during
trading session times and is a derivative calculated for 30 stocks traded
in real time.

The Dow Jones ETF: DIA

The Dow Jones Index [DJI] is tracked by the “Diamonds” ETF,

symbol DIA. The DIA is meant for people, of which there are a great
many worldwide, wanting to link their money to this index’s yield. Just
like SPY and QQQ, the DIA is traded like a stock. In other words, it
has a symbol, and supply and demand.

The Dow Jones Futures Contract: YM

The YM is the Dow Jones futures index and is professionally known as:
E-mini Dow Jones Industrial Average Futures contract. As with
the other futures described, the YM represents the expected futures
outcomes of the Dow. It is also electronically traded 24 hours a day on
the Chicago CME.

The YM Symbol
This, too, follows the pattern of the ES and NQ. The YM expires on
the third Friday of the last month of each quarter. An example of aYM
for the fourth quarter of 2010 is: /YMZ0.
Rebalance: How to Pro t from Index
Updates
Once each year, the research organizations Standard & Poor’s, Dow
Jones, and NASDAQ undertake a joint review of the composition of
companies included in the indices they manage. When a specific
company is encountering difficulties and its stock has plummeted, it is
highly probable that this company will be removed from the list and
replaced by a “new star.” Stocks such as Apple and Google did not
always appear on the index, but made their entrance due to strong
successes and to ousting stocks that were doing poorly or were
completely inactive.
Why does this need to interest you? For two reasons: first, never
believe a person who says something like, “If you had invested $1000 in
the Dow Jones 30 years ago, you’d be rich today.” That’s no less than
fraud, used by Wall Street salespersons and fund managers trying to
solicit you into a long-term investment. In actuality, the index changes
annually since stronger stocks replace those doing poorly. If you’d have
invested in the original index, you’d have lost a lot of money by now.

The second reason is based on a known trading method: many

funds link to an index. For example, a fund may promise its investors
that it will only invest in stocks belonging to the S&P 500 index. When
a stock is removed, the fund is forced to sell it and instead buy the
stock moving into the list.

So far, so good. Do I need to detail how money is made from this

activity? Since the information concerning stocks being removed and
entered into the index is publicized several weeks before the actual
update, the funds are forced to sell and begin buying in advance. In
other words, a stock being removed from the index will drop, since
the funds are forced to sell it; a stock entering the index will rise,
since the funds are forced to buy it. It’s that simple. Type the term
“S&P Rebalance” into your search engine to find the dates and
precise list of stocks leaving and joining the index.

Summary: Market Indices

It’s time to make some order out of all the information above.
If you’re working with just one screen (which I hope won’t be for
too much longer), the chart that needs to cover nearly one-quarter of
the screen is the ES if you have access to futures, or the SPY if not.
If you have two or more screens, devote between one-third to half
of one screen to the ES alongside the NQ (or the SPY and QQQ). I
allocate about three-fourths of a 23-inch screen to these two indices.
Display the information in five-minute intraday candles. The larger
your screen is, the more trading days you’ll be able to display at once. I
suggest your display covers at least three trading days. Showing a
three-day history helps me search for the support and resistance
points over the last few, most current days.

Spot  Test

Answers follow.
1. You are about to buy a stock that is about to break out, whereas
the ES index jumped a few minutes ago to a new high. Should you
buy?
2. You want to buy a stock currently running up, whereas the S&P
500 is trending down. Should you buy the stock?
3. You want to buy a stock, and at the same instant, the S&P 500
breaks out to a new high. Should you buy?
4. You want to execute a short on a stock, and it looks to you that the
S&P 500 index is about to break down to a new low, whereas the
NASDAQ 100 is trending up in a reverse pattern to the market
index. What should you do?
 5. You want to buy a stock just as the NASDAQ 100 is breaking out,
but the S&P 500 has not broken out yet. Should you buy?

Answers:
1. As noted, 60% of a stock’s movement is dictated by the movement
of the market index. If the index has gone up and your stock didn’t
jump higher together with it, something doesn’t sound right. Maybe
a large-quantity seller is preventing it from going up? Maybe other
buyers aren’t interested? It is reasonable to assume that the market
will self-correct fairly soon for at least part of the highs, which
means the stock will likely drop rather than rise.
Conclusion: don’t buy, or buy only a small amount with a close stop
order, to protect yourself.
2. In your first three years of trading, I do not permit buying stocks
moving in the opposite direction to the market’s movement. If you
do, or if you execute a short on stocks not following the market
direction, the chances of you losing money are at least 60%. Once
you have amassed experience, you will learn how to operate against
market direction in some cases, but only under unique
circumstances and in specific stocks which show extreme movement
and ignore market conditions. First, gain much more experience.
3. Of course! If you’re about to press the buy button just as the
market breaks out to a new high, buying is a correct move that
reduces risk and significantly improves opportunity. It is reasonable
to assume that the market will strongly impact your stock and the
price will go up, even if you’ve made a wrong choice.
4. The NASDAQ 100 very often precedes the market index. If the
NASDAQ 100 is rising when it looks to you as though the market is
about to trend down, there is a reasonable chance that the market
will not break down, which increases your risk. Wait for the market
index’s breakdown to occur, and only then press the short button. If
the stock breaks down before the market cooperates, short for a
smaller quantity and be constantly on the watch for reversals.
5. Since it appears that here, too, the NASDAQ 100 may precede the
market index, it is indeed better to buy, but with great caution. Buy,
for example, half the total amount you might want in the hope that
the market index will also break out to a new high. If this does
occur, buy the second half of the quantity you had in mind, on the
condition that the stock’s price has not run too far ahead.
Sectors and Industries
So far, we have learned that 60% of price movement is influenced by
the market index (S&P 500) movement. But this is only partial
information. Of the remaining, 30% of the influence on movement is
derived from the movement of the sector to which the stock belongs.
Only 10% of the time will a stock “take itself into its own hands” and
make its own way in the market independently.
Stocks belong to industries, which together comprise a sector. The
financial sector, known simply as financials, is subdivided into four
industries: banks, various finance organizations, insurance companies,
and real estate companies.

Let’s assume you wish to buy a bank stock, such as Citigroup,

symbol C. We already know that the S&P 500 is responsible for 60% of
stock movement, so before you click “buy,” you would glance at the
market index and make sure it is trending up. Now I would ask you to
also glance at the chart for the industry to which the stock belongs: in
this case, the banking industry. I assume there is no need to remind
you that during the 2008 Financial Crash and afterwards, banks were
the weakest market industry: in other words, the market index might
be moving up, but the banks dragged far behind, and may even have
been trending down. A stock belonging to an industry which is not
functioning correctly will find itself in difficulties even when the
market is optimistic in general.

When you are about to buy a stock, first check to which industry it
belongs. This may take a few seconds before you reach a decision, but
they are definitely a few seconds well spent. Over time, you will come
to recognize most of the stocks and will not need to check each one’s
industry. For example, to which industry does TEVA Pharmaceuticals
(symbol: TEVA) belong? Drugs. To which industry does INTEL
(symbol: INTC) belong? Semiconductors. The next time you
encounter these two, for instance, you should be able to remember
them. Within two to three years, you should be fluent in the sectors
for 70% of the stocks in which you trade.

SMART I do not always check the sector or industry

before taking a trade. Stocks belonging to a
MONEY marginal sector are not checked.

A good proportion of the stocks we trade will belong to one of four

main industries: banking, technology, semiconductors, and
biotech. On the screen which displays the two most important
market indices, I also allocate space to relatively small charts showing
five-minute candles for three of these industries: banking, biotech,
and semiconductors. Of course there are many more sectors, from
stocks related to aircraft and flight to the production of paper, but the
impact of those sectors on the market is negligible, therefore I do not
allot them screen space.

Exercise in Comprehension:
On the daily chart, Southwest Airlines’ (LUV) stock shows a nice
pattern while trending up, and you wish to buy for a range of several
days (remember that several days is called “swing”). You’re waiting for
the best possible conditions.
When the trading session opens, you notice that the market is
rising strongly and the Oil & Gas sector is rising even more strongly
than the market. You check the reason and discover that fuel prices
are rising. An immediate outcome of rising fuel prices is a drop in
Airline sector stocks which are highly dependent on fuel costs.
Conclusion: today is not the right day to buy Airlines sector stocks.

On days when the market is trending up, the associated question is

which sectors also rose, which of them rose more strongly than the
market, and which dropped despite the market’s move. On a day of
highs, we can assume that between 70% to 90% of the sectors are also
rising. On the other hand, as noted earlier, some sectors will almost
always move in opposite directions to each other, such as the
contradictory movement of the Airline sector to the Oil & Gas sector,
because of the strong impact of fuel prices on airline profitability.
When the market index drops, for example, the price of gold will
almost always rise. When the price of gold goes up, the Mining
sector will also rise. We see that gold and mining companies often
move in opposition to market direction. On a day of sharp upward
movement in the market, would you want to bury your money in a
stock belonging to a dropping sector? Of course not. So, check sector
direction before entering the market.

Here is a list of the main industries and their symbols:

Symbol Sector/Industry

DJI$ Industrial

BKX$ Banks

NBI$ Biotechnology

SOX$ Semiconductors

MVR$ Retail

NDXT$ Technology

DJUSEN$ Oil & Gas

QNET$ Internet

DJT$ Transportation

DJUSAR$ Airlines

DJU$ Utilities
 DJUSAP$ Autos

DFX$ Defense

RXS$ Pharmaceuticals

IXTC$ Telecom

Note that sectors and industries tend to mingle: banks, for

example, are an industry within the Financials sector, but because
their weight in the sector is varied, traders tend chiefly to follow the
banking industry.

Multiple Symbols
To check the status of banks, it is possible to follow several
different symbols, sourced in the various indices developed by the
different companies. Dow Jones, for example, has its own banking
index, which is different from the index produced by Merrill Lynch.
This simply means that the Dow Jones analysts grade certain banks
differently from Merrill Lynch’s analysts. The symbols in the table
above are the most commonly used among traders, but individual
traders may have other preferences.

Integrating Tools
The most successful formula calls for cleverly integrating all the tools
described above. The ideal trade will integrate buying at the correct
technical entry point for the stock, while monitoring the market and
the industry to which the stock belongs. If you choose to buy a stock
that is stronger than the market and that belongs to an industry
showing strength on a day of an up trending market, you will greatly
enhance your chances of success.
Chapter 7 - Indicators: The
Trader’s Compass
Indicators, like a compass, show the
direction but not the path.
Reading a Million Individuals’  Thoughts
We have learned about trends, chart patterns, and indices, and now
we will discuss indicators, which are generally derived from the trend.
Indicators do not usually add new information which cannot be
learned from the chart, but sharpen and clarify the information
inherent in the chart. Let’s say, for example, that you have bought a
stock running up, and you wish to know when to sell it as close as
possible to its high. What defines the high? How can you use the
index to identify the high?

SMART An “indicator” is an assistive tool for

decision-making. Indicators do not add
MONEY new information, but help us decide when
to hit the buy/sell button.

There are, in fact, no small number of indicators which claim to

provide you with the absolute answer. I would say that indicators are
what their name implies: they provide orientation, but they are not
the absolute final factor upon which your decision should be based.
Using indicators is similar to navigating with a compass. The compass
shows which direction you are facing, but cannot instruct you how to
arrive at your destination. You need to decide which path to take, and
often that path will not be what the compass has shown. If stock
trading were as simple as using an indicator, any computer could
replace me successfully!
 When I started out as a trader, I relied strongly on indicators. Now,
after many years’ experience, they are well-embedded in my
subconscious and I hardly look at them anymore. Furthermore, to save
screen space and “clean up” the charts of stocks in which I am trading,
I removed all the indicators from the display. Do I suggest you do the
same? Of course not. After many years of screen time, I have reached
the stage of “understanding” the charts just as Neo “sees” the matrix. If
you’re just starting out, and even some years into trading, you still
need to use indicators to base your understanding upon and to gain
guidance. Over the years to come, I believe that you will also reach the
advanced stage of freeing yourself from dependence upon indicators.
Until such time, use them, understand them, but don’t take them as
given, and do not operate mechanically as though they are the only
instructing factor.
There are many technical indicators, including the RSI, MACD,
ADX and more. The more that technical analysis develops, the more
indicators and new technical tools develop. But a professional trader
is assisted by very few indicators, since during trading there is no
time to read multiple indicators, and because the trader is
concentrating on the chart from which the indicators are derived.

The most important indicator for analyzing a trend is the volume,

as it is one of the few technical tools not derived from the trend and
provides the trader with an important, additional perspective on a
stock’s status. Trade volume is a unique indicator that I am never
willing to forego.

Volume of Trade
The volume of trade, or as it is simply known, volume, notes the
number of shares being traded at any given moment. Volume is
marked by bars at the base of the chart. Beneath each Japanese candle
is the volume bar appropriate to that timeframe. If the Japanese
candle represents five minutes, the volume will present five minutes,
and if the candle is green, the bar will also be green. Occasionally,
according to the trader’s choice or the platform’s limitations, the color
of all volume bars will be identical and it will not be possible to
distinguish between down volume and up volume.

Volume for TEVA in Five-Minute Candles:

For the five-minute candle marked on the chart above, beginning at

14:50, volume shows 45,010 shares. To see the volume for each candle,
position the mouse on the candle and press the mouse button (this
may vary, depending on the platform).
Volume indicates the strength of the trend. Some claim, however,
that because every transaction involves a buyer and a seller, or in other
words, someone who thinks the stock is cheap and someone else who
thinks it is expensive, the sum total of opinions in the market is zero
and volume has no significance. There is some degree of truth in this
claim, but those who hold this view ignore the identity of both buyers
and sellers. Since institutional buyers are usually the smart ones in the
market, their opinion holds greater weight, which makes it harder to
claim that the sum total of all opinions is zero. As a result, it is
important to identify volume changes deriving from the activity of
these institutional buyers.

Volume Precedes Price

One of the most well-known clichés concerning volume is that
“volume precedes price.” Why would volume precede a rise in price?
Institutional traders who receive instructions from large clients
wishing to buy millions of a certain company’s shares do not feed a
buy order into their platforms for the entire amount in one go, as that
would completely expose the client’s intentions, jump the price higher,
and reduce the bonus the traders receive for buying cheaply. Traders
will therefore be interested in buying cheaply in order to receive the
client’s full remuneration, since the traders’ bonus increases the lower
the net price that they get for their client. Traders will therefore
conceal their intentions, enter and exit the market repeatedly, each
time buying a relatively small quantity. In this way, traders can hide
their intentions, and may succeed in preserving the stock’s low price,
but the scope of purchases as manifested in the volume cannot be
hidden. The volume may therefore reveal that stocks are being
collected prior to a price spike. The same is also true for drops in
price. Large sellers, usually investment funds, receive information
prior to it reaching the public and begin operating in large volumes
before the stock has moved.

SMART Buy and sell orders can be hidden, but

volume can never be hidden. An increase in
MONEY volume always indicates a reason: someone
knows something that you do not yet know.

Average Volume

It is important to check the average daily volume of trade before

entering a stock, for two reasons:

1. Identifying Relative Increase in Volume

A significantly large intraday volume compared to that of the day
before indicates some special activity involving that stock. We love to
locate and follow up on stocks showing volume increases, especially
with a double leap, or even much higher. Stocks with increased
volume can be easily found using simple screening software or while
glancing at the stock’s chart. We can easily discern the growth in
volume if we compare the charts showing the prior and current day’s
volumes. Of course, a comparison is only possible after at least
midway through the current trading day, and must be made for the
same timeframe of the previous day. When I consider buying a stock
and see a relatively noticeable growth in volume, I can make the
decision more easily. I may even increase the quantity of my purchase,
based on the premise that the increased volume indicates increased
interest and therefore increased chances of success.

2. The Possibility of Buying and Selling at Any Time

Traders will buy a stock only if they are certain that they can buy and
sell at any time, at any price, and for the entire quantity purchased.
When the average daily volume of trade is low, for example only
100,000 shares per day, the spread between the bid (buyers) and ask
(sellers) will usually be more than one cent. This makes it difficult for
you to buy and sell at your desired price. For example: you bought a
stock and wish to sell immediately, but find that you’re forced to sell at
a considerable loss because the closest buyer is too far beneath your
buy price.
Furthermore, stocks with low volumes carry no “meat,” and their
buy and sell liquidity at any price, even if buyers do exist, will be
relatively small. Because of the large spread between bid and ask, and
the absence of “meat,” just one large transaction is enough to strongly
impact the stock price. It could suddenly go up, which is great if you
bought it. By the same token, it could suddenly drop, leaving you no
time to sell with minimal loss. In short, light volume stocks are not for
the fainthearted or those who hate high risk, like me.

SMART With time, you will recognize most of the

stocks you are trading and will not need to
MONEY check whether they match volume
 requirements. You will get to a point where
those checks are needed only for a small
range of stocks.

Conclusion

A professional day trader will usually not trade stocks with an average
volume of less than one million shares per day. Not to worry: there are
thousands of stocks with a day volume in excess of that figure.
In summary, a professional trader looks for stocks trading over one
million shares per day on average, but also with volume better than
the prior day’s volume.
How can we know, after an hour of trading, whether the day
volume is going to top one million? Switch quickly from the intraday
five-minute candle chart to the daily chart, and check the volumes
over the previous few days. With just a glance you should be able to
see whether volume is only several thousand shares, or above one
million. If the volume is borderline, compare the volume of the
current day’s opening with that of the previous day’s opening, and try
to assess the current day’s potential on that basis.
Pay attention to another phenomenon which may mislead you.
Sometimes, a considerable portion of the volume derives from several
trades, or one single large trade. In other words, you might believe
that the intraday volume is large enough, but in actuality most of it
derives from one trade of hundreds of thousands of shares. To check if
this status is relevant, check the volume indicator and look for a single
candle that represents an extremely high volume.

What  Volume  Changes  Mean

A wise rule states: “Buy the rumor, sell the news.”

Sometimes rumors can be exposed by identifying volume increases.
Volume changes, if interpreted correctly, can in certain circumstances
constitute an important index for buy and sell decisions. For example:
when a stock rises and breaks over resistance, the breakout should be
typified in a noticeable volume growth and thereby indicate increased
interest of buyers. A rule of thumb says that volume increase is
considered significant when the five-minute candle showing the
breakout doubles relative to the candles preceding the breakout. Later
we will examine several rules that we need for interpreting volume
changes as the stock moves.
We need to differentiate between volume increases prior to daily
breakout (in one-day candles over several days) and volume increases
preceding intraday breakout (in five-minute candles during the
trading session).

How to Interpret Volume Increase Prior to Daily

Breakout

When the volume of activity for a stock increases before the daily
breakout, we should suspect something significant happening to the
stock. Daily volume grows for a reason. Sometimes, it indicates news
that has yet to be publicized formally but has already leaked to “those
in the know.” It could also indicate a large institutional buyer who has
accumulated shares. As is customary in funds, once 90% of their target
is reached, the institutional buyers release the brakes and want to let
you know, by making large purchases, that they are interested in
supporting the stock. The trader is hoping that you, and many others
like you, are noticing that volume increase, and will join in and help
drive the stock price up.
Growth in daily volume can be simply identified using free Internet
screening software such as Yahoo Screener or Stock Fetcher. For
identifying intraday volume change, you will need to buy a more
advanced program such as Metastock. Most new traders should not
feel the need to buy these software packages and do all of the work
themselves. Trading is enough work. Use professionals and the tips
that they are willing to share to find stocks until you become
successful enough to try to find stock patterns for entry yourself.
 One of the differences between the professional and amateur trader
is the former’s ability to correctly identify the entry price. Volume
growth helps us locate the entry price. An amateur will analyze several
indices (usually an unnecessary action) and make the buy decision
with a delay, only after his or her confidence level is sufficiently strong.
It is a known fact that the amateur’s confidence rises in direct relation
to the stock’s price rise, so that in most instances, the amateur’s entry
price will be lagging. A pro trader knows how to ignore extraneous
indices and reliably evaluate the correct entry price, with the stock
about to break out. Volume growth right before breakout is, in many
cases, the earliest sign of the impending breakout. Amateurs join later,
while professional traders are watching the stock’s price rise. To a
great extent, this is also the difference between profit and loss.
Big breakout volume represents the point of change in the public’s
perception of the stock’s worth. During pre-breakout consolidation,
very few are interested in buying the stock. The more the volume
grows, the greater the number of newly-interested parties. The more
buyers there are who believe that the stock will continue its new
trend, the greater the chances of success.
A stock that breaks out with a small volume does not catch the
“radar” of traders, and its chances of succeeding in the new trend are
much lower. After the breakout, investors are more skeptical, seeking
additional “proof” supporting the move. Large volume is definitely one
of the more important signs assisting us in deciding whether to hold
the stock. A stock not showing a volume increase will generally
encounter intraday institutional sellers for up to three days from the
breakout. Institutional supply will create a new area of resistance
which the stock will find hard to break.

Breakout Volume Increase for Caterpillar, CAT

 In the daily chart on the right, you can see how Caterpillar broke to
a new daily high of over $80. You can also see, at the base of the chart,
that the breakout involved almost double the volume of that of the
preceding days. On the left, the intraday chart shows how the stock
consolidates below $80, and when it breaks the resistance, volume
jumps to 1.2 million shares in just one single five-minute candle!
Without a doubt, a lot of interest was shown in this stock, which
increases its chances of continuing to trend up. Caterpillar’s potential
breakout was identified in the trading room several days before the
actual jump, and we followed it closely in the hope of buying at
breakout. This trade was definitely a highlight.

SMART Funds hold stocks for the long term and are
therefore not sensitive to intraday price
MONEY changes. Traders buying before the
intraday breakout are highly sensitive to
even the slightest price change.

How to Interpret Volume Increase Prior to Intraday

Breakout

As noted, a differentiation must be made between volume increase

prior to a daily breakout, and prior to an intraday breakout. At the
intraday level, volume increases prior to the breakout are not usually a
good sign, as it is generally caused by independent day traders rather
than institutional traders. As we will study in depth later, traders
buying stocks prior to intraday breakout may be particularly sensitive
to even the slightest drop in price. A large pre-breakout volume
indicates that there are multiple “new hands” buying the stock. These
new buyers, unlike the veterans who bought the stock when it was
much cheaper, are still in a dangerous position. They have not yet
profited and are therefore far more sensitive than the veteran traders.
If the stock should break out and correct even slightly, there is a
reasonable chance that the new buyers will flee quickly, causing a
temporary price drop. Usually these drops correct rapidly and the
stock resumes the upward trend. Experienced traders will even take
advantage of the temporary low to buy cheaply.

Buyers Fleeing Caterpillar, CAT

Looking at Caterpillar’s $88 breakout at the one-minute candle

resolution, we see Caterpillar’s buyer shakeout precisely at the
breakout. The price broke with a large volume of 600,000 shares in
one minute (most of whom are new buyers like me) and rose by 15
cents [1]. So far, so good. A high volume integrating breakout on the
daily chart and a nice technical breakout in the trading session should
succeed, but pay attention to the pre-breakout volume increase. The
problem occurs when many of those “new hands” feel pressured, and
start selling after the price rose by just 15 cents, creating a snowball
that within two minutes sends the stock to a pullback of 38 cents [2].
Many years ago, I, too, would have been among those feeling
pressured, selling at a loss and gaping when the stock turned back up
and reached new highs. Many years of experience later, with many
insights gained into human behavior, on this occasion I doubled the
quantity I bought at $79.89 and enjoyed watching the continuing
uptrend. An amazing trade instead of a burning loss!

How to Interpret  Volume in an Uptrend

Since volume increases indicate the trend’s strength, we would want to

see volume increase every time the stock returns to moving in the
direction of its trend. If volume does not grow as the trend develops,
perhaps a reversal is about to occur, which brings its reliability into
question.
When trying to decide whether to buy a stock trending up, we need
to examine the behavior of volume at the points of price change
within the trend itself.

Example of Intraday Change in Volume of Akamai, AKAM

In the chart above, notice Akamai’s strong day of highs shown in

five-minute candles. Notice also that the volume during the first
trading minutes and last trading minutes is higher because of
automatic buy and sell orders from individuals and institutional
traders; therefore, these points have no technical importance. In the
area marked [1], the stock is trending up with a (relatively) large
volume. In the area marked [2], Akamai is dropping with a small
volume: this is a sure sign of lack of enthusiasm over the drop. In area
[3], it is running up again strongly with large volume. In area [4], it
trends down once more with small volume, and at [5], it peaks at a
new high with large volume. The conclusion is simple: more
enthusiasm during the upward moves than the downward moves
indicates that the trend’s chances of continued highs are greater than
its chances of dropping.
What might have occurred had we seen the volumes grow during
lows? Would we have sold? Not immediately, but we would definitely
have started being “suspicious” about the trend’s continuation, and
begun planning our exit point should the reversal strengthen.
Sometimes increased volume is no more than coincidental “noise” that
means nothing.

SMART A stock trending up needs to show

increasing volume when trading upward
MONEY (indicating enthusiasm), and smaller
volume when trading downward. A down
trending stock needs to show the opposite.

How to Interpret  Volume in a Downtrend

The behavior of a stock in a downtrend is slightly different from that

of a stock in an uptrend. It is more difficult to interpret the volume of
a stock when it is trending down compared to when trending up.
Sometimes, when the stock breaks support, the breakdown is not
typified by large volume since many investors tend to deny their
failure and continue to believe in the stock even though it is a losing
trade. Amateurs tend to remain true to a stock in much the same way
as they stay true to a football team on a losing streak. Have you ever
seen a football fan leave his or her losing team? Amateurs will always
offer the same response: it’s good, it’ll come back, it’s got good
products, its management is good. Pros, on the other hand, know
when to cut their losses quickly. Amateurs will deny their own failure,
and are sometimes drawn into big losses that cause emotional
paralysis, preventing them from functioning logically. Paralysis and
denial may reduce volume of a stock during initial lows.
Another reason for low volume is the absence of demand. A losing
stock is dropping due to lack of demand, which does not enable sellers
to sell. At a more advanced stage when the stock continues falling, fear
takes over. The public is beset by panic, and volume increases when
sellers begin vying for demand, selling aggressively at any asking price.
On the other hand, this is also the stage when some institutional
traders begin accumulating the stock again.
Generally, three to five days before a stock falls, when the volume
grows, the stock will find support and possibly even return to a high.
Price correction with small volume chiefly indicates that “flea market
players” have joined the short-term trade, seeking bargains. Usually
they will fail, as the stock will usually continue to trend down, but this
never prevents them from bragging about their amazing success. I
meet such players frequently at conferences where I lecture. They
always boast of the latest stock they bought. It sounds something like
this: “I just bought Citigroup when it was at $2 and now it’s at $11.”
Almost always, they recall their rare successes rather than their
multiple failures. They conveniently forget that they also bought
Lehman Bros. at $3 and discovered the next day that it had dropped to
zero, just as happened to any number of other trades they executed,
all of which lead to the eventual closure of their trading account.

How to Interpret Large Volume without Any Price

Movement

Large volume without any significant price movement can come about
from an institutional trader’s demand. The decision-making processes
of institutional traders are very different from those of day traders or
private investors. Institutional traders will give some weeks, if not
months, of consideration to buying a stock. During that time period,
they conduct an in-depth economic study, known as fundamental
research, on the company and its products, its financial reports, its
market status, and much more. As institutional traders manage huge
sums of money, they need to purchase extremely large quantities of
stocks, typically in the hundreds of thousands if not millions of shares,
in order to “move money.” That kind of quantity, if bought in the
market from random sellers, will create high demand and cause price
spikes before the fund has managed to collect the required amount.
The solution is arrived at through several avenues. First of all, the
fund will try to locate sellers holding large quantities and buy them
direct in “out of exchange” transactions. These usually cover hundreds
of thousands of shares in one transaction. Large-quantity buyers are
prepared to pay a little more than the market price based on the
premise that if they try to buy within market activity, the price will be
pushed up. A seller approached by an institutional trader knows that if
he or she tries to sell a very large quantity within regular market
activity, it will force the price down, and the seller will then receive
much less than the price offered by the fund.
However, by law, these out-of-exchange transactions must be
reported to the stock exchange, which means that the trade volume
will appear on your trading screen without its impacting the balance
between buyers and sellers, and therefore does not affect the stock
price even if the trade was executed at a price higher or lower than the
price currently traded on the market. A fund will try to obtain 80% of
the total planned quantity in this way. It will then go about trying to
purchase the remaining 20% slowly, carefully, quietly, in small
quantities each time, direct from stock exchange sellers. This volume-
dependent process may take from several days to several weeks.
The next stage is of great interest. The fund is already holding a
large quantity, and is now interested in signaling its interest to the
market, which causes the stock price to rise. The fund starts buying in
the market, creating volume and price highs which arouse interest and
draw the stock price to greater highs. The price trends up even more
strongly, and additional buyers, noticing the resonance, join the
trading. This in turn thrusts the price to even higher highs. Since a
large portion of liquidity is already held by the fund, the path has been
paved for the stock to climb virtually without resistance.
Does this sound a bit fishy to you? Who said the stock exchange is
the epitome of fairness?
How to Interpret Large Volume at the Daily High

When a stock breaks to a high on the daily chart, we can often see at
the high an extreme volume increase, known as climactic volume. It
usually takes some time until the public is convinced there is a real
story behind the breakout, and begins to buy. The reason for the
climactic volume is public enthusiasm. When, usually with some
delay, the public is finally persuaded and buys en masse, the “big
money players” move in: these are institutional sellers taking
advantage of the highs and large volumes in order to be rid of large
“blocks” of stock while the uptrend is at its highest. We call this
phenomenon “selling into the power.” Sellers cause resistance to
continued highs, creating the climactic volume. Large supply invites
short sellers, and price correction begins to appear. The last group of
sellers, the public, is the biggest loser. They feel pressured, sell, the
stock drops to near support level where it is again accumulated
cheaply by the institutional traders, and begins to reach highs again
with large volumes.

SMART The public does not buy a stock as it starts

to rise. The public always buys with a delay,
MONEY after the stock has “proved itself” as strong.

How to Interpret Climactic Volume at the Intraday

High

Climactic volume at the high is usually a warning signal for an

anticipated correction.

Intraday Climactic Volume Correction, BBT

 On this sample day above, BBT is hitting highs at the trading
session’s opening, approaches the high and adjacent to the high,
volume grows noticeably [1]. As we learned, volume that grows during
the uptrend is a positive sign. This is usually true, but not for a sharp
jump in volume, as in the example above. This is an irregular volume.
Veteran buyers are taking advantage of the high to realize profits and
to sell into the power, while less-experienced buyers are chasing the
stock, continuing to buy close to the high. Now, many new buyers
enter the market, and at this point, before even earning a cent, they
are highly sensitive to any small change in the stock’s price. Just one
tiny correction of only a few cents will be enough to pressure them
and cause the stock to return down with a sharp plummet. This
process is similar to the first failed Caterpillar breakout we analyzed
earlier.

Moving Averages
As we learned, stocks do not rise in a straight line, but in zigzags. This
is the nature of the trend. Part of the natural process of reaching highs
involves pullbacks. A stock in an uptrend and correcting is still a stock
following its trend, and this is how we should view it.
Of course, not every low will be accepted with forgiveness, which
means we need an assistive tool for defining the trend. Moving
averages (MA) are tools that assist in Screen Configurationtrend
and warning of possible reversals. Their role is to flatten the zigzag
and make it easier to read the trend. Unlike other indicators that will
be described further on, the information provided by the MA is
unequivocal and makes reaching conclusions easy.
The MA is computed according to the averages of closing prices
for a defined period, and appears on the line chart as a continuous
line. By way of reminder, the “closing price” is the price at which the
last trade was made for the period being examined. For example, this
could be the closing price for the trading day if the timeframe is in
days, or the price of the last trade if the timeframe is five-minute
candles.
The average is called moving because the average of closing prices
is computed for each time within the period being checked. An
example is a moving average known as a “10 period MA” on the daily
chart. The average of closing prices for the past ten days is computed.
In this way, the average “moves” each day according to the closing
price of the day being added on to the previous nine days. The closing
price is the basis for calculating the MA, since the closing price is the
most important data.

Sample Calculation
Exercise: Calculate the 10 period moving average (10MA) at the
end of the 10th day for a stock that rose from $10 to $20 with a spread
of $1 per day over 10 consecutive days.
Answer: Let’s add up the closing prices of the past ten days:
11 + 12 + 13 + 14 + 15 + 16 + 17 + 18 + 19 + 20 = 155
The average for 10 days is 155/10 = 15.5
In other words, the MA at the end of the tenth day is 15.5, and is
written as follows:
10MA=15.5

If we also knew the trading data for a few days prior to this group of
ten, we would be able to calculate the MA for the 9th day, the 8th day,
and so on, connect all these results using a continuous line, and arrive
at the MA for 10 periods.

Example of Moving Average (MA) for FFIV

 I have added to the FFIV daily chart the moving averages line for
ten periods (10MA). On July 27, 2010, the trading day closed at $86 [1],
and for that day, the 10MA was $80 [2]. If we add the closing price for
July 27 [1] to the closing prices of the preceding nine days and average
them, we arrive at $80.
Traders tend to use two of a variety of moving averages: the Simple
Moving Average (SMA) and the Exponential Moving Average
(EMA). No need to panic! Understanding both, and the differences
between them, is not overly difficult.

SMART For intraday trading in ve-minute candles,

use a moving average of eight or ten
MONEY periods. For swing trading (one-day
candles), use 20, 50 and 200 periods.

The Achilles heel of moving averages is that the data is historical,

i.e., it relates to information from the past and is therefore known as a
trend-following indicator, or “lagging” indicator. The more we
distance over the axis of time, the data used to calculate the average at
the start of the period becomes much less relevant to the present. For
this reason, instead of being assisted by a simple moving average
giving equal weight to each timeframe, many traders use the
exponential moving average, which gives greater weight to the
timeframe closest to the present. In other words, closing prices of the
more recent timeframes are considered more meaningful than those
of the more distant timeframes. There is some logic to this approach,
of course, but we need to keep in mind that the essential use of the
MA is to act as an indicator alone. Interestingly, traders using the
regular MA will reach the same conclusions as those using the EMA.
It’s more a matter of habit, preference, and experience than anything
else, so just go ahead and use whichever MA appeals to you most. New
traders will generally prefer the EMA, but even then they tend to use
the SMA when relating to 200 timeframes. Why? That’s the norm, so
that’s what you should follow too.

“Fast” and “Slow” Averages

A long-range moving average, such as 200MA, is less sensitive to

recent closing price differences, since the weight of each timeframe is
relatively small, and therefore changes will be “slower.” A short-range
moving average, such as 20MA, shows higher sensitivity to recent
closing prices, so changes will be “faster.” As we will see, integrating
the slow and fast MA can be a good indicator of trend direction.
Within the trading session and using five-minute candles, we
would prefer to use the 8MA or the 10MA. For longer-term trade, such
as when reviewing the chart for the purpose of entering a swing of
several days, we would use the 20MA, the 50MA and the 200MA.
Later, we will practice their correct application.

How to Apply the MA

As noted, the MA assists us in defining the trend. Identifying the

trend and its reversals can be done in two ways: examining the link
between MA and the Japanese candle chart, and examining the links
between the MAs. In addition to trend analysis, the MA also serves to
define the entry and exit points, as we will learn later.
When analyzing the meaning of MAs for a stock that is trending
up, remember that the explanation in reverse is valid for a down
trending stock.
• Rule 1: A stock’s ride above the MA indicates a continuing trend. A
drop beneath the MA signals the trend’s end.

Daily Chart Trend Development for Akamai, AKAM

In March, Akamai leaves a long period of moving sideways and

begins to rise [1]. Notice how the stock “rides” the 20MA. In some
cases, you can see the stock drop beneath the 20MA line, but these are
all intraday lows which began and ended in the same trading day. The
first suspicion of a trend change occurs towards the high when it
breaks the 20MA, but finds support in the 50MA. Eventually it breaks
down [2] and abandons the uptrend.

What You Should be Anticipating

First and foremost, you should expect an up trending stock to ride the
20MA exactly as Akamai does over several months, starting at [1] and
up until the breakdown of the moving average. Riding above the 20MA
is considered a classic uptrend.
The 20MA line is therefore the line of support. When I look for an
entry point on a stock trending up, I need to find it as the stock is
close to the 20MA. This assumes that a strong stock will separate from
the 20-period line of support but will return back to support as it
continues to trend up. When the stock drops clearly below the 20MA
line, we expect it to be supported by the 50MA line, but this is also the
stage where we begin suspecting a reversal may be occurring. Breaking
down under the 50-period line almost always means a trend reversal.
Additional support should come from the 200MA line.
For upward trending stocks, when the chart crosses below the
20MA line, it means the uptrend could be about to reverse. Similarly,
for stocks trending down, when the chart crosses above the 20MA
line, it means the downtrend is about to reverse.
A formal reversal can be defined when both the slow and the fast-
moving average lines converge: for example, in the chart of Akamai,
we see where the 50-period and 20-period lines converge at [2]. The
significance of the reversal is that in the short range of 20 periods, the
stock has dropped, while at the longer range of 50 periods, the stock is
still holding the uptrend. Some traders wait for this convergence point
to sell, but in my opinion that is already too late. Checking the Akamai
chart, we see clearly that the decision to exit could be made long
before then.
Moving averages that parallel each other and are known as
“railway tracks” indicate a long, continuous trend. Distancing of MA
lines from each other indicates a strengthening trend, while closeness
indicates a weakening trend. At [1] we see the start of distancing
(divergence), and near [2] we see signs of closeness which ends with
convergence of the lines.

SMART Divergent “railway tracks” indicate a

strengthening trend. Tracks that begin to
MONEY converge indicate the potential danger of
trend reversal.

Why Calculate a 20-Period Line?

There are two reasons. First, it has become the normal conduct for the
market. Second, it is a self-fulfilling prophesy. Many traders assume
there will be support at the 20MA and therefore buy stocks supported
by this line, which is considered the technical support point.

What’s Up? What’s Down?

In a stock trending up, you will want to see the stock riding above the
20 period line, which is above the 50 period line, which should be
above the 200 period line. This is the classic definition of an uptrend.
Can the 200MA line be above both the 20MA and 50MA lines? Of
course it can. Imagine that the stock has trended up for 50 consecutive
days, meaning that both the 20MA and 50MA lines are beneath the
stock price. However, checking 51 or more days previously reveals that
the stock crashed from an extreme high, and therefore the 200MA line
would be higher than the 20MA and 50MA lines.
When to Buy?
Once you’ve identified a stock trending up and you wish to join its
continuing trend, you need to buy when the price is reversing, as we
learned in the previous chapter. The entry (buy) point needs to be on,
or fractionally above, the 20MA line, but not too far distant from that
line.

When to Sell?
You sell when the stock’s closing price for two consecutive days is
lower than the 20MA line.

When to Buy or Sell within the Trading (Intraday) Session?

The same rules apply for intraday trade, except that the period you
follow is ten periods of five-minute candles, although some traders
prefer only eight periods. In actuality you will discover, as we will later
learn, that your intraday buy or sell decision will not be based only on
the behavior of the MA, but will also integrate other factors.

The Unique Signi cance of the 200MA

The 200MA is known as either a strong area of support or of

resistance, depending on the direction from which the stock price
approaches it. When a stock is down trending, it will find very strong
support along the 200MA line. By contrast, in instances when the
200MA line is above the stock price, the stock will find difficulty in
crossing it on its trend upwards. Even traders who prefer using the
exponential moving average (EMA) will almost always use the simple
moving average (SMA) when relating to a period of 200 timeframes.

Remember that you, too, should follow the behavior of the majority
of traders. If you choose to work with an MA that is different than
what the majority of traders use, you won’t receive the support of that
majority.

Example of 200MA Resistance for TEVA Pharmaceuticals, TEVA

TEVA maintains a clear downtrend right beneath the 20MA line.

The 50MA line is properly positioned above the 20MA line, and finally,
the 200MA finds itself between them. At [1], TEVA tries to reverse
trend, crosses the 20MA line, crosses the 50MA line, and then rams its
head against the 200MA ceiling. The 200MA line’s resistance is an
amazing phenomenon that recurs several times. What does it mean
for you?
Let’s say you wish to buy TEVA because you believe it will move
higher. Don’t buy it when it is just below the 200MA line, since the
stock shows difficulty in crossing that barrier. If you bought the stock
much lower than the 200MA, it would be wise to realize some of the
profit as it approaches that line.
While we are already paying close attention to TEVA’s current
status, we should also notice the beautiful consolidation at [2]. The
stock is “picking up steam” and is about to move sharply in one of two
directions, up or down. Both of them are suitable for trading and it is
likely that both would make good trades. I followed the stock with the
intention of trading if and when it decided to leave that short range
area.

In the end, I couldn’t resist. Here is the outcome, just weeks after I
wrote the paragraphs above: a jump of 9% within several days.
Sometimes it seems that this game is just too easy…

Oscillators
The oscillator is a technical tool that assists in identifying
overbought and oversold statuses, and signals that the current trend
is reaching its end before the change shows on the chart. In other
words, the oscillator is a kind of indicator which helps identify when
“stupid money” is entering the market, contrasted with “smart
money” leaving the market; and vice versa.
When overlaid on a chart, oscillators are very useful for identifying
the extreme points and overbought and oversold prices of stocks.
Sometimes, though, oscillators can be too effective and cause
unnecessary and even mistaken trade activity. This is why an initial
signal for entry is insufficient, and it is best to wait for the second,
confirming signal. When the oscillator does not move in the same
direction as the trend, it is alluding to an approaching trend reversal.
 Unlike trend-following technical tools, oscillators are very effective
when the stock is moving sideways. As the field of technical analysis
develops, there are increasing numbers of oscillators. In general,
because I am a total fan of “understanding the stock” and because I
don’t like a lot of “noise” on the chart during the trading session other
than volume, I tend not to use oscillators. At the outset of my trading
experience, I was far from understanding the stock and needed
oscillators just as you will during your initial stages. Hopefully, over
time, you will no longer need them either. Some years down the line,
when you’re completely free of dependence on oscillators, you will be
able to operate faster and more effectively.
Despite the above, however, when it comes to screening stocks,
there is no substitute for oscillators. Identifying candidates for trade at
the end of the trading session, before the new session opens, or during
the trading day all require using oscillators to help you prepare a
filtered, useful list of choice stocks.
Now is the time for an important cautionary note: sometimes new
traders attempt to use multiple oscillators simultaneously, magnifying
the “noise” as they work: usually, the result can be summed up as “not
seeing the forest for the trees.”

The Relative Strength Index – RSI

The Relative Strength Index is an oscillator that measures the force

of any stock’s acceleration, rather than comparing two or more stocks,
as “relative” may possibly appear to indicate. It does this by checking
the average of changes occurring in closing prices over a specific
timeframe. The indicator was developed during the 1970s by Welles
Wilder, and is meant to assist in identifying the overbought and
oversold points.
Any oscillator you display on your charts will need to be defined to
retroactively check a predetermined period. The normally accepted
timeframe for the RSI is fourteen days for swing traders. Some traders
define it for shorter terms of nine days, and others for even longer
periods such as twenty-five days.
• The shorter the predetermined period, the more sensitive, or fast,
the oscillator is, and the greater the possibility of multiple false
signals.
• The longer the predetermined period, the less sensitive, or slow, the
oscillator becomes, but then there is a higher possibility that you
will get the buy and sell signals after the move has begun.

Sample of RSI Oscillator Feed in My Screening Software

In my trading platform (COLMEX Pro), as with other similar

programs, I need to click the chart to choose the type of oscillator I
want to add to the chart. As you can see, I have added a total of five
features: price in Japanese candles, the three moving averages
discussed earlier (20, 50, 200), and the RSI for a 14-day period.
Double-clicking any oscillator opens a window where I can change
that oscillator’s parameters: for example, its timeframe and color on
the chart. It’s that simple.

• The RSI oscillator operates on a 0-100 scale.

• Once it goes higher than 70, we need to suspect a possible
overbought status, i.e., a signal that the stock is about to drop.
• Once it drops under 30, this could be indicating oversold status, i.e.,
a signal that the stock is about to reverse to highs.
• In addition to signaling the optimal buy and sell area, the oscillator
also indicates lines of support and lines of resistance even before
 they are clearly seen on the chart.

Example: Finding an Extreme Point on Net Ease Daily Chart,

NTES

I have added the RSI calibrated to fourteen periods to this NTES

daily candle chart for six months. Figures on the right of the chart are
the indicator reading and not the stock price. I also added the
horizontal lines which are the two RSI lines of extremes at 30 and 70.
As seen in the chart, you can find three points where the indicator is
warning of transition, above or below the extremes. At [1], the
indicator fractionally crosses over 70, i.e., it is indicating a top, and it
is right. At [2], the indicator drops beneath 30, warning of an expected
bottom, and it is right again. At [3], it is again hinting at expected
drops.
Is this the time to short? I can promise you I have no intention of
shorting a stock that is trending up, so why use the oscillator? We use
it as an advanced warning system. If you are currently holding a stock,
you should be concerned, but you do not necessarily need to sell
unless other indicators, such as trend, volume, reversal configurations,
and more, are supporting that decision. In short, the RSI is only an
assistive tool. And, it is only one of many.

The MACD Index

MACD stands for Moving Average Convergence-Divergence. Analysts
dub it the “Mac-Dee.” It serves as both an indicator and oscillator. The
MACD is displayed on the stock chart as two lines moving adjacent to
each other and signaling buys and sells at the points where they cross
over each other.
You don’t necessarily need to read what follows, but if you really
want to get tangled in a technical explanation, clench your teeth and
read the rest of this paragraph. The MACD is comprised of two lines.
The first is derived by deducting the exponential moving average for 12
days (12EMA) from the exponential moving average for 26 days
(26EMA). Alongside this line is the second, which is the exponential
moving average for 9 days (9EMA). When this second line crosses the
first, by moving either up or down, the relevant buy or sell signals are
produced. Remember that we discussed the moving averages that
cross each other and indicate trend reversal? The MACD is a slightly
smarter use of these moving averages.

Examining the MACD on the Same NTES Chart

The result is interesting, without a doubt, especially if we compare

the MACD buy and sell instructions each time the 26-12 EMA cuts
across the 9EMA with the buy and sell readings for the RSI. Food for
thought: will integrating both these indicators improve the outcome?

Fibonacci Sequence
The Italian mathematician Leonardo Fibonacci (1170 – 1250) wished to
find a mathematical depiction for the way rabbits reproduce. From his
experiments, he created a mathematical sequence bearing his name.
The sequence is as follows: 1, 2, 3, 5, 8, 13, 21, 34 and so on. The
sequence is based on several interesting rules: from the third number
on, each new number is the sum of the two previous numbers; from
the fifth number on, the ratio of any number to the preceding number
is approximately 1.618, and for any number and the number following
it, the ratio is 0.618.
So what is fascinating about 1.618? It is known as the “golden ratio,”
and amazingly, it can be found in multiple areas of our lives, from
natural phenomena to artistic works, and all the way to the behavior
of stock prices.

SMART Does Fibonacci really impact your stocks? In

my opinion, this is no more than a self-
MONEY ful lling prophecy, but since it is so, I have
no choice but to give the indicator its
rightful place.

Followers of the “golden ratio” theory will claim that the ratio is
highly common in art and architecture. In actuality, it is a little
difficult to prove or refute this claim, chiefly because of the difficulty
in measuring it. Among buildings claimed to have been structured
according to the golden ratio are the ancient pyramids of Giza, the
Athenian Parthenon, and even the Dome of the Rock in Jerusalem.
Since the pervading opinion for many years now is that the golden
ratio is the most proportionate and hence attractive balance perceived
by humanity, architects and artists have adopted it in their works of
art and structures. It is known that Leonardo da Vinci applied it to
several of his most famous works, among them the facial features of
the Mona Lisa.
So just what is the connection between rabbits, culture and art, and
stock trading? The trader Ralph Elliott published a theory in 1932
known as the “Elliott Wave Principle.” I won’t describe the theory in
full detail, since I do not consider it important for short-term stock
traders, but will mention that according to this theory, the most
common ratios between the market waves are 38.2%, 50% and 61.8%,
the latter being the golden ratio. Being able to recognize this ratio
assists in estimating how the next wave will look, and determining the
appropriate entry and exit points. From that time on, the golden ratio
in short-term trading also grew in importance, as will be explained
further.

Main Application: Price Correction

The main application of the Fibonacci ratio in short-term stock
trading is to calculate price correction: for example, take a stock that
has reached its high and begins to return downward. Where will it
find support? According to the Fibonacci ratio, that should occur at
several points: when it drops 31.2% from the high, 50% from the high,
and 61.8% from the high. So if the stock rose by one dollar, it should
find significant support if and when it drops by 31 cents, 50 cents, or
62 cents from its high. The view is that buyers will wait for the
Fibonacci correction and buy based on the assumption that the
Fibonacci point is the point of support. The opposite will be true for a
stock trending down and returning upwards.
In light of the great many Fibonacci aficionados, I must admit that
very often, the ploy succeeds. But as you may have understood from
the tone of my remarks, I am not counted among this indicator’s
followers. On the other hand, we should never argue with buyers or
sellers waiting patiently for the designated support point, even if I
personally feel the method is worth little more than fortune-telling in
a coffee cup. So, I have no choice but to give Fibonacci waves their due
respect. Here are two examples:

Example of Price Correction for Bank of America, BAC

 Bank of America stock is dropping during the day’s trading from
point [1] to point [2]. The distance between the two points is 100% of
the drop. How far will the stock correct upwards? It corrects precisely
up to the Fibonacci point indicating 61.8% [3] of the low. Is this a
coincidence? No. The greater the number of people believing in the
method, the easier it will be for the prophecy to self-fulfill.

Additional Application: Setting Targets Using Fibonacci

Extensions
When a stock price breaks resistance and rises to a new high, some
traders plan the breakout target price according to the Fibonacci
principle. In such a case, the high prior to the breakout up to the line
of resistance is 100%, and the price target should the stock break out is
131.2% or 161.8%. For example, if the stock rose one dollar and stopped
at the line of resistance, the breakout target will be 31 or 62 cents. This
is called a Fibonacci extension, rather than a Fibonacci retracement.

Example of Breakout Target Calculation for Cephalon, CEPH

 Cephalon consolidates below the line of resistance in a classic cup
and handle pattern. The distance from the base up to the line of
resistance is 100%. When the stock breaks out, it reaches the precise
Fibonacci target of 161.8%. Another interesting case? Or, perhaps just a
large number of traders who believe in the method and take profits at
the commonly accepted target point. Were they actually the ones
inhibiting the stock’s progress at that level because they believed it
would be resistance?

Bollinger Bands

These were invented by John Bollinger at the start of the 1980s.

Bollinger’s concept was simple: he drew a moving average line across
the chart and sketched two bands, one above and one below it. In this
way, a kind of “tube” was formed, outlining the stock’s movement. The
premise for creating a tube around the stock’s movement is that the
stock can be expected to move in the future within the same frame in
which it moved in the past.
“Tubes” are not a new concept and certainly preceded Bollinger.
The problem with this method is its reliability: in various market
conditions, such as crises, stocks tend to be more volatile and
therefore break the boundaries of the framework more frequently.
Bollinger’s innovation was to set the bands a variable distance from
the MA. He did not set the distance on the basis of a fixed percentage,
but on a known statistical method which you might well have learned
years ago, called “standard deviation.” Standard deviation is a
calculated statistical value representing the volatility of data. Using
the standard deviation, we can measure stock volatility, and thus use
deviation to set the distance between the bands and the MA in a way
that adapts to stock volatility. The beauty of the standard deviation is
the fact that the distance between the bands expands when stock
volatility increases, and lessens when stock volatility drops. In
actuality, Bollinger created a tube that shrinks or expands according to
volatility, and thereby significantly and successfully increased the
method’s reliability. An exhausting explanation. This is likely the stage
when you wish to know its application.

If we commence with the premise that in the vast majority of cases,

a stock will move between the bands, then when the price reaches the
upper line, this means the stock is in a state of “overbought” and
therefore should return downward. By contrast, when the stock price
drops to the bottom line, it means that the stock is in a state of
“oversold,” and there is a reasonable probability that it will now
return upwards.

When you define Bollinger bands on your charts, you will need to
take into account the following data: the MA should be set to ten
periods and the SD (standard deviation) should be set at 1.5. In other
words, the Bollinger bands wrapped around the movement of the
stock you are watching will be calculated according to volatility over
the past ten trading days. The mathematical value of the SD is that
90% of the stock’s movements will be captured between the two
bands.

When I take into account in advance that the Bollinger bands

according to the parameters above will encompass 90% of the stock’s
movement, should the premise not be that a stock which has gone
beyond these boundaries would not return inside them? Can this
mathematical fact not define a trading method with more than 90%
success rate? Yes, of course it can. We will learn more about this in the
chapter on trading methods.
Bollinger Bands for Visa, V

Note how 90% of the stock’s movement is caught between the two
bands. Notice also that the distance between the bands widens as
volatility increases. In my personal opinion, Bollinger bands are the
most interesting and useful of all indicators that I display on my
intraday charts.

