6.- step 4 - technical analysis

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5-Step Investing Formula

Online Course Manual

Step 4: Technical Analysis

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© 2005 INVESTools Inc. All rights reserved

6Section 6 of



THE 5-STEP INVESTING FORMULA Step 4: Technical Analysis

page 2 of 47© 2005 INVESTools Inc. All rights reserved.

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SECTION 6 Step 4: Technical Analysis

Technical Indicators ....................................................................................4

Moving Averages ..............................................................................6

MACD ..............................................................................................10

Stochastics ......................................................................................12

Volume ............................................................................................15

Support & Resistance .....................................................................17

Buy Signals ...............................................................................................18

Money Management .................................................................................30

Sell Stop Orders .............................................................................32

How Many Shares to Buy ................................................................35

Sell Signals ...............................................................................................39

Insider Trading ..........................................................................................43

Section Contents

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INTRODUCTION

SECTION 1 Getting Started

Logging into the INVESTools Investor Toolbox

Support Links

Workshop Review

Account Information

Subscription RenewalTechnical Support

Contact an Instructor

SECTION 2 Introduction to Investing

Tolerance for Risk

Setting Goals

Asset Allocation

Tax Exposure

Brokerage Firms

Introduction to the 5-Step Investing Formula

THE 5-STEP INVESTING FORMULA

SECTION 3 Step 1: Searching for StocksUsing a Prebuilt Search

Navigating the List of Stocks

SECTION 4 Step 2: Industry Group AnalysisTop-Down Analysis

Big Chart

AutoAnalyzing All Stocks in a Group

Best & Worst Industries List

SECTION 5 Step 3: Fundamental Analysis

Phase 1

Phase 2

Price Pattern

VolatilityZacks Report

Market Guide

News

AutoAnalyzer™

SECTION 6 Step 4: Technical Analysis

Technical Indicators

Moving Averages

MACD

Stochastics

Volume

Support & ResistanceBuy Signals

Money Management

Sell Stop Orders

How Many Shares to Buy

Sell Signals

Insider Trading

SECTION 7 Step 5: Portfolio Management

Creating a Portfolio

Managing Your Portfolio

Paper Trading Account

BONUS SECTION

SECTION 8 Bonus Topics

TurboSearch

Index Tracking Stocks / Exchange-Traded Funds

Dow Jones Industrial Average—

The Diamonds (DIA)

S&P 500—The Spider (SPY)

NASDAQ—The Qs (QQQQ)

SECTION 9 Introduction to Options

Advantages/Risks of Options

Leverage

Call Options

Put OptionsCovered Calls

SECTION 10 Appendix

Phase 2 Stock Scoring Form

Phase 2 Quick List for Zacks Report and

Market Guide

Investment Tracking Record

SECTION 11 Glossary

Course Overview







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Step 4: Technical Analysis The next step in the process of systematic evaluation is technical analysis.

Fundamental analysis looks at the company, helping you decide whether or not

it would make a solid investment. Technical analysis, on the other hand, looks

at a company’s stock to determine when to buy and when to sell. Technicalanalysis is useful in forecasting potential direction to better time your entry and

exit points.

Technical Indicators

Five simple indicators for technical analysis are widely used in the financial

industry:

Moving Average: Helps you determine the current trend of the stock. “The

trend is your friend” is a common saying in the market. You want to trade in

the direction of the dominant trend and stay away from buying stocks or call

options when the trend is clearly down.

MACD: Measures short-term momentum. The MACD tends to be the first of

the indicators to give a buy or sell signal and gives an early warning as to when

a trend is losing momentum.

Stochastics: Measures a stock’s bullish or bearish sentiment. It helps you

determine whether the buyers (bulls) or sellers (bears) are dictating current

trading in the stock.

Volume: The number of shares traded each day. High volume is relative to the

average volume, showing when institutional money is buying heavily (if stock

is going up) or selling heavily (if stock is going down). Significant uptrends

and downtrends tend to begin with large volume surges.







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Support and Resistance: Knowing how to read these indicators can help

protect you from buying just before the stock hits a peak and comes back

down. Support and resistance areas help you see trading ranges more clearly

and to forecast stock movement more accurately.

IMPORTANT: You can never get a valid buy or sell signal for a stock basedon just one indicator. Certain combinations of indicators must occur in certain

ways to indicate buy and sell signals. We will fully outline these combinations

later in this section.

Do not blindly follow buy and sell indicators without following the rules

(to be discussed). You will have much better success by correctly implementing

the buy and sell signals versus haphazardly investing your hard-earned money

on one or two green arrows.







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Price Bar

The price bar represents the high price,

low price, and closing price of a stock. On

the one-month, three-month, six-month,

and one-year charts, each bar represents

the high, low, and closing price of one

trading day. On the five-year and ten-year

charts, each bar represents the high, low,

and closing price of an entire week of

trading. The one-day, five-day, and ten-day

charts are for day traders, with each bar

representing just a few minutes of time.

Each bar is created using the trading

information for the time periods noted.

These bars make up the price pattern on a

stock graph. Each vertical bar has a “tick”

on it that shows the closing price of the

stock; the top of the bar indicates the high price and the bottom indicates the low.

Note: When looking at technical indicators,

you never get a valid buy or sell signal

based on just one indicator.

Moving Averages

A moving average visually shows you the

average price of a stock over a set periodof time and is used to determine the path of

least resistance. Stocks tend to follow their

trend—knowing this can help you become

more accurate in your forecasting and more

successful in your investing.

On the one-month, three-month, six-month,

and one-year charts, this indicator shows

the average price of the stock over the past

30 days. On the five-year and ten-year

charts, this indicator shows the average

price of the stock over the past 30 weeks

(this is the long-term trend, giving buy andsell signals for long-term investors).

In the Investor Toolbox, the red line that

appears on a stock chart represents this

moving average. (Again, the 30-day moving

average is the default setting for the one-

month to one-year charts in the system.)

