WHEN THE MARKET MOVES, WILL YOU BE READY? How to Profit from Major Market Events Peter Navarro McGraw-Hill New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto 00_200274_FM/Navarro 7/31/03 12:52 PM Page i Copyright © 2004 by The McGraw-HIll Companies, Inc. All rights reserved. Manufactured in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a data- base or retrieval system, without the prior written permission of the publisher. 0-07-143594-8 The material in this eBook also appears in the print version of this title: 0-07-141067-8. All trademarks are trademarks of their respective owners. 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We hope you enjoy this McGraw-Hill eBook! If you d like more information about this book, its author, or related books and websites, please click her e. DOI Page 6x9 10/2/02 1:33 PM Page 1 , To the loving memory of Ruby, my honey. Foresight could have saved her from a fate more cold and cruel than the stock market itself. Let us always remember to look ahead—and never forget the lessons in kindness, gentleness, and peace she taught us. 00_200274_FM/Navarro 7/31/03 12:52 PM Page iii This page intentionally left blank. CONTENTS Acknowledgments xi Introduction xiii Part One The Big Picture 1 1 So You Want to Make a Million in the Stock Market 3 Anatomy of a Crash 4 2 What’s Your Wall Street “IQ”? 7 3 The Four Stages of Macrowave Investing 15 The Four Stages of Macrowave Investing 16 Stage One: The Four Dynamic Factors 17 Stage Two: Three Key Cycles That Shape Market and Sector Trends 19 Stage Three: Picking Strong and Weak Stocks and Sectors 23 Stage Four: Using Solid Money, Risk, and Trade Management Tools to Buy, Sell, and Short Stocks 24 Part Two The Four Dynamic Factors 27 4 Follow the Earnings Calendar! 29 Key Point #1: Fall into the Gap? 30 Key Point #2: Buy on the Rumor, Sell on the News 31 Key Point #3: Consensus Estimates versus Whisper Numbers 32 Key Point #4: Sector Watch 33 Key Point #5: Earnings and the Broad Market Trend 33 5 Follow the Macroeconomic Calendar! 37 Key Point #1: The Market’s Major Fuel 38 Key Point #2: Use Macro Scenario Building 38 Key Point #3: Mr. Market Hates Inflation 41 Key Point #4: Mr. Market Hates Recession 42 Key Point #5: Mr. Market Hates Productivity Decreases 43 Key Point #6: Mr. Market (Mostly) Hates Trade Deficits 44 00_200274_FM/Navarro 7/31/03 12:52 PM Page v For more information about this title, click here. Copyright 2004 by The McGraw-Hill Companies, Inc. Click Here for Terms of Use. 6 Uncle Sam and the Stock Market 49 Key Point #1: The Tools of Monetary Policy 50 Key Point #2: The Fed Moves in Cycles, Not Isolated Steps 51 Key Point #3: Monetary Policy Ripples through the Stock Market 52 Key Point #4: You Can’t Push on a String 53 Key Point #5: The Two Problems with Financing Fiscal Policy 54 Key Point #6: Fiscal Policy’s Blunt and Irreversible Tool 55 Key Point #7: The Problem(s) with Tax Cuts 55 7 Exogenous Shocks and the Strategy of the Macroplay 59 Key Point #1: The Art of the Macroplay 60 Key Point #2: Contractionary Oil Price Spikes 61 Key Point #3: War Premiums and Penalties 62 Key Point #4: The Terrorism Tax 63 Key Point #5: The Market Stain of Scandals 65 Key Point #6: The Role of Disruptive Technologies 66 Part Three The Three Key Cycles 69 8 Tracking the Market and Sector Trends 71 Key Point #1: The Market Trends Up, Down, or Moves Sideways 72 Key Point #2: Individual Sectors Move Up, Down, or Move Sideways 74 Key Point #3: Use Exchange-Traded Funds to Track Market and Sector Trends 75 Key Point #4: It’s Easy in Hindsight to Spot Market and Sector Trends 77 Key Point #5: Use the 3-Point-Break Method to Spot Changes in Trends 78 9 The Business Cycle and the Stock Market Cycle 85 Key Point #1: The Business Cycle’s Ups and Downs 86 Key Point #2: The Stock Market’s Crystal Ball 88 Key Point #3: The Stock Market and Four Dynamic Factors 89 Key Point #4: The Profitable Patterns of Sector Rotation 90 10 As the Interest Rate Cycle Turns. . . 