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Rules rule the world in trading. W. D. Gann really didn’t care about what a company’s earnings were. He didn’t care what a company’s debt ratio was. What was more important to him was the price that the market was at and the time that it was at it. He was the first one to really take a scientific approach to the markets with price and time and patterns that would develop and repeat. “The public loses because they do not stick with a well-defined set of rules and cannot organize themselves.”

Did you know that the greatest secret of the stock market is not buying? It’s selling. Never keep a loser, and never dollar-cost-average down. Protect your capital, so you’ll have enough to invest when the bull returns.

In a survey of professional and semi-professional traders, 95% of them agreed that failing to cut losses resulted in the largest trading loss they ever had. This lack of self-discipline is the single most common thread to most traders’ losses. The most common reason cited for not cutting the loss early was that they thought the stock would ‘come back’ (think Nortel). Simply controlling your losses and setting stops (actual or mental) will dramatically improve your bottom line profits.

Did you know that one simple number in a company’s financial statement could point you to sky-high profits?

And did you know that a 20-year academic study PROVED that companies which have this number moving in the right direction return an average of 15% a year… compared to the measly seven per cent a year you’d get from companies with a bad number?

You might find it interesting to know that the number I’m referring to is ‘Number of Shares Outstanding.’ So what, you say? Who cares what how many shares of a company’s stock are outstanding? Tell me about cash flow, earnings, and revenue growth!

You SHOULD care, because companies where the number of shares is declining have an AWESOME probability of outperforming the market!

The reason is simple: when companies buy back their own stock, they are voting with their shareholders money to invest in something that they KNOW is dirt cheap – their own stock. These companies aren’t stupid – they only buy their own stock when it’s low, and sell it when it’s high.

Buying back shares makes the stock go up for good reason – other investors see the company’s confidence in itself. And, simple algebra tells us that current earnings divided by fewer shares means INSTANTLY higher earnings per share!

As companies reduce their shares outstanding, the earnings per share increase, making each share more valuable. This is ultimately reflected in share prices.

The stock of an average company announcing a repurchase plan will beat the market.

Makes sense, doesn’t it? After all, when a company buys back their own stock, it’s an enormous vote of confidence by those who know it best – senior executives.

But, those executives aren’t talking. They keep their plans, research, and tactics behind closed doors. The only indicator of their well-founded optimism is a stock buy-back. It’s a powerful indicator that no serious investor should ignore.

In the 10 years (up to 2001), if you had invested $10,000 in a typical S&P 500 portfolio, your investment would have grown to $67,917. But that same $10,000 invested exclusively in value buyback stocks would have grown to $130,254 – nearly $70,000 more in profits!

Buybacks are announced almost on a daily basis in the financial section of national newspapers. All you have to do is unearth them, and voila!

One of the most common yardsticks used to measure stock performance in the U. S. is the Dow Jones Industrial Average (DJIA). The goal of many professional money managers is to meet or beat the performance of the Dow – the world’s most popular market gauge – and yet, as dull as a car’s odometer, but still a good barometer. It includes a basket of stocks, and is weighted by stock prices, rather than market capitalization.

The Dow is the number that measures the market for Main Street on a daily basis. It is referred to as the benchmark for the U. S. market. It carries a lot of weight with traders, who consider its blue-chip stocks the ultimate bellwethers of the U. S. economy. There have only been a handful of changes to its composition over the years, and there were no changes at all between 1959 and 1976. Talk about stability.

According to ‘Mr. Dow’ – market strategist Charles ‘Chuck’ Kadlec – the Dow will advance at an 11.1% annual rate long-term, which means it would double three times in less than 20 years. Just by way of comparison, Warren Buffett – the Wizard of Omaha – believes returns during the next decade or two will average about seven per cent a year after inflation and frictional cost, such as trading fees.

The DJIA is an average of the prices of its major companies whose stocks are listed on the New York Stock Exchange. The Dow uses a weighted number that takes into account stock splits and dividends, when determining the index’s movement.

This is an investment strategy that historically has outperformed the Dow Jones Average, more often than not.

