Stockology

This post sort of strays from the norm. But I think it’s necessary. It’ll be short and sweet, I promise.

I read an interesting article from SeekingAlpha.com by Matthew Hougan called “Has the Internet Made Us Better Investors?” You can read it here. In it, the author talks about how he did not have internet in his office, and woe and behold, got tons of work done. Then he goes on to say that the amount of information we have our fingertips might be overload. And that’s the meat of the issue I want to get to.

This kind of goes back to using research resources efficiently. There is so much information we have to digest on a daily, hourly, minutely (word?) basis that there is no way for our brain to functionally process it all.

First of all, information needs to be presented in a useful way. This is one of the problems I face everyday. I’m reading all these publications that basically regurgitate the same information, maybe with a tad bit of differentiating analysis from each… Maybe 10%. So 90% of the information presented on an article is either 1) something I’ve already read about and know, or 2) something I’ve already read about and know, but presented in such an obtuse way that it confuses me. Either way, it sucks.

Alright, so I guess that was more of a rant… Probably not informative at all. But keep that in mind next time you’re reading something. Are you wasting your time or are you really learning something new? And if you are learning something new, is this really the best way to go about doing so?

A last reference to that article from SeekingAlpha.com. The author poses a question near the end: Is the average investor doing any better today (assuming we have so much information at our fingertips) than they were 10 or 20 years ago?

That’s interesting, isn’t it? Today, it takes all of 10 minutes to do some solid due diligence on a company. 10 years ago, it would have taken a hell of a lot longer and a hell of a lot more work. But “is the average investor making more sensible decisions?”

Something to think about…

Technical analysis is the topic for today. I mentioned in the previous post that it would be impossible to cover every aspect of technical analysis in a blog, not to mention one post in a blog. But I’ll do my best to go over some more common indicators and ones I use on a daily basis.

First of all, a stock chart is a chart that tracks the price of a stock. So if you were to look up Microsoft’s chart on Yahoo! Finance or something, the chart would show Microsoft’s stock price plotted out on a chart. As far as aesthetics are concerned, there are a few chart types: Line chart, Bar chart, and Candlestick chart. I think the default chart on Yahoo! Finance is a Line chart.

Personally, I use the Candlestick chart. (No particular reason, they all display the same information, just from a different perspective.) Aside from the price, there are a bunch of indicators used on a chart to help identify patterns and whatnot. The most common indicator on a stock chart is the volume indicator. That should be pretty self-explanatory. Volume is usually shown as bars. So each day’s trade will have a corresponding volume bar. If a lot of shares were exchanged on a particular day, the volume for that day would be high.

Say Dell came out with earnings that disappointed Wall Street analysts. The stock price plummeted 10% and volume was unusually high. What could you derive from that situation? (Hint: There weren’t a lot of buyers…)

Another indicator that’s widely used is the moving average. I’m not even going to try and define a moving average in my own words, so here’s the definition from Investopedia.com: A moving average is the average stock price over a certain period of time. You calculate it by adding the closing price of the stock for a number of time periods and divide it by the total number of time periods.

So, to get a 5-day moving average for Apple, you’d add up the closing price of Apple for the last 5 days and divide it by 5. I don’t know anyone who uses a 5-day moving average. I use a 20-day, 50-day, and 200-day moving average. Moving averages are good for identifying trends. If the price of a stock today is higher than the average price of the stock for the last 20 days, it’s gone up. Get it? If the price today is higher than the average price for the last 50 days, it’s gone up!

Some more tidbits from Investopedia.com: Traders watch for short-term averages to cross above longer-term averages to signal the beginning of an uptrend.

Think of it this way, if the average price for the last 20 days is higher than the average price for the last 50 days, the price has gone up! Sounds really simple and kind of obvious, right? The truth is, it is! But because so many people use these indicators, stocks have been known to find levels of support at moving averages when they’re going up, and ceilings at moving averages when they’re headed down. In simpler terms: say the stock of a good company has been going up and up and up. It’s bound to take a breather and come down a little bit before going back up. That breather is likely to be at or near a moving average.

