How permanent are trends?

Wall Street's judgment has been influenced by past trends more than by any other single factor related to security values.

The avowed object of people in the market is to anticipate future developments, and the past is held to have no significance except as it aids in such anticipation.

Yet in practice it is almost the universal habit to base forecasts of future happenings on a projection of past trends.

This is notoriously true of both the professional's and the public's view of market prospects.

Nearly everyone is optimistic (or "bullish") because the market has been enjoying a spirited advance and pessimistic (or "bearish") after a decline.

In the same way, an industry or a company which has grown in the past is almost always expected to keep on progressing; those which have been on the downgrade are expected to get worse and worse.


Momentum

It is true that every established trend has a certain momentum, so that it is more likely to continue for at least a while longer than it is to reverse itself at the moment of observation.

But this is far from saying that any trend may be relied upon to continue long enough to create a profit for those who "get aboard."

Rather extensive studies which we have made of the subject lead us to conclude that reversals of trend in every part of the financial picture occur so frequently as to make reliance on a trend a particularly dangerous matter.  

There must be strong independent reasons for investing money on the expectation of a continuance of past tendencies, and the investor must beware lest his weighing of future probabilities be unduly influenced by the trend line of the past.

Can money be made on balance by following the trend of the general market?  This subject is too complicated and controversial to admit of our treating it her with out own selection of statistical evidence.

But it is appropriate to point out (a) that playing the trend is the standard formula of stock market trading by the general public and (b) that the general public loses money in the stock market.


Industrial groups

The public has a similar tendency to speculate in those industrial groups which have established the best market records in the recent past.  It is easy to show that this naive effort to exploit a historical trend is dangerous.

The trend of industry profits is no more reliable than that of industry prices.

Using earnings as a percentage of invested capital, between 1939 and 1947  we find that the average of the five best industries declined from 24.6% to 17.7%, whereas that of the five poorest advanced from 4.2% to 18.5%.

War conditions and their aftermath, of course, have played an important part in bringing about this extraordinary change in the relative position of prosperous and non-prosperous industries.

There are many unexpected reasons for the changed performance; the important thing is that performance trends do change and investment values with them.


Benjamin Graham
The Intelligent Investor

Trend Trading Tips for Swing Trading and Day Traders

Trend trading using higher highs and higher lows can be devastating to your account. Here's a more accurate way to trend trade whether you are a day trader or you are swing trading.

The Hidden Secret of Technical Analysis

The cycle of market emotions

I find this a good depiction of mass human psychology in the stock market. Look at how most of the investors feel when they are riding up a bull run – “excitement”, “thrill”, and “euphoria”! Alan Greenspan would have called it irrational exuberance. It is indeed the greed and behavior of the investors that drove the price up into a self fulfilling prophecy – the share price is going up, let’s invest. The more money gets thrown into the market, the higher the share prices go. The masses continue to do it to a point that no more greed is able to sustain the run.

When the downturn begins, many (denial) investors will want to ‘believe’ they have made the right investments and will continue to ‘believe’ the stock will rebound. Often, they will call themselves long term buy and hold investors when they admit that a short term gain is not realized.

As the downturn worsens, “fear”, “desperation” and even “panic”, create another self fulfilling prophecy – the share price is falling, we need to sell. The more they sell, the more the prices will drop.

So how do you capitalize on market emotions? It really depends on what kind of investor you are. I believe there are 2 kinds of investors that will probably make the best out of such situations.

Value Investing

The first would be the value investors. The point where they are likely to make investment will be between “capitulation” and “depression”, also denoted in the diagram by “point of maximum financial opportunity”. The fact that I stated a region rather than a point is because I believe not all value investors are able to locate the point where market bottoms, and it would be already profitable by buying around the region of bottoms. Thereafter, they will wait out for the next bull run to sell for profits.

It is apparent that the person who came out with this diagram is a value investor since he feels that the maximum opportunity is at the bottom of the market. Trend followers on the other hand, would see opportunities throughout the cycle.

Trend Following

Trend followers would follow the crowd riding up the bull run. The difference between them and the mass investors is that they will liquidate their stock holdings when the market begins to reverse, while the mass investors will still hold on to their stocks. After confirming the downtrend is valid and strong, trend followers would short the market, making money as the stock prices go down. Hence, trend followers are able to make money in both up and down markets, bull and bear runs.

http://www.bigfatpurse.com/2008/12/cycle-of-market-emotions/

Understand the characteristics of trend following as an investing strategy:

The diagram shows a typical trend following model. Read further to understand the characteristics of trend following as an investing strategy:

Contrarian market psychology

The masses have often proven themselves wrong. Many so-called investors have short term price memory such that when they see a stock drop in price, they will think it is ‘cheap’ to buy. But more often than not, this ‘cheap’ stock would continuingly drop further in price! Trend followers on the other hand, would only buy a stock when it proves that it has the momentum to go higher, usually when the stock breaks new high and while the Majority thinks it is too ‘expensive’. The Majority only knows how to buy a stock up in price to gain profit, but not know how to profit from a stock’s drop in price. Trend followers practise shorting of stocks, which allow them to ride the trend even during a market’s poor run.