TRIN

As discussed in the chapter on market indices, to determine market

direction and evaluate its continued direction, we tend to rely chiefly
on the S&P 500 and are assisted also by the NASDAQ 100. These two
indices are excellent tools which allow evaluating market direction,
but they do have a disadvantage: when the market rises or falls, it is
difficult to know the force of buyers and sellers. This is because charts
show market direction but do not show an additional, important
component that influences our decisions: volume. Completing the
picture requires that we know the force of the trading volume flowing
into rising or falling prices. The TRIN, also known as the Arms Index
after its creator Richard Arms, is meant to improve this state of
uncertainty. The function of the TRIN is to measure declining trading
volume compared to rising trading volume.
The symbol for TRIN on your charts differs from one broker’s
platform to another, but will generally be $TRIN, although the dollar
sign may also be after the letters. We display the TRIN indicator in
five-minute intraday candles.
The premise behind the TRIN indicator is that we should not relate
only to market direction. For example, imagine a situation in which
the market is rising on low volume, but more and more trades are
actually being executed for dropping stocks. In other words, the rising
stocks show no buyer enthusiasm compared to stocks that are
dropping in high volumes. This state indicates there is no change of
direction at that particular moment, since the quantity of rising stocks
is still higher than the quantity of dropping stocks, but the rise in
trade volumes of dropping stocks definitely seems to indicate an
approaching pattern reversal.
The TRIN examines trade volumes of stocks on the NYSE and is an
extremely useful intraday tool for the short term. The fact that it
represents only stocks traded in the New York Stock Exchange is of no
significance, since these stocks represent the overall market. In other
words, if you are trading a stock linked to the NASDAQ, there is no
need for concern: the indicator also represents the anticipated
behavior of your stock.
Below is an explanation of the formula by which the TRIN is
calculated:

Volume of trade of falling stocks

TRIN = ---------------------------------------------------------
Volume of trade of rising stocks

Analyzing the components of this formula, we understand that:

• When the TRIN is greater than 1, it means that the trading volume
of dropping stocks is higher than the trading volume of rising
stocks. In this case, the risk of purchasing the stock is greater, and
conversely, the chances of succeeding with a short are also greater.
• When the TRIN is less than 1, it means that the trading volume of
rising stocks is higher than the trading volume of dropping stocks.
In this case, the risk in short selling is greater, and on the other
hand, the chances are better for buyers.
 In most cases, when you look at the TRIN indicator in a dropping
market, the TRIN will be above 1, and in extreme cases, around 3 or 4.
When the market rises, the TRIN will be less than 1 and in extreme
cases, around 0.3. Mathematically, the outcome of the formula can
never be less than zero.

SMART In a normal market, the TRIN will show a

scale between 0.7 and 1.3. In extreme
MONEY situations, the indicator may move from 0.3
on days of sharp highs to 4 on days of sharp
lows.

Why do we need the TRIN indicator if we can see market patterns

and guess fairly clearly where the TRIN is? Very simple: Because the
TRIN allows examining two main variables:

1. Points of extremity. The points of extremity for the TRIN are

higher than 1.4 for a falling market, and lower than 0.6 in a rising
market. The meaning of the TRIN reaching these extremes usually
shows an extreme market. Let’s say that the market is rising quickly
and the TRIN shows a reading of less than 0.6. This indicates that
the market is about to reverse and return downward. By contrast,
when the TRIN shows a reading above 1.4, it means that the market
is exhausted on the downside and is about to reverse upward.
2. The TRIN trend. When the TRIN shows a reading of 0.7 (a rising
market), and continues to rise continuously for approximately 30
minutes toward a reading of 1, there is a reasonable chance that it
will continue the trend (as you remember, we learned that the trend
is our best friend) and cross a reading of 1 into territory that
represents a downtrend. This means that the number of buyers is
lessening and the number of sellers growing. In other words, the
market may reverse its uptrend and switch to trending down.

TRIN Behavior in Five-Minute Candles

 Let us analyze the TRIN without looking at the market chart:
At the start of trading, the TRIN rises and we understand that the
market is trending down. About half an hour later, we find a jump to
2.2 [1]. This means it is reasonable to presume that a sharp low has
occurred, with high volumes of trade. A 2.2 reading is very extreme,
and indicates that the market is in a state of downward tension (a
state of oversold) and we can expect a correction. The TRIN drops to
below 1, indicating that the market is moving back into highs. At [2]
we see the trend of highs stop, and the market begins moving
sideways. At [3] the TRIN drops slowly, indicating a further try for
highs, but its slow movement indicates that the market is rising in
small volumes which are not creating enthusiasm.

Now we will examine the SPY at those same points:

Examine the TRIN and the market chart and try to “understand”
the relationship between these two indices. I do not expect you to
reach conclusions at this stage, but I do expect that when you start
trading, you will carefully observe both and try to understand the
balance and influence on anticipated trade patterns, especially at the
points of extremities.
 Reservation: the TRIN is not a reliable stand-alone indicator. It is
only one of several indicators which together provide insight for a
trader. The TRIN must be integrated with additional indicators, and
all the information weighed to create a more informed comprehension
of anticipated market patterns.
Further note: The TRIN operates well on normal days. On days
when Wall Street is really riled up, many indicators, including the
TRIN, may show extreme outputs such as a 3 reading. The trader
needs plenty of experience to know just when to use the indicators for
a market that is beyond normal activity and operating chiefly on the
emotions of fear or greed. Such days can indeed be highly successful
for your trading account, as they are days on which it is relatively easy
to guess market patterns without the use of indicators.

TICK

A tick on a stock is a change of one cent. The TICK is a simple but

important indicator that examines the “ticks” at any given moment for
rising stocks, minus the “ticks” for dropping stocks on the NYSE, and
displays the outcome, i.e., the difference between the quantities of
rising and dropping stocks.
Let’s say, for example, that at a given moment, 2500 of the
approximately 4000 companies trading on the NYSE are rising, and at
exactly the same moment, 1500 companies are falling. The indicator’s
result will be 1000, according to the following calculation: 2500 minus
1500 = 1000. In other words, at that particular moment, more
companies’ stocks are rising than there are stocks falling. The
indicator can show an up outcome like that of the example above, or a
down outcome, where the quantity of companies with falling prices is
greater than those with rising prices. Ticks can move very speedily
between up and down readings even when the market is rising or
dropping, since they represent momentary outcomes. During an
upward pattern reversal, the number of stocks rising will be higher for
that moment than those falling: the tick will show a positive number
even if the market overall is trending down. When the tick is negative,
the quantity of falling stocks is greater than that of rising ones. When
the market is moving sideways, the tick data is around the zero mark.

SMART During an uptrend, the tick’s highest highs

will be higher in absolute value than the
MONEY tick’s lowest low when the market returns
downwards.

The symbol on your charts will be $TICK, although the dollar sign
might be on either side of the word. Displaying the indicator can be a
problem. Few platforms know how to display it properly, since the
regular chart usually is unable to display a negative outcome. For this
reason you may need to make do with only the positive TICK results.
We display the TICK in five-minute intraday candles.
Even though the TICK indicator shows NYSE data and not
NASDAQ data, you should relate to it as though it represents data for
the entire market.

Exercise
The market is rising, the trend is up, and the TICK shows a strong
up reading of 1000. The stock you want to buy has just reached the
trigger point. Should you buy, or not?

We can utilize the TICK in two ways:

1. Point of extremity.
A reading of minus 1000 is an extreme reading. This is an extreme
negative status in which the quantity of stocks falling is greater by
1000 than the stocks rising. Conclusion: the market is showing an
exhaustion low and should therefore be reversing upwards.
A positive reading of 1000 also represents an extreme status in
which the quantity of rising stocks is 1000 more than those falling.
Conclusion: the market is showing strong upward exhaustion and may
therefore be returning downward shortly. In rare instances, the
reading may reach a positive or negative 1300. Generally around the
800 to 1000 mark, it will turn around as the market pattern reverses.
Did you understand the answer to the exercise?
An extreme high or low point can occur several times a day and
generally correct within several minutes. Following the pattern
reversal, the TICK returns to the sideways area of between -500 to
+500, an area in which the indicator is basically telling us nothing.

SMART An extreme reading will not stop us from

entering the market for a long-term swing
MONEY of several days, where brief intraday
uctuations have no effect.

Answer to the Exercise:

How does an extreme reading affect our decisions as traders? Very
simply. If you plan on buying a stock trending up, believing that it will
continue to trend up, you need to buy it at the optimal time and not at
the point of extremity which holds a greater feasibility of it dropping.
Therefore, before buying, it is worth checking the TICK indicator.
Let’s say you saw the indicator display a positive reading of 1000. As
we learned, this is an extreme reading meaning that the market
anticipates an impending reversal. It is very reasonable to presume
that the stock you are about to buy will also correct with the market
trend. The market cannot withstand a positive reading of 1000, so it is
worth your waiting until the stock reverses, together with the market,
and perhaps buying it at a lower price as it reverses. The same is true
for the opposite direction: an extreme negative reading usually
indicates a reversal, and this correction will cause the stock you are
about to sell short to rise.
I frequently present this same exercise to my students, and almost
all of them miss the correct answer. They interpret the positive 1000
TICK reading as indicating a strong market, and are interested in
buying. Big mistake! Now you can see how, while it is indeed a very
strong reading, it indicates that the market is nearing exhaustion and
a correction can be anticipated. Market support is important for your
stock’s breakout, and therefore while it is reversing, the chances of
failure are even higher than usual. Wait patiently for the reversal and
buy cheaply. A stock price may not always drop, but it is better to
lessen the risks and increase the percentages of success.

2. TICK trend

TICK in Five-Minute Candles

• When the market is showing an intraday downtrend, the TICK will

often move between negative readings of minus 1200 (enthusiasm
over lows) and positive readings of plus 800 (non-enthusiasm over
reversals).
• When the intraday trend is up, the TICK will move between minus
800 to plus 1200.
Every so often during the day, you need to examine the TICK trend.
For example: while the market is trending up, is the TICK showing
readings of more than 800 with increasing speed? In other words, is
there increasing enthusiasm?
I am aware that the chart above looks like a complete mess, but if
you try to decode it according to the TICK trend, you will find that the
market rose at the start of the trading session, moved sideways, and
then dropped towards the end of the day. In actuality, when you
observe the TICK in real time, you will understand it much better than
the chart above. I do not expect you to comprehend the chart at this
stage, but definitely do expect that when you observe the TICK and
the market direction in real time, you will try to understand the
relationships and influences of the TICK on anticipated trade,
especially at the points of extremities.

Summary
The TICK primarily warns of points of exhaustion where the market is
about to undergo a short-term reversal lasting some minutes. Since
the market direction influences 60% of the movement of stocks you
are trading, you need to know if the stock you are buying is at the
point of extremity and about to return.
In special cases, despite the explanation above, we may buy a stock
for intraday trade even though a TICK reading hints at an anticipated
reversal. In such a case you need to relate to the action as a scalp,
which is buying and selling for a brief period of seconds to minutes. In
other words, you must be aware of the fact that the stock may
suddenly return and you must be more attentive and take some profit
at the first moment of weakness, when the stock appears about to
reverse. With a little luck, it won’t return.

The VWAP Indicator

The Volume Weighted Average Price, or VWAP, is one of the most

important tools available to the intraday trader, since it very reliably
represents the moves of many institutional traders. As we have
learned, institutional traders are responsible for 80% of the volume of
stocks in which we trade. If for a moment we disregard the public,
which constitutes just 20% of stock volume, we see that at any point in
time, institutional buyers and sellers are not acting for the purpose of
short-term trade profits, but are operating on clear instructions: “buy
cheaply” and “sell at high prices.” This is where an essential problem
surfaces: it would be easy to check traders’ successes if they sold the
stock on the same day they bought it. However, when institutional
traders buy stocks in order to hold them over the long term, how can
we know if these traders bought at high or low prices? How are
“expensive” and “cheap” defined over a day of trading? This is the
function covered by the VWAP. It allows defining expensive and cheap
relative to a stock at any point.
The first platform to present the VWAP indicator was from a
company called Instinet, which included the new tool on the trade
screens of many institutional traders.

The VWAP calculation. Take a deep breath, and then read this
twice: the VWAP is the average intraday price of a stock as a function
of volume at all levels of price. To calculate the VWAP at any given
moment, a sampling of the price of every transaction made up to the
calculation point is taken, the price is multiplied by the volume of
each transaction, all values are added up to the sampling point, and
the result is divided by the accrued number of shares traded up to that
same point (volume). If this explanation is too complex, don’t try too
hard to understand: skip it and just make do with the example below.

Example: Let us say that when the trading session opens, the first
trade in the stock of ABC is made at $30, for a quantity of 100 shares.
Multiplying those two figures produces 3,000, therefore the VWAP
(dividing the outcome by volume) is $30. Let’s say that the second
trade in ABC is at $30.10 for 1000 shares. The result of multiplying
those two figures is 30,100. Now the sum of those two first trades is
[3,000 + 30,100 =33,100] and the total trade volume is [100 stocks +
1000 = 1,100]. Dividing the accrued result of 33,100 by the trade volume
of 1,100 produces a quotient of $30.09.
Had we calculated a regular average of two trades without
encompassing the different volumes of trade for each transaction, the
result would have been $30.05. Does this figure reliably reflect the
stock price? Of course not. It is clear that a transaction of 1000 shares
carried far greater weight than a trade of 100 shares. The VWAP
produces a higher average as a function of including the volume in
each trade. It produces what is known as “the fair price” for ABC.
Now let us return to the institutional traders: when they receive an
instruction to buy 100,000 shares “on the cheap,” their clients and
managers are hoping that they will be able to make most of the
purchases at the lowest possible price below the intraday “fair price.” If
we draw the VWAP line across the stock chart, it will show us the
price above and below which 50% of the stock’s volume occurred. In
other words, if institutional traders succeeded in purchasing the stock
at lower than the VWAP line, they will enjoy a bonus, and if they
bought it at above that line… perhaps they need to find a different job.

SMART When a stock trades for a long time around

the same price, we call this “dynamic fair
MONEY value” or “balance of power.”

Over time, the VWAP became a favorite among institutional

traders, especially when large hedge fund buyers began using it to
review the intraday successes of the traders they employed. Currently,
an institutional trader’s worth is measured by his or her ability to
“beat the VWAP.” Every transaction the traders make is compared in
real time to the VWAP indicator. Traders are considered successful if
they beat the VWAP, i.e., if the trade’s average buy price was lower
than the VWAP at that moment. The more a trader beats the
indicator, the greater that trader’s worth. From here to calculating
trader remunerations was a very short path. Interest peaked in the
VWAP when it eventually became the tool by which bonuses were
calculated for traders.

SMART Do you understand the amazing

signi cance of this indicator? Knowing
MONEY what institutional traders are about to do
at any given moment is vital and highly
useful information!

The VWAP was first recognized as important, and adopted broadly

by traders, at the start of 2003. Originally, it came about as a need by
groups with big money and by funds. The latter were assisted by
institutional traders when buying and selling very large quantities of
stocks. The only way they could supervise the effectiveness of
transactions was to instruct traders to beat the VWAP. Funds generally
remunerated institutional traders on the basis of a 2.5 to 3.5 cent
commission per stock. However, a trader beating the VWAP could
receive a bonus of 10 to 12 cents per share instead.
Most of the activities of institutional traders occur during the first
90 minutes of trading and the last hour of trading. Traders currently
operate multiple algorithmic platforms geared to promoting activities
connected with the VWAP price, such as the program that buys stocks
when they suddenly drop lower than the VWAP and sells them when
they move above the VWAP price.
Now that we know how the institutional traders operate, let us
review several practical ways for utilizing the VWAP in intraday trade.

Practical Applications
From our viewpoint, the VWAP indicator begins to get interesting
only after the first half hour of trading, once significant volume has
already been traded. Our starting point is that a stock being traded
above the VWAP can be expected to “return” to the VWAP. This is
because institutional traders instructed to buy the stock will not buy
when its price is above that level, and institutional traders instructed
to sell receive incentives for selling above the “fair price,” i.e., above the
indicator level. The opposite will occur when the stock is beneath the
VWAP: it will receive support by institutional traders buying “cheaply,”
while on the other hand sellers will wait for it to go over the VWAP.
For us, the meaning is clear and simple: a stock above the VWAP can
be expected to drop, and a stock below it can be expected to rise. The
VWAP therefore serves as a magnetic point over the course of the day.

Reviewing the Intraday Chart Showing VWAP for Apple, AAPL

 Notice the VWAP line. Why does Apple constantly return to it?
Simple: when the stock is above the line, which makes it considered
“expensive,” institutional traders instructed to sell do so; and when it
is below the line, therefore considered “cheap,” institutional traders
instructed to buy do so.

Additional Practical Uses

When a stock showing an uptrend pulls back, i.e. returns down,
how far will it go? You have probably answered correctly: to the VWAP.
At this point, institutional traders will start buying again, and it is
highly probable that this is also when the price will begin rising again.
What happens if the price is not supported but continues trending
down? If the downtrend leads below the VWAP level, it is reasonable
to assume that the stock has reversed its pattern. Buyers who had
been the victors are now defeated. In the balance of power, buyers and
sellers have changed places. The clearest support for that assumption
is that even the institutional traders are not buying.

PIVOT POINTS

Pivot points are actually intraday lines of support and resistance.

We can display them on the stock or index chart we are following.
When the price drops down to the pivot line or rises up to it, the line
serves as support or resistance.
Pivot points are based on a calculation that averages the highest
price, the lowest price and the previous day’s closing price. Later we
will learn how the calculation is made.
• Pivot points are represented on the intraday chart by five lines: S1,
S2, PP, R1, R2.
• S = support, R = resistance

Pivot points have two functions:

1. They allow us to determine market trend. A breakout of the first
resistance line, R1, indicates a good chance of a continued uptrend;
vice versa, a breakdown through the support line, S1, indicates a
downtrend.
2. They determine entry and exit points. For example:
o When the pivot line is broken, the next anticipated resistance line
is at R1. Therefore, at this level, it is worth taking some profits or
buying above it.
o If this first line of resistance, R1 is also broken out, the next goal is
R2, and there, too, it is worth taking profit or buying above it.
o The same follows for the opposite situation, trending down: the
lines of support at S1 and S2 may delay a drop in price, therefore
profits should be realized at the S1 or S2 support lines, or shorts
should be entered beneath those two lines when they are broken.

Impact of the Pivot Points on Shares of the Steel Trading

Company, X

X is trending up strongly when trading opens, and stops very close

to the pivot point (PP) line. As you will understand from the
calculation below, the pivot point line is considered the intraday axis
of movement of the previous day’s trading, which in that respect
makes it also considered a “fair price,” like the VWAP.
This means that when the stock opens below the pivot point,
buyers will be found who are ready to buy the stock. Of course, they
will buy only up to the stage when the price reaches the pivot point,
which currently serves as resistance.
The price then drops and is supported at S1 [1]. Buyers return to the
scene, and the price trends up but encounters resistance at the pivot
[2]. It succeeds in breaking through the pivot and returns down,
supported by the pivot which now serves as support [3]. The price
continues up to the next line of resistance at R1, stays there a while as
expected [4], and then continues trending up to the next resistance
point R2 [5].
How to Calculate the Pivot Point
No need for panic: even though the calculations appear complex,
finding the pivot point is simple, even very simple, and in truth, fairly
unimportant. In short, skip the following explanation if such things
bore you!
• Pivot Point (PP) is the average of the highest price, the lowest price
and the closing price of the previous day’s trading:
Pivot Point = (High + Low + Close) / 3
Once the pivot point is calculated, we use this to calculate the support
and resistance points. Note that there is importance to the order of
the results:
• S1 is the first (1) level of support (S) and is the pivot doubled, minus
the high of the previous day:
S1 = (PP x2) – High
• R1 is the first level of resistance, and is the pivot doubled, minus the
low of the previous day:
R1 = (PP x2) – Low
• S2 and R2. Once the first levels of support and resistance are
calculated, we can calculate the second levels of support and
resistance:
S2 = Pivot – S1 – R1
R2 = Pivot – S1 +R1
Summary
What is the true meaning of the support and resistance lines
calculated relative to the previous day of trading? As with Fibonacci,
the pivot lines would be meaningless if the institutional traders and
market makers would not have made increasing use of these methods.
They are again a kind of self-fulfilling prophecy. The original use of
pivot points began when floor traders would receive lists of pivot
points on paper charts at the trading session’s opening. The nature of
their work required constant movement, shoving each other out of the
way with their elbows and shouting over each other’s heads.They
simply could not move around with intraday charts, so were forced to
glance at a ticker of numbers running across the screens covering the
trade hall walls. When the stock they owned moved up and reached
one of the pivot points, what did the traders do next? They sold. That’s
all there was to it. Most of the trading halls have closed, and traders
still physically inside them are apparently using iPads now, but pivot
points have stayed with us. Since institutional traders buy and sell
according to pivot points, it leaves you little choice but to follow their
lead, and give pivot points their due.

Which Indicators Should You Use?

Too many cooks spoil the broth, says the proverb. Too many indicators
are not helpful, but harmful! If you try to reach decisions using a
number of indicators, it is probable that I would buy and sell a stock
before you’ve even managed to say “Fibonacci.” While still novices at
trading, I suggest you use the following indicators:
• On the intraday chart in five-minute candles:
1. Volume
2. Moving Averages for 8 or 10 periods
3. VWAP on one chart and Pivot Points on a second chart

• On the daily chart with one-day candles

1. Volume
2. Moving Averages for 20, 50, 200 periods
• On a second daily chart for analyzing stocks:
1. Volume
2. MA of 20, 50, 200 periods
3. MACD or Bollinger or RSI depending on the type of analysis
Chapter 8 - Shorts: Pro t from
Price Drops
Crises always provided the best
opportunities.
The History of Shorts
The first known incident of shorting is attributed to a Dutch trader
named Isaac Le Maire, who in 1609 sold “more shares than he owned”
in VOC, a Dutch company. By this act, he did something unique in the
capital markets of that time.
This deal also led to the first regulatory law in history prohibiting
execution of shorts for a brief period of two years. Since then and to
date, short sellers have drawn the ire and fire of regulators, politicians
and the general public. Short sellers were blamed for the infamous
collapse of the first-ever “public stock” company in history, the East
India Company. They were also blamed for the crash of the Dutch
tulip market in the seventeenth century, for the Great Crash of 1929,
for the fall of the British Pound in 1992 when George Soros, the world-
famous Hungarian investor, sold £10 billion and profited by billions
overnight. Short sellers were also blamed for the Dot-Com Crisis of
2000, and even for the Sub-Prime Crash of 2008. Napoleon called
short sellers “the enemy of the people,” President Herbert Hoover
denounced them, and FBI head J. Edgar Hoover opened an
investigation against them. That’s a lot of people opposed to short
selling!

Short sellers have never been liked by either the public or

legislators, since they are known for profiting from other people’s
losses. No one likes to hear about financial success stories when he or
she is on the losing end, and everyone needs a scapegoat upon which
to heap the woes of the world. On the other hand, shorters, as they are
known, gained the blessing of famous investors such as Warren Buffet,
who support their positive influences on the capital market. Shorters
can be credited with one simple fact: when they find a bubble, they
will do all they can to expose and explode it! Usually the bubble will
burst much faster than it would have if left alone, but on the other
hand, bursting bubbles prevents additional investors from bringing
their money into the market and afterwards losing it all. Shorters are
the oppositional force to investors, a kind of contra-balance in bubbles
and overpricing of all kinds. In short: they are the ones who monitor
the market, bring in liquidity, and warn of mishaps waiting to happen.
They hold an important role, and are aptly rewarded. In addition,
once the bubble is burst, they are the buyers preventing the stock
from going to zero!

Shorting: Why?

Two-thirds of the time, the stock exchange trends up, and one-
third of the time it drops. Sometimes the periods of dropping markets
are long, and as with the Dot-Com Crash of 2000, can last for several
years. Crises occurred in the past, and crises will occur in the future.
Even during periods of dropping markets, a trader has to earn a living.
During such periods, I have no intention of looking for a new job in
hi-tech. This is when shorting comes into play. When you buy a stock,
it is called going “long.” A “short” is the opposite action.
• We use shorts to try and profit from down trending stocks.
• Usually the laws of entry for long buying are valid in reverse for
shorts.
We will learn more about this later. In this chapter, we will examine
how shorts operate.

Shorts: the Potential

The potential for profiting from shorts is far greater than from
longs. In fact, most of my profit as a trader derives from shorts. Why is
there greater chance of profit? For two main reasons:
• First, because stocks fall faster than they rise.
Why? A pressured investor will sell faster than it took a greedy
investor to buy a rising stock.
• Second, shorts are a superior means for making a profit, since 99%
of the public does not understand them nor knows how to execute
them.
As usual, the big money is where the public doesn’t know what to
do.

SMART The majority of the public does not know

how to execute a short sale. The big money
MONEY can be made where the public does not
know what to do!

How Do Shorts Work?

We execute a short on a stock that we think is about to drop.

Technically, when we buy a stock trending up, we hit the BUY
button. A short is no more complex to execute. In the trading
platform, next to the SELL button you will find the SHORT button. All
you need to do to execute a short is press it. You still don’t understand
how to do it? Just press the button: everything will work out fine.
Here’s an example from real life. When we execute a short, we are
selling a stock that we do not own for a high price, with the intention
of buying it later cheaply.

How can we sell a stock we do not own? Very simply. Here is a

description of a familiar situation: Let us say that you enter an
exclusive furniture shop and buy a sofa on special order, upholstered
specifically to your taste. Since this is a custom order, it is reasonable
to assume the sofa is not in the store’s warehouse, and you will only
receive it once your wishes have been carried out. Let us say that the
shop assistant sells the sofa for $5000, takes your money and promises
delivery within several weeks. Once you have left the store, the
salesperson phones the manufacturer and orders the sofa for less than
what you paid: for example, $4000. Some weeks later, the sofa is
delivered as promised.

Does this sound like a common-enough situation? Note, however,

that in the first stage, the salesperson sells a sofa that the store does
not have for $5000, and only after you have left, the store actually
buys it for $4000, making a profit of $1000. In stock market
terminology, the store has executed a “short” sale: in other words, the
sofa was first sold at a high price, and only afterwards bought for
a low price. The exact same procedure holds for stocks as for sofas,
cars or any item ordered which you do not receive immediately on
paying for it. The system works. So, how can I sell stocks I do not own?

Example of Short Sale of Checkpoint, CHKP

Checkpoint sank below the line of support at $35. Let’s say I want to
sell 100 shares short, and I press the short button at [1]. What
happens? I have just sold 100 stocks I don’t have!
How can I do that? Very simply, because my broker loaned them to
me. How does my broker have 100 Checkpoint shares? The broker
manages the accounts of multiple clients. Since Checkpoint is a high-
volume stock, it is reasonable to assume that some of the broker’s
clients hold Checkpoint shares.
Now let us say that one of the broker’s clients, a fellow named
David, holds 300 Checkpoint shares in his account. David bought
them two years ago, and believes in their long-term future. When I
pressed the short sale button, the broker took 100 of David’s shares
and sold them for me according to my instructions.
In actuality, I sold 100 authentic shares, but they are not mine. If
David were to suddenly check his account, would he find 300 or 200
shares? Since no one bothered to update David that I sold 100 shares
belonging to him, David still thinks he has 300 in his account, even
though in reality there are only 200. What would happen if David
decided to sell all 300, right then? The broker would simply shift 100
from someone else. Legal? Absolutely.
In one of the conferences where I taught, a young woman raised
her hand and said in all seriousness that she felt the system of selling
short did not withstand the test of integrity. Perhaps not; but it
definitely does hold up to the test of the market and the law. Markets
are not socialist by nature. The market is not intended to assist
anyone, and no shorter gives consideration to the best interests of the
public, only to his or her own interests. We can think about that
situation in the following way: I borrow David’s shares and sell them.
David has an interest in his shares going up in value, but by selling his
shares, I increase the supply and cause a drop in stock price. Not only
does David have no idea he is helping me, but by selling his shares, I
cause him damage. Pure capitalism.

Does that sound dreadful? The truth is that compared to other

services we have become accustomed to accommodating, shorting is
not so horrible. For example, you know, of course, that when you
deposit money in the bank, it is used as the basis of loans for other
people. It is the Capital Adequacy Law that makes it legal for banks to
lend nine dollars for every dollar you deposited! Shorts are child’s play
by comparison to the regular banking system.
When I execute a short on Checkpoint, I sell 100 shares for $35,
receiving $3500 for them. Actually this is not my money, and the value
of the shares is counted against me to ensure that I return David’s 100
shares as soon as possible. Remember that by selling 100 of his shares,
I owe him those shares in return. There is only one way to exit a short,
whether that incurs profit or loss: at some point, I must buy 100 shares
and return them to David.
 To my great joy, I discover I was right and that Checkpoint has
plummeted to $33, as I had anticipated. At this point, I decide to exit
the trade and realize the profit. How is that done? I buy 100 shares at
[2]. Since the price is now $33, the cost of my purchase is $3300. The
100 shares I bought are now returned to David’s account, and the trade
comes full circle. I now owe David nothing.
Examining the process, I bought at $3300 and sold at $3500,
therefore am left with a profit of $200.
The difference between a short and a long is the order by which the
process is conducted. With a short, we start by selling and end by
buying. We sell for a high price, and try to buy for a low price. This is
known as sell high, buy low.
What could have happened if my prediction turned out to be a
failure, and the stock price rose to $37 instead of dropping to $33?
Under such circumstances, I would be forced to buy 100 shares for
$3700. Since I sold them for $3500, and now have to buy back for more,
the process ends up being sell low, buy high and a loss for me of $200.

Summary

When we expect a stock to rise, we can buy low and sell high. When
we expect a stock to drop, we still buy low and sell high but in reverse
order: first we sell high, then buy low. As you see, no one has yet
come up with a better way to make a profit other than the ancient
method of buying cheaply and selling at a higher price.

SMART The difference between a short and a long

is the order of actions. To execute a short,
MONEY we start by selling, and end by buying.

Are Shorts Riskier than Longs?

In light of the fact that stocks drop faster than they rise, shorts
work better and are faster and more reliable than longs: from my point
of view, intraday trading in shorts is less risky. The risk in shorts may
ambush you if and when you swing trade a short, holding it for days at
a time, since you can never know what the situation will be when you
wake up. We execute shorts on weak stocks. When a weak stock
reverses, the effect of the upward correction can be sharp. (Later we
will learn about the “short squeeze.”)
Another aspect is the potential for loss. If you are holding a long
position, the maximum potential for loss is the value of the stock. A
stock worth $20 can drop to $0, so the maximum loss is limited to $20
per share. By contrast, when you hold a short, the potential for loss is
unlimited since a stock worth $20 can also rise to $200, or in theory,
“to infinity.” This occurs in very rare cases and your likelihood of ever
experiencing such a situation is very low, but it is definitely a risk that
must be taken into consideration and recognized.

Summary

During the day’s trading, shorts are not any more risky than longs.
However, if you choose to hold shorts for several trading days, they
can definitely become dangerous and will require a high level of skill
and caution.
How long does a broker let you hold a short? This varies from one
broker to another. Some require closing shorts within three trading
days, while others set no limitations.

Shorts for Advanced Traders

So far, I have reviewed the principles of short selling, why they exist
(the need to profit from dropping stock prices), and how the
procedure is conducted. Now it’s time to look deeper.
You know that when executing a short, you are selling shares that
are not yours in the hope that when the stock drops, you will buy it
back at a lower price than what you sold. Up to this point, it sounds
simple, and for many traders and investors that is all you need to
know. But from the viewpoint of those who like to understand how
trading works, there is a lot more to learn.
Can short selling be executed with every stock? What might
happen if you were interested in shorting on a stock your broker does
not hold? In actuality, you will discover that you cannot execute a
short on all stocks. The limitation is tied to the stock’s public
ownership and the number of open shorts on it. In other words, a
stock with low public ownership will not be held by a great many
clients, and therefore the possibility of your broker loaning it to you is
limited. A second limitation often occurs when a stock with high
tradability drops sharply, usually as a result of a newsworthy event.
Sometimes the quantity of shorts on a stock is so large that all
available shares have been leant to other shorters. However, for 95% of
the stocks with high tradability, which is the only type in which we
trade, shorts can be executed and any limitation is actually fairly
uncommon.

Example of a Stock that Temporarily Cannot be Shorted

In this daily chart, you can see a rare example of a large percentage
crash in Goldman Sachs (GS) stock, resulting from the publicized
criminal investigation into the company’s conduct based on the fear of
investor fraud during the 2008 financial crisis. In the Tradenet trading
room, we shorted at the start of the process, when the stock dropped
to below $174. Two days later, when we saw that the downtrend was
continuing and we wished to increase the quantity of shorts, we found
that this was not possible because all available shares had already
been taken by other shorters.
 Regulatory limitations can occur, although very infrequently. In
cases such as the financial meltdown of 2008, shorts were prevented,
based on political considerations. Once every few years, usually during
crises, the public’s voice rises to a shout against shorters, and a moral
argument ensues concerning the contribution or harm shorters wield
on market stability. In some rare instances, shorts were prohibited on
certain financial stocks for several weeks. In actuality, the limitation
was set only towards the close of the crisis at points in time that no
healthy shorter would execute new shorts. So in actuality, the
prohibition barely affected traders. As traders, we have become
accustomed to the resurfacing every few years of the time-honored
dispute between supporters and detractors of shorting. Each side has
its “justifiable reasons,” but in the final run, history has proven that
the voice of logic overcomes opposition.
How can you know that it is not possible to execute shorts in a
certain stock? When you press the SHORT button, the trading
platform will display a message, usually of one word: Unshortable.
Some trading platforms allow accessing this information even before
you give the order.

SMART An alternative to shorts in cases where your

broker does not hold the particular stock is
MONEY the PUT option. We will not learn about the
put option here, but it is not a complex
process.

Is it possible that one broker will allow executing shorts in a certain

stock, and another will not allow it? Yes. In actuality, it is not your
broker who lends you the shares, but the clearing bank, which is a
central organization working with a great many brokers. The different
brokers themselves work with different clearing banks. Although the
clearing bank your broker works with may have no shares of that
stock, another competing clearing bank may have shares. If you really
insist on executing a short in a stock that your broker’s clearing bank
doesn’t hold, you can request to trade in stocks labeled HTB (hard to
borrow), but you will need to pay almost double the commission for
each short executed. Usually this makes using HTB stocks less than
worthwhile. There are also interest charges for borrowing shares,
especially if you hold the position overnight.
The quantity of shorts allowed on a stock is supervised by the
Regulator to ensure that brokers, craving their commissions, are
prevented from shorting quantities larger than the amount of shares
they actually hold. Once each month, all brokerage companies must
report the quantity of shorts in their clients’ accounts. By way of
example: a company has 100 million issued shares. Is it possible for the
public to borrow from brokers all 100 million and sell them short? This
is a highly unfeasible situation, but it is technically possible. To
borrow the entire quantity, they must all be purchasable. But every
company holds shares that cannot be purchased. Some are held by
company owners and defined as Restricted. Some are held physically
in the form of paper deeds by people who have purchased them. Since
they are in the owners’ homes or safes, and not deposited with
brokers, they are not available for lending. The quantity of a specific
company’s shares open to short selling can be viewed on a range of
financial Internet sites, such as Yahoo Finance.

Reviewing Current Short Status on Yahoo Finance for

Checkpoint, CHKP
 According to Yahoo, the quantity of CHKP shares sold short for the
particular date checked is 3.9% of all CHKP shares. Is that a lot? Not
much? It makes no difference. Firstly, the information is not precise: it
relates to data received via brokers several weeks earlier! Secondly, this
data contains no details that allow you to reach any conclusions about
the stock’s anticipated direction.

Example
Let’s say a company called ABC has a high quantity of shorts.
• Does the large quantity of traders executing shorts on the stock
mean that the stock must drop?
• Or does it mean that with so many shorts executed, the shorters
eventually needing to buy the shares in order to return them to the
owner will cause the stock to rise?
• The answer is: both situations can occur, and it all depends on
timing.
The truth is that for a company losing value, with its price
plummeting towards zero, it may get to that point irrespective of the
quantity of shorted shares. The reverse can also occur: if there are a
large number of shorters and for some reason the stock begins to rise,
shorters will panic since they will need to buy high. As a result, short
covering may begin: shorters, pressured by the need to return the
shares and seeing the price rising, will need to “cover” open shorts.
You can never know what is happening behind the scenes without
checking the stock chart. And this issue brings us to the next, very
important topic.

Short Squeeze

Occasionally a situation called a “short squeeze” occurs. Let me

describe a true event concerning a stock that for a very long time
traded at around the $2 to $3 mark.
The company was known to be having difficulties, and therefore, as
can be expected, there were a large number of shorters involved who
believed that the company would close and the stock price would drop
to zero. In a surprise announcement, some good news surfaced and
the stock shot up overnight from $3 to $5. This panicked the shorters,
who had entered close to the $3 point. Some, especially those using a
high margin, woke up the next morning to find they were holding a
losing position and were forced to close those positions by buying
while the price was rising. The more the price rose, the stronger the
avalanche of shorters closing trades. Every price rise caused increasing
numbers of shorters to close losing trades. As a result of the shorters
needing to buy no matter what, the price was pushed to a peak of $15
in just two days.
Did reasonable investors reach the conclusion that the stock was
worth $15, and buy in? No; in fact the opposite was true. It was clear to
everyone that the price would return to zero. It was mainly the panic
of short sellers forced to buy at any price that caused the spike. Once
their pressured actions eased off, the price increase ended and the
stock dropped back to a value of several cents.
Every so often, players with deep pockets will try to increase the
quantity of their shorts as the price is rising in order to average up a
losing trade, but even they have limits. Shorts come under great
pressure when these heavy players try to borrow shares from the
broker and execute more and more shorts as the price trends up. At
some point, though, they cannot receive any more shares on loan from
brokers because the brokers themselves hold only limited quantities,
and using them “on credit” from the original client, cannot be
stretched any further.
What drives the stock price? This is what we should always be
asking ourselves. Is the stock being driven by fundamental data that
improved overnight? No: prices spike when an imbalance develops
between buyers and sellers. An imbalance results from there being
more reasons to buy and fewer reasons to sell. Thus, until the stock
reaches its new balance, it will continue rising.
An amazing phenomenon can sometimes be observed during
trading: a stock that hits the heavens! What should you do as you
watch this happening? Should you join in? If you are not extremely
experienced, the answer is a definite “no”! This is very dangerous
territory. The long-term core investors have no fundamental data to
infuse confidence in the stock, and short-term traders usually find no
good technical formation that helps them decide whether to enter or
exit. The clamor can stop at any second, and without any warning.

SMART It is best not to trade extreme intraday price

spikes. This is when the game gets too
MONEY dangerous. You can never know when the
spike will peak, and usually you will not be
able to see a valid technical entry point.

Summary

So far, we have learned how shorts operate, the fundamental

principles, and what happens behind the scenes. You now know that:
• The purpose of shorts is to profit from dropping stock prices.
• Selling a stock short means borrowing shares from the broker who
in turn borrows from one of his or her clients.
• If the broker cannot lend them, such as when they are out of stock,
we cannot execute a short, in which case the opportunity must be
waived.
• “Short squeeze” means that a stock is rising sharply usually due to
some good news about the company, which sets into action a wave
of shorters rushing to close their position, which in turn causes the
price to jump even higher disproportionately to the company’s true
value.
Is the explanation now complete? No. It gets even more
complicated.

Naked Shorts

We will now take a look at the dark side of short selling and learn
about the phenomenon known as “naked shorts,” so called because
they have no real cover. The phenomenon occurs when a large
organization, usually a hedge fund, interested in shorting a very large
quantity, sells shares it cannot borrow!
How can it do this? After all, we have just learned that shorts
cannot be executed on shares that cannot be borrowed. But as we
know too well, nothing stands in the way of those who really desire
something, and market makers can make that something happen.
They do this by selling shares they do not have, and transferring these
“naked shorts” from one account to another for periods so short that
the regulatory body cannot follow the trail. They can also do this by
executing shorts in stocks of US dual-traded companies which are
simultaneously traded on stock exchanges outside America. These
foreign stock exchanges are not concerned with enforcing the
regulations.
Why would organizations make a naked short trade? It often
creates big business, especially during periods when the economy is
weak and the dollar has dropped heavily compared to its competitors.
In such times, company values drop, they weaken, and eventually are
forced to issue more shares in order to recruit funds. This works in the
shorters’ favor. Even shareholders may eventually be forced to sell
more shares which until that point had not been in circulation in the
market.

Naked shorts are not listed anywhere, so if you look at Yahoo

Finance and see that a company with 30 million traded stocks has 3
million shorted, you can be sure that 3 million actually means
nothing, and has the same probability of being correct as incorrect.
Perhaps millions more shares are shorted with almost no one
knowing, since the trade is not registered.
Let me close this section by saying that this is yet further proof that
examining data on shorts in the market is not a good basis for making
your trade decisions. Those should be based on checking the stock
chart. Charts do not lie. People definitely do.

Summary
The bulk of the public loses money during economic crises. You and I
will also lose when the economy collapses, inflation runs wild, and the
funds in which our money is invested are negatively affected by a
dropping market. In short, during crises we all lose out, and we have
no control over that. By contrast, however, as traders we must learn
how to profit from dropping markets, and not merely profit, but profit
big. The learning process is long, and you will not be able to start it
during the next crisis or just weeks in advance of it. You need to
prepare for the next crisis years before it happens. In other words, you
need to start preparing right now.
Chapter 9 - The Trading Platform
Practical Steps to Choosing,
Con guring, and Operating Your
Trading Platform
My Trading Platform

Most how-to books do not provide instruction on trading platforms. I

think that’s a mistake. A trader must know more than just how to
choose the right stock. Traders must be able to choose their platform
and know how to use it. I recall my early days as a trader and the
shock of opening the trading platform for the first time, with no idea
where to begin, what to look at, or how to click the button. Even when
I learned the basics on my own, no easy feat at all, I was still very far
from being able to configure the charts and the platform I currently
use. I also remember how on the first time I visited Chris, my mentor
in Phoenix, Arizona, I very precisely recorded every chart and window
and their exact positions on his screens. The purpose of this chapter is
to save you a lot of effort in figuring out, by trial and error, how to
make your monitors work best for you.
The trading platform is the trader’s pipeline to the market. The
platform must be fast, effective and reliable. It does not need to be
overly sophisticated, since such platforms tend to be slow and
cumbersome to operate. Have you ever seen a racecar driver’s cockpit?
If not, you’re likely to be disappointed the first time you do. We tend
to think of racing drivers as needing special, smart controls with a
whole gaggle of electronic devices. The opposite is true: the driver
needs very little. What the driver needs are speed, agility and
dependability. The same is true of the trading platform. Don’t look for
unnecessary platform “toys.” Just like the racing driver, you need a fast,
dependable foundation. In the long run, the trading process is based
on just three buttons: BUY, SELL, and SHORT.
During my years as a trader, I have used just seven different
platforms. The first was from “Ameritrade,” an online platform that
required no installation, but did not provide the performance speed
needed for trading. As a web-based platform, it was ideal for long-
term investors, but was far from supporting the intraday high speed
execution needs of a day trader. The second platform I used was the
wonderful CyberTrader, which unfortunately was bought out by
Charles Schwab, a company that specializes more in investment than
active trading, and therefore killed the platform.
My next choice was a top-of-the-line technology called Trade
Station. It was advanced and smart, containing endless “toys,” but it
created a “too many trees to see the forest” situation and was unsuited
to day trading. Three months later, I realized I needed to be like
racecar drivers, who can’t compete in a luxury Mercedes model. I set
out to look for the next platform.
My fourth choice was an excellent one, but it had no charts. Its
execution performance system was excellent and fast, but to check
charts I needed to link with an external program. The charting
program was also excellent. However, needing to integrate two
platforms required not only an additional payment of several hundred
dollars per month to the charting company, but it was unwieldy. Even
though I really liked the platform, I realized it was worth letting that
one go as well.
My fifth attempt lasted no longer than two weeks. The platform
was slow as a turtle and highly sensitive to my Internet speed. It would
crash, get stuck, and stutter several times a day. When I sought service
for it, I came up against a stone wall in the form of an employee in
New York named Chang with a service awareness that left much to be
desired.
I finally reached a good “resting place” when I began using the
COLMEX Pro platform, which adapts well to novice traders and
experienced traders alike. At last, I had found a real “cockpit” for stock
trading, with a few extras, but no bells and whistles.
Choosing a Trading Platform

In Chapter Two, I detailed the characteristics required of a trading

platform, and therefore I will only repeat the main points:
• The platform must be of the Direct Access type, allowing the trader
to buy and sell shares directly for every target according to the
trader’s choice or an effective automatic router.
• The platform must be installed on your computer and not web-
based, since only the installed programs are fast, reliable, and can be
personally configured.
• The platform must be simple and user-friendly, with the ability to
simultaneously display at least 20 different charts over several
screens.
• The platform must display over several screens and provide the
ability to save the installation configurations, so that each time you
reopen it, it will return to the multi-screen configuration you
defined and saved.

Download and Installation

First, you need to open an account with a broker and deposit money
in it. This issue was covered in Chapter Two. Once you have completed
the account opening process, which should take no more than a few
minutes, you will have to wait for the broker’s authorization, which
could take a few days. You will receive an e-mail congratulating you for
joining, and a platform download link. The download process is
simple and identical to that of any program, and therefore needs no
explanation. The questions begin to surface after installation and with
the first time you open the platform, since at this stage you still have
no clue, really, about what to do. More on that later.

First Activation and Screen Con guration

All trading platforms are very similar. This explanation is structured
around the COLMEX Pro platform, but will not vary greatly for any
platform. When you first open the platform, you will find a window
layout which the broker has chosen for you. Since brokers do not
understand much about day trading but understand a lot about
trading commissions, you will generally find that the configuration
they offer is nothing like what you need. It is no more than a place to
start. If this is your first day of study and you are using only one
screen, you will need to start with the basic windows configuration I
demonstrate later.
The trading platform allows you to arrange various windows across
your screen, each of which has a specific function. You will configure
the position and number of windows according to your needs. Further
on, I will recommend several basic configurations and explain their
components. Once the windows are set up the way you want them,
you will need to save the display configuration (Save Screen, Layout, or
Page) under a name. I tend to save several configurations: suited to
one screen, to two, to three and so on. I also save my favorite
configurations on a USB stick on my key ring, so that if I need to trade
when I’m away from home, I can easily install my platform on any
computer and upload the screen layouts (Open Screen) that I prefer.

Screen Con guration

The Most Basic, Simplest Trading Platform
Con guration
The screen configuration I will demonstrate below is the most basic,
suited to a 12-inch screen. I use this one with a laptop when I am away
from home. The configuration comprises seven different trading
windows (to be explained). The larger your screen, the more windows
you will be able to add.

Example of Basic Configured Windows on One Screen

1 – The Main Stock Chart

On the main stock chart, I display the stock I am following at the

time. It shows five-minute candles [1] of [2] intraday data for a range of
two days. Notice the dashed line [3] separating the two days of trading
on the chart. To see the stock’s daily formation over a longer period, I
simply click the DAY button to the right of the intraday MINUTE
button [2].
2 – The Market Index Chart

On the market index chart I display the SPY, which as we have already
learned is the most important index for traders. The chart will display
intraday information and five-minute candles for a two-day period.
Note the perforated line separating the two days.

3 – The Secondary Chart

On the secondary chart I display the stock I am following. I may be

watching a new stock on the primary chart [1], while simultaneously
following up on a stock I have just bought on this secondary chart.

4 – The Trade Window

On the broader left side of this image, the stock box window is
displayed. On the narrow right side is the Time & Sell (T&S) window,
on which I will expand later. Both these windows must always be side
by side. In some trading platforms, they even appear together in the
same window. The stock box is a trader’s central execution tool. In the
top left corner of the stock box, we can type in the stock symbol [1]. In
the upper section we find information known as Level I data [2]. This
is data such as the previous day’s closing price, the highest and lowest
prices of the current day (high and low), the current day’s trade
volume (number of shares), the price of the most recent trade (Last
Px), percentage of rise or drop of the stock relative to the previous
day’s close (0.04% according to this image), and the price change in
points (0.02; in other words, the share price rose today by two cents).
On the stock box’s right, we can see a small anchor. If you drag it
with the mouse into the T&S box on the right, a link will be made
between the two windows, so that from now on any stock you display
in the stock box [1] will have its data displayed in the T&S. In the same
way, you need to link the stock box and the primary stock chart, so
that every time you change the symbol in the stock box [1], the
relevant data will immediately display in the primary chart and in the
T&S. In this way you can create a link between a large number of
windows and charts.
Beneath the Level I upper data area are the buy, sell, and short
buttons, as well as additional commands to be explained later.
Beneath them are buttons [7] that can be personally defined. I use
them (from left to right) for feeding in protection orders (ARCAs),
cancellation orders (CXL symbol) or for fast purchases of 1000, 2000
or 5000 shares. You can set both the text on the buttons and the
commands linked to them.

Level II
Beneath the personally defined buttons is the data area known as
Level II. It displays buyer demand [5] and seller supply [6] or, as it is
known by traders, “market depth.”

In the instance shown above, you can see that the best purchase,
known as BID (on the upper left) stands at $54.25, whereas the best
selling price, known as ASK (upper right) stands at $54.26. In other
words, the difference between buyers and sellers, known as between
ask and bid, and called SPREAD, is one cent. To the left of the price
column is the MMID (market maker ID) column. This contains
identity details of the buyer or seller. The buyer’s or seller’s source may
be an ECN, as with ARCA or NASDAQ; or a market maker like SBSH
(Salomon Smith Barney). Sometimes, you can find the market maker
for both parties: for buyer and seller simultaneously. In the case that
both a buyer and seller are available on an ECN, this usually indicates
different clients of the same ECN, and in the case of a market maker
for both parties, the market maker is trying to profit from the one cent
spread. One cent, in very large quantities that only market makers
generally see, can end up being a lot of money!
The market depth (that is, the quantity of buyer demand and
quantity of seller supply) is very significant. We see how the buyers
(the bid) at $54.25 spread across three lines which are emphasized
with the same color. Each price layer receives its own color. The total
demand quantity at that level of demand is 2900 shares. Notice how
the accepted display form of quantities is in units representing
hundreds. In other words, 14 + 14 + 1 = 29 represents a demand of 2900
shares at $54.25. Demand, in this case, is divided among three
different buyers. On the sellers’ (ask) side, you can see a relatively
smaller supply of 1700 shares at $54.26. The meaning of larger demand
than supply is clear: when there are more buyers than sellers, there is
a good probability that the stock price will rise. On the other hand, if
the surplus demand has caused you to decide to buy, then it is first
worth glancing at the number of sellers found at two cents above the
current supply price. Notice that at $54.28, two sellers are trying to sell
a quantity of 2900 shares. In other words, if you buy the stock and it
goes up only two cents, it may have difficulty in crossing the resistance
of the next batch of sellers. Have you already cancelled your buy
order? Or is it worthwhile buying only if it passes $54.28?
Let’s say that despite the resistance, you are considering buying.
Before that, you must check your escape path. If you check the buyer
depth, which is below the price of $54.25, you will discover that
demand is very low. In other words, if you purchase several thousand
shares, you will find great difficulty in exiting at a reasonable price.
The solution may be in buying a smaller amount, or perhaps not
buying at all. On the other hand, if you are planning to execute a short
on the stock and when pressured, may need to exit the short (that is,
buy), you can rely on a large number of sellers from whom to buy.
Every stock has a different tradability, which means you need to check
each one from the point of view of quantity you are willing to risk, and
adapt it to the number of bids and asks as displayed in the Level II
market depth.

Hiding information
Large quantity buyers and sellers tend to hide the real quantities they
are offering since they do not want others reading their intentions. For
example, when I want to sell a quantity of up to 1000 shares, I use a
command known as RESERVE which displays a sale of only 100 shares
even though the amount in actuality is far larger. The buyers, who do
not know they are watching a large quantity seller, buy a small amount
each time, until eventually they buy the entire amount I intended to
sell. What might happen if I displayed an amount of 3000 shares, for
example? Without doubt I would scare away small buyers who would
avoid buying, since they know that if they buy a small quantity, the
stock will not move until a large buyer would come along and
purchase all the stocks I am trying to sell.
Sometimes, when you hold a stock whose price has stopped at a
certain position and refuses to continue trending up when you are
long, or refuses to trend down when you are short, try to discover in
the MMID column who the seller is, insisting on adding quantities, or
in the case of a short, who the buyer is that insists on renewing
quantities. The phenomenon is very common in cases when the stock
is trending up and reaches a round number, and heavy sellers can
often be found who are not interested in revealing the true quantity
they are offering for sale.

Market depth exercises

The opposite situation occurs when large scale market makers who
have accumulated shares may wish to display a large quantity for sale,
and which they have no intention of selling. They hope that the large
quantity will deter potential buyers and even translate into seller
panic. They hope that displaying a large amount will reduce the stock
price and make it easier for them to accrue more for a cheaper price.
This is also why, sometimes, you will find the same market makers on
both sides of the transaction: on one hand, the market maker will sell,
or at least display like a large seller, and on the other hand, the market
maker will buy.
Until a few years ago, market depth manipulations using the Level
II are were a common phenomenon. Many traders tried to decipher
the nature of market maker behavior, and act according to what they
felt the market maker was about to do. This was known as “find the
bull”: traders would spend entire days seeking the bull that would take
them to their promised land. Thick books were written on this activity,
and thousands of traders tried following market makers as a way of
making profits. Over time, the methods by which market makers
could display or hide orders became increasingly elaborate, the market
depth exercises dissipated, and all the books on that subject were sent
to paper recycling. Market makers can rout their orders exactly the
way any trader can through an ECN, so that you will never know who
is on the other side, and any attempt to try and understand the other
side’s ‘methodology’ of actions is doomed to utter failure. In short, do
not waste your time on this: time is too precious. Focus on the
quantity of buyers and sellers, and the market depth as displayed in
actuality, and just accept the fact that it is rarely the full range of
information concerning true depth. Look for reasons in the shape of a
large seller renewing stock, give the seller a few seconds or minutes,
try to understand if that seller is about to disappear, and then make an
informed decision.

Varying layers of colors

As noted, each layer of color represents a different price level. When
the first layer representing buyers is broader than the first layer
representing sellers, there are more buyers than sellers. Note that a
larger quantity of buyers does not necessarily mean a larger quantity
of shares, but the larger the quantity of different buyers and sellers,
the better the market depth is, since the supply or demand are divided
among a large number of traders. If you were considering selling, what
would you prefer to see on the buyers’ side: a single buyer, buying a
large quantity of shares, or three different buyers simultaneously
purchasing that same quantity? I would prefer the latter: the division
among multiple buyers is better than one single buyer.
The purpose of these colored layers is to allow you to catch, at a
glimpse, a visual image of the pressures felt by buyers and sellers. Over
time, the changes in color will be an inseparable part of your overall
awareness over the strength or weakness of a stock at any given price.