You really have to see it in action to get a better idea of how it works.

The last indicator I’m going to cover today is the stochastic oscillator. It’s a momentum indicator that compares a stock’s current price to a price range over a period of time. There’s a crazy formula that’s used to calculate the stochastic, but I’m not going to get into that…

Basically what it does is indicate whether a particular stock has been overbought or oversold. It’s shown on an oscillator so that you can gauge the stochastic against the stock’s chart. The stochastic is plotted on a chart scaled from 0 to 100. The way I use it is this: When the stockastic is below the 20-, it’s oversold. When it’s above the 80-, it’s overbought. I place my ‘buy’ trades just when the stochastic is breaking out above the 20-, and place my ’sell’ trades just when the stochastic is dropping out of the 80-.

It doesn’t always work, because an oversold stock can continue to be oversold, but at least it guarantees you buy it at a relatively low price. And vice versa.

Fundamental analysis and technical analysis. These are two terms that you might hear today far less frequent than you might have maybe a decade ago. The reason is that most investors today take a hybrid approach of combining both fundamental and technical analyses when making investment decisions.

That said, it’s still important to know what the heck they are. First, know that no matter which method you use, the name of the game is to predict a stock’s value.

Fundamental analysis is evaluating financial statements, macroeconomic trends, industry trends, management competence, and some others I can’t think of right now, to try and value a stock. This is the more old-school method of valuation analysis. Typically, it involves a lot of reading, and quantitative and qualitative analysis. It means knowing what the company does, downloading a company’s quarterly and annual reports and pouring over those, keeping abreast of news to keep informed on industry and macroeconomic trends, and listening in on conference calls to see if you agree with the direction the management is leading the company.

Basically it’s a lot of work. Necessary work. When you hear people say, “I did my homework on this stock,” it means they conducted fundamental analysis on the company. 

The newer school of thought is technical analysis. Technical analysts believe past performance of a stock is indicative of future price performance. Basically, technical analysis uses charts to identify patterns, then tries to use these patterns to determine what will happen. In more detail: Volume and a gamut of oscillators are used to help in the analysis. These include, but are not limited to, moving averages, relative strength indices, stochastics, bollinger bands, and a whole bunch of others. It’s impossible to cover all of these because 1) there are just too many, and 2) I don’t know all of them. But I will try to go over a few of them in Part 2.

On a side note, one of my lifetime goals is to get in a time machine, travel to the future, and pick up a stock almanac (kind of like Biff with his sports almanac in Back to the Future). Then I’ll be the founder of “Almanac Analysis,” where all you do is buy the stock you already know is going to go up. Simple, no?

Moving on…

It used to be fundamental analysts hated technical analysts. The two groups were always arguing over whose method of valuation was better. Fundamental analysts thought it was a joke to look at some charts and decide whether or not a stock was going to go up or down. Technical analysts, on the other hand, believed that “charts don’t lie.” They think all the news, past performance, future earnings projects, and everything else, is already factored into the price of a stock. Obviously, arguments can be made for either side.

I mentioned earlier that these days, most investors take a hybrid approach to investing. Part of it is being more informed. Think about it this way. If a whole lot of people are making investment decisions based on studying a company’s financials, industry, etc. and knowing it inside out, wouldn’t it be pretty prudent to know why they do that and maybe taking a look at those things yourself? And vice versa. If a whole lot of people are making investment decisions based on looking at a chart and some squiggly lines, (aside from it being intriguing) wouldn’t you want to know what they’re up to?

The overall investing community has also done a good job of fostering both methods. You won’t find a financial website that doesn’t have both financial statements and charts. Likewise, any brokerage you open an account with will provide both research tools (typically refers to fundamentals research), and charting tools. For now, just know that the two exist.

