The Market Guys’ Five Points for Trading Success IDENTIFY, PINPOINT, STRIKE, PROTECT, AND ACT! A. J. Monte Rick Swope John Wiley & Sons, Inc. ffffiirrss..iinndddd ii 1111//22//0077 1122::0066::4400 PPMM Copyright © 2008 by A. J. Monte and Rick Swope. All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. Wiley Bicentennial Logo: Richard J. Pacifico No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978)750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic formats. For more information about Wiley products, visit our Web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Monte, A. J., 1958- The market guys’ five points for trading success : identify, pinpoint, strike, protect, and act! / A. J. Monte And Rick Swope. p. cm. Includes index. ISBN 978-0-470-13897-7 (cloth) 1. Stocks. 2. Investments. 3. Speculation. I. Swope, Rick, 1964- II. Title. HG6041.M653 2008 332.63'22--dc22 2007028034 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 ffffiirrss..iinndddd iiii 1111//22//0077 1122::0066::4411 PPMM Contents Preface ix Acknowledgments xiii About the Authors xv Introduction xvii Chapter 1 Blueprint for Success: Creating Your Trading Plan 1 Trading Is No Longer a Team Sport 2 Beware the Siren Song of Gurus 8 Know When to Fold ’Em 11 Shucking Right Down to the Cob 15 Grow with Your Plan 25 Chapter 2 Are You Out of Your Mind?: How to Work with Your Emotions 27 Avoiding Pain, Seeking Pleasure 27 Piloting Your Trades 29 Technical Analysis or Tea Leaves? 31 Fundamental Seduction 32 Using Best Practices 33 The Business of Trading 34 Overcoming Fear and Greed 36 Filtering Your Emotion 39 Case Studies 40 Mind Your Emotions 45 iii ffttoocc..iinndddd iiiiii 1111//22//0077 55::0033::5522 PPMM iv Contents Point I: Follow the Money Trail: Identify the Trend Chapter 3 I t Pays to Be Trendy: Putting Your Money with the Money 49 The Crowd May Be Wrong, but They’re Still the Crowd 50 Dow Theory 51 Uptrends 55 Downtrends 61 Sideways Trend 63 Support and Resistance 63 Moving Averages 65 Back on Track 66 Chapter 4 T he Trader’s Toolbox: How to Pick a Hammer when the Market Gives You a Nail 67 Trend Lines 70 Channel Lines 74 Moving Averages 78 Fibonacci Retracement Lines 84 Stochastic Oscillator 86 Moving Average Convergence Divergence (MACD) 91 Bollinger Bands 95 Don’t Plow a Field with Your Mercedes 98 Chapter 5 T en Common Mistakes Made by Traders (And How to Avoid Them!) 99 Mistake 1: Marrying Your Stock and Finding Trades that Aren’t There 100 Mistake 2: Failing to Accept a Loss 103 Mistake 3: Doubling Down on a Losing Position 106 Mistake 4: Lack of Training and Preparation 108 Mistake 5: Trading with Scared Money 110 Mistake 6: Buying Cheap Options 112 Mistake 7: Overcomplicating the Analysis 114 Mistake 8: Unrealistic Expectations 116 Mistake 9: Using Software Crutches 117 Mistake 10: Trading without a Plan 118 ffttoocc..iinndddd iivv 1111//22//0077 55::0033::5533 PPMM Contents v Point II: Establish a Clear Support Level: Pinpoint Support Chapter 6 T he Role Reversal: Working the Buyer/Seller Battle Line 121 Market Mechanics 122 Your Opinion Won’t Move a Market 126 Defining Role Reversal 126 Dollar Cost Averaging versus Cost Averaging Down 127 A Good Plan Gone Bad 128 Pursuit of the Breakeven Point 129 The Building Blocks of a Role Reversal Pattern 130 The Psychology behind the Move 132 The Role Reversal from the Short Side 133 More Traders Drawing the Lines 135 Chapter 7 S eventh-Inning Stretch: Managing Market Stress 137 Analyzing Alex 139 Sweet Nothings—Literally! 142 Trading Fingers of Steel 144 Small Steps, Big Changes 146 Chapter 8 E Pluribus Unum: Out of Many Stocks, One 149 It May Be a Small World but It’s a Big Market 152 Viva Simplicity! 153 Back to the Basics 154 Getting Technical 162 Putting the Fun in Fundamentals 170 Buy the Rumor, Sell the News? 172 “When You Come to a Fork in the Road, Take It” 175 Point III: Wait for the Pivot Point: Strike with the Buyers Chapter 9 G oing with the Flow: Don’t Jump in Too Early 179 Jiu-Jitsu Trading—Knowing When to Tap 180 Identifying the Pivot Point 181 The Pineapple Principle 184 Pivot Point Patterns 185 Bullish Pivot Point Patterns 186 ffttoocc..iinndddd vv 1111//22//0077 55::0033::5533 PPMM vi Contents Bearish Pivot Point Patterns 192 Use the Market without Guilt 198 Chapter 10 E ssential Options, Part 1: Knowing Your Options 201 What Is an Option? 