This is the 30-day simple moving average, which shows the average price of

the stock over the past 30 days.







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You can change the number of days as you

get more advanced with technical analysis,

but it is highly recommended that you

begin with the default settings.

Moving averages are trending indicators,

meaning they will give you much more

useful information when a stock is in

some kind of a trend. They commonly act

as support for stocks temporarily pulling

back in the middle of an uptrend, provide

resistance for stocks temporarily rising

during a downtrend, and, once broken, help

to identify when a trend is likely ending.

The concepts of support and resistance

will be covered in more detail later in this

section.

When a stock is trending sideways, youwill see a high number of red and green

arrows on the indicator during sideways

moves (as seen in this example), which

would not lead to very profitable trades if

you were using this indicator alone.

Note: Red and green arrows only appear permanently on the chart if thestock closes for the day above or below the moving average. The chartupdates throughout the day so an arrow can appear early in the day and thendisappear by the end of the day if the stock reverses its course. This worksthe other way around, as well.

For example, if a stock starts the day below the moving average but thenmoves above it by mid-afternoon, a green arrow appears on the chart at thattime. But if the stocks falls below the moving average by the end of theday and closes there, the green arrow disappears. Arrows may come andgo throughout the trading day, what makes them permanent is if the stock closes above or below the moving average.







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What makes the green and red arrows

appear on this moving average indicator?

1. The “up” green arrow indicates the

price bar has moved above the 30-

day moving average. This actioncan be seen as a buy signal when

you incorporate it with the rest of

the indicators.

2. The “down” red arrow indicates

the price bar has dropped below

the 30-day moving average. This

action can be seen as a sell signal

when you incorporate it with the

rest of the indicators.

As previously stated, moving averages are

most useful when the stock is in some kindof a trend.

With stocks that score well in Phase 2,

the 30-day moving average commonly

acts as support for stocks that may have

temporarily declined in the middle of an

uptrend (support is an area where the stock

stops going down and starts to rally). This

phenomenon is particularly true on the

first pullback after a stock breaks out of a

sideways move, as seen in the example.

Here is an example of a moving average

acting as support.

So why is this useful?

1. If you buy a stock on an initial

breakout buy signal, you will have

more patience with the stock,

allowing you to achieve higher

returns as a result. More often than

not, such stocks will pull back to

around the moving average and

then rally back to the recent high

or higher. Strongly trending stocks

can act this way multiple times

before the trend finally exhausts

itself and the stock gives a sell

signal.

The red arrow appears whenthe stock has closed belowthe moving average.

The green arrow appearswhen the stock has closedabove the moving average.

On stocks that grade well in the system,the moving average will commonly act as asupport area on pullbacks within the uptrend.This is particularly true on the first pullback after a breakout form a sideways move.







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2. If you missed the initial buy

signal, wait for a pullback near the

moving average. If this support

area holds and the stock rallies,

you will often get a buy signal

with this rally off the movingaverage.

3. Once the moving average is

clearly broken, it is a sign the

trend is likely ending. While

there are times when a stock

can quickly recover from such a

break, the trend usually ends and

the stock starts moving sideways

for several weeks/months or

begins a downtrend. In either of

these cases, higher probability

investments exist elsewhere—andyou want your capital in a higher

probability play.

With stocks that grade poorly in Phase 2,

the 30-day moving average commonly acts

as resistance on rallies within a downtrend.

This phenomenon is particularly true on the

first rally after a stock breaks down from a

sideways move (usually due to bad news).

This is an example of the moving average

acting as resistance.

Once you learn how to make money when

stocks are going down using put options,

this information will help you pinpoint

likely areas of resistance and entry points in

such plays.

How can you tell when a downtrend is

likely ending? When a downtrending stock

rallies above the moving average, pulls

back, and gives a new buy signal at or

above the moving average, the downtrend

is likely over.

Keep in mind that when you enter a trade

on buy signals in a downtrend before this

kind of action occurs, it usually results in a

loss or poor performance.







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MACD

The MACD (Moving Average Convergence

Divergence) is a short-term momentum

indicator that appears as a blue histogram

directly below the price bars on a chart.The line running through the center of the

MACD histogram is called the signal line.

The MACD itself is the combination of

two moving averages: a fast one and a slowone and how they interact (converge and

diverge).

Here is a chart without the stock’s price

bars to better show how the two moving

averages interact.







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The Investor Toolbox utilizes a histogram

to display the MACD—shown at the

bottom of this stock chart. Notice how

the green and red arrows on the moving

averages correspond to the green and red

arrows on the histogram.

1. When a “down” red arrow appears,

this indicates the MACD has dropped

below the center signal line.

2. When an “up” green arrow appears,

this indicates the MACD has moved

above the center signal line.

The actual mathematics behind the

indicator are a little more complex than

the example, but this example gives you a

basic understanding of what the indicator ismeasuring.

The MACD tends to be the shortest-term

indicator on the chart. Over the course of

a year, it is usually the indicator that gives

the most green and red arrows.

You can use the MACD as an early warning

indicator, which alerts you as to which

stocks you should follow more closely in

the days to come for potential buy or sell

signals.

When the MACD is above the signal

line and is surging higher, watch for the

indicator to roll over. This action is the first

sign that short-term momentum is slowing

down.

Keep in mind that a red arrow only appears

when short-term upside momentum

has completely exhausted itself and the

indicator has crossed below the signal line.

For stocks in strong uptrends, the MACD

can have multiple momentum peaks before

the red arrow appears, and vice versa for

stocks in strong downtrends.

View the MACD arrow as a warning to the

coming of a valid buy or sell signal and

start watching the stock more closely for

that signal.







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Stochastics

Stochastics is a widely used indicator that

measures who is winning the daily battle

between the bears (who are selling and

driving the stock down) and the bulls (whoare buying and driving the stock up). It

uses crossover lines of 25% and 75% to

determine when the stock is overbought

(bullish) or oversold (bearish).