Emotionless, mechanical and automatic system

Humans have emotions even when they are investing. Trend followers believe emotions are detrimental to investing. Majority of the investors usually hold onto losing stock and ‘hoping’ that the stock will regain its value, and tend to sell off their stock early for a small profit as they ‘fear’ they may lose the profit. Thus, in order to removed such negative emotions, trend followers have a system of rules to instruct them when to enter and exit the market. In addition, they would have a computerised system with their technical analysis algorithms installed to filter out stocks based on their rules. They want to detach themselves from the stocks – “Do not fall in love with a stock” or “get married to a position” – and this is one of the most difficult challenges.

Pre-determine entry and exit points, and allowing profits to run cutting losses

Majority of the investors get in the market without knowing when to get out. This would allow emotions to take hold of their decision-making process as the market moves. They would then tend to hold on to losses and take profits too early. Trend followers know what price they shall enter and exit the market. They would cut loss when the market has proven them wrong and let the profits run when they are right. The ability to detach their emotions has allowed them to cut loss without thinking twice. This is vital to their survival as they know they cannot be right all the time and they need to minimize their losses – Live today in order to fight another day. By allowing profits to run, over the long run, these large profits will be able to offset the small losses to achieve capital gain.

Price is the main indicator – employment of technical indicators while company fundamentals carry little importance

Trend followers believe price of a stock provides the most clues than anything else. Price suggests trends and they are to follow these trends – Do not fight the trend. Many times, they buy stocks without even knowing what businesses are these companies into, lest to say analysing their fundamentals in annual reports. They would employ technical indicators like moving averages to assist in identifying stocks to buy. Usually, each trend follower will have his/her own selection of a few technical indicators to form a trading system.

Short term and no buy-and-hold

In a bull market, there will be mini-bear periods and vice versa. Thus, a price trend does not last very long – the longest being several months. Trend followers are considered short term investors because they exit trade once the trend reverses. They do not believe in holding on to losses or investing for the long term.

Sounds like gambling and cruelty of a zero-sum game

It may sounds like trend following is gambling but unlike the latter, it does not make predictions. It basically uses indicators and rules to determine the trend and follow it. Gambling depends on pure luck but trend following depends on the accuracy of the trading system and mastery of personal psychology to increase their probability of winning in the market. This means that for a trend follower to win, someone has to lose. On the other hand, it looks more ethical for a buy-and-hold investor to invest in sound businesses to improve economy and at the same time, receive capital gain for his/her investment. However, we need to remember for a company to succeed and increase in profits, its rivals and other industries have to take lesser profits or even go out of business. It is a zero-sum game too, just that it does not seem so direct.

http://www.bigfatpurse.com/2008/03/investing-strategy-trend-following/

Trend analysis of Company's Business Fundamentals

Trend Analysis

Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

Revenue: In general, slowly growing trend, but not consistent (down years in 2001 and 2002). The average revenue growth for last 10 years is 15.3% (with 12% standard deviation).
Cash Flows: Increasing trend for operating cash flow (except a dip in year 2008). The free cash flow very close to the net income. There is little flexibility in allocating cash for dividends.
EPS from continuing operation: In general, this follows revenue trends. Slowly growing trend (with dips in 2001 and 2002)
Dividends per share: Consistently growing dividends.


Quality of Dividends

This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

Dividend growth rate: The average dividend growth of 25.2% (stdev. 8.34%) is more than average EPS growth rate of 17.8% (stdev. 22%). The two years where EPS were negative, has effect this calculation. If we remove the two negative years, the dividends seem to be well covered. The low payout factors allow for this flexibility and help cover for dividends.
Duration of dividend growth: In recent times, dividends have grown only since last 10 years.
4 year rolling dividend growth rate for past ten years: More than 10%.
Payout factor: In the past 10 years, it has been consistently less than 50%. In 2008 it increased to 53%. This is an indicator to keeping watch for dividends reduction.
Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.6%; and (b) MMA yield is 3.4%. Considering the last 10 year average dividend growth rate of 25.2%, the stocks dividend cash flow at the end of 10 years is 4.27 times MMA income. However, with my projected dividend growth of 15.3%, the dividend cash flow is equal to 2.04 times MMA income.

http://seekingalpha.com/instablog/347787-dividend-tree/6165-trow-potential-dividend-growth-investment

Strategies to Make Money in The Stock Market

One great way to grow your money is to invest into the stock market. But deciding how to invest into it can be a bit tricky. Everyone is different, but there are 5 strategies that all traders use to make money in the market.