5 – The T&S  Window – Time & Sales

The Time & Sales window is a separate part of the attempt to
understand a stock’s direction. Some time ago, I invited a friend with a
year’s experience in trading to sit with me during one of my trading
sessions. He was a little amazed that alongside each stock box, I
always positioned the T&S window. I was equally amazed to hear that
until now, he had never used it. After spending a short amount of time
with me, he realized its need.

The T&S window shows every transaction executed for a stock. The
usual display is for the latest trade to appear in the window’s upper
section. As you see, the latest trade occurred at $54.25 for a quantity of
shares listed as “1”, in other words, 100 shares. The trade before that
was for 400 shares. If you look a little further down, you will find a
trade at $54.249, a transaction that only market makers are capable of
making as they “cut” the price between buyers and sellers, and it is the
first in the list between the spread. This is their advantage area, since
you and I have no legal ability to perform trades with fractions of
cents.

Why is the T&S window so important to me? For several reasons.

• The first reason is explained with this example. Let’s say a large scale
buyer is not interested in showing the quantity of shares she or he
wishes to buy at $54.25, and therefore I cannot see the true quantity
that the buyer seeks. But the information that the buyer cannot hide
from me concerns the number of transactions, ie: the volume of
trade occurring at that price. In the T&S window, I see every trade
and the rate at which they are being executed. This information,
 together with the quantity of shares displayed in the market depth
window, will give me a reliable and realistic image.
• The second is the following: the T&S window has an additional
important characteristic: the color used to display each transaction.
When a trade occurs where a buyer is willing to pay the supply
price, known as ask, which in this case is $54.26, the color of the line
in the T&S window, representing the quantity being sold, will be
green. Green means buyers are more aggressive than sellers: in other
words, they are willing to pay the full price requested by the stock’s
sellers. On the other hand, when a trade goes through at the
demand price, ie, the bid, it means sellers are capitulating to the
buyers’ demands, and they are willing to sell at their price. The
transaction color in the T&S window will be red. A sequence of red
colored trades tells us that buyers are under pressure, and a
sequence of green colored trades tells us the sellers are under
pressure. If the spread between buyers and sellers is greater than
one cent, a transaction might be executed at some intermediary
price, which would be colored white. You can define these colors
yourself on your trading platform, and even add additional colors
for various other types of signals.
Some years ago, when I was explaining the meaning of these to one
of my students, he asked: “And what does the yellow color stand for?”
Well, it turns out I am color blind. For years, apparently, I’ve missed
out on seeing another color…

Practical examples
• A sequence of green trades: the stock is strong, and trending up.
Buyers are pressuring.
• A sequence of red trades: the stock is weak. Sellers are getting rid of
the merchandise at any price.
• A sequence of red trades but the stock price is not dropping: a large
scale buyer hiding a large amount.
• A sequence of green trades but the stock price is not rising: a large
scale seller hiding a large amount.
• A sequence of white trades: market makers are trading at an
intermediate price. It is hard to interpret the meaning of this, but it
 is interesting to know that market makers are involved.

Executing orders

The main use of the stock box is to execute buy, sell, short, and
additionally, more complex orders such as defining profit and
protection targets.

1.  The “short” button

  2.  The amount of shares sought. You can define your default amount.
  3.  Instruction to display in the window [2] the quantity of shares you
are holding – called POSITION
  4.  The LIMIT price at which you are willing to execute the trade. This
order will be explained later.
  5.  Two possibilities: ANY, which is an instruction during buying or
selling to execute the trade for any quantity that can be obtained. For
example, if you wish to buy 400 shares and only 350 are being
offered, the trade will be executed for 350. The second option is
AON, standing for All Or Nothing, an instruction to execute the
trade only if all the quantity of shares you want is available. In other
words, if 400 cannot be bought, then buy nothing. I don’t
recommend doing that.
  6.  The DEF (Default) button will bring you back to the default status
if you have changed any parameters in the meantime.
7. BUY button.
  8.  Order validity limitation. When DAY appears, the order will cancel
at the end of the trading day. When GTC appears, standing for Good
Till Cancelled, the order will remain open until you manually cancel
it.
  9.  The trading account from which you execute orders. If you have
several accounts, such as portfolio managers do, you can use this
window to toggle between them.
  10.  Cancellation of any waiting order for the specific stock.
  11.  Order routing to different liquidity targets. We will learn more
about this later.
  12.  The SELL button.

6 – The Account Manager Window

The account manager window contains two tabs in the lower bar: one
is the open positions marked as POSITION, and the other is the
ACCOUNT tab. In the first, you will be able to see the profit and loss
status of every open trade. In the account tab, you can find a summary
of all open or closed activities. The image above shows a realized profit
of $136; buying power available to the account during the trading day,
where BP stands for buying power; the overnight BP; the number of
trades, which here is two, and is also known as Tickets; and the
volume of trading day sales and purchases, here showing 1200 under
the Shares tab, which in this case refers to a purchase of 600 shares
and a sale of 600 shares.

7 – The Trade Manager Window

The most important and useful tab in the trade manager window is
the open orders tab, labeled Orders. In the image above you see that
my trading system is currently in a buy status (B) for 600 SanDisk
(SNDK) stock at $36.87. The time of the order is also displayed, as well
as its validity, DAY, under the TIF (time in force) tab. This means the
order will cancel at the end of the trading day if it has not been
executed. The order can be cancelled by clicking the button marked X
on the left of that bar.

• the Market Watch window

This window allows following up on stocks or indices. You choose

which stocks or indices to feed into the window. You can also choose
the columns setup. In this image, you see the columns I have chosen:
symbol, change as a percentage, change in points, volume, and last
price. In the upper section, I chose symbols of important market
indices and sectors. Beneath them are several stocks I am following.
You can open several such windows and save different types of stocks
in each, according to various follow-up categories. For example, stocks
on the verge of breakout, stocks trending up, stocks trending down,
and so on. Right clicking with the mouse on a symbol opens that
stock’s chart and allows you to quickly check a long list of stocks or
indicators. Your trading platform updates every symbol and indicator
in real time. This means that the more symbols you add to your tables,
the stronger your internet bandwidth needs to be. For this reason,
most brokers limit the number of charts offered to several dozen, and
the number of symbols for follow-up to several hundreds.

• the News window

This window displays real time information derived from various data
suppliers. The window shows the notification’s time, the stock’s symbol,
and a summary of the information. Clicking the button on the summary
line allows me to see an image, opening an additional window
displaying the detailed information. I do not tend to follow market
notifications. The rate at which they enter is very high and it is difficult
to efficiently scan them and focus only on the important, impactful
notices. For me, working with this window wastes precious time. On the
other hand, perhaps I am not providing a good example, since one of
the traders in our trading room insists that he absolutely makes his
living from the real time information coming through. So the choice is
up to you.

• The Alerts window

When you plan to buy a stock if it reaches a specific price, but you are
following several other stocks simultaneously, it is wise to feed in an
alert. In the case above, I fed in an alert that will activate when the
ASK for AAPL is equal to or more than $264.10. If and when Apple
reaches this price, a warning will pop up on the screen and play a
sound. You can set any number of warnings, but I recommend using
this tool in a very measured way, since too many alerts disturb trading
procedures with all their noise.
The Trading Orders
Limit

The limit order is very common and very useful. Its simple meaning is
“Buy (or, sell) at this price limit.” The two commands are called buy
limit order and sell limit order.
Here is an example: when I look at the Level II window, I see that
the ask (ie: sellers) are offering stock of TEVA for $54.26. I decide to
buy 1000 shares at no higher than that price. To do this I will use the
limit order, which I feed in and execute in the stock box as follows:
1.  I enter the stock symbol TEVA [1]
  2.  Enter the amount of shares wanted: 1000 [2]
  3.  Enter the limit ($54.26) in the order execution window [3]. It is also
possible to choose this price by clicking on it in the Level II window
on a seller at that price.
  4.  I choose the limit order [4]. For example, ARCAL. There are
several limit options possible, which will be detailed later.
  5.  Lastly, I click the BUY button [5]
• Notes
If there are sufficient sellers to supply the 1000 shares I seek, I will
receive the entire amount. However, if someone else hit the buy
button faster than I did, the full size that I want might not be
available. For example, if someone else gets to 300 shares before me, I
will be executed on 700 shares and an open buy order is created for
the 300 shares I still want. My demand for 300 shares will now appear
as the highest BID and will wait until sellers come along. At any time,
I can cancel the bid for 300 shares by clicking the cancel button.

• Practical example
In the market depth image (Level II), you see that the number of
sellers at $54.26 stands at 1700 shares. What would happen if I wanted
to buy 2000 shares with a limit of $54.26?
Answer: since only 1700 shares are offered there, that is the
maximum quantity I could buy at the limit price I have set. The only
way I can receive all 2000 is if there are sellers hiding their real supply.
Outcome: since there are insufficient sellers at $54.26, the ASK
price will go up by one cent to $54.27 and the BID price will also go up
one cent to $54.26. My bid price will display as an open order for 300
shares. It will remain open until someone is willing to sell at my limit,
or until I cancel the open order.
What would happen if I tried to buy 2000 shares at a limit of
$54.27? Note that at this price, one seller is offering 100 shares. In
other words, I would receive 1800 shares total: the 1700 shares at
$54.26 and 100 at $54.27.
What would happen if I had set a limit of $54.28? Judging by the
number of sellers at $54.28 you can see that I would have received the
whole amount of 2000 shares from the moment I clicked BUY. I could
even have received more than 2000, if I had wanted them.
Would it not have been worth buying some of that quantity of 2000
shares from the beginning, at the higher price? Not necessarily; it
depends on how much you really want the entire amount. It is usually
better to take the smaller quantity, and wait a few seconds, or a little
longer, for more sellers willing to meet your lower limit.

Additional uses for the limit order

• Buy limit
Let’s say I decide to buy a stock if it goes higher than $30. I prepare
a buy limit at $30.01 and when the price reaches that limit, I click the
buy button. The buy order is executed at the requested price if a seller
is found at that price. The meaning of a limit order is to let me limit
my bid at $30.01; in other words, I am not willing to buy at a higher
price. So in this case, I am placing a Limit order that is already at least
partially executable by the sellers displayed in the market.
The advantage: I fix my maximum price.
The disadvantage: I take a risk that there will not be enough sellers
at the price I set, and the trade will not be executed at all, or will be
executed for only part of the amount.
Possible solution: I can enter a limit for $30.03.
This is the order you would usually use, but it depends on the
nature of the stock. For stocks with low volume and high volatility, you
may need to increase your limit price, buy at a higher price than you
had originally wanted, and increase the risk. By contrast, with stocks
of high volume, you may be able to manage with a more precise limit,
since the chances are higher of receiving the stock at your bid price.

• Sell limit (SHORT)

 I decide to sell a stock when its price drops below $30. I prepare a
sell order at $29.99 and when the price drops below $30, I click the
Sell/Short button. The sell order will be executed at the requested
price on condition there is a buyer for that price. The meaning of the
limit is that I limit the sale price to $29.99. In other words, I am not
willing to sell for less than that price.
The advantage: I fix the minimum price I am willing to accept.
The disadvantage: I take the risk that there will not be enough
buyers at that point and the trade will not be executed.
Possible solution: setting the limit at $29.97. This means I want to
sell when the share drops below $30, but limit the sell price to $29.97.
Every limit must be planned according to the nature of the stock.
For stocks with low volume and high volatility, it is worth increasing
the limit’s spread, but then I might be selling at lower than I had
wanted. By contrast, for stocks with larger volumes, it is usually not
necessary to increase the limit’s spread, since there is reasonable
chance of selling the stock at the requested price.
• Pending Limit buy order
I am watching a stock trending strongly up, and intend to buy. I
don’t want to buy it at a high price, but rather I want to wait for it to
pull down so that I can buy if and when it drops. For example, the
stock price reached $30.60 and I want to buy if and when it drops to
$30.25. I enter a buy limit at $30.25 and click the buy button. The order
is ready for execution, but is not immediately filled when I hit the
button. Instead, it waits for the price to drop to my limit, and is then
executed when someone sells shares to me.

• Pending Limit sell order

I bought a stock at $30 and plan to sell if it rises by 30 cents. I enter
the sell limit order at $30.30 and click the sell button. The order is
waiting in the system and will not be executed immediately, but only
when the sell limit is reached.

Market order
 The market order, by contrast to the limit order, indicates: “I want
to buy or sell now, no matter what the price is!” This order is executed
immediately when the button is clicked, hitting all shares available for
sale until I am filled. For example, if I try to buy 2000 TEVA shares via
a market order, I will immediately get the quantity I want, but at what
price? According to the supply we saw in the Level II window, I will
receive 1700 at $54.26, 100 more at $54.27 and 200 more at $54.28.
That’s not bad for shares with high liquidity. If I try to buy 2000 shares
with low liquidity using the market order, I may in extreme instances
jump the stock price by tens of cents, and then discover that when I
want to sell, there are not enough buyers. The market order is
therefore very effective and fast, but useful only when you want stock
with high volume.

Example of order execution

I want to buy 1000 TEVA shares by a market order. I enter it into
the stock box as follows:
1. Enter the symbol TEVA [1]
2. Enter the quantity of shares wanted, in this case 1000 [2]
3. Choose the “market” order in the window [3], eg: ARCAM
4. Click the BUY button [4]
Advantage: This is a fast way to enter a trade because you don’t
have to enter a price, skipping one field of work, but you must use this
order only for stock that allows a broad “market depth”, ie: are of high
volume.

Stop order

The stop order is conditional upon the stock moving up or down to

a certain price before it executes. One example would be when I do
not hold a certain stock and want to move to buying it if it rises above
a certain price. Another case might be when I hold the stock and want
to sell if it drops beneath a certain price. The stop order does not
stand alone: it is always linked to another execution order.
 For example: if the stock rises to price X, then buy, but at no more
than Y cents above price X. In other words, this is a stop + limit
because I am only willing to pay up to a certain price. I might also
choose a buy stop + market combination, such as buy above price X at
any price.
Confused? We will clarify this further with additional examples.

• Stop loss order

The most common type of protective stop order is called a “stop
loss”. As with all stop orders, this one too indicates a change of status,
i.e.“I hold a stock and wish to sell when it breaks under a certain
price.”

For example: I bought a stock at $30 and want to define in advance

my exit point at a loss if the stock drops below $29.70. In other words,
if the stock drops to $29.70, I want to sell it, lock in my loss, and “stop”
it from getting worse. To do this, I need to use a stop order. When
entering the order in the trading platform, I will first need to click
STOP, and in the window that opens, enter the stop price of $29.70. I
now define what I want to happen when the stock falls to the stop
price. I need to choose between selling at limit of X cents (which
means, “I want to sell but for no less than price Y”) or selling at market
(which means, “If the price drops to $29.70 I want to sell immediately
and for any price”.)

The outcome: if the stock drops to $29.70 it will sell at my limit or

at market. The advantage of the stop limit order is that it ensures the
sale will not be executed beneath the defined price. The disadvantage
of the stop limit order is the fact that if there is a shortage of buyers, I
might find that the stock has gone further below the limit and
dropped to a level which is far lower than I had wished, and now I am
still in the stock, waiting to sell it higher than the current market.
Hence, the advantage of the stop market order is that I will know
clearly that I exit the stock when it drops past the stop price.
 SMART Not all stop loss orders are orders that stop
losses. The stop loss is also entered in cases
MONEY where you want to limit a stock’s drop in
pro tability.

Since, from the outset, we are trading in stocks with a good

liquidity, I would recommend you always use the stop market order.
One of my ways of coping with large quantities is to enter several
sale orders in the form of stop market at spreads of 5 to 10 cents. For
example: if I want to protect 3000 shares from drops in price, I will
enter 3 different orders at measured intervals of several cents per 1000
shares per sale. Obviously for stock with high liquidity, this would be
an unnecessary step.

Entering the Stop Order

Let us say you are holding 400 shares of ABC and are interested in
entering a stop market order if the stock drops to $29.70. The
sequence of actions you need is as follows:
1. Enter the stock symbol [1]
 2. Enter the quantity of shares you want to protect in case of falling
prices [2]. You don’t need to enter the entire amount you hold.
3. Choose the order type [3]. In this case, ARCAS was chosen. We
will learn more on this later.
4. Click the SELL button [4].
5. An additional window will open: enter the type of order – market
or limit – to be executed if the price drops to the stop price [5].
6. Enter the stop price [6], which in this case is $29.7.
7. If at step [5] you chose a limit order, now you need to enter the
limit (e.g. $29.67). Not recommended!
8. Authorize the execution by clicking OK.
9. Check in the trade manager window, under the Orders tab, that
the order was lodged. If it does not appear, check why in the
Messages box and correct any errors.

• Short Stop Loss Order - When you short a stock, you are selling a
stock you borrowed from the broker, and you will want to protect your
account should the stock price go up. Your stop order will be a BUY
rather than a SELL (step 4 above), and your stop price (step 6 above)
will be higher than the stock’s current price. Other than that, the
procedure is identical. It implies that if the stock price rises to price X,
please buy according to your choice of a limit or market.

• Stop Order for Buying a Stock - A trader intending to buy a stock

breaking out is not always interested in following the stock for hours
until the breakout, if at all. It is possible to enter a conditional buy
order.
For example: Let’s say that ABC is consolidating beneath the
resistance line at $30. You want to buy ABC only if it breaks out above
$30. This is the procedure:
1. Enter the stock symbol ABC.
2. Enter the quantity of shares you want to buy at the breakout: let’s
say 400.
3. Choose the stop order, for example, ARCAS.
4. Click the buy button. Remember that the order is not executed
immediately.
 5. A window opens for the stop order. Enter the type of order (limit
or market) to be executed when the price rises to $30.01.
6. Enter the stop price, which here is $30.01.
7. If at step 5 you chose a limit order, enter the limit price, e.g.
$30.03.
8. Authorize the action by clicking OK.
9. Check in the trade manager window under the Orders tab if the
order has been lodged.
The opposite is valid for a situation where you want to execute a
short in a stock if it drops beneath the support level.

• Trailing Stop Order - The trailing stop order is very attractive to

new traders, but is less interesting to veteran traders. The order links
the stop order position with the stock’s changing price. Let’s say that
you bought a stock for $30 and want to enter a stop order for a price
drop of 30 cents. Of course you can do this the regular way with a stop
order for $29.70, but you can also enter instead a trailing stop for 30
cents, or if you prefer (I never do!), as a percentage, in this case 1%.

SMART The trailing stop order is problematic since

it does not take into consideration support
MONEY and resistance levels, reversals or any other
technical behavior. Generally it is not
recommended.

With a trailing stop order, the stop price moves up with the stock.
In other words, the stop will always maintain the distance of 30 cents
below the stock’s peak price, no matter how much it goes up. In other
words, you can enter the trailing stop and go on vacation. This, by the
way, is the only time I would recommend using the trailing stop –
when you are on vacation. Its disadvantage is that it is based on
nothing: not on areas of support or resistance, and not on intraday or
daily reversals. If you’re going to be away from the computer for
several hours, enter a stop order at one single, lower price for a while,
according to the stock’s behavior, and suited to the right technical
area. A trailing stop is usually a bad idea.

Entering the Trailing Stop Order

This is a relatively simple process and very much like entering a

regular stop, except that in window [1] you need to choose “trailing”
through one of two ways: either as $ or as %. I have chosen $ in the
image above. Now enter the range. In this case I chose $0.30 [2].
Authorize the order by clicking OK, then check to make sure the order
is listed in the trade manager under the Orders tab. That’s it.

Complex Orders

Not all trading platforms are able to execute complex orders, but the
COLMEX Expert system can. These orders are structured from several
different steps that, when activated, cancel other steps. For example,
Stop Limit +TTO does the following: (1) buys the stock at a specific
price (stop price), but not for more than a defined price (limit), and
then (2) if the stock was bought, activates a profit or loss order. Then,
(3) if the price goes up to profit target, sells and (4) if the price drops
to the stop loss, sells. When either the stop loss or profit target is
reached, it cancels out the other.
The significance of this complex order is clear: it makes defining all
parameters of the trade possible by defining both the trigger price,
controlling the maximum execution price (the limit), and then the
target or loss prices. These orders can be entered before trading hours,
and then you can go on vacation. Amazing!
Here is an example of a complex stop order for buying 1000
SanDisk shares, SNDK:

The order will be executed if SanDisk reaches $41.01 (stop) but at

no more than $41.04 (limit). If the stock reaches the trigger price and
is bought, then two further conditional orders go into action: it will be
sold if it reaches the profit target of $42.28, or if it reaches the stop loss
of $39.80. Note that both these actions are set at “market.”
Order Routing
Routing to Different Destinations

When you buy or sell a stock, you need to decide how you want to
route the orders. Routing is a topic on which entire books can be
written. At this stage, I do not suggest you delve too deeply into it,
since it is particularly interesting for those who trade in very large
quantities of thousands or tens of thousands of shares.
First, we need to understand what routing is. In Chapter 1, we
learned that when you are interested in buying or selling a stock, you
need to find a buyer or seller willing to take the role of the other party
in the transaction. One possibility is to route your orders to the
market makers. We learned that they make their profit within the
spread between buy and sell prices. We also learned that we might
encounter the specialists, the NYSE version of the NASDAQ market
makers. Another routing option is direct to the ECN (Electronic
Communication Network). The ECN is a network of computers that
links buyers and sellers and in which you can set buy and sell orders
without the agency services of market makers.
 As stock traders, in contrast to investors, you need to use a Direct
Market Access (DMA) trading platform. This allows you to route your
orders to whomever you choose: direct to market makers, or to the
ECNs. The advantage in market makers is that they do not take
commissions for executing the order, but they will be a little slower. By
contrast, the ECN options are much faster, but if you remove liquidity
(to be explained later), they will take a commission which is currently
$3 for every 1000 shares.

Automated Routing

If you trade in small quantities and find it difficult initially to

understand how to use the routing options, ask your broker if he or
she can provide you with automated routing. The broker, through the
automated routing program, knows how to choose the cheapest,
fastest destinations with the highest liquidity, which are really the best
options when dealing in small transactions.

Manual Routing

If nonetheless you want to route direct, for example to an ECN called

ARCA, you will need to choose the ARCAL order when setting the
limit, or the ARCAM order for an order directed at the market. When
I want to execute a stop order, I can choose ARCAS. In other words,
the last letter indicates the type of order: limit, market, or stop. If, for
example, you want to route a limit order to market makers, you can
use SBSHL (Salomon Smith Barney), or NITEL, or a range of other
routes to various market makers, according to the routing options
offered by the broker you have chosen.

Choosing the Appropriate Route from the Available Options

When I open the routing dropdown list [1], I can choose my order
type (limit, market or stop) and where to route it. As you see above,
the first three orders are the ones I generally use. If, however, I want to
direct my orders to other destinations, I can choose from many
options.
Why might I want to change the destination? Notice the amount of
sellers on the ASK side. You can see that the first seller, with an
amount of 2100 shares, is ARCA, and the second, with 1200 shares, is
NASDAQ. If I am interested in buying up to 2100 shares, I would
choose the ARCAL navigation, click the button and buy the shares
direct and fast via ARCA. On the other hand, if I want a larger
quantity, I would need to buy shares via the other, NASDAQ ECN
marked as NSDQ.
The advantage of ARCA over many other ECNs is the speed and
nature of its operation. If the entire amount sought is not on ARCA,
they commit to finding it for me from another ECN or market maker.
In other words, they will supply me with 2100 shares which they are
holding, and then buy the rest from another ECN. In my opinion,
ARCA does the work better and faster than other ECNs, although if
you are buying very large quantities, you may need to route your
orders direct to different destinations.
Adding and Removing Liquidity

ECNs compete with each other and try to attract traders to their
services. The more one ECN’s market depth increases relative to a
competitor, the more traders will use its services and pay its
commissions. When I buy stock displayed by a buyer in the ASK
column, I am “removing liquidity,” meaning that I reduce the number
of sellers of the stock I bought, which is not good from the ECN’s
point of view. When I sell shares to a buyer on the BID side, I am
removing liquidity of buyers, which decreases market depth. For
removing liquidity, I pay the ECN a commission of $3 for every 1000
shares. This commission is in addition to that which I pay to my
broker, and the broker passes that extra commission down to me.
These are known as pass through commissions and are collected
separately from the regular commission agreed upon between me and
my broker.
Another cheaper possibility is to position my buy order on the BID
side and wait for a seller to offer shares to me, instead of buying direct
via the ASK. When I do that, I am actually adding liquidity, and for
that the ECN gives me $2 for every 1000 shares, which the broker also
passes along to my trading account. In other words, I have just
reduced the costs of my trade. The advantages of this method are dual:
I receive a commission instead of paying it, and I buy the stock at one
cent less, which is a saving of $10 for every 1000 shares. The
disadvantage of adding liquidity arises from my needing to wait until a
buyer comes along who is willing to sell the shares at my BID price.
From my experience, if you want to exit, it is almost always
preferable to remove liquidity and pay the surplus commission, since
in most cases the price will just “take off” and you could be left with
even greater damage.

Summary

Order Routing
 Working directly with the ECN, adding or removing liquidity, is
usually the most appropriate mode of operation for advanced traders
operating with large quantities of shares. It is reasonable to assume
that as you start out, you have sufficient other details to pay attention
to, therefore I recommend once again that you choose the automatic
routing provided by your broker. If you have no such option, choose
the ARCAL default.

Trade Orders
You can’t see the forest for the trees? The bottom line is very
simple. This is the best way to get ahead: your trading platform should
always be set to the limit order, since you will be using it 90% of the
time. In special cases, you will use the market order, and generally,
only after you have bought a stock or are planning a complicated
entry, will you use the stop order. As you accrue experience, you will
find that it’s not as scary as it sounds.

The Trading Room

So far, we have gotten acquainted with the trading platform, its
windows, and how to use them, but we still have not learned how to
position the platform’s windows, especially if you are trading with
more than one screen. To explain this, we need to take a few steps
back and observe the bigger picture: arranging the screens and the
trading room.

My trading room is my fortress. Woe to whoever dares step foot

inside during trading hours. I am far from user-friendly, including to
my wife, three daughters, and even our dog, whose bond with the
family trader earned her the name “Shorty.” In other words, my door is
closed. I would even lock it quite happily if this were not considered
exceedingly antisocial. Pleas from the inner depths of our home, such
as “Daddy, the TV’s not working” or even screams of fear along the
realms of “Daddy, come quickly, there’s a huge cockroach!” gain no
traction during trading hours.

As worthy of the most important room in the house, I devoted a good

deal of thought and effort to planning this room to suit my needs.
Your trading station must also match your available space, equipment,
and budget.

My trading room
Scary? Since taking this photo, I have added another screen, which
is outside the frame. Together with the projector, I use no less than ten
screens. Sometimes I do wonder if I need them all, or whether I buy
them just to impress the pool cleaner who, with every visit, tells me
how he dreams of being a trader, “but never finds the time for it.”
I use a lot of screens because I like to see what’s happening in the
market. Sectors, indicators, and dozens of stocks can be displayed at
once. As the head analyst of the Tradenet trading room, I must be
constantly up to date in real time with every event. In addition, this is
my profession and my hobby. Every professional invests in good work
tools, whether that’s a quality drill which is effective, reliable and
therefore saves time, or any other kind of tool in constant use.
Similarly, I invest in quality computers and screens. Can you guess
how much it costs to set up three desktops, two laptops, seven 23-inch
screens and a projector? Approximately $4000. A builder/renovator’s
toolbox costs a great deal more!
 If you’ve made the decision to become a trader, invest in the
infrastructure. You can start with a computer linked to two screens,
although very quickly you will move to a desktop linked to four. Trying
to save money? Like the ”chicken or the egg” argument, buying cheap
will end up expensive. If you do not invest in a quality infrastructure,
you may never succeed. If you are still unsure whether this is the
profession you want to pursue, start with just two screens but be ready
to add more fairly quickly.

My Screen Setup
Let’s start from left to right. The projector is hooked up to my old
laptop which should long ago have made its way into the trash can,
but it serves well for displaying content from financial sites. The
projector is also linked to the cable converter, and occasionally, when
there is important news or when planning the trading day, I display
CNBC on it. The other screens display the following information:

1. Charts of the two market indices: SPY and QQQ, as well as three
sector charts: Bioteck (NBI$), Banks (BKX$) and semiconductors
(SOX$)
2. Screens 1 to 4 are operated by two dual screen cards in one desktop
computer. Screen 2 follows 15 stocks. In the lower quarter of the
screen are my Account Manager and my Open Orders.
3. Two stock boxes, each linked to a Time and Sale (T&S) window and
the chart for their relevant stock. Along the right of the screen are
 charts for four stocks for intraday follow-up. That section of the
screen is where I usually display several open trades.
4. Two stock boxes, each of which is linked to Time and Sale (T&S)
and their relevant charts.
5. This screen follows stocks trending up: charts for some 16 strong
stocks I am following during trading hours. These are stocks for
which I seek opportunities to enter in reversal in an up trend, or buy
at breakout. This screen is linked to a laptop for which screen 6 is its
main screen.
6. Stock box linked to the Time and Sale (T&S) window and a chart
showing the stock, my second account manager (my second
brokerage account), and orders. It displays the leading 20 rising or
dropping stocks: my Top 20.
7. This screen follows stocks trending down: charts for 16 weak stocks
I am following during trading hours. These are stocks for which I
seek opportunities to short a reversal in a down trend or short at a
breakdown.
8. A stock box linked to the Time and Sale (T&S) window and chart
displaying the stock, my third account manager (my third brokerage
account), and orders; a follow-up list for sectors; and a real-time
stock scanner operating to predefined parameters, meaning stocks
that have risen or dropped by certain percentages and stocks
reaching new highs or lows.
Chapter 10 - Winning Trades
It’s Time To Click the Button: Best
Entry and Trade Management
Methods
How Many Times Will You Need to Read This Chapter?

Before we start the most important chapter of this book, let me share
some of my concerns with you. I am afraid you might miss something
important, something huge! Why? Because naturally, the first time
you read this book you will not understand its significance in the same
way you will after several months of experience. When I ask myself
what the chances are of you reading this chapter a second and even a
third time, I fear the chances are slim. And I am fairly certain that on a
first reading alone, you will not grasp the real meaning of this chapter.

SMART A successful trade comprises the right entry

point and money management. Only the
MONEY right combination of the two leads to
continued success.

I hope I’m wrong, so prove me wrong. Reread this entire section:

every word and every trade idea appearing in it will become etched in
your mind as to what makes a profitable trade and what makes a loss.
Every word is carefully weighed, and every sentence and trade idea
contains the experience of many years of trading. I wish to emphasize
that this book, and particularly this chapter, were not meant to be
read just once. They are geared to second, third and fourth readings,
separated by some months and years. Many topics covered in this
chapter will become comprehensible once you’ve traded for several
months, and, in the hope you continue successfully as a trader, will
become clear once you’ve traded for several years. I can virtually
guarantee that each time you reread this chapter, you’ll be sorry that
you didn’t read it just a short while earlier. The earlier you begin to
analyze and internalize, based on your experience, the more you will
reduce losses and begin to see a dramatic boost in your chances of
surviving as a trader. That’s enough of my emotional input for now.
Back to business…

Integrating Tools

We have learned why we need to trade with the trend, the meaning of
the important trading indicators, and what to be careful of, but does
that now imply that we can find any stock trending up and buy it? Can
we enter the stock at any moment while it is trending up and the
indicators support continued uptrend?
No!
The market direction and use of indicators are important
components, and even critical to success, but they are not enough. To
succeed, we need to choose the right stocks under the right market
conditions, and most important, at the right points!
You need to know when to click the button and when to get out.
The purpose of this chapter is to integrate these tools, trends,
indicators, and most vital of all, entry points.
Remember! The right entry point is responsible for 80% of your
trade’s success.

How to be a Breakout Winner

Trading at a breakout is a basic trade strategy. It is the most
important and the most used by traders. At the breakout, we expect to
see fast movement of prices beyond the technical formation. The
assessment is that the momentum of the breakout will lead the stock
price to new highs which will allow the trader to realize a profit. The
breakout will always be in the trend’s direction and never against it.
Breakouts are usually accompanied by high volume.

A breakdown is the reverse price action of a breakout. With

breakdowns, we execute shorts. Breakdowns also always occur in the
direction of the trend and never against it. To make the explanation
more accessible, I will focus on breakouts, but remember that the
explanation in reverse is valid for breakdowns.
In the section discussing formations, we learned that the breakout
is based on transitioning beyond the familiar technical formation. We
must plan the breakout at the stage where the formation is taking
shape, and we must remember that not every development ends with
a breakout.

When we identify the breakout formation taking shape, we can

plan the entry point and the appropriate trade strategy. Intraday
breakout is planned for a short interval of seconds, minutes, or several
hours, and usually will be based on a technical formation comprised of
five-minute Japanese candles.
Swing traders planning on holding a trade for several days will plan
their breakout in the same way, but using daily candles instead.

Intraday Breakout, PCAR

In the image above, we see that PCAR begins the day’s trading at
$46.40, rises, encounters resistance at $47.5, and consolidates [1]
beneath the upper price range until the breakout [2]. The interesting
point in this breakout is the fact that the volume did not increase. The
reason is simple: notice the time that the breakout occurred. It was at
the start of the lunch hour break, when most market players (usually
the institutional traders) have gone out to eat.

Why Do Breakouts Occur?

Breakouts occur when there are more buyers than sellers and the price
breaks over resistance. Naturally, our purchase point will be one
cent above the line of resistance. We can imagine a breakout as a large
quantity of water held back by a long dam. The dam wall is the line of
resistance. What happens if and when the dam wall breaks?
Obviously, not only you and I know the answer to that. A large
number of buyers are waiting for the breakout, and many others with
less experience will join the move at later stages, fueling it a little
further. To a great degree, breakouts above resistance are self-fulfilling
prophecies.

Most Breakouts Fail

A breach of the dam will certainly lead to flooding. Unlike the dam, a
breakout from a technical formation does not always succeed.
Statistically, no less than 80% of breakouts fail!
Despite this high percentage, we should not conclude that buying
at breakouts is unwise. On the contrary: we need to understand the
stock’s behavior at the breakout point, anticipate when and why it
may fail, and manage it such that we are assured of our profit from the
initial move, even if the breakout eventually fails.

SMART Eighty percent of breakouts fail. Failure

does not have to lead to loss. We need to
MONEY acknowledge the fact that most breakouts
fail, and instead learn how to take
advantage of them.

A false breakout is defined as a state in which the stock breaks the

line of resistance but returns to it and even below the breakout price
at a later stage. Does a false breakout necessarily lead to monetary
loss? No! The conclusion we should reach is that we must
acknowledge the fact that most breakouts are false, and learn how to
take advantage of them even under those circumstances. If you know
how to handle a breakout, you can leave the losses to less-experienced
traders while you realize a comfortable profit, even as the breakout is
failing.

Consolidation

The more a stock consolidates prior to its breakout, the stronger the
breakout will generally be. A well-known snippet of wisdom states:
the longer the base - the higher into space.
Simply put, consolidation is the breakout’s energy source. The
longer the consolidation, the more attention people will pay to the
stock; the more people there are following the stock, the more people
there will be buying it at the breakout, thus increasing the chances of
success. As the consolidation lengthens, one can almost feel the steam
building up and waiting to burst through!

Planning and Execution

The entry point is simple and clear: we buy a stock that has gone up in
price one cent above the breakout formation.
Later, we will learn that it is occasionally possible to buy even
before the breakout if we are able to assess that there is a strong
chance the breakout will occur. Breakout buying is a very common
method of trading, but requires nerves of steel, the concentration of a
fighter pilot, and high-level technical skills.
Prior to breakout, we need to plan our target price. We estimate
this in cents, and not in percentages: in other words, how many cents
will the price rise after breakout? Estimating the target is based on
integrating market direction and market force, the stock’s force on the
breakout day, and the stock’s history of breakouts. Its history refers to
its intraday behavior over the past two or three days.
It is reasonable to assume that if we look back, we will see that this
is not the only breakout over the past few days. By how many points
did it jump in the previous breakouts: 20 to 40 cents, or perhaps 50 to
70? Every stock has its own unique “‘personality,” and you need to get
to know your stocks “personally.” For some, an amazing breakout is
just a few cents, and therefore will not tend to interest us. Others
breakout often with a range of tens of cents.

What is the Stock Volume?

Low volume is dangerous since it becomes more difficult for us to

realize quick profits. By contrast, stocks that trade millions of shares
per day, such as Citigroup (C), will tend to have more trouble moving
and breaking out. We will therefore look for breakouts in volumes of
more than one million shares per day, but be less interested in those
stocks that trade many millions of shares per day.

The Personality of the Citigroup Stock, (NYSE: C)

Notice how the Citigroup stock locks within a short range of 4 to 6

cents over two consecutive trading days, with a volume of hundreds of
millions of shares per day?
The large volume of buyers and sellers on each side does not allow
the stock to move, and ruins all chances of a big breakout. This unique
“personality” trait damaged the price and only changed when
company management understood the problem and implemented a
reverse split at a 1:10 ratio to the stock price.
A 1:10 reverse split means that for every 10 shares held, the holder
receives only one without incurring damage to his or her capital,
because all shareholders are adjusted accordingly. The price of the
stock then adjusts naturally, so if the price had been $4 per share, it
would now be $40 per share since only 1/10th of the shares now exist.
The outcome was immediate: volume sank and the stock’s nature
altered overnight.

How and When to Click that Button

The correct entry price is one cent above the line of resistance, i.e. the
moment you see that the first trade goes through above the breakout
formation.
Stocks tend to breakout fast, and you need to remember that you
are not the only one waiting for the breakout. At the breakout point,
you will be competing with other traders who will also try to buy.
You can use two kinds of orders:
• If you use the LIMIT order, limiting to 3 or 4 cents above breakout
price, there is a fair chance you will not get your shares, or perhaps
only a much smaller quantity than you had hoped for. For stocks
with low volume, use only the limit order.
• If you use the MARKET order, there is a far higher chance of
successfully entering the trade. The risk is that the MARKET order
carries a “buy at any price” condition, and you may be buying at
higher than you intended to pay. This is a possible, though very rare,
scenario with stocks having high volumes.
In most cases, you will get better results with the limit order.
Do not expect at this point to understand what you have just read.
Practical experience will make it all make sense.

Buying Before Breakout

 As we have learned, the correct technical entry point is one cent
above resistance, but in many cases we try to buy the stock before the
breakout. This is a point in time where, in our assessment, the chance
of breakout is good.
How do we define good chances? Generally, greater than 80% is
considered a good chance.
Why not wait until the first trade above the line of resistance, and
only then buy? For two reasons: to decrease competition with other
traders after breakout, and the possibility of improving our
risk/reward ratio because the purchase price is lower.
In principle, you should try to predict the breakout and buy before
it actually occurs. To do that, you need to closely follow the stock’s
behavior in the seconds prior to breakout. Your trading platform
should be providing you with all the necessary data. You must follow
the chart, the volume, and the balance between buyers and sellers
manifested in the BID and ASK, for every single cent in which the
stock is being traded beneath the breakout point.
Where a price consolidates in the short range, you will see that the
balance between the bid and ask is identical, since the nature of
consolidation is that neither side is victorious in this “war.” However,
when the price approaches the breakout, you can see how the balance
is breached in favor of the buyers, and that the volume of trade begins
to soar. Once you see that the volume is increasing and that the
sellers’ liquidity is almost depleted, that is the point to click the
button.
• Seller’s liquidity refers to the number of shares appearing in the
ASK dropping to zero.
Over time, as you gain experience, your success rate at predicting
breakout moments before they occur will improve.

What happens if you buy pre-breakout and the price does not
breakout? This does not mean the stock will not breakout later on.
Most stocks eventually do, and the only question is if you are able to
cope with the loss until it does. The solution is simple: before the
breakout, buy only half the total amount you had planned on, and at
the breakout, buy the rest if you can. When you estimate that the
chance of the price breaking out is not as good as it initially seemed,
you can generally sell at a loss of just a few cents.

Which order should you use when buying pre-breakout?

When I buy pre-breakout, I tend to use the LIMIT order, limited at
most to the ASK price. If I feel that the price is about to break out
within seconds, I use the LIMIT for up to 3 cents higher than breakout
price. If you realize you have clicked the buy button too late, the stock
has passed your limit and you are left with no merchandise, leave the
limit order open another ten seconds following the breakout. In many
cases, the price pulls back slightly prior to its continued trend up,
making it possible for you to join the breakout. Don’t leave the order
open for too long, since you don’t want to get it filled hours later if the
stock returns to the breakout price after making a good initial move.

Pre-Breakout Volume

Would you want to see an increase in trading volume prior to

breakout?
I imagine your answer would naturally be “yes,” that increased
volume indicates strong interest, and strong interest prior to breakout
would lead to a stronger breakout, right?
In fact, this isn’t necessarily true. Once on the verge of breakout,
the price has already taken the long journey up to this point. The price
has risen, is resting, and we await the next leg of its journey.

SMART Large volume prior to a breakout is not a

good sign, since it indicates a change of
MONEY ownership. Nervous buyers, who may ee at
the rst sign of weakness, take the place of
veteran, relaxed shareholders.
 When you watch a stock’s chart, try to decipher the state of buyers
and sellers. Try to imagine who they are, what they are thinking, and
what you would do in their place. Let us analyze the situation: veteran
investors are the ones who bought the stock a long time before it
reached its current breakout point, and can therefore be defined as
“the strong hands” of the game. They profit nicely and are not
sensitive to slight fluctuations in price. By contrast, new buyers, who
bought around the consolidation point prior to the breakout or
immediately following the breakout, are the “weak hands” since they
have not yet earned a cent. They are highly sensitive to every loss, and
any small change in price may pressure them to exit, contributing to a
failed breakout.
Large volume during consolidation and pre-breakout means
multiple buyers and sellers and a lot of shares changing hands. We
need to assume that veteran investors are realizing profits, whereas
nouveau buyers are the “weak hands.” The conclusion is simple: when
large amounts of shares change hands, ownership moves from strong
holders to new, weak holders who will likely panic at the slightest fail.
Compare the situation to a residential neighborhood where you
live. Let’s assume a large number of real estate transactions occur
there. A lot of homes are changing hands. In a few years’ time, will it
remain the same neighborhood you know so well? Of course not. The
populationchanges, and the nature of the neighborhood with it. The
same happens to the stock you are buying. Large volume prior to
breakout means a change of ownership. That, in turn, means changed
behavior of the stock. The change may cause higher sensitivity or
jitteriness, and even a failed breakout.

The Fear of Clicking the Button

A common phenomenon among new traders is the fear of clicking the

button. The price breaks out and new traders watch it, paralyzed,
trying to gain confidence while the stock rises cent by cent. By the
time new traders buy, they will usually pay too high a price. It is a
familiar phenomenon. I was there, and extricated myself. No doubt
you will experience it too.

Summary of the Buy Process

During consolidation, you do not want to see a particular high

volume. You want to try and predict the breakout and buy, if possible,
a fraction beforehand. After the breakout, you want to see increasing
volume. Volume that is dying down indicates loss of interest, and
raises the danger of a failed breakout.

When to Sell?

Entering a breakout is a precision technique. It does require no small

amount of experience, technical ability, and psychological stamina,
but it can be clearly defined. By contrast, identifying the exit point is
far more a matter of “artistry” than precise information.

As we learned, you should try to estimate the breakout target in

advance. This estimate will be based on past price behavior and
market conditions, but during the breakout, you need to examine
several variables in real time:

• Has there been a reduction in volume following the breakout,

indicating decreased enthusiasm?
• Are buyers increasing their buy orders during the uptrend? When
buyers chase a stock, its chances of success are greater. You can
watch the pursuit in the form of renewing quantities in the BID.
• As the price trends up, can you see a large seller displaying a serious
quantity in the ASK?
• Is that seller renewing quantities each time he or she successfully
sells?
• What is the market direction? Does it assist you? Go against you? Or
is it going nowhere?
• What is the direction of the sector to which the stock belongs?
All these factors need to be taken together to present you with an
overall status of the stock and its chances of lifting off to new heights,
or the immediate need to click the button and realize your profit. As
you see from the bulleted points above, there is no precise, black and
white answer, as you may have wished. A rule of thumb generally says
that most breakouts end with taking a partial.
• The first profit-realizing point, which is a partial profit, is known
simply as a partial.

A first partial can be taken at between 14 to 30 cents from the

breakout point. High-priced stocks, however, may allow you to take a
partial of a half dollar, dollar or even more. As you see, there is no
hard and fast rule.

How Much to Buy? To Sell?

Every trader must operate within his or her limitations: the amount of
money in the account is one factor, and the other more important
limitation is his or her psychological ability to gain or lose money.
There are several more factors that dictate the correct mode of
operation, and which have nothing to do with your own limitations.
The minimum amount of a breakout purchase must be 400 shares,
and the maximum is generally thousands of shares and dependent on
liquidity and the amount of money in your account.
• Why the minimum of 400? The main reason that I like to use 400
shares is because I prefer to take a partial of at least three-quarters
of the amount bought at breakout. An amount of 400 allows you to
execute a partial with a round figure of 300 shares. A smaller
amount, such as 300, will not allow you to sell three-quarters which
would be 225, and a round figure of 200 is not three-quarters but
only two-thirds.
• Another reason to use 400 shares is the dollar profit target: an
amount of 400 shares should contribute an average of $100 profit at
breakout. If you are day trading, you should not be satisfied with
less than this.

SMART At breakout, realize three-quarters of the

amount you bought and put that money
MONEY deep into your pocket. Remember: we never
return our pro ts to the market!

After closing out 300 shares, you need to continue managing the
100 shares that remain. I tend to realize three-quarters of the amount
in the first partial, since I am a firm believer of “putting that money in
my pocket” when I am shown to be right. I am also aware of the fact
that holding the remaining 100 shares is like a gamble without any
apparent advantages, since the real advantage was reaped at the
breakout. The rest depends on the trend and fate. Sometimes those
remaining shares will allow me to reach a greater profit than the
partial, and sometimes they will drop beneath the entry price and
cause some minor damage. In any event, the 100 shares left after a
partial of 300 are never meant to bring you to a loss. Remember this
fundamental important rule: We never return our profits to the
market!

What Happens When a Breakout Fails?

You’ve bought at the breakout. The price goes up several cents, and to
your sorrow, begins to drop. Why did the breakout fail?
The answer is simple: there are more sellers than buyers. But that is
not enough an explanation, so let us look a little deeper at who these
sellers are. There are two possibilities: the first is that you have simply
made a mistake and gone for the wrong stock at the wrong time. In
other words, the stock you chose was weak, or the market or its sector
dropped at precisely the breakout moment. In such cases, you should
exit as quickly as possible and absorb the loss. Another explanation is
that the big players are trying to shake out buyers like you. The big
players, who know your entry point and know how pressured you will
be over a drop in price before making any profit, may take advantage
of the expected volume at a strong breakout in order to sell large
amounts, which would otherwise be difficult to sell. The result is a
drop in price that snowballs and brings the price down to where large
market players are buying up again, much more cheaply. Perhaps from
that point on they will allow the stock to rise safely.
When I find myself in this situation, I tend to wait until the
hysteria has died down, and then happily increase the amount of
shares which are now 15 to 20 cents beneath my entry price, before the
stock price begins to pull back to the breakout level. This kind of
situation generally occurs within several minutes. If the stock does not
return to its high within several minutes, get out!

How to Short at Breakdowns

As noted, shorting at breakdowns is essentially identical to buying at
breakouts, but in reverse. The goal, of course, is to take advantage of
the down-trending momentum of the price. Whereas breakouts are
nurtured by greed, which by its nature weakens once the object is
attained, breakdowns are fed by the fear that fills the investor who
sees a stock crashing before his or her very eyes, and wants to be rid of
the holdings as quickly as possible.
Hysteria takes hold very quickly, and therefore breakdowns are a
favorite of mine, more so than breakouts. Since breakdowns are
speedier, you will need to be faster in your reaction, keeping your
finger on the mouse, but you will generally receive good
remunerations faster, too.
 The second difference between breakouts and breakdowns is the
timeframe that breakdowns last: which will be as long as the hysteria
continues, and the nature of hysteria is like a house catching on fire. It
erupts fast, but dies down even more quickly. The “festival of lows”
will generally end within one to two hours of commencement, and
then a stock that broke strongly will tend to pull back, or retrace, a
considerable part of its fall. This is also why I generally will not “sleep
on” shorts with the same quantities as I would if I were holding longs
for a swing of several days.

Breakdown Short, Estee Lauder Cosmetics, EL

At [1], EL breaks down with the classic inverted cup formation. We

see a lot of enthusiasm, large volumes and eventually, the calm. Notice
how after the first breakdown the stock continues to move sideways,
and by the end of the trading day [2], ends at the price level of the first
low. In other words, the hysteria has lessened and the stock has
“calmed down.”
Winner Reversals
Buying at a breakout is the fastest but also most dangerous method.
Buying a reversal (change of direction) is based on patterns of
direction change, which we learned about in previous chapters. It is
simpler, slower and far less risky. Relative to other methods, it is
definitely a method recommended for beginners!
Reversals are based on continuing trend. The classic definition is a
change of direction within the trend. This describes a stock’s
movement from highs to lows and back to a high (or from low to high
and back to low).
• A reversal that brings the stock back into the uptrend is called a
roll-up
• A reversal that brings the stock back into its downtrend is called a
roll over

When are Reversals Preferable to Breakouts and

Breakdowns?

During the opening hours of the trading day, when the trade volume is
relatively high, both methods work well. However, the closer it gets to
lunch hour, the volume of trade decreases, together with chances of
breakouts and breakdowns working. This does not mean we cease
trading breakdowns and breakouts in later hours of the day, but as
time passes and volume decreases, we will also lessen our risks by
trading in smaller quantities.
For this reason, beyond the first ninety minutes of trading we
prefer not to enter a stock at a breakout or breakdown, but wait for it
to pull back, knowing that almost certainly the correction, or pull
back, will occur. Stock prices never rise in a straight line. They always
pull back, which allows you to buy them more cheaply. Buying at
pullbacks reduces the risk of loss and provides a greater range of
security. When the stock has ceased pulling back and once again
reaches the breakout point, we are already in a position of good profit.
The stop point is still a way off, and the chances of a second breakout
where the stock will peak are much higher.

Entering a Reversal: Market Rules

For a successful trade, we need a market helping us in its general

direction. This means we need to enter a reversal with a trending up
stock only when the market, as embodied by the S&P 500, supports
continuation of that trend (or the reverse for a trending down stock).
Of course, we must ensure other fundamental market conditions as
with any trade, such as an appropriate risk-reward opportunity ratio, a
reasonable stop point, and changes in volume that match the trend
direction. For example, when a trending up stock pulls back, we must
check that the volume is decreasing as the stock drops, but when the
stock returns to its initial trend, we would prefer to see volume
increase. The meaning of increasing volume is that you are not the
only ones identifying the opportunity, so you benefit from the
assistance of other traders.

The Entry Point

The correct entry point is responsible for 80% of a trade’s success. The
entry point in reversal is not a precise science, but I will try to define it
in a way that allows you to come as close as possible.
We buy a reversal only when the stock has made a real pullback
from its peak. The way to “feel” the right entry point is to try and
imagine when you might sell the stock if you had bought it at its peak,
but it trended against you. Observe the entry point and imagine where
you would feel pressured and want out. If the stock has dropped below
that point, it means that most of the weak buyers have already sold,
and that this is therefore the correct position for clicking the button.
You need to do the exact opposite of what pressured buyers who
bought at the peak did.

Intraday Reversal for the Fuel Company Occidental, OXY

In this example, you can see the intraday reversal traded in my

trading room. OXY opens strongly and rises when trade begins for
four five-minute candles, from $86.50 to $89, a rise of 2.9%. A stock
rising almost 3% in 20 minutes with a volume of hundreds of
thousands of shares has a strong chance of reaching higher peaks.
OXY did display strength at the start of the day. Remember that a
stock chart rising a half-percent looks similar to the stock chart for a
stock rising 2.9%, but they are not identical at all. Most stocks will be
traded with sharp highs or lows during the first ten minutes of
trading, which says nothing about what will occur later. However, a
stock’s rising more than 1% in large volumes causes me to understand
that something positive and not coincidental is happening. Clearly the
stock wants to keep rising, and its chances of preserving the uptrend
are very high. OXY pulls back for about half its high, displays a classic
reversal at [1], and then easily goes higher than its first peak.

Since I tend not to buy stock during the first ten minutes of
trading, and definitely do not “pursue” a stock rising quickly, I waited
patiently for the painful pullback. Why “painful”? Read what I wrote at
the start of this section: imagine a situation where you made the
mistake of so many novices and bought during the stock’s first jump,
or even at its peak at $89, then saw the stock drop halfway back to its
starting point. How would you feel to watch a pullback of $1.50?
Would you stay steadfast, or sell? Would you feel pressured? Try to
imagine where you would feel pressured: that is the buy point! If you
also need visual assistance, you can use the Fibonacci lines for entry at
pullback with a range of 30% to 60% from the peak.

Once the pullback is established, the stock shows a classic reversal

in five-minute candles, and indicates its willingness to bounce. In the
trading room, I announced an entry at $88 [1]. We entered, sold half
the quantity at [2], and another quarter at the peak [3], totaling some
$1.40 above the entry point. We left the last quarter until the end of
the day, and one-eighth was transferred to the next day when, to our
great joy, the stock continued trending up.
What would have happened if I had entered at the wrong point and
suffered a loss of 20 to 30 cents? The answer is simple: I would not
have exited. I would wait for the reversal in five-minute candles even
at the lower price, and pray for the stock to rise. Why? Because the
stock rose several percent in just a few minutes. Without doubt,
something positive is happening there: after all, it’s a strong stock. The
fact that I bought at $88 [1] says nothing. I could have been wrong. The
stock might have dropped several tens of cents and only then begun to
trend up. No one can promise that my entry point is the correct one,
even if I were buying according to the best of rules. But the formation
of the five-minute candles led me to believe that chances were good
for this being the best entry point. You need to keep in mind that the
stock is strong, and therefore in most cases, it will end up, even if it
temporarily drops below the buy point.

