How Sales and Earnings Growth can affects a Stock's Performance

If you go back through the history of the stock market there is a recurring theme among those stocks which have had some of the strongest price appreciation and it's related to their Sales and Earnings Growth. Let's look at two companies over the past few years and compare their Sales and Earnings Growth. First let's look at Microsoft (MSFT) which has hard meager Sales and Earnings Growth in 2002 and 2003. Since the market made a bottom in October of 2002 MSFT has seen very little price appreciation since then. Back in early October of 2002 MSFT was trading around $22 a share and in late March of 2004 MSFT was trading near $24 a share.

Thus while the major averages saw significant gains from October of 2002 into the early part of 2004 MSFT was only up 9%.


Now let's look at a stock which has been exhibiting strong Sales and Earnings Growth over the past year or so. As you can see below Taser (TASR) has seen accelerating Sales and Earnings Growth over the past two quarters which has been reflected in its stock price. TASR formed a "Cup and Handle" pattern before breaking out in September of 2003 and rose nearly 800% from September of 2003 through mid February of 2004.


As these examples show those companies which have accelerating Sales and Earnings Growth have the potential to perform very well while those with poor Sales and Earnings will languish even in a Bull Market environment.

I would imagine those investors who have held MSFT over the past few years aren't very happy as the stock price has virtually gone nowhere since October of 2002 into the early part of 2004.
         

The key is to recognize those companies which are starting to establish a trend of accelerating Sales and Earnings Growth before everyone else does which takes a lot of time and research. This is what I do every week as I spend over 20 hours a week looking for companies that are starting to show signs of accelerating Sales and Earnings Growth.

Regards,

Bob Kleyla

Mark-to-Market Accounting: Is It Right for You?

One of the most important decisions you will make as a trader is whether to elect the mark-to-market (MTM) accounting method. Although MTM is only available to traders, not investors, and does offer some significant tax advantages, it is not right for everyone. What makes this decision so important is that once you select MTM, you're stuck with it; there is no going back simply because it would be to your advantage tax-wise to do so.

Here is what you need to know about mark-to-market: how it works, advantages and disadvantages, the process to elect it, and how to separate and exempt long-term investments.

The MTM Method

Since 1997, mark-to-market accounting has enabled traders to change the tax status of their earnings from capital gains/losses to ordinary income/losses. This occurs on the last day of the year, at which time you tally all of your open holdings as if you were selling them at the market price that day (they are "marked to market"). On January 1st, you re-tally your holdings as if you were repurchasing them at the current price. The basis of each holding is then adjusted to reflect these hypothetical gains and losses for tax purposes.

Advantages of MTM

No wash sales: MTM traders are exempt from the wash sale rule; because holdings are tallied at year's end, there is no need to account for gains or losses that might occur within the 30-day wash sale restrictions. Many traders elect MTM specifically to avoid cumbersome wash sale accounting.


Favorable tax rate: Under MTM, income is taxed at a lower rate than capital gains.


Losses are fully deductible: Because your income/losses are treated as ordinary and not capital gains/losses, you are not bound by the $3,000 capital loss limitation. This means you can deduct all losses in the year they occur, providing tax relief when you need it most.


No change to self-employment exemption: Even though MTM income is not considered capital gains, traders who elect MTM remain exempt from self-employment tax, the same as investors and non-MTM traders.
Disadvantages of MTM

No capital loss carryover: Capital losses can only be offset by capital gains. If you are carrying forward a substantial capital loss, beware: by selecting MTM, your gains would be considered ordinary income moving forward, hence only $3,000 per year could be used to offset your capital loss.

Loss of long-term capital gains: A trader who deals mainly with 1256 contracts may not want to elect MTM because they would lose the 60% long-term capital gain on futures.

Election is permanent: As an individual trader, once you've made the MTM election, you're stuck with it. You can petition the IRS, but don't expect leniency, especially if there is a tax advantage to you. However, if you establish a legal entity for your trading business first, you may un-elect MTM if circumstances dictate, or simply dissolve and form another entity without electing MTM.

How to Elect MTM

To elect mark-to-market as your accounting method, you must enclose a statement of intent with your tax return or extension request and file by the appropriate tax deadline (March 15 or April 15) the year prior to beginning MTM accounting. The one exception: if you're filing as a new legal entity, such as an LLC, you have two months from opening to note your accounting preference in your meeting minutes.

Your first year using MTM, you will fill out IRS Form 3115 (Application for Change in Accounting Methods) and submit it with your tax return. This form contains an adjustment, Section 481(a), which captures duplications and omissions resulting from the change in accounting methods. If the adjustment is $25,000 or less, you may deduct the full amount on your return; if it exceeds $25,000, you may deduct 25% each year for the next four years.

