Joe Duarte

Article / Updated 08-31-2023

No matter which analyst’s report you’re reading, you must remember that the analyst’s primary income is coming either from the brokerage house or the large institutional clients that he or she serves. Analysts rate stocks on whether you should consider purchasing them, but no standardized rating system exists. The three most common breakdowns that you can expect to see are shown here. Common Stock Recommendations from Analysts Analysis by Company A vAnalysis by Company B Analysis by Company C Buy Strong buy Recommended list Outperform Buy Trading buy Neutral Hold Market outperformer Underperform Sell Market perform Avoid Market underperformer You can see from this table that you must understand how a company’s analysts rate stocks for that company’s recommendations to have any value. Company A’s Buy recommendation is its highest, but Company B uses Strong buy for its highest rating, and Company C uses Recommended list for its top choice. Merely seeing that a stock is recommended as a Buy by a particular analyst means little if you don’t know which rating system the analyst is using. Unfortunately, when it comes to stock analysts, if the information is free, it’s probably no better than that free lunch you’re always looking to find. Someone has to pay the analyst, and if it isn’t you, you must find out who is footing the bill before you use that advice to make decisions. The best way to use analysts’ reports is to think of them as just one tool in your bucket of trading tools. Analysts are one good way to find out about an industry or a stock, but they’re not the final word about what you need to do. Only your own research using fundamental and technical analysis can help you make your investment decisions. Tracking how a company’s doing Analysts are good resources for finding historical data about how a company or industry is doing. Their reports usually summarize at least five years of data and frequently provide a historical perspective for the industry and the company that goes back many more years. In addition, analysts make projections about the earnings potential of the company they’re analyzing and indicate why they believe those projections by including information about new products being developed or currently being tested at various stages of market development. These reports help you track how a company is doing so you can find the gems that may indicate when to expect a company to break out of a current trading trend. For example, if an analyst covering a pharmaceutical company mentions that a new drug is under consideration by the Food and Drug Administration, you may look for news stories about the status of that drug and monitor the stock for indications that drug approval may soon be announced. Watching the technical charts may help you jump in at just the right time and catch the upward trend as positive news is announced. Stocks usually start to move in advance of news. Providing access to analyst calls In addition to reading reports, you can track companies by listening in on analyst calls. Some calls are sponsored by the companies themselves to review annual or quarterly results, and others are sponsored by independent analysts. Company‐sponsored calls Analyst calls sponsored by companies more often are earnings conference calls primarily for institutional investors and Wall Street analysts. They occur on either a quarterly, semiannual, or annual basis and can be the richest sources of information concerning a company’s fundamentals and future prospects. Senior management, which usually includes the chief executive officer (CEO), president, and chief financial officer (CFO), talks about their financial reports and then answers questions during these calls. The calls sometimes are scheduled to coincide with announcements of major changes in a company’s leadership or other breaking news about the company. After a formal statement, senior management answers questions from analysts. That’s when you usually can get the most up‐to‐date information about the company and how management views its financial performance and projections. Access to these calls used to be limited to professional analysts and institutional investors, but today more than 97 percent of companies that sponsor analyst calls open them to the media and individual investors, according to a survey conducted by the National Investor Relations Institute. This change primarily is credited to the SEC’s Fair Disclosure (FD) Regulation, which requires companies to make public all major announcements that can impact the value of the stock within 24 hours of informing any company outsiders. This rule helps level the information playing field for individual investors. Analysts no longer can count on getting two or three days of lead time on major announcements, which heretofore helped them inform major investors about company news. Often that amount of lead time enabled analysts to recommend buy or sell decisions to their key clients, but that same practice hurt small investors and traders who weren’t privy to the news. Some complain this new rule actually hurt the flow of information because companies clammed up in private conversations with analysts, making it harder for the analysts to write their investigative reports. Since the regulation first took effect in 2000, the fair disclosure rule has helped to level the information playing field. Independent analyst–sponsored calls Firms that provide independent analysis also sponsor calls primarily for their wealthy and institutional clients. During these calls, analysts often discuss breaking news about a company or an industry that they follow. Doing so gives their clients an opportunity to discuss key concerns directly with the analysts. Unless you’re a client, opportunities for listening in on these calls are rare.