In some cases, however, the price will not recover and I will lose
money. When that happens, it is definitely not pleasant, but it is part
of the statistics which overall work in our favor. It pays to absorb a few
losses if more frequently we generate handsome profits. It is better to
occasionally suffer and frequently profit. Remember that intraday
changes of direction, even if based on clear reversals in five-minute
candles as you see in the stock chart, are significant but do not
necessarily indicate the correct entry point. It is enough for one large
seller to want to drop a large quantity at the click of one button to
change the chart’s ideal status. My suggestion is simple: believe in the
stock, even if it continues to drop after you bought it. Remember that
when that happens, it has still done “nothing wrong.” That’s what
stocks do. The stock does not care whether you have erred in
estimating the entry point and bought a little too high. You must keep
in mind that strong stocks reverse back to highs in most cases. Period.

SMART Have you entered a stock that is not working

in your favor? Before eeing at a loss, check
MONEY the chart carefully and ask yourselves
honestly: “Has it really done anything
wrong?”

When can we nonetheless start “getting angry” at a stock? When

does the concept of “it’s done nothing wrong” no longer apply? Look
at the chart and imagine a situation where you bought at [1], but the
stock did not return to its uptrend, and instead continued trending
down. Where is the point at which you’d start to get angry, or begin to
doubt whether it would reverse and trend up? My answer would be at
around $87.25. At this point, I would begin to realize that “something
wrong” has taken the place of the strong start, and I would exit. You
can definitely be assisted by the Fibonacci line of 61.8% to determine
when the price pulls back a bit too much. I would not exit precisely at
the 61.8% level, but I definitely would not stay with a stock that
dropped much below that.
Why did I exit so quickly at [2]? In retrospect, it is clear that I
should have waited a little longer, but in real time I had no idea that
the stock would rise by almost $1.5 from its reversal point. Secondly, I
needed to put that trade behind me as quickly as possible. Remember,
I want to see profits. In this case I realized “half my size” in order to
get to the point where the other half was a “free trade.” In other
words, following the initial realization, I am at the point where I
cannot lose on the trade even if the price drops below the entry point.
Selling half the quantity, even at a smaller profit, helps me let the
second half reach a peak that I am not sure I would have
psychologically been able to allow had I been holding the “full size”
and fearing I might lose out on the entire process. Realizing profit
does not have to be logical from a purely mathematical viewpoint.
When it is psychologically logical, it becomes mathematically logical,
i.e. within the range of profit.
Should we buy only after a clearly displayed reversal in five-minute
candles? The example above is clear and simple, but many other
stocks do not offer a chance to wait for a classical technical direction
change such as the lower doji. In such cases, you need to develop
sensitivity and buy the stock during its downtrend at the point where
you estimate a suitable change of direction. Clicking the buy button
will occur before the classical reversal shows on the chart in five-
minute candles. To improve your estimated entry points, carefully
examine the quantity of buyers and sellers noted in the BID and ASK
areas of your trading platform. When it seems to you that the stock is
at its optimal point and the number of buyers is greater than sellers,
click the button. In cases such as these, which are naturally less clear
than the classic reversals in five-minute candles, I will usually buy
using half-size and wait for clearer technical indicators in order to buy
the second half. I will also buy that second half even if the price is
lower than my initial entry point, or if the price rises immediately,
than at a higher entry point that is not significantly higher than my
initial entry. In other words, I am willing to admit my error and
understand that I bought the half-size at a slightly too high price, and
add the remainder at a lower price. However, if it becomes clear that I
have bought at the right entry point and the stock price rises, I am not
willing to chase the price and buy at significantly more than I
originally paid, and will therefore make do with just half the size.
Being in control of this procedure requires a good degree of skill,
experience, and “artistry,” and is not suited to new traders. As long as
you are still new to trading, seek classical reversals, and if there are
none, forego the trade and wait for the next interesting stock.

Summary: Reversals
Unlike buying at a breakout or shorting at breakdown, buying at a
reversal is a more correct and calmer entry point, less risky, and with a
better risk/reward ratio. Its disadvantage is its psychological strain. It
is far more natural and simple to buy at the breakout of a new high. At
the breakout, we buy a stock reaching new highs, while in reversals we
buy stocks trending down during their overall uptrend. Buying a stock
trending down will always be more difficult psychologically than
buying a stock trending up. We need to overcome our natural
emotions and hesitation, understand that strong stocks almost always
pull back, and that their chances of returning to highs are far greater
than their chances of continuing to drop. Be courageous, and click the
button. Don’t worry: with a little practice and experience, it will all
become clear.

Trading Gaps
First we need to define the term “gap.” It is the difference between one
day’s closing price and the next day’s opening price. When a gap
forms, the first trade of the day will be higher or lower than the
closing price of the previous day.
• A GAP UP forms when the stock opens at a higher price than the
previous day’s close
• A GAP DOWN refers to an opening price which is lower than the
previous day’s close
In fact, a gap almost always forms, and the first trade of the day in
any stock will be different even by one cent than the previous day’s
close. Small gaps are insignificant, so we will describe how the more
fundamental gaps come into being. These are usually in the range of a
half-percent or more.
Why would a price open differently than the previous day’s close?
Usually this is the result of news or rumors circulating between
closing time and the next day’s opening of trade, such as when a
company publicizes its financial reports during the after hours. In
other cases, it may be no more than a pullback from a day of sharp
lows or highs, or due to market news that is not related to the stock
itself but to the mood of investors.

Gaps Almost Always Close

Gaps have expectable behaviors. This means you need to learn how to
handle them, whether you are holding stock you bought the day
before and which opens the new day with a gap, or whether you are
planning an entry into a new stock opening with a gap.

SMART Most gaps ll: 80% of gaps ll on the day of

trading in which they come into being, and
MONEY 90% close within ten days.

The most important information you need to know concerning

gaps is that 80% of them fill on the same day they developed, and 90%
are filled within ten trading days. For example, if a stock opens with a
gap up, it is likely that during the same day of trading it will drop to
the previous day’s close, thereby closing or filling the gap. The
opposite is true for a stock opening with a gap down. It is reasonable
to assume that during the current day, its price would climb to the
previous day’s close and the gap would close.

Gap Up for Baxter at Opening of Day’s Trading, BAX

 Baxter ends the day’s trading at $47.24 [1] and opens the next day at
$47.61 [2], showing a gap up of some 0.8%. Here we see the common
phenomenon resulting from negative information which led to the
previous day’s drop, followed by opening the next day with a gap up
that somewhat pulls back from the previous day’s sharp low. Note that
in this particular case, the gap created on the second day of trade is
“trapped” in the range of the first day of trading. The fact that the gap
is trapped further increases the chances of the gap closing. As you see,
during trading, the price drops and closes the gap [3] and immediately
thereafter changes direction and rises back to the opening price level
[4].
The gap-closing phenomenon, especially when relating to a gap
trapped in the previous day’s trading range, is well-known and carries
an 80% intraday chance of success.

Important note: the above is valid for gaps less than 3%. Higher
gaps will not close to the same degree, and in many cases will
continue moving in the direction of the gap rather than towards
closing the gap.

Why Do Gaps Form?

Generally, a gap already forms at the pre-market stage, because buyers

are willing to pay a higher price for the stock than the previous day’s
closing price, or sell for a lower price than the previous day’s closing
price. The pre-market open price is set by the market makers in
accordance with supply and demand, as conveyed to them several
hours prior to trading. When demand is greater than supply, the stock
will gap up; when supply is greater than demand, the stock will gap
down. As we will learn, stocks are also traded during pre-market
hours!

Why Do Gaps Close?

The explanation begins with the previous day’s trading, where an

institutional buyer received instructions to sell a large quantity of
shares (in the current example, BAX).
Firstly, we need to keep in mind that institutional traders buy or
sell large quantities of shares and therefore scatter their sell orders
across several days so as not to adversely affect the stock price. Their
goal, of course, is to sell at the highest price possible, since if they do
so (relative to the stock’s behavior on that particular day: see the
section on VWAP), they receive handsome bonuses.
Let us assume that the institutional trader who sold BAX on the
first day of trade has not yet completed his or her task, and still holds
several hundred thousand shares which must be sold the following
day. At the start of the next day, the trader tries to complete the task
and sell more shares.
Keep in mind that the trader was willing to dispose of them for
yesterday’s close of $47.27 [1]. To his or her great joy, the second day of
trading opens and the trader finds that buyers are willing to pay $47.61
[2], some 0.8% more than the previous day’s closing price! For the
institutional trader, this is a gift sent from heaven! The trader knows
that if he or she sells for more than the previous day’s close, a fine
bonus awaits. What does the trader do? Rub his or her hands with
glee and sells! How far down will the trader sell? For as long as the
price remains above yesterday’s closing price: in other words, for as
long as he or she can earn a bonus! Institutional traders do not rush.
They know they have the ability to flood the market, but they do not
want to see sellers changing market direction too quickly. So they sell
a little, wait until buyers return, sell a little more, and so on. We need
to keep in mind that the institutional sellers are also competing with
other institutional sellers. Within a short time, buyers run out of
steam and only sellers remain. This is when the stock begins to move
“south,” or to drop. For as long as the price remains above yesterday’s
close, institutional sellers keep selling, which earns them a bonus. The
instant the price drops to yesterday’s close, there is no bonus anymore.
The institutional seller sells until the price drops to $47.27 [1], and at
this point stops. This is when the stock frees up from the institutional
traders and begins to rise again [4]. The outcome: the gap has filled.

Most gaps close by the first hour of trading. It all depends on the
quantity of institutional traders taking advantage of the chance to
profit from the gap, and the competition among themselves as to who
will sell first.

We must also remember that at every price level are non-

institutional buyers and sellers. When a stock opens with a gap up at
the start of trading, it does not arouse automatic buy orders. This is
because buyers generally do not lodge automatic buy instructions
when a stock is rising and goes above a certain price, but sellers do set
automatic orders. Let us say, for example, that you bought BAX at the
bargain price of $47.27 [1] and set an automatic sell order in order to
realize profit, should the stock reach $47.61 [2]. Admittedly, you
expected to earn your profit by hard work, but happily you woke up in
the morning to a wonderful new reality: with the opening of trade, you
discover the price is $47.61 [2]. What happens to the automatic order
you set before the day’s trade began? It is immediately hit! In other
words, as long as we are above yesterday’s closing price, we are in the
territory of private sellers joining the institutional traders until the
gap closes.

Clearly, all the conditions relating to a gap up apply in reverse to a

gap down, where the stock price opens lower than the previous day’s
close. In the case of a gap down, the price will be pushed up by the
activities of institutional buyers. In this case, the number of buyers
who began purchasing the previous day will discover that the stock
price is lower than it was at yesterday’s close. For them, this spells a
bonus! They will buy until the gap closes, or at least 80% of the time.

Closing the Gap, BBBY

In this chart, we see the gap up for BBBY which closed its prior day
of trading at $46.03 [1] and opens the second day at $46.22 [2]. Notice
how it dropped and closed the gap within just fifteen minutes. The
point where the gap closed [1] is the point where institutional traders
ceased selling and the stock receives the “green light” to keep trending
up. Remember that 80% of the gaps close on the day of trading itself,
and over 90% close within ten days!

Never Chase Gaps

Let us say you decided prior to trade that you wish to buy BBBY if it
goes higher than $46.3. You check at the start of trading and find it
opens with a gap up, and in just a few more cents it is likely to reach
your trigger price. Looking wonderful! Should you buy?
At this point, an alarm should sound in your mind. Remember the
saying: “We never chase gaps!” Even if your heart says “buy,” the
hours of study we’ve spent together should be enough to loudly ring
“stop!” Why? Because the chances are high that the gap will close.

SMART Do you want to buy a stock? Not if it

opened with a gap up. Remember: we never
 MONEY chase gaps

Gaps in Dual Stocks

Breaking the norm are stocks traded on more than one stock
exchange, such as Toyota, which is traded on both Wall Street and the
Tokyo Stock Exchange. These are known as dual-exchange traded
stocks.
Since the trading times on Wall Street and Tokyo do not overlap,
Toyota will almost always begin the day with large gaps in accordance
with the closing price of the other stock exchange.

SMART Gap formations in dual-exchange traded

stocks are not valid! In general, we avoid
MONEY trading in most of the dual-exchange
traded stocks.

Note how easy it is to determine that Toyota (TM) is a dual-

exchange traded stock:

In the daily chart above for Toyota, we can clearly see that every
trading day opens with a gap. This is a distinct formation indicating a
dual-exchange traded stock.
Market Index Gaps

Since the S&P 500 market index represents the 500 leading stocks, it
will display the cumulative gaps for all the stocks it encompasses.
When the market index opens with a gap up of a half-percent, what
does this imply for all the stocks comprised on the index? The
cumulative meaning must also be a gap up of a half-percent. Of
course, some stocks may open with a greater gap up, some with less,
and perhaps even some with a reverse gap, but the average must be at
least equal to a half-percent.
Let us presume that the 500 top Wall Street stocks open with a gap.
What should happen next? Eighty percent of the money in those
stocks belongs to institutional rather than private players. Since the
institutional players, as we have learned, are interested in selling as
long as the gap is open, in most cases the market index gap will close
exactly the same way as the gap for a single stock comprising the
index will close.

Gap Close for the ETF – SPY

Notice the openings for the last six trading days on this chart. They
all open with gaps, and they all close. Days 1, 3, 5 and 6 already close
perfectly on the same day, and days 2 and 4 close partially the same
day and complete the close by the next day. Based on these gap
closings, can we define a winning trade strategy? Of course we can!
Strategy Label: Closing the Gap for the ETF – SPY
• Entry point: at opening of trade, long or short in the direction of the
gap closing
• Entry conditions: the SPY must open with a gap of at least 20 cents,
on condition that the gap is no greater than 85% of the range of
movement of the previous day’s trading (the difference between the
highest high and lowest low of the day’s trading), nor less than 15%
of the previous day’s trading. Reason: a gap that is too large
indicates extreme events which may lead the market into sharp
movement, increasing risk. A too-small gap is not interesting.
• Exit point:
1. Sell at the end of the day’s trading if the gap has not closed; OR
2. Sell when the gap closes.
• Outcomes: during the three years between October 2007 and
October 2010, 471 gaps upheld these criteria.

Assuming you had invested $16,000 in each trade, these are the
results:
o Maximum profit per trade: $373.9
o Maximum loss per trade: $778
o Average profit: $55.86
o Average loss: $145.01
o Success rate: 81.95%
o Weighted success rate: 63.62%
o Overall profit for three years: $9,236
o Average annual yield: 17.58%

Summary
The method works. The method’s Achilles heel is the 18.05% of cases
where the gap does not close: days when the market opens with a gap
and keeps moving, or as the phenomenon is known, Gap & Go. On
rare days when the market “escapes” us, the average loss is far greater
than the average profit, thus the weighted success rate is lower.
Trading the QQQ
In the chapter detailing indicators, we learned the importance of using
Bollinger Bands. We also learned that when a stock price reaches the
upper band, it is in a state of overbought territory and must return
down. By contrast, when it drops to the lower band, it is in oversold
territory and there is a strong chance of it retracing upwards.
We also learned that you need to define the band data in your
trading platform to calculate 10 periods and a standard deviation of
1.5, which means that the Bollinger Bands will be calculated according
to stock’s volatility over the previous ten trading days. The
mathematical significance of a 1.5 standard deviation is that 90% of
the stock’s movement will be caught between the two bands.
Based on the above, we should be able to assume that a stock or
ETF which moves beyond the boundaries of the bands will return to
these boundaries. Here is an amazing trade method which takes
advantage of this premise:

Daily Chart for NASDAQ 100 ETF – QQQ

For four months, I wrapped the daily chart for QQQ (known as the
Qs) with Bollinger Bands according to the definitions above. Notice
how the bands expand or contract as the Qs’ volatility increases or
decreases. You can see how the bands “wrap up” most of the Qs’
movement. Notice also that every time the Qs break the bands, they
return.
 SMART Hedge funds use similar strategies. The
advantage of the Qs for hedge funds is in
MONEY the large volume, which allows reliable
entries and exits with large sums of money.

Strategy Label: Daily Pullback for QQQ

• When to buy? When the Qs drop beneath the lower band
• Indicator: Bollinger, 10 periods, SD 1.5 (standard deviation)
• Buy point: Buy the day after the closing price was lower than the
bottom Bollinger Band. Buy the ETF at the opening price of the next
trade day ONLY if the opening price is still lower than the bottom
band.
Why do we NOT want to buy at the previous day’s closing price?
Buying on the day after the first drop is meant to ensure that
hysteria has passed and the dust has settled. During periods of
hysteria, the opening price of the second day is likely to be far
beneath that of the first day’s close. On the Qs chart, five buy points
which uphold these criteria are marked “B.”
• Sell point: Sell immediately when one of the following conditions
appears:
1. At the end of any day of trading when the NASDAQ QQQ closes
higher than your buy price (even if that is the same day on which
you bought); OR
2. At the end of 20 trading days (one month).
• NOTE: as long as a trade is open, do not enter another trade. Close
the open one first. The purpose is to prevent a large loss during
periods of extreme hysteria when the market may not “return” as
anticipated.
• Exercise: in the Qs chart, analyze the buy and sell points according
to the rules we learned. You will find that we have a 100% success
rate. In four of the five instances, the sell point occurred at the end
of the same day that the buy was made, and in one case, we were
forced to wait for five trading days.
• Outcomes: in the three years during which I checked this strategy,
January 2005 to end 2007, I documented 45 events in which the
NASDAQ QQQ provided buy opportunities according to the
strategy above. Here are the details:
o Successful trades: 41
o Failures: 3
o Success rate: 93%
o Average profit per trade: 0.4%
o Average hold time per trade: 5.07 days
o Overall period profit: 17.6%
• Parameter change: the Achilles heel of any trade strategy is its
sensitivity to minor changes. A slight change of parameters can
bring about considerable change to outcomes, but may impinge on
the method’s reliability. If, for example, you change this method’s
parameters to 20 periods and SD 1, you will find that the success rate
stands at over 90%!
Is this method also valid for single stocks? Yes. Instructions follow:
• Buy point: Buy the stock that belongs to the NASDAQ 100 the
morning after it closed beneath the lower Bollinger Band, on
condition that its new opening price is still lower than that band.
• Sell point: Sell immediately when one of these conditions is met:
1. At the end of any day of trade when the stock closes higher than
your entry point (even if that is on the same day you made the
purchase); OR
2. When 20 trade days (one month) have passed.
• Outcomes: during the four-year period I checked, from January 1999
to January 2003, a total of 3,870 trade opportunities upheld these
criteria. Details for that period as follows:
o Successful trades: 3,684
o Failures: 186
o Success rate: 95.19%
o Average profit per trade: 2.77%
o Average holding time per trade: 3.06 days
o Sequence of successes: 121
o Sequence of losses: 3
Summary
Not bad at all!
Results can be improved if one is willing to increase the risk and
operate as hedge funds do, using margin to double and even
quadruple their outcomes. No large investment is needed to execute
44 NASDAQ QQQ trades over a period of three years. Any sum of
money is suitable, and the risk is relatively small.
On one occasion, a man who recognized me in a public place
approached and said, “You don’t know me, but I owe you a lot of
money!” I was amazed to hear his story. It seems that based on an
article I’d penned describing this strategy, he’d tested the method,
reached favorable outcomes, established a hedge fund, and recruited
tens of millions of dollars from investors. Although the fund now
employs diverse strategies, this is still its leading, most successful one.

Scalping
Traders can be divided into three types: swing traders, day traders,
and scalpers. The three methods can be integrated, which is my
preferred mode of operation.
Scalping refers to very short-term trades. Swing traders hold stocks
over to the next day, and day traders generally try to get as much from
the stock as possible within one day of trading. Both swing and day
traders generally base their systems on technical analysis with a touch
of fundamental analysis.

Scalpers are based one hundred percent on technical analysis. Their

goal is the very short term. Changes of just a few cents for several
seconds up to some minutes are sufficient. This means that in order to
earn a livelihood from the market, scalpers need to trade in relatively
larger amounts than day or swing traders. Scalpers with little backing
(which is, sadly, the case for most of them) make up for what their
pocket lacks by trading in financial products which can be leveraged
more than the typical leverage of the world of stock trading. These
may include futures, leveraged twenty times more, options, and of
course FOREX (foreign exchange) which can reach leveraging of up to
500 times more, expressed as 500:1 margin. The absurdity is that
trading in these strongly-leveraged products is harder and incredibly
more risky than stock trading. Nonetheless, the dream of “striking it
rich quick” draws people with no funds and no experience into the
hardest areas of trading, where they will often begin, and almost
invariably end, their trading careers.
Here is a classic career-end scenario typical of most of the
leveraged-futures traders I know:

Note What Happens to the SPY Within Several Minutes:

On May 6, 2010, for reasons that remain unclear, a large fund

accidently sold a huge amount of S&P 500 futures in one sad click of
the button. In recent years, in light of increasing usage of algo trading
platforms, such events occur with increasing frequency, so much so
that the name “fat finger”was invented for the phenomenon. In this
case, the fat finger sold S&P 500 futures and crashed the futures index
(ES) by 10% within seconds.
It was a shocking event, known as the “Flash Crash,” which kept
traders worldwide glued to their screens, thinking for a moment that
the end of the world had come! And indeed, the end of the world had
come for some of the larger futures traders who use 20:1 margin. In
actuality, by what would become understood as the halfway point of
the drop, when the ES fell “only” by 5%, their entire accounts were
wiped out, since 5% at 20:1 = 100% ! When their accounts reached a
zero balance, their brokers automatically closed the accounts, and
when the market pulled back just several minutes after the fat finger
had made its move, those traders were left in complete shock, with
accounts showing a perfectly round zero. That was the last day many
futures traders I know ever traded, and I’m sure the same is true for
thousands more whom I do not know.

SMART Leveraged scalps are guarantors of failure:

if not today, or even next year, their day of
MONEY judgment is bound to come.

As I hope you now understand, trading with margin is extremely

dangerous, since scalpers tend to “stretch” their accounts using
leverage to the very furthest boundaries possible. They can, in fact,
profit hugely and for long periods, but it is enough that just once every
few years they encounter one single fat-finger incident or other
extreme phenomenon (such as the 9/11 tragedy) to wipe them out of
trading forever.
In my experience, scalping can cause you far more harm than
benefit during your first years of trading. I wondered if I should even
devote any space to scalping activities, fearing that you may be
influenced by reading about them and be drawn to trying the method
out. I chose a compromise: to describe the activity while emphasizing
the extreme dangers. A successful trader needs a high level of self-
discipline. If you have that, read, internalize, and please stay clear of
scalping until you are very far advanced in your development as a
trader.

When are Scalps Executed?

There are several ways to execute scalping. One occurs when we
estimate that a sharp price movement is about to occur. The goal will
be to enter and exit quickly. Why exit quickly, rather than stay a little
longer and improve the results? The answer depends chiefly on the
timeframes, of which there are several that are suited to very short-
term scalping:

• When trading opens

During the first ten minutes of trading, most of the volatile stock
prices are seen on our screens as “going crazy,” and in most cases, this
is because of private investors who have given their brokers pre-
market buy or sell orders. These are executed at market price during
the first half hour of trading, and can agitate stock prices strongly. If
you follow a particular stock, such as Apple (AAPL), you will learn
how to gauge its start-of-day behavior and find, over time, that with a
surprising degree of reliably you can predict its behavior. Apple can go
up as much as one dollar during the first five minutes, retrace the
entire price rise in the next two minutes, and continue to any
direction afterwards, regardless of those first minutes. Can you profit
from a fluctuation of one dollar in either direction? Of course, on the
condition that you have a lot of experience, the nerves of a fighter
pilot, and a lot of money to waste until you “perfect” the method.

• Lunch hours
Often enough, I encounter a winning formation during New York’s
lunch break (11:30 to 13:30). During this timeframe I do not expect
considerable market movement and therefore I know that if I buy a
stock at the breakout, I should not expect continued strong movement
in the breakout direction, but rather a very short breakout often
followed by quick failure. Lack of trust in the breakout continuity does
not mean I am unwilling to take a profit of 10 to 20 cents and quickly
flee before the stock breaking out changes its mind! Lunch break is
also the time when the “one cent traders” are most active: more on
that method later.

• Close of trading
 For scalping, this is the best time possible. During the last hour of
trade, and especially during its second half, volumes grow due to end-
of-day institutional fund activity. The problem with this last hour is
the lack of continuity. Continued movement cannot be expected, so
developing profit can’t either, since the day’s trading simply ends.
During this timeframe, reverse formations are usually most successful:
for example, a stock that rose strongly may pull back for part of the
high since many investors may wish to realize part of the profits,
lessen risks, and “go to sleep” with fewer open trades. The reverse
occurs with a stock price dropping strongly, when short sellers that
pushed it down all day begin to realize profits (i.e. they are now
buyers) and the stock pulls back part of its drop.

Example of Scalping with DOW

This is a classic scalp, executed on May 4, 2010 in our trading room,

during the last half hour of trading. DOW, a leading chemicals firm,
crashed with the entire market as a result of rumors publicized on
that date that Spain would be the next European country reaching
insolvency. Whereas the market indicator dropped by 2.5%, DOW
dropped some 8%. We estimated that shorters, who enjoyed a field
day with the stock for almost all the trading hours (note the perfect
downtrend), would close some of the shorts towards the end of the
day: i.e. they would buy. At [1], for the first time that day, the stock
changed trend in five-minute candles. We anticipated this change
several seconds beforehand, and entered a long at $28.95. At [1] the
trend change showed as strengthening, and at [2] we realized a profit
of 40 cents. Also note the high trading volume just before the stock
changed its trend. A large amount of shares changed hands during
those minutes, which considerably reinforced our assessment that a
pullback can be expected.

The Scalping Technique

The first condition: you need to keep your finger on the mouse, and
your eyes glued to the screen. You need to give your full attention to
the stock. You must buy and sell with precise LIMIT orders. You must
absolutely NOT chase the stock, because with scalping, profit or loss is
measured in just a few cents. In many cases, I place an exit order in
advance. For example: if I buy 3000 shares at $20 and anticipate an
increase of 30 cents, I will set a sell limit order in my trading platform
of:
o 1000 shares at 20.15
o 1000 shares at 20.25
o And wait with my finger on the mouse for the first sign of
weakness in order to sell the remaining 1000 shares

SMART Scalps are meant to be short term, and are

therefore not executed in small quantities.
MONEY Trading in small quantities of shares causes
the “small-money syndrome” and leads to
failure.

Scalping is not executed in small quantities of shares. New traders

scalping in small quantities, such as 300 shares, find themselves
caught in the trap of negligible profits, or as the phenomenon is
known, the “small-money syndrome.” Selling 100 shares for a profit of
15 cents seems like too small a yield, so they will try to drag the trade
out for a few more cents, and usually discover that they have waited
too long before selling. The stock pulls back down by 10 cents, so it
does not pay to sell because the profit is even less now, and they wait a
bit longer. Then the stock returns to their entry point, or even below
it, and the scalping ends in a loss!
With large quantities of shares, by contrast, a decent profit is
earned with each partial trade locked in, without the need to cope
with the small-money syndrome.
Note: the terms “small money” and “decent profits” are relative and
will differ from one trader to another, depending on each one’s
monetary backup and psychological makeup relative to profits or
losses.
The One Cent Scalp
Cent scalping is a trading method geared at making profits of one or
just a few cents, from light intraday fluctuations in stocks with “locked
prices.” Stocks with locked prices are stocks in which hundreds if not
thousands of traders are operating, executing bids and asks at one
cent above or below the stock’s traded price. This is not a classic
trading method based on noticeable intraday fluctuations resulting
from breakouts, breakdowns, or direction changes. In contrast with
everything we have learned so far, scalping for one cent is based
chiefly on lack of volatility. I wish to emphasize that this is not my
area of specialization, or even a method I like too much, but in certain
market conditions detailed in the next section, it can be applied
successfully.

One Cent Scalping and the Commission Barrier

The first condition for participating in this method is to have a large
trading account. If you want to profit from the movement of one cent
and still overcome the barrier of commission, you need to operate
with no less than 10,000 shares. A profit of one cent on 10,000 shares is
worth $100, from which commission must still be deducted. The
commissions with this method are the key to success or failure.
Here is an example: let us say that you profited one cent on 10,000
shares, producing $100. Let’s assume that you pay a commission of one
cent per share, and you bought 10,000 shares. That totals $100 profit,
cancelled out by the commission, and when you sell, that costs
another $100. Altogether, a loss of $100. Even if you paid commission of
one-tenth of a cent, totaling $20 for both buy and sell executions, you
have still left 20% of your profit with the broker.
This may sound reasonable to you, but you must also take into
account the sad fact that when you lose (at least 30% of your
executions will end up as losses), the loss plus the commission will
total $120. The weighted average is definitely to your detriment.
The solution: unlike the method of charging one cent per share,
which will only be worthwhile if you operate in quantities of up to
2000 shares per click, when you trade in large fixed amounts, you need
to ask your broker to define a different commission system based on
the Per Trade Commission Plan rather than the Per Share
Commission Plan. If you trade in large amounts, it is probable that
you will be able to close on a price of $3 to $6 per click of the button,
unlimited in quantity.
In actuality, large-scale traders usually receive commissions rather
than pay them. How? When you set your bid and ask orders and wait
for their execution, you are adding liquidity to the market! When you
do that, as we have already learned, you receive a commission of $2 per
1000 shares from the ECN. With a simple calculation, you can
understand that the relatively small quantity of 10,000 shares will
bring you an ECN return of 0.2 cents per share, which is $20, while you
paid only $6. What would happen with a quantity of 100,000 shares?
The ECN return is worth $200, while the commission you pay is still
$6. Can you see where this is going? I am familiar with traders who
make their living from buying and selling a share at exactly the same
price, for profits of hundreds of dollars from the ECN return alone. If
they’re lucky, they also manage to earn another cent per share.
Sound easy?
No, it isn’t easy at all!

One Cent Scalping: the Method

• First find a low-priced stock

 This should ideally be in the $5 to $10 range, with low volatility and
a volume of tens of millions of shares per day. The candidates change
during different periods of market activity, volatility, and price.
Remember that volatility is this method’s worst enemy. Just imagine
how much you could lose if the stock moved ten cents against you!
This is also why you MUST operate according to the following rules:
1. The stock must be moving sideways with no trend, or in industry
terms, the stock must have a locked price
2. The stock must show no volatility and movement of up to 5-10
cents per day
3. The market is moving sideways with no trend (generally occurs
during lunch hours)
4. The stock is priced up to $10. You can buy cheap stocks in large
quantities even if your name is not Warren Buffet
5. The stock shows large trading volume of tens of millions per day

The simplest way to choose a stock is to fish it out of the list that
always contains the “top ten” high volume stocks traded on NASDAQ
or NYSE. Notice that I do not relate to stocks that made it into the list
by chance, but those which are on that listing constantly. On some
days, you might choose Bank of America (BAC) or Intel (INTC),
Microsoft (MSFT) or others. Citigroup (C) used to be the scalpers’
favorite as long as its price hovered around the $4 mark in volumes of
hundreds of millions of shares per day, before the reverse split was
executed, as already described.
When you bring these stocks up on your screen, you will see
intraday volumes of tens if not hundreds of millions of shares, and
enormous numbers of bidders and askers. Many of them are playing
the one cent game.
Who in fact shifts the stock if no one wants it to move more than
one cent? Of course this would not be the scalpers working at the
single cent level, because they are basically locking the price and
preventing movement. The real change comes from the public and
from funds bidding and asking with long-term investment in mind,
and they are not interested in whether the stock has gone up or down
one cent.
 Let’s assume you have chosen your stock and it’s time to trade. The
operation itself is fairly simple but requires a good deal of experience.
First, even if the price is moving sideways, examine the overall market
trend and the stock’s trend. If the trend is up, you will want to execute
a long rather than a short, and vice versa. Now you need to enter your
buy limit order in the BID, and wait patiently until sellers hit your bid.
The moment you have bought the desired quantity, you enter a sell
limit order on the ASK side, with a profit target of 1 to 3 cents, and
wait for buyers to hit your ask in the reverse direction.
Notice that there is no need to use the short order, since for most of
the trading platforms the regular SELL will operate exactly like a short.
Now that you have sold the quantity you bought at a profit, and added
to that sale a double quantity, you are in a short and therefore need to
position a double quantity on the BID side with a targeted profit of 1
to 3 cents, repeating the cycle. Once the market becomes more
volatile, and based on the premise that you are on the right side of
market direction, you need to cancel the exit order and try to profit
from a few more cents beyond the original profit target.
I wish to stress, yet again, that this method sounds simple. In
reality, it requires a great deal of patience, self-discipline, and deep
familiarity with the market. You need to follow the stock chart in one-
minute candles. You also need to watch the market chart which will
indicate if you need to flee the trade with an unexpected loss, or
cancel an exit order and let the market take you to unanticipated
profits of a few additional cents. For the same reasons, you need to be
following the stock’s sector chart. You should be avoiding any trade
when the stock is at a breakout or a breakdown point which may shift
the stock into dangerous territory.

Example of One Cent Scalping with Citigroup, C

 Citigroup (C) is trading with high volatility up until the end of the
opening hour [1], making it an inappropriate time for cent scalping.
Citi slows at 12:30 during the lunch hour [2], and from that point up to
the end of the day, it fits the scalping criteria. Notice that in addition
to the high volume during the opening hour of trade, which does not
include scalpers, the volume from point [2] up to the end of the day
shows an average of ten million shares in five-minute candles. Notice
how the stock price is locked in the range of just 4 to 6 cents
fluctuation.
A good reason for scalpers to work Citi hard prior to its reverse split
was the fact that its price was so low! To buy 10,000 shares at $4
required them to provide a relatively small capital of just $10,000
which, leveraged at 4:1, allowed them buying power of $40,000. Some
time ago, I watched a trader whose entire trading involved scalps of
one cent on Citigroup shares. For several hours I watched how an
account of $100,000 and a quantity of 100,000 shares per trade brought
him to a profit of $32,000 by the end of the trading day. The next day
he did return some $18,000 to the market when Citi moved a few cents
against him and did not pull back, but for the most part, he held that
positive balance over time.
But the story is not all rose-colored. He was forced to change
brokers once every few months, because sooner or later the new
broker would realize that this person is involved in what is known as
toxic trading. More on that later.

Types of Orders
Generally we do not route orders direct to market makers, but for
quantities of tens of thousands of shares, you will find that it is the
market makers who will provide the fastest execution. Market makers
are pleased with large quantities, so you should consider executing
your orders through businesses such as NITE (Knight Capital Group)
and SBSH (Salomon Smith Barney). For example, with a quantity of
100,000 shares, it is preferable to place two separate orders of 50,000
with each of these two market makers, and during trading, observe
which of them fills the order faster. The advantage of this method of
using market makers is execution speed; the disadvantage is that you
will not receive the ECN’s refund commission.
How can market makers fill orders faster than the ECN? Because
they themselves are trading within these small spreads. The role of
market makers, as we have learned, is to provide the market with
liquidity, which they do not do in return for a guaranteed place in
heaven. They provide liquidity since they want to profit, just like you
do, from the gaps between the bid and ask prices. What you are doing
with thousands or tens of thousands of shares, they do with millions.
Relative to stocks traded at locked prices, they do this best and easily
because they have one advantage over you: they are allowed to trade in
fractions of a cent.
The phenomenon of trading in fractions of a cent will anger you
deeply. For example, you may be waiting to get rid of a stock with a
one cent profit. Let’s say you bought at $8.01 and are planning to sell at
$8.02, but in your trading platform you notice thousands of shares
being sold at $8.019. In other words, someone has “overtaken” you at a
better price of just one tenth of a cent. This is one of the market
makers’ advantages, and you will simply have to wait your turn
patiently. On the other hand, since they’re playing in the gap, they will
most likely be the ones who will buy from you and sell to someone
else. At some point, they could very well buy your stock at $8.02 and
sell it to other market makers in the gap for $8.019, aiming to profit
from a little less than a cent, but in gargantuan quantities.
One Cent Scalp Trading is Toxic

As noted above, scalping at one cent profit is not a standard trading

practice. It is doing no more, in fact, than taking advantage of market
inefficiency. Up to the end of 1999, scalp traders benefitted from a
different structure of the market, since stock prices were not traded in
increments of one cent but in eighths of a dollar: $8, $8 1/8, 8 2/8, and
so on. In those times, locking the price of a stock between the bid and
ask yielded a profit of 1/8 of a dollar, which is 12.5 cents in either
direction. Intraday scalpers flourished, but since then the method is in
decline, since the stock exchanges are looking to be rid of anyone
specializing in this method. Professionally, the supply and demand
that such traders add to the market is defined as toxic liquidity.
Market makers who identify you as providing toxic supply will
block access to your broker, who in turn, fearing what may happen,
will block your account. This is usually why retail traders cannot
operate alone using this method. The retail trader needs to join a
trading room operated by companies specializing in trade of this kind.
These companies are actually brokers themselves, and hold private
ECNs in order to overcome the limitations. This is not trading you can
do from home in your spare time. It is an office job. You need to work
with the platform and services of a specific company, and you actually
become a kind of salaried robot living from the boring fluctuations of
one cent per share. If you shut down the air conditioners in these
trading rooms, you’ll probably discover they’re more like a third-world
sweatshop than pleasant stock trading centers. Nonetheless, if your
financial situation does not allow investing in studies and making an
initial reasonable deposit in your trading account, these companies
offer you a work environment, studies, and capital that can help you
start out as traders. While still young, within certain financial
constraints, and despite other kinds of disadvantages, this may be a
good starting-point choice.

SMART One cent scalps are de ned as “toxic

 MONEY trading.” If that is the ONLY method of
trading you’re using, expect your broker to
close your trading account!

This explanation on how to utilize scalping is to show that under

certain conditions and in the right proportions, the method can be
made to work for you, but I do expect that your main operational
method will be the classic forms of profiting from volatility, market
and stock trends. I believe that if classic trading is your main method,
you will be able to earn an income under any market condition with
any broker and without exploiting market failures. Nonetheless, in
non-volatile market conditions during the NY lunch break, and with
sufficient experience, scalping will help you take home a few hundred
dollars more. A broker will not forego working with you if you
integrate a reasonable level of scalps in your regular trading activities.
The Little Red Riding Hood Trap
The term is clearly borrowed from the world of criminal behavior. Red
Riding Hood is a trap in which a candidate for elimination is invited to
a seemingly innocent event, only to discover that it was the biggest
and last mistake of his or her life. In short: seduction, deception,
destruction.
In the world of trading, we apply the term “red riding hood” to an
enticing formation that rouses our inherent greed, draws us into
entering a stock full speed ahead, and usually leads to scathing losses.

What identifies a red riding hood formation? It’s usually one that
looks too good to be true: for example, when a stock consolidates at a
distance of just a few cents from the breakout line for several long
minutes, or even a few hours, it may look as though it is consolidating
nicely in the short term, readying for the perfect, full breakout. But in
many cases it is a trap. When you see a really good-looking formation,
try to ask yourself what is making it so attractive. A stock stuck in the
narrow range beneath the line of resistance is a very clear sign of one
thing: a large seller. The stock wants to rise, but the seller is not done
just yet. Even if the stock breaks resistance, there is a good chance that
the seller will renew quantities, buyers will panic, unload their
merchandise, and the stock will fall enough to shake you into a loss.
What should you do in this case? First, thoroughly examine the
resistance point. Take a careful look at the Level II window, check the
quantity of shares being offered for sale, and try to identify the seller.
Is this a market maker attempting to refresh stock all the time? Since
it is often difficult to access clear data through the Level II window
because sellers can hide their sell orders, carefully check the T&S
(time and sales) window where you will find the flow of trades actually
being executed. No one can hide the amount of shares being sold at
the resistance point! If you see a large quantity changing hands
without being able to identify a seller renewing stocks, you will
understand that this is a smart seller concealing sale instructions.
How Do We Make Money from this Situation?
As noted, buying a red riding hood at breakout is not a good idea, but
buying it after its failure is a whole different story. Wait for the
breakout, wait for the failure, and buy when disappointed buyers are
getting rid of their stock at a loss of 12 to 25 cents beneath the
breakout point. In most cases, the stock will return to the resistance
level where you will be able to sell at one to two cents below the
original breakout point. You may be able to do this several times, as
long as the stock has not broken out. It is a nice, simple intraday
scalping method with relatively high success rates.
Be warned, however: the method requires psychological stamina,
since it involves buying as a stock is trending down. If this is a strong
stock, it will want to go up. The reason for its temporary drop beneath
the breakout point is because a large number of buyers have suddenly
fallen in love with the formation and bought before the breakout, then
panic when the stock direction moves against them by a few cents.
You need to train yourself to operate against your natural instincts and
buy precisely when inexperienced traders are selling at a loss. On the
other hand, if you bought the stock at the breakout and it gets stuck at
up to ten cents above the resistance point and seems to be showing
signs of dropping beneath your buy point, flee it as fast as you can.
Exiting a stock which is not doing what it should be doing is also a
tough psychological demand, since we tend to convince ourselves that
“if we just wait a little longer, it will be ok.”

Example of Red Riding Hood for Textron, TXT

 Textron rose strongly in trade’s opening hour. The stock
encountered resistance at $20.91 and consolidated [1] beneath the
resistance line for 45 minutes. Without doubt, a lovely breakout
formation! Several problems I found with this formation led me to
pass on it. First, the stock was consolidating beneath the resistance
line for too long and too perfectly. That already makes it suspicious.
Second, I noticed that sellers were renewing supplies all the time, and
that was also the reason why the stock did not break out for 45
minutes. Thirdly, even if the stock would break out, it was too close to
resisting the round number of $21 (see section on “round numbers”
further on). The stock had risen just 9 cents, encountered sellers
waiting for the round number, and dropped. Who were the sellers that
caused it to plummet?
Throughout the consolidation process [1] prior to the breakout, a
large quantity of shares changed hands, and “weak buyers” who had
not yet locked in their profit were entering. When the large sellers
continued selling shares beyond the breakout point, weak buyers felt
pressured and at a certain point dumped their merchandise, causing a
drop in price of 15 cents below the breakout level [3]. This is the point
where you should buy, and then sell at [4] when the price returns to
the breakout level. If you familiarize yourself with these rules and this
method, it becomes child’s play!

Pre and Post-Market Trading

Wall Street is open to regular trading for six-and-a-half hours,
between 9:30 am to 4 pm in New York (EST). These are busy hours
which start and end with the ring of the bell, but these are not the
only hours of activity. In addition, it is possible to trade during periods
of minimal activity before and afterthe official trading hours.
Some brokers allow their clients the opportunity to utilize pre-
market and post-market trading. The NASDAQ stock exchange, for
example, allows trading in stocks from 4 am and until 8 pm, New York
time. It is probable, however, that your broker does not provide
services at 4 am. You need to check pre- and post-market trading
times with your broker. While they will differ from one broker to the
next, the usual timeframe is two hours each way beyond the formal
trading day. These extra hours are set by the exchanges as an
opportunity for those that wish to be able to exit and enter stocks due
to news outside of market hours.
Why would we want to join pre- or post-market trading? For the
greater majority of stocks, no major volume changes are noted during
these hours. By contrast, when well-known companies publicize
quarterly reports or convey important information outside of normal
trading hours, their stocks will show lively activity. This means that
you, too, can join the pre- or post-market trading. The theoretical
advantage is that you can be among the first reacting to financial
announcements, long before the general public reacts. In actuality, if
you wish to listen to my advice, keep a safe distance. I strongly
recommend that you never trade out of regular hours. I can pretty
much promise you that in the long run if you ignore this advice, you
will lose far more than you will make.

The Dangers of Pre- and Post-Market Trading

1. Low volume: Unlike during regular trading hours, there are very
few active buyers and sellers during pre- and post-market
timeframes. This means that you might not obtain the shares you
want, or find a buyer for shares you wish to sell.
2. Wide spreads: Due to the low volume, spreads between the ask
and bid tend to be wide. This means that at the moment of
 purchase, you have already lost the spread should you wish to exit
the trade.
3. High volatility: Again due to low volume, volatility may become
particularly high but generally will not show a clear trend. In other
words, one moment you may be profiting, and the very next you
could be losing, fleeing in fear, and the cycle continues.
4. Price uncertainty: Pre- and post-market prices are not always
linked to the regular trading hours prices. You may often end up
paying much more than during the regular trading day.
5. Limited use of trading orders: Before and after regular trading
hours, it is only possible to use LIMIT orders for immediate buying
and selling. This means that if the stock shows sudden movement,
you are likely to miss the entry or exit point you wanted, especially
dangerous when you do not have any stop order to protect you.
6. Competition with professional traders: Most of the traders at
such hours are professionals or large funds who are better informed
than you.
7. Faulty platforms: Online trading carries the risk of faulty trading
platform reaction times. During pre- and post-market hours, the
level of service you will receive from your broker will generally be
very poor.
8. High commissions: Brokers tend to charge higher commissions
for trades executed outside normal trading hours.

Summary
I realize that on the face of things, trading before and after regular
market hours--especially following financial announcements--sounds
exciting, and indeed it is. That’s also why I tried my hand in pre- and
post-market trading. I developed my own special techniques, got
enthused over financial announcements, bought and sold, and in the
end… lost! I am well aware that you might very well succeed, unlike
me, but I strongly recommend avoiding unnecessary problems. So I
stand by my initial advice: steer clear of these hours. You can believe
me when I say they’re nothing but big trouble. Save your time, and
you’ll be saving a lot of money over the years. After my cumulative
experiences, I developed my own special rule: never touch the button
during pre- and post-market trading, no matter how seductive the
situation looks.
I recall instances where I held stocks over from the previous day’s
trading, and during pre-market trade saw them being traded for
amazing profits or searing losses. In both cases, the psychological
pressure requires bringing the situation to a close as quickly as
possible. The brain demands that you realize the profit or the loss,
driven by just one thought: get past the pressure! Wrong! That’s about
the worst mistake you can make. In the greatest majority of situations,
you will receive a better price during the first five to fifteen minutes
following the opening of trade.

SMART Pre- or post-market trading inherently

contains multiple risks and in the long term
MONEY does not pay. We do not trade before or
after trading hours, period!

In 2010, with the stock exchange reaching peak prices over a 14-
month period, and after eight straight weeks of unstoppable price
rises, I was invited to a television financial program in my capacity as
analyst. While all other analysts predicted continued increases, I
predicted a 10% pullback. The next day, the market rose another 1.1%.
The next day, the wheel came full circle. I was spot on! Within several
days, the market dropped by 8% and provided us with an amazingly
successful week of shorts. By the weekend, I realized that the drop had
been extremely sharp, and must retrace at least a little. For the
weekend, then, I positioned myself in three stocks which I estimated
would retrace upwards more than all others: Apple (AAPL), Goldman
Sachs (GS), and TEVA. I waited patiently for the opening of trade on
Monday. An hour before trading opened, I took a look at the pre-
market status. I couldn’t believe what I saw on the trading platform:
the market was opening with gap up, the size of which I had never
seen before…4.5%! For my account, the gap established a pre-market
profit of $28,000! That’s when my hands started to sweat and my pulse
began to race: what to do next, sell at pre-market or wait?
I have already taught you that at this stage you must never sell, but
instead wait. But just for this one occasion, I wondered if I should
bend my own rules. That would require no more than hitting the sell
button and all the pressures would evaporate. And such a lot of
money! I didn’t give in. I waited. One hour later, some ten minutes
after the opening of trade, the profit jumped to $36,000 and I locked
in almost all of it. For the first time that day, I took a deep breath. Not
bad for one hour’s work. What might have happened if I were a novice
trader? I have no doubt that I would not have been able to withstand
the pressure, and would have sold in the pre-market. Remember that
pre-market buyers buy in the pre-market because they believe they
will see a better sale price during regular trading hours. They are
usually the top level professionals, and they are almost always right.

Notice What Happened on that Day to Apple, AAPL:

The chart above shows regular trading hours as well as pre- and
post-market trading [3]. Apple ends Friday’s trading at $235.63 and is
traded post-market with a slight downward bias [1]. I buy 900 Apple
shares before trading ends, assuming that on Monday they will open
at a higher price. During Monday’s pre-trading [2], I am happy to see
Apple traded between $247 to $249. Pressure is increasing! The
question is: to realize profits or to hold the stock? Notice the low
volumes of trade [3] in the post- and pre-market. I managed to stay in
control, and sell after the initial price spike at opening of trade,
around $251, for a profit of $15 per share [4].

Using VWAP at Opening of Trade

In Chapter Six, we learned that institutional traders use the VWAP
indicator during intraday trading. Now we will learn how to use this
index for short-term trading, right out of the trading gate.

Often, and usually as a result of some news item, we expect strong

volatility in a stock during its first seconds of trading. One technique
customarily used when we wish to take advantage of strong volatility
in a stock is the Pre-Market VWAP test, applied several seconds before
trading opens. As we know, orders can be executed prior to the official
opening of the stock exchange. Based on pre-market trading activities,
the VWAP can be measured prior to the opening of trade, for example:
a stock opens with a large downward gap before trading begins. As a
result, an institutional process occurs when trade opens, known as
“finding the price.” Institutional traders, with their huge quantities,
check the levels of support and resistance during the minutes prior to
the start of trading, looking for the “fairest” opening price at which
they will begin shifting large quantities of shares. If the stock opens
with a downward gap and in its first seconds of trading is below the
pre-market VWAP, we know that sellers are dominant when the
market opens. The probability is therefore great that the price during
the first seconds of trading will fall. If the opposite situation exists,
where the stock opens with a downward gap, but during the first
seconds of trading is above the pre-market VWAP, we can assume
institutional buyers are busy, allowing us to take advantage of the
situation and buy immediately when trading opens. The pre-market
VWAP allows us to enter orders earlier than other traders who are
trying, a little later in the day, to estimate the initial market direction
through changes of price and the momentum several minutes after
trading opens. By nature, the act of waiting and the altered prices at
opening create greater risks for those who wait. Using the VWAP will
reduce the level of risk for professional traders, giving them certain
advantages.
One of the toughest problems of trading based on pre-market
VWAP is the question of when to enter stop loss orders. That’s not a
simple matter. Sometimes stocks tend to go a bit “crazy” when trading
opens, which is why I request and stress that it is an activity best -
suited to experienced traders.

Taking Advantage of Round Numbers

Stocks find difficulty in going beyond round numbers. When a stock is
trending up and hovers below a round number, it will generally
encounter resistance and withdraw. Round numbers serve as precise
points for resistance and support. The “rounder” a number is, the
stronger its support or resistance will be. Numbers ending with fifty
cents, such as $28.50, also serve as areas of support and resistance. A
figure such as $40 is rounder than $35, while $50 is rounder than $40,
and so forth.

Why do stocks stop at round numbers? They hold psychological

significance. We view them as stronger and more whole, even though
there is no mathematical basis for this view. Think about that next
time you’re considering a purchase priced at $9.99.

Let us presume that an average investor has bought the ABC stock
at $44.28. Generally, following the purchase, the broker or banker will
ask that investor, “If the stock rises, at what price do you wish to
realize your profit?” Most likely, the investor’s answer will be a round
number, such as $50. Can you imagine a situation in which the
investor will tell the broker to sell at $49.98? Since the majority of
investors makes the same exact mistake and sets their sale orders at
round numbers, when the stock reaches that number, a stream of sell
orders accrued by brokers over anywhere from months to years is
automatically set into motion and the large supply of sellers at the
precise round number stops the stock from moving. When that
happens, buyers who bought at the peak begin to lose their patience
and sell. The number of sellers eventually outweighs the number of
buyers, and the most likely outcome is that the stock price will drop.
How far might it go down? No one knows that.

Behavior of TEVA at a Round Number

In the daily chart, we can see the behavior of TEVA over three years.
Twice on its way up, it ceased progress at the round number of $50.
The first time, in January 2008 [1], it dropped back to $43; the second
time, a month later, it dropped back to $36 [2]. The third time, 18
months from the first attempt to break the $50 mark, buyers finally
succeeded in outweighing sellers and the stock rose. Automatic orders
fixed at the round number by sellers succeeded in holding the stock
back for a full year-and-a-half!
How do we, as traders, make use of the round number
phenomenon? If you bought a stock and are considering when to
execute a partial (lock in part of the profit), you need to consider the
option of setting your order at one or two cents below the round
number, staying wary of the fact that the stock may be likely to fail
there. As it reaches the round number, you need to keep your finger
on the mouse and check the quantity of buyers and sellers carefully.
Give the stock a chance to move past the round number, since if it
does, the momentum of success may send it into highs of several tens
of cents. But at even the most minimal sign of failure, lock in the gain
immediately. On the other hand, if you have decided to buy a stock
which is currently being traded just below the round number, it is
preferable to wait until that round number is passed.

Intraday Round Number Breakout – MFB

We bought MFB in the trading room when it broke out above the
round number of $25. Before the stock broke out, it reached the round
number and stopped there several times [1]. The breakout sent it
upwards by 30 cents, allowing us to take a good partial of three-
quarters of the quantity bought. Notice the increase in volume [2] at
the breakout point. The final quarter was closed at a loss of ten cents
[3]. Not a big trade, but definitely some nice clean work there, taking
advantage of the round number breakout in the correct way.

SMART Round numbers serve as points of

resistance and support. We try to buy above
MONEY round numbers, and realize pro ts below
them.

When a stock drops towards a round number, things turn around.