Exempt Your Investments from MTM

Before you elect mark-to-market, be sure to separate your investment holdings from your trading stocks and options. Why? Because unless they are clearly separated, you will be required to mark them to market at year's end and report any gain as ordinary income. That could prove disastrous for stocks that have greatly increased in value over the years.

The IRS lets you exempt your personal investments from your trading business, but only if you identify those investments up front. Like the MTM election itself, this designation is irrevocable; you cannot decide later to fold your investment losers into your trading stock for ordinary losses or cherry-pick your trading winners for capital gains treatment.

Under the IRS guidelines, you must clearly identify your investment stock as such in your records by the close of the day on which you acquired it or when the MTM election was made. There are two ways to do this: you may establish a separate account for your investment stocks (the wisest course of action for MTM traders), or simply note in your records which securities are not part of your trading business.

Be prepared to convince the IRS that your investments have "no connection" to your trading business; otherwise, you'll be required to mark them to market at year's end and report any gains as ordinary income.
         

Get Advice Before You Decide

Is the mark-to-market method right for you? Every trader faces different circumstances. For some, MTM is the obvious solution to the time-consuming task of tracking wash sales. For others, the ability to fully deduct their losses in the year they occur can make a big difference starting out. Oddly enough, traders who close their positions daily may not ever have to go through the MTM since there is typically nothing left at year's end to reclassify.

If you find yourself carrying forward a capital loss or have other questions relating to mark-to-market accounting, be sure to consult one of our tax professionals about your situation before you decide.

by Jim Forrester

Pivot Point Trading

You are going to love this lesson. Using pivot points as a trading strategy has been around for a long time and was originally used by floor traders. This was a nice simple way for floor traders to have some idea of where the market was heading during the course of the day with only a few simple calculations.

The pivot point is the level at which the market direction changes for the day. Using some simple arithmetic and the previous days high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels.

Every day the market you are following has an open, high, low and a close for the day (some markets like forex are 24 hours but generally use 5pm EST as the open and close). This information basically contains all the data you need to use pivot points.

The reason pivot points are so popular is that they are predictive as opposed to lagging. You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).

Because so many traders follow pivot points you will often find that the market reacts at these levels. This give you an opportunity to trade.

Before I go into how you calculate pivot points, I just want to point out that I have put an online calculator and a really neat desktop version that you can download for free HERE

If you would rather work the pivot points out by yourself, the formula I use is below:

Resistance 3 = High + 2*(Pivot - Low)
Resistance 2 = Pivot + (R1 - S1)
Resistance 1 = 2 * Pivot - Low
Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot - High
Support 2 = Pivot - (R1 - S1)
Support 3 = Low - 2*(High - Pivot)

As you can see from the above formula, just by having the previous days high, low and close you eventually finish up with 7 points, 3 resistance levels, 3 support levels and the actual pivot point.

If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points are to look for a reversal or break of R1 or S1. By the time the market reaches R2,R3 or S2,S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

A perfect set would be for the market to open above the pivot level and then stall slightly at R1 then go on to R2. You would enter on a break of R1 with a target of R2 and if the market was really strong close half at R2 and target R3 with the remainder of your position.

Unfortunately life is not that simple and we have to deal with each trading day the best way we can.

I have picked a day at random from last week and what follows are some ideas on how you could have traded that day using pivot points.
         

On the 12th August 04 the Euro/Dollar (EUR/USD) had the following:
High - 1.2297
Low - 1.2213
Close - 1.2249

This gave us:

Resistance 3 = 1.2377
Resistance 2 = 1.2337
Resistance 1 = 1.2293
Pivot Point = 1.2253
Support 1 = 1.2209
Support 2 = 1.2169
Support 3 = 1.2125

Have a look at the 5 minute chart below

pivot point

The green line is the pivot point. The blue lines are resistance levels R1,R2 and R3. The red lines are support levels S1,S2 and S3.

There are loads of ways to trade this day using pivot points but I shall walk you through a few of them and discuss why some are good in certain situations and why some are bad.