Article / Updated 05-26-2022

Many trend‐following trading systems use a moving average for their starting points. In this trend‐following example, the system is designed for position trading, which means you use a relatively long moving average. Short selling isn’t permitted with this simple system. The first step is to define buy and sell rules for your initial testing. The actual code for defining these rules depends on your specific system‐development package. Therefore, trading rules are described as generally as possible. The rules for an initial test may look like this: Buy at tomorrow’s opening price when today’s price crosses and closes above the 50‐day exponential moving average (EMA). Sell at tomorrow’s opening price when today’s price crosses and closes below the 50‐day EMA. To test whether using a moving average as a starting point is a good idea in a trend‐following system, apply these two rules to ten years of historical data for the stocks of your choice. After testing this idea, you find that this simple system works fairly well when stock prices are trending, but it’s likely to trigger many losing trades when the prices of stocks are range bound. You can try to avoid these losing trades, and possibly improve your overall trading results, by filtering out trading‐range situations. One way to accomplish that goal is by changing the buy rule to read as follows: Buy at tomorrow’s open when the following conditions are true: Today’s closing price is above the 50‐day EMA. The stock crossed above the 50‐day EMA sometime during the last 5 days. Today’s 50‐day EMA is greater than the 50‐day EMA from 5 days ago. These added conditions serve as signal confirmation. When you test these rules, you find they reduce the number of whipsaw trades for most stocks, but they’re also likely to delay buy and sell signals on profitable trades and thus usually result in smaller profits on those trades. However, this adjustment makes the overall system more profitable because the number of losses is reduced. You can find out whether other changes that you can make in your simple system can actually improve profitability. You may, for example, test different types of moving averages. Try, for example, a simple moving average (SMA) instead of an exponential moving average (EMA). Or you may want to try using different time frames for your moving average, such as 9‐day, 25‐day, or 100‐day moving ­averages. Identifying system‐optimization pitfalls Most system‐development and testing software comes equipped with a provision for system optimization, which allows you to fine‐tune the technical analysis tools used in your trading system. You can, for example, tell the system to find the time frame of the moving average that produces the highest profit for one stock and then ask it to do the same thing for a different stock. Some systems enable you to test this factor simultaneously for many stocks. Although this approach is alluring, using it is likely to cause you trouble. If you find, for example, that a 22‐day moving average works best for one stock, a 37‐day moving average works best for the next stock, and another stock performs best using a 74‐day moving average, you’re going to run into problems. The set of circumstances leading to these optimized results won’t likely repeat in precisely the same way again in the future. It’s almost guaranteed that whatever optimized parameters you may find for these moving averages won’t be the optimal choices when trading real capital. This is a simple example of a problem that’s well known to scientists and economists who build mathematic models to forecast future events. It’s called curve fitting because you’re molding your model to fit the historical data. You can expend quite a bit of effort fine‐tuning a system to identify all the major trends and turning points in historical data for a particular stock, but that effort isn’t likely to result in future trading profits. In that case, your optimized system is more likely to cause a long string of losses rather than profits. Testing a long moving average and comparing the results to a short moving average is fine, and so is testing a few points in between a long moving average and a short moving average. As long as you use this exercise to understand why short moving averages work best for short‐term trades and why longer moving averages work better for traders with longer trading horizons, you’ll be fine. Otherwise, you’re probably moving into the realm of curve fitting and becoming frustrated with your actual trading results. Testing with blind simulation Blind simulation is a method for setting aside enough historical data so you can test your system‐optimization results and avoid the problem of curve fitting. For example, you may test data from 1990 through 1999 and thus exclude data from 2000 through the present. After you’ve developed a system that looks good enough for you to base your trades on, you can then test your system against the data that was excluded. If the system performs as well with the excluded data as it did with the original test data, you may have a system worth trading. If it fails, you obviously need to rethink your system. Another approach is choosing your historical data with extreme care. You can expect trend‐following systems like a moving‐average system to perform well during long, powerful trends. If your stock had a strong run up during the long‐lasting 1990s bull market, that kind of price data can skew your results, magically making any trend‐following system appear profitable. Whether that success actually can be duplicated during a subsequent bull market, however, must first be thoroughly tested. If the majority of your profits come from a single trade or only a small number of trades, the system probably won’t perform well when you begin trading real money. You may want to address this problem by excluding periods from your test data when your stock was doing exceptionally well or when the results of any trades were significantly more profitable than the average trade. This technique is a valid approach to eliminating the extraordinary results arising from extraordinary situations in your historical data. Using it should give you a better idea of your system’s potential for generating real profits in the future.

