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Beginner’s Guide to Stocks

Chapters 1.1 - 1.6

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Stocks
Chapter 1.1 / Introduction

Introduction

Welcome to this Academy introduction to stocks investing. In this course, we will focus
on what stocks are, main benefits of investing in stocks and strategies for investing
in the stock market.

Long before the New York Stock Exchange (NYSE) introduced securities trading in
1792, the Italian city-states, led by Venice, pioneered the exchange of securities in
13th century. Following the steps of the Venetian merchants, other European busi-
nessmen looked to fund explorations and trading ventures through the issuance of
shares. In 1602, the Dutch East India Company issued the first paper shares of a com-
pany. Investors were not only able to pool their money together and become share-
holders of the company, but they were able to freely exchange the shares among
them. Soon, other companies followed the example and the first brokers of shares
started to appear. In London, brokers would gather in a coffeehouse to trade stocks.
That coffeehouse would later change its name to London Stock Exchange (LSE) in
the year 1773.

Today, the world’s largest stock exchanges can be found around the globe from New
York to Bombay. New York Stock Exchange is considered the largest by value and
volume, followed by Nasdaq, Tokyo and London Stock exchange.

Why do companies list their shares on stock exchanges?

In attempts to grow and transform their businesses further, private companies will
look to raise capital by offering their shares to the public. By doing so, the owners of
the company will give up some of their ownership in exchange for the capital they
need to expand. The process of listing shares is known as “underwriting” and large
investment banks such as Credit Suisse and Goldman Sachs typically administer it.

After shares of a company are issued at the “primary market” or at the initial public
offering (IPO), they start to trade on an exchange. The pool of shares available to buy
and sell at the open market is then known as the ‘float.’ For example, the Chinese on-
line retailer, Alibaba, recently listed its for what became the largest IPO in history. The
company raised capital in excess of $20 billion, as a result.
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Key Terminology

Share
When you buy shares of a company, you become an owner in the company and thus
you are entitled to the earnings generated from the company’s business. You become
a shareowner. Stocks are also referred to as equities or securities.

One of the most famous stock investors of all time, Benjamin Graham, defines stock
as an ownership of an actual business with underlying assets with value that does
not depend on its share price.

Shares outstanding
The total number of shares issued by a company is defined as shares outstanding.
Authorized shares describe the total number of shares a company is authorized to
issue. This takes place when the business is first incorporated. For instance, if com-
pany’s articles of incorporation show that XYZ has authorized one million shares, then
only one million shares can be issued and not more.

From the authorized shares, company XYZ may offer 300,000 shares through an
IPO to the public. The company, in the form of treasury stock, retains the remaining
shares of 700,000. At a later stage, the company may offer more shares or decrease
the number of shares in the market in the form of ‘buyback.’ Buyback can occur when
companies have extra cash on hand and are looking to ‘retire’ or cut down the sup-
ply of stocks in the market place. By cutting the supply, the value of the shares may
increase further.

Market capitalization
The term refers to the market value of a business measured by its price per share
multiplied by the shares outstanding. In the example below, the market capitalization
for the U.S. Company Microsoft is shown at $394 billion.
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With capitalization of $394 billion, Microsoft will be referred to as a large capitalization

company, or just ‘large-cap’. By definition, if a company has a market value above $10
billion, it’s considered large-cap. If between $2 billion and $10 billion, that capitaliza-
tion is considered ‘mid-cap’ and below $2 billion- ‘small cap.’

Investment vs. speculation

There is a fine line between what constitutes investing and speculating, but it is im-
portant for stock investors to come in grips with the two as it may help them define
their approach to the stock market.

Investment may take many forms; you may invest in land, commodity like gold or in
a company as in the case of stocks. As an investor you mays look at the value of the
underlying business of the company and compare to its current market price on the
exchange. As a result, you may hold this investment from several months to several
years.

As a speculator, however, you may not take time to know the business that intimately.
You would look to benefit from the fluctuations of the stock prices and buy shares in
order to sell them at a higher price to someone else. As a time horizon, you may hold
these shares from a few days to a few weeks.

Again, it is difficult to distinguish the two terms without being subjective. Most indi-
viduals would speculate in the market place simply because we don’t have the time
to investigate in details the businesses, assign a ‘fair’ value to these and ‘stick’ with
these investments for a long time.

