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How The Stock Market Works

Let's imagine that you want to start your own pizza shop. Now starting the pizza shop would require some investment.

For example, you would be investing in equipments, land, furniture, food supplies etc. All the money that you invest to start your pizza shop business is called as capital. Let's say, you would be requiring the investment of $2000 in order to start your pizza shop business.

But what will happen if you do not have the investment of $2000 in order to start your pizza shop? In that situation, you have 2 options.

You would take a loan from somebody that need to be paid with interest. Or,

Issue stock (or share the ownership in the company) to people who may be willing to invest in your pizza shop in return for a proportional share of profits that your pizza generate.

Okay, let's take both the situations one-by-one and find out the advantages and disadvantages with them.


It is not very easy to take loan. In our example, if we want to take loan from anybody, then the first thing we would be doing is to convince the person that his money is safe and we will be able to return his money back. The person who is giving us loan would certainly be interested in knowing about the future plans of the business and lot more things.

Next, we will have to return all the money that we have taken as a loan with interest. This interest would increase as the time passes. The more time we take to repay the principal amount, the more interest we would be paying.


You do not have to share the ownership of the company.

Issuing Stocks


A company can raise more money than it can borrow.

You do not have to make periodic interest payments to your creditors.

And you do not have to make the principal payments.


You have to share your ownership with the other shareholders

Your shareholders have the voice in company’s policies that affects the company operation.

So we can say that...

Companies sell stock (pieces of ownership) to raise money and provide funding for the expansion and growth of the business. The business founders give up part of their ownership in exchange for this needed cash.

The total number of shares will vary from one company to another, as each makes its own choice about how many pieces of ownership to divide the corporation into.

One corporation may have only 2,500 shares, while another may issue over a billion shares such as IBM and Ford Motor Company.

How Super Traders Confidently Pull the Trigger and Win

As a trader, have you had occasions when you just could not pull the trigger and afterward you were mad at yourself?

Have there been times when, as soon as you pulled the trigger, you started doubting yourself?

You are not alone. There are a lot of traders who go through this.

Studies have shown that when traders consistently do not succeed, it's not because they aren't smart, don't work hard or aren't lucky. It's because they simply don't understand how successful trading works.

There are different factors contributing to not being as successful as you want to be.

One factor might be that it is a new market for you and you do not have enough experience in how to deal with this market.

Another reason might be that at one point, you lost a great deal of money. You might be afraid of making the same mistakes.

Thirdly, it might be that your personality traits are not a match for the markets, systems or mentors that you are following.

The fourth reason is that you might be afraid of losing money, period. If you are in this category, then trading is not the right business for you. In trading, you will lose money. The challenge is how to cut losses faster and how to let winners run longer.

If you are in the first three categories, there are 8 steps that you can take to enable you to confidently pull the trigger and have more wins.

1. Be prepared. When selecting a market, select one that matches your personality.

You all have heard the saying that “people do not change.” The fact is that it is very tough for us to change. Instead of trying to change who you are, why don’t you adopt a market that fits your personality traits?

You really have to prepare yourself technically and emotionally. Learn the skills that you need to trade the markets. Select the systems that match who you are.

2. Limit your input. Whatever markets you are watching or news you are listening to, you’ve got to limit your input. You cannot listen to all of the information and do everything. Your brain cannot absorb it all. It overloads and just shuts down. You may have heard the saying “a confused mind does not make a decision.” You’ve got to limit your input.

3. Trust Yourself. Once you have done your research, chosen the trading methodology, trading system and trading mentors that match your personality, and you have a gut feeling, trust it.

When in a study asking top CEO’s what had made them successful, do you know what their responses were? It was their gut feeling. They followed what they believed was the right thing to do.

4. Take Action. I know this sounds obvious. However, I have seen people who have studied and paper traded for about 18 months. They have headed investment clubs and talked about strategies, yet they still have not pulled the trigger.

You just have to do it. Nothing replaces the actual experience. You can start very small. Only invest the money that you can afford to lose. Think about it as the cost of education.

We are not defined by our abilities. We are defined by our choices. What are you willing to choose?

5. Be Present. What do you do when a trade goes against you? How do you react? Do you get angry? Do you blame yourself? Do you go into denial? What happens to you?

Are you missing opportunities? Are you overtrading?

This is the time to use the pause method. Take a break. Do not make any decisions. Step back. Change your focus. Where you focus, you’ll spend your energy and that will create results.

Look at the market objectively and concentrate on the next deal. Think of each trade as an individual deal. Evaluate it by using your system and make a decision based on your rules.