The Breakout Trade

At the beginning of the day we were below the pivot point, so our bias is for short trades. A channel formed so you would be looking for a break out of the channel, preferably to the downside. In this type of trade you would have your sell entry order just below the lower channel line with a stop order just above the upper channel line and a target of S1. The problem on this day was that, S1 was very close to the breakout level and there was just not enough meat in the trade (13 pips). This is a good entry technique for you. Just because it was not suitable this day, does not mean it will not be suitable the next day.

pivt point channel

The Pullback Trade

This is one of my favorite set ups. The market passes through S1 and then pulls back. An entry order is placed below support, which in this case was the most recent low before the pullback. A stop is then placed above the pullback (the most recent high - peak) and a target set for S2. The problem again, on this day was that the target of S2 was to close, and the market never took out the previous support, which tells us that, the market sentiment is beginning to change.

pivot point pullback

Breakout of Resistance

As the day progressed, the market started heading back up to S1 and formed a channel (congestion area). This is another good set up for a trade. An entry order is placed just above the upper channel line, with a stop just below the lower channel line and the first target would be the pivot line. If you where trading more than one position, then you would close out half your position as the market approaches the pivot line, tighten your stop and then watch market action at that level. As it happened, the market never stopped and your second target then became R1. This was also easily achieved and I would have closed out the rest of the position at that level.

pivot point brakeout

Advanced

As I mentioned earlier, there are lots of ways to trade with pivot points. A more advanced method is to use the cross of two moving averages as a confirmation of a breakout. You can even use combinations of indicators to help you make a decision. It might be the cross of two averages and also MACD must be in buy mode. Mess around with a few of your favorite indicators but remember the signal is a break of a level and the indicators are just confirmation.

pivot point advanced

We haven't even got into patterns around pivot levels or failures but that is not the point of this lesson. I just want to introduce another possible way for you to trade.

Good Trading

Best Regards
Mark McRae

Stop Placement

Stop placement is where we separate the kids from the adults.

Stop placement is the sole responsibility of you as the manager of your trading business. It is one buck that you cannot pass.

You are the end of the line when it comes to placing stops.

Let me show you why you, and only you, can decide where to place the stop. There are several considerations:

The size of your margin account has the greatest effect on stop placement. When you look at a trade and see where the stop should go, or where you would like it to go, you then have to look at the size of your margin account and determine whether or not you can even consider the trade.

Your comfort level. Although you may have sufficient margin to place the stop where you would like to, and although the stop is logical for the trade, you may not feel comfortable with the stop being so far away (or even so close), and so you will decide not to take the trade with the stop far away, or move the stop back if it appears too close.

Volatility. You must take into account market volatility when placing your protective stop. If a market that normally ticks two ticks at a time suddenly begins to tick five ticks at a time, you must certainly take the level of volatility into consideration. You may find out that you have to place your stop too far away for the size of your bank or your comfort level.

When you use mental stops, there are two other considerations which you must ponder when placing your protective stop. They are: Your speed in placing the order, and the speed at which your broker can place the order. Let's look at each.

The speed at which you can place the order. This depends upon how fast you think on your feet. There are three factors here: Perception, decision, and action. How long does it take you to perceive that NOW is the time to pick up the phone and place your stop in the market?  Or, NOW is the time to enter your stop via your electronic trading platform?
     

Then, once you make the perception, how long does it take you to decide to do something about what you have perceived? Are you quick to decide upon your perceptions? Finally, are you quick to act once you have made a decision?

Some of us are very quick in all three areas. Some of us are too slow to utilize mental stops. Only you can tell from the experiences you are having in the market whether or not you are quick enough to use mental stops.
         

by Joe Ross

Chart Patterns to Avoid: Climax Top Off a Parabolic Move

This pattern occurs when a stock rises very quickly out of a base and gets overextended.

Stocks in a Parabolic Move can double or triple in value in a very short period of time (usually less than two weeks).

As an investor you certainly don't want to be one of the last passengers on the train and get quickly thrown off.

Some examples of this pattern are shown below.

Notice the quick move upward in MCOM back in July. In 5 trading days it went from $20 to $57 for a gain of 185%. Also notice that on the biggest volume day (point A) that it gapped up strongly to $53 and then closed poorly around $41. This was the Climax Top Off the Parabolic Move. As an investor you should have sold this day if you had bought the stock in the $20's. Meanwhile you certainly should have not bought this stock this day. Notice how the stock eventually pulled all the way back to $20 by early August (point B).


Another example of a Climax Top Off a Parabolic Move is demonstrated by LWIN. This stock skyrocketed from $30 to $95 in 10 trading days for a whopping gain of 217%.

The Climax Top occurred on the 10th and 11th days of trading as the volume peaked (point A). The stock then sold off and retreated back quickly to around $42 by late November.

As you can see stocks that go up very quickly, in a Parabolic Move, can also come down just as fast.
         

My advice is if you buy a stock and it doubles or triples in value in a very short period of time (1 to 2 weeks) take your profits and congratulate yourself for a job well done. If you become greedy then you could lose most of your gains as the above examples indicate. Furthermore if your buying a stock in this type of move be very careful and watch out for the Climax Top if the stock is trading on its biggest volume day.

Regards,

Bob Kleyla