Risk
In finance, the possibility of losing an investment principal is referred to as risk. The
more risk you will take in the market, the bigger the potential for loss or gain. Some-
times, risk is referred to as volatility or how much an investment can fluctuate up or
down. It is imperative for novice and experienced investors, for that matter, to under-
stand the implied risks of a stock investment.

There are other risks involved with investing in the stock market is systematic and
unsystematic risk. The systematic risk is non-diversifiable risk as it is simply the risk
of being in the market. No matter how diversified your portfolio was during the 2008
financial meltdown, it was probably hit by the falling market prices. Unsystematic risk,
on the other side, is risk, which you can diversify against. This is the risk you would
take with one particular stock investment, which you can offset with another, unre-
lated stock position.
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Take time to research the companies you are considering and assume worst-case
scenario. Warren Buffet, one of the most successful investor, once said that risk comes
from not knowing what you are doing.

Summary
Throughout the century exchanges around the world have become an important
mechanism for companies to raise capital. Shares, with trillions of dollars are bought
and sold on the secondary markets through exchanges like NYSE, LSE and Nasdaq.
Whether you are looking to speculate on the stock market or you are looking for the
next Apple shares, or both, you must take time to learn understand the risk in the
market and manage it. Only by minimizing the risk and the potential losses that could
come with it, you would be able to hold onto your gains and move forward.

Stocks
Chapter 1.2 / Types of Stocks

Stocks can be classified according to various characteristics such as type, location,

sector and size.

Type
Publically traded company will offer two kinds of stocks - common and preferred. A
common stock is typically what most businesses will issue. As mentioned in section
one, common stock represents an equity ownership in a company. Owners of common
shares may or may not receive dividends from holding the equity. Shares of British
American Tobacco, in the example below, pay annual dividend yield of 4.13%. Most
common shareholders, however, would prefer the price appreciation than the income
from dividends.
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Preferred shares will almost always distribute dividends to shareholders. Due to its
“preferred” status, the payment of dividends will occur before any payments made to
common stockholders.

Size
In section one, we mentioned that according to their market capitalization stocks are
divided in three different categories: large-cap, mid-cap and small-cap. Large capi-
talization companies, such as Daimler AG or General Electric, are more established
and tend to have more stable earnings. Stable earnings can often translate to stabil-
ity in the share price. On the contrary, small capitalization companies tend to have
unstable earnings and share prices. Investors could find a compromise with mid-cap
stocks, which offer growth and stability of a larger company.
The graph below illustrates the growth cycle of companies. During the “infancy” pe-
riod small-caps may experience modest growth illustrated by the slight upward slope
of the “S” curve. During the “expansion” businesses will have accelerated growth be-
fore reaching “maturity” where they will show little or no growth.

Price
Maturity & Situa-
Development

Introduction

Profit
Growth

Decline
tion

Loss TIME

Domestic vs. Foreign Stocks

By location stocks are simply defined as domestic and international. Wayne Gretzky, a
famous hockey player once said: ‘ I skate where the puck is going to be and not where
it has been’. Perhaps this is why investors would need to be mindful of both domestic
and global opportunities for investing.

According to the World Trade Organization, over 50 per cent of developing markets
merchandise was sent to developed countries in 2014. China has become the world’s
largest exporter of merchandise, recording a trade surplus of $259 billion or 2.8% of
its GDP. While we certainly don’t want to “bet the farm” on Chinese stocks, we could
consider allocating a portion of our investable assets towards international stocks.

Over the last decade, some investors have approached index-based investing or in-
struments called Exchange Traded Funds (ETFs) to gain exposure of foreign markets.
Others, with direct access to global stock exchanges have been able to invest directly.
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What are the advantages and disadvantages of investing in foreign stocks?

One of the main benefits to investing in foreign stocks is diversification. Most of inves-
tors my have near-site vision when it comes to investing and invest in we know best
– our own market. This bias towards domestic companies has its benefits but it also
has its risks. For instance, if you invested your entire portfolio in Greek stocks over the
last decade, you probably got “crushed” by the economic meltdown in that country.
According to MSCI Greece Index, since 2008 Greek stocks are still down 51% on aver-
age. In contrast, world markets are on average 35% for the same period.