STEP ONE

List all stocks included in the DJIA from highest to lowest in terms of dividend yield.

STEP TWO

Select the 10 stocks with the highest dividend yield, and invest an equal amount on money in each. You’ve just bought some of the biggest and most well-established corporations in the world at a value price.

STEP THREE

Repeat the process each year at a set time. Adjust the stocks in your portfolio as necessary, making sure that the stocks included in the portfolio have the highest dividend relative to their prices.

History has shown the 10 highest dividend-yielding stocks have typically provided investors with above-average total returns. In fact, this strategy has outperformed the DJIA 14 of the past 20 years.

This strategy is so successful, because the companies listed on the Dow are well-established and financially sound. This gives them stability and staying power even during economic downturns. The 10 highest-yielding stocks are typically companies that have been temporarily undervalued by the marketplace. Therefore, when these companies rebound, they are likely to provide you with an above-average total return. The strategy buys equity stocks that are out of favour. This ‘contrarian’ discipline has historically yielded above-average returns for equity investors.

It appears this strategy will work with other indices as well. If you’re considering investing in Canadian or other markets, this strategy provides a simple way to add global diversification to your portfolio.

WINDOW DRESSING

Window dressing is a term used to describe the process whereby mutual fund portfolio managers sell the ‘bad’ or unpopular stocks in their portfolios at the end of their reporting quarters, in order to buy stocks that have performed well in that same period. They do so, because they must provide shareholders with reports of stocks they own on the last day of the quarter. By buying the best performers, they seduce shareholders into thinking that they have owned the best stocks all along. Boo hiss.

As you can appreciate, this trickery tends to create selling pressure in underperforming stocks and buying pressure in outperforming stocks going into the last week of every quarter. Knowing this, short-term traders who short the biggest losers and go long the biggest winners of the quarter make nice quick profits.

What happens in January is generally seen as a precursor to the strength or weakness of the stock market during the remainder of the year. Small caps tend to do well in January. The first three trading days of January are almost always up, even in a bad year.

The January Effect is associated with a tendency for stocks, particularly those of small firms, to rally in the first two weeks of the year. This phenomenon is generally associated with December/January portfolio adjustments, or ‘window dressing,’ by fund managers.

Smaller caps are suitable for patient investors with a long-term horizon. They tend to outperform their bigger-cap counterparts over the long haul. From a trading perspective, lack of investor enthusiasm for smaller caps translates into lack of liquidity in these stocks. Consequently, you get significant gaps between the bid and the ask, and it’s not always easy to sell your stock at the price you want. Small-cap stocks are risky and volatile.

If you’re a day trader, you are primarily interested in EPS, volatility, volume, and good trading technique.

Profits are STILL the KEY to stock market fortunes!

When you buy bonds, the single most important thing to consider is inflation. Benign inflation trends favour the maintenance of low long-term interest rates.

Stock prices usually fall on the announcement of a convertible debenture issue, because investors buy the debenture and short the underlying shares, putting downward pressure on the stock price.

Did you know that 90 percent of all stock shares are owned by 10 percent of the people?

Buy when it snows, sell when it goes. Over the past 50 years, you would have profited immensely by buying at the beginning of November and selling at the end of April. Traders traditionally gobble up more than just turkey between U. S. Thanksgiving and Christmas, with the market up 88 percent of the time.

Baseball coaches tell their players that hitting for power alone is the surest way to strike out. Not every fastball is going to be driven over the fence. The focus should not be home runs. It should be singles and doubles. In trading, as in baseball, the focus should be on incremental gains, not going for the gusto.

Sell your shares the instant they fall a penny. Then buy on an uptick, and hold the stock until the price drops again. The key here is to not hold onto a losing stock. It sounds obvious, but it seems to run against human nature. Selling a stock when it starts to fall requires more discipline than you might imagine.

This pattern, and 50% retracement, are the most reliable reversal patterns there are in technical analysis. This pattern indicates that shares are being sold by those who bought the stock at lower levels – perhaps when it was basing. The minimum downside implication of this pattern is obtained by measuring from the neckline to the tip of the head, and then projecting this distance down from the neckline.

