Hope you all enjoyed the three part series on stock replacement. Here’s what started it all:

Most recent video from Cramer/Altucher
http://link.brightcove.com/services/link/bcpid1155328549/bctid1254124213
First video from Cramer/Altucher
http://link.brightcove.com/services/link/bcpid1155328549/bclid1111461880/bctid1224769899
And in case it gets lost in the blogosphere, here’s the link to the three part series

Introduction

The Plan

The Cycle

I was listening to one of my lessons from thinkorswim when one of the instructors suggested something unusual. He said, in a nutshell, to overtrade. In other words, experiment with different derivatives, invest in small quantities, and trade, trade, trade until you learn how things work. That made some sense which then got me to thinking. Everyone always touts paper trading as practice before taking on the real thing. But paper trading’s the same as Monopoly. Everyone does silly things because at the end of the day, it’s a game. Well what if I were to take a stance against paper trading and tell you that the best way to learn isn’t paper trading but actually blowing up a real cash account?

Here’s my question to you. Assuming you’re entering the market for the first time, what’s the best way to make sure you pay attention to how things work? Do you pull up a website with $100k in paper money or do you jump right in (after doing your research of course) with a few thousand with the understanding that you may lose it all? What’s going to force someone to pay attention to how the markets work? Now, I’ve been in the markets since June of this year. While paper trading is nice, I very rarely pay attention to my papertrading account. I’m always following, adjusting, and learning from my cash account. If I were to lose everything in my cash account tomorrow, at the very least I’d know why. There is no reset button.

Overtrade and blow up an account. I think that’s the best way to learn how to invest in the stock market. Not only are you getting the experience from trying different strategies on a small scale but you’re forced to follow with due diligence since your money is actually at risk.

As I learn every day I trade, today I learned about market breadth and how it can affect the markets during the day and potentially the following day. Today, the Dow closed approximately 12 points higher with the Nasdaq down a few points and the S&P unchanged. Normally, I’d think of that as a flat day with little to no action. Thanks to my trading platform, thinkorswim, and their chat room with the shadowtrader, I learned how to analyze market breadth and how it can impact tomorrow’s open. Here’s the setup I was taught to analyze market breadth on the fly:

A quick explanation of the setup. In order from top left to bottom right going down each row, you will see advancing volume against declining volume for the NYSE and the NASDAQ, advancing issues against declining issues for the NYSE and NASDAQ, and the TRIN (also known as the Arms Index) for the NYSE and NASDAQ. The green line for each represent positives while the purple represents negatives.

So while today was relatively flat, let’s look at the volume and issues for the NYSE and the NASDAQ. For the NYSE, notice the volume chart (top left) versus the issues chart (middle left). While the advancing issues were above the declining issues by about 1.12 to 1, the declining volume outpaced the advancing volume by about 1.6 to 1. The NASDAQ shows a more consistent story with declining volume and issues versus advancers 1.5 to 1, and 1.75 to 1, respectively. If I had to take a guess, I’d say today was overall a win for the bears.

What’s interesting is the concept of the TRIN, or the Arms Index. Without going into detail, the Arms Index, is a contrarian indicator. A value above 1.2 suggests an oversold market while a reading below 0.8 suggests an overbought market. So what does that mean for today’s action? The NYSE TRIN finished the day at 1.7, or reading an oversold NYSE while the NASDAQ TRIN is reading 0.66, or overbought.

So what does all of this mean? Well the NYSE TRIN is reading oversold with declining volume outpacing advancing. I’d take a guess that we’ll see the NYSE have some sort of bounce, perhaps early in the trading period. The NASDAQ TRIN is reading overbought with declining issues and volume outpacing advancers by a bit. My guess is we’ll see more weakness in the NASDAQ tomorrow morning. Now remember that this is my first attempt at reading market breadth so it’ll be somewhat of a trial and error but so far, without accounting for the jobs data and other economic indicators being released, my guess is we’ll see more weakness continue tomorrow. Great start to the January bounce, eh?

· General Market Psychology

o Markets tend to overshoot based on psychology

o Great traders are made when they show poise and confidence and rational behavior in the face of irrational behavior

· “End of the world” – capitulation

o Markets normally shoot first, ask questions later

· Timing always a problem

o Lowest levels of cash held by funds usually signals a market top

· No cash available -> no way to push markets higher

· What is window dressing?

§ Funds attempt to keep numbers up for end of quarter/year and promptly sell afterwards

o Most technicians prefer to see a weak open and strong close

· Flushes out all the sellers giving room for buyers

· Normally a bullish sign if for at least a short term bounce

o Two stages of market environments

· Economic and market events

§ Repricing of assets, economic status

· Geopolitical economic shift

§ Election year

o Market dynamics which accelerate selloffs

· Margin calls (forced liquidations)

· Forced redemptions

§ Shift from equities to fixed income

· Perception of a due “dead cat bounce”

§ Market orders tend to widen bid/ask spreads

o Markets are pendular!

o Risk management

· Risking 10% to make 2% can and will burn you

· Best traders are obsessed with risk management, NOT PROFITS!

o Interest Rates

· Cutting rates expands P/E multiples and vice versa for rate expansion

o Always have Live News (fundamentals) up on TOS

· Watch CNBC but don’t listen to the pundits 100% of the time

· Couple news with technical analysis and intuition!