Foreign stocks, particularly in emerging markets as these economies are in the midst
of rapid economic growth, could also reward investors looking for higher growth. The
comparison chart below could support this argument, at least in numbers. While
shares of American tech giant Google have returned an outstanding 103%, shares of
its Chinese counterpart Baidu, have gained formidable 460% on average during the
last five years. One must mention here that potentially higher returns could lead to
higher investment risks.

One of the biggest disadvantages of investing in foreign stocks could be the risk of
foreign exchange. Foreign companies trade and pay dividends in their own currencies.

For instance, if you were a German investor and you owned shares of U.S. Company
Wells Fargo, you would receive dividends as shareholder. If you held 500 shares of
Wells Fargo and the company paid out quarterly dividend of $.20 per share, you
would receive $100. That amount, however, could be subject to tax withholding and
would have to be converted in euros – the currency of your brokerage account.

Aside from the potential tax and exchange rate conversion fee on the distributed
amount, you might be at a disadvantage simply from a weaker U.S dollar. Suppose
the dividend income of $100 converts into 82 euros. If the dollar rises relative to the
euro, it would be benefit you since you would receive more euros. However, if the dol-
lar weakened and instead of 82 euros you received 75 euros, your total investment
return would diminish.
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Other potential risks that you could experience with foreign stocks could come as a
result of geopolitical events. Egyptian equities outperformed their emerging market
benchmark consistently over five and ten year time frame. Nevertheless, in the last
three years the country has suffered political instability, which has impacted its eco-
nomic production.

Last but not least, smaller markets around the world trade significantly less volume
than some of the bigger exchanges. This may lead to lack of liquidity where investors
might be at risk of not being able to easily sell their stock holdings.

Summary
Corporations will generally issue common and preferred shares. Preferred shares
have advantage over common shares, as their shareholders will receive any paid out
dividends before the common shareholders. Investors looking for total return could
consider stocks that pay out dividends and also provide growth.

The market capitalization of a company is determined by the number shares out-

standing multiplied by it’s price per share. Large-caps are stocks of companies in
“mature” stage with stable or limited growth potential. These companies tend to grow
from acquisitions of other companies.

Investing in foreign stocks can potentially require higher tolerance for risk but could
reward investors by providing diversification away from domestic assets.
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Stocks
Chapter 1.3 / Corporate Actions

A corporate action is an event, which will influence the stock shares of a company in
different ways. Some examples of a corporate action are stock splits, dividend distri-
butions, buybacks, mergers and acquisitions, rights issue and others. The company’s
board of directors typically initiates the process. In the following section, we will define
each of these actions and provide an opinion on the potential impact to shareholders.

Stock splits
As the name implies, when such action takes place a company will split its outstand-
ing shares according to a certain ratio, i.e. 2 for 1, 3 for 2 and so on. The two types of
stock splits are forward and backward or reverse split.

Recently, shares of Apple went through a forward split of 7 for 1, shareholders received
7 additional shares for every 1 share they owned. Upon the stock split, the share price
is also adjusted. If shares of Apple traded at $630 just before the split of 9th June,
after the split the opening share price adjusted according to the ratio of 7:1,or $92.83.

The weeks following the split, Apple’s stock rallied 17%. Although we cannot expect
such bullish sentiment from every forward split, investors who have a little more ap-
petite for speculation can carefully consider buying into a stock split.

Some experts argue that the benefit of stocks splits to investors is almost zero. Mi-
cheal Sheimo in his book Stock Market Rules argues that the affect is only psycho-
logical and conveys just a warm feeling. One on side, we could site with this argument
if we looked at the investment from a different angle. Our total capital investment
would not increase, just the amount of shares. It’s like having a one 20-euro note in
your wallet versus holding two 10-euro notes. The value of 20 euros stays the same in
each case. It maybe worth noting here, that the class A shares of Berkshire Hathaway
have never split despite of the astronomical price tag per share of $226,500.
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In a reverse stock split, instead of increasing the number of shares and decrease the
share price accordingly, the event will decrease the number of shares and increase
the price per share according to a ratio. For instance, a management can vote for a
reverse split, when the value of the underlying shares has moved too low. Suppose
that level is $5. Certain institutions, such as mutual funds, may avoid lower-priced
stocks as part of their offering memorandum.