Following are some factors to help you

understand the stochastics indicator:

1. The stock is overbought when

the indicator crosses above the

75% line. Just because a stock is

overbought DOES NOT mean there

are no more buyers! All it means

is the buyers are in control of the

stock, dictating the action of how

the stock is trading. Stocks in strong

uptrends can stay overbought for

months. Do not sell simply because

a stock becomes overbought.

Wait for the red arrow to appear

and confirmation from the other

indicators.

2. The stock is oversold when the

indicator drops below the 25% line.Just because a stock is oversold

DOES NOT mean there are no

more sellers! All it means is the

sellers are in control of the stock,

dictating the action of how the

stock is trading. Stocks in strong

downtrends can stay oversold

Overbought(Buyers in Control)

Oversold(Sellers in Control)







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for months. Do not buy simply

because a stock becomes oversold.

Wait for the green arrow to appear

and confirmation from the other

indicators.

3. The red arrow indicates the

stochastics has dropped below the

75% line and the market is selling

out of the stock. It is a sign that

sellers are starting to gain control

of the stock. The red arrow only

appears on the chart if the indicator

has been above the 75% line and

then drops below it.

4. The green arrow indicates the

stochastics has moved above the

25% line and the market is buying back into the stock. It is a sign that

buyers are starting to gain control

of the stock. The green arrow

appears on the chart only if the

indicator has been below the 25%

line and then rallies above it.

What do the 25% and 75% lines represent?

The mathematics behind the indicator looks

at the highest price a stock has traded at

over the past 14 trading days (roughly three

weeks) and the lowest price it has tradedat over that same time frame. This process

establishes the trading range. The current

position of the stochastics tells you where

the current price is in relation to this range.

A stock with a stochastic reading of 75 is in

the upper 75% of its recent trading range,

while a stock with a reading of 25 is in

the lower 25% of the recent trading range.

The mathematics behind the indicator are

a little more complex than that, but this is

basically what the indicator is showing.

Sellers coming in







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Ghost Green/Red Arrows

Occasionally, a green or red arrow will

not appear on the stochastics when the

conditions are saying it should. This

situation is called a ‘ghost green’ or ‘ghost

red.’

Look at this chart as an example. At

the beginning of June, notice how the

stochastics turns upward at the 25% line,

but there is no green arrow. This is a ghost

green. The reason the arrow does not

appear is because the stochastics indicator

never actually drops below the 25% line.

Since it never drops below the line, it

cannot cross back above it, which is what

generates a green arrow.

Then, looking at the middle of August, thestochastics turns downward near the 75%

line, but there is no red arrow. This is a

ghost red. The red arrow does not appear

because the indicator never actually goes

above the 75% line. Since it never moves

above that line, it cannot cross down below

it, which is what generates a red arrow.

When the stochastics indicator is between

the 25% and 75% lines, look at the

direction it is heading to determine its

signal (up is green; down is red). The

closer the stochastics is to the 25% or75% lines, the more significant the turn.

If the other indicators are turning green and

the stochastics is between the 25% and 75%

lines and turning upward, treat the action as

a potential buy signal for the stock, going

through the buy signal checklist (outlined

later). The same is true for sell signals. If

the other indicators are turning red and the

stochastics is between the 25% and 75%

lines and turning downward, treat the action

as a potential sell signal.

Ghost Red

When the stochastics is between the 25% and 75% lines, look at the slope of

the indicator to determine the current color of the arrow:

Sloping Up = Green Sloping Down = Red







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Volume

The red bars at the bottom of the chart are

a visual representation of how many shares

trade each day. Taller bars represent spikes

in the volume, where activity significantlyincreased for that day. This surge in activity

is usually a sign that institutional money

(mutual funds, banks, etc.) is heavily

entering or exiting the stock. Volume spikes

usually mark the beginning of significant

trends.

A volume surge is considered to be 1.5

times the average 20-day volume (multiply

the 20-day average volume by 1.5). You

can find the day’s volume and the 20-day

average volume listed directly above the

stock’s chart.

When entering a stock on green arrowswith a spike in volume, you are greatly

increasing your chances for success. The

volume surge shows the institutions’ clear

commitment to the stock, as they are

buying a lot of it… and institutions rarely

buy an entire position in one day.

When we further explain buy signals,

you will learn that a volume surge is

required before entering a stock that has

been moving sideways. To break through

resistance and start an uptrend, stocks

usually need a volume surge. Just like if

you were sitting on a hill with a bicycle,

you would have to put in a little more

energy to get the bike moving up the hill,

stocks need that extra push (volume surge)

to get going up the uptrend hill.







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For example, if a sideways trending stock

normally trades 200,000 shares a day, when

that stock gives a buy signal, you want to

see at least 300,000 shares being traded (1.5

times the average) to confirm the signal.

If a stock normally trades 1,000,000 shares

a day, the stock needs to trade at least

1,500,000 to confirm a signal in a sideways

trend.

Calculating Volume Surge

In this example, average volume is slightly

over 3 million shares. Again, to calculate

the target volume for a volume surge,

multiply the average volume (3,051,035)

by 1.5:

3,051,035 x 1.5 = 4,576,552.5

Thus, volume must increase to about 4.5

million shares to support a buy signal.

To calculate the target volume for a volume

surge, take the average volume listed above

the stock’s chart and multiply it by 1.5.

Looking at our example chart, the stock has

been trading sideways over the past four

months and is starting to move downward.

Recently, a green arrow appears on the

MACD and stochastics, but volume is less

than 2 million shares. This shows a lack

of commitment by institutions and is not a

good time to buy.

IMPORTANT: In general, you’ll want to

avoid buying stocks with very low average

volume. These stocks are more prone to

manipulation and have a higher failure

rate on buy signals. Look for average

volume to be above 100,000 shares beforeentering a stock on buy signals.