Think about basketball players. They cannot concentrate on the shot they did or did not make. They have to look ahead to their next game and next opportunity.

6. Be Resilient. At the end of each day, look at what worked and what did not work.

* Did you follow your system?
* Were you self-disciplined?
* Were you reactive or proactive?
* Did you play to lose, or play to win?

This is a good time to set your strategy for the next day. What can you do differently tomorrow? Forget the losses, but not the lessons. Create contingency plans.

7. Celebrate for taking action. If you had an up day, that’s great! If you did not, celebrate even harder.

When you get mad at yourself, you tend to retreat into your shell. When you celebrate, you acknowledge taking action. You give yourself permission to go forward.

Stock Trading Tips

On a constant basis, we are constantly bombarded by “stock trading tips”, in emails, by regular mail, and in many other forms of print. We’ve all seen those nice glossy newsletters in our mailbox proclaiming the next hot stock that is “Going to Quadruple Your Money in Only Six Weeks”, and other similar ridiculous claims.

Most of these stock trading tips are worthless and will only end up causing you to lose money or break even at best. But, how do you determine if these stock market trading tips that are being freely given have any real value or not?

Luckily, there are a few basic guidelines you can follow that will help you to determine if these tips are going to have a likely chance of improving the value of your stock trading portfolio. Follow these few simple guidelines listed here and you’ll be able to eliminate most, if not all of the “stock trading tips” you receive.

Guidelines to Determine Whether Stock Trading Tips Have Real Value

1) Who is paying to have these tips delivered? A lot of what you receive are simply paid advertisements. Look closely at the bottom of the last page. By law, if a company has been paid to promote a stock, they must state this fact. And usually it is in small print at the bottom or end of the document. If it says they were paid to promote the endorsed company, you can usually bet that you will NOT “get paid” by investing in it.

2) Check the recent volume of the underlying stock tip. If there was significantly higher recent volume surges before the stock tip was sent out, you can usually rest assured that someone (the people providing the stock tip) have already purchased this stock and hope to make a profit when those that receive their “tips” purchase this same stock from them at an elevated price due to the frenzied buying of their duped targets (you).

3) Search for recent information and news on the recommended tip. If you can’t find out anything about the “great” company they are recommending, then you should strongly consider staying far away from it.

4) Do the providers of these stock trading tips make statements like “largest off-shore oil find ever” or “so profitable they don’t know what to do with all the extra cash”? If so, you should be able to research these stocks and find at least something that backs up these outlandish claims. If not, well, then once again it is probable that you are being misled.

So next time you receive yet another hot stock tip, simply follow the above guidelines to help determine the validity of the investment. You will find that a large proportion of all the free stock tips you receive will meet one of the guidelines above.

Remember, these stock market tips are being given to you for “free”, and more than likely you’re getting what you paid for.

Buyer beware!

Key Terms To Stock Market

Market Capitalization

A company's market capitalization (or "market cap") is calculated by taking the number of outstanding shares of stock multiplied by the current price-per-share. It is the amount of money you would have to pay if you bought every share of stock in a company.

The price that an investor pays for a security. This price is important, as it is the main component in calculating the returns achieved by the investor.

For example, if an investor buys XYZ at $35, then this would be the purchase price. When looking at the return on the investment, the investor would compare the purchase price of $35 to the price the investment was sold at or the current market price for XYZ.


Certificates representing ownership in a corporation. Shares are also known as stocks or equities.

P/E Ratio

The P/E ratio is how much money you are paying for $1 of the company's earnings. If a company were currently trading at a P/E of 20, an investor would be paying $20 for $1 of earnings.

The P/E looks at the relationship between the stock price and the company's earnings. You calculate the P/E by taking the share price and dividing it by the company's EPS.

In other words, if a company is reporting a profit of $2 per share, and the stock is selling for $20 per share, the P/E ratio is 10 because you are paying ten-times earnings
[$20 per share dividend by $2 per share earnings = 10]

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.

However, the P/E ratio doesn't tell us the whole story itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, or to the market in general, or against the company's own historical P/E.

It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

Price / Earnings To Growth - PEG Ratio

A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:

PEG Ratio = Price to Earnings ratio / Annual EPS Growth
PEG is a widely used indicator of a stock's potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued.

Keep in mind that the numbers used are projected and, therefore, can be less accurate. Also, there are many variations using earnings from different time periods (i.e. 1 year vs. 5 year). Be sure to know the exact definition your source is using.

Short Selling

The selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.