Cheat Sheet / Updated 08-30-2021

Trading options is a bit different from trading stocks, but they both require research and study. If you’re going to trade options, make sure you know what the different order types are, how to read changes in the market with charts, how to recognize how stock changes affect indexes and options, and how indexes are built. In this market, you need to know how artificial intelligence traders, often called algos, do their work.

Article / Updated 07-01-2021

A financial option is a contractual agreement between two parties. Although some option contracts are over the counter, meaning they are between two parties without going through an exchange, standardized contracts known as listed options trade on exchanges. Option contracts give the owner rights and the seller obligations. Here are the key definitions and details: Call option: A call option gives the owner (seller) the right (obligation) to buy (sell) a specific number of shares of the underlying stock at a specific price by a predetermined date. A call option gives you the opportunity to profit from price gains in the underlying stock at a fraction of the cost of owning the stock. Put option: Put options give the owner (seller) the right (obligation) to sell (buy) a specific number of shares of the underlying stock at a specific price by a specific date. If you own put options on a stock that you own, and the price of the stock is falling, the put option is gaining in value, thus offsetting the losses on the stock and giving you an opportunity to make decisions about your stock ownership without panicking. Rights of the owner of an options contract: A call option gives the owner the right to buy a specific number of shares of stock at a predetermined price. A put option gives its owner the right to sell a specific number of shares of stock at a predetermined price. Obligations of an options seller: Sellers of call options have the obligation to sell a specific number of shares of the underlying stock at a predetermined price. Sellers of put options have the obligation to buy a specific amount of stock at a predetermined price. In order to maximize your use of options, for both risk management and trading profits, make sure you understand the concepts put forth in each section fully before moving on. Focus on the option, consider how you might use it, and gauge the risk and reward associated with the option and the strategy. If you keep these factors in mind as you study each section, the concepts will be much easier to use as you move on to real time trading. Use stock options for the following objectives: To benefit from upside moves for less money To profit from downside moves in stocks without the risk of short selling To protect an individual stock position or an entire portfolio during periods of falling prices and market downturns Always be aware of the risks of trading options. Here are two key concepts: Option contracts have a limited life. Each contract has an expiration date. That means if the move you anticipate is close to the expiration date, you will lose our entire initial investment. You can figure out how these things happen by paper trading before you do it in real time. Paper trading lets you try different options for the underlying stock, accomplishing two things. One is that you can see what happens in real time. Seeing what ­happens, in turn, lets you figure out how to pick the best option and how to manage the position. The wrong strategy can lead to disastrous results. If you take more risk than necessary, you will limit your rewards and expose yourself to unlimited losses. This is the same thing that would happen if you sold stocks short, which would defeat the purpose of trading options. Options and specific option strategies let you accomplish the same thing as selling stocks short (profiting from a decrease in prices of the underlying asset) at a fraction of the cost.

Cheat Sheet / Updated 06-30-2021

Trading options is a bit different from trading stocks, but they both require research and study. If you're going to trade options, it's important that you know order types, how to read changes in the market with charts, how to recognize how stock changes affect indexes and options, and how indexes are built.

