Short-Term Trading in the New Stock Market
By Toni Turner
St. Martin's Press Copyright © 2005 Toni Turner
All rights reserved.
The New Stock Market
In democracies, nothing is more great or brilliant than commerce; it attracts the attention of the public and fills the imagination of the multitude; all passions of energy are directed towards it.
— Alexis de Tocqueville, statesman and author (1805–1859)
Welcome to the new stock market!
It formed from the Big Bang of 1990s market mania, when Wall Street shot up, ballooned, exploded, and then imploded on itself.
After a three-year cooling period — a black hole stretching from 2000 through 2002 that devoured corporate dynasties and those who chose to tout them — our stock market emerged transformed, renewed. Now, as it spins into the future, it remains a churning mass of energy that feeds from its own fiery core of human emotions and the nonstop whirlwind of global events.
While our sizzling orb may slow again and even cool, it will never grind to a halt. For as long as we, as market players, profit from guessing the future, we will continuously nurture this crackling power sphere ... and keep it alive and expanding.
The Birth of Short-Term Traders: A Brief Time Line
Until the last decades of the twentieth century, trading equities in the U.S. stock market remained largely the province of institutions.
As early as the 1960s, only about one-fifth of the U.S. population owned stocks. Indeed, well into the 1970s, a wide chasm of unfamiliarity lay between most American households and the mysterious world known as the stock market.
Then several catalysts occurred, which encouraged investors to take their financial lives into their own hands.
In May of 1975, the Securities Exchange Commission (SEC) lifted the standardized broker commissions. By the 1980s, discount brokers were luring customers to open accounts by offering two-digit commissions, instead of the usual three-digit or higher, charged by full-service brokers. As more and more Americans started to explore the equities market, the shift into stock ownership was born.
The 1980s produced three major events that, although largely unnoticed by the American public, shortened the technology timeline immeasurably for traders and investors. First, in 1983, discount broker Quick & Reilly's introduced DOS-based software for private traders. Next, 1984 brought the NASDAQ's electronic SOES (Small Order Execution System), which gave private traders the ability to electronically execute small orders against the best quotations from institutions. Finally, in 1985, Charles Schwab & Company unveiled the Equalizer, linking PCs directly to the discounter.
Enter 1993. The World Wide Web, an electronic maze known only to valiant techno-geeks, suddenly became more accessible to the public, via a new browser called Mosaic. Traffic on the Web increased that year by 289,000 percent.
In 1997, discount broker Ameritrade launched an online price war, and lowered its commission to $8 per trade. Other brokerage firms joined in, slashing their commissions.
Suddenly, we realized that we no longer had to depend upon our stockbrokers to provide us with financial reports or information. We could jump online and access our own portfolios, at our broker's Web site. We bought and sold stocks with a mouse click, paid cheap commissions, and then viewed the transaction seconds later. Life was good!
From "Yippee" to "Yikes" in a Heartbeat
As the Internet puffed, it birthed dotcoms by the dozen. The dotcoms "went public" (issued stock as publicly held corporations) at the speed of light. Excited Americans jumped onto their new online brokerage accounts, happily buying any NASDAQ stock that breathed. Many of the tech issues went ballistic, soaring to dizzying heights by skyrocketing twenty to thirty or more points a day.
The frenzy increased, as people quit their jobs to become day traders. Normally complacent investors stayed glued to their computer screens. The stock market and its daily gyrations soon dominated all walks of life. Indeed, "What's the market doing today?" was a typical opening comment heard on many television morning talk-shows.
Ambitious CEOs soon realized that "shareholder value" held higher importance than a well-run business. Lush pay packages — adorned with generous stock options — came quickly to those slick Armani suits who could spike their company's stock prices. Soaring share prices fueled mergers and a spending boom, and many company employees chose stock options over salaries.
Came the autumn of 1999, and we thought the merriment would never end.
The Amazon.coms and Yahoos! of the newest global culture boasted "Earnings: Nonexistent" as badges of honor. Indeed, Mary Meeker, noted analyst at Morgan Stanley, reputedly wrote in a report, "We have one general response to the word 'valuation' these days: 'Bull Market.'"
Stoic, bespectacled market technicians, knowing the parties would gleefully kill any messenger who muttered the words "Nothing goes straight up forever," stared glumly at their charts and, for the most part, kept their suspicions to themselves.
If the concerned clucking of a few old-timers managed to interrupt our reverie, we pooh-poohed them with New Economy super-speak. We were profit druggies and the market was our supplier.
As we dashed around town in our new Porsches sporting license plates emblazoned with "QCOM," it plumb slipped our minds that industrialized economies expand and contract. We ignored the fact that this universe of ours progresses in natural cycles of action and reaction. Or what goes up ... eventually comes down.
