Day trading consists of buying and selling the same securities within one day. It’s not investing, per se, but capitalizing on the price movements found within a 24-hour period and making money that way.
Swing trading tries to capture gains in a financial instrument within an overnight hold to several weeks. Swing traders normally use technical analysis to look for stocks with short-term price momentum.
Advantages of Day Trading
- Potential to make substantial profits: The biggest lure of day trading is the potential for spectacular profits. But this May only be a possibility for the rare individual who possesses all the traits—such as decisiveness, discipline and diligence—required becoming a successful day trader.
- Be your own boss: The day trader works alone, independent from the whims of corporate bigwigs. He can have a flexible working schedule, take time off whenever needed, and work at his own pace, unlike someone on the corporate treadmill.
- Never a dull moment: Long-time day traders love the thrill of pitting their wits against the market and other professional's day in and day out. The adrenaline rush from rapid-fire trading is something that not many traders will admit to, but is a big factor in their decision to make a living from trading, compared with spending their days selling widgets or poring over numbers in an office cubicle.
- Expensive education not required: For many jobs in finance, having the right degree from the right university is a prerequisite just for an interview. Day trading, in contrast, does not require an expensive education from an Ivy League school. While there are no formal educational requirements for becoming a day trader (see Best Undergraduate Degrees for Day Traders), courses in technical analysis and computerized trading may be very helpful.
- Self-employment benefits: As a self-employed individual, a day trader can write off certain expenses for tax purposes, which cannot be claimed by an employed individual.
Advantages of Swing Trading
- Does not have to be your full-time job: Anyone with the knowledge and investment capital can try swing trading. Because of the longer timeframe (from days to weeks as opposed to minutes and hours), trades do not have to be constantly monitored. A swing trader can even maintain a separate full-time job (as long as he or she is not checking trading screens all the time at work).
- Potential for significant profits: Trades generally need time to work out, and keeping a trade open for a few days or weeks may result in higher profits than trading in and out of the same security multiple times a day.
- Constant monitoring not required: The swing trader can set stop losses in place. While there is a risk of a stop being executed at an unfavourable price, it beats the constant monitoring of all open positions that is a feature of day trading.
- Less stress and risk of burnout: Since swing trading is seldom a full-time job, there is much less chance of burnout through stress. Swing traders usually have a regular job or other source of income from which they can offset or mitigate trading losses.
- Expensive investment not required: Swing trading can be done with just one computer and conventional trading tools. It does not require the state-of-the-art technology of day trading.
Forex (or FX) means foreign exchange. What exactly does this involve? Exchanging one currency for another – it’s as simple as that. With a daily turnover of over 5 trillion US dollars, the Forex market is the largest financial market in the world. As a comparison, New York Stock Exchange only has 22.4 Billion US dollars as average daily trading volume.
When Can I Trade Forex?
The forex market is open for 24 hours, 5 days a week – Monday to Friday. Trading begins with the opening of the market in Australia and continues to Asia and Europe, followed by the USA until the markets close.
How Do I trade on Forex?
Generally, traders and investors buy (long position) the financial instrument when they think the value of it will increase, or sell (short Position) when the expectation for the value is to decrease. Forex Traders do both simultaneously. For example, opening a long position on EUR/USD currency pair means buying Euros and selling US dollars at the same time.
In the currency pair, the currency on the left is called the BASE currency. This is the currency you wish to buy or sell; the one on the right is the QUOTE currency, and is the one you use to make the transaction.
What are the most popular currencies?
So called "The Majors" are the most heavily traded currencies: EUR (Euro), USD (US Dollar), JPY (Japanese Yen), GBP (Great British Pound), AUD (Australian Dollar), and lastly CHF (Swiss Franc).
What is "Pip"?
PIP is a very commonly used term for forex traders and stands for "Price Interest Point”. This is the basic and most important unit of measurement in forex. PIP usually refers to the 4th digit after the decimal point in the price of a currency pair.
What is a "Spread"?
Spread is the transaction fee while trading on currencies. The broker executes a trade at a slightly higher Buying price and lower Selling price than the actual market rate. Therefore, the difference between the selling (bid) price and Buying (ask) price is called spread and it is measured in PIPs.
What is a "Leverage"
Leverage allows individual investors to trade on Forex market without high capital. Merit Forex gives traders leverage of up to 400 on currency pairs. This means that trader's account balance is multiplied by 400 to open a trading position. Without leverage trader needs to have minimum $100,000 on the account to open a trade of 1 lot. With a leverage of 100 on the account as an example, trader can buy 1 lot of a currency with only $1000.
Check the complete Forex Glossary here Glossary
Register now to get the Personal Coach for professional Forex education Real Account.
Fundamental analysis is helpful for making trading decisions. On the FOREX market, it is mainly influenced by economic indicators such as national monetary policy and financial forecast, as well as central bank statements.
Advocates of fundamental analysis claim that a country’s economic situation is enough to determine the movement of its currency value. Thus, an abrupt change in an economic indicator will have a knock-on effect on the financial market. This point of view is also applied to stock value, which is believed to be influenced by the company’s performance, business plan and financial conditions. Share prices are also dependent on statements by the company’s president or CEO regarding the financial outlook of the company, as well as on the quarterly financial reports.
All these economic factors certainly influence the market, although their effects are largely short-termed. Following the publication of important news or during a statement by a central bank’s president, there may be a few minutes of abrupt market fluctuations.
As Gold is one of the most traded financial instruments, the fundamental analysis is used to predict its price movements. Being a precious metal, gold is typically considered a safe haven in times of crisis and uncertainty. Thus, when unfavourable data is released about the global economy, and by the US in particular, the price of gold can be expected to rise. An inverse correlation exists between the value of the US dollar and that of the gold. If the news about the US economy is positive, the dollar rises against other major currencies, and gold drops. However, if the economic situation in the US deteriorates, it is expected the price of gold to increase as traders seek safe investments.
Economic indicators are published independently by each country, but are more or less the same in nature. They have the greatest impact on the currency of the country they concern. Depending on the trading instruments, the investors have to closely monitor the news which would directly affect their positions.
There are three possible impact levels: low, medium and high. Economic indicators marked as high impact have the greatest impact on the financial markets. These include statements by leading economists and politicians, as well as monetary policy decisions and reports issued by the country’s central bank. Those marked as medium are important economic statements, which have less effect on the financial markets than those marked high. Those labelled low generally have little impact on the financial markets.
Other important indicators considered by the fundamental analysis are: unemployment, inflation, GDP, balance of trade.
A decrease in unemployment means that the country’s economic situation has improved. As a result, the national currency of that particular country is expected to rise against the other currencies. For example, if US unemployment data shows a decrease in unemployment over the last month, the US dollar is likely to increase in value against the other major currencies. Therefore, a drop in US unemployment is a good signal to purchase the US dollar.
A country’s level of inflation is measured by the Consumer Price Index (CPI). The CPI measures the change in price of a variety of everyday essentials, such as food, clothing, rent and medical care.
An increase in inflation means that more funds are needed to purchase the same consumer goods in the country. This means that if the CPI increases, then the country’s currency can also be expected to rise. For example, if inflation in the Eurozone increases, the demand for the euro will also grow, as consumers will need more money to purchase the same goods as before.