Usually there will be a large number of buyers at the round number,
therefore if you are in a long, it is better that you let your stop order
remain beneath the round number in the hope that the stock will find
support and return to highs. If you’re planning a short, it’s best to
execute it only when the price drops below the round number. If
you’re already in a short with a stock dropping towards the round
number, consider taking a partial several cents before it reaches the
area of support at the round number and turns around.

Summary
When we are in a long, we should consider realizing profits a little
before the anticipated round-number resistance. When we plan to buy
a stock trading just below the round number, it is preferable to buy if
and when it gets past the round number resistance point. When we
long a stock, it is preferable to enter a stop order a little below the
round number. Traders wishing to short will prefer to execute the
short below the round number, and place their stop orders a little
above the round number.

Trading Small Caps

Special significance is applied to trading in low-priced stocks. Many
traders love them because of their high volatility. Known as “small
caps,” some such stocks move through ranges of tens of percentages
during a single day and are highly popular among risk-loving traders.
Small cap trading requires the trader to be highly proficient in the
technique, and is therefore not suited to novice traders with
insufficient experience who could easily be drawn by the low price and
theoretical potential of large profits arising from high volatility.

SMART We de ne “low-priced stocks” (small caps)

as stock being priced below $10. Most funds
MONEY worldwide are prohibited from buying stock
priced at less than $10, which accounts for
their high volatility.
 What is a “small stock” or “small caps”? There is no absolute
definition, but the currently accepted explanation defines it as stock
from a company with a market value of between $300 million to $2
billion. To calculate a company’s market value, its stock price is
multiplied by the number of shares issued.This information is
available from sites such as Yahoo Finance.
The definition of small caps has changed through the years. For
example, stocks currently considered “small” may have been
considered of mid to high-market value twenty years ago. Before
entering the stock during trading hours, should we perform a
multiplication exercise to assess the company’s market value? Of
course not; that is why we search for a common denominator that
makes checking fast and easy. The simplest solution is to fix a price:
almost all stocks traded below $10 are “small caps.”
Why are small caps more volatile than others? Two reasons apply:
due to the higher risk in small caps (their title being indicative of their
inherent risk as issued by small companies), and because for the
greater majority of international funds, a standing prohibition
prevents them from investing the public’s money in inherently volatile
stocks. Funds buy in large quantities; the movement of stocks held by
large funds is gentler, since a drop in price will often lead them to
increase the amounts they hold. When a stock rises sharply, however,
they will take advantage of the large volume to sell. Small caps, which
do not receive the support of institutional investors, are dependent on
the whim and will of private investors who can buy or sell with one
click of the mouse.
A second reason for high volatility in small caps relates to
something we have already discussed: stocks move in cents rather
than percentages. The smallest possible gap in trading is one cent,
whether the stock price is $5 or $50. At breakout, traders will push a
$50 stock upwards by tens of cents in just the same way as they may
do with a $5 stock.
Very few funds are permitted to trade in small caps (under $10), but
generally all funds are prohibited from trading in stocks with a price
lower than $5. When a stock price drops below the $10 mark, traders
anticipate that institutional traders will begin releasing their holdings,
creating expectations which tend to become self-fulfilling, causing the
stock to drop sharply. We can use this knowledge to our advantage in
two directions:
• Use the dropping price to short a stock beneath the $10 mark I am so
fond of. These breakdowns often turn out to be particularly strong
when they integrate a downtrend together with a breakdown
beneath the round number of $10.

Short in Dean Foods Company below $10, DF

Right at the start of trading, our trading room team executed a

short on Dean Foods below the $10 level. The stock had shown
weakness the previous day, and it seemed natural that it would
continue dropping. At breakdown the stock dropped by 61 cents [2] for
five consecutive five-minute candles, virtually without looking back. It
was a great trade to start the day.
Trending up: when a stock traded for a lengthy period beneath $5
begins to climb and looks as though it will break out above the $5 level
(being the price at which some funds may begin buying), a situation is
created where traders familiar with institutional behavior starting
“pushing” the stock upwards in large volume, assuming that fairly
soon the institutional funds will start purchasing.
Important: When I am considering whether to trade in small caps,
I relate to stocks that belong wholly and solely to the stock exchange’s
main trading list. These stocks show daily volumes of above one
million shares. It is absolutely forbidden to trade in stocks not on this
list, such as pink sheet stocks, which you will easily recognize by the
PK suffix next to their symbol. I also believe you should keep away
from “Penny stocks”. Penny stocks is one of the most dangerous scams
in trading. They are cheap for a good reason. All institutional funds
and big traders never trade or invest in them. Beginners get attracted
to penny stocks because they think that they can profit easily and
because penny stocks are cheap. In reality, penny stocks are easily
manipulated by scammers, very volatile and very risky to trade.
Scammers use junk emails, one page “Stock Picking” websites and
forums to push traders to invest in penny stocks. When the beginners
are buying the scammers are the sellers. Sometimes scammers go as
far as offering “Penny Stock Courses” or sell “Penny Stock Picking”
services, which is even more dangerous. In fact, novice, unexperienced
traders, are paying in order to be scammed.

How Can Small Caps Be Found?

Small caps are generally dormant stocks that “awaken” for a few days.
When they do, they can be identified on the first significantly volatile
day based on volume increase or sharp price changes, or on the
following day. We can expect that the momentum will keep them
moving for some days. Every day you should make a list of the small
caps that appear interesting on that day. You can identify them in
various ways: by a follow-up list, or by using free, simple programs
called stock screening software which we will learn more about
later. Define these programs according to the following filters: stocks
priced $3 to $10, with trade volumes growing exponentially, and which
rose in one day by more than 10%. To find small caps during trading, I
use my COLMEX Pro tool called the Top 20 which identifies and
displays the leading 20 stocks in the market at any given moment,
many of which are small caps.

What is the Best Time for Trading in Small Caps?

You can trade in small caps throughout the day, but my preferred time
is during the lunch break, which is 11:30 am to 1:30 pm, New York time.
Regular stocks are “resting” because the institutional traders have
gone out to eat, but by contrast, the small caps generally traded by the
public are much more active and provide interesting trade triggers.

What is the Entry Point for Small Caps?

Use the accepted formations, especially breakout and reversals,

according to your personal preferences. Choose the stock based on
volatility and volume considerations: in other words, choose stocks
traded in volumes that are no less than one million shares per day. You
must also be sure there is a reasonable spread of no more than 3 to 4
cents and an appropriate risk-reward ratio.

The Russell 2000 – Market Index for Small Caps

Just as we do not trade in regular stocks without checking the market

direction as embodied by the S&P 500 intraday behavior, we do not
trade in small caps without a strong backwind from the small caps
index, known as the Russell 2000, symbol RUT$. Just as we use the
SPY for following the S&P 500, we are similarly assisted by the IWM,
the Russell 2000 ETF. In actuality, when a small cap breaks out in large
volumes, the Russell 2000 direction will have no effect on it. By
contrast, if you wish to understand the nature of small caps on any
particular day and their chance of breakout on that day, check the
Russell 2000 for an overview of the direction and market force of small
caps. Clearly, then, we do not use the Russell 2000 in the same way
that we use the S&P 500, which is an intraday tool for certifying
breakouts and breakdowns and for reaching decisions on profit
realization. We use the Russell 2000 only for insight on the “nature” of
the small caps.

Should  We  Short on Small Caps?

The volatility of small caps in cents is very similar to that of larger
stocks. As we learned, stocks move in cents rather than percentages,
and therefore you should not try to buy 10 times more in small caps
than you would for regular stocks, since you will still be increasing the
risk tenfold! As a rule of thumb, we trade in small caps in exactly the
same quantities as regular stocks. In actuality, you must check the
stock’s volatility in real time and decide on the spot as to the best
quantity, according to stock volume and behavior.

SMART The volatility of small caps in cents is

similar to that of large stocks. Therefore,
MONEY we will usually buy small caps in the same
quantities as we would buy large caps.

Summary
To reduce risk, professional day traders will generally trade in large
and medium caps with high liquidity and narrow spreads. It is
definitely possible to trade in small caps, but prior to entering the
stock, be very sure of your choice and handling decisions.
Professional, precise handling will generally produce higher yields
relative to the stock’s price.

Reciprocal Range Play

This method is applied to a stock which opens trading with a
considerable gap (opening price is significantly higher or lower than
the previous day’s closing price – see previous sections on this topic).
The objective of this method is to enter the stock after the gap is
closed, when it technically appears that it may continue moving to an
equal distance in the opposite direction.
Reciprocal Range Play for Myriad, MYGN

The chart shows MYGN’s behavior over two days of trading. MYGN
closed the first day at [1] and opened the next day with a gap up [2].
Several minutes after trading opened, it became clear that the stock
was moving down to close the gap. We have already learned that there
is a clear tendency for gaps to close on the same day of trading.
Experienced traders know how to take good advantage of this known
opportunity, and many execute shorts, “helping” the stock drop
further.
As we see in the chart above, closing the gap is only half of the
stock’s movement. Sometimes, as in the case above, a “bi-directional”
or reciprocal opportunity forms when the strong gap-closing
momentum breaks after the close [3] and causes the stock to continue
trending down [4]. Note how the distance between points 3 and 4 is
identical to that of between points 2 and 3.This is the basis for the
term reciprocal range.

Analyzing the process: At the start of trading, the stock opens

with a gap up [2]. Within minutes, bears take control and the stock
begins closing the gap. Long players, who had hoped that the stock
would continue rising (Gap &Go) find themselves trapped on the
wrong side of the game and set their exit point (stop order) at the
most reasonable point: this is the gap-closing area [3]. Short sellers
who sold at [2] are aware that stocks have a good chance of changing
direction after closing the gap [3], and they therefore set [3] as their
profit target. When the stock closes its gap [3], we can expect a
reversal of direction, or at the very least a slight retracement upwards.
Indeed, a little below [3] we find the upward retracement [5]. The
entry trigger into reciprocal range trading is where the bear flag at [5]
breaks just below the midway point.
What happens when the bear flag breaks? Everyone has a common
interest in selling: new short players will enter shorts when the bear
flag breaks, short players who entered at [2] will be sorry they closed
their shorts and some will execute new shorts, buyers who entered at
[2] when trading opened understand that the closing gap will not save
them and they sell. Other aggressive buyers who bought when the gap
closed [3], assuming that the stock would begin to rise once the gap
had closed, find themselves on the wrong side of the action and are
also forced to sell.
Who are the losers? Buyers are, of course, are the biggest losers; not
only the aggressive ones entering when the gap closed [3] in the hope
that the stock would reverse and begin an uptrend, but also those who
bought during the previous day and now find themselves trapped in a
crashing stock. The coming together of energies created during the
down movement, together with the closing of new and old longs and
the entrance of new short sellers, leads the stock to a further sharp
drop which, in most cases, can be expected to bring it down to its
double-distance target [4].
To increase the success rate of this process, it is best if the gap-
closing point [3] is in the vicinity of the previous day’s pivot point.
This is true for the case above. As we have learned, the pivot point is
a mathematical calculation of the price at which most of the previous
day’s trading volume occurred. As can be seen in the previous day’s
chart, most of the activity occurred around the point where the gap
closed. The pivot point is generally referred to as Fair Value. This
indicates that the majority of buyers bought during the previous day
at the average found at [3]. When the current day’s price drops below
[3], all those who were caught in the wrong direction get trapped. The
closer the gap-closing point is to the pivot, the more disappointed
buyers there will be seeking to exit the stock if it keeps dropping,
which pushes the reciprocal range process along even better.
 SMART The entry point for reciprocal range trading
will be at the breakout or breakdown of the
MONEY technical formation emerging above or
below to the gap-closing point.

Analyzing reciprocal range trading in the opposite direction is

exactly the same. When a stock opens with a down gap, rises to close
the gap, reaches the closing price, and continues rising, it is
reasonable to presume that it will allow us a chance for good, long
reciprocal trading. In such a case, the trapped ones are traders who
entered into a short around the previous day’s pivot point, and are
now forced to buy when they move into a loss.

Trading at Financial Reports and

Announcements
At the start of each quarter, public companies must report to the stock
exchange, investors, and to the public on the outcomes of the previous
quarter, together with their forecasts for the months ahead. Quarterly
earnings reports are typically publicized during April, July, October
and January, as soon as the quarter ends. Most companies issue their
quarterly reports before or after trading hours, although this is not a
requirement. As such, earnings reports will almost always cause a gap
in the stock’s price. The gap direction can never be known. Even if you
have in-depth financial knowhow and can analyze any company’s
financial reports for yourself, do not imagine even for one moment
that you are able to predict the gap direction. It can happen that great
reports lead to equally great drops, or vice versa. I have never yet met
an economist who was surprised by the stock’s direction following a
quarterly report. That is odd, but in retrospect, the explanation goes
something like this: “Yes, outcomes were excellent, but in clause […] of
the balance sheet, the company informed of its reduced expectations.”
In short, the market is comprised of two kinds of people: those who
simply do not know, and those who have no idea that they do not
know. Nor do I ever know with any certainty which way the price is
going to move. So how do we nonetheless profit from quarterly reports
and announcements?
Company balances are detailed and contain a great deal of
economic and business data. For short-term traders, this data holds no
interest, but the short-term outcome on long-term investors interests
us a great deal!
During the “earnings season,” institutional investors closely follow
the stocks in their portfolios, and decide whether to hold or dump
them. Two important, if not the most important, factors in the
institutional investors’ decision-making processes when considering
whether to increase or decrease holdings of a specific stock, are:
• Forecasts by analysts reviewing the stock
• Analysts’ predictions on whether the company will increase profits
and revenues during the coming quarter
These factors, together with several others, have the power to drive
institutional investors to take action. Such action includes
extraordinary announcements, changing recommendations, and
macro-economic announcements which influence the market in
general and the stock’s specific sector in particular.
Generally, the stock price will rise proportionately to sector and
market movement, and any “moving outside the lines” will generally
be possible only through significant economic triggers. During crises
or fear of an upcoming crisis, the market “punishes” stocks which do
not follow their predictions, thus a careful follow-up on stocks
showing sharp daily movements can create good short-term (days)
and medium term (weeks) opportunities.
To find opportunities during the quarterly reports period, you need
to check the date of the particular stock’s report, or simply ready
yourself for any day’s trading by preparing a list of all stocks that
interest you. If you wish to locate the stocks according to the date of
their report, a wide range of financial sites can help. My personal
favorite is Yahoo Finance.

Locating Report Dates Using Yahoo Finance

 This page presents all the stocks for which reports were publicized
on July 27,2010. I chose to have the results displayed according to
alphabetically-arranged ticker symbols [2]. If you wish to check the
report date of a specific stock, you can enter its symbol into the field
[1].

SMART We do not “go to sleep” holding stocks

about to publicize reports, since even if the
MONEY report results match our trading direction,
the stock’s actual behavior can be
unpredictable.

Allow me to clarify: it is absolutely prohibited to “go to sleep”

holding stocks about to publicize a quarterly company report. If you
plan to buy a stock for a swing of several days, you must always clarify
its report date. If that date occurs tomorrow pre-market, you are
taking an enormous risk! In fact, even if the report is due out the next
day after the market or even the day after, it is enough for a rumor or
two to cause a sharp gap even before trading begins. In a best case
scenario, the situation might bring you a handsome profit, but in the
worst case scenario, you might experience a scathing wipeout. It is
important to keep in mind that the gamble has 50% odds of the price
going either way. Even if you believe that the report’s results will be far
better than analysts’ expectations, and even if you are proven right, it
is still a huge risk. Stocks tend to surprise, without any connection at
all to the reports. Good reports can be followed by a crash, and vice
versa. Even if you are right, the market may not want to support you.

The only situation in which I am prepared to hold a stock during

the reports period is when I have sold at least three-quarters of it for a
very good profit, and the additional 25% no longer endangers me.
Below is an example with the Lexmark [LXK] company. I bought its
stock for upwards of $46. The profit target for selling three-quarters of
the quantity was 3%. I knew that in several days the company would
publicize its quarterly report, but predicted its stock would reach the
profit realization point beforehand. Indeed, that is what happened.
The stinging slap on my face came with the report’s appearance.
Notice what happened to Lexmark:

Publicizing the Quarterly Report for Lexmark, LXK

Lexmark breaks out above $46 [1], and within four days reaches the
planned target price. On reaching a 3% profit I sold 75% of the
quantity I had bought, knowing that the quarterly report would
appear the next day. During the day following the report’s publication,
I discovered that Lexmark had opened with a wild down gap of 9%
below my entry price. The stop order intended for the entry price of
$46 executed at the shocking low of $42, and the 25% of shares
evaporated at a huge loss.
 Now check the bottom line: a profit of 3% on three-quarters of the
stock together with a loss of 9% on one-quarter of the quantity of
stock leads to the grand total of…zero! Overall summary: I didn’t lose,
I didn’t win. Moral of the story: very simply, do you want to take huge
risks and sleep on a stock right before its quarterly report is
publicized? Make sure that you have realized a handsome profit
beforehand for the greater portion of the shares you are holding and
take a calculated risk only on a very small percentage, if at all.
What might have happened had Lexmark not reached my profit
target before the report’s appearance? I would have sold the entire
quantity. In the long term this is not a problematic phenomenon,
since statistically in half the instances, when a gap is to your
detriment, you will lose; whereas in the other half of instances, when
the gap benefits you, you will profit. The cumulative result of dozens
of such gaps will, most likely, be zero.
By contrast to quarterly earnings reports, the outcomes of analyst
recommendations can be fairly well predicted: for example, a “strong
buy” recommendation by a Goldman Sachs analyst will generally
cause a price spike. The “sell” recommendation, or a significant legal
claim, will generally cause drops in the stock’s price. The problem with
financial announcements is that you can never know when to expect
them. Here, too, statistics comes to your aid. Unlike the completely
unpredictable market reactions to the publication of quarterly reports,
when you buy a strong stock which is rising, it is highly presumable
that one reason for its uptrend is a positive announcement which until
publication had been known only to a few with insider knowledge
who began buying before the public. True, they are not operating
legally, but do not be naïve. If you have bought the stock because it is
demonstrating strength rather than because you know a positive
announcement is about to go public, then following the
announcement the stock will generally continue moving in the
direction in which you are trading.
So far, we have analyzed a situation in which you “sleep” on a stock
for a swing of several days. Next, we will relate to intraday trading.
Intraday Trading at Announcements

Our goal is to profit from a stock’s volatility, whether derived from a

quarterly report or an announcement, rather than guess the stock’s
direction. Before the start of trading, we will check several financial
sites for stocks expected to make reports public at the end of the day’s
trading, and look for stocks expecting changes due to changed
analysts’ recommendations. They will be fed into a follow-up list, and
if you have sufficient computer screens, I strongly recommend
displaying each one with its own chart and following them all over the
course of the trading day.
When should we buy, or execute a short? First of all, remember
that we are not going to enter any stock before we have seen its actual
direction in real time. We will examine its direction and hit the button
only when the acceptable technical formation develops. Notice that
market direction will have much less impact on stocks in the news
than on other stocks. In other words, even if the market is trending up
and the stock you have chosen is “suffering” from the analysts’
changed recommendation, you can still short it. The success rate of
the short will increase if the market is behind it, but in this particular
situation of reports and announcements, the market direction is not
vital.
Macy’s (M) on the Day it Announced Profit

On May 12, 2010, following an excellent quarterly report, the retail

giant Macy’s opened with an up gap of 2.2% [1]. In addition, a positive
review was also publicized relating to Macy’s growth in sales.
Immediately after the trading day opened, Macy’s dropped sharply
and closed the gap [2]. As we have seen, the gap-closing point is very
often also the point where direction changes, which was true in this
instance. Macy’s recovered and closed at the highs [3]. What would
have happened if, following publication of these positive reports, you
would have bought the stock at the opening of trade [1] in the hope
that it would continue rising? Most likely, with a drop of more than
2% towards the gap-closing point, you would have found yourself with
a loss. The conclusion is that a stock’s behavior following publication
of financial information is erratic and cannot be anticipated.
Everything is possible, and anything can happen. If the stock moves
up, it can be bought long if it also shows a satisfactory technical
formation, and backed up by a reasonable stop order.

Question: Can you identify a good technical intraday entry point for
a long? I see the “inverted head and shoulders” formation at $24.40.
Can you also see it?

How to Identify a Bottom

Crises are an inseparable part of stock exchange life. Once every few
years, the stock exchange crashes due to one crisis or another.
Statistically, the average investor experiences at least three major
crashes during his or her lifetime. During the past decade alone,
markets crashed due to two mega-crises: the Internet Bubble of 2000,
and the Financial Crisis of 2008. Second-level shakeups appear as
mini-crises, such as with the collapse of the Twin Towers on 9/11, or
the Dubai crisis, the Greek crisis, the Japanese tsunami, and other
events which I have already forgotten.
At the peak of the market’s reaction to the March 2009 Sub-Prime
Crisis, very few people actually identified the bottom. Nor could they
have even imagined in their wildest dreams that in just over a year, the
market would lurch from the bottom with a meteoric rise of 100%,
with hardly a backward glance. Buyer opportunities at the bottom are
extremely rare, but allow us, if we identity the bottom correctly, to
utilize trading methods for longer than the short term to which this
book relates. I believe that as traders, we must be open to all types of
opportunity, even if it sometimes deviates from the limitations of our
short–term approach. We must operate as day traders, yet hold stocks
for periods of several days to several weeks using swing methods, and
in special instances, try to profit from longer-term volatility of several
months.
Since 90% of the public loses in the stock market, we need to
conclude that the public tends to buy stocks when they are at peak,
and dumps them when they reach “rock bottom.” What can we
conclude? That we need to do exactly the opposite to what the general
public is doing. The way to do that is to identify the peak or bottom,
neither of which are simple tasks. I will try to provide you with several
rules for identifying a bottom. They are not perfect mathematical
rules, but they will help you consolidate your views when you next
encounter a crisis.
These rules are very simple, but somewhat difficult to master. The
greatest difficulty is psychological. Our brains tell us it is time to act,
but our hearts resist. This resistance may derive from fear of loss, from
social pressure, from being spooked by the unknown, and more.
Resistance derives from the simple fact that we are human. Although
the physical distance between mind and heart is short, for most
people it presents a gap that cannot be bridged. Success requires you
to undergo a mental shift that merges thought and emotion into a
single path. It is a tough mental process which generally takes some
years to internalize.

• Rule 1: Blood first needs to flow in the streets

When you are looking for a stock’s bottom, try to imagine how you
would feel if you bought it at its highest price before it plunged. If you
think you could handle the drop without fleeing, then it’s not the time
to buy! If you feel you could not withstand the pressure, that you
would break and sell, then that IS the time to buy. This is an
important rule, but notice that it does not apply to all stocks. You
need to focus on stocks with good fundamentals, where no one quite
understands why they have dropped, rather than on those which are
trending down because of negative earnings reports. You will be
looking for stocks dropping as a result of overall market hysteria.
Usually, I do not buy stocks because of their fundamental value.
That’s a game best played by the funds. I am sufficiently experienced
to know that there is no link between book value and stock price; but
sometimes, when a stock is being traded shockingly below its real
value, that’s the time to buy.
Within the framework of this rule, you also need to check which
sector the stock belongs to: for example, during a severe financial
crisis (2008 Sub-Prime Collapse, for example), if you would have
considered buying a bank stock traded at a dreamy 1:6 Price to
Earnings ratio (PE) based on the next year’s profits, I’m not sure you
would have been making a good trade. It is more reasonable to assume
that over the next year, the bank would not make even half of that PE
ratio. By the same token, I would also not recommend looking for
bottoms in dotcom stocks during Internet crisis years. Remember that
the more pain caused by the drop in price, the higher the chance for a
successful bounce.

• Rule 2: Don’t listen to analysts’ recommendations

Pay no heed to technical analysts, financial analysts, financial sites,
hocus-pocus software that forecasts the future, fund managers, and
especially not to economists who claim they have identified the
bottom. They are all no more than background noise, and you need to
keep your distance. This is not an easy game to play. It is not about
reading a newspaper article. Fund managers who claim to be “bullish”
on a stock are virtually declaring that they have already invested in it.
Remember the first rule: the greatest pain is at the bottom, and the
situation needs to seem hopeless before you enter as a buyer. If too
many people tell you that the market will go up, you still haven’t seen
the bottom. The less you listen to people speaking “with authority,”
the greater your chances of success. The faster you conclude that no
one can assist you, especially the economists, the better off you will
be. Most economists will not admit, despite years of formal education,
that they are unable to explain why the market rises and falls. But to
justify their academic degree and their career status, they will find
convincing explanations. Ask them if they have put their money where
their mouth is!

• Rule 3: Analysts have to lower their rating

When searching for the bottom, you need to do precisely the
opposite of what the analysts are recommending. Most of their
recommendations are misleading. In many cases, funds use analysts to
recommend stocks which the funds have just stocked up on.
Companies also lead analysts and feed them internal information from
morning to night. Did you ever wonder how an analyst knows how to
“precisely calculate” a stock’s anticipated profit? The analyst receives a
precise figure from the company’s finance manager.

SMART When a stock at a low is “suffering” from a

lowered recommendation or downgrade
MONEY which does not cause the price to continue
falling, that is a sure sign that the weak
sellers are already out of the picture, and
usually indicates that the price will now
start trending up.

The stock you are buying must be “suffering” from an analyst’s

downgrade. In all my years as a trader, I have yet to meet an analyst
who upgraded the rating to “buy” at the bottom. Almost without
exception, analysts will lower ratings at the bottom. A stock which had
been rated a “strong buy” will become a “strong sell.” The problem is
the method: most analysts rate stocks based on the ratio of
anticipated profit and real profit. When a stock realizes its forecast,
analysts will upgrade their recommendations, and when it does not
uphold the forecast, they will downgrade. When the stock fails even
slightly or temporarily, they will downgrade. When a recommended
stock crashes, analysts will shamefully downgrade. In other words, this
is all part of a cop-out. Things get worse after a crisis, because crises
catch most analysts by surprise. They get caught at the peak of the
crisis with too many “strong buy” recommendations. The outcome: the
stock exchange regulator fumes. Regulators do not like situations
where analysts recommend and the stock exchange is crashing. In
response, regulators issue instructions to lower expectations. The
outcome: if you are hoping for “buy” ratings at the bottom, forget it.
To buy a stock at bottom you need to see that a decisive majority of
analysts reviewing the stock recommends selling. But pay attention: if
the removal of the last remaining “buy” recommendation does not
topple the stock price further, this is a sign that all the weak sellers are
now out of the picture, and the stock price reflects all the negative
expectations. From here on, the only way left is up.

• Rule 4: The volume at the bottom must be large

Before deciding that the bottom has been reached, you need to be
sure that the weak investors are out of the picture. This is called
“capitulation.” A large spike in volume means that there are a large
number of sellers, but remember that for every seller there is a buyer.
This means that the stock is moving through a lot of hands. Weak
sellers have gotten rid of the stock, and new owners have entered.
These new owners bought at a low price. They have more patience and
stamina. The greater the volume grows, the more weak sellers are
being replaced by strong buyers. Remember: a stock traded at its
lowest with large volumes is what we want to buy, not sell.

• Rule 5: Bad news has no impact at bottom

When a stock is at its lowest, bad news and even more anticipated
bad news is already embodied in the price. When all the weak sellers
have left, the remaining buyers are not disturbed by bad news. This
rule needs to be integrated with information on the financial state of
the company and its sector. If the company is wiped out, or is in a
sector that suffers from a very poor macro-economic situation, bad
news may prevent it from redeeming debentures, and then control
may be turned over to its shareholders.

• Rule 6: Wait a bit longer…

 This is the final and most important rule. Have you decided that
you want to buy? Stop! Hold out a bit longer. It might even be worth
waiting for a further drop, proving to you that your assessment of the
bottom was incorrect. One of the most common mistakes relates to
our tendency to identify too many bottoms in too many instances.
True, if you observe this rule, you may discover you’ve missed out on a
good trade, but in most cases you will be happy to discover that the
bottom is even further down. Even if you miss several trades, your
overall success rate will still be improved from this last step.
Remember: bottoms don’t happen quickly. There is usually plenty of
time.

Identifying the Market Bottom during the 2008 Financial Crisis:

SPY

In October 2008, the markets crashed. The SPY (the S&P 500 ETF)
dropped from a peak of $175.52 to a low of $67.1 [2]. Then it shot up by
82% in 14 months [3]. Notice that the first bottom [1] was not the real
one. Could you have identified the bottom and profited from the highs
that followed? That would have been very difficult. Even if you had
identified it, most likely you, like many others, would still have been
filled with fear that prevented you from thinking clearly. Like many
others during that period, I also felt as though the sky had fallen and
the world was about to come to an end, and that the entire financial
system was about to sink. I had no idea whether the ATMs would still
provide cash the following day.
As traders, we profited well from the continuing price drops, but
were fearful that we were in a crisis of a scope the world had never
experienced, and hence were afraid to buy. That does not mean we did
not profit from some of the upward movement, especially once it
became absolutely clear that the market trend was indeed upward. But
we did not join in the uptrend festivities as investors who bought at
the bottom and held out for the long term. On the other hand, how
many investors really identified the bottom and bought? Very
carefully, however, as short-term traders we profited from a long streak
of days with upward trends.
When the market started trending up continuously and
determinedly, as it has done since March 2009 [2], a rare situation
occurred in which the long-term trader could profit more from the
market than the short-term trader. The sadder aspect is that generally
such investors also absorb all the lows. The overall outcome is that
they tend to cover their losses, and no more. I have yet to meet a long-
term investor who knew how to exit prior to the collapse, and buy
exactly at the bottom.

Integrating Tools

On May 28, 2010, our trading room traded in a stock that,

extraordinarily, integrated several of the tools we have learned about
in this chapter. It was an excellent trade, which provided my
colleagues and me with the best trade of that day. We traded the stock
of 3Par Inc.

Trading with 3Par, PAR

 On the day before our entry, PAR rose almost 10% from around $9
to $9.89. We call stocks like these “momentum stock.” They are strong
stocks, which we like finding prior to the day’s trading, assuming that
the previous day’s momentum will draw new buyers and will also
continue into the next day.
PAR’s momentum did not disappoint, and when trading opened,
the stock jumped to $10.14, pulled back, and executed a classic reversal
[1] followed by a move of over $10. At the reversal point [1], we bought.
There was reason to doubt, since we did not know if the stock would
go higher than its previous peak. When it did [2], we increased the
quantity. The stock shot up to a new peak, where we realized good
profits for most of our shares. We then noticed that the price was
consolidating around the peak point with almost no pullback. The
volume at the consolidation area was not too large: in other words, not
many new buyers or “weak hands” were entering, and the stock was
slowly developing a classic breakout formation above $10.45. We
bought more at the breakout [3] and sold again close to the next peak.

Which tools learned so far were applied to this trade?

1. We learned that we love stocks rising above the $10 mark, since that
is the point where funds show interest.
2. We learned that we need to buy above round numbers: therefore,
above $10.
3. We learned that we need to buy at reversal [1], which is our first
entry point.
4. We learned to buy at breakouts [2], where we add quantities.
5. We added a quantity at an additional breakout, since we learned
that a long consolidation at the peak with low volume is a good
recipe for continued highs [3].
6. We learned that when the stock breaks through the line of
resistance, this line becomes the line of support, and the stock may
execute a “reassessment” (known as “retest”) [4] of the breakout
point [3] before continuing to new highs.
How to Take Advantage of Retest
We discussed the concept of a “retest” in the section explaining
support and resistance, but because of its importance, I will now
expand on the initial information.
Often, following a breakout of the line of resistance (and the
reverse is true for a breakdown below the line of support), the stock
will retest the line. It drops back down to the breakout point, is
supported at the line of resistance which has been broken out, and
thus becomes the line of support followed by continuing highs. In the
PAR chart we saw the breakout [3] and the retest [4].
Retest is a common phenomenon, and therefore in most instances
it can be anticipated that the stock will find support and continue to
trend up. In order to understand the retest, we need to analyze the
predictable behavior of buyers and sellers. Let us analyze the example
presented by PAR:

• The disappointed trader who missed a good chance

Traders who missed the breakout [3] watch the trending up stock
with disappointed eyes and regret to the depths of their souls that
they did not buy it when it was still a good opportunity. Following
breakout, they are no longer interested in buying at a high price and
therefore wait for another opportunity to buy when it pulls back.
When PAR executes a retest [4], they take advantage of the chance to
buy, thereby helping to push the price back into highs.

• The disappointed buyer

These are the people buying PAR at the breakout [3], but even
when they profit, they aren’t happy. They feel stupid because they did
correctly identify the breakout, but they didn’t buy an even larger
quantity of shares. Of course it’s easy to be smart in retrospect, but
when PAR drops back to the breakout price [4], they are happy to take
advantage of the pullback and increase their position. They, too, are
helping the stock price go up again.
• The short trader
Traders with shorts in PAR prior to the breakout hoped it would
drop, but were disappointed when the price broke through the line of
resistance [3]. Now they are losing, but are not interested in exiting
with large losses. They therefore wait hopefully for PAR to drop. When
to their great joy it does, they take advantage of the retest point [4] in
order to close their shorts “before the catastrophe.” In other words,
they too are buying and helping the stock price rise.

The conclusion is simple: all the players in the market share the
same goal of buying at the retest point [4]. No one is interested in
selling there, so that in most cases, a stock which has broken out and
pulled back to the breakout price will receive the support of buyers
and return to highs.
The retest point can be used to our advantage in two ways: by
placing a stop order below the retest area in case the stock should
suddenly not receive the anticipated support; or to increase our
position in a stock based on the assumption that it will return to
highs.

SMART A stock breaking out will generally execute

a retest of the breakout area, i.e. it returns
MONEY to the line of resistance, which now turns
into the line of support. The opposite is true
for breakdowns.

The Top Down Analysis Method

“Top down analysis” is an accepted method among careful traders.
Before trading opens, traders review the strong industries and sectors
and follow their movements. If the pharmaceutical sector excelled on
the previous day relative to the market index and other industry
indicators, these traders will check a list of stocks belonging to the
pharmaceutical industry and seek out the notably dominant ones. Of
these, the traders will choose several with attractive technical
formations and follow them as potential candidates for the coming
day’s trading. During trading, these stocks will be bought at planned
entry points, on the condition that all of the criteria we have studied
are properly filled:
• The market is trending up
• The specific industry is trending up
• The stock is at the correct technical point

Top down analysis considerably reduces chances of failure, but

requires no small amount of preparatory work and follow-up. It is
recommended for traders with plenty of time, or who are particularly
wary and cautious. Since you have the support of so many components
of the market, the probability of winning is much higher.

Summary
This was one very heavy chapter! We studied breakouts and
breakdowns, volume change, buy and sell points, reversals, gaps,
trading strategies, scalps, pre- and post-market trading, VWAP, small
caps, reciprocal ranges, how to use financial announcements,
identifying the bottom, retesting, and more…So, where do we start?
It would not be normal to be fluent with all this information at this
stage. As novice traders, you should choose one method and get to
know it well before moving on to new methods.
A practical suggestion: focus on reversals. Look for stocks with a
clear trend, very strong for buying or very weak for shorting, which
display daily reversals (one-day candles) if you are interested in a
swing of several days, or intraday reversals (five-minute candles) if you
are interested in trading within the same day. Trading with reversals is
simple, slower and clearer than trading at breakouts and breakdowns,
or any other method. Once you have reversals pretty much under
control, move on to the next method.
Chapter 11 - Risk Management

We have learned how to play offence,

now we will learn to play defense.
Learning to Play Defense

Some months ago, an old friend called and recommended I buy a

certain stock which “without any doubt” should be shooting up fairly
soon. As a good friend, he tried to explain to me what a dreadful
mistake I would be making if I didn’t buy. Since such good ideas had
already lost me no small amounts of money in the past, I politely
promised to consider buying the stock, but of course I chose to forget
the whole thing. Some days ago, I met my good friend again, but he
did not forget to ask if I bought the stock. “Wow, I forgot…” I
pretended, and asked if he had bought it. “What do you think!” he
answered, and asked with some amazement,
“Why didn’t you buy it? I’m telling you, you lost out on the deal of
your life!”
“So in the end what happened to that stock?” I asked.
“Well, so far it’s dropped about 20%,” he said, “but just wait and see
what’s about to happen soon!”

I truly admire my friend’s psychological stamina in holding a stock

that drops over several months and even years, in the hope that it will
make a comeback. I can’t do that. I’m a coward. I need to know in
advance precisely how much money I might lose in any transaction,
not just in percentages, but especially in dollars! I also want to know
that I am able to limit my losses to a predefined figure. Remember
that in order to be successful in most sports, we first need to learn
how to play defense: as they say, defense wins championships. If
you know how to limit your losses, profits will be made.
There is no stock exchange in the world that approaches the
volume of activity on Wall Street. On the London Stock Exchange,
some 200 high-volume stocks are traded. On Wall Street, some 10,000
are traded, of which about 1500 show high volumes of more than one
million shares per day. Large volumes allow you to buy a stock at the
click of the mouse, and no less important, sell it in one click too. Low
volume stocks usually have low supply and demand, and the spread
between bid and ask prices is likely to be large. This means that you
cannot enter and exit such low volume stocks at any price: for
example, when you want to sell, you may discover that the closest lone
buyer is several percentages below the last traded price. Selling at that
price means you will need to absorb heavy losses. You can always try
placing a limit order at a high price, but that means waiting patiently
for a buyer who may never show! You will encounter the same
problem in reverse if you want to buy a stock, or worse, if you want to
cover a short (in other words, buy) only to discover that the closest
seller is far above the stock’s last traded price.

Large volume stocks usually have small spreads and high liquidity.
This means you can use automatic orders to realize profits or losses
and rely on the computer to provide you with fast, effective executions
as close as possible to your chosen entry or exit point.
Several stop orders can be applied, the most familiar and important
being a defensive order known as a stop loss, which we discussed in
the section detailing trading platform orders. In this chapter, we will
understand their significance and how to use them.

Fundamental Risks
Every occupation carries its inherent risks. The athlete’s risk is a
physical injury; the surgeon’s risk is human error. Every profession is a
world unto itself, which makes it difficult to comprehend the risks
until we dive deep into that profession.
An athlete’s risks or those of a surgeon can be estimated, and
therefore they can be insured. Athletes insure themselves against
injury, doctors are covered by medical malpractice insurance, but no
company in the world will agree to insure a stock trader’s accounts.
Insurance companies employ professionals to calculate and manage
risk. Since insurance companies will not insure us, it is up to us to
manage our risks. We cannot do that unless we understand just what
the risks are.

Risk Management and Loss

Management
First, we need to define “risk management” by distinguishing between
two areas that most traders mistakenly tend to lump together: risk
management and loss management. Correct loss management is a
stand-alone theory having nothing to do with risk management.
Risks must be managed under the assumption that part of our
trading activities will lead to losses. Correct risk management should
limit us to absorbable losses, which we will need to manage separately
according to a different set of rules.
Figuratively speaking, risk management is how a pilot plans
to avoid an accident, whereas loss management is how the pilot
must execute an emergency landing.

Fundamental Capital Risk

How much money did you deposit in your trading account?

What percentage of your trading capital are you willing to lose?
How much of that figure are you willing to lose in one trade?
Before you start trading, you must have clear answers to these
questions. They will help you define your trading strategy. Each of us
has different red lines based on our backgrounds, psychological
capabilities, financial soundness, and monetary commitments.
Define the percentage of trading capital you are willing to lose. This
figure is your first red line. Many of the traders I know have never
defined a red line, and sometimes become aware of it only when they
actually reach it. This is a big mistake: setting limits in advance will
help you cope better with the psychological aspect of trading.

Psychological Risk

Willingness to absorb risk does not derive from our financial status,
but rather from our psychological stamina. “Hating to lose” features
strongly in research which unequivocally concludes: we hate to lose far
more than we love to win, at a 2:1 ratio (Kahneman & Tversky, 1991).
Research indicates that loss is perceived as a change in our financial
wealth relative to a neutral status. Each of us has a different relative
status, derived from both our actual financial status and our
perception of the significance of loss. For example, when we buy stock
at a higher than normal price but do not sell at a profit, we tend not to
see the buying stage as an expensive error, but rather focus on our lack
of profit when we sell.
By contrast, when we buy an item at a higher than usual price for
personal usage, we tend to view the transaction as a loss.
What significance do you apply to losses derived from stock
trading? A pro will absorb losses as an inseparable part of the
profession. This does not meant the pro reaches a 1:1 psychological
balance between love of profit and hate of loss, but it is reasonable to
presume that his or her psychological stability will be greater than
that of an amateur for whom loss holds greater weight, even if the
amateur loses the same amount as the professional trader and their
point of neutrality is identical. In short, we can conclude that the
amateur trader’s red line will be different to that of the professional, or
simply put, each person’s red line will be different.
This is why it is essential for you to define your own, private red
lines in advance. Doing so will improve your chances of success. Your
red line should be based on the amount of available money you are
prepared to lose. Money intended for buying a new car or for the
family’s vacation is not available money and should not be used to
fund your trading account.This is scared money, which you are
scared to lose. Later we will discuss mental management more deeply.

SMART Trading with “scared money” causes

improper psychological management,
MONEY increases hatred of loss, and almost always
leads to real losses.

Leverage Risk
 If you open a trading account with a US broker, you will be able to
get margin of 4:1 by simply signing a margin agreement with the firm.
If you are not a US resident and you open a trading account with a
non-US broker, you will be able to get a margin of up to 20:1. A 4:1
margin means that if you deposit $10,000, you will receive leverage
when you execute intraday trading of up to $40,000. This is called
intraday margin. By contrast, if you hold stocks overnight, you will
be able to receive margin of only 2:1, called overnight margin. A 2:1
margin will let you sleep on stocks valued at double the amount you
deposited in your account. The reason for the broker reducing margin
on overnight usage is due to the fear of financial announcements that
may go public after trading hours, endangering your money as well as
the leveraged funds, which are the broker’s money.
A 2:1 margin held overnight will cost interest, but the 4:1 intraday
margin or even 20:1 margin does not. Most traders use margin. If you
also plan to do so, you need to be aware of the risks involved and
manage them correctly.
Using leverage correctly brings successful traders much higher
returns on their investment. Here, too, the correct way of coping with
leverage risk is to define your red lines for leveraged trading. Avoiding
any deviation beyond the red line will prevent you from suffering
heavy losses in the future. If you are not cautious, one heavy loss can
take you completely out of the game forever.
Are you familiar with the double-down roulette method? It’s very
simple: you place $10 on the red in the hope of winning. If you lose
and black shows, you gamble on the red again, this time with $20, and
so on. Each time you lose, you double the bet until eventually red
comes around again, returning all your losses with the addition of a
small profit. The problem is that if you do this for a long time, sooner
or later you will get a sequence of the same color. I met someone who
lost a huge amount of money when red came up 24 times in
succession! That’s definitely enough to put the kibosh on what could
have been a pleasant evening.
Now, back to stocks. By way of example, let us assume you are
using personal capital to the tune of $25,000. You set your loss red line
for any single trade at no more than 2% of your trading account: in
other words, you are not willing to risk more than $500 for any single
trade. Strong self-discipline is one of the most important aspects of
trading, and you will need to stick to this maximum loss factor which
you yourself have defined.
Note that following a loss of $500, your trading account balance will
be $24,500, so that now 2% of that new balance will be $490. If you
adopt the 2% factor, you will always be able to calculate in advance the
amount of money left in your account after a losing trade, however
many sequential trades may end up as losses:
• Following 10 successive losses, there will be $20,486 left in your
account
• 100 successive losses will leave just $3,315 in your trading account
The probability of losing 100 times in succession is extremely low,
but nonetheless you need to be aware of your red line at all times from
the angle of maximum loss as well as the single-trade loss figure.

Technical Risk

Correct entry and exit points must be determined, first and foremost,
according to the stock chart’s technical behavior. The exit point must
be planned in advance and cannot be set according to a figure you are
willing to lose, but rather based on volatility and the unique technical
behavior of each of the stocks in which you are trading. As we have
already learned, when you buy a stock, you must set your exit (stop) in
advance. For example, let us say that your entry point is at $30 and
your stop is planned for $29. If you buy 100 shares at $30 and the price
drops by one dollar to $29, you have taken a loss of $100. But if the
maximum loss you are willing to absorb is no more than $50, then you
must limit yourself to buying only 50 shares and not allow yourself to
buy 100 and “self-compensate” by setting a stop at $29.50, which was
not the correct technical stop in the first place.
In addition to the calculation you have set in advance, you also
need to understand that your actual exit point might be further than
the planned exit. For example, if the price dropped to $29 but has not
yet executed a five-minute reversal, you may have to absorb a greater
loss than planned. Therefore, you need to take into account in advance
an additional margin of error that allows you to operate correctly at
the technical level and wait for the reversal, while still preserving your
planned reasonable-loss framework.

Exposure-derived Risk

Part of the risk of trading in stocks derives from dependence on

unknown factors. These include political news, financial and market
announcements, company bulletins on the stocks you have bought,
sector information, analyst recommendations, and any other rumors
that may affect price. Since no one can anticipate the timing, content,
or impact of any news, the best way to reduce risks is to reduce market
exposure time. The less exposed you are, the more you reduce risk.

SMART The more you reduce exposure to the

market, the more you reduce your risks.
MONEY

Since day traders operate with large quantities, they exit most of
their transactions during the trading day. Holding stocks means taking
risks. Swing traders buy smaller quantities and are therefore willing to
take the risk, which can last several days until they close part of the
transaction. But even swing traders will try to sell 75% of their
quantity as early as possible to reduce the risk of exposure to market
mood shifts. Medium and long-term investors who hold stocks for
weeks, months, and years are even more exposed. Conclusion: the
more you reduce exposure, the more you are reducing risks, allowing
you to increase your trading quantity.

The “Stop Loss” Protective Order

This order does exactly what its name says: it limits losses. After
entering a stock, I place a stop loss order into my trading platform and
define the precise price at which I want to exit should its direction
move against me. In some trading platforms, such as COLMEX Expert,
the stop loss can be entered even before purchasing the stock. In this
way, it is only activated when the stock is actually bought.
Generally, I do not trade for more than two successive hours per
day, but I do hold some of those stocks while I am taking a break. This
is when I use stop orders for positions that are still open.
Usually, when I am actively trading and following my screens, I
don’t tend to place automatic stop orders. I use what traders call the
mental stop: in other words, I will exit the stock with a click of the
mouse if it reaches my pre-set stop point. This will be described more
fully later on. When I am holding more stocks than I am able to
handle easily, I am careful to always place a stop order. As with most
trading platforms, the stop orders I place are kept in the broker’s
computer, so that if for any reason my computer crashes midway
through trading, or the Internet connection falters in any way, there is
no need for concern: the stop orders will be executed as set.

Not All Stop Orders are Stop-loss Orders

First let’s talk terminology. It is important to understand the

difference between stop orders of various kinds, such as stop limit,
stop market, and so on (see section on “trading orders”) and the stop
loss order.
• Stop limit, stop market and others are defined trading orders found
in every decent trading platform.
• Stop loss is not a defined order. You will not find the words “stop
loss” in any professional trading platform. Its meaning is simple:
“cut my losses.” With this order, you define the exit price if a stock
you bought starts to fall.
• In contrast to the word “stop” in stop loss, “stop” in stop limit, stop
market, etc. means “put on hold.” Thus, a stop limit means “wait
until you can execute a limit order at the set price.”
• Not all stop loss orders are orders meant to reduce losses. In many
cases, it is simply a higher exit point for a stock that is rising. For
example: you bought at $30 per share, and placed a stop loss into
the system for $29.70. This indeed is a stop loss. But if the price had
risen to $31 and your stop loss was set at $30.70, clearly you have not
absorbed any loss, in which case the most appropriate term is
simply what traders call a stop.

How to Set the Stop Point

The loss exit point should already be set at the trade planning stage,
but as we will understand soon, we cannot always know in advance
exactly where the exit will be. In any case, even if we cannot pinpoint
the actual exit with certainty, we can plan it in advance. We do this for
two reasons: it is correct professionally, and it is good psychologically.
• Professionally: Before each trade you need to check the risk/reward
ratio. How can you figure the risk if you do not know where the stop
is? Traders who do not set their stop point before entering the trade
are operating very unprofessionally. A pro first calculates the risk,
not the reward.
• Psychologically: Can you set a reliable stop after entering the stock?
No. Once you’ve bought, you are no longer the same clear-thinking
person.Greed taunts you, and fear of loss plays with your emotions,
infringing on the ability to stay rational, and possibly causing you to
realize profits too early or cut losses too late.

Some traders will set their stop before entering the trade, but then
the demon gets to work: as the price approaches their stop, they
cancel it and set a new one further off. What do they do as the price
approaches their new stop? Correct, they reset it. The greater the loss,
the harder it is for them to admit losing. Exiting at loss is a painful
event. The human body has a psychological trait of protecting against
pain. Is exiting the stock painful? Then let’s not hit the button. When
they need to choose between the hope that the stock will turn about
and begin showing profits versus the pain of loss, they choose hope.
As the scope of the loss increases, they turn from short-term traders to
long-term investors. They ask themselves, “Why did this happen?” and
then begin searching for reasons to explain the dramatic change in the
stock’s direction. They deny the truth and seek to justify the situation
in which they are caught with any excuse possible: “The company has
good products,” or “It’s got top management,” and so on.
In my view, the stop can move only in one direction, and that is
NOT towards increasing a loss. As explained in the section dealing
with trade management, after realizing the first profit, the stop can be
moved as close as possible to the entry point or above it, in order to
prevent a profitable trade from becoming a failed one.

Repeat this in your mind until it becomes embedded: We never

give money back to the market. This is one of the stock trader’s
most basic rules, although for most, it will take a great deal of time to
learn and understand it.

The Importance of the Stop

Over time, I learned that the main error enacted by failed traders was
the difficulty in cutting losses on time. Your main resource is the
capital you deposited in your account. If you do not do everything
possible to preserve it, you are doomed to a complete wipeout.
“Everything possible” means ensuring losses are as minimal as
possible. Always.Without any allowances or excuses. Without “just
this once,” and without, “I’m just testing…” Without “I trust myself, I
know what I’m doing,” or “I’m prepared to pay the market for my
education.” Small losses. First and foremost, play correctly from the
defensive position. Always.

SMART A better trader is not necessarily one who

chooses the right stocks, but one who
MONEY knows how to cut losses faster than
everyone else.
 Loss is an inseparable part of stock trading. In fact, many
professional traders lose on about half the trades they execute. The
significant difference between a failed trader and a pro is the ability to
cut losses on time, but not exit a stock too quickly when it is moving
in the right direction. When professional traders lose, they
immediately admit their error, cut their losses and move onto the next
trade. They do not comfort themselves with excuses or justify their
loss with statements such as, “but the stock shows good earnings,” or
“the market is trending up, so the stock will no doubt reverse.” All
these actions start with loss and end with lamentations.

Time-based Stop

It may happen that you entered a stock and it has gotten stuck. It
makes no difference if that occurs when you have made a small profit
or loss. It is just not conducting itself in the way that you had
anticipated.
First, you need to understand that there is a good reason the stock
has stopped moving. Generally, you will not know the reason, but it is
probable that something is happening. For example, when you buy an
up-trending stock and it gets stonewalled by sellers, it is reasonable to
assume that the buyers will soon despair and start looking for the exit
door.You, like others, have noticed the perfect technical formation and
bought, hoping for success, but it is best that you are among the first
to exit.

How much time should pass between your entry and your exit? The
answer depends on each trader’s personal experience, but if you want
a guideline I would say that if it has not “provided the goods” within
ten minutes, then something not good is going on. When a stock stops
moving, I exit! When stocks are not moving fast, they usually will not
move at all.
 I realize that sounds very simple: “Not moving, so exit.” In reality, it
is not simple at all. Our brains resist clicking the button. We believe
we have made a good choice, and we are afraid that in the end it will
be a success but without us if we exit. Yes, this is a tough psychological
decision, but you need to persevere and click the button. If you stay
with the stock, chances are high that first it will “visit” your stop point
and then it will either succeed or fail. Remember that you entered the
stock because you believed that it needs to move fast in the planned
direction. If that did not happen, you have made a mistake. Now you
are in casino territory. You leave nothing to luck. Take your money,
even if you are in loss, or no more than a small profit, and invest it in a
more successful stock. Keep in mind that discipline is the name of the
game.

The Five-Minute Reversal Stop

This is the correct technical stop, but it is not necessarily the correct
stop for every trade. This is the stop that requires the toughest nerves
of steel, which are not usually in the arsenal of novice traders. When I
enter a stock, I never know if I have chosen the precise entry point. I
enter a strong stock trending up at a correct technical point or execute
a short in a weak stock, but the stock or the market may not “agree”
with my entry choice.

