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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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Getting Started in Stock Investing and Trading
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  • Leveraged ETFs – What You Need To Know

    Mutual fund investors have enjoyed professional management and diversification for decades. However, the latest version of mutual funds - the exchange traded fund (ETF) has taken a big part of the mutual fund investment market. The popularity of this form of mutual fund is traced to several reasons:

    1. Predetermined portfolio. The ETF is defined by a specific market sector (retail, real estate, oil and gas or financials, for example), region (China, Europe, or emerging nations) or special markets (currencies, commodity pools for specific commodities, for example). The full portfolio is identified in advance, so there are no decisions to be made by a management team.

    2. Lower management fees. Because the "basket of securities" in the ETF is identified beforehand, management fees are lower.

    3. Convenience of trading. Shares of an ETF are traded just like stocks, on the public exchanges. Old-style mutual fund shares could be traded only with the fund directly and only at the ending price each day.

    4. Option writing. Many ETFs allow options trading, which makes them attractive to those traders looking for hedge positions in precious metals, currencies and other specialized markets.

    5. Leverage. The newest entry in the ETF field is the leveraged ETF. This type promises bigger returns potential, but also comes with bigger risks.

    The leveraged ETF duplicates performance in a predetermined index fund, but borrows money to increase exposure to the movement in the basket of securities. So a 2x fund is going to move $2 for every $1 in change in the underlying index fund. These come in many shapes and sizes, including those maximizing returns not in a bull market, but in a bear market.; So a trader can buy (go long) shares in a bear 2x ETF. This means that the investment is going to grow at twice the rate of the basket of securities, if and when those securities decline in value. The same rule applies in a bull 2x; an investment grows twice as fast as the basket of securities if and when the price rises.

    Leveraged ETFs also come in 3x configurations. In these, the movement of the basket of securities in the desired direction accelerates at three times the value of the portfolio. This makes leveraged ETFs very attractive.

    The downside: Leveraged ETFs are also going to lose at an accelerated rate when the values of the basket of securities move in the wrong direction. So a 3x bull leveraged ETF whose securities fall in value is going to lose at three times the speed of the collective securities. And a 2x leveraged ETF would lose at two times the decline of the basket of securities.

    Another downside is found in margin requirements. Because exposure is greater in leveraged ETFs, margin requirement can be as high as 90% (for 3x).

    Leveraged ETFs add another layer of possibility to the trading world. The added profit potential comes with higher risk potential as well, but that is always the case. For those who want to accelerate their returns, leveraged ETFs are worth taking a look.

    To gain more perspective on insights to investing observations and specific analysis, I hope you will join me at ThomsettStocks.com where I publish many additional articles. I also maintain a virtual portfolio of stock at ThomsettStocks.com. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site to learn more.

    Mar 01 12:13 PM | Link | Comment!
  • Candlesticks — Hanging Man And Hammer

    Candlestick formations consisting of a single-session can be powerful signals of reversal that is just about to occur. The most popular among these are exceptionally long or exceptionally short candlesticks. Long white sessions or dojis (sessions with little or no real body) signal a bullish reversal at the end of a downtrend. And long black sessions or dojis signal a bearish reversal at the end of an uptrend. This "rule" is the basic observation of candlesticks. Any session that is exceptionally long or short compared to other sessions may signal reversal.

    One pattern signals reversal depending on where it appears. This indicator has a relatively small real body (distance between opening and closing price), but its color does not matter. Both white and black sessions have equal value in this, the hammer or hanging man session. Besides the small real body, the pattern requires a longer than average lower shadow and no upper shadow. The shadow is the area of trading above or below the real body, and its exceptional length reveals that price moved during the session but retreated back into the narrow real body's range.

    The hammer or hanging man is shown in the illustration.

    When this pattern shows up at the bottom of a downtrend, it predicts a bullish reversal. This is when it is called a hammer. If it shows up at the top of an uptrend, it is bearish and then its name is hanging man. Some traders place more reliance on two-session or three-session candlestick formations, but don't overlook the strength of one-session indicators like these.