If you do enter a stock on buy signals

with lower average volume, be more

conservative on the position size to

compensate for the risks that come with

these stocks. It is more difficult to get in and

out of low-volume stocks at a fair price.

Volume: 1,893,600 Average Volume: 3,051,035







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Support and Resistance

Support is any price area a stock has

gone down to and rallied off of in the

past. Think of support as the stock’s floor.

The more times a stock moves down tothis price area and then rallies back up,

the more significant the support is. Watch

this area closely; if the stock price clearly

drops below the established support, expect

heavier selling to occur and for the stock to

accelerate downward.

Resistance is any price area a stock has

rallied up to and dropped back down

from in the past. Think of resistance as

the stock’s ceiling. The more times a stock

moves up to this price area and then falls

back, the more significant the resistance is.Watch this area closely; if the stock price

clearly breaks up through the established

resistance, expect heavier buying to occur

and for the stock to continue upward.

Notice that support and resistance refer to

price areas. Very rarely will a stock go up

or down to the exact same price over and

over. Keep this in mind, particularly for

a support area that is around the moving

average.

Sometimes a stock will come down to

exactly where the moving average is

located, find support, and then rally back

up. But sometimes the stock will stop just

above the moving average or just below it

and then rally. In each case, the area around

the moving average is considered support.

Here are some key concepts:

• Once resistance is broken, it often

becomes new support. In other

words, when a stock breaks out

above resistance and then pulls

back, the old resistance area

commonly acts as the new support

area.







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• Once support is broken, it often

becomes new resistance. This

means that when a stock breaks

down below support and then

tries to rally back, the old support

area commonly acts as the newresistance area.

These concepts will be particularly

important later in this section in helping

you determine where to place exit orders

and how to determine the correct number of

shares to buy.

Buy SignalsBelow are simple buy signal rules for

stocks that grade well in Phase 2:

1. An uptrending stock with three

green arrows. When the most

recent arrow on each individual

indicator is green in an uptrending

stock.

2. A sideways moving stock with

three green arrows and a volume

surge. A sideways moving stock needs confirmation of big money

coming into the stock, which is

shown by a volume surge; this must

happen before the signal can be

considered valid.







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This is an example of a buy signal on an

uptrending stock, with three green arrows,

on the indicators (moving average, MACD,

and stochastics).

This is an example of a buy signal on a

sideways-trending stock, with three green

arrows on the indicators and a surge in

volume.

Uptrending

3 Greens

Sideways Moving

Volume Surge







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Strong Buy Signals

To put the odds of a successful play even

more in your favor, check to see that

the stock fits the following profile (each

element will be explained in detail with thefollowing example):

1. Stock grades well in Phase 2

2. Good price pattern

3. Strong industry group

4. Institutional money coming into

the stock

Putting It All Together to

Buy a Stock

This is an example of an uptrending stock

with three green arrows, meeting the simple buy signal rules. The buy signal price is the

closing price on the day of the last green

arrow; the closer to this price you enter the

stock, the better you will do.

What if you missed the buy signal by

several days? The amount of time you

miss the buy signal does not matter. What

matters is the price of the stock when you

are considering purchasing in comparison

to the buy signal price.

If you miss the buy signal by five days butthe price of the stock is still the same as the

buy signal price, then you can purchase the

stock. If you miss the buy signal by two

days but the stock has already risen 5%,

10%, or more, then you missed the window

of opportunity. Thus, wait for the next buy

signal or move on to a different stock.

3 green arrows inan uptrending stock







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Checklist for Strong Buy Signals

To increase the probability for success,

make sure the buy signal fits the profile

of a strong signal. While doing this may

eliminate stocks that could ultimately go onto do fine, it eliminates a large number of

buy signals that ultimately fail—it forces

you to put your capital into the strongest

plays.

Once you better understand the

requirements, it takes just a moment to go

through the checklist for each stock with

buy signals. Check for:

1. Solid Phase 2 Score: MG-Zacks

combined score of 3.25 or higher.

2. Good Price Pattern: a score of 2.50

or higher.

3. Strong Industry Group: a stable

or increasing group rank of 70 or

higher; or the group chart not in

a downtrend over the past two to

three months.

4. Institutional Money coming into

the stock at the time of the buy

signal.

1. Solid Phase 2 Score: MG-Zacks

combined score of 3.25 or higher

Look at the MG-Zacks combined score in

the Phase 2 criteria directly below the stock

chart. The scores should be 3.25 or higher

for the stock to pass and for the buy signal

to be valid.







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In our example, the MG-Zacks score meets

the minimum requirement of 3.25.

2. Good Price Pattern: score of 2.50 or

higher

Key point: DO NOT consider buy signals

on a stock in a clear, definitive downtrend.

Price patterns with automated scores of

2.50 or higher have an upward bias and

offer higher probability buy signals.







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In our example, the price pattern has a

score of 3.82, which is a great score. This

indicates a solid uptrend over the past one

year and five years.

3. Strong Industry Group: a stable or

increasing group rank of 70 or higher; or

the group chart not in a downtrend over

the past two to three months

Stable or Increasing Group Rank of 70 or

Higher

The group rank is always a number

between 0 and 99.5. The group rank is like

a standardized test score that measures

how well an entire industry is performing

relative to all other industries. The higher

the number, the more institutional money

is flowing into the stocks in that group.

Studies have shown that about 50% of a

stock’s rise or fall is directly related to the

strength or weakness of its industry group.

If the industry group rank is in the range

of 60-79, check the trend of the group

rank over the past several months. Thisinformation is located below the Phase 1

and Phase 2 tables on the stock graph page.

Note: The group rank graphic is updated

weekly, whereas the Phase 1 group rank

number is updated daily. The Phase 1 group

rank is the most up-to-date.







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The larger the group, the more significant

the group rank becomes. The number (#) of

stocks in the industry group is found in the

third column of the group rank graphic, just

to the right of the group symbol.