After forming the head, which can be double by the way, price corrects back to initial support, rallies but then rolls over, forming the right shoulder of the pattern. When price falls through the neckline, that zone reverses roles from support to resistance as traders, fearful of giving back profits or wanting to cut losses, sell into strength.

The upside-down version of this pattern is an indication of a basing formation.

The peak, or head, of the ‘Head and Shoulders’ pattern is not confirmed by either momentum or volume, an indication that buying demand is falling off. Following the formation of the H&S pattern, rallies not accompanied by a pickup in volume indicate that accumulation of shares is not taking place. Many rallies into falling moving averages are knocked over by the 40-day or its 80-day counterpart, suggesting that the stock is at risk of retesting lower levels.

If volume surges as price drops, this is bearish. If volume drops as price surges, this is also bearish.

Volume is at its highest during the formation of the left-hand part of a pattern – like a rectangle, for example – and at its lowest at the right hand. This does not imply that every successive session on a daily chart is associated with lower and lower volume. We are simply concerned with the overall trend. In other words, is volume trending down – albeit with spikes along the way?

When you are reading this next piece, be sure to refer to the section below called ‘HORSEBACK RIDING.’ An upside breakout, not accompanied by increasing volume is suspect, because it does not have the buying power to support a sustainable trend. The actual level of volume does not have to be spectacular, but a definite change in the previous declining trend in volume should be readily apparent.

Downside breakouts are a different story. Here, prices can easily collapse with a lack of bids. Volume can be light or heavy. Light volume is okay, because volume is just following the trend, which is down. If prices are falling, it is reasonable to expect that volume will also be contracting. Falling prices accompanied by expanding volume signals urgent selling. This can also be a precursor to a downside breakout.

Volatility usually precedes a reversal in direction. The to-and-fro process eventually leads to upside movement, as the underlying asset is taken away from scared traders and held by longer-term traders – two steps up and one back, so to speak. Here we have a trading range – pretty much an even mix of bulls and bears. Swing days, where the undecided cast their votes, move prices from the bottom to the top of what is hoped is an even-higher trading range.

When a near-term top is done on relatively light volume, that usually means that any pullback will be limited.

If price consolidates as volume spikes, this confirms overhanging supply, as selling stops the advance. Volume is one thing, but On Balance Volume tells you the whole story – how much of the volume is going into buying versus selling. You can have lots of volume, but you must know what’s driving it. If more of the volume is made up of selling than buying, price doesn’t stand a chance. This is perhaps one of the most important indicators you should watch. It will give you ‘The Big Clue.’

For all you momentum traders out there, it’s easier to ride a horse in the direction it’s going. Just remember that the previous trend is in force, until proven otherwise. A trend is a trend, after all. When you are looking at a formation like a ‘W’ or ‘1-2-3’ bottoming pattern, for example, you should always assume that it is a continuation of the previous trend, until the chart tells you otherwise. After all, pattern failures do occur. The longer a pattern takes to form, the longer the new trend is likely to last.

A solid breakout is constituted by price closing for two consecutive sessions above or below the pattern. For day traders, this would translate into two five-minute or 30-minute bars, etc. By looking for two consecutive solid closings above or below the pattern, you are in essence validating the legitimacy of the breakout.

To protect yourself against whipsaw breakouts, you could place a stop below the previous minor low prior to the whipsaw rally. If that poses too much risk, then use ‘the 50% rule.’ This entails placing your stop just above or just below the halfway mark of the pattern, depending upon which way you are playing the pattern – i.e., going long or short.

I personally like to buy on an upside breakout, wherein I am expecting my price objective to be met quickly. Oftentimes, however, the price will experience a retracement move, offering a second chance to buy under quieter, more controlled conditions than those associated with the breakout. You can construct a downtrend line by joining the minor retracement peaks. When this line is violated, this denotes a buy signal.