Thus, a reasonable increase in inflation has a positive impact on a country’s currency and economy, since it boosts consumer spending and results in an increase in the Gross Domestic Product (GDP). A decrease in inflation can have a very negative impact on a country’s economy: if costs are low, people will generally limit their spending, expecting the decline to continue.
Gross Domestic Product (GDP) measures the total production in a country or region over a period of time. GDP can be estimated by using three different approaches: expenditure, income and production.
In the United States, GDP represents the market value of goods and services produced by the US labour force in the United States. GDP is the sum of gross private sector investment; personal consumption expenditure, expenditure on goods and services; the net export of goods and services, the amount of exports minus the amount of imports; and government expenditure and gross investment. There are three versions of GDP published every month: preliminary, revised and final.
In the Eurozone, Gross Domestic Product is calculated by adding together the values of all goods and services produced.
Since GDP is a measure of an economy’s growth, it is not surprising that an increase in GDP has a positive impact on the value of a country’s currency.
Broadly speaking, the balance of trade is the difference between a country’s exports and imports. It can also be explained as the net export of goods and services. When a country’s exports exceed its imports, there is a trade surplus.
However, when a country imports more goods than it exports, there is a trade deficit. Figures are given in the respective country’s currency.
As every country is dependent on international trade, information regarding a country’s balance of trade can provide an insight into economic growth and currency valuations. A trade surplus inevitably leads to an increase in the currency’s value. For example, if Germany posts a trade surplus, the value of the euro will increase.
A country’s currency is largely dependent on its monetary policy. Monetary policy is determined by a country’s central bank and aims to ensure price stability. Whenever a central bank raises interest rates, this is generally perceived as a sign of economic growth. This, however, is not valid in situations of extreme inflation, known as hyperinflation.
The main central banks are:
The US Federal Reserve
The US Federal Reserve is responsible for controlling the availability and value of the US dollar, as well as for ensuring the stability of the US financial system.
The Federal Reserve was established in 1913 and controls the three components of US monetary policy: open market operations, interest rates and minimum reserve requirements. The Federal Reserve Board of Governors is responsible for setting interest rates, which are then applied to commercial banks and other financial depository institutions, and minimum reserve levels, i.e. the funds that a depository institution must hold in its reserves. The Federal Open Market Committee (FOMC) is responsible for monitoring the purchase of government securities. The FOMC consists of 12 members who meet eight times a year to discuss monetary policy.
By using these three instruments, the Federal Reserve is able to influence the supply and demand of the US dollar. For example, a change in the base interest rate, the rate at which the Federal Reserve lends money to commercial banks, affects numerous areas, such as commercial interest rates, the availability of credit and unemployment.
The European Central Bank (ECB)
The European Central Bank is responsible for setting the monetary policy within the Eurozone and maintaining the stability of the euro. The ECB’s goal is to maintain inflation levels below, but close to, 2%.
The ECB has the exclusive right to issue banknotes within the EU and, as the sole entity responsible for the amount of money in circulation, is responsible for determining lending conditions to commercial banks. Thus, the ECB controls the conditions under which commercial banks trade with each other. It also has the power to set interest rates and, as a result, influence the interest rates offered on loans and deposits by commercial banks.
Bank of England
The Bank of England is responsible for keeping inflation close to the target determined by the Monetary Policy Committee. The Bank’s main objective is to ensure financial stability in the United Kingdom. To do this, it keeps inflation close to the 2% target level and has the power to change interest rates at any time.
Bank of Canada
The Bank of Canada (Banque du Canada in French) controls monetary policy within Canada and was established to promote the economic and financial welfare of Canada. This is accomplished through, amongst often things, altering the ‘overnight rate’, the interest rate at which financial institutions borrow money overnight before paying it back, with interest, the next day. The purpose of the Bank’s monetary policy is to maintain a stable level of annual inflation. Since 1995, the target level of inflation has been between one and three percent.
Bank of Japan
The Bank of Japan is responsible for ensuring the stability of the Japanese yen. Through monetary policy, it can influence the amount of yen in circulation and the country’s interest rates. Decisions on changes to Japan’s monetary policy are made during meetings of the Monetary Policy Board (MPB). The Bank’s governor, who is also chairman of the MPB, also gives a press conference to provide details on the decisions made.
Reserve Bank of Australia
The Reserve Bank of Australia (RBA) is, like all the other central banks, responsible for monetary policy decisions. The main objective of RBA is to control inflation. Monetary policy decisions are taken by the Reserve Bank Board. Any decisions made during the meeting are published on the Bank’s website. Any changes to interest rates become effective the day after the meeting.
Statements made by leading politicians and representatives of financial institutions also form part of fundamental analysis. Policy makers’ views on a country’s economic state and outlook can substantially impact the financial markets. During speeches, traders look for hints that the market may move in a different direction to the one forecast or for indications about the central bank’s future decisions. Should such a signal appear, the markets can become extremely volatile?
The central banks of the world’s major economies have the power to influence global financial markets to a great degree. One example of this is the global financial crisis in 2008. On 8 October 2008, the central banks of the United States, the UK, the eurozone, Canada, China, Switzerland and Sweden cut interests rates in order to combat the consequences of the financial crisis. Later, they cut interest rates further to almost 0%, and invested huge amounts to support the collapsing economies. The stimuli packages, called ‘quantitative easing’, consisted of bond purchases. These unprecedented actions which helped preserve the financial system, also triggering significant movements in the financial markets.
The financial markets are also dependent on the global geopolitical situation. Geopolitical uncertainty normally makes investors opt for secure assets, such as gold. During periods of political tension and military threats there is usually a leap in the price of gold.
Precious metals and the Japanese yen are commonly considered as safe havens for investors. In times of crisis, it is normal to see a decline in the USD/JPY currency pair, while the USD appreciates against all other major currencies. It is also normal to witness a general decline in the stock market.
Geopolitical events can also impact the price of commodities. For example, tension in the Middle East, where most oil producers are located, typically threatens supplies and, therefore, leads to a rise in the price of oil.
Natural disasters are another factor which influence the market. A recent example is the earthquake, and subsequent nuclear disaster, near Fukushima, Japan. The crisis led to a sharp rise in the yen. This caused the Bank of Japan to conclude an agreement with other central banks, under which they bought euros and sold Japanese yen in order to reduce the value of the yen and alleviate the disaster’s negative consequences.
Leverage – Leverage is the ratio between the amount needed to open a position and its actual amount. In essence, this means you can use less money than the transaction would normally require. Merit Forex offers leverage of 1:400 for currency pairs, which means that each £1 you deposit has a potential value of £400.
Example: Therefore, if you deposit £500, you can trade with £100,000 (500 deposit x 1:200 leverage = 100,000). Using leverage gives traders the opportunity to achieve a better result with limited funds, while the potential losses are restricted to the amount deposited.