If there are 10 or more stocks in the group,

the group indicators are important. If the

stock is in a small group, more emphasis is

placed on strong buy signal requirements 1,

2, and 4.

For this example, the group rank is 97 and

there are ten stocks in the group. Looking

at the graphic, the green shows that the

group has been strong over the past few

months.

Group Chart Not in a Downtrend the Past

2-3 Months

If the industry group rank is weak or

marginal, click on the group’s ticker symbol

in the “Corporate Highlights” table to pull

up the group chart. This shows you how the

average stock in the group has been moving

over the past year.

Looking at the last two to three months,you want to see an uptrend, meaning the

average stock is rising (an indication that

big money is coming into the group). A

group moving sideways is okay, as long as

all other requirements in the checklist look

good.

It is possible that in strong markets when

most stocks are rising for a group chart to

be rising and have a group rank of less than

70. Just remember, the group rank shows

how well a group is performing relative to

all other industry groups.

If the stock you’re looking at is in a group

that is rising, but not rising as fast as some

other groups, the group rank may be below

70, even though institutional money is

coming into the group.







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With this group requirement you are

looking to avoid situations where you are

taking buy signals in a group where big

money is clearly selling most of the stocks

in the group. Good stocks in bad groups

typically go nowhere. In fact, the groupaction can be so strong that even good

companies can have their stocks go down

significantly when institutions are selling

the group.

In our example, the group chart is clearly

in an uptrend over the past seven months

and the group rank is strong (97). To fulfill

this third requirement, only one of the two

needs to be true—either a strong group rank

or an uptrending group chart. It is nice to

have both, but it is not necessary.

4. Institutional Money Coming into the

Stock at the Time of the Buy Signal

Not only do you want big money coming

into the entire group of stocks at the time

of the buy signal, you also want big money

coming into the particular stock you are

thinking about buying. This can be done

through either a volume surge or a strong

Acc/Dist indicator.

Volume Surge

As previously discussed, if the volume is

1.5 times the average volume at any point

from the day of the first green arrow to

the day of the last green arrow, it is a sign

that institutional money is coming into the

stock. Just make sure the high volume day

occurs on a day when the stock is going up,

not down!

Typically a volume spike occurs when a

stock is breaking out of a sideways move,

but it can also occur during a trend. Volume

surges are clear indications that big money

is entering the stock at the time of the buy

signal, thus increasing the probability of a

profitable trade.







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In the example, a volume surge clearly

occurs during the formation of the three

green arrows, showing big money is

coming into the stock at the time of the buy

signal.

Accumulation/Distribution (Acc/Dist) of 60

or Higher

Acc/Dist (Accumulation/Distribution) is

an indicator that measures whether big

money has been entering or exiting the

stock recently. If the stock has been rising

on the days volume is above average, then

Acc/Dist increases, which is a sign that big

money is quietly entering the stock. If on

the days of above-average volume the stock

has been trending downward, it is a sign

that big money is exiting the stock.

Readings of 60 or higher usually indicate

high volume days have consistently been

uptrending days, while readings below 40

usually indicate high volume days have

consistently been downtrending days.

Rather than the volume surge, the Acc/

Dist indicator is usually the confirmationsignal on buy signals within an established

uptrend.

Volume Surge







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Acc/Dist can be found in the Phase 1 table.

In our example, Acc/Dist is a strong 78.

Thus, both a volume surge and a strong

Acc/Dist reading have occurred. You only

need one of the two to be true to fulfillrequirement 4. It is nice to have both, but it

is not necessary.

Checklist Conclusion

For strong buy signals, you want the stock

to meet all four requirements. If any one is

not met, then do not consider the buy signal

to be strong.

The only exception to this is if the stock

is in a small industry group of less than

ten stocks. If this is the case, put more

emphasis on requirements 1, 2, and 4, as

the industry group doesn’t have as much

impact on the success or failure of the

signal.

In our example, all four requirements are

met, meaning the buy signal is strong and

the stock will most likely make a good

investment at $59/share.

Strong Buy Signal







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Interpreting Green Arrows that

Don’t Line Up Directly

While most buy signals consist of green

arrows that line up within a few days of

each other, there are times when greenarrows appear many days apart; but the buy

signal is still valid.

Keep the simple buy signal in mind: as

long as the MOST RECENT arrow on each

individual indicator is green, it is a valid

buy signal.

Situation 1

The moving average turned green several

weeks ago and the stock pulled back a

little. Now the MACD and stochastics are

turning green with the stock still above themoving average.

Since the stock has never closed below the

moving average, another green arrow will

not appear. So while it may appear that

there are only two green arrows, in reality

the most recent arrow on each indicator is

green, making the buy signal valid.

You can see this more clearly looking at the

one-month chart.

Most recentarrows on eachindicator look

to be green.







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Situation 2

The stochastics indicator has a shallow

pullback but does not go completely into

the oversold end zone (below the 25%

line). A green arrow does not appear.

Since the green arrow appears only when

crossing back over the 25% line, there is

no green arrow on the stochastics indicator.

However, this is a ‘‘ghost green,’’as

previously outlined. If the stochastics is

between the 25% and 75% line, look at the

slope of the indicator to determine the color

the arrow should be:

Sloping Upward = Green

Sloping Downward = Red

Important Point to Keep in Mind

When the market is going down strongly,

you WILL NOT get many (if any) strong

buy signals. The system is working. It is

keeping your capital safe while most others

are losing money.

Once the market reverses to the upside, you

will get a very large number of strong buy

signals, particularly on stocks that resisted

the market downtrend and went sideways.

These stocks are usually the first to break out—buy signals in these situations

typically offer the greatest reward.

To make money when the market is going

down, learn how to trade put options. Put

options are beyond the scope of this course;

they are taught in the Basic Options course.

Trading put options is not a difficult thing

to do once you learn how.







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Money Management

Good money management is critical to your

overall success in the market, regardless of

what system you’re using.