This is a reversal pattern. The advance that follows a rally and reaction fails to take the price significantly above the previous rally high. If the second peak does top out well above its predecessor, then the double-top call is invalidated. Assuming we have a legitimate double-top formation in place, the price then subsequently retreats below the previous low, signalling a trend reversal. In terms of spotting a valid double top, it doesn’t matter where the second top develops; it can be a little above the first, a bit below, or at the same level. Also, volume on the second peak is substantially lower than that of the first. This denotes buyers’ lack of interest, and makes the price more vulnerable should sellers persist. What is happening with a double top is a reversal in the rising peaks and troughs.

A double bottom is the exact opposite. It is pretty much the same thing happening, but here you have two reactions developing at around the same level and a rally on strong volume (indicating aggressive buyers) that takes the price above the previous peak – in between the two bottoms. The first leg of the double-bottom formation usually occurs on heavy volume. The second leg down is typically characterized by lighter volume. An air of bearishness sets in, as traders get disappointed in seeing the initial rally off the first low all but retraced in the second swing down to the second bottom of the formation. For a valid breakout to occur, volume has to expand, as complacency at the second bottom is replaced by enthusiastic buying, and the price breaks out beyond the high point between the two bottoms.

The triangle is constructed from two converging trendlines, one joining peaks and the other troughs. Breakouts occur when either is these lines is violated. When one line is declining and the other rising, the triangle is referred to as a ‘symmetrical triangle.’ When one line is horizontal, it is called a ‘right-angled triangle.’

When the other line of a right-angled triangle is declining, the triangle is known as a ‘descending right-angled triangle,’ and it signals bearishness. When the other line is inclining, you have an ‘ascending right-angled triangle.’ In the case of an upside breakout, the horizontal line acts as resistance before the breakout and support afterwards. In the event of a downside breakout, the horizontal line acts as support, until the breakout occurs and then becomes resistance.

A breakout from a right-angled triangle is usually more powerful than one from a symmetrical one. A breakout can be a continuation of the previous trend prior to the formation of the triangle, or it can be a reversal. What happens in some cases is a breakout may in fact be invalidated, if it fails and simply converts the triangle into a rectangle. This, in and of itself, is not a big deal, as the breakout may then occur as a breakout from the newly formed rectangle.

Sometimes you get a surprise directional move when a breakout from a right-angled triangle goes in the opposite direction to what you expected. However, equally noteworthy is the nasty reversal of fortunes when the unexpected breakout fails. For example, this can occur when the failure to rally above the horizontal level of resistance leads to exhaustion.

A good way to determine how far price will go after the breakout is to measure the deepest part of the triangle, and use that distance to gauge how far price will go away from the point of departure.

This contrarian pattern works for day traders and position traders alike. I’d put on my conspiracy hat and say that the market is ‘engineered’ from within. The three consecutive cycle days are: the ‘Buy Day,’ the ‘Sell Day,’ and the ‘Short Sale Day.’ On the ‘Buy Day,’ the market opens near or at its low prior to a price rally. The market is selling off, as the uninformed sellers sell to the smart-money buyers. In effect, the market is taken down to create selling. Often, the overnight stops will be hit, and buying absorbs the sell-off. When selling subsides, the market is ready to rally, as new buying enters the market.

On the ‘Sell Day,’ the long positions acquired on the ‘Buy Day’ are sold at or near the previous day’s high. What is happening here is nothing more than smart money taking profits, where resistance exists. One would think that the market would now decline – but first, it is ‘engineered’ higher. On the ‘Short Sale Day,’ the market opens higher and rallies. But, the rally is short-lived, and soon after the market declines, closing near its lows. The appearance of strength has fooled the buyers. After the three-day cycle, the buying strength has dissipated, and lower prices become the path of least resistance. Once again, the smart money is on the right side, selling near the highs.

This pattern appears again and again – only to disappear, and then reappear once again. It may be consistent for four or five weeks, and then disappear. It is most consistent in markets that are not trending.

This setup is very similar to the one above. It involves waiting for the first higher close following a five percent, or better, rout over the past couple of days. The higher close indicates that the selling is complete, at least for the short-term. Normally, a three-day rally will take hold, as sellers back away, and traders perceive bargains are available.

