Economics, Glossary, H - M

Inflation

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Inflation is how much less a dollar is worth next year compared to today. Most consumers hate inflation – it erodes your savings, and eats away at the real benefits you get from increasing income. However, inflation plays a necessary role in the economy, and without it much of the economy would quickly fall apart.

Inflation Definition

Inflation means that the general prices of goods and services goes up from one year to another. A bottle of Coke might go from $1.00 to $1.05, or a loaf of bread might go up by a few pennies per year. This means that if a person has a fixed income, their actual buying power gets reduced as inflation goes up.

Inflation is a normal part of the economy, resulting in the tens of thousands of companies all modifying their prices throughout the year.

Measuring Inflation

There are two main ways economists measure inflation – the Consumer Price Index (CPI), and the Gross Domestic Product (GDP) Deflator.

Consumer Price Index

The Consumer Price Index is the most basic way to measure inflation. Economists pick a set basket of goods, and simply compare their prices between years. For example, the CPI can include milk, eggs, bread, televisions, computer monitors, compact cars, circular saws, and hundreds of other products. The basket will have one of each item.

The key of the CPI is that the basket does not change, so researchers are always comparing the prices apples to apples. The CPI is simply the average percentage change of all items in the basket.

CPI Advantages

CPI is the most widely-used measure of inflation, mostly because it is the most transparent. This means that the CPI calculation is easy to understand, and easy to verify. Many government programs are tied to CPI – for example, Social Security benefits increase automatically every year based on CPI to ensure retirement benefits are not eroded by inflation.

CPI Disadvantages

One problem with the base CPI measurement is that the types of products people consume will vary widely across the economy, meaning a single CPI figure is not a very good match for anyone. People living down-town in a major city consume different products (from different providers) than people living in farming communities.

To try to fix this problem, there are numerous sub-types of CPI calculations. For example, Consumer Price Index for Urban Wage Earners and Clerical Workers (or CPI-W) uses a basket of goods more likely to be consumed by office workers in cities and suburbs (the CPI-W is the calculation actually used for Social Security benefits).

The biggest disadvantage of using a pure CPI calculation is also its strong point – the basket does not change. This means technology goods, like VCRs, end up staying in the basket for years, or decades, after they are no longer regularly consumed. This can make the overall CPI figure less reliable. Economists created another sub-type of CPI called the Chained Consumer Price Index to try to address this as well – the Chained CPI also considers the prices of substitutes that people switch to from the main basket (so if the price of Beef goes up but the price of Chicken goes down, some people will switch to Chicken, affecting the chained CPI measurement). This is less-than-perfect as well, since it is a less transparent calculation, and results in a lower inflation estimate.

Gross Domestic Product Deflator

The GDP Deflator is another measurement of inflation, which abandons the basket concept entirely. The GDP Deflator instead tries to use ALL goods and services produced in the economy as its basket, and uses it as a ratio of prices between years.

Calculation GDP Deflator

To calculate the GDP Deflator between 2010 and 2015, for example, economists first look at the average price and total quantity of all goods produced in 2010 and 2015. This would give the Nominal GDP of each year.

2010Quantity Sold (2010)Average Price (2010)Total Value
Candy Bars10,000,000$1.00$10,000,000.00
Smartphones1,400,000$350.00$490,000,000.00
4-door compact cars45,000$12,000.00$540,000,000.00
Nominal GDP  $1,040,000,000.00
    
2015Quantity Sold (2015)Average Price (2015) 
Candy Bars9,500,000$1.10$10,450,000.00
Smartphones1,800,000$500$900,000,000.00
4-door compact cars46,000$13,000$598,000,000.00
Nominal GDP  $1,508,450,000.00

Next, they apply all the prices from 2010 to the quantities from 2015, which will give the Real GDP for 2015:

 Quantity Sold (2015)Average Price (2010) 
Candy Bars9,500,000$1.00$9,500,000.00
Smartphones1,800,000$350.00$630,000,000.00
4-door compact cars46,000$12,000.00$552,000,000.00
Real GDP  $1,191,500,000.00

The actual GDP Deflator number is the ratio of Nominal GDP to Real GDP in 2015:

 2015 Nominal GDP2015 Real GDPRatio x 100
GDP Deflator = $     1,508,450,000.00$1,191,500,000.00126.60

Advantages of the GDP Deflator

The GDP deflator is very useful because it compares the entire economy against a previous year. This means not only is change in prices reflected, but changes in quantities are reflected too. This means that changing spending habits is reflected in the GDP deflator, making it a very accurate measurement of the inflation felt by the average consumer.

This accuracy is why economists usually use the GDP Deflator, and not the CPI, when conducting economic research.

Disadvantages of the GDP Deflator

The biggest disadvantage of the GDP Deflator is that it is very hard to calculate. Instead of having a basket of a few hundred specific products like CPI, the GDP deflator needs price AND quantity data from thousands of different products every year.

The calculation is also more complicated, making it harder to understand to the average consumer. Generally speaking, researchers will use the GDP Deflator, but the average consumer has an easier time seeing the impact of CPI.

A more practical drawback is that the GDP Deflator will almost always be lower than CPI. This is because it reflects substitutes in consumption – if the price of beef goes way up and people switch to chicken, CPI will simply look at the average increase, but the GDP Deflator takes into consideration that fewer people are now buying beef relative to chicken. This makes the GDP Deflator very unpopular for calculating things like Social Security benefits – switching from a CPI to a GDP Deflator calculation would mean benefits do not increase as much per year.