Good money management involves buying

the correct number of stock shares/option

contracts. It involves diversifying your

capital across a number of stocks in

different industry groups, letting your

winners run and, most important, keeping

your losers small.







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Poor money management is sizing positions

incorrectly and putting too much money

into one trade. It is also selling strong

buy signals too quickly and sitting on

your losers “hoping” they will rally back

upward.

No system is perfect on every trade because

there are external events beyond our control

that can ruin a perfectly good buy signal (a

group rotates out of favor, bad news comes

out, etc). Michael Jordan has missed some

game-winning shots; Tiger Woods has made

bogeys; you will not win on every trade.

Implemented correctly, the system will

result in more winners than losers over time

with the average winning play much bigger

than the average losing play. But how youdeal with your losers will go a long way in

determining how successful you will be.

Great System + Good Money Management= Consistent Performance

Great System + Poor Money Management

= Poor Performance







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Sell Stop Orders

A sell stop order is a protective order

placed below the current stock price that

automatically sells the stock if the price

of the stock falls to or below the price youhave specified.

When placing this order with your broker,

you are not charged initially. The order can

be cancelled or modified without cost. You

are only charged a regular commission if

the stock falls below the specified price and

the order is actually executed.

Every now and then, bad news comes out

on a stock and it falls very rapidly or gaps

below the price for a loss. With a stop

order, you get out at the best available priceonce the stock penetrates that sell stop

price. Usually, this type of fast, downward

move is the kick-off to a much larger

downward thrust and you want to be out of

the stock, even if it is at a lower price than

what you specified.

Use a regular sell stop order rather than a

sell stop limit. A regular stop order becomes

a market order as soon as the stock falls to

or through the price you’ve specified.

A sell stop limit order turns into a sell limit

order and sells only at the specified price

or higher when the stop level is hit. Thus, a

limit order will keep you in the stock even

if really bad news occurs and the price

rapidly falls through the sell stop price

specified or gaps below it. You want to be

out of the stock in these situations, so use

regular sell stops!

Some brokers refer to sell stop orders as

stop-loss orders. They are the same thing.







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You should place a sell stop order when

you first purchase the stock. Where you

place the sell stop determines how many

shares you should buy and ultimately

determines your risk in the trade. We

suggest you place the stop at 3% belowrecent support.

There are two ways to do this:

1. Place a sell stop 3% below the

lowest price the stock traded at

in the two weeks prior to the buy

signal.

2. Place a sell stop 3% below other

support identified on the chart.

The first way is the easiest, while thesecond is more advanced. We suggest you

use the first method until you become more

comfortable with the system.

Place a Sell Stop 3% Below the Lowest

Price the Stock Traded at in the Two Weeks

Prior to the Buy Signal:

All buy signals appear after a stock has

pulled back, stopped going down, and

then started to rally. In this case, you are

identifying short-term support—the low

price just prior to the buy signal.

If a stock fits all the criteria for a strong

buy signal, has just made a low, and is

now showing all greens, the stock has

no business being below that recent low.

Therefore, you should place your initial sell

stop 3% below the lowest price in the two

weeks prior to the buy signal.

All buy signals show recent support,

making it the easiest to identify. Use

the one-month or three-month charts to

magnify recent activity and more easily see

where to place a sell stop.

Note: Do not use the one-day, five-day, or

ten-day charts, as they show day trading

signals, which are different.







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In our example, the recent low is about

$52; 3% below that price is $50.44. The

easiest way to calculate the sell stop price is

to use the following formula:

Recent Low Price x 0.97 = Sell Stop Price

Here is another quick way to think of

approximate sell stop prices: for every

$10 in stock price, the sell stop is 30 cents

below the recent low. So, for a stock near

$50, the sell stop is going to be about $1.50

below the recent low.

On more volatile stocks, this process

compensates for additional risk by forcing

you to buy fewer shares than you would

in non-volatile stocks. (We’ll explain

the process for determining how many

shares to buy in a moment.) With proper positioning, your risk profile on every trade

is essentially the same, regardless of how

volatile the stock is.

Place a Sell Stop 3% Below Other Support

Identified on the Chart

Using the second method, place your stop

3% below other support identified on the

chart. Other support is present on some buy

signals, but not on others. For example, if

the stock has been moving sideways and a

buy signal breaks out above the resistance

level, a higher support level is likely present in the trade. Remember, resistance

once broken commonly acts as support.

In our example, the stock has rallied up to

$58 twice in the previous month and gone

back down, making $58 the resistance. The

buy signal then occurs on large volume and

the stock breaks through the $58 resistance.

Since resistance broken on high volume

commonly turns into support, you can place

your sell stop at a much higher level in this

case.

Use this formula:

Other Support Price x 0.97 = Sell Stop Price

Thus, in our example, $58 x 0.97 = $56.25,

which is the sell stop price.

Stock closed above resistance withhigh volume on a buy signal.







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How Many Shares to Buy

So how many shares should you buy? Once

you know the buy signal price and the price

at which you’ll be placing a sell stop, it’s

time to determine the appropriate number of shares to buy.

Buy only enough shares so that if your

initial sell stop is hit you can live with the

loss—the amount you can handle losing

every now and then without losing sleep

over it.

Here is a good rule to follow: Never

lose more than 1-2% of your TOTAL

ACCOUNT VALUE on any one trade.

This does not mean put only 1-2% of your

account into each play; it means buy onlyenough shares so that if the stock hits your

sell stop (3% below recent support), you

lose only 1-2% of your total account value.

If you have a small account of less than

$10,000, you can be more liberal with this

rule. But as your account grows to $20,000

or $30,000, start using the 2% rule. When

you get a much larger account, start using

the 1% rule.

Once you know the buy price and the sell

stop price, use this formula to determine

correct position size:

• Acceptable Loss: The total amount

you can lose on any one trade

without losing sleep over it.

• Risk: The difference between the

buy signal price and the price at

which you place a sell stop

(Buy Price - Sell Stop Price = Risk).