Leverage with Merit Forex for different instruments:
Stocks and ETF's 1:20
Indices commodities 1:50
Crypto Currencies 1:20
Margin – Margin is the amount that allows you to open a position whose value is greater than your deposit. A 0.5% margin requirement means that only 0.5% of the total traded amount is needed to open a position. For example, if you want to open a position with £10,000, you only need to cover 0.5% of this amount (for 0.5% margin requirement) – that is, £50. This amount is blocked, and cannot be used, as long as the trade remains open.
Exchange Rate – An exchange rate is the current price of one currency expressed in another. For example, the price of one euro in U.S. dollars. A EUR/USD exchange rate of 1.0950 means that for every euro you must pay 1.0950 dollars. Exchange rates fluctuate constantly in response to the current state of the market.
‘Buy’ and ‘Sell’ Rates – Each financial instrument has two prices: a ‘buy’ and a ‘sell’ price. The ‘sell’ price is always lower than the ‘buy’ one. If you believe the price of an instrument will increase, use the ‘buy’ rate, and vice versa for the ‘sell’ rate. The difference between the two prices is known as the spread.
Spread – The spread is the difference between the ‘buy’ and ‘sell’ prices. The spread is, in essence, the fee that traders pay to the broker for opening a position on their behalf
CFD "Contract for Difference" is a transaction with a financial instrument which expresses the right to use only the difference in the market price in order to gain profit. The client does not receive the product in real. Only he uses the opportunity to buy and sell when the price is moving.
Lot - a specific quantity of a financial instrument that can be traded. Each company determines what should be. For example, with Merit Forex 1 lot for Forex is 100 000 units.
Minimum Quantity – The minimum quantity is the smallest amount that can be traded. Each broker determines their own minimum quantity; for example, at Merit Forex, the minimum quantity for currency pairs is 0.01 lots (1,000 units).
Pip (percentage in point) – A pip is a unit of change in exchange rates. A pip is the fourth digit after the point in exchange rates and is equal to 0.0001. In transactions involving the Japanese yen, it is equal to 0.01, as JPY quotes have just two decimal positions rather than the usual four. For example, if the price of the EUR/USD currency pair rises from 1.0950 to 1.0953, the increase is three pips (0.0003). With a currency pair involving the Japanese yen, such as USD/JPY, if the price drops from 102.11 to 102.01, the decrease is 10 pips (0.10).
Liquidity – A liquid market is a market with many participants conducting a large number of transactions. The greater the number of transactions, the more liquid the market is. A liquid market enables traders to execute transactions faster, as there are many buyers and sellers.
Volatility – Volatility is a measure of the changes in an instrument's price over time. The more an instrument’s price changes, the more volatile the market is.
Interest Rate Swap – Interest rate swap is a small amount of money charged or received for keeping a position open overnight. At 22:00 (GMT), positions are transferred from one day to the next, and the amount is charged or received. It depends mostly on the base interest rates of the countries whose currencies the positions involve. The interest rate swap can be positive or negative, meaning it can either be added to, or taken from, your amount; this depends mainly on the direction of the trade – whether you have bought or sold.
Islamic account - a type of an account that is swap-free
Trend – A trend is the direction of the market movement. If the price of an instrument increases for a prolonged period of time, this means there is an upward trend. Conversely, if the price falls for a prolonged period, the trend is a downward one. If the price is going neither up nor down, the market is said to be ranging, meaning there is no clear upward or downward trend.
Correction – A correction is a brief change in market direction against the prevailing trend. For example, if a financial instrument has been rising in price and then suddenly falls for a short period of time before continuing its upward trend, this short decrease is known as a correction.
Bar chart - A type of chart in which the top of the vertical line indicates the highest price, and the bottom – the lowest price over a given period. The closing price is displayed on the right side of the bar, and the opening price – on the left side of the bar.
Candlestick chart - A graphic image that displays the movement of a financial instrument over a period of time, including opening, closing, highest, and lowest price. The ‘body’ of the candlestick is formed by the opening and closing price, and its color depends on whether the closing price was higher or lower than the opening price. Also known as ‘Japanese candlestick’.
Scalping – Scalping is a strategy used by some FOREX traders and consists of buying or selling a financial instrument for a short period of time in hope of a quick result.
Commodities - They include food, cereals and metals that investors buy or sell, usually via futures contracts. Most favorite ones are Gold, Oil and Gas.
Futures - A standardized contract for the delivery of goods, shares, currency, or indexes at a fixed price and time in the future
Equities - These are shares or stocks that are published by the bigger companies in a particular country. People that are trading with equities are long-term traders and in order to do this they should invest much more money.
Indexes - The index is an imaginary portfolio of stocks/shares representing a particular market or a portion of it. It is presenting the economy of a country and you could follow the domestic development by the price of the index.
Broker - A company or individual acting as an intermediary between the seller and buyer in return for some commissions. In most cases, a license is required.
ECN Broker - A company that provides direct access to the financial market through ECN accounts. It means that the spreads are tighter than in the classic accounts. Usually the clients pay commissions for trading through an ECN account.
STP Broker - A company that is not trading against the clients’ interest. This type of the broker forwards all the clients’ positions/trades in a bigger company or a bank in order to meet all clients’ profits. The STP broker does not carry a risk for the result of the clients’ trades.
Market maker - A company that is not obliged to forward the clients’ positions. It is up to the broker whether to do this or not. It carries the risk for the result of the clients’ trades.
Margin call - A broker's demand to the trader to deposit additional money or securities when the amount has reached the minimum maintenance margin.
Stop out - The moment when all your open positions are closed due to insufficient margin. The level for Stop out with Merit Forex is 10% of the margin,
Market order - An order to purchase or sell a financial instrument at the best available current price.
Pending order - An order to purchase or sell a financial instrument at a specific price in the future.
Stop loss order - A pending order determining the price for the purchase or sale of a given financial instrument in a direction opposite to the open position, in order to minimize the loss.
Take profit order - A pending order determining the price for buying or selling a given financial instrument in the direction of the open position, in order to make a profit.
Slippage - executing the order at a rate different from the requested one.
Long positions – positions in which you buy a financial instrument
Short positions – positions in which you sell a financial instrument
Bull market – a market in which the price increases
Bear market – a market in which the price declines
Bid price - this is the sell price
Ask price - this is the buy price
Federal and state governments have a myriad of agencies in place that regulate and oversee financial markets and companies. These agencies each have a specific range of duties and responsibilities that enable them to act independently of each other while they work to accomplish similar objectives. Although opinions vary on the efficiency, effectiveness and even the need for some of these agencies, they were each designed with a goal in mind and will most likely be around for some time.
With that in mind, the following article is a complete review of each regulatory body.
Australian Securities and Investments Commission (ASIC)
The ASIC is an independent Commonwealth Government body established by the Australian Securities and Investments Commission Act (ASIC ACT). The ASIC Act requires the ASIC to:
- Maintain, facilitate and improve the financial system*'s performance;
- Promote confident and informed investor participation;
- Administer and enforce the law effectively and efficiently
- Process and store information efficiently and quickly;
- Make information regarding companies and other bodies public in a timely manner.