Inflation’s Impact on the Economy

Inflation has two major impacts on the economy – eroding interest rates, and promoting growth.

Eroding Interest

This is why everyone hates inflation – if prices go up every year, savings are worth less. This also applies to loans like mortgages – if wages increase every year, mortgage payments take up a smaller and smaller percentage of your total budget.

This means that all interest has two calculations – nominal interest, and real interest. The nominal interest is the amount listed on the loan itself, while the real interest subtracts the inflation rate over the period of the loan. This means that for some savings accounts, the Real Interest rate can be negative – if the interest you earn is less than inflation for that year, your real savings actually loses value.

Promoting Growth

Inflation is also responsible for promoting growth in the economy. Part of this is due to Eroding Interest, but part is due to the nature of long-term growth of both the economy and the money supply.

Eroding Interest and Growth

Inflation means you can buy more with a dollar today than the same dollar tomorrow. This encourages people to either spend or invest their money.

Spending gives the benefit of more consumption (or buying durable goods means long-term benefits) to the consumer, but it also means more total economic activity for businesses. The more people can spend, the more goods are produced, more people employed at higher wages, and more business can be created.

Inflation also encourages investment. If an individual does not want to consume their money today, they are still interested in using it to earn a higher return than the inflation rate. This encourages investment in stocks and bonds, which in turn helps fund new companies and businesses.

This works when inflation is fairly low – less than 10% per year. If inflation starts to rise higher, wages struggle to keep up with prices, causing people’s real earnings to decrease. Extreme cases of run-away inflation are called hyperinflation – in this case, there is serious fear of money losing its value in very short amounts of time, causing most people to pull all of their money out of investments and try to convert it into durable goods. This will cause an economy to crash – recessions caused by hyperinflation are very difficult to recover from.

Deflation

If inflation is negative, meaning average prices go down between years, it is known as deflation. Deflation reverses both of the positive effects of inflation: if a dollar is worth more tomorrow than it is today, people will instead hoard their cash instead of spending or investing it. This pulls money out of the economy, and reduces the total amount of economic activity.

If the economy looks like it is heading for deflation, the Federal Reserve will lower interest rates to encourage more borrowing and spending to prevent a recession.

Long-Term Inflation

Money is created when people take loans out from banks, either to make big purchases (like buying a home) or to start/expand a business. These loans inject new money into the economy, meaning the total money supply increases with each new loan.

As people pay loans back, that money is removed from the economy, reducing the total money supply. If the total size of the economy (measured in GDP) grows at the same rate as the total money supply, there would be zero inflation, since money would be getting paid back on all loans at the same rate that new money is lent out to fuel new growth.

In practice, not all loans are paid back – some businesses fail, some people default on their mortgage, and some loans simply do not generate the growth that the borrower was hoping for. Every time a loan is not paid back, it means that money is left circulating in the economy without being pulled back out. This means that the money supply usually grows a little bit faster than GDP, causing long-term inflation.

Hyperinflation

Hyperinflation is the extreme case of this – more and more money gets injected into the economy, much faster than it can be paid back. Hyperinflation becomes a self-fulfilling prophecy: if borrowers expect inflation to be very high, they will continue to borrow at very high interest rates, because their real interest rate will still be low. This means money is pushed into the economy much faster than it is taken out, pushing up prices very quickly.

Short-Term Deflation

Short-Term deflation happens in the opposite case – not enough people and businesses take out new loans. If more loans are being paid back than new loans taken out, money is being removed from the economy, causing deflation. This is why the Federal Reserve lowers interest rates to promote economic growth – lower interest rates encourage more people to borrow, which in turn encourages more economic activity and growth.

This means there is a constant balancing act for interest rates – the Federal Reserve raises interest rates when too many people are borrowing (which risks hyperinflation), and lowers them when not enough people are borrowing (which can cause a recession).

A - G, Glossary

Certificates of Deposit (CDs)

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A CD or Certificate of Deposit is one of the safest and liquid forms of investment available. Insured by the FDIC (Federal Deposit Insurance Corporation), CDs are a type of interest earning deposit account. Unlike savings accounts, a CD requires a fixed sum of money for a fixed period of time ranging from six months to several years. CDs are attractive to investors because they typically pay a higher rate of interest than a traditional savings account and have FDIC insurance up to $100,000. Don’t expect to get rich from investing in CDs but they are a valuable addition to any portfolio to assist in providing liquidity. Use these quick tips to get started in purchasing and investing in CD’s:

  • Use a ladder approach to purchasing certificates of deposit. By using a ladder approach you spread out the interest rates and redemption times. Should you need to cash in a CD you will have more options available and lose the least amount of potential interest.
  • If investing more than $100,000 spread it between two or more banks or brokers. Remember, FDIC insurance only covers up to $100,000 per entity.
  • Confirm the maturity date – see it in writing before signing or finalizing the purchase. CDs can mature in as little as six months or as long as twenty years.
  • Confirm the interest rate and yield. Is the interest rate fixed or variable?
  • Understand penalties and early withdrawals. Pre-payment penalties, early withdrawal fees and other related items can dramatically impact yield.
Glossary, H - M

Market Capitalization

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Most of the broadly-used market indexes today are “cap-weighted” indexes, such as the S&P 500, Nasdaq, Wilshire, Hang-Seng and EAFE indexes. In a cap-weighted index, large price moves in the largest components (companies) can have a dramatic effect on the value of the index. Some investors feel that this overweighting toward the larger companies gives a distorted view of the market, but the fact that the largest companies also have the largest shareholder bases makes the case for having the higher relevancy in the index.