To get the acceptable number of shares to buy, divide your acceptable loss by the risk

(Acceptable Loss / Risk = Shares).







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Example 1—Recent Low

Using an example, let’s say you can live

with a $300 loss on a play. Our example

stock, which meets all ‘buy’ requirements,

has a current buy price of $59 and a recentlow support at around $52. Therefore…

Buy signal price: $59

Recent low support: $52

Sell stop 3% below recent low =

$50.50

Risk: $59 - $50.50 = $8.50

In the example, acceptable loss was $300,

thus: Acceptable $ Loss / Risk = Number

of Shares

$300 / $8.50 = 35 shares

The signal on this example is more volatile,

as most buy signals occur within 10%-15%

of the recent low. Keep in mind that you

will never get in at the exact low or get out

at the exact high. What you can expect to

do is capture the middle part of the trend.

If it is a big uptrend, you’ll make a lot of

money; if it is a little uptrend, you’ll make

a little money.

Example 2—Other Support

Since the buy signal breaks through

resistance at $58 on high volume, there is

‘other support’ on this buy signal. When

resistance is broken on high volume, it

usually turns into support. This occurs at

about $58 in this example.

Using the same stock example and

acceptable loss as above ($300), the price at

the time of the buy signal is $59 with other

support at around $58. Therefore...

Buy signal price: $59

Other support: $58

Sell stop 3% below other support =

$56.25

Risk: $59.00 - $56.25 = $2.75







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With our example, the acceptable loss is

$300, thus: Acceptable $ Loss / Risk =

Number of Shares

$300 / $2.75 = 109 shares

Another Alternative:

Buy the Call Option on the Stock

If you have a small account and do not feel

like you can afford a $59 stock, or if you

are fully invested with only a little cash in

your account, there is another alternative.

You can buy the $60 call option, which

gives you the right to buy the stock at

$60/share until expiration day. To do this,

you only have to pay the price, which is

a fraction of the actual stock price. As an

example, a $60 call option might sell for

$3.50 per share, compared to the stock

price of $59 per share.

A call option is like a coupon with an

expiration date. That coupon reserves the

right for you to buy the stock at a set price

until the expiration date. Each call option

contract controls 100 shares of stock; thus,

one contract costs $350 ($3.50 x 100 =

$350) in this example.

You never have to take possession of the

stock, as options trade each day just like

stocks. Also, you do not need to hold them







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until the expiration date; you can sell and

take profits at any time.

If we have a call option on our sample

stock and the price goes up to $70 over

the next few weeks, you have the right to

buy that stock at $60/share. Thus, the call

option is now worth at least $10 per share.

With just a $3.50 investment, that is a $6.50

profit (10 - 3.50 = 6.50), a 185% return.

With a stock, you have the $11 profit per

share (70 - 59 = 11), but the rate of return is

much lower at just 18.6%.

While a call option is a nice alternative to

buying stock, you SHOULD NOT buy

options until you fully understand how they

are priced and how they work.

Options can be a risky investment if you

don’t know what you’re doing. However, if

you understand options and how to choose

the right option, this type of investment can

actually be less risky than buying the stock.

The reason most people lose money on

options is that they don’t know how to buy

and sell options correctly. They just see the

lower investment price and haphazardly

enter into an option play they know nothing

about. Do not let this happen to you. If

you want to trade options, first get your education in options.

This example simply shows that there are

other low-cost ways to profit from the same

buy signal on a stock.







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In this example, notice the three red arrows

that appear over a three-day period. The

lowest price at which the stock traded

during those three days was $45.75. Notice

the red arrow appears on the moving

average when the stock closes just belowthe moving average.

The most common area of support in a

trending stock is the moving average.

Remember: support is an area, not an exact

price. The stock may be a little above or

below the moving average before turning

around and rallying. You do not want to sell

immediately on this third red, as the stock

may find support just a little below the

moving average.

In the example, the sell stop is at $44.38(3% below $45.75). The stock goes as low

as $44.80 and then promptly turns around

and rallies strongly. This kind of activity

happens all the time in strongly trending

stocks in strong markets. So though the

three red sell indicators have appeared,

your sell stop is not hit, and you are still in

the play to enjoy the further uptrend.

Sell Signal ExampleLooking at this example, the initial buy

signal occurs at $23 with the stop just

below the recent low.

Low Price

Sell Stop

The buy signal is at $23. Place

the initial sell stop below the

recent low.







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Six weeks later, the middle of March, the

stock is largely moving sideways when the

first set of three red arrows appears. As you

go back in time, this is the first day where

you can say the most recent arrow on each

individual indicator is red. Move your sellstop up to 3% below the lowest price of the

three reds.

Staying in the play pays off, as the stock

rallies immediately without hitting your sell

stop.

When the next set of three reds appears in

May, move up your stop to 3% below the

lowest price during the time the red arrowsappear.

The most recent arrow on eachindividual indicator is now red.

Move the sell stop to 3% belowthe low price of 3 reds.

The stock never hits the

sell stop.It rallies off the moving

average support then

shows 3 new reds.

Move the sell stop up.







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Continue this process until the stock

convincingly breaks down below support.

Remember it costs you nothing to place a

sell stop (stop-loss) order and nothing to

modify it as the play develops. You are onlycharged a regular commission once the sell

stop is executed.

In this example, the buy signal occurred in

January. Nearly nine months later, you are

still in the stock with close to a 100% gain.

Short-term Sell Signals

If you are a short-term trader and are

looking to be in and out of a stock in a

matter of weeks, then sell the stock when

red arrows appear on the MACD and

stochastics. This sell signal is appropriate if

you are simply looking to take short-term

profits or lock in profits on a short-term

option play. It’s also appropriate if the

market has been in a general downtrendmore than an uptrend over the past several

months.

The advantage of the short-term signal is

that you get out of the play at a slightly

higher level if the stock does not go on to

make a large run. The disadvantage is you

will get out early on stocks that ultimately

do go on to post large gains in the market.