1. Buying and Holding for the Long Term

Everybody knows what buy and hold is. In fact the vast majority of market participants buy stocks and hold onto them for the long term. And it does make sense, stocks do go up over the long term, so buying and holding can be a passive way to grow your money.

2. Trading The Trend

One other strategy is called trend trading. It involves buying stocks that are going up and selling stocks that are not going up. While it might sound like it was invented by a 5 year old it really can work if you get the hang of it. Sometime the simplest answer is the best.

3. Swing Trade

Swing traders use technical indicators to buy and sell stocks in the short term in order to make profit when all is said and done. Any trade that takes over 1 day and has a profit target as well as a stop loss can be considered to be a swing trade.

4. Options

Stock options give investors a way to leverage their money and to make huge returns from the stock market. There is only one problem; they can also give traders huge losses. For that reason it is best to only consider options after you are already profitable trading stocks.

5. Day Trading Stocks

Day trading is exactly what the name suggests. You buy and sell stock within one day in order to make money on the small moves that occur throughout the day. Day traders are not always profitable, but over the long term it can be a great way to make money.

Every strategy has its ups and downs. But it is up to the individual trader to determine which one fits them the best. Learning the basics of each and experimenting with them can help you determine how you want to approach the market.

http://www.freefinancialtoday.com/2010/03/20/strategies-to-make-money-in-the-stock-market/

My occasional rumination

One of the most fascinating figure in investing is the wide range of intrinsic value one can obtain from various types of valuations and by various analysts.

It is this inability to determine the intrinsic value or the lack of consensus of what constitutes the right intrinsic value that allows the price of the market to zig-zag but always tracking the intrinsic value.  Over the short term, the price may be up or down by a wide margin.  However, over the long term, it always reflect the fundamental value of the business.

Are you a bargain hunter? Are you a trend follower?  There are more than one way to make a profit from the stock market.  There are also more than one way to make a loss from the stock market.  The rules are generally fair, though one need to watch out for manipulations in certain price movements of certain stocks. 

There are those who discard the fundamentals and only study and follow the sentiment driving the supply and demand of the stock.  Buy low and sell high.  Buy high and sell higher.  It sounds so easy for an "expert" to pronounce that those who did not do this on the first trading day of this month by following the chart would have been stupid or foolish, given the chart patterns.  To these believers, fundamentals do not matter in their trades.

On the other hand, there are those who discard the charts.  They painstakingly study the fundamentals.  They patiently analyse their thinking and behaviour guiding their investing.  They are generally followers of value investing as practised by Benjamin Graham and his students.  They track a few high quality stocks and bargain hunt when the price is right.  They have strict rules too guiding their selling.  Their achievements are not measured by the days, weeks or months, but over a long period of years.  After an initial period of investing, their returns are often positive by a huge percentage over their initial cost.  Short term fluctuating prices in the stocks of their portfolio rarely cause a capital loss in their portfolio value.  The low markets significantly reduced the compound annual growth rate returns for the whole investment when these were measured at those times.  On the other hand, the compound annual growth rate rebounded when the returns were calculated at the time when the market shot up to stratosphere. 

Those who trade protects their downside with stop loss strategy.  They often take profit when a certain percentage gain is achieved.  They may also allow the winners to climb higher at the same time moving their stop loss value higher. 

Those who employ value investing, protect the downside through buying with a margin of safety and careful stock picking.  They often allow these stocks to eventually reflect the fundamental intrinsic value.  Often the carefully chosen stock can be held for long term, without the necessity to take short term profit.  Compounding over years provide the substantial returns.  The reinvested dividend returns contitute a substantial part of the return too, this return is not enjoyed by the chartists whose investing period are often short term..

While the traders may plough in a certain amount onto a certain stock, to make big gains over a short trading period, this amount has to be meaningful and substantial.  Short term volatilities are unpredicatable and this constitutes the main risk in trading. 

On the other hand, those who value invest can usually afford to keep a large amount in their portfolio permanently.  This is safe except druing those times when the market is truly bubbly.  The volatilities in the market over the short term do not affect their investment behaviour which is strategized for the long term.  The short term volatility is often treated as a "friend" when the price can be taken advantaged of.  Over the long term, these short term volatilities - often a tinyl blip on the long term price chart - is in fact very small for carefully chosen good quality stocks.

Doing Your Homework: Trend Analysis

The information in the financial statements (BS, IS or RE statement), the basic (per-share) financial metrics and the various ratios are snapshots of the company's financial condition at a point in time, but there are trends in motion that need to be identified so you can understand if the company's position is improving or deteriorating.

For example: 

http://spreadsheets.google.com/pub?key=tdTJEsOwTqdvL-tOgwfeb9A&output=html

• Company ABC's year-over-year trend analysis indicates a generally positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share. 
• The leverage, value, and dividend ratios are all positive or well within acceptable ranges, with the exception of the quick ratio. 
• Based on analysis, the dividend looks to be secure and Company ABC would be a good buy.