Example of Shorting in Moody’s Corporation, MCO

 I executed a short in Moody’s below $20.10 [1]. At this point, the
stock was looking good for further lows. It started with a gap down of
2% and the path seemed paved all the way. The market also started
with a gap down. Of course I was concerned about the gap closing (i.e.
the market trending up), but the market had been weak for several
days and I estimated that chances were good it would continue to
drop. I was wrong. The stock dropped to $20, encountered round
number support (which we have already discussed) and the market
then moved against me. In other words, it trended up towards closing
the gap. In just a few seconds, Moody’s changed direction with the
market, and rose to $20.37 [2]. Ouch!
What does one do in such cases? Where is the stop? As we have
learned, a stop loss should have been determined at the outset,
whether it is actually placed into the trading platform or kept in mind.
When you expect a stock to break and crash quickly and powerfully,
but in fact it moves ten cents against you, understand that something
not good is happening. In such cases, the stop loss should get you out
of the position at between ten to fifteen cents from the entry point.
Two scenarios now become possible. One is that you exited at the
correct stop and this is precisely what should have happened. The
other is that for various reasons you did not exit on time, and now, in
contrast to your plan, you are absorbing a larger loss than anticipated.
If you got swept up with the stock into territory where you should not
be finding yourself in the first place, you need to handle it using the
five-minute reversal rule. Unfortunately for me, this was my
situation with Moody’s. The stock literally shot up and I did not
manage to exit at the planned stop.
While the stock was moving up, I had no clue where it might stop.
It could have gone another dollar higher without looking back. I was
short 3000 shares, with a loss of more than $800, so that every ten
cents the share price rose increased my loss by $300.
What would you have done, fled or held on? Once upon a time, as a
new trader, I would have run like a frightened rabbit, absorbing the
loss, and been sorry afterwards when the stock pulled back. Not
anymore. Now I simply realize that the stock “did nothing bad.” There
was no argument about the fact that the stock was weak. The chances
are strong that it would reverse into lows, but during the process of
falling, it might also trend up briefly even if I am in a short, or even if I
am losing my pants. All I need to do is wait until commonsense and
the weak stock’s downtrend take over again. In most cases where a
weak stock moves up with the market, as in this case, it stops and then
reverses back down--which is what happened, happily for me, after
the reversal [2]. What might have happened had it not reversed? I
would have lost a good deal more, but that too would have been okay.
I have no problem with losses as long as I know I am operating
correctly, and then I do not get angry with myself. To start with, you
should not reach this level of loss, but if it does happen to you,
manage the situation correctly from the technical aspect. In this case,
the correct technical management requires placing a stop above the
reversal point [2] and hoping for success.

Quantity Test: Think about what you would do in my place, if you

had bought 3000 shares. Would you exit, or wait for the reversal?
Would you do the same if you had bought 1000 shares? 200? Only 50?
If your answer relative to a quantity of 50 shares, which creates a $13.5
loss at the pullback peak, is different than your answer for 200 shares,
then your problem is not the method but the quantity of shares you
are trading in. Conclusion: reduce your size. The day will come when
together with your cumulative knowledge, experience and confidence,
you will start increasing size.
Moody’s executed a reversal in five-minute candles [2], returning to
a downtrend, and closed the day with a drop of 6%. A trade that
started well continued in the possible-error zone but eventually ended
brilliantly. The five-minute reversal principle states very simply that if
you get caught in an awkward situation,wait for a change in direction
in five-minute candles before you set your stop beyond the reversal
point. In this case, that stop was above $20.37, but only after a clear
reversal was identified by being comprised of at least three candles.
The stock was weak. It started low and continued dropping. The
only reason that the price temporarily moved against me was the
unfortunate fact that the market was moving in the direction of
closing the gap and dragged Moody’s, among others, along with it.
Remember that Moody’s had been weak at the open, and stayed weak
until the close. It started with lows and therefore chances were good it
would continue down. Generally speaking, a stock showing relative
weakness compared to the market will continue down, even if the
market trends up.

Market Behavior at those Particular Points: Five-Minute Candles

for Two Days

On the market’s ETF (SPY), it is clear that [1] was the turning point
for upward movement, which matches [1] on Moody’s chart, the point
at which it dropped and stopped at the round number. At [1] Moody’s
“wants to continue down,” but gives in to the changed market
direction and trends up. When the market executes a reversal [2], the
same reversal point [2] shows on Moody’s chart, where Moody’s
capitulates and returns to lows.
Summarizing, if I had not kept the five-minute reversal rule in
mind, I would have panicked from the uptrend, exited with losses
higher than planned, and missed out on the later lows. The five-
minute reversal was my protection. It gave the stock time to cool off
from the market’s movement up, and allowed bears to keep in mind
that it is basically a weak stock. The five-minute reversal rule let me
realize the trade with a nice profit.

Extreme Situation: On rare occasions, the five-minute reversal

will nonetheless cost you a searing loss. A stock might move very far
against you before executing the hoped-for reversal. These are also the
rare cases where, despite the pain, it is worth temporarily absorbing
what appears to be a loss, since generally the stock will return to its
initial trend and justify your confidence in its overall movement.
Under what conditions should you flee if the stock keeps moving
against you? This is where you need to be level-headed. Sometimes, it
becomes very clear that “something bad is happening there” even if
the stock has executed a five-minute reversal. For example, if the stock
goes higher than its intraday high [2], then that is a good reason to
exit fast with a loss even if it did not yet make the five- minute
reversal. This is the only point at which you might suspect a
reasonable chance that the stock has changed its trend. Should you be
angry with yourself over this misjudged trade? Absolutely not: you
shorted a weak stock, you waited for the reversal which almost always
brings the stock back to lows, and you operated in strict accordance to
“the rule book.”
In Moody’s case, we concluded that going higher than the intraday
high was the furthest level of tolerance. With other stocks, you may
not always be able to identify the alternative exit points. What might
happen if a stock moved against you without executing the five-
minute reversal, and without your identifying a different, logical exit
point at a reasonable distance? This is an extremely rare, but possible,
situation. Sometimes you might find you have traded in a stock that
intraday news has caused to spike against you, and the price may not
pull back, causing a shocking loss. I remember this happening to me
some two years ago, ruining profits I had accrued over an entire week.
Even if you do encounter this very rare eventuality once every few
years, you should still respect the five-minute reversal rule, since in
the great majority of cases, statistics will be on your side.
What can happen, nonetheless, if the stock goes seriously against
you? Imagine a situation in which Moody’s would have risen to $20.70,
and only there starts pulling back. It is probable to assume that from
this high, it would not go back to lows. In such a case, you need to
start thinking about an exit with as little damage as possible. The
solution is to wait for a pullback just below the peak. I would set a buy
order (in order to exit the short) at $20.40, hoping that a pullback
from a $20.70 peak would reach $20.40 and allow me to exit with a
more absorbable loss. This is a LIMIT order and will execute only if
the stock price drops to my limit. On the other hand, I would also set
a stop above $20.70 in case the price does not drop, and exit with a
larger loss than planned. True, this is not a pleasant situation to be in,
but by comparison to so many other successful trades providing good
profits, a situation like this definitely conforms to the statistics.

Hard Stop or Mental Stop

• A hard stop is an order placed into the trading platform. If and

when the stock price reaches the pre-set stop, the broker will
execute the order automatically.
• A mental stop is one we decide on in our minds, but do not feed
into the trading platform and therefore will not be executed
automatically. We will execute it manually if and when the stock
reaches the point which we have defined for ourselves.
Each of these stops holds advantages and disadvantages, and we
will later learn how and when to use them.

SMART A hard stop can be serious trouble! Avoid it

as much as possible and opt for the mental
MONEY stop. Using it can save you no small number
of unnecessary losses.

What is best: setting a hard stop, or exiting the stock manually

when it reaches the point we have chosen as our stop? The answer will
differ from one trader to the next, and also depends on a trader’s
experience. For new traders, I recommend placing an automatic (hard)
stop. It helps you cope more correctly with fear and will likely improve
your achievements. For more advanced traders, I strongly recommend
not using the hard stop and using the mental stop instead. The reason
is chiefly technical and derives from the unpredictability of intraday
volatility. With a hard stop, you may encounter a situation where a
large-quantity seller might cause the price to momentarily plunge,
showing a sharp, fast red candle, and shake you out at your stop. Then,
the price might return within seconds to its original level. You do not
want to be shaken out under this kind of volatility. In most cases, the
price will return to its high and you will feel like the perfect idiot for
having exited.

When is It Worth Placing a Hard Stop?

• When I am concurrently holding several (usually more than three)
stocks and it becomes difficult to track each of them
• When my stop point is very far from the current price and I am not
afraid that unexpected spikes might shake me out
• When I leave my desk for more than a few minutes

Different strokes for different folks: some traders are unwilling to

lose more than a specific amount of money per trade, irrespective of
the stock’s technical formation, and will always place a hard stop in
the trading platform. Sometimes it will be a timely rescue from loss,
and at other times the traders will be shaken out sharply and suddenly
without enjoying the highs that follow, since they have not given the
price a reasonable breathing space. This is not my modus operandi
during trading, but that does not mean using hard stops is an
incorrect method. Both options have their good and bad points. Either
method is correct if it contributes profitability over the long term and
suits the trader’s personality. Hard stops may be excellent for the
novice trader, since they ease the psychological coping with market
fluctuation, but may be harmful to the experienced trader who is less
likely to react to sudden market movements.

Summarizing: The hard stop is usually worth avoiding. Use it only

when you have no other choice. The mental stop, despite its
disadvantages for the inexperienced, is the correct one to use. As you
develop your trader skills and your self-discipline, try to become
accustomed to it.
Risk Reward Ratio
Before trade opens, you have scanned the stocks in your follow-up list
and chosen those that interest you as trades. Some are marked “to
buy,” but your buying power is limited, and by nature you will want to
lessen financial risks as much as possible. How will you choose what
to buy? Among the various parameters that must be checked is the
Risk Reward ratio.
It is known simply as the RR.
• Risk refers to the sum of money you are willing to lose in a trade
from the entry point to the predetermined stop point.
• Reward relates to the sum of money you wish to gain from the
trade, from the entry point to the predetermined exit point.

In reality we calculate the risk to reward ratio in points. A typical

sentence may sound like: “It looks to me like the stop is half a point
and the target is one point.” In other words, I am taking the risk that
the price will move against me by half a dollar, in the hope that I will
profit by one dollar.
If you ask professional traders, they will usually say that they expect
an ideal RR of 1:3, but in practical terms, they are willing to accept a 1:2
ratio, and sometimes, even lower than that. What they mean is that
during the process of choosing a stock, they will be looking for one
that may jump by $3, but has a planned exit point (their stop) of only
$1.
To determine the RR, traders will analyze the stock’s daily chart
and its intraday chart, watching for the closest support and resistance
points and the intraday volatility.
Why would we look for a 1:3 or even a 1:2 RR? What is wrong with
1:1? Our goal, of course, is to earn money with as little risk as possible.
Let us say you are experiencing a bad luck streak in a tough market,
and you successfully beat the market in only half your trades. If you
profit in only half the trades you execute, and are additionally paying
commissions, you will be doomed. By contrast, if you succeed to
maintain a 1:2 ratio, so that for every trade where you lose $1 you earn
$2 in another trade, you will maintain a positive balance. In this way,
even if you choose the right stocks in only half the instances, your
status remains stable. Obviously, choosing stocks with a good RR
means you need to accumulate no small amount of battle experience.

Calculating the Risk to Reward Ratio in Aon PLC, AON

Aon gapped down at the open, then continued dropping, found

support at $39.15, rose to $39.34 [2], executed a reversal to lows and
broke support [1]. This was also the point where I entered a short. But
before entering, I calculated the risk/reward ratio as follows:
• First, where is the stop? That’s easy: it is without any doubt above
the reversal point [2]; in other words, 20 cents above the line of
support, the short entry. But this is just half the answer.
• To complete the calculation, I need to estimate where the target is.
Glancing at the chart, we can see the outcome in retrospect. Aon
dropped to $38.32 [3], which is 82 cents below my entry point. We
can see that the RR was 1:4, in other words, I risked 20 cents and I
could have profited 82 cents.

Of course there are none so wise as those with hindsight, but

clearly I did choose a correct stock with an excellent RR. Could I have
known where the target was, and what risk/reward ratio could be
expected in the final outcome? To determine the answer, I need to
examine the stock’s intraday volatility over the last few days of trading:
no better tool for that than the daily chart.
Aon Daily Chart, AON
 If we examine the stock over several days and concentrate on the
black (down) candles by checking the height of the candle from end to
end including tails, we see that the intraday trading range in Aon at
the marked points [1,2,3] is around $1.50 between the highest and
lowest prices. If you really want to, you can translate the outcomes
from points to percentages: the daily volatility is some 3%. Looking at
the last few trading days, I can see that Aon had some less volatile
days, and I can therefore carefully estimate with reasonable
expectation an intraday fluctuation of $1.

Now I return to the intraday chart and see that Aon’s high is $39.44,
which is a difference of some 30 cents between the intraday high and
the planned entry point [1]. Conclusion: based on a check of past
volatility, we can reasonably assume that Aon is able to move another
70 cents or so below the breakdown price. Since the risk is 20 cents
and the profit target is 70 cents, the risk to reward ratio is 1:3.5. Very
decent! In actuality, as you have seen, the stock moved 82 cents, a little
more than the expected figure. I executed a careful short of 1000
shares, added another 1000 at the start of the fall, and locked in
several pieces of profit on the way down. In short, I risked $300 but
profited $752.05.

SMART Planning the trade is usually the easy task.

Sticking to the plan is where,
MONEY psychologically, things get much harder! To
 stay with the plan, we need to maintain the
rules for correct money management.

This is how the result looked in my trading account:

A word of warning: even though a high risk to reward ratio seems

better, from my experience it tends to make successful trades more
difficult. By contrast, a reasonable 1:2 ratio is usually more accessible.
Additionally, despite the 1:2 ratio sounding much better than a 1:1, note
that if you succeed in only one of every three trades, you will be losing
money. However, if you go for a 1:1 ratio but succeed in two out of
every three trades, you will be profiting. The only way to choose the
ratio that suits you best is through experience. Over a long term,
follow your results, examine the ratios and see which trading method
suits you.

Money Management
You have chosen a stock correctly, and bought or shorted it at the
correct point. What happens next? Correct money management is
the difference between the professional trader who earns a living from
trading, and the amateur who provides the pros with their earnings!
Many new traders place too much weight on technical and financial
aspects and view money management as extraneous, although it is an
imperative tool.
Ask yourselves what you would do when a stock you bought at the
correct point breaks out and trends up strongly. Amateurs will look at
the stock’s chart, rub their hand with glee, admit their good fortune,
and perhaps even increase the amount. What does the pro do
following a breakout? Certainly not shout out, “I’ve got a winner!” The
pro shouts out, “Who’s the sucker I can now push this stock onto?”
If you have ever bought stocks, try to remember and reconstruct
the trades you executed in recent years. Let me describe the process. I
am familiar with the stocks you bought and your methods of
managing them. Is this what you did? You usually bought at the right
time. I will also give you credit and say that shortly after buying, you
almost always were in the money and were even quite pleased with
your decision to buy: am I correct? The only problem was that you
held on to them for a fraction too long, enough for the whole episode
to end in a loss.
Correct money management allows you to profit even if your
success rates are below 50%. One day recently, as I was writing this
book, I closed a day’s trading in profits even though I lost over eight
trades and gained in just three. Correct money management lets me
exit a failed trade with a small loss, and milk a successful trade to the
maximum.

• Rule 1: Lock In Profits

In trading jargon, a partial means realizing a partial profit. Once
the stock has broken out, immediately when its first weak point
shows, you need to sell at least 75% of the shares you bought at the
breakout. This is called selling into the power. Then, continue
trading with the remaining quarter amount alone. The smart thing, of
course, is to identify the first weak point, but not to flee too early. One
rule of thumb says that you must try to ensure that the distance
between the entry point and the first profit target is not shorter than
the distance between the entry point and the stop. In other words, you
must try to attain at least a 1:1 ratio for the quantity you sell.
When I worked as an entrepreneur in the world of hi-tech, I
devoted a good deal of my time to recruiting investments for the
company I established and managed. One of the most important facts
I learned is that “money needs to be recruited when it is available and
not when it becomes needed.” In day trading, as in hi-tech, we need to
sell when buyers’ craving is at peak, and not at its decline. True,
sometimes you might see a stock continue moving up and will regret
selling too early, but generally the first target point will be the only
profit you will see from the stock. Remember that after a strong
upward movement, some traders will realize profits, others will short
based on the assumption that the stock will pull back, and yet others
are experts at shaking out. The function of this last group is to shake
out weak buyers and force them to sell by causing the stock to drop
below the entry point. I will generally sell 3/4 of the quantity I bought
after a rise of some tens of cents. In cases where the stock rises quickly
beyond my first target, I will wait for its first sign of weakness and
then execute a partial.
A common mistake by new traders is to trade in quantities that are
too small. If, for example, you bought 200 shares and your partial
point is at 20 cents profit, how much will you sell? Since, as we have
learned, you are supposed to sell round figures of hundreds, you have
little choice but to sell 100 shares. This means that you will make just
$20. For a stock successfully breaking out, this is not enough, since the
other half of your quantity still puts you at risk. However, selling 300
shares from a total quantity of 400, or 800 of 1000, already promises
you good profits at the partial point. Starting with a good profit early
in the trade allows you to put doubts and tensions aside and continue
trading in the technically correct way without having to suppress
emotional reactions. I must say that I have not changed my earlier
recommendation to accrue initial experience with small quantities of
less than 400 shares per trade, but several weeks into trading, the
quantities you trade in must start increasing.

SMART Novice traders, unlike experienced pros,

tend to exit a successful stock too early, and
MONEY a failing stock too late.

As noted, you must take a partial at the first pullback beyond your
first target. How will you know this is the correct partial point? At first
you won’t know: that comes with the “art of trading” as you gain
experience and insight. Generally, I would say that a partial for a share
priced between $20 to $60 should be between 20 to 40 cents from the
breakout price. The problem with a generalization of this kind is that
sometimes the price will break out without looking back for up to one
dollar from the breakout point, so that realizing 20 cents is far less
than the potential profit. To identify the correct partial point, you
need to “feel” the stock, understand it and have tens if not hundreds of
attempts at figuring that point until you come to understand naturally
where to take the partial piece. Sometimes, the difference between the
successful and the unsuccessful trader shows precisely at the first
partial. New traders, unlike the experienced hands, exit too quickly
from a stock running up and too slowly from a failing stock.

• Rule 2: Buy More

Has the price broken out, have you realized your initial profit, and
is the stock proving to be strong? Buy more! Always give preference to
a stock with which you have already booked gains over another that is
about to break out but with which you have no experience, good or
bad. No one can tell if that new breakout will succeed, and never will,
but the one you are currently trading in has already proved itself. It
has broken out, you have taken a reasonable partial, and now you are
ready to join it for round two.

SMART Show faith in a strong stock: wait for the

pullback and buy more. Buy it even if you
MONEY do not see a perfect technical reversal.

How and when should you buy more? Once you have taken the
partial of 3/4 of the quantity you are holding, set a limit order at a
lower price but which is just slightly above the original buy price, and
wait for the pullback. For example: you bought 1000 shares at $29 and
took a partial with 800 shares at $29.25. Set a buy order for 400 more
at $29.05, using the limit order which waits in the BID column and
will execute only if the stock reverses. In many cases, you will find that
in a short time, the stock will execute a retest (described in earlier
chapters) close to the initial breakout point.
Why is it necessary to enter a limit order rather than simply wait
for the stock to pull back, and then click the button if and when it
starts to trend up again? The answer is simple: when a stock retests, it
usually drops, then shows rapid upward movement. Usually, you
simply will not have a chance to wait for the clear technical reversal in
five-minute candles, nor even in two-minute candles. The correct way
to buy more and increase quantities at the retest point is to set a limit
at a low price. The limit waits for the price to drop and will execute
only when the preset conditions are fulfilled.
What is the correct price for adding shares? That depends on the
breakout point. For example: if I took a partial of 20 cents per share for
a stock that rose by 25 cents, I would be happy if the stock pulled back
to just five cents above the breakout. If I took a partial of 50 cents out
of a high of 60 cents, I would be happy to buy more even at 15 cents
above breakout. In other words, I am willing buy more if the price
pulls back by 70% to 80% of its post-breakout movement.
 As with the partial point, the point at which we buy more is also
part of the “art of trading.” Until you reach that level of capability,
think in these terms: “After realizing a profit of x cents per share, what
is the highest price at which I am willing to buy this stock again?” This
is a simple business management question which has nothing to do
with stock trading.
• You sold “merchandise” for profit at a certain price. You are sorry
you did not have a greater quantity of that same merchandise at the
original price, and now someone is offering you the chance of
buying at slightly above your original purchase price.
• You already know that this is good merchandise since the stock
broke out and you booked a profit, and you believe that you are able
to sell more of this merchandise at a profit. You see that the price is
now a little higher, and do not wish to take too much risk by buying
the same amount that you bought the first time around.
• How much should you be willing to pay? How much should you be
willing to buy? Answer this question for yourself, and that is where
you will place your buy limit order for the additional quantity you
wish to buy.
• The quantity I buy at the retest will never endanger my profits from
the original partial. In other words, the maximum quantity I will
buy is about half of the quantity I already locked in with the partial.

Here’s how it works: I bought 1000 shares at the breakout, took a

partial by selling 800 shares, and was left with 200. Now I buy another
400 at the retest, 400 being half the quantity of my partial. The total
quantity I now hold is 600 shares.
Q: Do all stocks execute retests?
A: Of course not. Sometimes you may find that you’ve taken a
partial and the price keeps moving up without returning to its
breakout point. This is a happy occasion where the small quantity
leftover after the partial will bring you greater income than the partial.
Enjoy it!
Q: What happens if I bought more at the retest, but the price keeps
dropping?
 A: No one can guarantee that you bought at the right point.
Statistically, stocks that begin with a trend up will continue to follow
through unless the market changes direction. Wait patiently for a five-
minute reversal, since it is reasonable to assume that the price will
continue trending up. Since you have already locked in a partial profit,
you are currently holding a smaller quantity of shares even though you
have bought more. You can let the price drop slightly without ending
up with a loss. Stay calm and relaxed. In eight out of ten instances, the
price will begin to trend up again. You should be able to easily allow
yourself to absorb two out of ten unsuccessful moves.
Q: How long should you wait for the retest with an open order?
A: Usually no more than five minutes. A quick retest may occur
after several seconds, a slower one might take a few minutes. With a
slow retest, wait with your finger on the mouse and execute your
second purchase with the click of the button. With a slow retest which
is taking more than five minutes, you will need to wait for a clear
reversal, since the price may then drop even lower than the retest
point. If the retest executes over more than a half hour, be very careful:
it could be that the stock has decided to change direction.

• Rule 3: Realize Profits Again!

Did you buy more at the retest? Let the price move up and look for
another partial, which will generally be slightly below the previous
peak’s line of resistance. At this second partial point, you should sell
half of the quantity of shares you are now holding. The goal is to “put
behind” you the risk that buying more shares brings with it as the
price moves above its previous peak.
For example: you bought 1000 shares at $30.01, taking a first partial
with 800 shares at $30.35. The stock retests and you buy 400 more
shares, which is half the amount sold at the partial, for $30.05. Now
you have 600 shares. The price goes back up and you take a second
partial at $30.30 with 300 shares. You are now left with 300. Result: you
have taken two partials and still hold a larger quantity than after the
first partial. You use these shares to try to capture a bigger gain
without any real risk.
 Why is the second partial taken below the first peak? Sometimes,
when a stock is strong, you may succeed in selling above the peak, but
the fear is that the price will encounter resistance at the same level as
the previous peak and then reverse. Taking a partial before the new
peak will reduce your risk. Occasionally, when the stock is particularly
strong, I keep my finger on the mouse and try to let it reach a higher
high before taking the second partial. These are usually the “big
winners” for that day’s trading.
Over time you will learn which stocks are strong enough to let you
buy more a third time, but generally the more a price trends up, the
weaker its new breakouts will be. Buying additional amounts gets
trickier, therefore the target for a third buy needs to be closer and the
quantity smaller.
The opposite of a breakout is a breakdown. For breakdowns, the
rules are identical, as we will see in the example below.

Short and Retest Adder with Illumina Inc., ILMN

I shorted Illumina below $42.30 [1] for 1000 shares, and took a
partial with 800 when the price dropped towards the round number
support level of $42. I was left with 200 shares. Next, the price rose
and executed a retest several cents above the entry point [2]. Imagine
how you would have felt had you not taken a partial! Around the retest
area [2], I increased my short position by 400 shares so that I was now
short 600 shares. The price dropped and I took a second partial with
300 of those shares [3] just above the round number support line. I
have now taken two partials and am holding 300 shares in short. The
price continues to trend down, to 90 cents below the entry point. The
psychological calm I was afforded by taking the first two partials gave
me the focus needed to realize a full profit for these remaining 300
shares.

• Rule 4: NEVER GIVE YOUR MONEY BACK TO THE MARKET!

Let us say you have taken a second partial with a stock in an
uptrend. The price is sufficiently far from the entry point and you are
left with a small quantity of shares which, with a bit of luck, may give
you even greater profit than the two partials. Now you need to raise
your stop to the entry price or slightly higher. In other words, don’t
lose on the quantity you have left.
Remember the rule we have repeated: never return your money to
the market! At the most, forego the profit and let the price slide back
to the entry point.
This is a golden rule that every trading newbie must constantly
keep in mind. If you are operating correctly, your entry point should
also be the point at which the original line of resistance breaks, and as
we know, a broken-out line of resistance now becomes a line of
support.
When you raise your stop to the line of support, which is also the
entry point, you simply cannot lose. In fact, you are trading with the
market’s money and removing all risk from the quantity you are still
holding.

• Rule 5: How to Manage the Balance

At this stage, when you are holding only a small percentage of the
original quantity of shares, you need to decide how to manage it.
First, check what the market is doing: is it supporting the direction
of your trade? Even a very strong stock can capitulate to a market that
has changed direction. If you feel there are clear signs of a market
directional change, move your stop closer. How is the stock behaving?
Is it holding its trend? Is its sector showing and holding a matching
trend? Now you need to decide if you are going to “sleep on the stock”
or make do with the profit you have already made. Generally you need
to take this decision during the final minutes of the day’s trading,
since that is when sought-after stocks tend to take off!
Sell all the quantity you are still holding towards the end of the
day’s trading or earlier, if the stock or the market has changed
direction. By contrast, if the particular stock ends the day with a clear
uptrend and is sufficiently far from your entry price, consider whether
it is worth holding the entire remaining quantity or perhaps reducing
it further.

Why would you want to reduce that quantity a little more? To avoid
too great a risk. It is really dangerous to “go to sleep” with stock in
hand, since you can never know the reality you will wake up to in the
morning. I have already seen situations in which a stock shot up one
morning and plummeted the next. Leaving yourself a small quantity,
based on the fact that you have sufficiently profited from all the stock
you have sold so far, greatly reduces risks. I tend to decrease quantities
as a matter of course. If you have chosen to “sleep on” the stock,
known in trader jargon as Swing Trading, you will need to continue
managing it correctly in the coming days. More on that later.

SMART When you are in a multi-day swing trade,

you need to disconnect from intraday
MONEY trading rules. Your decisions must be based
on the daily charts alone, and not on
intraday volatility. This is a worthwhile
guideline that pays off!

• Rule 6: Raise Your Stop

Are you staying for a swing? Excellent. The profit potential in a
swing is higher, and you need to aim for a swing with a strong stock.
Often, you will rake in more on the balance of your remaining stock
than you did on the intraday trades. Now you need to understand that
you are in multi-day territory, which is completely different from
intraday conduct. You need to relate to the stock’s volatility from now
on only in terms of its daily chart.
Has the price changed direction? Within the trading day, that is no
longer interesting information. But at the daily level, yes, it is
interesting. Do not get angry over the price movement even if its trend
changed at the intraday level, or the next day, or even if it opens on
the next day with a gap down which wipes out half the profits you
made the previous day. On the contrary: if it drops below your entry
point, or below yesterday’s low, that’s another story.
Every day, raise your stop on the quantity left. Raise it to a point
about 2 to 3 cents below the previous day’s lowest price, on condition
that the low is still higher than your entry point. In other words, you
absolutely must not lose on the remaining quantity of shares you are
holding if you can help it. On every additional day that passes, you
need to raise your stop to the lowest point of the previous day. When
that lowest point breaks, you will be out of the stock. The only risk is
that the stock gaps down on news.

Swing with PAR

Do you remember PAR from the previous chapter?

Take note of the daily chart for several days after the entry [1] at $10.
I left a small quantity of shares over for a swing. Three days after the
original entry, the price had already reached $11 [2]. Notice that on the
second day of trade the stock rested, not going down to the entry
point, and not going up to any new high. This continued into the third
day. As we have learned, in such situations, the stop order for the
remaining quantity is a slightly lower than the previous day’s low. On
the third day, the price had not yet awoken, but to my joy nor did it
drop below yesterday’s low. The first three days formed the bull flag
formation.
On the fourth day, the price broke out of the bull flag and provided
a handsome yield for the rest of the swing. The stop can now be raised
to the fourth day’s low, and so on.
What are the chances of the trend continuing? High: but is there
any risk? Of course there is. As I said above, the price can open with a
gap down below the stop and wipe out all the profits accrued from the
swing! Is the chance of continued uptrend greater than the probability
of a drop? Absolutely. The stock is in an uptrend, and the smallest
item of negative news can topple everything. But if you manage the
situation in this way, out of 100 opportunities you will take home extra
income 70% of the time. It not only pays, but it is correct to take
strong stocks for the swing.
Notes: Every trader, every trading method, every market period,
whether moving sideways or volatile, has a different money
management mode. My trading method may not necessarily suit other
traders, but every trader must develop a method that suits him or her.
There is no single “correct” or “incorrect” method, but there does need
to be a method of some kind. Traders who operate only on “gut
instinct” rather than an organized method rarely see anything good
come of their efforts in the long term. They are the people from whom
I earn my living. You can, and should, use the rules in this book as
your infrastructure for developing rules that suit your psychological
and financial abilities. Occasionally you may also need to alter those
rules to suit your own development or market conditions. In a market
moving sideways, you should take a partial of less than 20 cents. In a
strong market you should be able to take a partial of half the quantity
and not three-quarters, and hold at least one-quarter over to the next
day.
 Some months ago, I experienced an extraordinary event. I lost for
over three consecutive trading days! With my self-confidence now in
the dirt, on the fourth day I was forced to change tactics. The solution
best suited to me was to trade in much smaller quantities, with much
closer partials. Some days later my successes once again became more
regular, my self-confidence was boosted, and I resumed my original
money management methods.

The 3x3 Method

I am aware of the fact that not all readers of this book can devote
several hours each day, or even each week, to trading. If you do not
have the ability to spend more than an hour or two per week in
trading, buy stocks that from the outset you wish to hold for swing
periods.
In other words, focus on stocks you want to hold for anything from
several days to several weeks. Work with them according to the 3x3
method. Even if you do have the time for daily trading, you need to
understand that swings can contribute nicely to your profits, so there
is no reason you cannot “spice up” your intraday trading with several
stocks held for more than one day, or even bought in advance for this
very purpose.

SMART The more you distance yourself from the

computer, the better off you’ll be. Use a set
MONEY of automatic orders to manage your stock.
This reduces the element of psycho-
emotional involvement and stress.

The 3x3 method of money management which I’ve developed and

fine-tuned over the years is likely the simplest, important, and
effective way I have of teaching you money management. It is so good
that I’m prepared to vouch for it by saying:
If you keep its principles, you will find it very difficult to lose!
You can, and should, apply the method’s principles using a set of
automatic orders, especially if you are among those traders who are
active daily. The method is valid for buyers and short sellers, but for
the sake of convenience I will focus on long buys.
• Choose a stock according to the rules we have learned so far. After
buying it, operate in the following manner:

1. Stop Point
Enter a stop order 3% below the entry point. Why 3%? When a
stock you believed would trend up goes against you by 3%, it would
seem you’ve made a mistake. You thought you bought at the right
entry point, you thought it would break out strongly and put money
in your pocket, and that’s not what happened. Of course, with a
little luck it will return to its uptrend, but usually you’ll do better
admitting the error, abandoning that stock and focusing on another
stronger one. Should you ignore the support and resistance lines?
No. If you identify a clear support line in a 2 to 4 percent range
below the entry point, use it.

2. First Profit Target

You need to sell three-quarters of your quantity at a first profit
target of 3%. Why three-quarters? Because of the demons! When
you profit or lose, you need to cope with your deepest inner voices.
Get to know the one perched on your right shoulder yelling into
your right ear, “Remember the time you reached a profit of 3%,
waited a bit too long and then the stock fell and you lost it all…” And
then there’s the demon that sits on your left shoulder,
simultaneously yelling, “Remember the time when you profited 3%,
locked in a gain, but if you’d only waited a bit longer, you’d have
made a bigger profit…”

There’s only one way to stave off these demons: sell three-quarters

of the stock. This way, you appease both demons. “You on the right,
 saying the stock’s about to fall: here’s your three-quarters. Now leave
me alone! And you on the left, telling me it will go up? Here’s one-
quarter and now go prove yourself!”
Only realizing a profit releases the stress. Once you’ve realized a
yield, you’ll be much calmer and will be able to manage the
remaining 25% with almost no emotional involvement.

Why 3% rather than 5%, for example? Stock prices rise, but always
pull back. The question is only one of when and how much. From
my experience, the pullback generally occurs after a high of 3 to 4%.
Why? Prices pull back once the public begins buying: the public
never buys at the start of the uptrend. They only buy once the stock
has “proven itself.” Usually the public is persuaded that the stock
has proven itself only after a 3-4% rise. At that point, why is the
price not going up further? Because it is convenient for institutional
traders to take advantage of the large quantity of buyers in order to
unload large quantities of shares. Since the institutional traders
comprise 80% of the money involved in all the stocks we trade in,
when they sell, we can reasonably presume that the price will drop.
In short: over the years, my records repeatedly show that 3% is the
figure.
3. Rising Stop Order
After selling three-quartersof the stock, you need to raise the stop
order for the last quarter to the entry price. Since our law states
“never return your money to the market,” you want to be sure that
the profits of that three-quarter quantity stayin your pocket. If the
last quarter returns to the entry point, you’ve lost profit only on that
quarter. But if you let the remaining quarter drop to below the entry
point, then you’ll be doling out money that you’ve earned to cover
the loss, and that of course is against our rules!

4. Second Target
Lock in the remaining quarter at 6%, or manage it according to
methods we have already learned. For example: raise the stop a little
below the previous day’s low each day that you remain in the trade.
Q&A
• What should you do if you have bought stock, but it is moving
sideways and deciding to go nowhere over several days?
Sell it! Remember, when you bought it, you thought differently:
that it would shoot up to your target. It didn’t. What does that mean?
Simple: you have made a bad choice. Admit it quickly, and sell. If the
price has not chosen your direction, you are in a gambler’s territory.
Remember the rule: if the price does not reach its profit target by the
end of the second week of trading from its purchase, sell three-
quarters of the quantity, regardless of whether you have made a profit
or loss. Continue managing the remaining quarter according to swing
principles.

• What should you do if the price approaches the target towards

the end of the trading day?
Give it some thought. Let us say the price has already reached 2.5%,
but it is also clear to you that it will not reach the 3% target by the end
of the day. Sell three-quarters before trading closes and reduce your
risks of what the next day might bring.

• Price gaps
When you are about to buy a stock for a swing at the start of the
trading day and a gap shows of up to 1% above the trigger, you can still
buy the stock. In this case, calculate your profit or loss point according
to the 3x3 rule relative to the actual entry point. When a gap of more
than 1% develops, cancel the buy order.

• Earnings reports
Before publication of quarterly earnings reports, we will always sell
our full quantity. As we learned in previous chapters, you need to
carefully check which reports are expected and sell the day before
anything major is to be released. It is common knowledge that the
results of these reports are not known in advance, and the risk to the
price is too great.
• Time of purchase
I never enter a swing later than the middle of the week’s last
trading day. We are looking to buy stock with strong chances of
reaching its target already within the first week of trading. If we buy
stock at the end of the last day of the trading week, its chances of
reaching the first target or even moving far from the entry point are
far less. Going to sleep over the weekend with a full quantity of shares
that still endanger my trading account is just not on my agenda.

• Which Stocks are Suited to the 3x3 Method?

Most of the stocks we trade in, with a share price of between $10 to
$80 and volume of over one million shares per day, suit 3x3 trading.
Some do not. Before choosing a stock,you must check that you are not
buying anything too volatile, or lacking volatility (such as MSFT and
others that trade similarly). Volatile stocks will more naturally suit the
4x4 or even the 5x5 method.

Summary
The 3x3 method works well! Using automated buy and sell orders
solves a good deal of the psycho-emotional aspects of money
management, and therefore, coupled with good choices of stocks,
should virtually guarantee success. If you have a limited time only for
trading and cannot find suitable opportunities for active intraday
trading, you can at least devote one hour each week to trading with
this method.
The Tradenet investors club is very successful when it applies the
3x3 method. As these lines are being written, average monthly returns
over the past six months have been 8.4%. Is there any good reason
not to invest an hour each week in trading this way?

Noise Cancelling
With due respect to classic technical analysis, stocks do not need to
behave “by the book.” Most of the money in the market belongs to the
long-term investors, to funds, and of course to a group of Warren
Buffet-type folk. They do not always check the chart before they buy a
stock. Did the stock breakdown in the perfect “head and shoulders”
formation? Why on earth would that interest them!? They may be
buying right when you sell, for entirely different reasons. Technical
analysis does have its limitations. In fact, I can assure you that if you
operate according to perfect technical rules, you will end up losing.
Technical analysis states that the uptrend is defined as a succession
of higher highs and higher lows. Let’s say you bought a stock currently
trending up, and its price has now dropped to a new low. Would you
sell it at precisely the point where it drops under the last low?
Technically speaking, yes; but in reality, no.
It is most likely that everything you have experienced during the
price’s drop under the last low is nothing more than “noise”. It could
be that you are seeing the first signs of a direction change, but in
many cases it is nothing more than a temporary pullback caused by
someone selling thousands of shares without checking the chart. At
the start of my trading career, I would set the stop order one cent
under the last low. I would forget that the stock owes me nothing:
neither behavior according to the technical analysis, nor according to
the price I bought at. The reason it may drop several cents under the
last low can be very simple: someone might have sold 1000 shares with
a market order, which drops the price by several cents under the last
low. Does every small change in price draw you out of the game?
Sometimes, yes; generally, no.
Noise in stocks is also one of the reasons why I try to avoid, as far as
possible, using hard stop orders. Stock prices constantly show spikes
in either direction. To understand the stock’s general direction, we
need to relate to its overall framework of movement rather than
chance price volatility, since the latter may cause you to imagine all
kinds of unrealistic statuses. I am not saying that in such cases you
should bury your heads in the sand. You do need to be cautious, and
remain ready for a change of direction, while not fleeing or buying on
the basis of any small price change.
 How can sharp fluctuations be neutralized? Switch to displaying
fifteen-minute candles and try to see the bigger picture. Jerky behavior
seen in five-minute candles will look completely calm in fifteen-
minute candles. That’s one reason why we hardly use two-minute
candles except when trading the first hour. The amount of noise after
the bell is unbearable!

Points, Not Percentages – Quantity,

Not Sums of Money
A math question for you:
Danny bought stock when its shares were $100. In the afternoon the
price rose by 20%, but later dropped by 20%. What is the price of the
share after it dropped?
If your answer was $100, think again.
After the price rose 20%, its value was $120. When it drops 20%, the
drop is calculated on the new price of $120. Therefore, after it drops,
the price per share is $96.
What is the conclusion? Percentages manifest relative values
and not absolute values.
If I say that the stock of ABC yielded a profit of 10%, how much
money did I actually make? There’s no way of knowing. It could have
been $10 per share if the share was bought at $100, but it could also
have been 10 cents per share, if its buy price was $1.
Here is another example:
Danny bought stock at $100 per share. One fine morning the price
dropped by 50% to $50. By what percentage does the price need to go
up in order to make $100 per share again?
If you answered 50%, think again.
To return to the original price, we need to see an uptrend of 100%
of its current price of $50.
By contrast, in absolute values, there is no confusion: the stock
lost $50 and must add $50 (i.e. 50 points) to return to its start value.
This example demonstrates exactly why percentage-based calculations
can get so confusing.
• Remember: Traders do not calculate profits in percentages. They
calculate in points, i.e. dollars, where each $1 = 1 point.

SMART A fundamental principle of stock trading

management is based on measuring gains
MONEY and losses in points and not in percentages,
and when buying, in quantities and not in
sums of money.

When you ask traders what sums they trade in, they will find it
hard to answer, since they operate in quantities and not in sums of
money. A novice trader will start off trading in quantities of 100 shares
per trade, and over a year of accruing experience will gradually
increase towards the 1000 shares per trade mark. Old hands at trading
with several years of experience up their sleeves buy stock by the
thousands of shares per trade, and in even more advanced stages, may
even reach single trades involving tens of thousands of shares.
I realize it sounds a bit odd to you: a trader may buy 1000 shares at
$20 each, for a total of $20,000 and then on another occasion, without
even blinking, he may buy 1000 shares at $50, operating with a figure
of $50,000.
And that is how it really works.
Here are three main reasons for referring to trades in these terms:

Reason Number 1: Fast Calculation of Profit or Loss

Traders who tend to buy 1000 shares per trade can easily calculate
their profit or loss: for example, if the stock you bought goes up 23
cents, you have profited $230 (23 cents x 1000 shares); if it rose by $2
you have profited $2000. This is not a calculation of yield on capital,
but profit in dollars per trade.
If you were to ask the owner of a shoe store what his monthly yield
is, you would likely be given a “what on earth…??” look. Ask what the
earnings per month are: that can be answered instantly.
 SMART You never count your money when you’re
sittin’ at the table.
MONEY There’ll be time enough for countin’ when
the dealing’s done
-Kenny Rogers: “The Gambler” lyrics

When you are completely focused on a stock’s breakout, analyzing

the stock and its market direction, the number of bids and asks, its
sector status, volume and so on, the last thing you need to be doing is
figuring yield in percentages and multiplying by the amount of money
in order to calculate profit or loss. This is where the points system
comes to your aid: profit or loss of ten cents on 1000 shares will always
be $100,regardless of the price of the share.
One of the mistakes I made in my early trading days was buying a
quantity of shares according to a sum of money. For example, I would
decide to allocate $5000 per stock. This is what I did: if I chose stock
at $36.49 per share, I would divide $5000 by that figure and buy the
result, 137 shares. Now let’s say the price rose by 17 cents: how much
have I made… See the problem? I would be spending more time on
math than on market direction.
Now imagine yourselves trading in three different stocks
simultaneously! But if I round off to “batches” of 100 shares, it gets a
lot easier to calculate the effect of 17 cents profit: $17. I can assure you,
it’s better to focus on actual trading than to start reckoning complex
monetary calculations.

Reason Number 2: Buy in Round Figures Based on 100

As we have already learned, executions of orders that are not round
figures of one hundred get delayed. The great majority of bid and ask
orders are set in round hundreds, known as “lots.” The ECN systems
give priority to round-lot orders. If I try to sell 137 shares, called an
odd lot, and at the same time a buyer wants 200 shares, the buyer
may receive a round 100 quantity from my stock. But it is highly
probable the buyer will not be interested in the additional 37 shares,
which is not a round figure, since it will be difficult for him to find
another 63 to make up a round number of 200.
A simpler solution for the buyer is simply to execute the trade with
a different seller who can provide the full round-figure quantity.
Worse than the above is the AON (all or nothing) order which
buyers use, and which translates simply into, “If I can’t have the entire
quantity I’m looking for, don’t buy anything.” This means that if I am
holding 137 shares, that buyer will not receive 100 from me. Instead,
the system will look for round-figure sellers.
Incidentally, AON is not an effective order for traders. Please
avoid it.
So, to sell those 37 shares, I will need to wait for a buyer who
specifically wants that amount. This could take a long time, and may
even end up costing me an additional commission. The only instance
where you might consider using non-round quantities of shares is
while you are learning to use the swing method, where holding shares
for several days makes you less sensitive to sudden changes in price.

Reason Number 3: Stocks Move in Points, Not in Percentages

When a price rises or falls, the average buyer does not think in
terms of percentages but in price per share. For example: I want to buy
a stock at $20 per share. I waiver a little and the price goes up by two
cents. I buy at $20.02. Another example: I want to buy a stock selling
at $2 per share. I wait a little and it goes up by two cents. I buy at
$2.02.
Do you see what happened here? My decision to buy or not was
based on the price moving up by one or two cents, rather than on
percentages. My consideration in both cases was that the price is
reasonable, and relatively close to the price I initially wanted to pay.
But note the difference in percentages: for the $20.02 share, I bought
at 1/10 of a percentage above the planned price, whereas for the $2.02
share, I bought at 1% of the planned price.
The principle is simple: people buy stocks according to their
movement in cents, not in percentages. Because of this standard
human behavior, a good breakout for a share at $20 will be
approximately 20 cents, and a good breakout for a share costing $2 will
also be around 20 cents. So how does this tie in to fixed quantities?
Where does the problem lie?
If I were to insist on buying stocks according to a fixed sum of
money, let’s say $10,000 per stock, I would then be buying 500 of a $20
stock or 5000 of a $2 stock. If both break out at 20 cents, and
breakouts can occur within seconds, then I have made $100 on the $20
stock, and $1000 on the $2 stock. Cool, right? No, not cool at all.
Remember: the potential for profit equals the potential for loss.
Within seconds, before you have time to say “there goes my account…”
the $2 stock can just as easily move 20 cents against you and wipe
$1000 out of your account.

SMART Traders naturally tend to buy stocks

according to their movement in cents
MONEY rather than percentages. A successful
breakout for shares priced at $20 will be 20
cents, just as it will be for shares priced at
$2.

Summary
Be disciplined about buying according to quantity rather than
sum of money. If you are comfortable with buying in multiples of 500
shares, then do that always, irrelevant of the share price. The
exceptions to this norm are for shares at $70 and up, or small caps
with clear, very low volatility. Remember that every stock has its own
“personality.” Therefore, a good rule of thumb is to always buy a fixed
quantity. Before clicking the buy button, just check the stock’s
volatility thoroughly and take your decision on whether to increase or
decrease the quantity.
Learn from Your Experiences…Keep a
Diary
No infant learns to walk without falling. The infant keeps trying until
the sequence of actions called walking becomes embedded in the
brain and turns automatic. Every trader undergoes “infanthood” and
“childhood” as he or she learns. Mistakes are part and parcel of a
trader’s learning curve and a very important aspect of shaping the new
trader’s capabilities and resilience.
Mistakes are a vital asset in learning how to succeed. Even old
hands make mistakes, but to lesser degrees than new traders. When I
started out, I made far more mistakes than I do now. I remember days
filled with self-directed anger. There were days when I would lecture
to students, teaching them what to avoid, then go and do exactly that
action I had warned against! Of course I felt like a complete idiot.
Now, years later, I still make mistakes, but far less frequently. The
fascinating thing about trading mistakes is that they are known and
familiar, but we make them anyway, even though we know we are
crossing into forbidden territory. It’s as though something stronger
than us is pushing us against our will.
The first step in coping with mistakes is to know what you should
and shouldn’t do. This book is meant to help you a lot in that respect.
The second step is your own determination to correct your mistakes
and strengthen your psychological stamina towards eradicating them
one by one. Traders need to know how to take best advantage of
mistakes rather than waste them. Mistakes, by virtue of their
unavoidability, are a valuable asset. As with any valuable asset, they
need to be documented and conclusions reached. The only way to do
that is to keep an activities diary.

Students in my courses are taught how to avoid typical trading

mistakes. I go over, emphasize and demonstrate every typical mistake
there is until I am certain the message is absorbed. At the end of every
discussion, there is that moment I am so fond of when I tell them:
“And I know that despite everything, you’re going to make this
mistake…” When I look at their faces, I see them all thinking, “Does he
think I’m a complete idiot? I listened, I understood, I wrote it all
down, and I have no intention of making that mistake!”
I know that’s what they’re thinking, but that’s not how it works in
real life. In real life, they’ll make every mistake covered by this book.
For each mistake, they’ll pay with their hard-earned money.
Nonetheless, the big advantage is that unlike others who did not study
the rules of trading, they have learned what those common mistakes
are. Most traders active in the market try to learn by themselves and
from their own experience. That, too, is a mistake. Trying to learn
trading by yourself means you cannot pinpoint the common mistakes
and try to avoid them, thus prolonging the process of gaining
experience and knowledge. So while even someone who has taken a
course will still make mistakes, that person will be more aware of what
to avoid, and will err less frequently. Identifying and acknowledging
your mistakes is the first and most important step to eradicating
them.
Keeping an ongoing diary is the perfect solution. It will help you
understand when you have erred, and how to handle the situation in
the future. When I started out trading, I read an article on keeping an
activities diary. Truthfully, at first I could not understand how
important this aspect was, just as it likely sounds to you now that I am
filling your head with petty ideas. I was sure I remained aware of my
mistakes and that I had no need of further documentation. In
retrospect, I was sorry for not keeping a diary earlier. I discovered the
need to manage an activities diary the hard, costly way. If you take my
advice, you will save yourselves an unnecessarily long and expensive
learning process.

SMART An amazing thing will happen to you when

you start keeping your activities diary. You
MONEY will nd that the kinds of mistakes you
make are within a relatively small range. If
 you see the same mistake showing up all
the time, then it’s time to make a change!

My wife, without even realizing it, helped me realize the need for
an activities diary. When I started my trading career, I would repeat
one of the most common mistakes of new traders: I would buy at the
right time but then sell at too small a profit or too great a loss. Every
evening I would tell my wife more or less the same story, “If only I had
done this… or not done that… I would have made a bigger profit…”
Every day it was the same thing, until she got sick of hearing how I
“almost” made money. What was abundantly clear to my wife, but not
to me, was that I described the exact same mistake, over and over. It
was time to look that mistake in the eye. It was time to make a change.
An interesting thing happened once I started keep a diary. I found
that the range of mistakes I made was limited. I found that I
consistently make the same classic mistakes of new traders. But I
found these things out only after I started my activities diary. At the
end of each day, I jotted down my trading activities, and once a week I
would sit with the diary and review the outcomes recorded there.
Most of my failures derived from a small range of repetitive common
mistakes.
From this point on, the path to success was shorter and sweeter. All
I needed to do was decide to kill off those mistakes, one by one. The
biggest, toughest battle, obviously, is psychological. But by the end of
the first week in which I declared war on my mistakes, armed with my
trusty diary, I was amazed by the results. By the end of the second
week, I was convinced that this was the best method, and the war got
easier. All I needed to do was keep a diary. So simple, and so amazing.

What to Record in your Activities Diary

• Date, hour and minute of your trade. This lets you study the stock’s
chart later.
• Stock ticker symbol
• Quantity of shares you bought
• Trade direction (long, short)
• Planned entry price
• Actual entry price
• Reason for entry (e.g. technical formation, stock in the news)
• Price of first target; actual first target
• Price of final target; actual target
• Stop loss point
• Hour and minute of exit
• Actual exit price
• Reason for exit (e.g. price reached target, market changed direction)
• Monetary outcome (profit/loss, how much)
• Notes: mistakes, changed market direction, etc.

I know of traders who rely on a broker’s activities printout. Don’t

rely on that alone. A broker’s printout will never be enough. You need
to manage your own lists in a handwritten booklet or Excel-type
format, whichever manner you find easiest. But you must record every
single trade you execute. I can assure you that as the conclusions
become clear, you will be amazed to find that you make only a few
types of mistakes. Once you’ve identified those that are typical for you,
you’re on your way to neutralizing them!

Putting It All Together

Now you need to set goals. Don’t try to make that goal eradicating
more than two mistakes simultaneously. If you discover that you tend
to make the same five mistakes, choose two and declare that over the
coming ten days of trading, which is two business weeks, you will
make sure not to repeat them. For example: you see that you tend to
exit a stock before it reaches your pre-set target. Decide that
unequivocally and without compromise, you will not exit even one
cent below your target. Enter a sell order at your target price, and
avoid changing it. You need to hit the target with a bull’s eye. You have
to resolve that for the coming ten trading days, you are going to place
a huge X over the two mistakes you’ve marked. Ignore all bothersome
information, and mainly ignore the profit/loss concerns. Stop
counting your money while you trade (one of THE most common
mistakes!) and start focusing on trading correctly while remaining in
control. I do not wish to imply this is easy work, but it is definitely
achievable. I was there too. I applied these tactics, as did many of my
students. Without exception, I’ve always been told later how great this
method is.
Keeping an activities diary works. Fact.

Chapter 12 - Choosing a Winner

Stock
From the Thousands of Stocks
Traded, how Can We Choose the
Best?
Around 10,000 stocks are traded on Wall Street. How can we choose
the best ones for the current day’s trading? A pro chooses stocks
according to predefined rules, not according to whim.

Do Your Homework

Before each day of trading, do homework. Start the day with a list of
candidates. Sometimes I get lazy and don’t prepare in advance. On one
such day, trading opened with a sharp gap up, and I had no candidates
on my non-existent list. As trading progressed, I quickly reviewed my
favorite stocks in search of a good opportunity, but to no avail. The
feeling that everyone else is making easy money and you’re the only
one wasting time is one of the worst psychological states for a trader.
It is fertile ground for stupid moves… and this mistake didn’t take long
to become apparent. I convinced myself that a certain stock was
looking great, and with an impulsive click, placed the trade. For a very
short time I did well, but in the long run I took a searing loss.

SMART Advance preparation for our day of trading

contributes to our psychological resilience
MONEY and helps us cope successfully with market
conditions.

Important moral to the story: when you really want to hit the
button, you’ll find that you possess awesome powers of self-
persuasion. Every so-so stock looks great. Remember this: sometimes
we profit more by not trading at all!
 The conclusion is simple: for each day of trading you need to have a
list ready with stocks you have analyzed, which will prepare you
mentally for the market. These are the stocks which would offer the
lowest risk of disappointment and the highest chances of success.
Later on, we’ll look at several ways of searching for stocks.

Using Analysts’ Reports

A professional, experienced analyst who invests a good deal of time

and energy in searching for stocks will succeed far better than a new
trader with no experience. The success rate of Tradenet’s trading room
analysts is about 65%.
The disadvantage of relying only on the trading room analysts’
picks is that it draws you into laziness and can create dependence. I
know traders who have been operating for years with only analysts’
reports. They are pleased with their outcomes, but are constantly
dependent on someone else and will never learn to identify stocks
themselves. It is an unhealthy status, since your ultimate objective is
to be independent. If you allow someone else from now on to choose
stocks for you, you will never progress as a trader and gain that vital
self-confidence and experience.

SMART You must learn to identify stocks yourself. It

contributes to your self-con dence,
MONEY experience, and development as traders.