To illustrate the above, let’s walk through an example. A company ABC has one million
shares outstanding and the price of its shares is valued at $5, or a total market capi-
talization of $5 million (1M shares x $5). If the company went through a 1:10 reverse
stock, the amount of shares would decrease to 100,000, while its share price would
be at $50. Most reverse splits tend to have very little impact upon the share price
and in some cases shares can fall right back down. Such was the case with Citigroup
in 2011 when the bank announced a 1:10 reverse stock split.

Dividends
The two forms of dividend distributions are share and cash. Dividends can be paid
out to shareholders on quarter, semi-annually or annually. There are also one-time
payouts. This was the case with Apple, which paid a one-time extraordinary dividend
of $3.29 per share. If you owned 100 shares of Apple, you would have received $329.
When a company pays out dividends, it could indicate that the company has got extra
cash on hand and financially stable. On contrary, when a company seizes its dividend
payout it could signal financial troubles.

The anatomy of a stock dividend is important, especially for those investors that are
interested in receiving regular income. There are four dates you should be aware of.
Declaration date is the date a dividend is declared as to size of payment and date of
payment. On date of record, a company would identify its shareholders. These share-
holders will be eligible to receive the dividend. If you are not a shareholder as of record
date, you can still receive a dividend if you purchased the shares before ex-dividend
date. On ex-dividend date, when shares trade without their dividend, you may expect
the market price of the shares to be down by the approximate amount of the divi-
dend. For instance, if $0.50 is to be paid out, the stock price may trade down $0.50
that day. Finally the payment date is the actual date when a payment will be made.

Buybacks
During economic recoveries, share buyback is one way for corporations to utilize their
cash on hand. Instead of investing in their own businesses such as inventories, equip-
ment or hiring new employees, the cash is used to purchase some of the shares that
are outstanding. This will decrease the pool of shares available. Thus, increasing the
earnings per
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share. The buyback can also boost the stock price for a short period of time. In the
long, however, companies have to find other ways to grow their bottom line. Investors
cheered the announcement from the American automaker Tesla, when the company
indicated that they would build a manufactory facility worth $5 billion. This could sug-
gest further long-term growth for the company.

Mergers and acquisition

Another corporate event that can also impact share prices is the mergers and acqui-
sition (M&A). In M&A two companies with similar businesses and sometimes different,
will merge to create one. One of the companies is said to be the acquirer, while the
other is being acquired.

In section 1.2, we indicated that some large companies would eventually reach ‘ma-
turity’ with respect to their growth. Before and during this stage, companies will look
for alternative means to grow their earnings. Instead of pouring cash for buybacks or
inventory build up, corporations instead will choose to buy another company. Often
times the acquired company would be a competitor or a business that would come
as a compliment to the acquirer’s business model. Such was the case with recently
announced M&A between the Swiss building materials manufacturer Holcim AG and
French cement maker Lafarge SA. The proposed deal is worth $43 billion but did not
have an immediate impact upon the share price.

Another merger announced in April 2014, between General Electric and French com-
pany Alstom SA sent the shares of Alstom up more than 30%, almost overnight. It is
expected that the acquiring company would offer some premium above the market
price of the shares, to the shareholders of the target company in order to ‘sweeten’
the deal.
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Rights offering
Allows existing shareholders to purchase additional shares of the company, gener-
ally at a discount. For instance, an ABC company may offer rights to shareholders at
a subscription price of $50, while shares are trading at $53. Let’s assume that these
rights are exchanged with a ratio of 4:1. This would mean that for every four rights, in-
vestors could buy one share at the subscription price. Under the terms, the rights will
have an expiration date and investors would need to elect whether to exercise these
rights or to sell them in the open market.

Summary
Corporate actions such as dividends, buybacks, rights offering, stock splits and others
will have an impact upon the underlying stock price. On ex-dividend date, or without
the dividend, the price of the shares could decrease by the amount of that dividend.
Buybacks can boost the share price, as companies are buying back their own shares
in the marketplace. Stock splits could also show some movement in the stock prices.
In a forward split, share price and amount of shares outstanding will also adjust ac-
cording to a pre-determined ratio. Brokers will normally notify their clients of the any
such actions in advance.