Market capitalization is calculated by multiplying the market price of stock by the number of issued shares of stock. Using an overly simplistic example, let’s assume the price per share of stock for company X is $10 and they have issued 1 million shares for a total market capitalization of $10 million. By this point a few questions should immediately come to mind including:

  • What is the total market for this given service or product? If company X in the above example was selling bejeweled dog collars for miniature tea cup sized poodles then will the demand warrant the total investment. Seems simple enough but novice investors might be surprised to learn how frequently a company over-estimates the total demand for a given product. This is particularly true with new and/or un-proven technology. The classic example is Beta video tapes. Although VHS video tapes went on to predominate the market, for a variety of reasons, the demand for Beta remained insufficient to take the lead.
  • What is the anticipated penetration level? Are the estimates realistic? It doesn’t matter if Company X is the only one today…they still can’t expect 100% market penetration because as soon as they become profitable copy-cat companies will move in. Without the start-up costs they might even have a distinct price advantage. Further, compare market capitalization with expected saturation levels. The more risky and/or unproven then the more conservative conservative penetration and saturation estimates should be for any given company.
  • Does the market capitalization level reflect the actual opportunity? Here is an example from a newly funded start-up. Company ABC operates in a $6 Billion dollar industry within the health care arena. The IPO was $50 million and they were quickly listed on NASDAQ. Closer scrutiny reveals that the sub-industry within which they operate is only a $40 million dollar annual industry. While it is true the industry is shifting toward the new technology, due to regulatory and insurance reimbursement schedules, that shift will require major overhaul and recognition before going mainstream.
Glossary, N - T

Systemic Risk / Market Risk

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Market / systemic risk is a measure of how much of a loss an investor is facing while trading. The market risk is usually measured using the beta of the stock that is being held in his/her portfolio.  Sometimes called “Systematic Risk,” it can happen for various reasons such as bad financial news or changes to the current rates. Because of the low-level of control investors have over this risk, portfolios generally can not be hedged against it.

Glossary, H - M, rewrites, The 10 Terms You Need To Know

Various Risks of Investing

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The average individual investor is saving for retirement, a house, travel money, or some other goal. They want some certainty that the money they put back now will be there when they need it. Because of this, it is important not only to analyze the opportunity an investment represents, but also the risk. Your ideal investment or investment portfolio gives you the most opportunity for the risk you can bear. In this sense, it is important to understand the risk inherent in an investment before you look for the opportunity. Unfortunately, the average investor does not understand risks even on a basic level. Most individual investors do not look at risk in any objective way. They base their decisions on perceptions and fear. They think things like “Google is popular, the stock won’t go down” and “Lehman Brothers has been around as long as I can remember, it seems like they’re pretty stable.” In a best-case scenario they will look at the beta of a stock. Unfortunately beta is a measure of volatility and is a poor substitute for analyzing risk. Even more importantly, beta is always a historical figure and does not in any way represent what might happen tomorrow. Though investors often do not analyze it, most do realize there is risk inherent in investing. Let’s look at the various types of risk investors face:

Market Risk

The risk most are familiar risk is Market Risk. Market risk is the risk that the market changes it’s perception of value for a particular investment. This risk is one of the most important risks when it comes to stocks, options, and commodities. This is exhibited clearly with the daily changes in share prices for any publicly traded stock. This risk can be analyzed by looking at the factors making up the perceived value of the investment. You would then determine how accurate these assumptions are and how they might change in the future. Some of these factors include earnings, dividends, growth, and perceived opportunities.

Default Risk

Another important risk that many people are familiar with is Default Risk. This comes into play more with debt investments than equity. Bonds, for instance, all carry the risk that the issuer will not be able to make a payment when it is due. The primary factor in default risk is cash flow, which can be different from income or revenue. If you own a bond that an issuer does not have the cash to pay, you would lose your accrued interest and principle. Default risk also has an indirect but important effect on stock equity investments because default on debt can put a company into bankruptcy. In bankruptcy, the debt holders get paid before equity holders. As a result the stock will generally be worth less after a default and can in extreme cases lose all of its value. Diversification is very important in reducing the effects of default risk.

Interest Rate Risk

Interest Rate Risk is another risk that affects primarily bonds. The price for a bond can be easily estimated by determining the required rate of return (yield) and adjusting the price to bring the yield in line with what is required. In practice, this means that with the exclusion of other factors, when interest rates fall, bond prices go up. When interest rates rise, prices go down. This is particularly important when we are at historically low interest rate levels. Low risk bonds that were purchased several years ago at higher yields are now selling at significant premiums, netting their sellers significant gains. Today’s buyers will have the opposite effect buying when rates are low. As rates rise, the prices they can sell at will drop. This is very important to institutional buyers but often overlooked by individuals trying to buy into something “safe.”

Opportunity Risk

Opportunity Risk is the risk that by buying one investment, you are reducing the amount of money you have to invest elsewhere. This means that when you consider investing in Google (GOOG), for instance, you are giving up the opportunity to invest the same money in Apple (AAPL). One is likely to gain more or lose less than the other, so you are forgoing the opportunity for that gain by buying one over the other. You can reduce this risk with careful research or diversification.