I will waive my opposition to my recommendation only when you

are starting out as traders. I believe that initially it is worth being
assisted by the knowledge of a more experienced trader, but that
would be for one purpose only: to learn and understand why your
mentor chose the particular stock and how you can do that yourself.
As long as you are earning income from someone else’s
recommendations, you need not give up being assisted. However,
always check well that the stocks chosen by the analyst will not
constitute more than half the trades you execute, and compare your
rate of success on stocks you have chosen with those chosen by the
expert. Your long-term goal is to improve your rate of success, to reach
that of the expert.
How does a daily analyst’s report look? Reports are adapted to the
nature of your trading. Swing traders use a report that analyzes up to
ten stocks each week, and intraday traders use a report that analyzes
up to ten stocks daily. The report contains a list of “candidates” for the
coming day’s trading and their trigger points (entry, stop loss, targets),
a technical and fundamental market review for the previous day,
predictions for the coming day, charts and analysis referencing the
main sectors and indicators, a list of specific stocks due to announce
quarterly reports or important statements, lines of support and
resistance closest to the main indices, a review of important upcoming
market announcements and their publication times, and an updated
follow-up table with targets and stop loss points of stocks in swing.

Sample of Stocks Table for Intraday Trading as Publicized in the

Report

Managing a Watch List

Many traders prepare a list of stocks for follow up. Generally, the list
runs from dozens to hundreds of stocks, sometimes up to two
hundred. Later I will explain how to prepare your own list. What
characterizes these stocks as desirable is their high volume and
volatility. The symbols are entered into the trading platform under the
Watch List field. At one click on any symbol, that stock’s chart opens.
 Every day before trading begins, traders manually check the charts
for those stocks they are following as they look for technical entry
points. Stocks identified as having potential for trading will be divided
into three sub-groups:
1. Hot shares – which are close to their trigger point (planned entry
point) and seem likely to be traded that day
2. Rising shares – showing an uptrend and which could enter the
“hot” list over the coming days
3. Falling shares – showing a downtrend and which might enter the
“hot” list over the coming days for shorts
Every so often, the main list should be checked and updated
according to the three follow-up divisions. List the stocks you plan to
trade over the current day in a separate table, including organized
columns for the trigger point (entry price), stop loss point, first profit
target (the partial), and final profit target.

SMART Prepare a follow-up list of 100 stocks sorted

into three categories: hot stocks, rising
MONEY stocks and falling stocks. Frequently update
the lists and mark stocks suitable for
trading.

How should you construct your follow-up list? I recommend

beginning with a list of up to 100 stocks, and expanding it over time as
you gain experience. You can choose leading stocks from two
important lists: the NASDAQ 100 and the S&P 500. Note that some
NASDAQ stocks will also appear on the S&P list. To find the symbols
for stocks in each of these two lists, Google the words “NASDAQ 100
index” and “S&P 500 index” and copy the symbols from one of the
financial sites.

Filters
• Remove from your follow-up list all stocks priced at over $100, as
they will not only be too expensive but also too volatile for novice
 traders.
• Remove all stocks below $10. We have already discussed the fact that
as beginners, it is best to avoid trading in small caps which
institutional traders are generally prohibited from buying.
• Remove all stocks with intraday ranges of less than 30 cents per day,
including the “heavy” stocks that show little volatility, such as
Microsoft (MSFT).
• Remove all stocks with very low volumes, initially those showing less
than 2 million shares per day, and later as you expand your list, to
those showing less than 1 million shares per day.
• Compile your list from what is left.

Over time, once you get to know the stocks you like most, and even
if they are not included in either of those indexes, you can add them
to your list while removing others, as you see fit. Most likely, after
some months of trading you will have developed your winner list.

Following Up on “Stocks in the News”

In addition to stocks you have identified through your watch list, you
also need to keep an eye open for “hot” stocks from the previous day
and add them to your daily list.
Don’t make the mistake that the bulk of the public makes: don’t
think, even for a moment, that there’s any simple way to profit from
shares that trend up quickly because of some announcement, or that
crash because of bad news. Usually, these are stocks that will start the
day with a gap and the ability to move either way, sometimes
completely against all logic. In principle, they are unpredictable, but
sometimes a good technical entry point can be found and the
resulting move can be strong because of the interest generated by
news.
When a significant article appears on a specific stock in such
prestigious media as the Wall Street Journal, and you make the
mistake of buying the stock along with millions of others, you no
longer have any advantage as far as price. Will a million readers all
make good profits on the same stock? How will the market react to the
news item? Will the price go up or down? One guess is as good as the
other. In most cases, a stock in the news has already seen its uptrend
prior to any public announcements, based on insider information or
the grapevine. If you are on either of those radars, you have an
advantage. If not, forego the urge to buy.
The well-known catchphrase “buy the rumor, sell the news”
alludes to the principle where the herd buys on hearing the news and
therefore the herd loses. The ones who profit are usually those who
break the law. They have received information from a friend inside the
company, or had access to the company quarterly report printed some
few days before the official publication. If you thought the stock
market does not operate like this – think again. Manipulation and
corruption abound in such subtle ways that the regulatory bodies
simply cannot catch the criminals.
In that case, should we buy a stock in the news because of an
analyst’s recommendation or removal of recommendation? Do
analysts know how to choose good stocks better than you do? Every
year, research is published that examines the outcomes of analyst
recommendations. Can you guess what your situation would be if you
based yourself on the analysts? It’s a certain way to lose your money.
If so, why should you be scanning for stocks in the news? I read the
news for a different purpose altogether: I want to know what the herd
is up to. I want to understand the herd, but I would never operate
automatically the way it would expect me to. I want to know which
stocks are in the news so I can follow them and perhaps find good
technical entry points during the day’s trading, no matter which way
prices are moving. Stocks in the news tend to be highly volatile. And
high volatility is important to me. Every day, I prepare a list of some
five to ten stocks in the spotlight and keep checking them for
technical opportunities. Sometimes I get lucky, sometimes I don’t.
An example of a stock in the news is British Petroleum, BP. The
price crashed due to the leak from the company’s drilling rig near
America’s shores in an event that came to be labeled “the worst
ecological catastrophe in American history.” Anticipated
compensation claims reached the billions of dollars, and a potential
total bankruptcy hovered over the company’s head. For several days we
monitored BP in the trading room, and finally, due to the alertness of
an analyst, its day arrived!

Trading Room Trade in British Petroleum, BP

As is common during crises, BP opened with a gap down. Can we

immediately short because of the news? Had you tried to enter a short
at the start of trading, it is highly probable it would have shaken you
out at a searing loss when it rose to close the gap. Later BP moved
down again and provided us with an excellent technical breakdown
point when it broke the intraday support line. Without doubt, this
was an impressive short for a weak stock in the news. The short was
executed at $33.45 [1] and the exit was executed when it first started to
show signs of a bounce [2]. For a moment, I thought BP had run out of
steam for further lows (notice the long tail indicating the intraday
reversal). In retrospect, I was slightly in error concerning the exit
point, but the earnings amounted to $2,920, as you can see from my
trading account:

Trade Details

Summary
Every day, dozens of stocks can be found in the news for a variety of
reasons. It makes no difference if the news is good or bad, since there
will always be strong volatility which provides interesting trading
opportunities.

Mergers &  Acquisitions

A company being bought or merging with a competing company is

not a rare event. There are many reasons for mergers and acquisitions,
and the reason most commonly tossed about is “synergy.” Mergers and
acquisitions create enticing trading opportunities.

SMART When one company buys another, usually

the price of the buyer’s shares will drop due
MONEY to the risks involved in the transaction, and
the purchased company’s share prices rise
due to the premium being paid for its
shares.

As traders, mergers and acquisitions interest us since the shares of

both companies involved – the purchaser and the purchased – can
usually be anticipated: the price of the buyer’s shares will drop,
whereas the price of the purchased company’s shares will rise.
On one hand, investors are expressing their concern that the
purchasing company has “bitten off more than it can chew” and that
the new purchase will weigh heavily on its balance sheets. On the
other hand, the purchasing company also takes control of the acquired
company’s shares at higher-than-market price and pays a premium to
the shareholders. By doing so, the purchasing company takes a certain
risk, but also displays its ability to absorb the purchased company as
part of its own, creating a greater whole than its parts (hence the
“synergy”). While no one can guarantee that the acquisition or merger
will succeed and that the merged companies will be more successful,
the simple fact is that the acquiring company will show a massive
expense on its balance sheets. Nonetheless, the acquired companies
were bought above market price, and will soon be traded in the
market at this premium price. Simply put, this means profit
opportunities for investors.
For example, the pharmaceutical megacorp Merck (MRK)
announced its purchase of Schering-Plough (SGP) for $41 billion, a
huge transaction by all reckonings. Schering investors would receive
0.57 shares per Schering share they held, plus $10.5 in cash. The
outcome: on the day of the announcement, Merck’s share price
dropped by 8%, whereas Schering’s rose by 15%. I wish to emphasize,
however, that even though this is highly expected behavior on the part
of both stocks, you should nonetheless carefully check your best entry
point, and the risk to reward ratio.

Staying Loyal to a Stock

Traders will often become “familiar” with stocks they feel more
confident in than with others. Each timeframe has its “stars,” stocks
with prices that are continuously trending up, drawing traders,
investors and funds to buy in for varying periods of time. Should we
get to know the more popular stocks and join the party?
First, I don’t believe in marrying any stock. Realistically, during any
timeframe, some will be defined as “wild kids” in the market. These
are traded in gigantic volumes and with crazy volatility. As I write
these lines, I can say that the two currently most popular ones are AIG
and SEED. By the time this book reaches the printer, most certainly
others will be the public’s favorites.
AIG’s story belongs to the financial crisis, that amazing crash and
the swift recovery. At such times, emotions work overtime. Some will
remember the company’s good days as a leader in the international
insurance market, and might buy AIG “for the children’s future.”
Others, like us traders, take advantage of this outpour of emotion to
trade the stock through days of fantastic volatility and high volumes.
Daily Behavior of AIG over Several Months

In August 2009, the share’s price leapt from $12 to $55 [1] during
crazy trading days and in volumes of hundreds of millions of shares
per day. In fact, AIG’s story began some time earlier, but without a
doubt, August and September of that year showed the wildest moves
in stock trading.
AIG, along with other “public favorites,” can show highly volatile
movement within a single trading day with high volumes and liquidity,
which is why many day traders earn a great deal of money from them.
Public interest causes price spikes, the company is usually assessed at
far above its real value, and most often will not uphold market
expectations. In most cases the share price will drop [2], volumes will
fall sharply [3] and the price will cease showing its earlier volatility. If
and when interest renews in the stock, it will likely “go crazy” once
more.

Conclusion: if you really want to “marry” a stock, get married to

the way it is traded within a specific timeframe rather than with the
stock itself. It is far better to avoid becoming “big experts” on any
stock, when we know that within several months the party will be over
and we will want to move on to something else. Stock traders seek
intraday entry points that allow them to trade in that stock once or
twice during the same day for profits. This method works only if the
stock maintains high volatility and volume, and these can calm down
at any time or even eventually disappear.
 The snowball usually gets rolling only once the institutional players
start buying the stock, pushing its volume and price up, and bringing
it to the attention of the investing public and traders. While investors
and day traders “acclimate” to the stock, institutional traders who
pushed the price higher are selling it to you in mega-volumes. Slowly,
the price uptrend calms down, day traders stop playing, institutional
buyers are generally out of the picture by now, volumes drop, and the
price begins to plummet back to its natural position.

SMART We never “marry” a stock for long periods.

We trade in it during interesting timeframes
MONEY and abandon it when volumes drop and its
price returns to its natural and less
interesting state.

How do investors behave? Let’s take, for example, AIG, which

began at $12, spiked to $55 and pulled back, at least for now. Most
investors did not enter at $12. Very few of them held the stock before
the price began to rise. The “lucky” ones discovered it at around $20 or
even higher, and rode it up to $55. Were they pleased with their
success and realized profits at that point? Mostly, no. Greed drew
them in further. When the price dropped all the way to $35, did they
realize profits? On the contrary: they started to “get smart.” They
convinced themselves that they “know” the stock, and are sure it will
move back to its previous high. So now, they buy more shares at $35,
planning on making easy money when the stock repeats its highs.
Eventually they discover that the price is continuing to move down,
below their original purchase price, and they end the trade at a loss.

It should come as no surprise to you that this scenario repeats itself

several times throughout the year. It also happens to more experienced
investors. Every year we will meet “the public’s favorites” along with
the investors and traders who “know” the stock, conclude they are
experts on its behavior, and find themselves well on their way to losing
money.

Intraday Search for Stocks

I find about one half or slightly more of the stocks I trade in during
the trading day by staying tuned to several sources. The most
important for me is the online trading room where I trade together
with hundreds of other traders every day. Many of them present
interesting stocks from their watch lists, or stocks they identified
during trading hours. The suggestions are inexhaustible! The hard
thing is to know which ones to choose.

SMART One of the most useful tools is identifying

strong and weak stocks during the trading
MONEY day. Follow them and look for good
technical entry points.

I also make use of my trading platform. Each platform contains

special tools for locating intraday stocks exhibiting uncommon
behavior. For example, lists of the strong stocks in each stock
exchange (New York, NASDAQ), the weak ones in each stock
exchange, and those with particularly high volumes. The COLMEX Pro
trading platform I use displays a “Top 20” scanner from which I gain a
good deal of intraday ideas! The method for using it is simple: during
trading hours I open each stock’s chart, for example for the strongest
stocks, and look for interesting technical entry points. Correct follow-
up can produce several good trades on any given day.

The COLMEX Pro “Top 20” Scanner

 As you see, the window is divided into columns, each of which
shows a list of stocks with the relevant criteria:
(1) NASD Gain – 20 strongest NASDAQ stocks
(2) NASD Loss – 20 weakest NASDAQ stocks
(3) NYSE Gain – 20 strongest on the New York Stock Exchange
(4) NYSE Loss – 20 weakest on the New York Stock Exchange

Every few seconds, the scanner executes a data update, so that any
particular stock may be replaced by any other. Displayed data can also
be filtered to suit your individual requirements. If your trading
platform does not display these details, you can find the information
gratis on a number of financial sites constantly updated in real time,
such as searching Google for stock gainers and losers, and
choosing the site you find most comfortable to use.

Using Special Stock Screening Platforms

Most traders who use special stock screening platforms are assisted by
programs geared to locating them at the end of the trading day. Very
few use them for intraday searches.
A wide range of stock screening platforms are available. Some are
Internet freebies and others can be purchased for anything from
hundreds to thousands of dollars along with a monthly fee. Paid
programs are generally geared toward professional traders.
Two useful sites are www.stockfetcher.com and www.finviz.com,
and both provide free basic services and paid advanced services.

How Does the Scanner Work?

A stock scanner for the end of the trading day is based on an
analysis of trading data for the entire stock market. This data includes
the opening and closing prices of every stock, its low and high, and its
volume.
To locate suitable stocks, you need to conduct a search. First, you
must define the program’s scan parameters. For example: if you want
to trade only in stocks with high volumes, activate a filter that displays
stocks with average daily volumes over the past month of more than
one million shares. An additional filter may display stocks whose
volumes increased over the number of days that you specify. You can
set the program to focus only on stocks that on the previous day
showed double their average daily volume over the past month. An
additional filter could be applied for identifying stocks with prices
above 20MA, i.e. stocks trending up. A more advanced filter would
require that the 50MA is below the 20MA, and that the 200MA is
below the 50MA. In this way, you not only assure yourself that the
stock is indeed showing an uptrend, but is trending up for a period of
no less than 200 periods.
The more filters you define, the more you limit the search results,
until at some point a click of the button will return “zero results.” The
ideal result will be around several dozen stocks, which you will then
check manually, one by one, to find those with your required
formations.
Over time, you will learn how to define filters that best suit your
trading method, and access the appropriate results with just one click,
displaying a daily list of likely candidates.

The Fundamentals of Using the Scanner

• The objective: identifying stocks suited to your trading method
• Remark: it would not be wise to reach a “perfect” set of filters since
you may miss out on many stocks that do not look ready for
immediate entry, but may nonetheless prove worthy of continued
follow-up and possibly being included in your watch list.

What Are We Looking For?

• Classic breakout and breakdown formations
• Reversals
• Patterns, such as “cup and handles,” “head and shoulders,” etc.
• Stocks showing up or down trends
• Gaps
• Volatile stocks
• High volume stocks (above 700,000 shares per day)
• Increasing volumes

Setting Up the Filters

Every program has its own method for setting up filters, but they
are all fairly similar. The examples shown here are taken from the
Stock Fetcher program.

Example: Let’s say I want to find stocks at no more than $1 from

their year high (i.e. towards a breakout), priced between $10 to $70,
with daily average volume over the past 30 days above 750,000 per day,
and trended up on the previous trading day.
This is the filter:
1. Show stock where close is between 10 and 70
2. and Average Volume (30) is above 750000
3. and 52-week high is less than 1 point above high
4. and close is above open
Once this filter is entered into the scanner program, one click on
“search” will display stocks fulfilling the above criteria. Were too many
stocks on the list? Increase the volume to 1 million.
Filters that search for formation will look like this:
1. Show stocks where pattern is a head and shoulders
2. Show stocks where pattern is a cup and handle
3. Show stocks where pattern is a double-bottom
 To all these filters, we add the definitions for price range, volatility,
and average daily volume.
Example: a filter searching for bull doji formation with reversal (we
are looking for reversals formed by candles rising after the doji) will
look like this:

1. close is above open

2. and close 1 day ago equals open 1 day ago
3. and close 2 days ago is below open 2 days ago
4. and open 1 day ago is below close 2 days ago
5. and open is above open 1 day ago
6. and close is above close 2 days ago
7. and close is below open 2 days ago
8. and close 2 days ago was decreasing for 2 days
9. and average volume (3) is above 750,000

Example: searching for a gap up of more than 2% over 2 trading

days:
1. show stocks where low is above close 1 day ago
2. and open is more than 2% above close 1 day ago
3. and open 1 day ago is above close 1 day ago

Summary
My recommendation to you, the novice trader, is not to get involved in
intraday stock searches. Just do the end-of-day search, prepare
interesting stocks for the coming day of trading, learn from your
mistakes, and improve your formulas until you attain reasonably good
control over the search results. The majority of traders do not activate
intraday searches at all.
Chapter 13 - How to Get Ready for
Your First Day of Trading

Important Tips Before You Click the

Button for the First Time Ever
Starting Slowly

You’ve read books, learned the principles of trading, bought a

powerful computer, connected to a trading room, and now at last
you’ve opened a trading account and deposited money in it.
That’s it. The much-awaited day is here. It’s your first day of work
as a stock trader. Understandably, you could be feeling euphoric, but
equally understandably, there’s tension and uncertainty. Did you sleep
well last night? Did you eat breakfast? Please – start your day slowly.
Be calm. Begin small. Operate carefully. After all, before you test your
swimming skills in the stormy ocean of the stock exchange alongside
sharks and whales, practice first in a quiet lagoon alongside the shore.
Go for just one trade a day throughout your first week. Learn from
each trade by examining it from every possible angle.
Why did you buy that stock?
What was the market doing when you were buying – trending up or
down?
What did the sector do?
Was the technical formation correct?
Did you operate professionally, or from an uncontrollable urge to
hit that button?
Learn to sit on your hands and do absolutely nothing but watch,
listen, and learn. There’s a long road ahead of you.If you feel that for
every moment you’re not trading, you’re actually losing money, then
you first need to learn how to stay very calm. Thinking about money
causes losses. Instead, think about the methods and the goal (money).
By the way, if you’re human, I don’t expect perfection from you.
Consistently careful, measured behavior is not human, in fact. I’d be
surprised to hear you withstood all temptations in the trading world. I
know that right now you’re thinking something along the lines of “he
doesn’t know me at all, I have incredible self-confidence, and I can
withstand temptations!” Mark this page with a yellow highlighter and
come back to it two weeks after you’ve begun trading, and let’s see
who’s right. If I’m wrong, let me know and I’ll be thrilled to send you
my best wishes and honest admiration. If only I could always operate
according to the rule book!
The good news, though, is that as time passes, you will experience
an ongoing mental transformation as you become a professional
trader. Now, as you start out, you are much more exposed to errors
than you will be in future. Over time, you will discover your
weaknesses and learn how to control them. Over even more time, your
control over your emotions will also improve simultaneous to the full
assimilation of your trading method.Correct trading behavior will
become second nature, and impulsive, irresponsible behaviors will
become the rare deviation. Yes, there is light at the end of the tunnel…
it just takes a while to get there.

Making Millions…with a Demo

When I was a young kid, I loved to play Monopoly. I bought buildings,

land, jumped turns, waited two, profited lots, and sometimes lost a lot,
too (and don’t I ever hate to lose!). It was all with small bits of paper
having no true value. It’s fun to play Monopoly. You always walk away
with your real life accounts intact. And that is exactly why it never
readied me for the real world of business. Back then, I could lose a
million in one go and still sleep as well at night as if I’d made two
million!

Demo trading is a demonstration program, also known as paper

trading. It is technically very similar to real stock trading, but it all
operates on “pretending,” just like Monopoly. You get to use a real,
professional trading program working with real time data, known as
streaming live data. The program operates on “play money,” allows
buying and selling of stocks, and displays profit and loss balances that
look as though they’re derived from real money. Mostly, there’s no
risk, and no pressure. It’s the ultimate adult computer game. Sounds
great? Well, not always, and now I will explain why.

SMART Demo trading is important for practicing

how to use the trading platform, but using
MONEY it for too long may cause the novice trader
to become overly con dent.

After several classes in Tradenet’s course, and after studying and

practicing the principles of trading, 95% of my students were earning
big money on the demo! Profits of thousands of dollars on a single
trading day by students carefully keeping to the rules is not an
unusual phenomenon. It made them feel like richly-experienced old
hands at trading. But naturally, these profits made many of them
dream of the “big money” they would surely make upon completing
the course, and that’s when phone calls started from students who
lack patience. They felt that time was slipping by when they could be
earning thousands of dollars, based on their paper trading. They
wanted to start playing the real market. They wanted instant
gratification with real money.
A student profiting at demo trading may think real time trading is
the same; the student may think trading with real stocks is easy. Let
me warn you: trading with real money is NOT like trading on the
demo program. They are two completely different worlds. Demo
trading is Monopoly.
Now the arguments start: most of the students are certain I’m
wrong and that seriously bad situations will never happen to them.
They have strong self-discipline, they are sure they will stick to the
rules even when trading with real money. The more polite students
smile and keep silent. That smile indicates that they are right and they
are sure I’m wrong, but they are too well- mannered to say so. The
brasher ones are not shy at insisting I’ve made a mistake. The more I
try to cool their enthusiasm, the greater it becomes. It’s a battle with
precisely foreseeable outcomes.

SMART Even if you’re a champion sharpshooter, it

will be hard to aim precisely when the
MONEY enemy’s weapon is aimed at your temples!

Why is demo trading unlike real life trading? After all, it’s the same
program, the same market, and the same trader using it. So where
does the difference lie? One of my students, a pro basketball player,
described it in these words, “I know players who get the most amazing
hoops all through training. The big question is what happens when
they’re on the playing field. Pressure, the shouting crowd, whether
your salary check is going to go through this month… all these
influence the game. How many of them can shoot incredibly during a
real time game? Very few!” Here too, it’s the same basket, the same
player, and the same game… but the outcome in competition is very
different. There’s a well-known story about a dueling champion who
was invited to a pistol duel. Beforehand, he warned his foe that he was
able to hit the stem of a champagne glass from a distance of ten
strides. The foe, more experienced with real battles, answered, “Let’s
see if you can hit the stem of the champagne glass when the glass is
aiming a loaded pistol at you…”
One vital component is absent in demo trading: emotion. When
you play with real money, a loaded pistol is being aimed at your brain.
Basic weaknesses such as fear and greed make it much harder for you
to remain cool and rational. You simply will not be the same person in
real time as you were in demo time, and even though right now you
are certain I’m wrong, you will quickly discover how profits on the
demo easily turn into losses in real time trading with real money.
Don’t be mistaken: I’m not saying you shouldn’t use the demo. If
you keep its disadvantages in mind, you will benefit well from its
advantages. A trader profiting “on paper” during the study period will
always remember that in an environment without pressures, it is easy
to beat the market. If and when that trader loses money in real time
trading, he or she will smartly seek the differences between demo
training time and real money trading, analyze them, internalize them,
and correct what needs correcting. Sometimes the new trader may
even stop trading in real money and go back to the demo for a very
short period, to better understand the differences now that some real
experience has been gained. Demo trading trains the trader to execute
technical actions quickly, and more importantly, teaches that it is
possible to make money if you maintain the rules and do not involve
emotion.
Avoid internalizing bad habits when you practice with the demo.
Use the demo to improve your reaction speed, practice trade orders,
and learn the trading program inside out. Even when using the demo
program, trade in small quantities and small numbers of trades, as
though you were dealing in real money. Analyze each trade well, as
though it was executed with real money. Stay tuned to experienced
traders in the online trading room. Don’t trade alone. And don’t bite
off more than you can chew.

Preparing for the Day of Trading, Step by Step

The work of day traders begins a while before trading opens. Readying
yourself from the technical and fundamental aspects is important for
both choosing advance stocks suited to trading, and preparing yourself
emotionally, which improves your degree of success.

How Much Time Should You Devote to Preparation?

In theory, you can spend hours preparing, without any real benefit
from so much time invested. If you want to read financial news, you
will find its scope on a daily basis can fill entire libraries, and in the
long run, most of it is meaningless. By contrast, if you want to execute
technical analysis on hundreds of stocks, you will be spending
unnecessarily long hours at your computer screens. To focus on the
core requirements and not waste time on activities that at best will
not assist and at worst cause damage, I recommend you follow these
outlines, adapting them to suit your own personality.
Currently, as an experienced trader, thirty minutes is enough for me
to ready myself. It may be that if I devote more time, my results will
improve, but that is true for everything in life. If you roll out of bed
one hour earlier in the mornings for any business activity, you will
almost certainly earn more. But thirty minutes is the balance I set for
myself between work and play. Golfers (my real occupation…) tend to
say “a bad day at golf is better than a good day at the office.” As you
start out, I recommend devoting more time, perhaps a full hour, to
preparing for your day of trading. A good one hour of preparation
should greatly assist in shortening your learning curve. Spending a
great deal longer than that on preparing will not contribute to your
success.
 SMART Devote no more than one hour to preparing
for your day of trading. More than one hour
MONEY contributes nothing and may even prove
harmful.

If you are a member of an online trading room, a good part of the

preparatory work will already be done for you and presented on a
virtual silver platter. This is the “daily report,” produced several hours
before trading opens. Later on, the same report is scanned and
analyzed in the trading room by the analysts about fifteen minutes
before trading opens. Traders who consider themselves professionals
will not rely only on this report, but will also personally analyze the
market and the leading indexes, while additionally searching for
relevant trade ideas. Traders might present these ideas in the trading
room, so that all traders can benefit from their work and increase their
chances of success.

Here is What You Should Look For:

Will the Market Go Up or Down?

We learned that 60% of a stock’s movement will be dictated by

market direction. Therefore, the first thought I start with every trading
day relates to expected market direction. I will buy a larger quantity of
shares with an uptrend if I presume the market is trending up, and
vice versa. We discover the real market direction, unfortunately, only
when trading hours have ended, but as detailed below, there are
several tools to help us predict the direction in advance:

• Market behavior over previous days

Market trend is an important component of anticipating the
direction. What is the general market direction? If the market is
trending up, there is a feasible chance it will continue to do so. If it has
trended up over three consecutive days, it is reasonable to assume that
on the fourth it may rest or pullback. If it pulled back on the fourth
and fifth days, it is reasonable to assume it will resume its uptrend on
the sixth day, and so on.

• Futures and the pre-market

About an hour before trading opens, we begin trying to anticipate
market direction via pre-market activity for futures, which unlike
stocks are traded 24/7. We can check the pre-market ES activity, or if
you do not have access to charts of futures, check the SPY pre-market
chart which is also traded during pre-market hours.

Several times each month, about one hour before trading, various
financial data are publicized such as the previous month’s inflation
rates, the status of unemployment, and so on. These data influence
early trading on futures, and you can see pre-market direction very
clearly. Good news will often influence the market open with a gap up.
Even if there is no news, you will be able to see the market trending
one way or another. For example, after a very strong day of highs
closing with peaks, there is a good chance the market will open lower
than the highest high and pull back for part of that high at least at the
opening of trade. By contrast, after a day of sharp lows, buyer hysteria
and pressure may dictate an even lower opening. As we learned,
opening above or below the previous day’s close is called a gap, and we
know that gaps generally close on the same day they occur, helping us
evaluate market direction during trading.
Market Direction and the Psychological Component
Market direction is determined by an encompassing range of
psychological aspects reflecting the views of all market components.
My recommendation, therefore, is not to belittle your gut feelings.
Stock trading is far from being a precise science, and in fact is much
more of an art than a science. Even if your “artistic” sensibilities are
not at all developed when you start trading, I recommend trying to
assess market direction and you will be surprised how often you are
right. When I was young, before I had a sight corrective operation, I
needed distance glasses. Every year I would go to a well-known
ophthalmologist who would trouble himself to point out that he is not
an optometrist. At the stage of the annual test where I needed to
identify the row of smallest letters, he would say, “You’re also allowed
to guess.” The interesting thing was that although I knew I couldn’t see
a thing, my guesses were very often right! The conclusion is simple: we
know a lot more than we are consciously willing to admit. Multiple
and often concealed components help us consolidate our views. Even
if you do not have easy use of all the tools, take a guess! You’ll be
surprised at your higher-than-expected success rate.

Read the Financial Headlines

Surf over to your favorite financial website, read the headlines and
perhaps the first few lines of key articles. Remember that the authors
may be excellent at analyzing the past, but generally have no clue
about the future. The reason for reading headlines is to absorb the
financial atmosphere and look for events that may impact trading. The
financial atmosphere will help you understand market direction.
Special events may help you examine entry points for stocks with
extreme behaviors. If, for example, headlines report that at the after
hours, IBM is intending to publicize its quarterly report, I can assume
that speculations prior to publication may cause the stock to be more
volatile than usual. This would allow you entry opportunities that do
not appear on a regular day, as we’ve discussed in detail in earlier
chapters.

Announcements Calendar
Choose your favorite financial site, search for the “Announcements
Calendar” link, and jot down topics of interest and important
announcements for the coming week of trading. Remind yourself
every day when the announcement will be appearing. We will deal
with announcements and publication behavior separately.
Take a Rest: the Quiet before the Storm
Intraday trading is a process requiring a great deal of mental
energy. After the first two hours of trading, I tend to feel very tired. To
ready myself for another two hours of rigorous activity, I freshen up,
equip myself with strong coffee, and get back to work.
The Workday Components

The trading day comprises three main sections. We need to

understand how professional traders behave in each of them.

1. Opening
Between 9:30 to 11:30AM, New York time, are the most significant
hours of the trading day. These two hours can be further subdivided
into two parts: the first thirty minutes, and the remaining ninety
minutes up until the lunch break.
The first half hour is typified by high volatility, particularly high
volumes and noticeable difficulty in determining market direction.
Our goal during this timeframe is to establish the trade that should
accompany us throughout most of the trading day.
After this half hour, and for the remaining hour- and-a-half until
the lunch break, market trend is more clarified and traders seek
winning trades which will yield their daily earnings. In these trades,
both the quantity of shares and the target will be relatively high.

2. Lunch Break
Between 11:30 AM to 1:30 PM, New York time, we usually see light
volume since many of the big players,the institutional traders, are out
to lunch.The market is calmer and generally consolidates.
This is a good time to rest, take care of existing trades, realize
profits, set new stops and targets, and prepare trades for the last part
of the trading day. Meanwhile we can trade in small caps. Since they
are not traded by the institutional traders who are on lunch hour, but
by the public, these stocks are not affected by the decreased volumes.

3. Close
The close is from 1:30 to 4:00 PM, New York time. It can also be
divided into two parts:
The first is the trading session following the lunch break, between
1:30 to 3:30 PM. It is typified by increasing volumes and sometimes a
strengthening of the trend from the day’s opening. This stage is very
suited to expanding existing trades or for scalping (trades with narrow
defined goals of 20 to 30 cents).
During the second timeframe, between 3:30 to 4 PM, we avoid
starting new trades, close the ones we do not intend to take for a
swing into the next day, and take advantage of this time to check
trades for the following day, based on interesting patterns identified as
the trading day closes.
Each timeframe has its own particular characteristics as far as
trading potential, specific methods, opportunities and risks.
Professional traders will adapt themselves to the timeframe in order to
take maximum advantage of the inherent potential offered by the
different parts of the trading day. Other traders may specialize at
trading during a particular timeframe and invest all their effort there.

Summary

Just as an attorney must prepare for a court hearing, you must also
prepare for the day of trading, your “hour of judgment.” Practice
trading techniques with the demo program, prepare lists of stocks as
suitable candidates for trades, get into the atmosphere of the trading
day ready and confident in your preparations. Self-confidence
improves your mental state and increases your success rate.
Chapter 14 - The Demons are
Coming!

e logic of the market is the illogic of

the individuals trading in the market.
Examine the Basic Premises

At a university, students of economics are taught two important basic

premises:
1. Financial markets are effective.
2. The individuals active in the market operate logically.
Most economists claim that people trading in the market have all
the relevant information, and they use it to achieve their personal
goals with the highest level of efficiency.
I ask you: true or false?

Market Psychology

As a disciplined student, I must accept the conclusion of the academic

consensus, read and understand the logic inherent in company profit
and loss reports, and invest my money according to these premises.
For years, the approach of economists has consistently been the
above. But informally, we all know that something here is not quite
right. We found that the market has a life of its own, and in many
instances, we saw market behavior completely contradict these
economic premises. After all, if life were so simple, we would be able
to read the economists’ recommendations, buy shares of various
companies at lower than their real value, and always make money.
But not anymore! Formally, we now acknowledge the fact that
alongside the fundamental economic approach, there is also the safe
and secure psychological approach. We have moved into the era of the
reign of psychology. Since the Israeli psychologist Dan Kahneman,
2002 Nobel Laureate for Economic Sciences, has taken the lead in the
field of economics, we can openly state that something is definitely
going on! Now, in contrast to the basic premises of “universal logic”
and “market efficiency,” we understand that the market is driven by
flesh and blood people, regular folk, with emotions, fears and wishes.
And their behavior can be anticipated. Since their psychological
conduct can be anticipated, correct analysis will help us anticipate
market behavior. This is the road to success.
In an efficient market where knowledge is accessible to all, the
phenomenon of price trends and basic laws of trading cannot exist. An
efficient market conducts itself randomly. In an efficient market, there
is no meaning to past, present, or future. In an efficient market, there
is no technical analysis, only economic analysis based on fundamental
principles.
Multiple studies clearly show that technical analysis, at least to
some degree, really works. One research study examined the
effectiveness of the technical formation of “head and shoulders.” It was
found that the trading volume on the day the formation broke out was
greater by an average of 60% than on the previous day. Many traders
make their living by buying and selling stocks based on technical
formations appearing on the charts. Since an increasing number of
traders rely primarily on these charts, even if we are sworn believers in
the efficiency and logic of markets, we cannot just stand on the
sidelines, thrust our heads into the sand, and ignore the psychology of
the masses.

Behavioral Models

Since we are dealing with flesh and blood humans, we need to check
the basic psychological models according to which these humans
conduct themselves. Let me name a few:
• Opportunity assessment: in many cases we tend to ignore
information we hold, and judge events only according to our
assessment of our ability to succeed or fail
• Conservatism: despite new information and events, we change our
views too slowly
• Distortion of truth: we tend to credit ourselves with successes, but
blame failures on events or external factors
• Excessive self-confidence: we tend to overestimate our abilities.
Understanding our shortcomings will help us comprehend why the
illogic can be perfectly logical, or as they say, “When the sun shines
on Wall Street, open your umbrella.”

In The General Theory of Employment, Interest and

Money written in 1936, John Maynard Keynes stated: “There is nothing
as disastrous as a rational investment policy in an irrational world.”
Translating that into the language of stock traders, it means that if
others invest unsuccessfully based on logic, hoping to achieve a
correlation between share prices which they perceive as illogical and
fundamental data which they perceive as logical, then the more they
fail, the greater are my opportunities for success.

SMART What would you prefer: a certain pro t of

$1,000 or an 80% chance of earning
MONEY $1,500… which carries a 20% chance of
earning nothing?

By way of explaining my claim, let me present for example a

company that reports on better-than-expected earnings. The
fundamental prediction is that the share price will rise, but as happens
so often, it actually falls.
The reason might be very simple: a large investment fund may have
decided that it has earned enough on the stock, decided to sell, and
used the high volume of buyers to its advantage. The fundamental
investor will relate to the dropping price as “illogical” and will buy it
“on the cheap,” while the professional trader perceives the drop in
price as very logical (the will of the market) and tries to profit from
the lows with a short trade.
Anyone who does not know that the dropping price is the outcome
of a fund selling will perceive the process as illogical. But can we say
that the market behaves illogically? Conclusion: if you hold an
economics degree, your chances of losing have just gone up a lot.
How do fundamental investors cope with loss? Generally by
doubling the investment, based on the premises that they are right
and that eventually the logical process will lead to success. As with the
casino, so with the stock market: a losing gambler doubles the gamble,
hoping (usually in vain) to beat the casino. The more the gambler
loses, the higher the gamble rises. At some point the gambler will
reach the maximum capital limit (or the limit at the table). And the
casino? The casino wins, of course. Fundamental investors will claim it
is worth taking the risk, since in the long term prices adapt themselves
to logical values. Concerning that, Keynes had a killer response: “In
the long run, we are all dead.”
Let me demonstrate the illogic of the individuals comprising the
market by presenting the results of research conducted by Nobel
laureate psychologists Dan Kahneman and Amos Tversky, who
examined the willingness of individuals to take risks.
A group of people being studied were asked to choose from the
following two options:
(a) Gambling on an 80% risk of earning $4,000 with a 20% risk of
not earning anything
(b) An assured income of $3,000

What would you choose? Kahneman and Tversky’s research

unequivocally found that despite the financial logic of choosing option
(a), when faced with a choice of assured income, four out of five
participants in the research group chose option (b) as best suited to
them.
Now let’s look at the results when the research group faces the
following options:
(a) Gambling on an 80% risk of losing $4,000 and a 20% risk of not
losing at all
(b) Losing a known sum of $3,000
Here, the overwhelming majority in the research group, being nine
of every ten research participants, preferred option (a) to take the risk
rather than absorbing an assured loss.
The parallel behavior of investors in the stock market has been
familiar to me for a long time now. One of the greatest mistakes made
by beginning traders is their cognitive inability to exit a losing trade at
their predetermined stop point. They prefer to gamble on the stock
price recovering to the purchase price rather than take the loss. They
even tend to double their investment when they see a larger than
expected loss. In professional jargon, they “average down.” When the
market is moving in the opposite direction, trending up, they tend to
realize profits earlier than necessary and make do with a safe profit
rather than wait for the larger profit.
Summary

The question each of us must ask ourselves as a trader or investor is:

“Can I adapt myself, my behavior and my thoughts to those of the
market?” The majority of people answer “yes,” but unsurprisingly the
majority, as usual, is wrong.

Are  You  Psychologically  Suited  to  Trading?

I’m going to ask some questions, and you need to answer them with
complete honesty. Don’t try to bluff yourself. Many people are not able
to examine themselves objectively. For them, this is a useless test.

“Scared Money” Test

When Tradenet was still very young, a man in his late twenties
phoned and introduced himself as David. He was married, had a
young child and had prepared all his homework, gone through the
Tradenet site inside out and backwards, read all the study material,
watched the video clips, and concluded that his future lay in stock
trading. In our conversation, David sounded very decisive and
determined to succeed.
He had managed to save some $15,000, which he was designating as
his initial trading capital. David requested to join the next course of
studies. But he failed the “Scared Money” test. David was
fundamentally unsuited to intraday trading.
The “Scared Money” test states that you must solidly believe that
even if you lose all the funds you designated for trading, the loss will
not significantly impact your economic and mental state. The term
“significant impact” is, of course, subjective, but in general I can say
that if the loss means you must forego your annual vacation or will be
unable to take your car to the garage for urgent repairs, then you have
not passed the test.
 David was about to trade with “scared money.” He would absolutely
have to profit in order to pay his rent and support his wife and child,
and therefore his chances of success were small. If David would have
had an additional source of income, or far more significant savings to
cover his expenses while he learned how to trade, I would have
evaluated his chances of success as high.
When you trade with “scared money,” you are not psychologically
free to function well. Success as a trader derives chiefly from your
psychological capabilities. If you are about to risk all your savings, or
worse, borrow money from the bank for trading, your fate is sealed in
advance. True, I have met a rare few who started out with small sums
that just grew and grew, but they are the extremely exceptional
Cinderella cases and not the majority of us who are fated to live in the
world of reality. And in reality, there are no shortcuts. Stock trading
can be an enjoyable, challenging activity, and I fully recommend as
you start out that you relate to it like learning a hobby. As with any
hobby, invest only money that you can afford to lose and do not expect
returns other than the pleasure of learning how to trade.
My hobby is the most popular sport in the world: golf. The cost of
golf lessons, equipment and an annual membership to the golf club is
far higher than what I expect you to invest for intraday trading. By
contrast, your chances of profiting from intraday trading are higher by
far than my chances of ever being a pro golfer!

The Self-Discipline Test

Ask any veteran intraday trader the secret of success, and you’ll get
this answer: strong self-discipline. Intraday trading is a technical
profession based on statistics and fixed, known rules. The rules are
simple, but the mental exertion needed to uphold them is tough and
requires a high level of self-discipline. The psychological conduct of
the novice trader runs against market behavior. The novice trader
finds it difficult to play “by the book” when it looks as though the
market is behaving differently to expectations, when it looks like the
profit accrued is becoming an impending loss, or when it looks as
though staying with the stock, even though it is moving against the
trader, seems like a good idea in the hope that it will still make a
comeback. These are just a few of the many examples of mental states
that cause the novice trader to deviate from the straight and narrow
path and betray the rules of trading.
I already know what your answer will be if I ask, “Do you have self-
discipline?” In all honesty, I have a problem with your answer. I have
never met a person yet who thinks he or she lacks self-discipline. It
seems that we all truly believe we are disciplined, just as alcoholics are
certain they can stop drinking whenever they want and smokers
reckon they can put cigarettes aside at the drop of a hat. This is also
why there is no need to test you on this question. Your answer is
predictable, but I accept it with a good deal of skepticism. I sincerely
hope you’re right and I’m wrong.
Was I strongly self-disciplined when I started out? In my dreams!
Even if you discover, as I did, that you lack discipline, don’t worry.
Most pro traders build their self-discipline as they develop their
trading skills. It may cost you a lot of money, but every slap on the face
you get from the market when you shift away from the rules will
reinforce your self-discipline.

The “Hate to Lose” Test

Hating to lose has no connection whatsoever with our financial
situation. Even some of the very rich are not psychologically built to
cope with risks that cause them monetary loss. It’s just that some
people hate losing money more than others.
How does the test work? It’s based on a visit to the casino. For
many, the casino is an enjoyable outing. Beforehand, most of us define
our maximum gambling loss, enjoy the atmosphere, lose a little more
than we planned, and call it quits. Later we will dress for dinner,
return exhausted, and fall asleep immediately. The day will be
remembered as a fun outing.
But not all of us will enjoy this experience. Some people will hate
having lost. They will be angry with themselves for losing two days’
pay in just two hours, and may even punish themselves by foregoing
other pleasures for several days to compensate for the gambling loss
which they perceive as a really stupid activity. It is almost too obvious
to say that they will never set foot in a casino again, not because they
lack money but because they just loathe the idea of being a loser.
Losing is a phenomenon that causes pain, but most of us take a casino
loss in stride with a smile. Which description best fits you?

SMART A loss resulting from correct behavior is not

painful. It is simply a lack of luck. And lack
MONEY of luck is also an inseparable part of
intraday trading.

How do we cope with the pain of losing? If we know that despite a

casino loss we would enjoy the evening out, then we cope well with
loss. The same is true of trading. Every trader, no matter how
successful, must cope with the pain of loss. Traders who understand
that this pain is an inseparable aspect of the trading process are able
to cope, and pass the test.
Keep in mind that as you start out, you will need to cope with days
of multiple losses based on mistakes generally derived from a lack of
self-discipline. Coping with the mistakes is painful, but remember that
every loss contains a learning curve. Over time, the pain dissipates
and you will mainly enjoy your successes. The reason that the pain
dissipates is simply because over time you will learn to avoid the silly
mistakes of novices. With a bit of bad luck, even a correctly executed
trade can lead to a loss, but loss caused despite correct behavior is not
painful. It is reasonable, and part of the game. As long as you keep
operating correctly and the overall outcomes are positive, there is no
reason to feel pain.
A little about me: when I started out, I didn’t pass any of these
tests… not the scared money, not the self-discipline, and not the
hating to lose. I hate to lose more than almost everyone else I know.
Novice traders who find themselves in my state would usually opt out
during their first year of trading. Not me. I succeeded because I am
stubborn to the extreme. I had set myself a goal and knew I had to
reach that level of other successful traders. My stubborn character
made up for my other deficiencies, and over the years, I learned to
uphold the criteria for two of the three tests. As my finances improved,
I passed the scared money test; as my trading capabilities improved, I
learned to take losses with a smile. As for self-discipline…I’m still
working on that.

Take Maximum Advantage of Your Tuition Fees

Losses are part and parcel of the market’s “tuition fees.” Few traders
are able to sustain themselves within just months of starting to trade.
Most lose money as novices. Keep this in mind before you start
trading. Why do I expect you to lose? Because trading with real money
is unlike anything you are familiar with, and because despite all my
warnings, you will make every mistake possible on your way to
success. Reading the book, taking the course, and participating in the
online trading room are all important, useful elements that reduce the
period of losses and the amounts you will lose. Never trade without
knowledge or practice, but these are not enough for success. To earn
real money consistently, you must accrue real life “screen time,” invest
effort, and be determined. There is no profession in the world that can
be learned and attained within just a few months.
Losses are not the aftereffect of trading, but an inseparable part of
trading. Becoming a winning trader rather than a losing trader, you
need to learn from every loss. Wring every bit of advantage possible
from the “tuition fees” you “pay” to the market. Analyze every failed
trade: its entry and exit points, the reason for entering, the reason for
the loss and so on, as explained in the section on keeping a trading
diary. I highly recommend printing out the stock’s chart and
analyzing it. Once a week, go over the data you have accumulated and
try to understand the reasons for your mistakes. Very quickly you will
learn enough to avoid repeating them. Leverage each loss and turn
that knowledge into a gain.

Succeeding…the Wrong Way

One of the worst things that can happen to a trader is to succeed… the
wrong way. For example, executing a trade against the trend which
produces a handsome profit. The sweet taste of profit leaves a strong
memory in the trader’s mind, who then continues trading against the
trend. But the outcome will too quickly “straighten out” and the
trader’s account will end up “crooked,” since trading against the trend
does not pay off in the long term. The trader who has learned to
execute bad trades will repeat that error in the future. Then, believe
me, this sure recipe for a gradual wipeout will become apparent soon
enough.

SMART The stock exchange has a shameful habit: it

gives loans to anyone asking, but wants
MONEY them back with shameless interest rates!

Sitting on Your Hands

Sometimes the best thing to do to avoid losses is simply not to

trade. Every employee has days off from work. Stocks traders need
them too. Some may be predetermined, such as when Wall Street
closes for the Fourth of July, but there are also days when the market
moves in too narrow a range to make trading worthwhile. On those
days, just don’t trade. The surfer needs the right waves to surf. The
trader needs market volatility. This is the trader’s daily bread. If, after
an hour of trading, you see the market is flat, take a day off. Who are
you working for? Believe me, the only ones who have earnings on flat
days are the brokers.

Handling Loss

Our success depends on our mental conduct. The psychological

baggage we carry with us strongly impacts our decision-making
processes, and therefore our chances of success. Before making
important decisions, we must examine our psychological
preparedness. On days when we are too deep into negative moods that
could affect our decisions, it is far better to keep a distance from the
market and find other things to do. These are days when we may be
fatigued, have argued with our spouse or someone else, when there
are problems at work, and so on. A well-known axiom states that
“knowing when not to make decisions is just as important as knowing
when to make them!” Deciding not to do anything is far harder than
deciding to do something.
How often has it happened that after making a bad decision, you
berated yourself with “why did I do that??!” Most frequently, bad
decisions derive from an unconscious negative frame of mind or
mood. We need to be far more wary of the unconscious than the
conscious. The problem is that we usually identify such states in
retrospect, and usually when it is already too late.
A familiar problem is our psychological state after absorbing a loss.
Every trader, even the most successful, experiences periods of losses.
They affect us mentally and emotionally, and impact our decisions.
They are the first and foremost reason for additional financial damage.
Get to know the scope of impact that loss has on you and how to best
cope with it.

Don’t We Just Hate to Lose!

Research proves that the effect of loss is double that of the effect of
profit (Kahneman & Tversky, 1991). One of my favorite examples from
Kahneman’s book is the coin gamble. In conferences where I lecture, I
often conduct that experiment: I flip a coin and ask a volunteer if he
or she is willing to participate in the gamble. If the volunteer guesses
the answer correctly, I will pay $120, but if the volunteer gets it wrong,
then he or she will have to pay me only $100. Despite the clear profit in
the gain, 95% of lecture attendees refuse to take on the risk. Why?
Because losing $100 is far more loathsome to us than gaining $120.
Research has further proven that only if I up the ante to $200 for a
correct guess compared to $100 paid to me if the volunteer guesses
wrong, a 2:1 ratio, the majority of the audience will be willing to take
the chance.

Losing Hurts
The human body is built to resist pain. It is therefore natural that
we deny loss and hope for the best. When hoping for good is illogical,
it is reasonable to presume that we will experience further damage. If
you check the investment portfolio of the average investor, you will
almost always find at least one stock showing a loss of 50% or more.
In my view, there is no logical reason to let any stock cause a loss of
this scope. Denying loss at the outset and moving to inexplicable,
somewhat euphoric optimism are the reasons for losses of this scope.
Another interesting phenomenon is that the stocks that have lost
the most are those that the investor ceases following. The
psychological handling of loss by most inexperienced traders is to
ignore that stock. This is when self-justification steps in, and the
investor spouts such phrases as, “it will make a comeback,” or “the
company has good products,” “the organization’s management is
strong,” or “it’s no more than a paper loss.” How about: “the prices
always go up in the long run” or even pleading with the price itself:
“please, just go up 10% and I swear I’ll stop smoking!” Occasionally
self-justification turns out to be a self-fulfilling prophecy. Generally,
though, it doesn’t.
A few weeks ago, a golfer friend told me about his 92-year-old
father-in-law who recently lost $150,000 in the stock market. That was
half his capital. He lost it on a failed investment in several stocks
showing price drops over the past few months of trading. Concerned
for his father-in-law’s psychological state, my friend invited him to
dinner, and was surprised to discover he was in an excellent mood.
Asking how that was possible, the old man said, “I’m not worried. In
the long term, the prices will go back up…”
Here’s a possible scenario: you bought a stock and discover you’ve
made a mistake. The price drops and comes very close to your planned
exit (stop loss). When you bought the stock, the exit point seemed
very far off and perhaps unreasonable, but now it is threatening you
with a searing loss. The stock continues to new lows, and you think: “I
didn’t make a mistake, I chose a good stock. It will change direction
for sure. I’ll just give it a bit more time…” The greater the loss is
shaping up to be, the stronger your powers of self-persuasion become.
You’re certain that this is not the time to sell, and move the stop
down a bit, then a bit more… and the stock keeps dropping till you’re
losing so much that if you exit, the loss will be almost lethal. Realizing
the loss at this point translates into strong pain. Keeping the stock
translates into hope. And hope suppresses pain.

SMART Loss causes us to drop our guard and switch

to crazy buys and sells, hoping to recover
MONEY the loss, which will generally lead to even
greater losses.

Continuing to hold a losing stock is much like holding a lottery

ticket before the winners are announced. In both cases, the chances of
succeeding are very poor. The principle of “as long as I haven’t sold, I
haven’t lost” is simply wrong. That’s a fact. Nor has the chamber of
horrors ended: the stock has reached an all-time low, and institutional
traders won’t touch it. But you have reached the amazing conclusion
that since it is already so cheap, instead of reducing the quantity you
are holding and closing out on the losing trade, you double the
quantity of shares in the hope that the price will recover even half of
its drop, returning your account to a state of balance.
Sound unbelievable? You cannot believe how many such cases I
have come across. If you’re smiling now, that means you’ve already
been there, done that. If you’re still doubtful, wait until you do just
that yourself. This phenomenon, already mentioned in previous
sections of the book, is called averaging down. In some cases, the
method will save you from loss, but only one instance of a stock on
which you have averaged down which does not recover and that will
be the last trade you ever execute.

Identifying  Loss-Derived  Behaviors

 y g
As noted, our psychological state has a determining impact on our
chances of success. Intraday traders must be functioning at their best
when they sit down to trade. A bad mood, a stormy argument, a
headache or stomach pain, a baby that kept you up all night… all these
will increase the probability of mistakes, which obviously reduce the
probability of success. In these or similar situations, keep away from
the screens. If you open the day with a loss or two, your ability for
reasonable decisions will almost certainly be detrimentally affected.
We hate to lose. Losing causes pain. Our bodies resist pain. We are
naturally not built to voluntarily exit at a loss, since that translates
into pain and failure. But when failure leads us to denial, which affects
the results of our activities, the result can be catastrophic.
When I had to absorb losses as a novice trader, I suffered. I love the
sweet taste of success and winning. Losing several times in succession
left me with weighty psychological baggage, and I did not learn
quickly enough how to cope with it.

SMART Learn to turn your hatred of loss into

acceptance, and use it to successfully avoid
MONEY additional losses. You must remain
conscious of the fact that your
psychological state alters as a result of loss.