Stocks
Chapter 1.4 / Top Down and Bottom Up Analysis

The aim of this section is not to recommend an investment model, which you should
follow, but to help you make better decisions when selecting your stock investments.
For the purpose, we will present you with two common strategies for evaluations -
top-down and bottom-up analysis.

As mentioned earlier, stock performance is affected on a micro level from the com-
pany’s ability to grow earnings over time. On a macro level, however, corporate results
would depend upon the economic environment, i.e. recession or expansion of the
economy and certainly by the sector that the company belongs to. The proverb ‘A ris-
ing tide lifts all boats’ refers to the idea that when the stock market or a market sector
rises, it would pull the stocks within that sector as well.
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What is a top-down analysis?

A top-down approach starts with defining which market sectors are performing better
than others. Once you have determined the stronger sectors, you would then move to
narrowing it down to individual stocks within these sectors. Stock analysts may also
refer to this method as sector analysis. For example, by using various tools such as
Saxo Bank’s Stock Screener, you can sift through different countries and industries to
find strength in the market place.

Let’s assume that after selecting criteria such as price performance, the stock screen-
er will filter out the stocks making out the transportation sector.

Now that we have identified strong sectors in the market; we would narrow it down to
one or two stocks within these sectors. Our analysis does not end here. If we selected
Aegean Airlines, Alaska Air and Air China based purely on how they have performed
over the course of 52-weeks, we would then put these stocks on a watchlist and in-
vestigate them further. Later in this section, we will cover what to look for in stocks
before investing in them.
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Although sectors might be labeled differently in Europe or Asia than in the U.S., a
developed economy could consist of the following sectors: Energy, Financials, Basic
Materials, Industrials, Health Care, Consumer Services, Telecommunications, Utilities,
Consumer Goods and Technology. Each sector may consist of several sub-sectors or
industries.

Developed economies will generally have large service sectors. In the United King-
dom, the business and financial services sector dominates the economy accounting for
nearly 30% of the country’s Gross Domestic Product. The sector consists of large bank-
ing and non-banking financial institutions such as HSBC, Lloyds and Standard Charted.
The energy sector is also a very important to the British economy. Among the largest
publically traded companies, part of the Financial Times Stock Exchange (FTSE) 100
Index, are Royal Dutch Shell and British Petroleum. Therefore, at times of economic
growth in the U.K., these two sectors would tend to lead the economy. Certainly the op-
posite is also true- the sectors might struggle during recessionary times.

Which sectors to select and how much to allocate?

It is often a difficult endeavor for many professional and non-professional investors to
decide in which sector(s) to invest and when. Industries such as auto manufacturing,
housing, retail and others that are part of the consumer goods might suffer when the
economy is weak. Weaker economy generally is accompanied by higher unemploy-
ment. At times of uncertainty, consumers might avoid big-ticket items such as housing
or a new automobile. On the other side, sector like consumer non-durables might fare
better during ‘soft’ economic environment. Most consumers might curb down on their
discretionary spending but they would not likely cut down on food or beverage con-
sumption.
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How much to allocate towards individual sectors?

Perhaps we have all heard the idiom ‘Don’t put all your eggs in one basket.’ We would
like to avoid dropping the basket and crashing all the eggs. Investing heavily in one
sector can put a big hole in your portfolio from which you may never recover. Instead,
spread your capital over many sectors. If markets are bullish most sectors should fare
well. In bearish markets, it is okay to remain on the sidelines holding cash. Cash is a
position. You might not achieve a complete diversification using only stocks in your
portfolio. Other classes such as bonds, commodities, and cash would be needed to fill
in the gap.

Investors might also use the versatility of exchange-traded funds (ETFs) in order to
cover different sectors and markets. Being listed on an exchange, these funds trade like
stocks but instead of investing in one individual stock, investors will have exposure over
a pool of stocks. There are ETFs that track sectors like technology or healthcare, com-
modities like gold and silver, foreign markets like China or Brazil and other asset classes.
Before you use these instruments, please take time to familiarize yourself with them.