    There are two main points about this that make it an unusually indicator. First, it is a single-session indicator, but even so it is a fairly strong reversal sign. Second, the color of the real body is not important; in candlesticks, the color of the real body is often among the most significant matters. A white real body results from the price closing higher than its open, and the opposite for a black real body. With hammer and hanging man, the color can be ignored. It might be considered a stronger indicator when the bullish (hammer) version has a white real body, and when the bearish (hanging man) is black. But this is not essential.

    All candlestick formations can reveal and foreshadow reversal, making the stronger ones such as hammer and hanging man valuable for entry and exit timing. Even so, any single indicator should be independently confirmed before you act. Confirmation can take place with candlesticks that follow the hammer or hanging man, by tests of resistance or support (especially if they fail, when reversal is most likely), or by volume spikes. Other methods of confirmation can be based on volume indicators like RSI or CMF.

    The most important point to keep in mind is that trading and timing accuracy is invariably improved when any indicator is confirmed with a second, different one. Candlesticks are valuable for this, but they are only one of many technicals that offer great value.

    To gain more perspective on insights to investing observations and specific analysis, I hope you will join me at ThomsettStocks.com where I publish many additional articles. I also maintain a virtual portfolio of stock at ThomsettStocks.com. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site to learn more.

    Mar 01 12:11 PM | Link | Comment!
  • Support And Resistance Flips And How To Spot Them

    In the unending quest for strong, reliable technical signals, most chartists invariably tie their analysis to support and resistance. However, one recurring pattern that many traders miss is the support and resistance "flip" - a change in the trading range in which old support becomes new resistance (or in the opposite trend, old resistance becomes new support).

    An example is found in the figure, showing Best Buy's six-month chart in which an established support level was broken through and a new, lower trading range established. Is this a permanent revision to the trading range, or a sporadic test that will fail?

    A problem with a breakout above resistance or below support is that you often don't know how or where to redefine the trading range. It has to be set anew and one of two things occurs: First, the breakout fails and prices retreat back to fill the trend (especially when gaps occur) and revert to the previous trading range. Second, new resistance and support levels are established. But where?

    As the chart for Best Buy reveals, a likely scenario is that the trading range does not establish itself independently from the previous range. In Best Buy's case, the previous support level became the new trading range's resistance. The breakout began with a very strong downward gap, the breakout in a very strong series of downward-moving days, and then a brief period of sideways movement. But was price going to return to previous levels or stay in their newly-set range? The newly established resistance line was tested once, but the test itself was weak. The day of the test consisted of a long black candlestick, a bearish indicator. In other words, prices opened that session near resistance but immediately moved downward. That session also had no upper shadow, meaning prices on that day never rose above the open.

    The support and resistance flip takes place often enough to be taken seriously as a trading pattern. The value is not only knowing it can happen, but in observing how reliably it sets a new trading range. In the example of Best Buy, after the test of resistance as part of the new, lower trading range, traders are likely to give up on the hope that price may break through to the upside and return to the previous range. It's more likely that the newly established trading range will remain in place, at least for the near term. In this market, even a newly established trading range might last only a few months.

    Given current volatility in stocks like Best Buy, any indicator is encouraging. The support and resistance flip is one example of a useful tool in anticipating price trends. Best Buy is difficult to read on this chart, because trendlines are short and inconclusive; the short-term downtrends are fast with many gaps and reversals; and trading ranges themselves are not clear or long-lasting. In this volatile environment, the support and resistance flip is reassuring and adds confidence to your longer-term price forecast.

    To gain more perspective on insights to investing observations and specific analysis, I hope you will join me at ThomsettStocks.com where I publish many additional articles. I also maintain a virtual portfolio of stock at ThomsettStocks.com. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site to learn more.

    Mar 01 12:09 PM | Link | Comment!
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