Liquidity Risk

Liquidity Risk is somewhat related to opportunity risk, though in a somewhat more tangible way. This is simply the risk that you will not have money available at the time you need it. It may be that a CD has a significant penalty to be broken or it may be that a bond is not heavily traded and cannot be sold for a fair price in the open market. Your best yield would be to wait until maturity, but the risk is that you will need it sooner.

Inflation Risk

Inflation Risk is one of the risks most overlooked by so-called conservative investors. This is the risk that returns on your investment will be lower than the rate of inflation. This results in having less purchasing power at the end of an investment period than at the beginning. Because this doesn’t show up clearly in the dollars and cents of an investment, people easily discount its importance. If you invest money for retirement today, you hope to be able to spend the same amount in the future. The reality is that if you invest in a security that does not exhibit the other risks discussed but yields only 1% in a world with 3% inflation, you will effectively have less than you invested to spend in retirement. It is dangerous to discount this risk because you will end up with less market and default risk at the expense of inflation risk.

Systemic Risk

Systematic Risk, Political Risk, Event Risk and Country Risk are all similar in that they refer to risks outside the control of the investor or the company to control. They represent the risk that something will happen in the external environment to change the value of an investment. A major hurricane or flood is an event risk closely related to real estate or insurance investments. When Katrina hit Louisiana, a number of insurance companies took bigger losses than investors expected them to take, reducing the value of investments in those companies. Health related investments are facing political risks right now in the form of health reform. It is currently unclear how any potential reforms will affect profitability for hospitals or insurers. There is a risk that the changes will make investments in health companies will be adversely effected.

Summary

These are the major risks associated with investing and can be found in most investments. Favorable trade-offs between these risks is important when picking the right portfolio for your needs. It is important to understand, for instance, that while Treasury Bonds have low default and market risk components, they have higher inflation, opportunity, and interest rate risks. It is dangerous to invest without concern for these risks, or to ignore risk altogether. An investor that is well informed of all the investment risks will be able to make better decisions with his/her money.

A - G, Glossary

Diversify to Reduce Risk

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Diversification to reduce risk should seem obvious to most investors but a surprising number of people follow their instinct rather than intellect when it comes to investing. Diversification is a simple concept: If you are shoe seller then you want to sell sandals and snowshoes to take advantage of sales in any season rather than putting all of your eggs in one basket. The same goes for stocks: diversification to reduce risk is easy once you conceptually understand that a limited amount of money is chasing the entire basket of available goods or services.  Diversification takes many forms: market capitalization, domestic vs. international, industry focus, etc. Also, asset allocation is a concept that involves several security types: stocks, bonds, cash. So, that’s not applicable.  A solid diversification strategy is to invest in a diverse basket of stocks by focusing on various industry sectors, like: banking, consumer staples, technology, natural resources, health care, etc. If you buy 1 or 2 stocks in each industry, you’ll manage risk better than buying stocks all from one industry or one country.

A - G, Glossary

Buy and Hold Strategy

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The buy and hold strategy is essentially just what it sounds like: Purchase stocks and then hold them for an extended period of time. The underlying assumption for the buy and hold strategy is that stocks tend to go up in price over extended periods of time. Research supports this trend in a growing capitalist economy and the strategy has made millions rich. There is also something to be said about not having to ride the emotional roller coaster with every increase and dip in the market…just buy the stock and check on it once in awhile. Is a buy and hold strategy right for you? Take this quick quiz to find out:

1. You are investing with long term goals in mind.
2. You are unlikely to need the additional cash on short notice.
3. You would like to reduce commissions and other fees.
4. You would like to reduce or defer taxes.

If you answered “yes” to any of the above then a buy and hold strategy might be a good fit for at least a portion of your portfolio. A Buy and Hold strategy is a traditional long-term investment strategy of buying a stock long and holding on to it for an indefinite period of time, usually 3-5 years. This classic strategy is associated with a bottom-up investment management style where the portfolio analyst uses the financial statements to forecast growth in earnings and buys the stock long-term, anticipating growth and therefore price appreciation for the stock over a period of time. Buy and Hold strategies are most often strategies used with registered non-taxable accounts, such as a 401k or RRSP’s, where the manager is limited to long only positions and does not have the ability to use derivatives or to sell short stock. For example, after extensive research and due diligence, a portfolio manager learns that a new small-cap company, Stock-Trak Group, has some earnings and is expected to be a leader in their industry. The portfolio manager decides that this is a potential great investment and sees good growth for the firm in the long-term. After analyzing his valuation models, the manager believes Stock-Trak Group is highly undervalued and that with growth in revenue and earnings over the next 3 years, the stock’s price will appreciate very quickly. He decides to purchase the stock today and hold for the 3 year term, unless some unanticipated events occur, and sell with a target gain of 300% (tripling the client’s money).