203 Call Options or Pizza Coupons 204 Put Options 217 Chapter 11 E ssential Options, Part 2: Knowing Your Strategies 221 On Expiration Day, the Option Must Be Worth at Least Intrinsic Value 223 Closing Your Option Position at Expiration 224 Closing Your Option Prior to Expiration Friday 225 Let’s Talk Volatility 226 Long Calls 227 Long Puts 229 Cash-Secured Put Selling 231 The Covered Call 233 Now You Have Options 236 Point IV: The 1% Rule: Protect Your Position Chapter 12 M anaging Risk: Learning to Lose Money the Right Way 239 Is There Really Such Thing as a Safe Investment? 240 I’d Like to Buy a Vowel 243 Everyone Should Be Above Average 244 Five Principles of Risk Management 246 Risk Management Action Steps 252 Managing Risk in a Probabilistic World 259 Chapter 13 T rading Hall of Shame: Traders You Don’t Want to Imitate 261 Barry the Bottom Fisher: Always Buys the Low (Until It Makes a New Low) 262 Breakeven Betty: Forget Profits, Breaking Even Is Her Goal 264 Seminar Sal: He’s Everywhere, But Is He Making Money? 265 ffttoocc..iinndddd vvii 1111//22//0077 55::0033::5533 PPMM Contents vii The Frozen Chosen: Holding Back Because of Fear 267 Larry the Lemming: Follows the Crowd, Not the Money 269 Norman Is an Island: Trades in Seclusion, to His Theme Song, “All by Myself ” 271 Urgent Carl: He’s Trading, but He’s Not Weaned 272 Oz and Trish: The Couple that Vows to Ignore Any Losing Position 274 It’s Funny Until It Hurts 276 Chapter 14 G oing to the Dance: Finding Your Broker 277 1. Accounts 277 2. Advice and Support 280 3. Trading and Investing Products 281 4. Costs and Fees 283 5. Software 284 6. Order Types 287 7. Research 289 8. Banking 291 9. Reports and Records 292 10. Security 294 You Are in Control 296 Point V: Take Action: Act for Results Chapter 15 T he Trade and Beyond: Wealth Has a Purpose 299 What Is Your Purpose? 300 Changing the World One Person at a Time 302 What’s Your Story? 303 Take Action 305 Glossary 307 Index 313 ffttoocc..iinndddd vviiii 1111//22//0077 55::0033::5544 PPMM ffttoocc..iinndddd vviiiiii 1111//22//0077 55::0033::5544 PPMM Preface W hen we stand before a new audience for the fi rst time, we often get some variation of the following question: “Why should I listen to anything you have to tell me?” It’s a fair question and one that we would expect you to ask of anyone who offers their advice. Over the years, we have had the privilege of working with hundreds of thousands of investors and traders all around the world. Long before this book was ever considered, The Market Guys were talk- ing to traders in London, teaching beginner options to students in Taipei, and helping investors protect their portfolios in Stockholm. Through all of these experiences, we have observed certain strate- gies and characteristics that are common to successful traders. We have also observed certain other strategies and characteristics that are common to unsuccessful traders. We have joined you on the front lines of trading and investing. We did not just read about stocks and options and use that information to build a supposedly better mousetrap. Rather, we have bought and paid for our education through real trades. We know what it feels like to go home with a trade that could ruin your family fi nances. We have watched helplessly as the market shut down for want of buyers when we desperately needed to sell. We counseled traders who were placing their last dollar on a high-risk speculative trade in the hope that they could possibly escape their failings in the market. Along the way, we realized that we were uniquely positioned to actually help people protect their assets while building wealth. You see, we didn’t create The Market Guys’ Five Points for Trad- ing Success as a marketing gimmick to entice you to purchase our version of beating the market. In a sense, this was a book that had to be written. It was born of our passion to teach and truly make a difference in peoples’ lives. If we can help one person preserve a retirement account through a simple risk management strategy, our work has been worthwhile. It has been said that teaching is ix ffpprreeff..iinndddd iixx 1111//22//0077 1122::0088::0066 PPMM