Kirkpatrick and Dahlquist, CMT2 Chapter 21

by Steve Kern on July 12, 2015

in CMT Level 2

Part VII: Selection
Chapter 21: Selection of Markets and Issues: Trading and Investing

Chapter Objectives
- factors to consider when choosing a security to trade
- factors to consider when choosing an investment security
- the relationship between hard asset and soft asset markets
- the basics of intermarket analysis
- the concept of relative strength among different investment vehicles and its implications for investors
- the basic methods of determining an individual stock’s relative strength
Intro
- Those interested in using technical methods in markets must determine whether they have the time, inclincation, and facilities to trade issues, or whether they wan to consume less time and utilize technical methods for investing over longer periods of time
Which Issues Should I Select for Trading?
- Intro
  - Trading requires:
    - complete commitment to the markets
    - time every day and night even if swing trading from day to day
    - Intraday trading requires:
      - constant attention
      - excellent execution abilities
      - high-speed price reporting
      - is not for everyone
      - is not advisable for people who have other jobs and limited time to commit
      - can be accomplished through mechanical systems but still requires heavy time commitment to perform the executions, monitor and develop new systems
  - It’s wise to select more than one issue to trade, especially in the stock market and futures market. Diversification is important because:
    - When a single issue becomes dormant in a small trading range and is difficult to trade, other issues with which the trader is already familiar can take its place
    - Following more than one issue increases the odds that a profitable trend will not be missed
    - Diversification, especially in issues that are not correlated, reduces risk
    - 3 to 10 issues should be selected, watched, and traded with the criteria discussed next.
    - In Chapter 23 “Money and Risk Management,” we will see that only a minimum commitment should be made to any one issue. Trading only one issue, and using more than the suggested initial capital in that one issue, substantially increases risk of failure.
    - Some traders prefer to screen the entire marketplace for issues showing signs of an impending trend change.
      - They program their computers to search for:
        
        New highs and lows
        
        gaps
        
        one- and two-day reversal patterns
        
        range and volatility changes
        
        volume changes
        
        moving average crossovers
      - They find issues to trade over short periods and then go on to the next selected issues
  - Choosing Between Futures Markets and Stock Markets
    - Factors to consider:
      - costs
      - personal risk preferences
      - preferred time horizon for trading
      - familiarity with each market
      - access to the proper equipment and execution capability
    - Costs
      - initial setup of equipment
        
        high-speed computer
        
        excellent data feeds
        
        reliable, quick execution capability
        
        backup system
        
        commissions
        
        slippage
        
        missing the intended price during a fast market
        
        limit days
        
        unexpected events
    - Risk
      - Futures are considerably more risky than stocks because they are usually traded with high leverage
      - Leverage is the amount of capital that can be borrowed to initiate and carry a position
      - With futures, the danger always exists that an adverse move will eliminate the trader’s protective margin, requiring the trader to come up with more funds or be “stopped out.”
      - Leverage risk is investigated in more detail in Chapter 23.
      - Stocks can also be leveraged, but usually not to the degree that futures can, and stocks are therefore not as risky to capital.
    - Suitability
      - Experience in the markets determines the issues with which you are most comfortable.
      - For beginners in technical trading, the slowest and least risky markets are the best.
      - Once your trading experience provides enough confidence, you can enter other faster and more risky issues
      - suitability also depends on time available, how much should be invested in equipment, etc.
    - Time Horizon
    - Volatility
    - Liquidity
    - Volume
Which Issues Should I select for Investing?
- Intro
- Top-Down Analysis
- Secular Emphasis
- Cyclical Emphasis
- U.S. Dollar and Gold
- Gold and Bonds (Long-Term Interest Rates)
- Bond Market and Stock Market
- Stock Market and the U.S. Dollar
- Implications of Intermarket Analysis
- Stock Market Industry Sectors
- Bottom Up-Specific Stock Selection and Relative Strength
- Relative Strength
  - Academic Studies of Relative Strength
  - Measuring Relative Strength
    - Percentage Change Method
    - Alpha Method
    - Trend Slope Method
    - Levy Method
Examples of How Selected Professionals Screen for Favorable Stocks
- William O’Neil CANSLIM Method
- James P. O’Shaughnessy Method
- Chalres D. Kirkpatrick Method
- Value Line Method
- Richard D. Wyckoff Method
Conclusion
Review Questions

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