Bottom-Up Analysis
While performing top-down analysis may give us a better prospective of the over-
all strength of a sector in the market, bottom-up analysis focuses on the individual
strength of a company. When applying this strategy, investors will look at the overall
strength and competitive advantage of the business and then decide on how fairly the
market has priced the shares of that company. The last factor is often the most critical
one. Are the shares overvalued, undervalue or fairly valued. Some of the basic financial
criteria that could indicate the value of a company are price-to-earnings ratio (P/E) and
book value (P/B). The yield of a dividend payout could be also important especially if
it’s above ‘average.’
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Most brokers and financial media will display this information for you. Let’s define
what these ratios represent. A P/E ratio is a basic but useful measurement of the
company valuation. It simply takes the current market price of the stock and divides
it by the yearly earnings. Therefore, if shares are trading at $50 and the company is
expected to make $2 per share this year, the P/E will be 25 (50/2). In the above ex-
ample, shares of Microsoft are trading at 17 times 2015 earnings estimates. The ratio
by itself is meaningless. We would need to find out what would be the ratio of the S&P
500 as the stock is part of the index. This would tell whether the stock is relatively
cheap or expensive to the overall U.S. market. For example, if the P/E ratio of the in-
dex were 20, then we would argue that Microsoft shares are undervalued relative to
the market. We could also compare the P/E against the technology sector. For inves-
tors making their decision solely on valuation, a lower P/E ratio would suggest the
stock price is fairly valued.

The price-to-book ratio is another valuation criteria, which takes the current market
price of the shares and compares it to the book value of the company. The book value
is calculated by dividing the stock’s price into the difference of the company’s assets
and liabilities (P/B = Price / Assets-Liabilities). Using Microsoft again, the book value
of the company is at 4. The number one more time is useless unless we can compare
it to another. If book value of the S&P 500 is at 3.2, that may suggest that Microsoft
value is overstated.

Summary
The two most common approaches to selecting stocks are conducted by top-down
and bottom-up analysis. While top-down starts with a big picture by choosing the
‘neighbourhood’ of the stock, the bottom-up approach looks at the company’s funda-
mentals. There are certainly advantages and disadvantages of the two methods. For
instance, it might be quicker to identify a strong sector in the market while it might not
be as easy to arrive to a share valuation. Some investors use a combination approach
and use both methods to make an investment decision. Firstly, they would examine
different asset classes and sectors before selecting stocks based on their valuation.
Whatever method you decide to use, exercise patience and take time to investigate
your next investment opportunity before deploying your capital.
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Stocks
Chapter 1.5 / Technical Analysis

In this section of the course we will learn what technical analysis is and how we can
apply it in our trading. We will also introduce rules based strategies to help you with
your trading.

If fundamental analysis (bottom-up approach) told us what stocks to buy, technical

analysis could tell us when to buy them. Investors using technical analysis rely more
heavily on stock charts rather than the valuation of the price. Moreover, technicians
will look to gain information directly from the stock price. For these type of investors,
it would not matter whether a company beat its quarterly earnings estimates or not,
instead they would look at the stock price and how strongly it has moved up or down
over the last week. That price action is what catches their eye. Technicians will look
for trend and patterns in the price movement.

Technical analysis is based on three premises: prices discount everything, prices move
in trend and price patterns tend to repeat themselves.

What is a price?
The price defines the daily action in the market place. A bar price is depicted by a
body, range of the daily price and opening and closing tick.

Closing Price

Opening Price
Body with Daily High / Low
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What is a trend?
The general direction of the stock price is referred to as trend. John Murphy in Tech-
nical Analysis Of Financial Markets defines trend as an essential tool in technical
analysis. All other tools such as price pattern, support and resistance, moving aver-
ages have a supporting role. Figure 8, illustrates the upward trend of the Sweden 30
Index. The general direction depicted by the two parallel lines is upward. Technicians
will identify three directions of a trend:

- Uptrend
- Downtrend
- Sideway

By definition, uptrend is defined as series of higher highs and higher lows.

On the contrary, a downtrend could be described as series of lower lows and lower
highs. In order to confirm a downtrend, investors should look for a lower low, the sec-
ond point, along the line from where the stock price moves down. Investors should
avoid buying into down trending stocks. Instead, focus on the strength of stocks that
are on an uptrend. Figure 9, shows downtrend for U.S. oil company Anadarko.
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In a sideway trend, the stock price would ‘bounce’ up and down without within a es-
tablish price level. Technicians will refer to this movement as ‘consolidation’ or ‘inde-
cision’ in the market. This equilibrium will be disrupted when either bullish or bear-
ish sentiment prevails and the price takes a direction. Investors should avoid buying
stocks for which the upward direction is not established. Instead, either confirm that
the stock has moved above the restrictive, upper line or focus on a better candidate.