Cyprus Securities and Exchange Commission (CYSEC)
CySEC is the Cyprus financial regulatory agency (Cyprus Securities and Exchange Commission). Brokers who are licensed by CySEC come under European MiFID regulation, meaning they are qualified to operate in EU countries – which is good for the brokers, of course, but even better for traders, because it requires licensed brokers to adhere to all relevant EU regulations. CySEC’s main mission is the protection of investors, and regulated brokers must meet a set of criteria to become and remain licensed. There are disciplinary frameworks in place to enforce the rules, and strict penalties for non-adherence.
Germany - Federal Financial Supervisory Authority (BaFin)
The Federal Financial Supervisory Authority (German: Bundesanstalt für Finanzdienstleistungsaufsicht) better known by its abbreviation BaFin is the financial regulatory authority for Germany. It is an independent federal institution with headquarters in Bonn and Frankfurt and falls under the supervision of the Federal Ministry of Finance (Germany). BaFin supervises about 2,700 banks, 800 financial services institutions and over 700 insurance undertakings.
Belize - International Financial Services Commission
The International Financial Services Commission (IFSC) is the Belize government agency responsible for financial regulation. It is responsible for regulating all financial market participants, exchanges and the setting and enforcing of financial regulations. Number of international online trading brokers obtain their international license from IFSC.
IFSC was established in Belize in 1999. The aim of the Commission is licensing of financial companies, as well as controlling and supervision of all regulated firms to bind all international financial services requirements to their activity. IFSC is regulated by the Ministry of Belize Securities and International Financial Services Commission Act. IFSC functions on a special Code of conduct, which is aimed to increase considerably the level of services provided by the licensed company under the International Financial Services Commission.
New Zealand - Financial Markets Authority (FSP)
A relative newcomer within the worldwide establishment of government bodies overseeing financial services companies, the New Zealand Financial Service Providers’ Register (New Zealand FSP) was established in the latter part of 2010, when it began accepting applications for registration. This opened up great possibilities for unregulated OTC brokers, as well as new start-ups with an interest in the Asia/Pacific (APAC) region to accrue customer confidence in a respected territory without the bureaucracy and timescale usually associated with applying for regulation within other Western countries.
Financial Conduct Authority (FCA)
The regulator of the financial services industry in the United Kingdom. The Financial Conduct Authority (FCA) has the strategic goal of ensuring that the relevant markets in the U.K. function well. It has three operational objectives in support of this strategic goal – to protect consumers, to protect and enhance the integrity of the U.K. financial system and to promote healthy competition between financial services providers in the interests of consumers. It was established by the Financial Services Act that came into force on April 1, 2013.
NATIONAL FUTURES ASSOCIATION (NFA)
The independent self-regulatory organization for the U.S. futures market. NFA membership is mandatory for all participants in the futures market, providing assurance to the investing public that all firms, intermediaries and associates who conduct business with them on the U.S. futures exchanges must adhere to the same high standards of professional conduct. The NFA operates at no cost to the taxpayer, as it is financed exclusively by membership dues paid by members and assessment fees paid by users of futures markets. The national headquarters is in Chicago and there is an office in New York.)
Autorité de Controle Prudentiel (France) (ACPR)
The French Prudential Supervision and Resolution Authority (Autorité de contrôle prudentiel et de résolution - ACPR) is an independent administrative authority, which monitors the activities of banks and insurance companies in France. It operates under the auspices of the French central bank, Banque de France.
The Comisión Nacional del Mercado de Valores (CNMV) is the agency in charge of supervising and inspecting the Spanish Stock Markets and the activities of all the participants in those markets.
CNMV was created by the Securities Market Law, which instituted in-depth reforms of this segment of the Spanish financial system. Law 37/1998 updated the aforementioned Law and established a regulatory framework that is fully in line with the requirements of the European Union and favours the development of European Stock Markets.
The stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. Also known as the equity market, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership in the company. The stock market makes it possible to grow small initial sums of money into large ones, and to become wealthy without taking the risk of starting a business or making the sacrifices that often accompany a high-paying career.
Dividends: A dividend represents the distribution of profit amongst shareholders. As the Merit Forex PRO platform offers CFD trading, traders who have bought shares of a company that subsequently issues a dividend will not receive any additional profit, although the dividend payment will be added to their account. This is because each time a dividend is paid, the company’s share price drops by the estimated value of said dividend. Thus, there is no overall change.
If investors have an open short position when a company decides to pay a dividend, it will be automatically deducted from their account, depending on the number of shares sold. However, since the price will fall after the dividend is distributed, they will neither gain nor lose from this.
Each company has its own dividend policy and the decision to pay dividends is made by its management.
The January Effect: Large publicly traded companies are required to publish financial statements, usually on a quarterly basis. In the last quarter of the year, many companies, increase their spending intentionally, in order to reduce profits. This is a common tax avoidance measure, since the higher the profit, the more taxes the company has to pay. This increased spending has a negative effect on the quarterly financial statement and results in a drop-in share price at the end of the year. Typically, in January stock prices manage to compensate for and even surpass their end-of-year level.
IPO: : IPOs are one of the most thrilling and promising financial phenomena available on the stock exchange. Sometimes called initial public offerings – IPOs for short – or just stock issues, they often produce once in a lifetime opportunity for big profits for the little guy sitting on his couch at home who buys a stake in the stock of a new company fresh off the press.
Stock traders: Individuals or entities engaging in the trading of equity securities, or the transfer of financial assets in any financial market, either for themselves, or on behalf of someone else. They operate in the capacity of agent, hedger, arbitrageur, speculator or investor.
Stock investors: Individuals or entities who use their own money to purchase equity securities, which offer potential profitable returns in the form of interest, income or appreciation in value (capital gains).
Stock investors: Stock investors are the market participants whom the general public most often associates with the stock market. They rely primarily on fundamental analysis for their investment decisions and fully recognize stock shares as part ownership in the company. Many investors believe in the buy and hold strategy, which, as the name suggests, implies that investors will buy stock ownership in a corporation and hold onto those stocks for the very long term, generally measured in years.
These investors, who purchase shares of a company for the long term with the belief that the company has strong future prospects, typically concern themselves with two things:
Value - Investors must consider whether a company's shares represent a good value. For example, if two similar companies are trading at different earnings multiples, the lower one might be the better value because it suggests that the investor will need to pay less for $1 of earnings when investing in Company A, relative to what would be needed to gain exposure to $1 of earnings in Company B.
Success - Investors must measure the company's future success by looking at its financial strength and evaluating its future cash flows.
Both of these factors can be determined through the analysis of the company's financial statements along with a look at industry trends. At a basic level, investors can measure the current value of a company relative to its future growth possibilities by looking at metrics such as the PEG ratio - that is, their price earnings (value) to growth (success) ratio.
Stock traders: Stock traders are market participants, either an individual or firm, who purchase shares in a company with a focus on the market itself rather than the company's fundamentals. A stock trader usually tries to profit from short-term price volatility with trades lasting anywhere from several seconds to several weeks. The stock trader is usually a professional. Persons can call themselves full- or part-time stock traders/investors while maintaining other professions.
Markets involved in the trade of commodities are beneficial to a stock trader’s strategy. After all, very few people purchase wheat because of its fundamental quality - they do so to take advantage of small price movements that occur as a result of supply and demand. Stock traders typically concern themselves with:
Price patterns - Stock traders will look at past price history in an attempt to predict future price movements. This is known as technical analysis.