Advanced Trading Strategies, Technical Analysis

The Art of Market Timing: Mastering Market Cycles for Profit

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Learn the classic market cycles of accumulation, mark up, distribution and mark down so that you can time the market -consistently – and make steady profits any time. When you hear someone on TV say that “market timing” is impossible, they are wrong. Let me be the first to say that market timing is not only possible, but also profitable on a consistent basis. As a technical trader, your purpose is to find the best trades and to time your entry and exit points. After all, you can find the best trade in the world, but if it is not timed well, it may turn into a loss. Every stock or asset class goes through a classic market cycle. When you look at the chart of any stock or index, it moves in cycles. We are all going through a life cycle, and we are also in the autumn stage of the seasonal cycle. By observing cycles, we know what to expect next. This is true for stocks. If you noticed, all three were homebuilders and they have completed their market cycles which has ranged from 5 to 10 years. If you are a long-term investor or trader, your understanding of market cycles will greatly benefit you. Let’s talk about each stage and what is going on during each stage of the cycle:

Stages of a Market Cycle

  • Accumulation Phase – This is the bottom (or near the bottom) of the market for a particular stock, sector, or general market. At this stage, prices do not move upward but rather stay within a neutral range. At this level, the smart money begins to buy up large blocks of shares to accumulate a large position for their portfolio. They are patient enough to be able to wait years, if needed, because it is difficult to determine how long a stock or sector will be in this stage. Regular individual retail investors do not even consider buying at this level because, in most cases, they have recently sold close to the lows. It is at this stage where you pick up the biggest discounted stocks. This is where long-term investors should be buying to realize the greatest long-term gains.
  • Mark Up Phase – This phase follows the Accumulation phase and the way to know if this phase is occurring is to see a stock or sector that has “broken out” of its neutral range. This means that it must break above the upper trend line of the neutral range. From this point on, you should see an obvious increase in volume. Most of the institutions and individuals who are aware of this early trend will jump on board and bring along significant buying power with them. Another way to tell if you’re in this stage is to see if we are forming higher lows and higher highs, confirming the start of a new uptrend. Toward the end of the mark up phase, you will see full market participation, meaning everyone from the shoe shiner to the cab driver will most likely have made an investment. This sets us up for the next phase:
  • Distribution Phase – This is the top of the market for a particular stock, sector, or general market. Supply overwhelms demand after the smart money sells their shares to the “greater fools” who buy at the top. Because there are no other buyers left to raise the price, a stock or sector cannot advance higher, and thus, will collapse under its own weight. The sentiment is extremely bullish. This phase is marked with extreme greed and fear. The best way to identify a top is through chart patterns, most notably, the head-and-shoulder and double top formations combined with breakdowns at the 200-day MA. This phase is usually marked by the greatest volume levels for a stock until we reach the Accumulation phase once again.
  • Mark Down Phase – Prices are in free fall and stocks are in full liquidation mode. This group is made up of people who held beyond the Distribution phase and did not sell, or those who bought at or near the top and refuse to sell at a loss. Either way, a loss will be incurred, and the size of it will be determined when an investor wishes to cut it. You should not be buying at this stage and those that try to find a bottom will be disappointed.
  • Return to Accumulation Phase

Phase Strategies

Accumulation Phase

    • Investors: Cash » Buy
    • Traders: Cover/ Buy

Mark Up Phase

    • Investors: Buy
    • Traders: Buy

Distribution Phase

    • Investors: Sell » Cash
    • Traders: Sell/ Short

Mark Down Phase

  • Investors: Cash
  • Traders: Short

Sentiment Cycle

In addition to the actual price cycle, there is also a sentiment cycle which accompanies each stock, sector, or overall market. Here is the general range of emotions that follow (each chart is different, so this model is not exact for every situation):   You may have found yourself within each of these emotional phases. Now that you know what to expect for each cycle, you’ll have to harness your emotional involvement and separate it from your trading activities. You are your own worst enemy because emotions give room for destructive impulse trading. By understanding each cycle and what emotions follow, you’ll be better prepared. By now, you understand why high flying stocks crash to their lowest levels. Market cycles are a normal and necessary function in balancing the financial markets and restoring equilibrium to the forces of supply and demand. You are now positioned to take advantage of every market cycle for every stock and every sector in the future. Take a look at 3-year charts for TRA, CROX, and MON for additional examples of full-length charts.

Glossary, N - T

Timing System

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Definition

A “Timing System” is a methodology to try to “time” the markets; the best way to “buy low and sell high”. Timing systems are often marketed by “stock gurus” who claim to know some market secret to making millions; other timing systems are based on strong technical analysis. The unifying factor of timing systems is that they are supposed to be a methodology one can follow to know the high and low points of a stock’s price within a given time frame.

Do They Work?

It is hard to tell if a stock timing system really works, but look at it this way; who is trying to sell it to you? By definition, a stock timing system cannot work if everyone is using it; you cannot “buy low and sell high” if everyone else is trying to buy when you buy, since many buyers and few sellers drives prices up.

Conversely, if one person is trying to buy when everyone else is selling, they will probably get it for a cheaper price. If someone is selling a “stock timing” method, are they profiting more from using their system, or just making money by selling it to other people?

Beginners generally should avoid market timing systems because it is very easy to get “in over your head”; all market timing strategies involve buying and selling at critical moments, which is both the highest possible point for profits AND losses. However, if you are able to build a strong background in technical analysis, the Kansas City Federal Reserve Bank has released a report of examples where market timing systems have worked well. Click Here to view.

Who Uses Timing Systems?

Timing systems are often used by traders who are fluent in technical analysis; analyzing chart patterns, knowing which macroeconomic factors most directly impact one or two stock’s prices, and hopefully make the right trades before the market as a whole. Again, all timing strategies are inherently risky; long-term investors should be more concerned with strong stock fundamentals rather than the specific minute, hour, or day to buy or sell a particular stock.