Imagine the days before there was the internet. Researching anything required either a drive or a long-ass hike to your local library, which may or may not have had information on what you were looking for. Back in the day, people got stock quotes by either 1) calling their broker, or 2) waiting for the quotes on the next day’s business section.

Now, we have all the information we need at our fingertips. Sure, some stuff cost money, but there are plenty of great resources available for free. The only thing I would recommend paying for, and incidentally the only thing I pay for myself, is a subscription to The Wall Street Journal. Being an investor without a subscription to The Journal is like being a priest without access to the Bible. What a great analogy. I surprise myself sometimes… Get it in print. Get it online. It doesn’t matter.

If $100 per year (translating to $8.33 per month, significantly lower than my porn subscription) is just too much to ask for, then you have a few options. Share the paper with a roommate or two, reducing your cost by 66% to 50%. Share the online subscription with a few friends (it’s frowned upon, but what the heck, right?). Go to the library and read it there. If none of those work, you’re likely an uptight cheap-ass and maybe shouldn’t be investing in the first place.

Every other resource I’m going to mention is free. Some will have premium content available for a fee, but you can do without those. Know that currently there is enough information out there transcribed every minute to dizzy you. And if you don’t have a set way to sift through, ingest, digest, and analyze and put to use all the information, you’ll be wasting a lot of time.

So here’s how this is going to work. I’ll tell you some of the research resources I use. You can pick and choose from those, and hopefully find some of your own. You mix and match to create a method that best suits your time restraints, interests, preferred-media, etc.

First off is Investopedia.com. I believe I mentioned this a little earlier. It’s an investment encyclopedia. A great place to go and look up terms you don’t know. The reason I put this first is because if you dive right into The Wall Street Journal or some other publication without knowing some of the basic terms you’ll run into. It’ll be like a Chinese guy reading Arabic. So have it bookmarked, put it in your favorites, whatever. You’ll use it a lot when you first start.

In the investing world, The Wall Street Journal is the publication of record. That aside, CNBC, the network station or the website are great resources. They have up-to-the-minute headlines, and great analysis. TheStreet.com is also a good place to get market news, investing advice, and stock picks. And finally, a site that I recently discovered, SeekingAlpha.com. This site is more focused on analysis on certain industries and companies than news. I like it because experts (albeit many are self-proclaimed) break down how news affects the stock prices. And besides, it’s always good to hear it from a fellow investor who is biased toward one company or another.

For researching individual companies, obviously the best place to go is their website. Aside from information on what they do, publicly listed companies all have this “investor relations” section where you can find and download their financial filings with the SEC. That’s the Securities and Exchange Commission, a government commission that regulates the securities markets. For watered-down versions of financial information, including income statements, balance sheets, and cash flow statements, Yahoo! Finance is the place i frequent the most.

I also subscribe to print versions of BusinessWeek, Forbes, Fortune, and The Economist. And no, I don’t really have time to read all that. That’s what tables of contents are for. You find the stories that interest you and just read those. There are online versions of all of those, so they’re definitely worth checking out.

There are also research reports published by analysts who cover particular companies or industries. Your online brokerage should provide access to some of these on their site. I use Charles Schwab where, in addition to its own ratings, it provides outside research from Goldman Sachs, Argus, S&P, and Reuters.

Finally, I have a charting software called TeleChart 2000 by Peter Worden. I have no idea how much it costs because I don’t pay for it, but I imagine it’s not cheap. It’s definitely not necessary. But just thought I’d throw that out there because I’ve been using it for about a decade and a half now.

So all in all, I mentioned about 10 research resources that you should be able to access for free. One of the great things about the internet is hyperlinking. Through your readings, you’ll run across a lot of cross-linking. For example: A Yahoo! Finance story linking to a relating story from Reuters, which mentions something a TheStreet.com reporter says. The Wall Street Journal usually won’t have that. They’ll be telling the story from their reporters’ point of view. That’s why it’s the paper of record.