Often, the market will tell you what its direction will be. A strong signal is a sharp break or rally shortly after the open. All you have to do is wait for the market to tips its hand. You simply wait for a pullback (in the case of a rally) or a rally (in the case of a break) to make your move. Typically, this signal will be short and fast.

Late-day momentum in a particular commodity, currency, stock, or the overall market typically carries over into the first part of the next day. Watch the close for a good idea of the next day’s open.

1. This pattern should be preceded by a sharp up or down price move. The formation of inside bars without a preceding strong trend generally does not signal a sudden balancing of supply and demand.

2. The trading range of the first bar should be wide by previous standards. This confirms the strong underlying momentum of the prevailing trend.

3. The trading range of the second bar should be much smaller than the first, which tells us the balance between buyers and sellers is much more evenly matched and the balance is tipping. The sharper the contrast between the two bars, the greater the potential for a reversal.

1. Develops after a prolonged rally or reaction. Often, this trend will be accelerating by the time the price experiences the key reversal bar.

2. The price opens strongly in the direction of the prevailing trend – above the previous close.

3. The trading range is very wide.

4. The price closes near or below the previous close. A classic reversal finishes below the previous bar’s low.

5. Volume should be climactic on the key reversal bar.

6. The upper end of the bar sticks out like a sore thumb above the previous two sessions. The price breaks out strongly to the upside, but is unable to hold its gains and, by the close, it gives up ground over the previous period.

7. Alternatively, the price opens close to its low, and closes higher in the opposite direction of the prevailing trend.

8. The extremely high volume is the tip-off that either buyers or sellers are exhausted, and the next trend is likely to be down or up.

1. The trading range encompasses that of the previous bar. They develop after both down- and up-trends, and represent a strong exhaustion signal.

2. The opening price is at a higher level than the previous bar’s close, but the closing price of the outside bar is not only down on the period – it also closes below the lowest point of the previous bar. If the price closes down a little, it is not as strong a signal as if it closed down sharply.

3. Alternatively, price opens lower, and then goes lower still, before finally closing up on the bar.

4. If the outside bar encompasses the trading range of three or four bars, it is likely to be more significant than if it barely encompasses one.

1. As an example, coming into such a bar in a declining phase, the bar opens on a positive note – on the high, above the previous close.

2. Then, for the rest of the period, price declines, and the close develops at the bottom of the bar.

3. This is definitely an outside bar, but the fact that it closes so weakly indicates it is not an exhaustion move in the classic sense.

1. Signals exhaustion. Develops after a prolonged advance or decline.

2. The first bar of the formation develops strongly in the direction of the prevailing trend. In an uptrend, we need to see the close of the bar at, or very close to, its high.

3. At the opening of the second bar, the price should open very close to the high of the previous bar.

4. A change in psychology takes place, as the second bar closes slightly above or slightly below the low of the first bar, indicating a change in trend.

5. To be truly effective, this must be a climactic experience. The two-bar pattern really needs to be preceded by a persistent trend, and the two bars in question should stand out as having exceptionally wide trading ranges.

One way of determining buying pressure is to subtract a price bar’s low from its close. Likewise, determining selling pressure is achieved by subtracting the bar’s close from its high.

Tom DeMark goes one step further, and takes into account two consecutive bars in the definition of his TD DIFF indicator.

If the closing prices of these two bars are both lower than their respective previous bar’s close, he compares the difference between each bar’s low and close. If the difference is greater for the current bar, he suggests that price will probably rally.

Conversely, if the closing prices of the last two bars are both higher than their respective previous bar’s closes, he then compares the difference between each bar’s close and high. If the difference is greater for the most recent bar, he concludes that price will have a tendency to decline.

On a clear day, you can see them bare-naked. They give clues. But first, have a look around. Are prices approaching a previous low or other significant support area? Is the downtrend stalling out or stabilizing? Are moving averages or other indicators suggesting an upturn? The key here is to watch price action.