When the year 2000 streaked out of the gate, the U.S. stock market rocketed to new highs. Euphoria reigned.
Then, out of nowhere, the piper appeared. He sneered and demanded payment.
Beginning in February of 2000 and continuing through the year, the bull market that created our dazzling "wealth effect" unceremoniously yanked that wealth away, leaving stockholders stunned. Tech stocks toppled from their majestic heights, seemingly in free-fall. Dotcoms exploded into dot-bombs, their ashes tossed to the winds and disintegrating without a trace.
Technology stocks weren't the only casualty. We watched, bewildered, as our traditional value stocks — paraded as "Strong Buys" by major brokerages — shriveled to a fraction of their former worth.
When 2001 stumbled in, we prayed the hand-wringing was over. It wasn't. Like Humpty-Dumpty, the market continued its "great fall," and neither the king's horses (politicians), nor the king's men (Greenspan & Co.) could glue the economic numbers back together again.
By March 2001, the economy began to slide into a recession. An excess of inventories lined manufacturers' shelves. Companies found it nearly impossible to increase their sales or force up their stock prices.
The tragic events of September 11, 2001, shook our nation to its core. Surprisingly, though, after an orderly sell-off that pushed major indexes into bear territory, the stock market rallied in October and continued to soar into January of 2002.
In fact, our courageous, resilient country had just struggled back to its feet when the Houston-based energy trading company named Enron, a market and media star, collapsed in a mudslide of crooked accounting and phony transactions. Its auditing firm, Arthur Andersen, soon followed. Then Citigroup and J.P. Morgan Chase, two of our nation's largest banks, fell under regulatory investigation for allegedly aiding in arranging some of Enron's shady deals.
Next, K-mart, huge retailer and home of the all-American "Blue Light Special," declared Chapter Eleven (reorganization bankruptcy). Hot on the heels of K-mart's misery, WorldCom, one of the country's most successful long-distance phone companies, admitted to billions in major accounting fraud.
The fast and furious domino effect shot forward relentlessly. One after the next, tycoons toppled from their pedestals, pausing only to be filmed by hungry, ever-present media crews. Tyco International chairman Dennis Kozlowski resigned after being accused of tax evasion. Merrill Lynch absorbed nasty allegations of misconduct by its analysts. And founders of cable-television Adelphia Communications starred on network news, shackled in handcuffs.
Spring melted into June's summer heat, and the former CEO of biotech company ImClone, Sam Wacksal, was arrested for insider trading. But the nation went slack-jawed when Wacksal's friend, Martha Stewart, fell under SEC scrutiny related to the sale of her holdings in ImClone stock.
How could our diva of American homes and hearths, the goddess of "weave your own slipcovers," pull the wool over our eyes about dubious stock transactions? Heaven have mercy. Were skeletons shivering in everyone's closet?
Lawmakers and the SEC moved quickly to establish fiscal reform. In the midst of a sweltering July, the Sarbanes-Oxley Act became law. It introduced legislative changes to the regulation of corporate governance and financial practice and established new rules to "protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws." Chief executive officers were required to sign financial reports published by their companies, attesting to their accuracy.
As 2002 waned into fall, the SEC continued their roundup of corporate scallywags and other folks who misused fiscal responsibility.
October pulled the Dow and NASDAQ to deep lows. But before it drew to a close, the sound of hooves was heard. The bulls were back! They charged into the market, and soon shooed most of the grumbling bears back to their caves.
Very slowly ... very cautiously ... we began to exhale.
If It Doesn't Kill You, It Makes You Stronger
Now, as we blaze into the future, those of us who played in the ill-tempered bear market — and lived to talk about it — feel stronger for the experience.
Investors steeped in the buy-and-hold-no-matter-what tradition learned that bull markets don't climb endlessly. They discovered that good fundamentals don't always support a company's stock price during a falling market, even if that company is a bona fide blue-chip.
They also realized that while handling the reins of portfolio control to a professional financial adviser can be wise, it's important to stay aware of market action and take responsibility for risk management by selling or standing on the sidelines in cash.
As short-term traders, we learned how successful trading tactics change in bull and bear markets, due to the obvious differences in demand and supply.
For example: In bull markets, a stock trading in an uptrend (daily chart) that closes at, or near, the price high of the day on strong volume will many times gap up (trade higher than the previous day's close) when the market opens the following day. Buying such a stock right before the closing bell and selling it at the following day's open can yield quick profits. In bear markets, however, this setup is unreliable. Stocks that close on highs with strong volume can just as easily gap down the next morning.