Loss causes two contradictory reactions. On the day of trading

itself, we seek to cover the loss with fast profits. The outcome: we tend
to drop our guard and trade on everything that moves. We exchange
good, healthy logic for embattled hope and convince ourselves
“everything will be all right.” You must surely have heard about casino
gamblers who lost everything they own by trying to recoup their
losses. Only in retrospect, they understand what actually happened,
that their mood spiraled down to the point where they denied the
dangers involved. Experienced traders will acknowledge this
phenomenon as it is developing. The warning bells and red lights will
go off in their minds and they will take steps to halt the downward
spiral immediately. Do you know what happens on the trading floor
on “black” days when stock exchange prices are falling too fast? The
main computer is programmed to stop trading, and an announcer
sends the traders home. Not a bad idea! You should adopt it, too.
Here is a possible scenario. You open the day with a loss. It can
happen and it’s not a big deal. Another loss makes your head spin
uncontrollably. You quickly discover you’ve executed an extraordinary
number of trades. Then you go ashen when you see you have doubled
or tripled your loss. By the end of the day, you realize only too well
what happened, and you promise yourself not to repeat this set of
behaviors. Surprisingly, the next time it happens, you discover you’ve
learned nothing at all! (Hey, are you keeping that trading diary?) This
is usually the stage where you acknowledge and begin to understand
the process, realize that the urge is stronger than you are, and that you
need to build a prevention plan.
The day after the loss you wake to a new day of trading and
discover new problems. Now you have become hesitant about clicking
the buy button. You avoid trading, miss out on good trades, and
quickly discover that yet another day has passed and you’ve earned
nothing. You remember the pain of yesterday’s loss and naturally try
to protect yourself from re-experiencing it. The psychological effect is
petrifying you. What is the solution? Avoid empowering the loss on
the first day by identifying the problem early and taking preventative
steps, understand that losses happen even to the best of traders, and
learn to put yesterday’s troubles behind you.
Using your hatred of losing productively can turn into significant
profit, which is why I think we need to love our hatred. We need to
leverage it, take advantage of it to learn how to cut losses before they
balloon, and distance ourselves from a psychological state that leads
us into further losses which, like a magic wand, will quickly make our
trading account disappear!

Know Thy External Foe

Who is your enemy? Remember that it takes two to tango in every
trade. Naturally, both buyers and sellers think they are making good
trades, but only one side is right in the end. If sellers profit (i.e.buying
at a low and selling at a high), then in their minds the stock “has done
what it needs to do.” On the other hand, even if sellers lose on the
trade (buying at a high and selling at a low), they feel they have done
good business by getting out of the stock which was causing losses
and may continue doing so. In both cases, each side is convinced it is
smart and the other side is stupid. So which side is smarter? Traders
sometimes think they are buying stocks from a machine that does
nothing but fulfill their requirements. Perhaps they think that if the
word “wall” is part of the name Wall Street, they’re playing squash
against themselves. And this is their big mistake. On Wall Street,
traders play “tennis.” On the other side of the trade is an investor, an
intraday trader, a market maker and a specialist, all of whom want to
take as much of your money as they can lay their hands on. These are
not colleagues but bitter, cruel foes, and they are not interested in
captives.
Keeping in mind that on both sides of the trade are flesh and blood
humans like yourself, driven by fear and greed, will help you keep the
upper hand and attain successful trades. Look at the chart of a stock
that is crashing. Can you hear the pain?

And Know, Too, Thy Home-Grown Foe!

A common question at job interviews is, “What are your drawbacks?”

The typical response is usually one that evades presenting a negative
character trait, and instead takes a positive one to an extreme: “I am a
bit too thorough.”
Intraday trading is a business just like any other. You are your own
CEO. Interview yourself for the job and ask yourself, “What is my
drawback?” Answer honestly, without evasion, without prettying
anything up, because your answer will have tremendously important
influence on your trading ability. Are you impulsive? Do you handle
pressure well? Can you take loss? Are you covetous?
 SMART The trader’s biggest enemy is… him- or
herself!
MONEY

The Rules of Psychological Conduct

Most of the time we live in denial. When we make severe errors we

need to admit it, and when we are in a tight psychological place, it’s
very hard to admit any error. Denying our state causes greater losses
or makes us realize profits too early. One of the ways to cope with
denial is to identify the existence of the denial mechanism and process
which bring us to problematic places - before there’s a chance to spiral
down. We must let go of those actions that undermine our capability,
and stop them as they are happening. I doubt most of us would be
willing to admit we are incapable, but if we admit to the existence of
the process and set suitable rules of behavior, we will overcome our
unwillingness to admit we are in a bad state. So, let’s set some rules.

• Three Straight Losses

Consecutive losses are known to lead to psychological incapacity.
You’ve started your day of trading. The first trade is a loss. Not so
terrible. The next one… is also a loss. Not so nice. If the third is a
loss, you are not in a suitable psychological state to trade capably
and responsibly. You may not want or like to admit it, but turn the
computer off and do other things. Note that I did not say “go away”
from the computer, but actually turn it off. If you don’t, you will be
tempted to “just take a look” which leads to “just recouping the
losses” and we are back at square one, still with a compromised
psychological state.

• Set a Daily Loss Limit

 Set a daily maximum loss figure and stick to it. If you have reached
it, turn off the computer. You really want to keep on trading in order
to recover the loss, but in 70% of such cases, you will only make
things worse. When you go over that maximum, you are no longer
capable of trading responsibly and are in a compromised
psychological state.

• Never Return to a Losing Stock

Did you exit a losing stock? Then forget about it. Reentering will
usually only lead to another loss. Once you’ve lost money on a stock,
it is natural to want to recoup the loss. Our tendency is to deny the
fact that we have made a mistake, and we look for a second chance
with that stock to make good. Sometimes, we even take a third
chance! This is the outcome of the human reaction known as “I’ll
show it!” When you exit a losing stock, do not return to it that same
day. Keep your distance from it as you would from wildfire,
otherwise you will get badly burned.

• Exit a Stock That’s Going Nowhere

You bought a stock, and nothing is happening. Is the price is moving
sideways, wavering between profit and loss, for ten minutes? Exit
immediately. Perhaps it will work, perhaps not, but the only reason
you’re still holding onto it is… ego. You’re not ready to admit that
buying it was a mistake. So own up, and tell yourself that the stock
is not doing what you thought it would. Within ten minutes, you
should have been seeing one or the other, profit or loss, but not
continued sideways movement. If the stock hasn’t decided which
way it is going, both options are still open. That means there is a
50% chance of profiting. But also a 50% chance of losing! Give up on
the trade and devote your attention to another stock. Free up
important screen space, free up your buying power, and don’t look
at that stock again. In fact, perhaps more importantly, free up your
mind to concentrate on something that isn’t stuck in place. To do so
would be no more than an irrational gamble rather than a
considered, careful decision.
The Top Ten: 10 Things Failing Traders Say

1. I don’t want to realize a loss.

Every huge loss started out as a small loss. Your exit plan must be
clear. Be disciplined and stay with it. Most traders encounter their
psychological issues when they need to stick to a stop loss which
seemed very logical before it started moving in a losing direction,
but now looks eminently movable “just a little bit…”

2. I’ll wait until the losing stock recovers to my entry price.

Duh… as though the market cares if “your” stock is ever going to
recover! You know what? For the sake of the argument, let’s say it
does recover. Presuming your investment is limited, you are tying up
good money to a bad stock and losing out on other opportunities.
Get out, forget about it, and focus your attention on more beneficial
options. Losses happen.

3. If I don’t sell now… it’ll go down!

It’s well known that inexperienced traders sell winning stocks too
quickly and exit losing stocks too late. Instead of selling a good
stock fast, take a partial and raise your stop loss on the quantity
that’s left. Stay with a stock showing a winning trend.

4. I lost $100 on ABC, so I realized a profit of $100 on XYZ.

Since when does a loss on one stock have any connection with
success on another? Manage your winning stock and forget the loss
on the other (despite the psychological difficulty), no matter how
fresh that loss. Statistically, if you’re operating correctly, you should
succeed in more than 50% of your trades. Every trade is an
independent entity having no relationship to the outcomes of any
earlier trade.

5. I’m not taking partials. I buy and sell one stock, once.
Maintaining correct money management will help you succeed. If
you take a partial on a winning stock, you will build up a good
 “profit cushion” which will allow you to take better care of the
remaining quantity of shares. Yes, this is no more than a
psychological solution meant to assist in overcoming the need to
sell when the stock is still doing well, but remember: correct money
management will avoid arousing those dormant demons buried
deep within us all.

6. I’m bored. I’ve got to buy something!

No day is like any other. Some days, the market is “heavy.” Bored? Go
out and enjoy the day away from your trading rig. The disease
known as “overtrading” is a tough one, and sometimes it’s hard to
prescribe medication for it. Some of the best traders around felt
desperately ill with this disease when they were novices, and some
traders fall so ill that they end up losing their trading account. The
psychological urge and need to click that button, no matter what,
brings many a good trader down. By the way, the disease has a
unique name: “Clickitis.”

7. I should have done that differently.

Easy to be smart in hindsight. Everything looks simple. Trust your
instincts, trust your knowledge, and take the right actions in real
time. Then have no regrets. Every loss is a learning curve. The way
to success is paved with learning curves.

8. I’ll average down just this once!

Let me remind you that a trader who thinks this way is already in a
losing streak and has increased the quantity of shares to “average
down” the loss. The trader hopes that the price will correct to
trending up, allowing an exit with no gain but at least no loss. The
only thing I can say about this method is “ha, ha, ha.” To anyone
who tells me it worked once and therefore it’s worth repeating, let
me add one more “ha.”

9. I invest only for the long term.

Long-term investment proved its effectiveness over the years, but is
becoming increasingly difficult to maintain. In our parents’ time,
 one could buy IBM, for example, put it beneath the pillow (yes, once
upon a time real, thick paper certificates would be given to the
buyer!), go to sleep, wake the next day and know everything was still
just fine. Those times have passed from our world. I do not oppose
long-term investment, especially if the method works for you, but at
least diversify your investment portfolio with some short-term
activity.

10. It’s the market’s fault.

It’s so easy to blame the market: I wasn’t taught well, I was promised
millions, the floor’s slippery, the stock market is known to be an
ungrateful place… and more. Not everyone is suited to intraday
trading and the market is not suited to everyone. In closing this
chapter, let me quote John Burroughs:
“A man can fail many times, but he isn’t a failure until
he begins to blame somebody else.”

Chapter 15 - Special Occasions,

Special Rules
e market, like humans, needs its own
special days.
Prepare for the Expectable

On certain days, at certain times known in advance, the market will

behave in special ways. This requires us to prepare specially for such
occasions. Sometimes the meaning of “prepare” is simply not to trade
on that day, and sometimes it will mean that those are precisely the
times when amazingly interesting opportunities will fall in our laps.
Each occasion has its own particular character.

The Last Day of the Week

The last day of the trading week is Friday. A drop in tension is felt by
stock traders on this day, and the volume of activity usually plummets
during the second half of Friday’s work hours. As activity thins on the
stock exchange floor, it signals the time for us, the traders, to close our
week as well. Without volume and other traders, there is no volatility
or direction, and the market is open to the manipulations of the big
players and the market makers who go to work in the “vacuums.”

On Fridays, most of the trading opportunities occur during the first

two hours of trading. Trading throughout the rest of the day depends
on market behavior, which can be very shallow though occasionally
does surprise for the better. My wife used to say that if I never traded
on Fridays, my trading account would show a higher balance… Well,
it’s not exactly like that, but I do admit that the quantity of successes
on Fridays is very low.
Note Market Behavior on a Typical Friday
 A classic Friday. The whole day was an “inside day,” meaning a day
on which trading occurred within the boundaries of the previous day’s
trading (to the left of the perforated line). In short, a disappointing,
directionless day. The day starts with a gap down and drops to a low
[1], changes direction, kills all my shorts, and closes the gap [2]. When
I finally convince myself to take some longs, it kills them, too, by
moving sideways the entire day [3].
On Fridays I tend to close, or at least greatly reduce the quantity of
open swing trades I am holding. If you are thinking of sleeping on
some stocks over the weekend, be aware that you are taking a risk,
since you can never know if some crisis will erupt during those two
long weekend days. This is even more applicable if you’re taking a day
off, making this a longer weekend. The more time you hold those
stocks, the more risk you take. I tend to keep stocks over the weekend
only if I have taken a partial of three-quarters the original quantity
bought for a handsome profit.

Options Expiration Days

These are very significant days. Every third Friday of the month, on
the Chicago Stock Exchange, stock options expire. This book does not
describe trading options, which is an entire profession in itself, but we
do need to understand the meaning of these expirations. This is when
the big options players, professional organizations, can dictate market
direction. Of course you may ask what connection exists between
options expiration and intraday trading. Well, there is a connection.
Options trading is highly varied, and much of the trading is impacted
by the activities in the options market. Therefore, as I will explain
later, options expiration noticeably influences intraday trading,
especially on the actual day of expiration.

What is an Option?
To understand the influence of options on stock prices, I will try to
give a definition at the most superficial level for options. An option is
a contract between the writer (seller) and the buyer, according to
which the seller allows the buyer, in return for a set price (the option
price), to buy or sell a stock for a predetermined quantity and price
(the strike price). Instead of trying to understand the previous
sentence, let’s focus on the following example: Assume that you
believe that Apple’s stocks will drop in price. You can profit in two
ways from this drop: by shorting it (which we learned) or by buying
options called put options. By contrast, if you believe the stock price
will rise, you can either buy the shares or buy the options, known as
call options. Let’s say you bought a put option and the price did
indeed fall. When the option expires (the third Friday of the month),
you can realize a nice profit. But if the price did not fall, or even if it
fell slightly less than what you expected, you may lose the entire cost
of the option purchase, and the seller of the option will profit. Of
course the total process is somewhat more complex and includes
various expiration dates and strike prices, but the above is sufficient to
grasp the concept.

Pros Always Profit

Options writers are experienced pros who earn their living from
trading in options. They know better than most investors how to
evaluate the probability of Apple’s stock falling, for example, and can
price the option accordingly so that their risk of loss is extremely
small. Statistics show that most options expire worthless, and the
pros, as can be expected, make their profit.
 SMART On the week that options are due to expire,
expect volatility in the stock market on
MONEY Tuesday and/or Wednesday, though more
often on Wednesday, and sideways
movement on Thursday and Friday.

What happens when the majority of the public believes Apple will
fall, buys large quantities of put options, and towards expiration date
Apple does indeed drop? Does this mean the pros have taken a loss?
Occasionally, yes, but not always. The pros who write the options have
deep pockets and are capable of shifting almost any stock back to the
price where most options expire worthless. Moreover, their way of
protecting themselves from any fall in the price of Apple stock is to
short the stock. When they short Apple, they profit from the drop in
the share price and can pay you your profit on the put option. When
do they close (i.e. buy) their short? On expiration day itself. When
they close shorts, which means they are buying stocks, they help the
stock price rise, and often cause the price to return to exactly that
point where most put options expire as worthless.
An exercise in logic: Let’s say that the public buys a large quantity
of put options on the market index. In other words, most of the public
thinks the market is going to go down. What do you think will happen
in the market towards expiration of the options? You’re right: the
market will go up! Since the options writers could lose from a drop in
market prices, they will bring the market to the price level where the
options expire as worthless. Remember that the options writers are
serious pros, and pros never lose.
When will we feel the professionals’ activities? Usually, they start
shifting market direction towards the required price over Tuesday and
Wednesday of the expiration week. After reaching the required price
during the first half of the week, Thursday and Friday will generally be
“flat” days.
Conclusion: expect a very volatile market on Tuesday and/or
Wednesday of options expiration week.
 The period is the week ending on July 18, 2010. It is a fairly erratic
time, towards the end of the financial crisis, and several weak
European countries are on the verge of bankruptcy. There is real
concern over a sharp fall in the stock market. Many funds and
investors fear market plunges, and by way of protection buy SPY put
options to hedge their long-term investments.
These heavy investors presume that if the market drops, they will
lose on their stocks, but will cover these losses through the profits on
options. It’s a bit like buying insurance meant primarily to cover your
own back rather than to actually help your clients. Who is selling
options to the heavy investors? The pros! With the period above being
a highly agitated one, the quantity of put options is far greater than
call options. All that is left for the pros to do is bring the market price
up on Tuesday [1] to where most of the put options expire as
worthless, and maintain that target until Friday [2]. It doesn’t take a
genius to predict the likely outcome. One only needs to be familiar
with the rules of the market.

Note the Behavior of the SPY ETF during Expiration Week (daily
chart)

On the third Friday of every third month, meaning March, June,

September and December, three types of options expire: stocks,
futures and commodities, and indexes. This is also why the day is
known as “triple witching day.” What that means for us as traders is
that market activity will be even more extreme than on a regular
options expiration Friday. Volatility will be higher, and the lack of clear
market direction will be more strongly felt. These are the days when
you need to be extremely careful.
Another very interesting phenomenon is that of options expiration
for stocks at round numbers. Options are issued in round numbers:
for example, you can buy put or call options for XYZ priced, let’s say, at
fifty dollars. This means that if you bought a “fifty dollar put”and the
stock falls below that price on the expiration day, you have profited. If
you bought a “fifty dollar call” and the price is above that on
expiration date, you have profited. As with the white numbers in
roulette where only the house is a winner, here too there is only one
price, where the options writer is the only one who can profit from it.
What is that price?
Yes, you’re right. Fifty dollars! In other words, towards the
expiration date which is the end of Friday’s trading, the options writer
will try to shift the stock price to the exact round figure. To see which
round figure the stock will aim for on expiration day, check your
trading platform’s “Options” window (if your broker provides this
information on your trading platform), and look at the price at which
the options were bought. If on expiration day the share price is close
to the round number at which the bulk of options were bought, in
most cases you can presume that the stock will end exactly at that
round number at which most trades were made. In other words, most
of the options will expire as worthless to their buyers and with profits
to their writers. It’s such a rigged game that it makes me laugh each
time.

Now let’s take a look at the quantity of options on Legg Mason Inc.,
the capital management company:

Options on Legg Mason Stock, LM

 Notice that at the round figure of thirty-two dollars [1], we find the
largest volume totaling 7,265 options [2] (known as open interest) on
the stock. Where do you think the price will be at the end of trading
on expiration day? As we have discussed earlier, there is only one price
at which the pros, who write the options, are the only ones who profit.
Now let’s look a little further:

Expiration Day Five-Minute Candles for Legg Mason, LM

As you see, the last trade on expiration day was executed at thirty-
two dollars. [1]. Now, pay attention to the thirty-two dollar line
running across the chart. LM is drawn to this price already at the start
of the day, and all it has to do once it reaches thirty-two dollars is to
consolidate above or below this figure until the day ends at thirty-two
dollars [1]. The pros know exactly where they need to bring the price,
and that’s where you will find it.
 SMART Because the options writers want to pro t
on expiration day, they will try to shift the
MONEY stock price on that day close to the strike
price of the largest open position of options.

In summary, if you insist on trading in stocks on expiration day,

first check the price their options were sold at. If you wanted to short
LM based on your conclusion that it would drop to below thirty-two
dollars, you need to understand that your chance of success is almost
nil. A more reasonable conclusion is that the stock will close at
precisely the price for which the greatest number of options were
written, and that is the price at which… yes, only the pros profit.

Interest Rate Day

The announcement of the periodic interest rate is the most

important of decisions and has immediate, strong impact not only on
the US markets, but worldwide. Interest rate decisions are known for
determining impact on stock market behavior for both the short and
long terms. The decision is announced on fixed dates eight times
throughout the year, when the Federal Open Market Committee
(FOMC) meets. The FOMC sets the short-term interest and thereby
influences the price of credit, and thus the entire market.
Interest, as we know, is the price of money. The higher the
interest, the more expensive money is. The lower the interest, the
cheaper money is. When money is cheap, it pays to “buy” money. We
do this by taking loans. When money is expensive, it pays to “sell”
money, by giving loans. A savings account is a way of you lending
money to the bank. Simple, right?
So how is all this connected to the market? That, too, is simple.
When money is cheap, the return or yield on money loans (savings) is
low. People with money who fear its value will be undermined (known
as inflation) turn to other investment channels such as real estate and
the stock market, in the hope that they will gain better returns. Cheap
money means more money available to the stock market, which
translates as more buyers, which means rates go up. In fact, it is even
worth borrowing money from the bank to invest in other channels
such as stocks and real estate. In addition, when money is cheap, the
amount of money available is greater and is therefore worthwhile
putting to use, which drives the economy and increases the profits of
companies traded on the stock exchange.

SMART On interest rate decision day, we prefer

trading only in the rst two hours. After
MONEY that, the market waits for the decision. In
limbo, it shows very low volatility.
Immediately following the announcement,
volatility will often be too high for trading.

So if everything looks so good, why is interest not kept constantly

low? Cheap money can cause two eventualities. First, it can lead to
inflation: that is, raised prices deriving from the undermined value of
money which is cheap. The second is the formation of a bubble, a
situation where the prices of real estate and securities swell
disproportionately to their real value.
When the Federal Reserve Bank raises interest, it increases savings
and restrains other economic activities such as investment and
consumerism. By contrast, when it drops interest rates, it decreases
saving and encourages economic activities in the marketplace. The
Federal Reserve’s interest policy determines the medium and long-
term value of investments and savings, and is therefore very important
to all participants involved in the stock market.
A week of trading in which an interest rate decision is announced is
usually a week in which the market shows agitation, since many
professional traders choose to “sit on their hands” rather than trade
close to announcement time. Once the announcement is publicized,
the market goes mad! Immediately following the announcement, the
market will usually move in three sharp waves of completely
unpredictable directions. Those who care about their money do not
usually try to ride these waves.
Unlike market direction, which is unforeseeable immediately
following the interest decision, the interest rate set by the FOMC is
generally very predictable. So what causes such erratic behavior in the
market if the interest rate can be fairly well predicted? The
announcement’s formulation: how it is worded is no less important
than the actual decision on the interest rate. Reading the
announcement enables an understanding of probable future interest
rate changes and the economic mood as expected by the committee
members. We can conclude that the wording of the announcement,
rather than the interest rate itself, is what causes market agitation.
What should we do on interest rate decision day? Generally, we
trade only during the first two hours. After that we can expect the
market to remain static until the announcement, always given at 2:15
PM, New York time. The high volatility thereafter is usually “too much
too late.” Before the announcement, exit all trades currently showing
prices close to your stop loss. The probability is high that the volatility
caused by the announcement will send your stocks up and down so
wildly that your stop orders will be executed even if those stocks
eventually do move in the right direction.

End of Quarter Window Dressing

Reliable fund and money managers handling the public’s finances

must announce the results of their investment actions at the end of
each quarter. Among a variety of data are two items of particular
importance: the list of stocks in which the fund invests, and yields of
those investments. But the managers want to present a rosy picture to
investors, so they tend to do some “window dressing” in the form of
prettying up investment portfolios with a few improvements. One of
these improvements is dumping weak stocks that caused losses, and
buying up strong stocks. This is how they show their shareholders a
different list at the end of the quarter from the actual list they traded
with during most of the quarter. This improved list leads clients to feel
that the fund managers know how to choose the right stocks.
Additionally, on the last day of the quarter, they tend to prop up the
price of stocks they are holding and prevent them from falling. Since
most of the money in the market belongs to funds, the outcome is that
at the end of the quarter, the market usually does not drop and
sometimes even trends up. Of course, poor monetary outcomes
eventually float to the surface, but the window dressing phenomenon
is known and will likely continue.
What does this mean for you? Simply this: do not expect the
markets to push lower during the last days of the quarter. If the
market needs to drop, it will do so at the start of the next quarter. You
can also expect that weak stocks from the previous quarter will
continue falling, since the funds exit them to swap for stronger stocks.
On the other hand, strong stocks being bought up by the funds will
continue climbing.

The Market at Year’s End

What happens at the end of the year to a stock that showed strength
throughout the year? Will it pull back? Will buyers realize profits?
Indeed, for reasons generally tied to taxation, the pullback will
generally not come at year’s end. In the US, taxes are paid only on
profits from stocks sold at a profit during the calendar year from
January 1 to December 31. An investor postponing the sale of stocks
showing a profit to the start of the next tax year can delay paying the
tax by a full tax year, and perhaps end up not paying it at all,
depending on the overall status of the next tax year.
Conclusion: strong stocks which rose during the year are expected
to continue rising in the final weeks of the year, since investors avoid
selling due to tax laws. By contrast, weak stocks are expected to sell in
order to “lock the loss.” In other words, a strong year will generally end
with continuing new highs and a weak year will typically see
continued lows until the end of the tax year.
It is commonly believed that investors who avoided “locking
profits” at the end of the year will realize their profits at the start of
January. This is not necessarily true. Strong stocks do not sell easily.
The more their price rises, the more the interest in selling them
decreases. The greater probability is that investors will continue
holding winning stocks well into the new tax year.
For how long will they hold these stocks? Until there is no choice
but to sell. April 15th is the date by which tax returns must be filed,
together with any payment due. Deposits to the IRS account can also
be made only until April 15th. As a result, many investors sell their
stocks only towards the end of March or early April to raise money to
pay their taxes.
An investor who needs the cash will execute sales generally up until
the first week of April, since brokers take three days to release cash to
their clients. The third day is known as settlement day. It takes
another two days until the settlement actually shows in the client’s
bank account.

Holidays

The stock exchanges are open most days of the year, other than certain
holidays. About a week before any of these, your broker will send you
a “short trading week” reminder with details.
Pay attention to the fact that sometimes trades will be executed
only during the first half of the day. You should receive information
from the broker on that as well. Shortened trading days are usually
“bridges” between vacations and are known to have low volumes,
making it best to avoid trading altogether.
Naturally, the risk of holding stocks for a swing over several
consecutive days of holidays is greater than for a regular weekend.
More days off means a greater risk that something bad could happen.
Towards vacations and long weekends, I tend to reduce the quantities
of stock I hold for a swing.
Summary

Below is a summary of non-trading days you should keep updated and

mark in advance on your personal calendar (highly recommended!)
j9

Special Occasions What You Need to Remember

Last day of the Volumes are likely to be low. The

trading week (Friday) market is generally not volatile
after the first two trading hours. It
is wise to reduce quantities of
stocks held for a swing.

Options expiration The market is not expected to be

days: the third Friday volatile. Stock prices tend to
of every month hover near round numbers.

Options expiration High volatility is expected on

week Tuesday and/or Wednesday. Low
volatility expected on Thursday
and Friday.

Triple options As above, but even more extreme

expiration, “triple
witching day”: the
third Friday of every
quarter

Interest rate decision Do not trade beyond the first two

day hours. Reduce quantities prior to
the announcement. Trading
immediately afterwards tends to
extreme volatility and can be
highly risky.
Interest rate decision The week in which the
week announcement is due is typified
by highly agitated trading in
advance of the public
announcement.

End of quarter Institutional traders can be

“window dressing” expected to guard the market
from lows, equip themselves with
strong stocks and exit weak ones.

End of year Expect sales of weak stocks, while

strong stocks can be expected to
maintain uptrends. At the end of
a weak year, the market tends to
continue falling. At the end of a
strong year, the market tends to
keep rising.
Income tax payment 7-10 days in advance, expect
day: April 15th investors to sell stocks in order to
finance their tax payment.
Holidays No trading, or shortened trading
hours with low volatility and poor
volumes. Avoid trading.
Chapter 16 - Preparedness and
Empowerment

Be ready, take the opportunity by the

horns, and succeed.
The Fear of Taking Risks

Willpower drives humans. It drives us to reaching our goals. The very

fact that you have read this book means you have a dream, a goal, and
the will to succeed.
 Willpower drives people to succeed financially, but the simple fact
is that most don’t. Their failure can be put down to two main reasons:
they lack the knowledge of how to operate in order to become wealthy,
or they know what should be done but take no action for fear of the
dangers involved. Humans are driven by fear. The dangers that drive
fear, in 90% of the cases, do not ever turn into the nightmare scenarios
that people might imagine.
The path to success is paved with risks. People who opt for “safe”
their entire lives will never go anywhere. The mental fear of risk comes
from our upbringing. From early on, we were programmed to avoid
risks, to go and learn a solid profession, to raise a family, to get a job
and achieve financial security. Yes, financial security – and not
financial independence!
The education we received instills fear in our hearts to step outside
the box and take a chance on change. Fear of risk paralyzes us and
returns us to the structured template which we incorrectly perceive as
secure. The way to break free from the chains of fear is to recognize
our ability to overcome obstacles, or in other words, boost our own
self-confidence.

Self-con dence

On the way to success in stock trading, as with life and business, we

must cope with obstacles. Most people avoid that, since they believe
from the outset that their chances of success are poor. Lack of belief in
oneself indicates a poor level of self-confidence and deficient self-
esteem. People who are born with a strong sense of self-confidence are
very few and far between. The rest of us need to learn methods for
improving our self-confidence.
Self-esteem is built while we are young. Initially, we develop
insights such as “I’m good at…” or “I have a problem with…” At this
point, we switch our brains onto autopilot and adopt positive or
negative programs as though they are decrees from heaven. One
random unsuccessful coping episode can create the feeling of failure
that causes us to quietly accept that the situation is due to our own
negative traits. The feelings we experience during failure are, in fact,
the way we choose to translate reality. We may translate failure into
disappointment, depression, lack of appetite, oversleeping. But we can
choose differently: we can translate failure into challenge, the urge to
improve, to feel adrenalin flowing strongly. Only you can choose how
to translate your reality. What differentiates between the behavior of
an outstanding athlete and a failed one? Their perception of reality.
Being confident of winning lets the outstanding athlete translate
reality positively. The way sports champions translate their reality is
identical to the way successful stock traders translate theirs. When
Thomas Edison was asked if he felt he had failed after 700 attempts at
developing the ideal electric light bulb, he answered that he had
discovered 700 ways that do not work.
If you were not born with Edison’s self-confidence, don’t throw up
your hands helplessly. Self-confidence can be improved through
diverse techniques known as “internal communication.”

Boosting  Self-esteem  through  Internal

Communication

Internal communication includes those 1000 words that pass

through our minds each minute. When we think, we use our own
unique vocabulary, telling ourselves what is allowed and what is not,
who we are and what we think about our abilities and limitations. The
key to self-confidence depends on the words we choose. To improve
self-esteem and self-confidence, we need to examine our vocabulary of
words and phrases, and if necessary to change our internal dictionary.
We need to peel away all words that do not offer a positive
contribution, such as “perhaps,” “I’ll try,” “I can’t,” and more. Do these
strengthen or weaken you? Change them to “I can” and “I will
succeed.” Talk about yourself to yourself in the first person: I’m
successful, I’m a money-making machine, I’m a magnet for other
people, I’m sure of myself, I’m happy, I’m pleased. The more we use
constructive phraseology, the better our perception of self becomes.
Believe in yourself and your abilities, since the views of others are
negligible. As long as you maintain your self-confidence and belief in
yourself, you will succeed and your financial success will improve in
direct correlation to your self-esteem. Good internal communication
improves your quality of life, your self-confidence, and no less
valuable, your external communication.

External Communication

This is the way you express yourself, the words you say, your body
language, your facial expressions. External communication is power. It
is your power to impact others and the way they perceive you.
Everything you wish to achieve, everything you lack, you can reach
through those very same people. First, you need to find them and
connect to them. If you mingle with people who have money, sooner
or later something of it will cling to you too. If you mingle only with
the people you grew up with, you won’t get far. During the most
challenging financial timeframe of my life (see what I mean? I swap
“difficult” for “challenging”) when I had not a penny to my name, I
joined an exclusive golf club. That was my way of mingling with the
haves rather than the have-nots.
Despite my dreadful financial state, how did I manage suitable
external communication with millionaires as an equal among equals?
When you come from a lower economic class, it’s not so easy to
communicate naturally with someone who is leagues above you. Try
imagining how you’d behave if invited to lunch, one-on-one, with
Donald Trump. Would your external communication be natural? Now
try to imagine the lines of communication between Trump and
Warren Buffet. Would they be more natural? Of course they would.
How does one millionaire approach another? Does he look him
straight in the eye when speaking, or look down? My way of
structuring good external communication was to structure
constructive internal communication. I constantly repeated to myself,
“I’m a millionaire. A check for one million dollars is on its way to my
account, but hasn’t been deposited yet.” Once I convinced myself I was
a millionaire and that the check was merely delayed in the mail, being
a millionaire was a given. With that problem behind me, my external
communication altered. The expensive membership fees quickly paid
off and were dwarfed by the scope of deals in millions of dollars I
closed on the golf course.
External communication puts amazing power into the hands of
those who know how to use it. Look how far external communication
led people like Barack Obama, or at the other extreme entirely,
Mussolini and Hitler. Strong external communication is the outcome
of correctly applying internal communication, which is the source of
power in individuals who succeed.

Aspiring to Be Powerful

The aspiration for power has impacted human history more than all
the forces of nature put together. For those doing the controlling, their
power is positive; for those being controlled, that power is generally
negative. It makes no difference how you feel about power. You need
to accept the fact that in the world we live in, the powerful control and
the powerless are controlled. So what is it that you prefer: to set your
own agenda, or live your life according to an agenda set by someone
else? Simply put: are you the sheep or the wolf?
Power itself can be controlled. Power does not necessarily mean
controlling the fate of other people. We can accumulate great power,
but use it only to the degree where we have absolute control over our
own fates. Power does not have to carry negative connotations, but
can be used positively by assisting others. I tend to lecture free of
charge to high school students, college students, and soldiers. The
demand for my knowledge gives me a great feeling of being powerful
in a different way.
The significance of power altered as civilization developed. In
prehistoric human history, the powerful individual was the physically
strongest. Over time, as the world developed into an economic
organization, the focus of power shifted to those with capital. The
wealthiest was the most powerful. At some point, an interesting shift
became apparent when the socially-accepted norm determined that
power would be passed down by inheritance from the nobleman to his
son. If you were not born into nobility, your chances of succeeding,
influencing, and accumulating power and assets were zero. The only
way that might happen was if you were close to the nobleman in some
way. These dark times, in which nobility was richly remunerated and
the commoner found no positive incentive, typified the Middle Ages, a
time in which the world almost stopped progressing. The Industrial
Revolution, when the holders of capital and therefore power were
those who owned machines, put an end to the power of nobility.
In our own times, power once again changed hands, moving from
those who held capital and assets to those who also held knowledge.
Up until some decades ago, it would have been impossible to compete
with heavily-invested companies such as General Motors or IBM. To
compete with a giant like IBM, a dreamy capital in the billions of
dollars would have been needed. All this was true until a “geek” in
jeans named Bill Gates overthrew IBM from the top by the use of
initiative and knowledge. So too for Apple, Facebook, Google and tens
of other companies that now control our lives, but were established
not by holders of capital but by holders of knowledge. The beauty of
our current times is that the chances of success are open to every
single person, even if you have no physical power, capital, or title of
nobility. Knowledge is power. Knowledge is the key to success. And
knowledge can be bought.

Knowledge and Action

Knowledge moves the world. Until the end of the nineteenth century,
if you had neither capital nor title, you could never break out from the
class into which you were born. In those times, knowledge was for the
privileged few, and banks funded the upper classes rather than those
with knowledge. Our world is completely different: we live in an era
where knowledge is readily accessible, and capital seeks good ideas
even if the person presenting them is a youngster with a ponytail who
never even finished college. Billionaires like Bill Gates and Steve Jobs
were not born into the nobility--they were simply born into the right
time. And they didn’t have a college degree.
Knowledge and ideas are available to anyone seeking them. If
knowledge is available to all, how is it that there are not more people
who are successful, happy, driving Ferraris and living in Beverly Hills
villas? Because knowledge in itself is not enough. Knowledge is the
potential for power, but to realize it, actions are needed. Success
begins with knowledge and ends in actions.
Knowledge in stock trading is also available to anyone seeking it, so
why isn’t everyone rich? Because operating in the stock market also
requires integrating knowledge with action. The world is full of people
with broad knowledge but who are inactive. What is unique about the
successful individuals is that they, unlike the bulk of the public, take
action. Their success, their power to control their own futures, derives
from accrued knowledge and cumulative actions.
If you want to succeed, use other people’s knowledge and emulate
the successful. You don’t even need to come up with an original idea.
Did Steve Jobs invent Apple’s graphic interface, the mouse or the iPad?
No. He took existing ideas and upgraded them to such a state of
perfection that he created an entirely new market. He fine-tuned
solutions and took action. Nor did Bill Gates invent the DOS system
which turned him into such a wealthy individual. He bought it from
an inventor who did not realize its inherent potential.

A Role Model

Success does not require you to reinvent the wheel. Find a working
model and copy it. I am not suggesting you give up on being the next
inventor of a dot-com enterprise. I am just trying to stay practical.
From the experience of decades of business activity, I’ve learned that
the chances of success are higher when emulating and improving
upon existing products, knowledge and methods. During the dot-com
bubble era, I failed in my attempts at inventing products and services
which I was sure would change the world. But I did succeed in
improving on existing ideas and products. Nor did I invent day
trading, but I was the first to turn it into a model for schools and
brokerage companies operating in various countries outside the
United States. This was a successful model I initiated, which did not
require my own capital. I brought knowledge and entrepreneurial
initiative to the table, and recruited investor funds. My life was not
one of successes only. I experienced some tough failures, but I always
kept one thing in mind: if I don’t try, I won’t succeed.
Success does not need to follow a model of worldwide scope such
as Facebook. If a business is doing incredibly well in Los Angeles,
there’s no reason it should not do well in San Diego. I suggest you
keep your eyes wide open, find a worthy role model, copy and
upgrade. If a stock trader is a role model for success, there is no good
reason why you shouldn’t contact that person, learn from him or her,
and try to emulate his or her success. You have to believe that if
someone succeeds, you can too! If you don’t believe that, then first
work on improving your self-esteem.
It is difficult to hide success. Successful people leave clear
footprints. Go after those footprints and try to copy the steps, one
after the other. You can do more than just copy: you can improve to
such a degree that one day you may be the role model for someone
else. Never forget that for every action you take, there is a price tag.
The price is measured in resources such as money and time, where
money is the cheaper of the two. Time is your most costly resource
which, if wasted, can never be recovered.
For success, you must have true, burning faith in your ability. You
must infuse yourself with this faith every day. Talk to yourself, tell
yourself how strong, smart and successful you are. Convince yourself,
believe in yourself, and simultaneously gain knowledge, knowhow, and
take a risk…take action.

Believing in Success

Believing in your ability is the key to success.

If you limit your belief, you limit the results in kind. If you convey
belief in your ability to your brain, there is no limit to what you can
achieve. We are not born with this kind of belief. We gain such beliefs
and develop them throughout our lives. Current negative beliefs can
be exchanged for new, positive ones. If you lack faith in your
capabilities, try to look back and find the source, perhaps in
childhood, religious belief, or politics. From our earliest childhood, we
develop in the shadow of our parents. In my childhood I was not
taught to initiate, take risks, or reach financial independence. I was
taught to choose the safest options because my parents felt that was
correct, either because that is how they were raised or because certain
life circumstances shaped these views. Most people do not develop
opinions and beliefs independently, but inherit them from parents and
the media.
As a condition for breaking out beyond the framework in which
you currently exist, develop independent beliefs of your own, adopt
them warmly, and take command over your future. If you’re ready to
formulate a new belief, then choose a task, preferably a tough one,
perhaps even one in which you failed in the past such as losing weight
or quitting smoking. If your gut reaction to this task is, “Wow, that’s
too tough, it doesn’t sound doable…” then you’ve chosen the perfect
option!

A Five-Step Plan
Here are five steps to formulating, internalizing and realizing a new
belief:

FIRST, repeatedly embed your new belief into your mind. Like
every belief you’ve developed over your lifetime, a new belief must be
meticulously implanted within your mindset. Repeat your goal over
and over to yourself until you firmly believe in your ability to achieve
it.
Your parents may have said umpteen times, “You need to learn a
profession.” The media relentlessly penetrates the political messages
you adopt, day after day, year after year. Even your religious beliefs
were not absorbed in just one day. Now your job is to choose a goal
and hammer that ability to achieve it deep within yourself. No one can
do this for you.

When I was twelve years old, I decided to become a millionaire. In

the economic environment of my reality, I had never met such a
person, but the target was marked and repeated in my mind daily.
Every time a momentous event occurred, I repeated my mantra, “I
want to be a millionaire.” Over the years, this belief became so much a
part of me that I never doubted my ability to succeed. With success
now a given in my mindset, the only thing left was to choose how to
achieve it.
One of the most effective ways to embed a belief is to write it down
every day in a notebook dedicated for this purpose. Doing this
reinforces your belief at the subconscious level. I would even suggest
writing it down on sticky notes and attaching them to all kinds of
objects in the house, but then your friends might arrange to have you
hospitalized before you’ve reached your goal.

SECOND, try to imagine success. How would you look if you were a
whole lot lighter? What sort of clothes would you buy? How proud
would you be when you join friends who knew you as a smoker and
they see you no longer disappear every twenty minutes to grab a
smoke? Imagining helps reinforce determination and helps cope with
the process of reaching your goal.
My golf coach, Ricardo, actually trained as a psychiatrist before
becoming a pro golfer. During one lesson, Ricardo taught me that a
successful golf shot requires me to imagine the outcome. “Before
hitting, imagine the flight of the ball and your target,” he would
repeat. And it works! The body amazingly moves according to what we
imagine.

THIRD, spread your belief. Tell everyone you can about your goal
and your determination to achieve it. Start with people close to you
and then expand the circle. The more people you tell, the more
committed you will feel to upholding your stated goal. At age twelve
when I decided to be a millionaire, I told all my friends, and kept
reminding them over the years. I joked with them that they would end
up working for me, which is indeed what happened to some. The
more I shared my goal with others, the more obligated I felt to
overcome the obstacles encountered on my way to realizing it.

FOURTH is application. With the belief now an integral part of

you, you’re ready for action. The stronger your belief, the easier it will
be to cope with the obstacles in the application process. One of the
most common mistakes is trying to take action before your belief is
fully established. Did you decide on the spur of the moment to stop
smoking? Your chances of success are poor. But once you have fully
internalized the belief that you can, the process will be simple and
natural. To apply your belief, you need to write up an organized
program comprised of targets and timetables.

FIFTH, we come to evaluation. Set intermediary targets, measure

your progress, and give yourself a small reward each time you reach a
new target. The process may be long, but there is no reason why it
should not be enjoyable. Training a puppy takes time and is reinforced
with treats. Retraining an adult human is no simple matter and
definitely deserves rewards for sub-targets reached: dinner in a good
restaurant, an electronic gadget, or whatever it is that makes you
happy. As you move forward successfully, your belief in yourself and
your ability to realize your goal will also improve. Write down the
results, track your progress, and don’t rely on memory alone.

Coping with Obstacles

Will you be able to overcome all the obstacles along your path to
realizing success, and realize your belief?
The answer is YES, YES, YES!
Sounds crazy? But that’s the truth. It is a historically and
scientifically proven truth. Nothing stands in the way of our will.

Handling Obstacles the Easy Way

 On your way to realizing your belief, you will encounter obstacles.
Acknowledge in advance the simple fact that obstacles do not signal
the end of the process. An obstacle is no more than a temporary
detour route. If I could change the dictionary entry for “failure,” I
would insert “obstacle” instead, in its sense of challenge. Challenges
arouse our creativity and draw us into seeking solutions. Would you
prefer an easy crossword puzzle or a challenging one? Obstacles and
overcoming them teach us to look for alternatives, gain experience,
and learn so that success becomes easier to achieve at the next
obstacle. Experience is one of your most important assets on the road
to success. There is no obstacle in the world that was not overcome by
someone, somewhere: if someone else could, so can you.
Success, like obstacles, is not finite. What happens once you’ve
reached your goal? Most likely at this stage you’ll set a new one,
backed up by a new belief in your ability to achieve it. In my
development as a trader, I set a target of attaining $200 profit each day.
Once I reached that, moving the target to $500 no longer seemed
impossible. And so on. This is what makes humans competitive, and
so very different from animals.
Failure, or challenge, is perceived very differently by successful
individuals than by the general public. For successful people, failure is
an opportunity to start again, from a new angle and with improved
methods. Never for a moment even give a thought to the idea that you
might fail. As infants and children, we naturally seek ways to
overcome challenges. As adults, we need to recover that innate sense
of being able to achieve. If you leave even the narrowest chink open to
the concept of failure, that concept will swell, become empowered,
and swallow up you and your hopes for a better life. If you fear failure,
fear will handcuff you. People fear failing at studies, sports, in
relationships, parenting and at work. Fear weakens our willingness to
cope with challenges that life places in our paths. Yes, some of the
blame can be placed on how we were raised and educated, generally
with methods that punished our failures rather than encouraging our
resilience. Successful athletes are known as being target-oriented,
strongly self-disciplined, and intensely determined. Research the
histories of famous athletes and you will often find at least one parent
who imbued the child with the spirit of winning, neutralizing fear and
failure. Earl Woods, father of Tiger Woods, golfer and the richest
sportsman in history, prepared his son for the game from the age of
two. Earl himself was a commando combatant in a Special Forces unit
in Vietnam: facing challenges was not a new concept for him. Earl
stuck with the goal he set for himself and his son. Despite the
challenges, he created one of the greatest achievers in sports history.
Obstacles are those frightful things you see when you
take your eyes off your goal. - Henry Ford

Commitment to Success

We’ve all heard Cinderella stories of people who made it rich

overnight due to some brilliant idea.
Don’t let these stories blind you. Success is achieved through hard
work and boundless determination and commitment. Extraordinary
commitment is what marks unique success stories.
That is also the story of Lionel Messi, the current Number One
soccer player in the world. At age eleven, Messi was diagnosed with a
growth hormone deficiency, or in simple language, dwarfism. When
the family was required to pay some $900 a month for growth
hormone treatment, far above what it could afford, Lionel was forced
to find a sponsor. He was forced to play soccer like no one of his size
had ever yet succeeded in playing, anywhere in the world. His
commitment produced results. At twelve, he was chosen to join
Barcelona’s children’s team and earned the much-needed funding. At
seventeen, he made history by being the youngest player to ever join
Barcelona’s all-star adult team. Messi joins the pantheon of other
famed, physically short success stories such as the basketball player
Tyron Bogues (159 cm/5’2), who played fourteen NBA seasons and was
the shortest league player in the history of the NBA.

Control Your Mood

Our moods change from day to day and even from hour to hour.
When we need to apply high levels of attention and concentration,
such as when trading, we must be at our best. Some days we wake up
full of energy and creativity, the world smiles at us, and it seems as
though anything we do works fantastically. Other days, nothing seems
to go well, we feel as though the whole world is against us, and
everything we do is doomed.
Have you ever wondered how amazing it could be to just press a
button and turn a bad day into a good one? Well, you can do just that.
First, we must understand where changes in moods originate.
Moods are determined by chemical balances in our brains. The
balance is so delicate that the smallest deviation can change our mood
from happy to blue. Mental balance is impacted, among other things,
by such environmental conditions as weather, strong winds, scents
and smells, sounds, taste--all the information that our five senses can
absorb.
Since the dawn of human history, humans have tried to find ways of
controlling moods. These include hypnosis, yoga, religious rites,
sports, drugs: all are among the options we use to alter moods. We are
all sensitive to situations that cause us to shift from one mood to its
opposite in almost no time. Just try and play rap anywhere near me…
and see what happens to me! So, what makes your mood change? And
what helps you stay in a good mood? Music, color, lighting and
warmth all affect us. Coffee and chocolate are quick pick-me-ups, but
usually have short-term influence and can leave you feeling a lot
worse. The heightened blood flow after a workout can help improve
mood. Find out the things that affect you positively, and then use that
information to your benefit.

Controlling Frustration

Since we know that the path to success is paved with challenges,

frustration is a natural outcome of coping. But we need to remember:
beyond the frustration is success, which is why we must find the right
way to first cope with frustration.
 Frustration is our personal translation of the reality we find
ourselves in. Therefore frustration, too, can be successfully coped with
by applying a different interpretation to that same reality, such as by
exchanging the frustration for a challenge.
Obstacles are temporary setbacks on the way to success.
Frustration results from not having the knowledge needed to cope
with the setback, whether the setback is a matter of bad luck, another
person’s stupidity, rejection, or anything else. Rejection is, in fact, one
of the main factors in frustration. We live in constant fear of rejection:
by our partners, boss, a client, or society. The champions at dealing
with rejection are sales staff. Ideal salespersons never let the word “no”
get the better of them, but instead it encourages them to look for an
alternative, creative way of solving the situation.
Why does one person handle frustration easily and another fumes
until sparks fly? The answer is buried deep within the human mind.
People who believe they can cope well will cope well. Understand the
reason behind your frustration, define it, and choose a method for
handling it which allows you to recover your calm. Have you ever
thought about the way movie producers use music to control your
mood? The same clip set to one type of music will arouse your fear,
but set to light-hearted music might even get you to laugh! Be your
own movie producer, jot down phrases on sticky notes that help keep
you positive and hang the notes on your mirror.Do whatever helps you
control your frustration. Only you know what’s best.

Accepting Responsibility

Did you make a mistake? Blow it? Don’t look for those responsible for
your failure. Take responsibility for your actions. We naturally tend to
blame our parents, teachers, employers, and the government. The
starting point for many who achieved success was much tougher than
for the average person. Many experienced extremely tough times in
their lives, and nonetheless succeeded. Did the obstacles they
encounter diminish their commitment to their goals, or reinforce
them? For most successful people, the obstacles are what drive them
to greater strength. The desire to succeed is greater than the need for a
warm meal at the end of the day. Successful people hold their own
ability to succeed in high regard, which is often viewed by others as
arrogance. Successful people can rightly be proud of their success, but
they are equally prepared to assume responsibility for their mistakes.
This willingness to accept responsibility derives from power; evading
responsibility derives from weakness.
Eric Schmidt, former CEO of Google, said, “I screwed up” when he
and other Google top-level staff did not handle the fledgling Facebook
startup and fight back at a company that dared take on the biggest
possible competitor in the Internet. By contrast, Bill Clinton with his
famous statement, “I did not have sexual relations with that woman”
evaded responsibility and paid by almost losing the presidency. The
public relates to acceptance of responsibility with understanding and
respect, and to evasion as a sign of failure. Accepting responsibility is a
sign of power and maturity. It also reinforces your faith in your ability
to overcome obstacles, and understand that they are an inseparable
part of the path to success. What do author Mark Twain, ketchup king
Henry Heinz, and automobile giant Henry Ford share in common? At
some point on their way to success, they all went broke, took
responsibility, recovered and came back bigger and better than ever.

Do You Like Your Job?

To succeed, you need a good reason to get out of bed in the morning.
You need to love your work. If salary is the only thing keeping you in
the workplace, you will not get far. Having worked for years in the
high-tech industry, I can tell you that the greatest aspiration held by
most high-tech employees is “not to work anymore in high-tech.” In
other words, even high salaries and great benefits are not enough to
make an employee love the job, let alone excel at it.
To succeed, you don’t need to be brilliant. You just need to be a
little better than average, and to do that, your work needs to interest
you. Your work needs to more closely resemble a game than a chore.
Find the job that pleases you so much that you never look at the clock.
If salary is what guides you, you could likely end up finding you’ve
devoted most of your life to a reality that has not led you to a greatly-
improved financial situation. At some point when you reach the end of
your tether with your job, you will discover that you’re too scared to
try and change your field or place of employment.
I’m very aware of the fact that changing your place of employment
is not easy. We acclimate easily to a particular routine and
environment, and any change rocks us. If, on one hand, you’re dying to
leave your job but find that hard to do, how should you overcome the
dilemma? Very simple: plan the future, define the goals, and create the
belief that you can achieve those goals. Remember the five steps to
formulating your belief? Establishing, imagining, spreading, applying,
evaluating. The process is slow and requires a lot of patience, but you
have no choice: you must start somewhere, and if not now, when?
Choose work that you love, and you will never need to
work another day in your life. – Confucius

Preparedness and Opportunity

I began trading in stocks in 2000, at the height of the Dot-com crash.

The market burst and short sellers enjoyed a lot of success. As we have
learned, a plunging market is a wonderland of profits, but
unfortunately for me I could not join the festivities since I lacked
knowledge at the time. I was just starting out, inexperienced, lacking
self-discipline, and bereft of knowledge. A chance to make big money
was just lying there on a silver platter, but I was a novice, poorly-
prepared trader.
Luck has little to do with the path to success. Luck is when
preparation meets opportunity. Every day, hundreds of
opportunities pass right beneath our noses, but our unpreparedness
prevents us from realizing them. Develop your state of readiness and
await the opportunity. Knowledge and experience in stock trading
during a bubble or crisis poses readiness against opportunity. In 2008,
during the sub-prime crisis, that same opportunity resurfaced, and my
readiness was at its peak.
Give me six hours to chop down the tree and I will
spend the first four sharpening the axe. - Abraham Lincoln

Success is an Avalanche

How will you measure success? Every small change is significant. If

you managed to make $100 and not $1000, never mind. The main thing
is that you’re learning how to profit. Success is like an avalanche: it
starts as a snowball and grows and grows. Success starts slowly and
gets easier all the time, until one day you wake up, look to the heavens
and say, “Thank you, thank you, thank you. I am so grateful for getting
to this place!”
It makes little difference how successful you are. Bottom line, your
life can be better if you just decide to change it. Everyone has the
power to change his or her life. It’s not necessary to hold three
university degrees or be extremely intelligent; it’s not even necessary
to work hard physically. All you need to do to change your life lies
right there in your subconscious.

So, Make a Decision!

You need to make a decision, right now, a decision that will change
your life. You know that doubting moment of “dive into the deep end,
or don’t dive into the deep end…” After you jump, you discover that the
water is fine, even if it was a tad cold at first. My advice to you? Take
the plunge! Now! Change your life. If not now, when? I’ve helped you
up to this point, and want to help you further. But now… it’s all up to
you!

To your success!
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