 Book: Timing The Market: How To Profit In Bull And Bear Markets With Technical Analysts
  
 Book: Spotting Price Swings & Seasonal Patterns: Techniques for Precisely Timing Major Market Moves
Glossary, N - T

Offer Price

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Definition:

The Offer Price (or Ask price) is the price an investor is willing to sell the asset. In most cases this is set by a broker who will set the price at the price he is willing to sell the asset. Stocks are sold at the Ask or offer price and not at the last price as many believe.

Explanation of Offer Price:

The easiest way to remember what the offer price is to remember that we are offering to sell something and this is the price we are offering to do so. What is more difficult to remember is that it is the broker who is generally offering to sell a stock and he is “asking” for a certain price to be able to sell it to you. This price will always be higher than the last price.

Glossary, N - T

Spread

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A bid price is the highest price at which a buyer is willing to purchase a stock. Conversely, the ask price is the lowest price at which a seller is willing to sell a stock. The role of the stock market is to match buyers with sellers at a price at or nearest to their threshold.  The difference between the ask price and the sell price is called the “spread” and it is kept by the broker. This is not the same as the commission, which is paid regardless of the spread. Generally, stocks that trade with the most volume will have the smallest spreads while stocks that trade with less volume (such as OTCBB, penny stocks or pink sheet stocks) will have larger spreads.

Glossary, N - T

Stock Symbols

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Definition

A “Stock Symbol” is the symbol used by exchanges to identify the shares of one particular company. For example, AAPL is the symbol for Apple, Inc, and F is the symbol for Ford. Stock Symbols are also referred to as “Ticker Symbols”

Why Do We Use “Tickers”?

Most beginning investors hate tickers; wouldn’t it just be easier if we used the company names? HowTheMarketWorks tries to help this with our Smart Trade Drop-Down, where by typing the company name in the trading window, we will give you tickers that match. Click Here to try! However, lets take a look at where ticker symbols came from, and why we still use them today.

Early Tickers

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Ticker machines first came into use during the 1800’s as a fast way to move news across far distances; they used telegraph lines to transmit messages electronically. However, with a telegraph machine, each letter of the message had to be speed out in Morse Code (a series of dots and dashes), read by the operator on the other end, and then typed out onto a message to be actually read by anyone.

This was a time-consuming process; the longer the message, the longer it took to write, translate, and read. To speed things up, short-hand writing (the predecessor of today’s “text speak”) was invented. Famously, an old British admiral was the first person to use “OMG” as shorthand in a message to one of his collegues.

For investors looking to get the latest stock prices, this was also a problem. Since there were dozens, then hundreds, of companies being traded and prices being updated every day, the longer it took to communicate a company’s price meant the whole stream of information was held up. Thus, company names were shortend down to 1-5 characters, and the first ticker symbols were born.

Rise of Electronic Trading

Today, the original reason for tickers is still important; computers still take time to process longer names, so shorter codes can be a lot faster when executing billions of trades per day (if you are making trades as fast as you could, it would take almost 5 times as long to write “The Coca-Cola Company” than it would “KO”). However, there is another reason why we continue to use tickers: sometimes companies have multiple “types” of stock, or multiple companies have very similar names.

For example, Google has stock both under the symbol “GOOG” and “GOOGL“. These stocks are very similar, but they were issued at differnet times and have different prices, since each share representes a different “slice” of the company.

Glossary, N - T

Stock Trading Risk Management: Introduction for Beginners

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Many people start trading stocks and never learn about stock trading risk management. The one’s that do learn, usually learn after they have been trading for a while, not before they start trading. Here is a timeline for a typical trader:

  • They start off and have a few winning trades in a row.
  • They read about other people making money trading and think “Hey, I have just had a couple of winning trades in a row, I CAN do this.”
  • Now after a few of these winning trades, they become confident that they can continue having the same success over and over again.
  • Next, they become Over Confident and they now think that nothing can stop them, and that trading is easy.
  • Now reality sets in. The same traders now experience one or two losing trades that wipe out their trading account or come darn close to doing so.
  • The people who have money left in their account, now stop and take a look to see what went wrong. They start to learn about Stock Trading Risk Management.

If this sounds like you, you’re not alone. If you haven’t been through these steps, great, now is as good a time as any to skip over the hard earned lessons above and learn about risk management now, rather than later. Keep in mind that every trader will have losses and the people who get wiped out with large losses are the ones who do not manage risk well, if at all. In order to be around to take advantage of the next trading opportunity, you must learn to mange risk on each and every trade. Here are some of the things you will be learning about when exploring stock trading risk management:

  • Determining your risk tolerance
  • Risk to Reward ratio
  • Determining Position Size for trades
  • Different order types to help minimize losses and capture profits
  • Diversification
  • Learning to identify possible entry and exit price points
  • When to cut your losses

Once you learn about these and other risk management topics, you will be able to evaluate each trade before and after entering into a position. You will also be able to make any necessary adjustments as the position moves either against you or “in your favor”. You may have noticed I mentioned “in your favor” also. Yes, that’s right. I have seen and read about many traders who at one time or another had a sizeable profit in a position only to keep holding it and watch as it turned into a losing trade, and finally selling when they can’t stomach the continued, increasing losses. These people need to learn about risk management also. Stock Trading risk management is not just about limiting or controlling losses, but understanding how to capture and try to maximize profits as well. All of these things can be learned and adjusted based on each person’s particular trading plan or system that they use. Whether you are an intraday scalper or a long term investor, risk management should be a part of every traders plan to achieve long term success. While there will be other area’s to explore in addition to these, having a place to start will help you get started and hopefully avoid some of the costly mistakes many traders make over and over again.

