Candlestick Trading Blog

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Understanding a Stock’s Beta
It actually sounds a little strange, doesn’t it? If you don’t understand a stock’s beta you are not alone. While it is overused by some people, this is actually another good ratio to have available for fundamental analysis of a particular stock. But so we don’t get too far ahead of ourselves, let’s discuss a stock’s beta.

What is a stock beta?
A stock beta is ratio that can be used to suggest stock volatility. By understanding volatility an investor can better understand the investment risk of a stock. Once risk is identified the risk premium can be calculated and an investor will have a better awareness of whether the stock’s return can justify the risk.

Now for the formula. Take the S&P 500, it is the most common index for this function and probably the most reflective of the entire market, and designate it as your baseline with a ratio of 1.

Let’s look at a couple of examples. MEW Industries has been a very stable company; you check the stock market on the Internet and its beta is 1. Since the market has an expected return of 8% and a beta of 1, your beta is 1 as well. This quick evaluation suggests that MEW Industries should bring 8%. In our second example, ABC Corp. is a young technology company with a lot of potential. The stock beta for ABC Corp is 3; since the market beta is 8%, the stock beta for ABC Corp is 24%. This sounds like a great investment, but since this is only one test, further analysis is needed.

What does stock beta tell you?
Stock beta gives you an idea about how volatile a particular stock is. After you know that, applying your fundamental and technical analysis can help you draw a conclusion about the risk premium of a stock. Stock betas over 1 indicate increased volatility and those below 1 are considered to be less volatile.

Does stock beta have any flaws?
First lesson when investing in the stock market; every ratio has its limitations. This is the reason that performing stock technical analysis requires more than one ratio. Some of the limitations of stock beta are:

• Beta looks backward and history is not always an accurate predictor of the future.



• Beta also doesn’t account for changes that are in the works, such as new lines of business or industry shifts.



• Beta suggests a stock’s price volatility relative to the whole market, but that volatility can be upward as well as downward movement. In a sustained advancing market, a stock that is outperforming the whole market would have a beta greater than 1.

Stop loss orders are the great insurance policy of the stock market. A stop loss order is an open order to your stock broker saying that if your stock drops to a certain target, he or she should immediately place a market order to sell on your behalf.

Setting a stop loss order is quite easy, although there are several different types. A typical stop loss order simple instructs your broker to sell if your stock drops to a specific price. This does not take into account any gains that your stock might have made after you placed the stop loss order. The other kind is a trailing stop; this is a stop loss order that instructs the broker to sell if your stock price drops by a certain percent; this allows for the stop to follow any increases in the stock price. Such techniques have created many successful traders!

Let’s look at an example of a stop loss strategy. You own a stock that has been trading at $40 per share. Since you’ve been tracking it, there has never a drop in price of more than $2 per share, so you have your broker set a stop loss order for $36. While you were away for a week on vacation, the company received some positive press and the stock jumped to $50, but later in the week the CFO was indicted for embezzling millions from the company and the stock plunged to $25. What was the effect on your stock? Since you placed the stop loss order for $36, your broker placed a market order to sell when that price was met. Instead of losing $15 per share, you only lost $4 per share.

In the same example, what if you had implemented a trailing stop loss order instead? You decided on a 10% stop since your stock has been very stable. At $40, that meant to sell at $36. When the stock rose to $50, your trailing stop rose to $45 and as the stock fell, your broker placed a market order to sell at $45. Instead of losing $4 per share, you still made $5 per share. These types of stop loss strategies and techniques will work well for the first trader but even better for the second.

It is important to note that the example is for illustrative purposes only and that any complex trade such as a stop loss order will increase the amount of commission that you pay. You also need to exercise care with a stop loss order because you are selling on a downswing; set it too close to your price and you may be out of a stock that is on a temporary trend. Set your target too far from your price and you could lose far more than you want to lose. In a case like this, you always want to consider risk reward ratios and act according to how comfortable you are.

Surviving the Risks through Asset Allocation
Are you someone who has been investing in the stock market for a long time? You probably have done this. If you are new, you will do it in the future. Imagine that you have analyzed your portfolio for the last ten years. The chart formations you draw will probably look like the moves from a line dance and not an ascent of a great mountain; it is probably a series of ups and downs where the downs routinely offset the ups. If you looked back, it is likely that the only thing that saved your portfolio was something called asset allocation.

Asset allocation is a method of portfolio diversification that hopefully is a part of your stock trading system. Smart investors never depend on only one stock, just as they rarely put their holdings in one sector of the market. Instead, they spread, or “allocate”, assets across a diversified portfolio of big and small stocks, as well as bonds and money-market investments.