o Portfolio Analysis

· Play both sides of the markets

· Extreme delta portfolios can cause trouble

· Balance out long positions with some short positions and vice versa

§ Gains aren’t maximized but risk is limited and margin pressures are reduced

· Fully invested at all times isn’t rational, have some cash at hand at all times

· Market Indicators

o On TOS platform

· Right click – Public – Indicators

o TRIN

· Designed by Dick Arms

· Formula for upticks and downticks

· Above 2.0 – markets oversold

· Below 0.5 – markets overbought

· $TRIN – NYSE, $TRIN/Q – NASDAQ

o Advancers and Decliners

· $ADVN / $DECN – NYSE Advancers / Decliners

· $ADVN/Q / $DECN/Q – NASDAQ Advancers / Decliners

· Diversion

§ Markets generally heading in one direction while ADVN/DECN are headed in the opposite direction

· NASDAQ down 50 points with $ADVN/Q and $DECN/Q reverse heading

o Advancing and Declining Volume

· $UVOL / $DVOL – NYSE Advancing / Declining volume

· $UVOL/Q / $DVOL/Q – NASDAQ Advancing / Declining volume

o Diversions in the Market

· Study: RSI Wilder

§ Below 20 (or 30): markets are at extreme oversold levels

· Call strategies

§ Above 80 (or 70): markets are at extreme overbought levels

· Put strategies

§ Technicians prefer to see more than one tag at either level for confirmation

· Study: Slow Stochastic

§ Typically you can buy (with other confirmation) when red crosses blue

o VIX Indicator

· Contrarian indicator

· “Fear Index”

§ Higher the fear, markets can be oversold, and vice versa

· Readings above 22/23 can indicate an oversold extreme

§ “World coming to an end” – capitulation!

o “Generals and Soldiers”

· Soldiers – gain 20-30% per year but aren’t considered “sexy”

§ Defense, steel, other low beta stocks

§ Usually fall first in a down market

· Generals – “turbo stocks”

§ Grind up quickly but grind down even quicker

§ Fall after soldiers

§ Keep on a watch list (GOOG, POT, RIMM, AMZN, etc.)

o Moving averages simply do not work in an irrational market

o Market volumes

· Analyze market volumes

· Study: Volume Average (30d for day /short term traders, 50d for swing traders)

§ Stocks at extremes tend to trade at extreme volume levels

§ Volume spikes – possible change of direction in stocks when facing market extremes

§ False rallies occur with low volume

Speaking of which, it might sound corny…but I am a big believer in setting personal goals and resolutions each year. If you haven’t done this already, spend a small amount of time over the weekend thinking it over. Make sure that you dedicate at least 5 specific trading goals. Don’t create a bunch of generic crap like…

I want to make as much money as possible…

I want to read two books that will make me a better trader…

I want to create better trading rules…

Be specific. Challenge yourself. More importantly; be realistic.

Since I found his blog back in November, I’ve become much more focused and have actually made some headway into profiting from the markets. In the three days I’ve traded this year, I’m up $250 on what started as an $1800 for the year. That’s approximately 15% so far in just three days. But in any event, here’s what I’ve come up so far in terms of resolutions and goals for the new year:

1. I’d like to try and double my current account balance ($1800). The current account balance is small so I don’t think it will be too much of an issue. I may have to take an extra risk here or there but I think it’s achievable.
2. Grow my deposited balance to $10,000. As much as I’d want to think I could turn a 500% profit in a year, I won’t have $10,000 in my account solely by trading (now if I do, I’m quitting school tomorrow and doing this full time!). I would like to save up enough money during the year to bring my account balance to $10,000 if possible.
3. This may sound generic, but I need to stick to my rules and become more disciplined. I didn’t have a great start to the year with this resolution and it did cost me. A few days ago I posted a nasty downturn in Mastercard (MA). Had I closed the position when it fell below my line in the sand, not only would I have not taken a $300 hit on Friday’s horrible action, but I would have had more funds available to short other positions which were profitable and perhaps be up more than 15% so far on my account. My puts on Friday brought in $400. Add that to the $300 UNNECESSARY loss I took, and yesterday would have been the single biggest gain since my lucky strike with EMC Corp. (EMC) back in September 2007.
4. Finish my reading resources! I really need to finish Murphy’s Technical Analysis text as soon as possible. Too many nuggets of information in there to pass up on. I’d also like to read Trading Rules that Work: The 28 Lessons Every Trader Must Master, by J. Jankovsky. The folks at Shadowtrader dot net have been reading excerpts from the book over the past few days and it appears to be a good and interesting read.
5. Involve my fiancee in our finances and investments.  This will be the hardest task to complete only because she’s so adverse to having any sort of money in an investment.  She’s had a bad experience with family attempting to invest and seeing it backfire.  I’m sure I can get her to begin accepting the markets as a way to bring in extra income, and perhaps make it a way of life one day, but for now we’ll take baby steps.
6. Improve my blogging habits.  I know I’ve been on a posting tear the past few days but you always find time when you have days off from work.  I know starting tomorrow my postings will become more spaced out since we start back to our routines but I’ll try my hardest to have at least 4 to 5 posts a week although I am enjoying throwing up 2, 3, or even 4 posts a day.

Have you made your goals and resolutions for the new year?  If so, I’d like to hear about it!  Drop me a line or a comment with some of your resolutions.  Have a great rest of your weekend and hopefully we’ll see the markets recover tomorrow (not like I care since I’m 80% cash, hah).