Wall Street has many colorful adages, such as “Don’t catch a falling knife,” “Sell in May and go away,” and my favorite, “How do you make a small fortune? Start with a big fortune.” Investing your hard-earned money takes knowledge, understanding, and skill. Real estate has been a good place to invest, especially in California, over the last several decades.
Business opportunities in technology, services, or retail have rewarded many investors, but there are few areas that offer liquidity and opportunity for fast profits and easy turnover.
There are probably five or more flights to Las Vegas daily from San Francisco for those anxious to beat the odds—and don’t forget the free drinks and scantily clad damsels. There is leverage at the gaming tables. You can take a small amount of money and turn it into a large amount—at least theoretically.
Another area that offers liquidity and the ability to leverage small amounts of money is the securities markets. There are very few investment vehicles that can rely on an offer to buy and bid to sell, all day long, every day. Since many securities are standardized, it’s easy for buyers and sellers to agree on price because the underlying asset is not in question. If two houses on your block are for sale, each must be evaluated separately. One may have a swimming pool and the other a three-car garage and a cottage out back. But, a share of Microsoft (MSFT, $30.91, as of April 28) is the same for everybody. This standardizing, along with strict accounting and financial reporting rules, help create flows and what Wall Street calls “a market.” This liquidity is often mistaken as an opportunity for fast profits.
There appears to be a number of characteristics that attract people to trading the markets. There is a fascination with detail, process, and focus. Traders have concocted a lot of rules and techniques that, when followed, become a whole system that can be implemented. There is also the enticement of gaining freedom from the daily grind and work-a-day world. Trading is usually not a group activity, but requires a loner’s mentality. Most traders will tell you that contrary to mythology, success is a result of shrewdness, not intelligence. Many professional traders do not have extensive or sophisticated formal education. Risk takers are attracted to the fast money in trading, but excessive risk taking is never a winning strategy for very long. Successful traders learn discipline and how to keep emotion out of their decisions as well as conservative money management skills.
Whole sections of libraries are filled with analysis of markets and trading. There are many parameters and methods to evaluate securities, trading techniques, and patterns. Valuation is one important methodology. The most popular and well known measure of a stock is the PE or price earnings ratio. It measures the price of the stock compared to the earnings of the company. For example, if a stock is trading for $10 and has $1 per share in earnings, the PE ratio is 10. Many would automatically think that the lower the valuation the more attractive the stock. It’s like shopping for a TV set and finding it for $400 at one store and the same set for $350 at another. We all know which the better value is. But of the two stocks, one may have better designed products, newer plants, and better product distribution. Which is the better value? The large company indexes have PE ratios that cycle between 14 and 25, but in 1960, Xerox Corporation (XRX, $11.10 as of April 28) had a PE ratio of 100. Was it overvalued? Subsequently, Xerox advanced 3,300 percent in price. Genentech (DNA, $80.43 as of April 28), the South San Francisco biotech company traded with a PE of 200 in November 1985, and then bolted 300 percent in the next five months. Tools like PE ratio have subtleties and nuances and one should learn to use them correctly.
Many traders will pick one stock or security to trade. They trade it daily and learn its patterns and characteristics, with a goal of taking many small profits and quickly taking small, manageable losses. Borrowing from the broker can accentuate gains and losses. For example, an account with $10,000 can control securities worth $100,000. If your position goes up 10 percent, your gain is $10,000, thus doubling your cash investment. But the knife cuts both ways. If you lose 10 percent, your account goes down $10,000, and your total investment becomes a fleeting puff of smoke. At least in Vegas you get the free drinks.
Traders use charts to help them manage strategy. Charts are graphs that show the price history of a security. But, they can be more than a rearview mirror. Charts can show volume as well as average price moves over time. A moving average is useful for striping the so-called “noise” out of a stocks price pattern. The average price of a stock over the last thirty days can filter out the daily ups and downs that may be reactions to news or overactive trading, which can be helpful in giving a picture of longer term direction. Volume can be viewed as a confirmation of a stock’s direction. If a stock moves sharply higher on larger than normal volume, it can be interpreted as a positive indicator that institutional buyers are committing to the security. If, however, the move is accompanied by lower trading volume, traders may be skeptical of the longevity of the upward movement.
Another useful tool is the MACD or moving average convergence-divergence. This indicator is simply two moving averages overlaid on each other to show a change in direction. Don’t get lost, stay with me here. I can take the last thirty days of prices and average them and each day I drop off the last one, then add the new one. If I do the same for the last ninety days, sudden price movements are less noticeable than in the thirty-day average. The short average changes quicker, and when it crosses the slower average in either direction, it may signal to traders to make a move to buy or sell.
Now you have enough information on trading to send you to your computer to book a flight to 
Vegas for the free drinks. See you there!
Rick Glaze is the president of Glaze Capital Management, Inc. of Los Altos as well as a General Securities Principal offering securities through First Allied Securities, member FINRA/SIPC. His first novel, The Middle Fork, was published in 2009.