Glossary, N - T

REITs

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Real estate can be a wise investment but beyond purchasing a home of your own, what is the best way to invest in real estate without getting your hands dirty and spending your spare time chasing tenants for rent? A REIT or Real Estate Investment Trust may be the perfect investment vehicle. REITs own, and often operate, real estate but are publicly traded like stock. Profit is paid as dividend to stock owners. To invest in a REIT, it is imperative that you do your homework. Real estate is a tangible asset, but there are major holding costs including maintenance, taxes and insurance. Local market conditions change dramatically and can take years to recuperate. Before investing in REITs research the following:

  • Is the REIT registered with the SEC and publicly traded? Use caution before investing in an REIT that isn’t registered or publicly traded.
  • Determine the type of REIT: equity, mortgage, hybrid?
  • What type of property does the REIT invest in? What is the economic forecast related to that industry?
  • Who is on the board and management team? What is their experience?
  • How will it impact your taxes? Most REIT distributions are taxed as ordinary income.

Some well known and actively traded REIT’s include:

Boston Properties Inc. (BXP), Simon Property Group Inc. (SPG), and Anthracite Capital Inc. (AHR).

A - G, Glossary

Currency ETFs

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Since 2002, the U.S. Dollar has lost more than 30 percent of its value relative to other world currencies. Shorting the U.S. dollar and buying other world currencies is one way to make money from this trend. Instead of playing the very risky and complicated foreign exchange markets, these exchange traded funds make it easy to short the U.S. dollar or go long foreign currencies. Now, you can buy euros, yen, pesos and pounds just as easily as you would buy a stock.
PowerShares DB U.S. Dollar Index Bearish Fund (UDN) gives you exposure to all the major world currencies and is designed to replicate a short position in the USDX, an index that tracks the U.S. dollar against the Euro (57.6%), Japanese yen (13.6%), British pound (11.9%), Canadian dollar (9.1%), Swedish Korona (4.2%) and Swiss franc (3.6%).

In other words, UDN goes up as the U.S. dollar goes down against this basket of other major currencies. PowerShares DB U.S. Dollar Index Bullish Fund (UUP) allows you to take the opposite position as the UDN. This one goes UP as the currencies mentioned above fall when measured against the greenback. CurrencyShares British Pound Sterling Trust (FXB) is an ETF that holds a position in the United Kingdom’s currency, the pound. CurrencyShares Japanese Yen (FXY) gives you a chance to profit when the Japanese yen is outpacing the dollar. The ProShares UltraShort Yen (YCS) is a bearish yen fund. It’s 2X leveraged, so your gains are amplified if your bet is correct. If the yen drops 10 percent, this ETF’s shares stand to rise 20 percent.

However, if you’re wrong, your losses can add up quickly. The PowerShares DB G10 Currency Harvest Fund (DBV) tracks an index that shifts exposure based on the yield of the ten top world currencies in the world — the G10. With DBV, you’ll have the equivalent of a long position in the three highest-yielding G10 currencies and a short position in the three lowest-yielding G10 currencies. If you know anything about hedge funds, you probably recognize this as the so-called “carry trade.” Put simply, it’s borrowing at low interest rates and using the loan to buy higher yielding assets elsewhere. It was an easy way to make big bucks for years. But those managers had their heads handed to them in 2008.

Glossary, N - T

Stock Index

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By measuring the compilation of similar stocks instead of just one or two stocks, a stock index provides information about that particular market or segment. One of the most talked about and popular indexes is The Dow Jones Industrial Average (DJIA) which consists of 30 of the biggest companies in the U.S.  Stock indices are typically related by some commonality: for example, the Dow Jones Wilshire 5000 is an index that measures or tracks almost every publicly traded stock in the United States. The Morgan Stanley Biotech Index is a small index that follows the biotechnology market. Each stock index has a specific focus that can provide highly specific or very generalized information.  Interested in learning more? Explore new stock market indexes such as: Ethical Stock Market Indexes and Environmental Stock Market Indexes.

Teacher Resources

NYSE Teacher Workshops

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TEACHERS: Come to New York this Summer and Attend a 5 Day Training Session at the New York Stock Exchange
–Financial Aid is available to cover travel!–

NYSE-Teachers-Summer-Workshop

  • Financial Aid requests due May 1st.
  • Registration Forms due May 17th

NYSE-SEC Summer Teacher Workshops are offered for teachers who want an in depth stock market experience and are hosted at the New York Stock Exchange in New York City.

These NYSE Summer Teacher Workshops are a partnership between the NYSE and the SEC. Teachers learn about how the market works and about Federal involvement in the financial markets. Most of the attendees are high school teachers, although some teach at the college level.

There are scholarships for the NYSE NY portions of the program but the essays are due by May 1st.