The market may take off on you in the form of a ‘V’ bottom. Or, it could sag sideways – and this is not desirable. Alternatively, prices could form a ‘W’ or ‘1-2-3’ bottom. Let me explain. Prices reach a low point (the number one point), and then rally. A short rally to a high point (the number two point) is followed by another decline to the number three point, which is not quite as low as the number one point. It’s as if the market is checking if this is indeed a low, or bottom.

The rally that follows is a little more solid. Prices traverse the high of the formation – the number two point. This constitutes the breakout that you should be looking for. In anticipation, you should always place a ‘buy stop’ just above the number two point. After the breakout, the market once again tests itself, and checks the move to see if it is legitimate – but does not violate the breakout point just above the number two point.

Every astute trader manages his money wisely. Accordingly, it is appropriate to place a sell stop just underneath the number three point of the above formation, just in case the trade breaks down. I personally favour a two percent stop – two percent below your entry point, just because that’s my own rule.

One further thing, if the distance between the number two point and the number three point is extreme, this denotes more risk. The less distance, the less risk.

A repeat from earlier on, but worthy of mentioning again… The 200-day moving average is the average daily closing level over the past 40 weeks. When it is breached, this flashes a ‘buy’ signal. It gives reassurance that the trend is still up, and it also signals that the rally is intact.

Let me elaborate… The 200-day (40-week) moving average facilitates a simple strategy that is 90% to 95% right: Sell a stock, when it falls below its 200-day moving average. If a stock is clearly in an uptrend above the 200-day moving average, stick with it. Otherwise, kiss it good-bye.

As previously stated, this strategy will never get you in at the bottom or out at the top. But, it will get you in for at least 80% of the move and get you out of a disaster.

I personally favour using the 200 EMA, as well as the 50 EMA, both of which focus the MAs on more recent price action. EMA stands for Exponential Moving Average.

Normally, a lasting upward price reversal comes only after the falling moving averages (50 and 200 EMAs) have flattened out.

The last trade is the sum total of all the beliefs out there on the Street. Despair, fear, greed and hope are all bundled up into one common denominator – price. Price is the most important factor – even more so than an indicator like MACD. If a downtrend continues, even after MACD forms a positive divergence, by making higher lows with lower price lows, price is the determining factor.

Support is a level in the past where buyers were stepping up to buy. A zone of support suggests buying is equal to selling pressure, and the underlying commodity, currency, market or stock is being accumulated. Resistance is an area where people can sell and break even, having had a loss after buying a stock, or whichever asset class or market is being traded.

Money flow analysis dictates that trades taken lower than the transaction before them are ‘sales,’ and trades taken higher are ‘buys.’ There can be net buying of a stock when the price is dropping, or net selling as it rises. Let’s suppose a 100-share trade moves a stock down US50 cents to US$49.50, and a 1,000-share trade bumps it back up to US$50. The significance here is that the price is unchanged, but US$45,050 has flowed into the stock. That’s what money flow analysis is all about – capturing the ‘true’ trend.

However, most of the time, when a stock is going up, the money flow is going up. And, most of the time when the stock is going down, the money flow is going down.

What money flow analysis is is just the modern day version of tickertape reading. Several decades ago, before the advent of computers or data retrieval systems, traders would watch ‘the tape.’ They would be watching for any unusual activity as they studied this trade-by-trade record of transactions of the New York Stock Exchange.

If you want an iron-clad trading strategy that really works, here it is… If MACD, Stochastic and the 30-day Moving Average all signal a trade within three days of each other, buy. If any two signal a sell within three days of each other, sell.

If you are position trading, be sure to implement a trailing stop loss that follows your order on its way up. Don’t just let your stop rest at a stationary price that can so quickly fall outside of your trading strategy. If you are into swing trading, two percent stops will let you sleep like a baby at night.

Buyers wait for bad news to take the market down, while sellers don’t want to sell. This imbalance between demand and supply is what keeps prices in ‘trading ranges.’ This is the proverbial ‘Wall of Worry’ being played out in real life.

When you lose, “It is like when your dog chews on a pair of your leather shoes. You just put them away and don’t think about it. It’s counter-productive.” (Lisa LaFlamme)

Overcast skies depress the markets. Sunny mornings in Toronto and New York give the markets a lift.