Learn How Economics Affects Stocks

Economics. Double ugh! No, you aren’t required to understand “the inelasticity of demand aggregates” or “marginal utility”. But a working knowledge of basic economics is crucial to your success and proficiency as a stock investor. The stock market and the economy are joined at the hip. The good (or bad) things that happen to one have a direct effect on the other.

Getting the hang of the basic concepts

Alas, many investors get lost on basic economic concepts (as do some so called experts that you see on television). I owe my personal investing success to my status as a student of economics. Understanding basic economics helped me (and will help you) filter the financial news to separate relevant information from the irrelevant in order to make better investment decisions.

Be aware of these important economic concepts:

Supply and demand:

How can anyone possibly think about economics without thinking of the ageless concept of supply and demand? Supply and demand can be simply stated as the relationship between what’s available (the supply) and what people want and are willing to pay for (the demand). This equation is the main engine of economic activity and is extremely important for your stock investing analysis and decision-making process. I mean, do you really want to buy stock in a company that makes elephant-foot umbrella stands if you find out that the company has an oversupply and nobody wants to buy them anyway?

Cause and effect:

If you pick up a prominent news report and read, “Companies in the table industry are expecting plummeting sales,” do you rush out and invest in companies that sell chairs or manufacture tablecloths? Considering cause and effect is an exercise in logical thinking, and believe you me, logic is a major component of sound economic thought.

When you read business news, play it out in your mind. What good (or bad) can logically be expected given a certain event or situation? If you’re looking for an effect, you also want to understand the cause.

Here are some typical events that can cause a stock’s price to rise:

- Positive news reports about a company: The news may report that a company is enjoying success with increased sales or a new product.

- Positive news reports about a company’s industry: The media may be highlighting that the industry is poised to do well

- Positive news reports about a company’s customers: Maybe your company is in industry A, but its customers are in industry B. If you see good news about industry B, that may be good news for your stock.

- Negative news reports about a company’s competitors: If they are in trouble, their customers may seek alternatives to buy from, including your company.

Economic effects from government actions:

Political and governmental actions have economic consequences. As a matter of fact, nothing has a greater effect on investing and economics than government. Government actions usually manifest themselves as taxes, laws, or regulations. They also can take on a more ominous appearance, such as war or the threat of war. Government can willfully (or even accidentally) cause a company to go bankrupt, disrupt an entire industry, or even cause a depression. It controls the money supply, credit, and all public securities markets.

What happens to the elephant-foot, umbrella stand industry if the government passes a 50 percent sales tax for that industry? Such a sales tax certainly makes a product uneconomical and encourages consumers to seek alternatives to elephant-foot umbrella stands. It may even boost sales for the wastepaper basket industry.

Most General Investment Styles

Your investing style isn’t a blue-jeans-versus-three-piece-suit debate. It refers to your approach to stock investing. Do you want to be conservative or aggressive? Would you rather be the tortoise or the hare? Your investment personality greatly depends on your purpose and the term over which you’re planning to invest. The following sections outline the two most general investment styles.

Conservative investing

Conservative investing means that you put your money in something proven, tried, and true. You invest your money in safe and secure places, such as banks and government-backed securities. But how does that apply to stocks?

Conservative stock investors want to place their money in companies that have exhibited some of the following qualities:

- Proven performance: You want companies that have shown increasing sales and earnings year after year. You don’t demand anything spectacular, just a strong and steady performance.

- Market size: Companies should be large-cap (short for large capitalization). In other words, they should have a market value exceeding $10 billion. Conservative investors surmise that bigger is safer.

- Market leadership: Companies should be leaders in their industries.

- Perceived staying power: You want companies with the financial clout and market position to weather uncertain market and economic conditions. It shouldn’t matter what happens in the economy or who gets elected.

As a conservative investor, you don’t mind if the companies’ share prices jump (who would?), but you’re more concerned with steady growth over the long term.

Aggressive investing

Aggressive investors can plan long term or look only over the intermediate term, but in any case, they want stocks that resemble jack rabbits they show the potential to break out of the pack.

Aggressive stock investors want to invest their money in companies that have exhibited some of the following qualities:

- Great potential: The company must have superior goods, services, ideas, or ways of doing business compared to the competition.

- Capital gains possibility: You don’t even consider dividends. If anything, you dislike dividends. You feel that the money that would’ve been dispensed in dividend form is better reinvested in the company. This, in turn, can spur greater growth.

- Innovation: Companies should have technologies, ideas, or innovative methods that make them stand apart from other companies.