Supply and demand - Traders keep close watch on their trades intra-day to see where money is moving and why.
Market emotion - Traders play on the fears of investors through techniques like fading, where they will bet against the crowd after a large move takes place.
Trader support - Market makers (one of the largest types of traders) are actually hired to provide liquidity through rapid trading.
Ultimately, it is traders who provide the liquidity for investors and always take the other end of their trades. Whether it is through market making or fading, traders are a necessary part of the marketplace.
Clearly, both traders and investors are necessary in order for a market to function properly. Without traders, investors would have no liquidity through which to buy and sell shares. Without investors, traders would have no basis from which to buy and sell. Combined, the two groups form the financial markets as we know them today.
A blue chip is a nationally recognized, well-established and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions. This helps to contribute to their long record of stable and reliable growth.
A penny stock typically trades at a relatively low price and has a small market capitalization, usually outside of the major market exchanges. These stocks are generally considered highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. They often trade over the counter through the OTCB Band pink sheets.
You have probably noticed that the instruments’ prices move in a zigzag pattern, whether upwards, downwards or without any specific direction. After a big increase, there is often a decline before the price recovers its original direction. This temporary decline in price is known as a correction. The same happens in the reverse direction: a steep decline followed by a small increase and then a continued downward movement in price. Some traders like to focus on, and trade, these types of adjustments by using the Fibonacci sequence.
The Fibonacci sequence was discovered in the 13th century by Leonardo Fibonacci, an Italian mathematician. It is based on a sequence of numbers, each of which is the sum of the two numbers which precede it: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597.
The importance of the Fibonacci sequence lays not in the numbers themselves but rather in the ratio between them. Each number is approximately 1.618 times greater than the number before it.
By using the Fibonacci sequence, it is possible to create a series of different percentages. The most important of these is 61.8%, which is also known as the ‘gold level’. This percentage is obtained by dividing a number in the sequence by the number which follows it. For example, 21/34 = 0.6176.
The two other main percentages are 38.2%, obtained by dividing a number in the sequence by the number two placed to its right i.e. 55/144 = 0.3819, and 23.7%, obtained by dividing a number in the sequence by the number three places to its right i.e. 13/55 = 0.2363.
By separating a large price movement into the above levels, you can expect that an adjustment will occur between 38.20% and 61.80% before continuing in its original direction.
These numbers play an important role in the FOREX market just as they do in nature. For example, the height of the Egyptian pyramids is 61.80% of the length of the base. The Fibonacci sequence can also be found in the arrangement of leaves, the rings in a tree trunk and the distance between the planets, as well as in many other places.
The support and resistance levels are price barriers that an instrument has reached at least twice but has failed to break.
Support levels are below the current price and act like a brake on the downward movement. Once the price reaches the support level, buying pressure increases, a large number of traders buy and the price rebounds. Conversely, resistance levels are above the current price and act as a barrier to a continued price increase. When the resistance level is reached, it usually prevents any further increase. If the resistance level holds, and the price rebounds, it is a good signal for traders to sell.
It is possible for support and resistance levels to be either horizontal or slanted. To draw support and resistance levels, you need at least two points, the highest or lowest values reached by the instrument over a time period. When the line is reached for a third time, you should experience the support and resistance effects, as described above.
In the absence of a clear trend, it is better to use horizontal support and resistance levels. This will allow you to easily determine the price range and get a good idea of when to expect a rebound from these levels. When the price approaches the support line, it is completely normal for the price to rebound and continue to move towards the first level of resistance you have identified.
However, when the movement direction is obvious, then the support and resistance levels slope and outline trends. In an upward trend, the support and resistance lines ascend and they are based on two or more of the lowest or highest points of the trend. Each point should be higher than the previous one. It is completely the opposite for the downward trend.
It is extremely important to draw these levels on a chart using a time period appropriate for your trading style, otherwise you may receive false signals. For example, if you prefer to keep long-term positions, you should draw your support and resistance levels on a 4-hour or 1-day chart.
What happens when the support and resistance levels are broken?
If the support level is broken during an upward trend, this is a potential sign for a reversal of the current trend; it is likely that the price will begin to decrease. In this situation, it is considered a breakthrough when a candle closes with its body below the line. If there is a downtrend and a candle closes with its body above the resistance level, then it is generally assumed that the downward trend is coming to an end and that an increase in price is likely. Breakthroughs do not only signal trend reversal, but can also confirm the current trend. For example, if the price of an instrument increases and reaches a strong resistance level, a potential breakthrough will prove that the increase will continue. Conversely, when a downward price breaks through a stable support level, the decline will continue.
Forecasting price movements and reading charts helps you better understand and know an instrument’s price trend. If the price of an instrument has increased for a period of time, the market is experiencing an uptrend. Similarly, if the price has fallen over a period of time, the market is experiencing a downtrend. If, however, the price is fluctuating within a narrow band, with no clear uptrend or downtrend, then the market is said to be ranging.
Following the trend is one of the most popular trading strategies. The fundamental rule is to always follow the trend and never trade against it. This means that when the price is rising, you should buy the instrument, expecting it to continue its trend alongside most market participants. Sometimes, trends in the currency and stock markets last a long time, even years.
Technical analysis is one of the tools used by traders to anticipate price movements. It is based on past data and uses three basic principles:
- the price shows everything; it is believed that all the trader needs is the price, and all other information is ignored.
- there is a trend in the price movements. Once a trend has been established, it is believed future price movements are more likely to follow, rather than move against, the trend.
- historically, everything repeats again and again. According to market psychology, traders are likely to respond in the same way when presented with similar market conditions.
This means that traders need to have basic information on how an instrument’s price has fluctuated over time in order to project future movements. In short, technical analysis focuses on interpreting charts, and the underlying belief is that market movements follow a pre-determined logic with recurring patterns.
Charts are fundamental to technical analysis and reflect the price movements of a financial instrument over a period of time. The horizontal x-axis shows time, while the vertical y-axis shows the price. Thus, each point of the price movement has two characteristics – the price value and the time when it was reached. That is why it is so important for traders to be able to use graphs efficiently.
The time frame used to display information on the chart will change depending on which time period you select. Naturally, each time frame reflects the price movements over a certain period. The smallest time period is one minute, meaning that every element of the chart contains price information for the respective minute. The other time periods are 5, 15, 30 minutes, 1 or 4 hours, a day and a week. The longer the time period, the more information will be displayed on your screen.
Usually, the period you choose to make your analysis depends on how long you expect to hold the position i.e. whether you trade long, medium or short-term. If you plan to keep your positions open for a longer period time, it is best to use the four-hour, daily or weekly charts. If, however, you prefer a riskier investment strategy and want to quickly enter and exit the market, then your analysis would, normally, be based on 5-minute, 30-minute, or hourly charts.
There are several types of charts ‒ line charts, bar charts, and the most commonly used chart, the Japanese Candlestick.