Long-term Sell Signals

If you prefer to buy and hold a stock for

potentially one year or more, then follow

the “3 and 3 Rule” as previously outlined,

except follow the buy and sell signals on

the five-year chart rather than the one-

year chart. The five-year chart is based on

weekly price movements (longer term),

Continually move the sell stop up on each subsequentset of 3 reds.







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while the one-year chart is based on daily

price movements.

If you have a 401(k) in which you are only

allowed to trade mutual funds, obtain the

ticker symbols for these funds and thentrack the long-term buy and sell signals

using the Investor Toolbox. You want to use

long-term signals for mutual funds, as it is

very difficult to be precise on entries and

exits in a fund due to their “end-of-day”

pricing models.

Insider Trading

Corporate insiders (i.e., a company’s

officers and directors, and any beneficial

owners of more than 10% of the company

stock) must file a Form 4 with the SEC

within two business days from the date of

any stock transaction of which they are

defined as an insider.

This is positive news for investors, as it

helps us to see what insiders are doing…

people who may know about upcoming

events. You want to know if insiders are

selling or buying, and then determinewhether you should buy or sell with them.

When viewing insider trading we want to

look for:

• Insider Buying Near a High: This

activity is particularly positive

news, as it shows that even though

a stock is currently high, insiders

are still adding their own money to

buy more.

• Insider Selling Near a Low: Whenthis happens, it demonstrates

the insiders’ lack of faith in the

company/its stock and usually leads

to lower lows.







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• Group Buying or Selling: When

there is a group consensus one way

or another, it is a strong indication

the stock will trade in the direction

of their buying or selling. For

example, if six or seven insiders are buying stock and no one is selling,

you can expect to see some upward

bias to the stock in the near future.

• Insider Selling the Majority of His/

Her Holdings: This is a negative

signal, indicating an insider has

found a better place to invest his/

her money and does not want to

own the company stock anymore.

It should be noted that some insider selling

is to be expected on every stock, as insidersoften sell stock options that come due each

year. This is a standard practice for most

companies. Whenever you see what looks

like large insider selling, check to see if it

is due to insiders exercising employment

options (Type OE). This type of transaction

is almost always followed by a sale of

shares (Type S).

Exercising options is a taxable event for the

insider, which is one of the reasons shares

are usually sold immediately when they

become due. Over the past 20 years, themarket has become conditioned to this kind

of selling, and rarely will such selling cause

the stock to drop significantly.

Insider buying is more significant than

insider selling, as there are not many

reasons why insiders buy. There are,

however, many reasons why insiders may

sell… not all of which are due to problems

with the company.







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To view the insider trading in the Investor

Toolbox from the stock chart you are

analyzing, click on the “Vickers Insider”

link in the left-hand menu under the

“Company Reports” heading. This brings

up a basic one-year stock chart.

The insider trades information is posted

below the insider trading chart.

Using the first row in our example for

the stock CPRT, the insider trading table

contains such information as:

• The date of the insider transaction

(10/9/2003)

• The ticker symbol of the stock that

was traded (CPRT)

• The insider’s position within the

company (Director)

• The name of the insider who placed

the trade (Blumenstein, Harold)

• The type of transaction (Buy)

• How many shares were traded in

the transaction (100,000)

• The price at which these shares

were traded ($11.200)

• How many shares the insider

currently owns (771,200)

• The date the transaction was

reported to the SEC (10/10/2003)







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If you want to see all the trades for a

certain individual listed, click on the

person’s name. This brings up a list of all

his/her insider trades over the past several

years.

Many investors like to follow what Warren

Buffett is doing in the market. He is a

director in many companies and is, thus,

considered an insider. He has made insider

trades on G and GMT and a stock with the

ticker symbol GLK.

Pull up GLK in the Graphs area, click on

the “Vickers Insider” link, and then click on

Warren Buffett’s name to see all his insider

trades over the past several years.





THE 5-STEP INVESTING FORMULA Step 4: Technical Analysiswww.investools.com

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Warranty disclaimer: The content included in this manual and the Investor Toolbox Web site is provided as is, without any warranties. Neither INVESToolsno any of its subsidiaries or affiliates make any guarantees or warranties as to the accuracy or completeness of, or results to be obtained from using, any of itsproducts or services (including any content therein). INVESTools and its subsidiaries and affiliates hereby disclaim any and all warranties, express or implied,including warranties of merchantability or fitness for a particular purpose or use. Neither INVESTools nor any of its subsidiaries or affiliates shall be liable to youor anyone else for any inaccuracy, delay, interruption in service, error or omission, regardless of cause, or for any damages resulting therefrom. In no event willINVESTools nor any of its subsidiaries or affiliates be liable for any indirect, special or consequential damages, including but not limited to lost time, lost money,lost profits or lost good will, whether in contract, tort, strict liability or otherwise, and whether or not such damages are foreseen or unforeseen with respect to any use of our products or services. In the event that liability is nevertheless imposed on INVESTools or any of its subsidiaries or affiliates, such parties’ cumulativeliability for damages under any legal theory shall not exceed the amount of fees you paid for the particular product or service. This warranty addresses specificlegal rights; you may also have other rights, which vary from state to state. Some states do not allow the exclusion or limitation of incidental or consequential

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The principals and employees of, as well as those who provide contracted services for, INVESTools have not promised, represented or warranted that you will earn a profit when or if you purchase securities. It is recommended that anyone trading securities should do so with caution and consult with a broker before doing so. Past performancesof any principals and employees of, as well as those who provide contracted services for, INVESTools or any of its subsidiaries or affiliates may not be indicative of futur performance. Securities used as examples presented in this manual or the Investor Toolbox Web site are used for illustrative purposes only and do not constitute arecommendation to buy or sell individual securities. They should be considered speculative with a high degree of volatility and risk.



6.- step 4 - technical analysis

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