Aggressive investors usually seek out small capitalization stocks, known as small-caps, because they have plenty of potential for growth. Take the tree example, for instance: A giant redwood may be strong, but it may not grow much more, whereas a brand-new sapling has plenty of growth to look forward to. Why invest in stodgy, big companies when you can invest in smaller enterprises that may become the leaders of tomorrow? Aggressive investors have no problem investing in obscure companies because they hope that such companies will become another IBM or McDonald’s.

Using Technical Analysis To Manage Risk And Maintain Top Quartile Performance

Recent market reversals brought about by the Sub-Prime mortgage melt down is clearly a significant market correcting event. No matter if you work in the risk department of a large bank with many employees or a small fund of funds as co-manager, you share the same basic concerns regarding the management of your portfolio(s).

1. how to maintain top quartile performance;
2. how to protect assets in times of economic uncertainty;
3. how to expand business reputation to attract new client assets;

It remains common in the financial industry to hear experienced Portfolio Managers state their risk management program consists of timing the market using their superior asset picking skills. When questioned a little further it becomes apparent that some confusion exists when it comes to hedging and the use of derivatives as a risk management tool.

Risk management analysis can certainly be an intensive process for institutions like banks or insurance companies who tend to have many diverse divisions each with differing mandates and ability to add to the profit center of the parent company. However, not all companies are this complex. While hedge funds and pension plans can have a large asset base, they tend to be straight forward in the determination of risk.

While Value-at-Risk commonly known as VaR goes back many years, it was not until 1994 when J.P. Morgan bank developed its RiskMetrics model that VaR became a staple for financial institutions to measure their risk exposure. In its simplest terms, VaR measures the potential loss of a portfolio over a given time horizon, usually 1 day or 1 week, and determines the likelihood and magnitude of an adverse market movement. Thus, if the VaR on an asset determines a loss of $10 million at a one-week, 95% confidence level, then there is a 5% chance the value of the portfolio will drop more than $10 million over any given week in the year. The drawback of VaR is its inability to determine how much of a loss greater than $10 million will occur. This does not reduce its effectiveness as a critical risk measurement tool.

A sound risk management strategy must be integrated with the derivatives trading department. Now that the Portfolio Manager is aware of the risk he faces, he must implement some form of risk reducing strategy to reduce the likelihood of an unexpected market or economic event from reducing his portfolio value by $10 million or more. 3 options are available.

1. Do nothing - This will not look favourable to investors when their investment suffers a loss. Reputation suffers and a net draw down of assets will likely result;
2. Sell $10 million of the portfolio - Cash is dead money. Not good for returns in the event the market correcting event does not occur for several years. Being overly cautious keeps a good Portfolio Manger from achieving top quartile status;
3. Hedge - This is believed by all of the worlds largest and most sophisticated financial institutions to be the answer.

Let's examine how it's done.

Hedging is really very simple, and once you understand the concept, the mechanics will astound you in their simplicity. Let's examine a $100 million equity portfolio that tracks the S&P 500 and a VaR calculation of $10 million. An experienced CTA will recommend the Portfolio Manager sell short $10 million S&P 500 index futures on the Futures exchange. Now if the portfolio losses $10 million the hedge will gain $10 million. The net result is zero loss.

Some critics will argue the market correcting event may not happen for many years and the result of the loss from the hedge will adversely affect returns. While true, there is an answer to this problem which is hotly debated. After all, the whole purpose of implementing a hedge is because of the inability to accurately predict the timing of these significant market correcting events. The answer is the use of technical analysis to assist in the placement of buy and sell orders for your hedge.

Technical analysis has the ability to remove emotional decisions from trading. It also provides the trader with an unbiased view of recent events and trends as well as longer term events and trends. For example, a head and shoulders formation or a double top will indicate an important rally may be coming to an end with an imminent correction to follow. While timing may be in dispute, there is no question a full hedge is warranted. Reaching a major support level might warrant the unwinding of 30% of the hedge with the expectation of a pull back. A rounding bottom formation should indicate the removal of the hedge in its entirety while awaiting the commencement of a major rally.

It is evident that significant market correcting events occur infrequently, in the neighbourhood of every 10 to 15 years. Yet many minor corrections and pullbacks can seriously damage returns, fund performance and reputation.

If you have ever been confronted with upcoming quarterly earnings or a topping formation which has caused you to consider liquidation then you should have first considered a hedge used in conjunction with the evidence from a well thought out analysis of technical indicators. Together they are a powerful tool, but only for those who have the insight to consider asset protection as important as big returns. I guarantee your competition understands and so does your clients who are becoming more sophisticated each year. It's important that you do too.

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