Article / Updated 06-30-2021

A variety of order types are available to you when trading stocks; some guarantee execution, others guarantee price. This brief list describes popular types of trading orders and some of the trading terminology you need to know. Market order: A market order is one that guarantees execution at the current market for the order given its priority in the trading queue (a.k.a., trading book) and the depth of the market. Limit order: A limit order is one that guarantees price, but not execution. When placing a limit on an order, it will be treated like a market order if: When buying, your limit is at or above the current market ask price and there are sufficient contracts to satisfy your order (for example, limit to buy at $2.50 when the asking price is $2.50 or lower). When selling, your limit is at or below the current market bid price and there are sufficient contracts to satisfy your order (for example, limit to buy at $2.50 when the asking price is $2.50 or higher). Stop order: A stop order, also referred to as a stop-loss order, is your risk management tool for trading with discipline. A stop is used to trigger a market order if the option price trades or moves to a certain level: the stop. The stop represents a price less favorable than the current market and is typically used to minimize losses for an existing position. Stop-limit order: A stop-limit order is similar to a regular stop order, but it triggers a limit order instead of market order. While this may sound really appealing, you’re kind of asking a lot in terms of the specific market movement that needs to take place. It may prevent you from exiting an order you need to exit, subjecting you to additional risk. If the stop gets reached, the market is going against you. Duration: The two primary periods of time your order will be in place are The current trading session or following session if the market is closed Until the order is cancelled by you, or the broker clears the order (possibly in 60 days — check with your broker) Cancel or change: If you want to cancel an active order, you do so by submitting a cancel order. Once the instructions are completed, you receive a report notifying you that the order was successfully canceled. It's possible for the order to already have been executed, in which case you receive a report indicating that you were too late to cancel, filled with the execution details. Needless to say, you can’t cancel a market order. Changing an order is a little different than canceling one because you can change an order one of two ways: Cancel the original order, wait for the report confirming the cancellation, and then enter a new order. Submit a cancel/change or replace order, which replaces the existing order with the revised qualifiers unless the original order was already executed. If that happens, the replacement order is canceled.

Article / Updated 06-30-2021

A call option provides you with profits similar to long stock, whereas a put option provides you with profits similar to short stock. This makes sense given your rights as an option holder, which allow you to buy or sell stock at a set level. There is one slight difference between stock rewards and option rewards: Options require an initial premium payment that you must consider when identifying potential gains. There are three key value points for option trades: break even, in the money (ITM), and out of the money (OTM). So, calculating potential option rewards requires you to add option premiums to call strike prices and subtract option premiums from put strike prices to come up with a price known as the position’s breakeven level. A stock’s price must Rise above the breakeven for call option profits to kick in. Fall below the breakeven for put option profits to kick in. In each case, this results in profits that are slightly less than your stock profits. A stock’s breakeven point is your purchase price when buying stock or your sell price when shorting a stock. As soon as the stock moves away from this price, you have gains or losses. Call option Purchasing a call option gives you rights to buy stock at a certain level. As a result, the option increases in value when the stock moves upward. After a stock moves above your call option’s strike price, the option has intrinsic value which increases as the stock continues to rise. Calls with strike prices below the price of the stock are referred to as ITM. For a call position you own to be profitable at expiration, it must remain above the strike price plus your initial investment. At this level, option premiums will minimally equal your cost when you bought the call. The breakeven for a call option is: Call Breakeven = Call Strike Price + Call Purchase Premium After a stock’s price is at the option’s breakeven level, it can continue to rise indefinitely. Your call option can similarly rise indefinitely until expiration. As a result, call option profits are considered to be unlimited, just like stock. An option’s moneyness is determined by the option type and the price of the underlying stock relative to the option strike price. Call options with a strike price that is below the stock price are OTM, and their premium is all time value. After the stock moves above the strike price, it is referred to as ITM and has intrinsic value along with the time value. Put option Purchasing a put option gives you rights to sell stock at a certain level. As a result, the option increases in value when the stock’s price moves downward. When a stock moves below your put option’s strike price, the option has intrinsic value, which increases as the stock continues to fall. Puts with strike prices above the price of the stock are referred to as ITM. For a put position you own to be profitable at expiration, it must remain below the strike price minus your initial investment. At this level, option premiums will minimally equal your cost when you bought the put. The breakeven for a put option is: Put Breakeven = Put Strike Price – Put Purchase Premium When a stock is at the option’s breakeven level, it can continue to fall until it reaches zero. Your put option can continue to increase in value until this level is reached, all the way to its expiration. As a result, put option profits are considered to be high, but limited, just like a short stock. Call options have risks and rewards similar to long stock, whereas put options have rewards that are similar to short stock. Put option risk is limited to the initial investment. The reason your rewards are similar rather than the same is because you need to account for the premium amount when you purchased the option.