Download the information here about the NYSE Summer Teacher Workshops (PDF)

Teachers at the NYSE

If you have any questions about the Teachers’ Workshop,
please contact the Educational Services Department at
212-656-2907 or email: teachersworkshop@nyx.com

This year’s dates are:

2013 Teachers’ Workshops (held at the New York Stock Exchange in New York, NY)
• June 24 – June 28, 2013
• July 8 – July 12
• July 15 – July 19
2013 SEC Graduate Program (held at the SEC’s headquarters in Washington, DC)
• July 23 – July 26

2013 NYSE Euronext Graduate Program (held at the New York Stock Exchange in New York, NY)
• July 30 – August 2

Current Events

Best Months for Stocks: Optimal Investment Periods

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Sixty-Two Years Proves Best Months to Buy Stocks

Have you ever wondered if there are best months for the stock market? YES!!! There is!!! Based on a 62 year study conducted by The Stock Trader’s Almanac, five months of the year produce significantly better and safer returns than the other seven months of the year. These months were November, December, January, March and April.  They added February to the list to formulate their Six Month Switching Strategy.

The simplified rule is to invest in the six months November 1st thru April 30th and then switching to safe fixed income products for the rest of the year. If you back test this strategy since 1950 with an initial investment of $10,000 in the DOW, you would have had gains of 6,740%. If you had invested the same $10,000 from May thru October, you would have lost $1,024. This is pretty compelling statistics especially when you also consider that if you had invested in November 1st thru April 30th, there were 48 years with gains and 14 years with losses or a ratio of 3.5 to 1. On the other hand, May 1st thru October 31st had 37 gains to 25 losses. Only three years had double digit losses during November thru April and they all coincided with financial crisis.  If you only used the last 26 years for the study, the results improved to gains of $585,910 versus $498.

Improving the Six Month Switching Strategy

There are two ways to see improved returns from the simple Six Month Switch Strategy.  If you dig into the numbers, you will see that February traditionally only gains 0.04%.  If you remove February and replace it with July which on average returns 1.2%, you will see improved returns.  Of course this change significantly complicates the simplistic Six Month Switching Strategy so it is rarely implemented.

The best change to this strategy uses MACD timing for trades as it improves results by 300%.  It allows an investor to get in earlier and keep stocks in the trade longer.  The Stock Trader’s Almanac claims that their newsletter has refined the strategy even further so that they only need four trades every four years which improves the results from the original study by 400%.

Summary

The basic Six Best Months to Buy Stocks strategy seems easy enough for anyone to follow.  You invest in DOW ETFs like DIA during the good months and money market ETFs like SHV during the rest of the year.  By adding a little common sense and only implementing this strategy during years when the market is trending upward provides a safe investment strategy for most people.  Those of us that want to improve their chances with hand holding advice should invest in The Stock Trader Almanac’s $180 a year newsletter.

Best months for stocks  –  January, March, April, July, November, December

Worst months for stocks – February, May, June, August, September, October

Glossary, H - M

Institutional Investor

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Institutional Investor

Definition

A non-bank organization that regularly trades large blocks of stocks. Because of the size of their investments, they qualify for preferential treatment and lower commissions. Institutional investors have less protective regulations as it is assumed that they have more experience with the market and are better able to protect themselves.

There are many consumer based investment strategies that watch what the big money (institutional investors) is buying and follow their lead. The larger the percent volume increase relative to a regular day sold of one company’s stock, the more likely institutional investors have identified that company as having strong growth prospects for the future. The most well known strategy is taught by Investor Business Daily.

Charts and Patterns

What are Candlesticks (video 2 of 3)

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Candlestick charts are the first known style of chart analysis. As you look at this chart, it is made up of many red and green bars which are called candlesticks. They are called candlesticks as they resemble a candlestick with a wick coming out the top and bottom.

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The Green candlesticks represent one time period where the stock increased in value. The Red candlesticks represent a time period where the stock decreased in value. The time period that each candle represents can be anything from a minute to an hour, to a day or even a month. If we are building a chart that represents a day, we might specify that each candlestick represents a minute or five minutes. If we were trying to build a chart for a year, we might specify that each candlestick represents a day or a week.

Candles are really EASY to understand. We need to start with the OPEN PRICE of a stock, the CLOSE PRICE of a stock, the HIGHEST PRICE the stock hits during the day and the LOWEST PRICE the stock hit. All these pieces are illustrated in a candlestick.

Let’s start with a candlestick that represents a stock increasing in price for one time period. The body of these candlesticks are GREEN.

The OPEN PRICE of the stock is the top of the body.

The CLOSING PRICE of the stock is the bottom of the body.

The Body of the candlestick is green to represent the stock increasing in price for the day.

The HIGHEST PRICE for the day is the highest point of the upper wick. The upper wick is called the UPPER SHADOW.

The LOWEST PRICE for the day is represented by the lowest point of the lower wick. The lower wick is called the LOWER SHADOW.

This illustration quickly shows the action of the price during the entire day. In another class we will discuss how a single candlestick along with volume will give any investor valuable information about the future direction of the market.

Let’s now look at a candlestick that represents the stock value going down for the day. As you might guess, this candlestick is RED to identify the loss.

In the case of a red candle, the OPENING PRICE is seen as the bottom of the candle body.

The CLOSING PRICE is the top of the candle body.

The bottom of the lower wick is the LOWEST PRICE the stock hits during the day.

As you would guess, this lower wick is called the LOWER SHADOW.

The top of the upper wick represents the HIGHEST PRICE the stock reaches and just as with the green candle, the upper wick is called the UPPER SHADOW.

Sometimes you will see green candlesticks represented by hollow and black-filled candlesticks. In these cases the hollow candlesticks represent the price closing higher than the open price. The black-filled candlesticks represent the price decreasing on that day like a red candle.