The first, and by far the simplest type, is the line chart. It displays the closing prices, which some traders believe to be the most important piece of information, for each time period, interconnected to form a continuous line. For example, when using 10-minute intervals, the closing price at the end of every 10-minute section will be used to form the chart. Although simple, a line chart gives traders a general idea of how the price has moved over time.
Bar Charts are another widely used chart type. They are largely identical to Japanese Candlesticks, but differ visually. They have no bodies, but tiny horizontal lines that represent the period’s opening and closing prices. The opening price is on the left-hand side of the bar, while the closing price is on the right. A bar chart provides significantly more information than the line chart; nevertheless, Japanese Candlesticks are much more widely used.
This type of chart is composed of individual elements, known as “candles”. Each candle contains information about the opening and closing prices, as well as about the highest and lowest levels reached during the selected time period. If the price has risen over the time period, the candle will be green. If it has fallen, the candle will be red.
Each candle is made of a body and shadows, also known as tails. The body displays the opening and closing prices, while the shadows reflect the highest and lowest prices reached. Candles display information for a specified time interval. If your chosen time period is one day, every candle represents the price movement over a day; likewise, if you select one hour, every candle corresponds to a 60-minute period.
It is generally assumed that the longer the candle’s body, the greater the price movement and the greater the buying or selling pressure. Likewise, short candles indicate only a small movement.
Japanese Candlestick charts are the most commonly used form of technical analysis. This is due to the fact that they provide much more information regarding an instrument’s price movement than a line chart and form various shapes which can be used to predict market movement.
In conclusion, it can be said that candles provide a unique visual representation of market dynamics, thus facilitating the interpretation of price-related information.
Since one of the fundamental rules of technical analysis is that history repeats itself, it is not surprising to observe recurrent price models, or ‘figures’. It is believed that the appearance of figures implies a movement in the market. Broadly speaking, there are two types of figures – ones that lead to a reversal in the direction of the market, and ones that confirm the trend and support its movement.
There are a few basic rules regarding figures:
• Before any figure forms, it should be preceded by a clearly defined trend;
• The bigger and more clearly defined the figure is, the greater the potential of the upcoming movement;
• The first, and most common, signal that a figure will form is the breaking of an important support or resistance level;
• The figures formed at a movement’s peak are usually shorter time-wise and more volatile that the figures that form at the bottom;
• The figures formed at the bottom of a trend usually span a smaller price range and need significantly more time to form the figures that form at the movement’s peak.
Head and shoulders
The most famous figure in technical analysis, and also the most difficult one to form, is the ‘head and shoulders’ formation. As the name suggests, the figure itself looks like a head and a pair of shoulders; it consists of three peaks, the head being the highest of the three, with the two shoulders on either side of it, although it is not necessary for the shoulders to be at exactly the same level. The figure’s bottom line is known as the neck line.
Usually, the head and shoulders formation occurs during an upward movement and its appearance signals a reversal in the market. Traders usually sell once the price level reaches the neck. In this situation, a Take Profit order should be placed at a distance equal to the distance between the highest point of the head and the neck. In order to limit potential losses, a Stop Loss should be placed at a level equal to the highest point of the second shoulder.
In rare cases, it is also possible to experience a head and shoulders figure in a downward trend. This is known as an ‘inverted head and shoulders’ formation, since it points downwards rather than upwards. An inverted head and shoulders is considered a signal to buy, and where you position your Take Profit order and Stop Loss should be determined in the same way as with a regular head and shoulders formation, albeit in reverse.
Double top/double bottom
These figures occur relatively frequently and are formed during both upward and downward price movements. The top figures are identical; the double top consists of two consecutive peaks in an upward trend, and the double bottom consists of two consecutive lows in a downtrend.
A double top resembles the letter M. It is formed during an upward movement when the price meets the resistance level but fails to break through, forming the first peak. In its next rise it again fails to break through the resistance level, creating the second peak. The two peaks show that the power of the buyers has been completely exhausted. This is a fairly common pattern and is highly reliable.
The rules for trading regarding double tops are exactly the same as those for head and shoulders formations. A short position should only be entered into when the support level has been broken. Normally, the Take Profit should be equal to the distance between the support and resistance levels. It is advisable to place a Stop Loss just above the support level; as once it has been broken it will become a resistance level.
A double bottom is formed during a downward trend and resembles the letter W. The lines of support and resistance are reversed, but the rules for opening positions are the same as for the double top. The only exception is that the position will be long rather than short.
Triple top/triple bottom
This figure is a combination of the previous two: head and shoulders and double top/double bottom. It is, in effect, a type of head and shoulders formation with the exception that all of the peaks, or bottoms, are at the approximately same level. If it does occur, although it is rarely seen, you should use the same rules as when dealing with double tops and double bottoms.
One of the most common figures to signal that a trend will continue is the so-called ‘triangle’. There are three types of triangle: symmetrical, ascending and descending. Each one has a specific shape and signals subsequent price movements. The figure itself is formed by two trend lines converging at one point, thus forming a triangle.
A symmetrical triangle consists of two trend lines which slope at an almost identical angle, albeit in different directions. Generally speaking, a symmetrical triangle indicates that there is no clear direction, meaning that the price could go up or down. Since it takes at least two points to draw a trend line, to form a triangle you need at least four: two to form the support level and two to form the resistance level.
Triangles are special because they have an expiration date: the point where the two trend lines merge. After this point, it is believed that the figure has been formed and that the trend will resume the direction present before the triangle forms. The moment the two trend lines meet, the upward trend resumes.
The general rule is that this movement will continue for a period which is as long as the width of the vertical base of the triangle. Many traders buy at the point where the two lines merge, hoping to capitalize on the anticipated upward trend. The situation is the same in a downward trend. After a symmetrical triangle forms, the decline will deepen, and will at least match the length of the triangle’s base.
Other variations are the ascending and descending triangles. As the names suggest, an ascending triangle indicates a price rise, while a descending triangle indicates a price drop.
The flag is another common figure that can serve to confirm the trend’s direction. A flag consists of a series of price movements within a narrow range, without a clear direction. These normally occur after an abrupt rise or fall in an instrument’s price.
The flag consists of two parallel lines, which are respectively the support and resistance levels. As flags are caused by a large fluctuation in an instrument’s price, they also have a flagpole.
It is important to note that flags are a relatively short-term phenomenon. In an upturn, once the price breaks through the resistance level, the formation is complete and the price is expected to continue rising. This is, therefore, the moment you should enter the market. After the price breaks through the resistance level, a price increase equal to at least the size of the flagpole can be expected. It is also advisable to place a Stop Loss at the support level to limit any potential losses.
Similarly, if the flag is formed during a downwards trend, then you should enter the market when the price breaks below the support level, i.e. when a bar closes below it. Your Take Profit order should be determined by the length of the flagpole, while your Stop Loss should be placed at the resistance level.
In general, indicators are a mathematical representation of the prices of financial instruments over past time periods, used to predict future price movements and to provide signals for entering and exiting the market.
There are three main groups of indicators:
- Trend indicators
- Indicators of volatility
This group of indicators, as the name suggests, provides the best evidence for the presence of a trend. The most commonly used indicators of this type are moving averages, which smooth out fluctuations in order to determine the trend direction. Trend indicators are not suitable for use when the market is ranging, as they can provide false signals when a market is ranging.