The length of each trend will vary. Charles Dow, the father of technical analysis, rec-
ognized three trends in regards to their length: primary or major, secondary and mi-
nor. The primary trend can last from a year to several years. The secondary, which
is an extension of the primary could last three weeks to three months. The minor or
near-term trend typically lasts a few weeks and is part of the secondary trend.

Regardless of whether you are going to trade short-term or long-term, it is always a

good idea for novice investors to confirm the primary trend and trade in that direc-
tion. The weekly charts should show you at least 2-3 years of price information. Don’t
fight the trend!
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What is support and resistance?

Price will create series of peaks and valleys which technicians will call support and
resistance. Support is defined as a level or an area from where price moves up. Re-
sistance, is just the opposite, is a level or an area from where the price moves down.
There are horizontal and diagonal levels of support and resistance. The more time the
price touches these levels, the stronger these levels could become. Two touches upon
such levels would be referred to as tentative support or resistance. Three or more
touches would be confirmed support or resistance.

Volume – If price is the rocket, the volume is the fuel to propel that rocket. In this
sense, volume is an important factor of technical analysis. When price is move up
on an increased volume, it could show great conviction from the side of the ‘bulls’.
The opposite could be also true; price moving down on an increased could suggest a
downtrend in the future.
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Moving Averages
A moving average is popular indicator that is used to indicate the overall trend of a
stock. The moving average will lag behind the price as it gathers the closing prices of
a stock during a particular time frame. For example, a 20-day moving average is used
for an indicator of the stock short-term trend. Investors will use a 50-day moving av-
erage and a 200-day moving average when the want to confirm more the secondary
or the primary trend of a stock. Let’s illustrate these using a stock chart of American
company Advanced Auto Parts.

You may notice that the 20-day MA, which is the shortest in length, follows the price
much closer than the others. This is because there is very little lag between the price
and the average. In contrast, the 200-day moving average will have a much bigger
lag and therefore would move fairly slowly. From the above chart, we can also con-
clude that since all three moving averages have an upward slope, investor might take
on a bullish trade for short, intermediate and long-term duration. In our next section
we will focus on basic trading strategies using moving averages.

Summary
While fundamental analysis focuses on the company’s business and valuation of the
stock price, technical analysis takes under consideration the price action. Moreover,
the main focus of technical analysts will be to study and follow trends. Neither fun-
damental nor technical analysis has all the answers of the stock market. Therefore,
novice investors should use both approaches to investing.
There are three directions of a trend: uptrend, downtrend and sideways. Trend is de-
fined as the general direction of the stock price. According to Charles Dow, there are
primary, secondary and minor trends. Each of these will follow a different time frame.
Confirming the primary trend of a market or stock will ensure that we are not at disad-
vantage and should bring confidence in your trading. Identifying support and resist-
ance levels could help you fine-tune the understanding of trends.
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Stocks
Chapter 1.6 / Investing Strategies

In the previous section, we introduced and defined some basic, but at the same time
important elements of technical analysis. Being able to spot a long or short-term
trend, support and resistance, will come with time and practice. Before moving with
real trades, test how technical tools work by practicing trades in your ‘demo’ account.
In the following chapter, we will present some strategies for short and long-term in-
vesting that you can use as a foundation and expand with time.

Using Moving Averages For Trade Signals

A moving average, as we defined it earlier, is simply an average of the closing prices
for the stock. For example, a popular short-term moving average is the 20-day mov-
ing average. The prices of the stock over the last 20 days are added and then divided
by 20, which results as an average price of that period. When a stock is above its 20-
day moving average, technically it would suggest that there is strength in the stock
price. Some investors would use this as a buy signal. Investors would exit a trade
when the stock moves below its moving average.