95 Key Point #1: The Four Stages of the Interest Rate Cycle 96 Key Point #2: Higher Interest Rates Negatively Affect the Market and Sector Trends 97 Key Point #3: Some Bond Market Basics 100 Key Point #4: The Term Structure of Interest Rates 101 vi CONTENTS 00_200274_FM/Navarro 7/31/03 12:52 PM Page vi 11 Unlocking the Mysteries of the Yield Curve 105 Key Point #1: Constructing the Yield Curve 106 Key Point #2: Shapes of the Yield Curve 107 Key Point #3: Some Historic Evidence of the Yield Curve’s Predictive Powers 110 Part Four Picking Strong and Weak Stocks and Sectors 115 12 It’s Finger-Lickin’, Stock-Pickin’ Good 117 Key Point #1: Buy Low on the Dips, Sell High on the Peaks 118 Key Point #2: Buy High, Sell Higher 119 Key Point #3: High Volume Movers 121 Key Point #4: The Ratings Game 122 Key Point #5: Buy What You Know 123 Key Point #6: The Way of the Red Herring 124 Key Point #7: Ignore Hot Stock Tips 125 13 It’s Absolutely Fundamental 129 Key Point #1: An Efficient and Random Market? Not! 131 Key Point #2: Exploit Price Deviations from “Fair Value” 132 Key Point #3: Many Fundamental Analysts Are “Value Investors” 133 Key Point #4: The Fundamental Analyst’s Tools 134 Key Point #5: Use the Internet to Simplify Your Fundamental Screening 135 Key Point #6: The Fundamental Analyst’s Traps 137 Key Point #7: Use Both a Fundamental and Technical Analysis Screen! 139 14 Technically Speaking 143 Key Point #1: Learn the Lingo and Underlying Psychology 144 Key Point #2: Price Chart Patterns Identify Trends! 147 Key Point #3: Some Common Chart Patterns Can Be Helpful 150 Key Point #4: Volume Speaks Volumes 154 Key Point #5: Moving Averages Clarify the Trend! 155 Key Point #6: The Signals of Momentum Indicators 157 Key Point #7: Au Contrarian! The Logic of Market Sentiment 159 Key Point #8: Use a Technical Screen! 160 Key Point #9: Some Tools Work Better Than Others, Depending on the Market Trend 163 CONTENTS vii 00_200274_FM/Navarro 7/31/03 12:52 PM Page vii Part Five Buying, Selling, and Shorting Stocks 169 15 Managing Your Risk 171 Key Point #1: Risk Represents Both Danger and Opportunity 172 Key Point #2: The Three Dimensions of Risk 173 Key Point #3: The Myriad Sources of Risk 174 Key Point #4: The Reward-to-Risk Ratio 175 Key Point #5: Some Useful Yardsticks to Measure Risk 176 Key Point #6: What Does “Well Diversified” Mean? 177 Key Point #7: Some (More) Risk Management Rules 177 16 Managing Your Money 181 Step #1: Calculate Your Investing Batting Average or Win% 183 Step #2: Determine Your Risk Capital 184 Step #3: Determining Your Reward-to-Risk Ratio 186 Step #4: Determining Your Position Limit and Position Size 189 Step #5: Increasing Position Sizes by Adding Units of Risk 190 17 Managing Your Trades 195 Key Point #1: Market versus Limit Orders 196 Key Point #2: Set Intelligent Stop Losses—Don’t Be Shaken Out! 199 Key Point #3: Use Trailing Stops to Lock in Profits 200 Key Point #4: Use Buy Stops to Play Breakouts 201 Key Point #5: Never Average Down a Loss 201 Key Point #6: Don’t Churn Your Own Portfolio! 202 Key Point #7: Some Inside Tips 203 Key Point #8: David Aloyan’s Top Ten Investor Psychology Tips 203 18 Executing Your Trades 207 Key Point #1: The Three Methods to Execute Your Trades 208 Key Point #2: Level I versus Level II Trading 209 Key Point #3: The Slippage Problem with Level I Brokers 211 Key Point #4: Direct Access Trading Eliminates Slippage 213 Key Point #5: The Virtues of Programmed Ordering 215 Part Six Macrowave Investing in Motion 219 19 Preparing for the Investing Week 221 The Savvy Macrowave Investor Newsletter 222 20 The Stimulation of Portfolio Simulation 229 Key Point #1: Simulate Your Portfolio With STOCK-TRAK 230 Key Point #2: The Tuition Bill Always Comes Due 230 viii CONTENTS 00_200274_FM/Navarro 7/31/03 12:52 PM Page viii [...]