Simple Moving Average (SMA)
The Simple Moving Average is the most commonly used and most reliable indicator. It is a curve that is placed on top of the price chart and is formed by averaging price information over a period of time. Traders that prefer to follow short-term price movements typically select a shorter period of time, e.g. 7 days. The information from that time period is then averaged to form a smooth curve. When a short time period is used, the indicator is known as a Fast Moving Average. However, traders that prefer to hold their positions open for days, or even weeks, usually prefer a longer period of time e.g. 21 days, and in these cases the indicator is known as a Slow Moving Average.
The main disadvantage of the Simple Moving Average is that the calculation is based upon a fixed number of past price points and, thus, does not take all aspects of an instrument’s price into account. A SMA also attributes equal weight to all the price points used in the calculation, meaning that prices in the past are considered as important as recent prices.
This type of moving average is less sensitive to price changes. The signals it gives are also more reliable than those of other types of moving average, although they occur later. As a SMA is based on past information, signals occur after the actual movement of the chart, meaning you may miss the start of a new trend.
Moving Average Convergence/Divergence (MACD)
The MACD is an indicator which can be used in both trending and ranging markets. As a trend indicator, it gives a delayed signal and confirms the existence of a new trend or the end of an old one. This indicator consists of the following elements:
1. MACD line – the MACD curve is formed from two moving averages, e.g. ЕМА12 and ЕМА26. The difference between the two moving averages creates the MACD line, which is applied to the indicator chart.
2. Zero line – this is the horizontal line on the indicator chart. When the MACD line is above the zero line, there is an uptrend. Conversely, when the MACD is below the zero line, there is a downtrend. The further away the MACD line is from the zero line, the greater the difference between the two moving averages. When the fast-moving average crosses the slow-moving average from the top down, the MACD crosses the zero line in the same way, which is a signal to sell.
However, when the fast-moving average crosses the slow-moving average from the bottom up, the MACD crosses the zero line in the same way, which is a signal to buy.
3. Signal line/trigger line – this is most often an EMA9 formed by the MACD curve. When the MACD crosses the trigger line from the top down, there is a sell signal (which comes earlier than the signal in point 2). However, when the MACD crosses the signal line from the bottom up, there is a buy signal. This signal appears a little before the ones described in the preceding point.
4. Histogram – the histogram consists of a series of bars located above and below the zero line. It represents the difference between the MACD and the signal line; the larger the difference between the two, the larger the bars on the histogram. Conversely, the smaller the difference between the MACD and the signal line, the smaller the bars on the histogram.
These indicators are quite inefficient at the emergence of a trend but become very useful near its end. All oscillators’ show the levels at which an instrument is considered overbought or oversold and are placed under the price chart. They consist of a scale and a curve which fluctuates between the overbought and oversold levels. If the indicator reaches either of these levels, the trend will weaken. It is, therefore, important to look for any discrepancies between the oscillator and signals from the price chart before opening a position. For this reason, oscillators are normally used alongside other indicators in order to avoid any false signals.
Relative Strength Index (RSI)
The relative strength index uses the same principle as all oscillators. It has a scale from 0 to 100 and a curve which fluctuates somewhere between those two numbers. The two most important numbers on the RSI are 30 and 70.
When the curve surpasses 70, the instrument is considered overbought. When the curve falls below 70 again, you should sell. The opposite is true when the curve drops below 30. This means the instrument is considered oversold and when the curve surpasses 30 again, you should buy.
Indicators of Volatility
Bollinger Bands consist of three lines: a Simple Moving Average, usually averaging the last 20 time periods, and two lines, each two standard deviations away from the SMA. The lines diverge during periods of price volatility and come closer together when prices are more stable. Abrupt market movements are usually preceded by a period where the bands are very close together. When the market is ranging, if the price rebounds off one line, it usually moves towards, and reaches, the other.
Price movements outside of the bands indicate a strong trend and signal that the price will continue to move in that direction. These indicators help determine when the current trend will continue – namely when the volume increases. When the volume decreases, the current trend is coming to an end, and will soon be reversed.
Forex (currency pairs)
On the FOREX market, currencies are always traded in pairs: euro/dollar (EUR/USD), dollar/yen (USD/JPY), euro/pound (EUR/GBP), etc. Each currency pair consists of a base and a quote currency. The first currency in any pair is known as the base currency, while the second currency is known as the quote currency.
It is important to note that whenever you buy one currency, you simultaneously sell the other. For example, if you expect the price of the euro to rise, you should buy the EUR/USD currency pair, or any other pair in which the euro is the base currency. However, if you expect the euro to fall, you should sell EUR/USD, or any other currency pair in which the euro is the base currency.
In exchange rates, the quote currency shows how much you need in order to buy or sell one unit of the base currency. Transactions are always carried out in the quote currency. For example, if the exchange rate for GBP/USD is 1.3405, in order to buy or sell 1,000 GBP, you will need $1340.50.
The opening of a new position always entails buying one currency and selling the other. If you expect the U.S. dollar to rise against the euro, you should sell a specified quantity of the EUR/USD pair, because it is perceived that the dollar is stronger than the euro, which would have a negative effect on the currency pair.
There is a large number of currency pairs, but the major and most traded ones are: EUR/USD, GBP/USD, USD/JPY, AUD/USD, USD/CAD, NZD/USD and USD/CHF. Currency pairs have different liquidity; the most traded and, therefore, the most liquid one is undoubtedly EUR/USD, followed by USD/JPY and GBP/USD. The U.S. dollar is involved in each of the seven most traded currency pairs and is, by far, the most popular currency in the world.
Each three-letter abbreviation denotes a particular currency. The first two letters indicate the name of the country, and the third is the name of the currency.
EUR – Euro
AUD – Australian dollar
CAD – Canadian dollar
JPY – Japanese yen
NZD – New Zealand dollar
GBP – British pound
CHF – Swiss franc
The four categories of trading commodities include:
Energy (including crude oil, heating oil, natural gas and gasoline)
Metals (including gold, silver, platinum and copper)
Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle)
Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar)
The Dow Jones Industrial Average (DJIA) is one of the oldest, most well-known and most frequently used indexes in the world. It includes the stocks of 30 of the largest and most influential companies in United States. The DJIA is what's known as a price weighted index. It was originally computed by adding up the per-share price of the stocks of each company in the index and dividing this sum by the number of companies - that's why it's called an average. Unfortunately, it is no longer this simple to calculate. Over the years, stock splits, spin-offs and other events have resulted in changes in the divisor, making it a very small number (less than 0.2).
The DJIA represents about a quarter of the value of the entire U.S. stock market, but a percent change in the Dow should not be interpreted as a definite indication that the entire market has dropped by the same percent. This is because of the Dow's price-weighted function. The basic problem is that a $1 change in the price of a $120 stock in the index will have the same effect on the DJIA as a $1 change in the price of a $20 stock, even though one stock may have changed by 0.8% and the other by 5%.