In order to confirm strength in the stock price, you should look for the following:

Step 1
Confirm the trend– to confirm an uptrend of a stock you can bring a moving average
from the ‘Studies’ and set it for 20-day period. If the MA is pointing up, the stock is
moving on an uptrend. Moving averages do not work well in a sideways market.
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Step 2
Support and resistance- always look at these levels, as they are part of a trend. Ask
yourself ‘where is the stock in regards to support and resistance’. If near resistance,
wait for the stock to clear that price level before buying. If near support, let the stock
bounce up for a day or two before buying. ALWAYS confirm the uptrend, first.

Step 3
Volume – is the fuel for the stock. When a stock is trending upwards volume should
be expanding. Look for spikes in the volume bars especially as the price is moving up.

The above are three simple steps that investors should have as a ‘check list’ before
making a decision to buy a stock. The shorter the length of a moving average, the
more trade signals you would experience. By changing the length of the moving aver-
age to 50-day or 200-day, you could create a system for longer-term investing. The
steps would be the same.

To exit from a short-term trade like the one illustrated, you should watch for a ‘rever-
sal ‘of the trend. Reversals could occur when the stock moves below its 20-day mov-
ing average or starts to ‘whipsaw’ between support and resistance.
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What are Oscillators?

An oscillator is a technical indicator, which could be used, in combination of a moving

average to confirm a trade signal. This indicator is referred to as an oscillator as its
movements typically oscillate between two areas.

The Moving Average Convergence Divergence is an indicator, which will move above
and below a zero line to produce a buy or sell signals. It is a simple tool that shows
the relationship between two moving averages. In the example below, these averages
have lengths of 26 and 12 days. When they cross a third line, a 9-day moving aver-
age, they produce signals. The bars also shown on the graph is another presentation
of the movement of the two lines. It is called a MACD Histogram.

The use of the MACD works well in trending markets. Therefore, you should always
ensure that the trend is up, before confirming the timing of your entries with an oscil-
lator. For instance, the period from October on is identified with a strong uptrend by
the higher highs and higher lows of the price. While during September – October the
stock is whipsawing up and down and its moving average is mostly flat.

Other commonly used oscillators are Stochastic and Relative Strength Index (RSI),
which could be found in most charts. Let’s walk over one more example using a sto-
chastic indicator for confirmation of a long-term entry signal.
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Long-term trade example:

Step 1
Confirming the trend – here again you could use a moving average to confirm the
trend of the stock. Instead of a 20-day moving average, you should choose a 200-
day MA. This moving average would be much smoother than shorter moving aver-
ages and would also produce less trading signals. Below, a 3-year daily chart shows
how random the signals become using a long-term moving average.

Step 2
Support and resistance – again we would need to ensure that after confirming the
uptrend, we are also looking for a recent resistance (peak) or support (valley) and
where is the stock price in relationship to these points. Although not as critical when
a stock is on an uptrend being aware of resistance, would help you with the timing of
your entry.

Step 3
Volume – is volume still increasing while the stock prices is advancing?
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Step 4
Stochastic Confirmation – the indicator measures the current stock price to the high
and low range during the past 10 days. The stochastic indicator is commonly used
to show overbought and oversold areas. A stock is considered overbought when the
stochastic reading is above 80 percent. The indicator illustrates an oversold condi-
tion when the reading is below 20 percent. As a note, stocks can stay overbought
for sometime before moving down. From the graph below we could assume that in
addition to a long-term uptrend, the stochastic is confirming an entry as lines of the
stochastic are rising are just below 80 percent.

Exits from a long-term position would follow the same rationale: you should exit when
the stock moves below its 200-day moving average.

Summary
Deploying technical indicators such as moving average and oscillators should help
you make more inform decisions as an investor. Depending on the length of the mov-
ing average, you might be in a trade couple of weeks or couple of years. Be patient
with your trades and before you enter the market, take time to carefully plan your en-
tries and your exits. Use of a trading journal or a system to record your trades would
allow you to have a post trade analysis and improve further.
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DISCLAIMER

None of the information contained herein constitutes an offer (or solicitation of an offer) to buy or sell
any currency, product or financial instrument, to make any investment, or to participate in any particu-
lar trading strategy. This material is produced for marketing and/or informational purposes only and
JSC Galt & Taggart (“Galt&Taggart”) and its owners, subsidiaries and affiliates whether acting directly or
through branch offices make no representation or warranty, and assume no liability, for the accuracy or
completeness of the information provided herein. In providing this material Galt&Taggart has not taken
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