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Mean Reversion Strategy Demystified PDF Print E-mail
Written by TheGainMaker   
Sunday, 27 April 2014 13:10

The Mean Reversion Strategy can be a very useful tool to identify which stocks to buy and when by giving entry and exit points that rely on historical data. Mean reversion is used by equity traders, day traders, hedge fund managers and portfolio managers. We’ll learn what it is, how it’s calculated, where to find some helpful tools and some of the drawbacks to utilizing this strategy.

What is the Mean Reversion strategy?

It is a method based in the statistical moving average of an underlying equity or asset such as currency or commodities. The mean, or the average, is center of where an asset trades over a period of time. The theory is that when an asset such as a stock is selling above or below its historical mean, it will return to that average selling price.

How is it calculated:

The simplest way is to go to the finance portion of MSN, Google, Yahoo or MarketWatch clicking their chart and selecting the technical analysis chart. Once the chart opens it allows you to choose the length of the moving average you would like to see with the price. Yahoo Finance for example allows you to choose, 5, 10, 50, 100 and 200 day moving averages and you can choose any or all of them together.

Figure 1 P&G Price Chart with 50 moving average

The other way to calculate the average is manually by downloading data into Excel or R from any of the financial search sites mentioned above. Using Yahoo Finance you would search for the stock you want to analyze by entering the company name or stock symbol. You would then select historical prices from the options on the left menu, the time period you’d like to see. At the bottom of the table is an option to download to a spreadsheet. You will need the Data Analysis Add –in and use the moving average function to utilize the data in this way.

Figure 2 Excel 25 day moving average of P&G stock

Using Excel in this way requires some knowledge of the program, installation of the add-in and some effort to make a chart that’s equally useful to the version readily available on any number of websites. The advantage to using Excel is that alerts can set up to buy or to sell if your stock crosses a 50 or 100 day moving average. The downside is that you need to refresh the data every day the market is open to have the latest information to make decisions.

 

Last Updated on Sunday, 27 April 2014 13:23
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Day Trading Strategy Demystified PDF Print E-mail
Written by TheGainMaker   
Sunday, 06 February 2011 17:02

A good strategy begins with a trend.  I spotted a trend a few years ago with a selected group of stocks I found by scouring the market using screening tools and charts.  After finding the stocks that fit my parameters I would narrow those down further by finding stocks that followed a particular daily pattern.

The pattern emerged as I was looking for small-cap companies with volume in excess of 250,000 shares per day.  I would find stocks that would move up or down $.15 to $.25 cents every day AND finish near their opening price.  These stocks were so predictable in their behavior that I could bank on making a few hundred dollars a day without even sweating.

Here is an example:

Last Updated on Monday, 17 March 2014 19:13
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Top 5 Stock Movers PDF Print E-mail
Written by TheGainMaker   
Monday, 17 January 2011 12:52

There hundreds of things to look at when picking a stock.  What is the macro economy doing?  What is the Fed interest rate?  Where are bond yields?  What is the competitive landscape?  Then there is the fundamentals of the company?  How is the balance sheet?  What does is the capital structure look like?  We also want to consider what the technical indicators are telling us.  The top 5 indicators of how a likely a stock is to advance are:

 

  1. Price Multiple: The price multiple or the P/E ratio is determined by taking the price and dividing it by the annual earnings.  This figure is the amount investors are willing to pay for earnings.  Different sectors will have different average P/E ratios just as different companies will have different P/E ratios depending on whether the country is in an economic recession or an expansion or if it a secular or cyclical stock.  This multiple gives investors an apples to apples comparison to one another and should be used as a primary method of determining future price.
  2. The Macro Environment: This is a major determining factor for stocks that are dependent on expansion for growth.  Durable goods, goods that last more than one year, fit into this category. When the country is in an expansion mode, these stocks are growing their earnings and therefore their price multiple, which will yield it a higher price from those on Wall Street.
  3. Earnings Growth: This ties in very closely with the price multiple but it's important enough to stand on it's own.  We look for quarter over quarter earnings growth because the past can be used to portend the future.  Strong earnings growth causes the the stocks they represent to trade at a premium to other stocks in their sector or their direct competitors.  To determine if the growth is enough to move the stock, look at the quarter over quarter net profit or earnings per share that is over and above their competitors, the sector and the market indexes like S&P 500, DOW Jones Index, and Nasdaq.
  4. Better than expected earnings: When CEO's announce better than expected earnings usually the market jumps on the stock, driving the price higher.  This catalyst for a big move is scrutinized intensely by bulls and bears looking to get in early on a big move.  This method for capturing profits is perilous though.  A smart investor will have done his homework and will be pouring over the data to determine if there is some legal accounting tricks being used just to "bring in the numbers".  If they beat the estimates is it because of one-time events like the sale of a division or something more subtle like pulling in cash from foreign investments.
  5. Sentiment: Sentiment is a huge mover of stock price.  Unfortunately it is not based on quantitative analysis or fundamentals, it's based on speculation and herd mentality. We do look at some technical indicators though to try to gauge sentiment.  The biggest indicator here is upward price moves on heavier than normal volume.There are tools like the stochastic oscillator that are used by chartists to spot short-term overbought and oversold conditions in a stock to predict future moves.