Another example: In bear markets, breakouts to the upside have little momentum and so they usually fail, or fall back to their prior support area. Why? Because when a stock shows any signs of positive life or strength, in most cases, terrified investors immediately dump their supply on the market (sell) in an effort to save a portion of their portfolio value.
Also, in bull markets, stocks that climb to fifty-two-week highs will often push higher. In a bear market, stocks that struggle to the same pinnacle can attract profit-taking bullets soon after.
The New Breed of Traders
There's a brand-new breed of trader, and you may be one of them. Whether you traded through the bull market/bear market cycle, or are an investor-turned-trader, or whether you are a novice trader, a new attitude about trading has emerged.
Individual traders participating in today's market project a different profile from those who dove in during the mid-90s mania. Most are eager to learn before they leap. Instead of the "buy-it-and-it'll-go-up" mentality displayed by novice traders during the go-go years of the late 90s, newcomers feel content to paper-trade for a month or two before they ante up real dollars. They are willing to study market psychology and apply personal discipline. In other words, they want to learn instead of burn!
The wild daily price swings — and possible profits — of the late 90s are now relegated to the memory attic. In today's market, daily price moves in a tighter, more realistic range.
Since we currently operate in smaller-price playgrounds, we know that the carelessness we got away with in earlier days can now trigger sizeable account draw downs, or losses. In today's market, precision must form the heart of each trade. We must locate setups that adhere to well-thought-out criteria, then execute precise entries and exits.
Does precision trading take more time and effort to learn? Absolutely. It also produces more profits, more often, and is the hallmark of the new breed of trader.
What Traders Know ...
More and more market participants have come to realize that whatever the time frame and channel targeted to make money, the powerful techniques utilized by traders are extremely effective and valuable.
First, as traders, we use charts as our primary tool. A basic chart gives us a complete picture of a stock or other derivative. With a quick glance at a price pattern and volume participation, we can instantly evaluate the current health of the stock, and its value as a worthwhile target.
It's no wonder that when the conversation rolls around to the stock market and someone offers a "hot tip," a trader's immediate retort is, "I'd have to see the chart." Indeed, for us traders to throw money into the market without seeing a picture of what's going on would be like driving a race car blindfolded.
We Be Trend-watchin'
Ask any trader worth her mouse where the market is today, and she will usually begin her comments with, "The S and P (Standard & Poor's 500 Index) is still climbing in an uptrend," or "The NASDAQ's rolled over into a downtrend."
The prevailing market trend represents one of the most important factors anyone involved in the financial arenas should know. It follows that those holding stocks for any length of time would also monitor price movement of that trend for signs of a reversal or deterioration.
I often think of all those disheartened souls who plunked down their hard-earned dollars for high-priced stocks in the bull market — stocks that soon plummeted in the bear market. If only those people had known about price uptrends, downtrends, and how trends "break." If only they had known what we traders can so clearly see on a chart ... when a stock tops out, "rolls over," and then makes a lower low, it's time to sell.
I recently attended a dinner party, where a guest, a big, burly man, purchased a biotech stock that had slid to a fraction of his purchase price.
The guest pounded on the dinner table and boomed, "I'll stay in that stock until the end!"
I bit my lip to stop myself from blurting, "Why?"
Why would anyone ride a stock to zero, or even close to it?
If only our disgruntled dinner guest could have seen a simply daily chart of his stock, with the price diving into a downtrend, making lower highs and lower lows. Perhaps he would have "gotten the picture" and sold the stock while he still had some cash to rescue.
As traders, we eat and breathe trends. One glance at a chart, and we immediately know whether the market, indexes, stocks, or futures we are trading are trending up or down, consolidating or range-bound (vacillating between two approximate prices).
We also watch trends on volatility indicators, such as the VIX — the Chicago Board Options Exchange (CBOE) market-volatility index — and the VXN — the CBOE NASDAQ volatility index. The trend of these indexes can be revealing, as they move in the opposite direction of the broader markets. (We'll talk more about these indicators in later chapters.)
As well as monitoring current trends, we also look for signs of trend reversals. For anticipating a trend change correctly — whether on a weekly, daily, or five-minute chart — is one of the most important skills a trader can develop. Why? Because when the trend reverses as supply overcomes demand, or demand overwhelms supply, that's when we jump into a position and ride the initial momentum that the trend change provides. Many times, from those entries, the juiciest trades are made.
We Know When to Ante Up
For years, folks gobbled up equity shares with little or no forethought as to whether it was really an appropriate time to buy or not. And, mostly, they got away with it. (Continues...)
Excerpted from Short-Term Trading in the New Stock Market by Toni Turner. Copyright © 2005 Toni Turner. Excerpted by permission of St. Martin's Press.
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