A change in the Dow represents changes in investors' expectations of the earnings and risks of the large companies included in the average. Because the general attitude toward large-cap stocks often differs from the attitude toward small-cap stocks, international stocks or technology stocks, the Dow should not be used to represent sentiment in other areas of the marketplace. On the other hand, because the Dow is made up of some of the most well-known companies in the U.S., large swings in this index generally correspond to the movement of the entire market, although not necessarily on the same scale.
The S&P 500
The Standard & Poor's 500 Stock Index is a larger and more diverse index than the DJIA. Made up of 500 of the most widely traded stocks in the U.S., it represents about 70% of the total value of U.S. stock markets. In general, the S&P 500 index gives a good indication of movement in the U.S. marketplace as a whole.
Because the S&P 500 index is market weighted (also referred to as capitalization weighted), every stock in the index is represented in proportion to its total market capitalization. In other words, if the total market value of all 500 companies in the S&P 500 drops by 10%, the value of the index also drops by 10%. A 10% movement in all stocks in the DJIA, by contrast, would not necessarily cause a 10% change in the index. Many people consider the market weighting used in the S&P 500 to be a better measure of the market's movement because two portfolios can be more easily compared when changes are measured in percentages rather than dollar amounts.
The S&P 500 index includes companies in a variety of sectors, including energy, industrials, information technology, healthcare, financials and consumer staples.
The Nasdaq Composite Index
Most investors know that the Nasdaq is the exchange on which technology stocks are traded. The Nasdaq Composite Index is a market-capitalization-weighted index of all stocks traded on the Nasdaq stock exchange. This index includes some companies that are not based in the U.S. Although this index is known for its large portion of technology stocks, the Nasdaq Composite also includes stocks from financial, industrial, insurance and transportation industries, among others. The Nasdaq Composite includes large and small firms but, unlike the Dow and the S&P 500, it also includes many speculative companies with small market capitalizations. Consequently, its movement generally indicates the performance of the technology industry as well as investors' attitudes toward more speculative stocks.
The Wilshire 5000
The Wilshire 5000 is sometimes called the "total stock market index" or "total market index" because almost all publicly-traded companies with headquarters in the U.S. that have readily available price data are included in the Wilshire 5000. Finalized in 1974, this index is extremely diverse, including stocks from every industry. Although it's a near-perfect measure of the entire U.S. market, the Wilshire 5000 is referred to less often than the less comprehensive S&P 500 when people talk about the entire market.
The Russell 2000
The Russell 2000 is a market-capitalization-weighted index of the 2,000 smallest stocks in the Russell 3000, an index of the 3,000 largest publicly-traded companies, based on market cap, in the U.S. stock market. The Russell 2000 index gained popularity during the 1990s, when small-cap stocks soared and investors moved more money to the sector. The Russell 2000 is the best-known indicator of the daily performance of small companies in the market; it is not dominated by a single industry.
The Bottom Line
It's good to know what's going on in the many diverse segments of the U.S. and international markets. If you're going to pick just one index, or market, to talk about, however, you can't go wrong with the S&P 500, which offers a good indication of the movements in the U.S. market in general. By watching indexes and keeping track of their movements over time, you can get a good handle on the investing public's general attitude toward companies of all different sizes and from varying industries.
Market Orders and Pending Orders
With a Market Order, you can buy or sell at an instrument’s current price, and the transaction is immediately executed. This involves spending time, sometimes even days, monitoring price movements and waiting for the moment when the desired price is reached.
Pending Orders, as the name suggests, are orders whose execution is delayed until a pre-determined price is reached. The two main advantages of Pending Orders over Market Orders are that they allow more trading flexibility (there is no need to wait for the price to be reached to make an order), and that they are a much more effective risk-management tool. After analysing the market, you can place your Pending Order knowing that it will be automatically executed at the desired price.
Pending Orders can be used in a variety of different situations; for example, to close an already open position, to open a new position, or to change the quantity of an existing position.
What is the difference between Stop and Limit Orders?
A Stop Order is a type of Pending Order placed in the direction of the price’s movement (to buy when the price rises or sell when the price drops). A Limit Order works in much the same way, but executes the reverse transaction – it sells when the price rises or buys when the price drops.
Using Stop/Limit orders to open a position
If, based on your market analysis, you decide that an instrument is likely to increase in price beyond its resistance level, then you should place a Pending Order to buy at this price; this is known in the industry as an ‘Entry Stop’. Thus, you no longer need to wait in front of a computer in order to open a position at the desired price. When the Entry Stop is activated, you will have an open long position. Though at a slightly higher price, it will be a more secure investment, as your analysis will have confirmed the upward trend.
If, however, your analysis indicates that the resistance level will hold and you expect the price to rebound, you should use a Limit Order known as an ‘Entry Limit’. When the resistance level is reached, you will have an open short position and, due to entering the market at a price higher than the current one, you will be in a good position to profit as the price rebounds.
The same is true when the price drops. If you believe that an instrument will fall below its support level, you should use an Entry Stop at the support level. Although you have already missed part of the instrument’s decline, it is still possible to profit from your open short position, providing your analysis is correct and the instrument’s price falls below its support level.
If, however, your analysis suggests that the support level will hold and the price will soon increase again, then use an Entry Limit set at the support level. This will trigger the opening of a long position when the support level is reached and you will profit as the price rebounds away from its support level.
If you expect an instrument’s price to rise and, therefore, decide to buy it, it is a sensible strategy to use a Stop Order in order to minimise losses. You can place a Stop Order known as ‘Stop-Loss’ at a certain distance below the instrument’s price, which will sell the instrument should the market go against you and the price fall to the price you have set. It is also possible to use a Limit Order known as ‘Take Profit’ to sell the instrument when a set price above its current value is reached. This approach is used by traders to lock in profits before the market moves again.
If you sell an instrument, the ‘Stop Loss’ will be a price higher than the instrument’s current price, as you want the fall to continue so that you can profit. Likewise, when selling an instrument, the ‘Take Profit’ price will be below the opening price to ensure the desired profit is obtained as the price falls.
The last type of pending orders which can be placed is a Trailing Stop. A Trailing Stop places a Stop Loss at a certain distance away from the instrument’s price. This stop follows the market’s movements. If the market moves in the desired direction, the Trailing Stop automatically follows the price of the instrument, at the set distance. However, if the market moves against you, then the Trailing Stop remains stationary and does not move.
Let’s say you buy gold, expecting its price to increase. A Trailing Stop should then be placed at a certain distance below the current price. When the price rises, the Trailing Stop will move upwards with the price. Should the price begin to decrease, the Trailing Stop will remain at the highest reached price before the decline started. If the upward movement is equal to the distance set, the position will, at worst, be closed at zero profit. From here, the price may continue to rise or to fall further. In the first case, when the distance between the Trailing Stop and the price is equal to the distance initially set, then the Trailing Stop will start moving upwards again. However, if the price continues to decrease, the position will be closed when it reaches the value set by the Stop.
When selling an instrument, the Trailing Stop will be placed above, rather than below, the current price, and will remain stationary when the price increases.
Like all other types of Pending Orders, Trailing Stops are a good way to maintain trading discipline. Once it has been placed, you do not have to worry about your position, as it will be executed at the optimal conditions you have set based upon your analysis.