These are just the top five catalysts for price movement on a stock.  Of course there are many other variables that lead to big gains or big losses in stocks price and if you are going to find them, do some research and find the events that have shaped the equity you are researching in the past.


Last Updated on Wednesday, 28 August 2013 15:11
 
Trading Algorithms PDF Print E-mail
Written by TheGainMaker   
Sunday, 12 December 2010 16:54

Program trading has gained a lot of popularity over the years and have been blamed for the "flash crash" back in May of '10 and the crash in 1987.  Program trading uses algorithms to thousands of data points to determine whether a trade should be made on a stock.  These trades can include selling shares the user owns, accumulating shares of an equity or selling shares short.  Program trading accounts for about 70% of all trading volume on the NYSE.

 

Who is using these algorithms? Hedge funds, mutual funds and other large institutional investors like Goldman Sachs, Morgan Stanly, and JP Morgan.  These large investors have algorithms that analyze data, and react to that data, thousands of times faster than any human can.  Often these programs will have the ability to trade by themselves with absolutely no human involvement.  This can be a powerful tool because it is so fast but it is a double edged sword, as we saw in the "flash crash" when there was a huge sell off that brought the Dow down close to 700 points in just a few seconds.  Circuit breakers have been put into place to avoid the next crash of this sort.

These institutions also use the programs to buy or sell a stock in a manner that does not broadcast to the market what their intentions are and so that their buying moves the price as little as possible.  Other programs are meant to "sniff out" these other algorithms that serve as a cloak that mask large buy and sell orders.

A report just came out detailing what findings of an investigation into the "flash crash" and can be found here.  There is also an excellent article in Wired Magazine that goes into greater detail on this new phenomenon and Mary Shapiro of the SEC details her prevention plan on PBS.

Last Updated on Wednesday, 28 August 2013 15:11
 
PEG Ratio Demystified PDF Print E-mail
Written by TheGainMaker   
Sunday, 12 February 2012 20:41

What is the PEG ratio and what does it tell investors?

The PEG is the P/E ratio with growth incorporated into it.

PEG = (P/E)/EPS per year.

Here is an example:

Noble Energy Inc. (NBL) has a price of $101.15 divided by its earnings of $4.44 gives us a PE ratio of 22.8.

22.8 divided by

the expected 5 year growth is .61.  This ratio implies a 37% compounded growth rate.

 

Because the growth is projected, it's subject to a lot of variation.  Earning estimates for 2012 are forecasting EPS of $5.31 and $6.45 for 2013.  The growth from $4.44 to $6.45 represents a 40% gain in EPS.

It's important to know where the numbers that get plugged into this equation come from even though sites like Yahoo Finance, MarketWatch and MSN Money give you the ratio already calculated.  Some will use trailing earnings per share for the previous four quarters, others will use the most recent year for the EPS.  This can create different PEG ratios from different sites.

The other thing to consider is the amount of growth analysts expect.  One analyst out the 20 that cover this stock forecast EPS of just $3.96 versus another that projected $8.23.  One is a much more aggressive growth estimate than the other and will give widely different PEG ratios.

In conclusion this ratio should be taken with a grain of salt.  Like the PE ratio, it's a starting point and useful in comparing different companies within the same industry but should be dissected in order to limit your risk.

 

Last Updated on Thursday, 03 October 2013 11:01
 
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