Article / Updated 10-26-2017

For many traders, the quest to find a profitable countertrend trading system is all consuming. Countertrend systems appear desirable because their goal is to buy low and sell high. These systems try to identify inflection points, or the moments when stocks change direction, so traders can take positions close to when they occur. This approach may work in a few narrowly defined situations, such as in a trading range or a trend channel, but it’s likely to fail in a spectacular and expensive way if attempted on a broader scale. The vast majority of trading systems follow market trends. This is simply a higher‐probability practice. Trend‐following systems tend to outperform countertrend systems, especially for position traders. Swing traders and some day traders sometimes use a countertrend approach, but even then, they usually do so in conjunction with a trend‐following component. Countertrend systems usually depend on oscillating indicators, reversal patterns, and channeling strategies to find turning points. Some countertrend systems also are based on cycle theory, and others are based on volatility, expansion, and contraction. Don't spend too much time evaluating countertrend systems, at least until you’re confident in your ability to use trend‐following systems to successfully make your trades. Countertrend systems generate a large volume of trades, and the more you trade, the more you spend on transaction and slippage costs. These costs alone often swamp potentially profitable systems. Although a countertrend strategy can sometimes work profitably in a trading range or trend channel, it’s still risky, especially for a new trader. Until you can confidently (and honestly) consider yourself a thoroughly experienced trader, stick with the proven techniques that are more likely to lead to profitable results over the long term.

Article / Updated 10-26-2017

Trend following is favored by many technicians for one simple reason: Trends offer excellent trading opportunities for profit. Unfortunately, the popularity of the trend‐­following approach is one of its greatest weaknesses. Too many of these systems generate very similar buy and sell signals, which, in turn, makes outperforming the average trader difficult for any individual trend‐following trader. Even the best trend‐following systems have a relatively large percentage of failed trades, primarily because they depend on several extremely profitable trades to make up for the large percentage of losing trades. If your trend‐following system is also a discretionary system, your discretion (or lack of it) can cause you to miss a few of these profitable trades. In this case, your overall results will suffer. Trend‐following systems are typically based on either moving averages or breakout patterns. Moving average–based trading systems are the most popular and can be quite profitable; however, they work only when a stock is trending. These trading systems depend on long‐lasting trends to generate enough profit to outweigh a relatively large number of losing trades. In fact, the number of losing trades can easily outnumber the winning trades with this type of trading system. When a stock is range bound (stuck moving sideways within a specific price range), a moving average–based system generates a large number of losing trades. Because of the high overall number of trades, this system is often accompanied by relatively high transaction and slippage costs. Smart money management protocols are critical when using a trend‐following trading system. You can make some adjustments to a trend‐following system that may improve its performance. For example, you can insist that its trading signals be confirmed by another condition before actually entering any positions. If your system triggers a buy signal, for example, you may want to see whether the signal remains in effect for at least a day or two before entering a position.

Article / Updated 10-26-2017

A mechanical trading system addresses some of the problems that arise when using discretionary systems. Mechanical systems usually are computer‐based programs that automatically generate buy and sell signals based on technical and/or fundamental data. You’re expected to blindly follow the resulting trading signals. Put another way, mechanical trading systems take your judgment out of the equation. In fact, some mechanical systems even enter buy and sell orders directly with your broker without your intervention. If your greedy impulses or your fear of losing routinely cause you to make poor trading decisions, a mechanical system may be a better choice for you. An automated approach tends to reduce the stress and anxiety that arise when you have to make difficult decisions quickly. As such, you can make and execute trading decisions in a consistent, methodical way. A mechanical trading system also enables you to automatically include rigorous money management protocols in your trading methodology. Another benefit of the mechanical approach is having the ability to thoroughly test the system. Through testing you can confirm whether your trading system performs the way you expect it to and explore ways to improve your system before actually committing your trading capital. You can adjust and fine‐tune your system after seeing the test results. Unfortunately, fine‐tuning your system may lead to other problems.