Things you can invest in are sometimes called investment vehicles or financial instruments. Normally, when you think about the market, you think stocks or mutual funds. A stock is a share of a company that you can buy or sell. A mutual fund, and there are many types, is typically a basket of stocks that you can buy or sell.

A quick bit: People buy mutual funds for several reasons. The two more prevalent ones are 1) because they don’t have time to track a group of companies, instead electing a professional fund manager to manage their money for them, and 2) to diversify their holdings, diminishing risk, since mutual funds include a bunch of companies (and if one company went bankrupt, it won’t completely wipe you out).

There are a whole lot of other things you can invest in, namely bonds, options, index funds, and exchange traded funds (ETFs). And while becoming an expert on each of these will literally explode your brain, you should have an idea of what each of these are. Ignorance and obliviousness is not rewarded in investing.

Bonds, and there are many types of these as well, are debts. Treasury bonds are issued by the government. Municipal bonds are issued by a municipality. Corporate bonds are the debts issued by a company. When you buy a bond, you’ll get paid interest. Bonds are less risky than stocks in general. The government isn’t going to collapse, so you don’t have to worry about your interest payments not coming through. I don’t want to get too into detail for now. So just know that investing in bonds can be an alternative or a complement to investing in stocks. Bonds are also known as fixed income securities because they pay out a fixed interest rate to their investors.

You can visit http://www.investopedia.com for more detailed explanations of each.

Moving on…

Options are part of a more general group of securities called derivatives. These aren’t the derivatives you learned you in your high school calculus class, but there is a correlation. Options are called derivatives because their price is derived from something else. I’m sure there will be a future post on how options work and all that good stuff. But for now, just know that options are contracts that give you the right to buy or sell a stock at a given price. The concept is actually really simple, but there’s a lot of ground to cover and I’m still learning it myself.

We kind of touched on mutual funds earlier, so now we’ll briefly touch on index funds and exchange traded funds (commonly known as ETFs). Index funds, as the name might suggest, track an index. I wrote about indices in an earlier post. So we know that the Dow Jones Industrial Average (DJIA), and there’s a fund that tracks that index. Likewise for the S&P 500 and Nasdaq indices. There are also indices that track a particular industry (like oil, technology, financials), or track a particular region (like Europe, emerging markets, etc.).

Exchange traded funds are essentially mutual funds that trade like a stock. For a conventional mutual fund, say the Fidelity Real Estate Fund, you’d have to have an account with Fidelity Investments to buy it. But for exchange traded funds, you buy shares just like you would for a stock. Nowadays, a lot of companies offer exchange traded funds. The more popular ones include iShares, PowerShares, and ProShares.

There have been volumes of books and tons of articles written on each of these instruments. And there are new bonds, options, and funds (especially) created every single day. So this is just a little recap of what each of them are.

Brokerages are a dime a dozen. But while the selection is great, choosing the one that’s right for you isn’t a walk in the park. First off, know that there are basically two types of brokerages: the discount brokerage and the full-service brokerage. I’m only going to cover discount brokerages because frankly, if you can afford a full-service broker, you can probably get the rest of the information on this blog from them.

So fear not! I’m going to break down brokerages for you nice and easy…

There are two main criteria when considering which brokerage to open an account with.

The first is commissions. Commission is what the brokerage charges you for making a trade. If you’re going to be trading with a lot of money, commission probably won’t be a major decision-driver for you. Otherwise, it’s no coincident that “low commissions” is what all discount brokerages advertise. If you trade a lot, commissions can really add up and eat away at your returns.

The second criterion is tools. ‘Tools,’ in this case, is a loaded term. It includes trading tools, research tools, and whatever other tools you can think of (I can only think of those two at the moment). Some brokerages have proprietary research tools. That means they have their own analysts who do research and you can read those reports. Other brokerages have third-party research tools, so you can get research reports from other investment banks, asset managers, and whatnot. Trading tools are less of a concern these days. All brokerages have real-time tickers so you can follow your stocks as they move up and down during market hours. Some offer real-time charts, Level II quotes, or proprietary trading platforms. I’ll get into these in more detail later.