Why do investors need to allocate assets? Look at your hypothetical chart again. The first five years, you enjoy a nice bull run through the late 90’s; your stock portfolio is fat because of that period. Starting just before the terrorist attacks of 2001, the market began to fall and fall it did. First, because the economy had begun to falter at the end of the Clinton administration and the stock market crashed to the ground shortly after the towers of the World Trade Center.

If asset allocation is important now, its importance was “life or death” in the past. Before this century, there were other times of bad Wall Street news, with periods of bear markets. In fact, between 1966 and 1982, five bear markets were recorded. Blue Chip stocks rose and fell with each cycle but stayed in the same price range for most of the 70’s. Because the economy had a combination of inflation and recession, interest rates rose to incredible levels, crushing the stability of the bond market. The very basis of hedge funds, the stable Blue Chip stocks, and the dependable bond market wasn’t there and the market suffered with only 20% of Americans owning stock, down from its earlier high of over 50%. Asset allocation had to depend on small-cap stocks, which soared to new heights in the late 70’s.

How does this apply to asset allocation and how does it apply today? Asset allocation is relevant because, while investors struggled with traditional methods of investing, the small companies, especially in the computer business, carried the day. With proper stock analysis, you can stand by your stock trading plan and find the companies that are performing well. Asset allocation shows that by having a proper mix of companies in various stock sectors, an investor can weather almost any economic storm.

Greed and fear can affect almost any investor if they are given the chance. For the investors who stick to solid stock trading basics and do their fundamental and technical analysis, it is possible to survive the risks of the stock market through asset allocation.

Who’s in Charge? The Art of Giving Orders
It’s how you show them who’s the boss; you’re in charge so you get to give the orders. Well, in the age of Internet stock trading, the same is true. More and more investors have taken their stock portfolios, and their money, away from the stock broker and have begun trading their own stocks. This requires successful traders to have a better understanding of both their stock portfolio and the rules of trading. These rules include such things as the buy and sell stock order and today we’re going to discuss them.

The stock order allows traders to have greater control over their transactions than just a simple market order. Some stock orders control the transaction based on price while others restrict it by time. Some of the common stock orders are Market Orders, Limit Orders, Stop Loss Orders, Trailing Stop Orders, Good Til Cancelled Orders, Day Orders and All or None Orders.

Market Order
The Market Order is the most basic stock order. It simply says to buy or sell at the current price. If there is much stock volatility, you might not get the price you last saw because of a quick change. Market Orders are usually the most simple and the least expensive stock orders to fill.

Limit Orders
A Limit Order is the most simple of the restrictive stock orders available in the stock market. Your purchase or sale will not happen unless your stock reaches the target price. If your purchase is influenced by the amount of commission, you might want to do some math here. If the stock is close to your target price, it may be better to go with the lower cost Market Order instead.

Stop Loss Orders
A Stop Loss Order is a target price that says, “If the price of this stock falls to X, sell it.” For example, if your stock is currently at $20 per share, you can set a Stop Loss Order for the stock at $16. If the stock drops to $16, this stock order will trigger a sale on your behalf. If the stock stays steady or rises, nothing happens. This one of the stop loss strategies that is an excellent insurance policy against sudden, painful drops in stock prices.

Trailing Stops
This stock order is very similar to a Stop Loss Order; the difference is that a Trailing Stop Order is triggered by a percentage of the market price, not a specific dollar amount. If you have realized a profit on a stock, entering a Trailing Stop Order will protect that profit for you. This stop loss technique says that if the stock price drops below your pre-determined percentage, you want to sell. As your stock price rises, the Trailing Stop rises too, protecting your profit.

Good Til Canceled
A Good Til Canceled Order keeps your stock order active until you cancel it. Obviously, you use this stock order with multiple time frame trading so that you are protected from a downturn in stock prices. It is good to note here that some brokers have limits on how long they will hold a GTC order.

Day Order
A Day Order is a stock order that, if not filled on the day it is placed, it is cancelled. With this stock order, you will need to re-enter the next day if you want to extend it.

All or None
The All or None Order states you want the entire order filled or none of the order filled. You would use this type of order for stocks that are not heavily traded.

Conclusion
The stock order puts you in charge! Whether you trade through a broker or with online stock market trading, you assume control over when you sell, what conditions are involved, and when you buy. It is important to understand the costs of these stock orders; frequently there are additional costs involved for the more complex orders. If you follow your stock trading plan, stock orders help you to be in charge of your portfolio. So start calling out orders General, you’re in charge!