... concepts to the day-to-day management of their individual portfolios This, of course, I am happy to do, and that is the purpose of this new book In When the Market Moves, Will You Be Ready? I will walk you step-by-step through the savvy macrowave investor method As you work through this book—which in many ways is a workbook you will see that each chapter is followed by some review questions you will be asked... this question On the one hand, and for you absolute beginners reading this book, the less capital you start with, the less you can lose And it is the rare beginner who doesn’t initially lose in the stock market something the Wall Street pros caustically refer to as “tuition to the market. ” On the other hand, unless you start with a large enough sum of money, whatever profits you may be lucky or skilled... other feel about your stock market investing? If your spouse or significant other is afraid you will lose all of the family’s money in the market, the chances increase that you will do precisely that This is because of the “P” word again, namely, pressure If you are not comfortable reporting a heavy loss to your partner, that, too, reflects a level of mistrust or lack of confidence that will cloud your... forms of gambling You bet against the house—and over time, the house never loses In contrast, the intelligent speculator only takes a risk when the odds are in his favor Poker is a form of speculation If you draw a bad hand, you drop out and forfeit a small ante But if you draw a strong hand, the odds are in your favor and you play it to the hilt You will see in this book that if you apply these very same... Aloyan In the next chapter, I will present the savvy macrowave investor trading method, and we will begin the exciting task of mastering that method But before we go there, I need to ask you a prior question—actually 11 questions I need to ask you these questions for a very important reason Together, we need to find out before you walk too far down the stock market s Yellow Brick Road, whether active... to your stock 10 THE BIG PICTURE market investing by always “cutting your losses” and “letting your profits run,” you will dramatically increase your odds of making money 4 Would you rather win big at the risk of big losses or would you rather consistently win small? This question is another way of uncovering any of your possibly “reckless gambler” tendencies If left uncontrolled, these tendencies will. .. stock market moves through six clear stages In the early bull, middle bull, and late bull stages, both the market trend and the prices of most stocks are moving upward Then, when we get to the early bear, middle 20 Figure 3-2 THE BIG PICTURE The stock market cycle leads the business cycle bear, and late bear phases, the market trend is clearly down—along with the prices of most stocks Finally, and most... managing your portfolio is hard work—and just as you won’t be beating the Yankees any time soon, you won’t be beating the secondmeanest men (and women) in pinstripes on an hour or two of research a week That’s why if you can’t devote at least five to ten hours a week to your portfolio, I humbly suggest that you forget about “playing the market. ” Instead, I strongly recommend that you simply stick your... Chapter 1 SO YOU WANT TO MAKE A MILLION IN THE STOCK MARKET Many of today’s traders and investors focus all of their energies looking for so-called “great stocks.” What they don’t understand is this very simple Macrowave principle: You can buy the best stock in the world BUT if it is in the wrong sector when the market is heading down, you are not only going to lose more money than you should; if you are... for most people, it will almost certainly add another major layer of stress This will be particularly true at the beginning of your investing career This is because as a novice investor, you will almost assuredly lose money because of little mistakes, perhaps toss away some big chunks of dough because of big mistakes, and maybe even at times you will do everything right but it will still go so very . WHEN THE MARKET MOVES, WILL YOU BE READY? How to Profit from Major Market Events Peter Navarro McGraw-Hill New. book. In When the Market Moves, Will You Be Ready? I will walk you step-by-step through the savvy macrowave investor method. As you work through this book—which