Naturally, the more advanced trading tools and research tools a brokerage offers, the higher its commission. At least that’s the way it used to be. These days, it seems every discount brokerage has pretty low fees and pretty decent tools.

Here’s a good tip: DON’T PAY MORE THAN $10 PER TRADE.

E*Trade, TD Ameritrade, and Scottrade are probably the most popular discount brokerages. Even Charles Schwab, which touts itself as “a full-service brokerage at discount prices,” only charges $12.

So, as personal preference really is, well… personal preference., I would recommend going to each of those sites and signing up for a free account. Browse around and see if you like the look & feel, the research tools it offers, and the platform it uses for trading. And make sure there aren’t any inactivity fees or anything like that. The brokerages I mentioned above all shouldn’t have any.

And that’s it for brokerages.

If you’ve ever cracked open the Business section of your local newspaper, or clicked on the Finance link on Yahoo!’s front page, or simply not been living in a cave for the last y years, you’ve undoubtedly heard of the Dow Jones. Dow Jones is the publisher of The Wall Street Journal and Barron’s (a weekly business journal). Yeah, it’s those things too. But that’s not the Dow Jones I’m talking about. I’m talking about the Dow Jones Industrial Average, or the Dow, for short.

The Dow is an index of 30 companies. Some smart people sat in a room and decided to create an index of 30 companies that would best reflect the United States. These 30 companies in the Dow are known as the Dow components. Like… the components that make up something… Anyway, the Dow components are usually big companies, big household name brands that you’ve heard of. You’ve got your Bank of America, Disney, McDonald’s, General Electric, Boeing, Verizon, Home Depot, etc. Usually when people say, “The market’s up 200 points today,” they’re refering to the Dow.

There are two other main indices that you’ll want to know: The S&P 500 and the Nasdaq Composite Index. I’ll save the Nasdaq for last because it’s more confusing.

The Standard & Poor 500, or S&P 500, is kind of like the Dow. But instead of tracking 30 companies, it’s an index that tracks 500 companies. A lot of the S&P 500 components are still companies you’ve probably heard of, like UPS, or Wells Fargo, E*Trade, eBay, Gap, etc. The two indices (the Dow and the S&P) overlap. The 30 Dow components are probably also components in the S&P. I haven’t confirmed this, and I’m not going to because I’m lazy. But just think about it. If you’re going to make a list of 30 really big companies, then make another list of 500 really big companies, some of those companies are going to be the same companies, right?

Before moving on to the rest of the indices, I’m going to talk about exchanges. Trust me, I’m not deliberately trying to confuse you. It’s just better to know these things in this order.

In the United States, there are no less than 10 stock exchanges, or bourses (a word I picked up from reading The Wall Street Journal and looked up on Dictionary.com). The good news is you don’t have to know all 10, just 3 of them. The bad news is, it’s confusing. So the 3 you should know: the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations (NASDAQ), and the American Stock Exchange (AMEX). The way exchanges work is this: When a company becomes public, it lists its shares on an exchange so that its shareholders can trade its stock.

The NYSE is the largest stock exchange in the world in terms of dollar volume. That means, more money exchanges hands on the NYSE than any other stock exchange. Then you have the Nasdaq, which is an electronic exchange. Most of the companies that trade on the Nasdaq are companies with smaller market capitalizations; smaller companies, if you will. That’s not to say there aren’t any big ones that trade on the Nasdaq. Microsoft, Intel, and Cisco are some of the biggest companies in the world that trade on the Nasdaq. It’s just that a lot of smaller companies, namely technology and biotechnology companies, tend to list on the Nasdaq rather than the NYSE.

I’m going to leave the AMEX out of this discussion because frankly, it’s not that important. 

Here’s where it gets confusing. We’ve established that the NYSE and the Nasdaq are exchanges. But they’re also indices! The NYSE Composite is an index that covers all the stocks listed on the NYSE. Likewise, the Nasdaq Composite tracks all stocks listed on the Nasdaq exchange. But wait! There’s more. There’s a Nasdaq-100 Index, which tracks the 100 largest domestic and foreign non-financial companies.

Is your head spinning yet? 

So while indices and exchanges are completely different things, there really is a fine line in distinguishing them when you hear them in the media. You’ll hear people say, ”The Nasdaq is up today,” in which case, they’re refering to the index. Or if you hear, “Apple was among the Nasdaq’s most active today,” they’re refering to the exchange that Apple is listed on. Conversely, you’ll probably never hear anyone say, “The NYSE was up today.” I don’t know why. It just doesn’t happen.

What is stockology? Stockology is the study of human growth hormones, otherwise known as HGH. Wait, what? Really? No. To be honest, what I really wanted for the name of this blog was “investology.” But that was already taken… So stockology it is.

I started this blog because I want to share my knowledge of investing with those who want to learn. By no means am I an expert, but I figure people can at least learn from my mistakes if nothing else.

Obviously, this blog is under major construction not only in terms of content, but also in terms of organization. The best way to share my knowledge would probably be in the format of a book, but how mundane would that be? Instead, it’s a blog. And I think by tagging key words or concepts, and by making them searchable, is a pretty decent way to go about it. At least for now.

Comments, questions, and suggestions are welcome. Actually, any kind of feedback would be great.

On with it then! 

The first rule of investing is… Just kidding. There are no rules to investing… Just kidding on that one too. The fact of the matter is, there are way too many rules to investing. I’ve read the basic self-help investing books as well as the down-and-dirty ones. And they’re always preaching rules. Rules to not let your emotions dictate your actions… Or rules to maximize your gains and limit your losses… I mean, they’re all great rules. It’s just that remembering them, and following them, is a bitch. Instead, I’m going to say, “Set your own rules.” So if you’re the type of person that functions most optimally without rules, and “setting your own rules” means NO RULES AT ALL, then more power to you.

The best thing to do is to be adaptive. Be adaptive and be proactive. Being adaptive means being able to adapt. Duh! Ok. It means being able to learn from your mistakes. Able to shift gears and change your game plan when things aren’t working. Simple enough, right? Being proactive is a bit more complicated. I say that because there’s a bit of persistence involved. Be proactive in learning. Subscribe to the Wall Street Journal (or just the online version, and split the cost with a few friends if you’re cheap like me), watch CNBC (or just the clips on CNBC.com if you hate sitting through commercials like me), and study annual reports (or at least get the abridged version via Yahoo! Finance like me).

Investing is not just about buying low and selling high, although that’s a really big part of it. It’s about keeping up with the news and learning what affects what. For example, an oil field explosion in Venezuela will affect oil supply, affecting oil prices, and in turn, affecting the stock prices of oil companies. Investing is also about making money. As the saying goes, “Rather than work for your money, let your money work for you.” Who hasn’t heard that one, right? The two kind of go hand in hand. The more informed you are, the more you’re able to make informed decisions when investing your hard-earned money.

If you think you’re going to be able to pick any stock and make money, you’ll probably be right 50% of the time.

If you think you’re going to be able to pick any stock and make money consistently, you’ll probably be right too, depending on what kind of market we’re in.

Wow, I’m really digging my own grave here… Let’s try again and change it up a bit.

If you want to make money by investing in the market and do it consistently in the long run, you’d better have a plan.

There we go.

So that’s it for now. I don’t want to bog you down with too many obtuse details, at least not for an entry titled “Introduction.” I just kind of want you to get into the mindset of what you need to be prepared for. There’s a lot I need to be prepared for as well. Undertaking a blog to edumacate my audience in investing is no short order. There’s a lot of brainstorming, idea-jotting-down, and all that good stuff to do. So yeah. That’s it for now.

And damn that guy for taking “investology!”