Chapter 10
Information Power
In This Chapter
• Active traders must be right with information
• Information must be tailored to trading strategy
• Information must be easily digested and acted on
• Information costs cannot be excessive
Active traders, more so than buy-and-hold investors, must have good up-to-date information as a basis for their trades. Data and information are not the same thing. Data is only helpful when it is digested into actionable information that a trader can use. Finding sources of information that distill and digest streams of data into information that can be used in making a decision is not always easy. One of the strengths of technical analysis is that it presents a lot of data in a graphic form that is easy to digest quickly. It would be impossible to digest and compare columns of numbers as quickly as looking at a chart.

Trading on What You Know

Active traders need to be focused to be successful. The key is identifying what information to focus on and how to translate that information into profitable trades. Active traders who keep their trades confined to a single trading day have different information needs than position or trend traders. Successful traders learn what information is important to what they are trading today. If they switch strategies tomorrow, their information needs will change, but for today, here is what information is needed.

Data Overload

The Internet has changed the way active traders conduct their business—in fact, without the Internet, it would be hard to imaging active trading as we know it today. One of the real benefits of being connected via the Internet is the vast amount of data and research that’s available, much of it free. For buy-and-hold investors who have the time, inclination, and expertise, the information on companies and stocks on the Internet is a gold mine. They can spend hours analyzing financial statements, analysts’ reports, historical stock prices, and all manner of research. For many, this access is a wonderful resource. For others, to quote a well-worn cliché, it’s like putting a fire hose in your mouth and turning on the hydrant—it’s just too much.
074
Trading Tip
Information management is an important part of an active trader’s daily tasks. The more organized and filtered it is, the more beneficial information will be to the trader.
075
Margin Call
Not only is there an overload of information on the Internet, some of it is wrong, and some of it is fraudulent. Be very careful, especially in forums and chat rooms, of people touting a particular stock or security—this is often a scheme to pump up the price and then the culprits sell a big block of shares and the price collapses.

Information by Design

Active traders soon realize that they don’t need and don’t have time to study the quantity of material most investors use. Depending of what they are trading, active traders will identify a small number of key indicators that serve as their primary “buy or sell” signals. Too many indicators and traders will miss an opportunity or see a trade go bad before they can check them all. Frequently, traders will use signs that lead to multistage decisions.
Short-term traders usually don’t have time for multistep decision-making. Short-term traders move when they see the opportunity based on a very few indicators. In most cases, these traders want to be out in front of the market, but always headed in the same direction. Technical analysis with its easy-to-read charts suits this type of fast-paced trading well, as we’ll see in several later chapters. Traders have favorite charts that they turn to for quick input.

By the Numbers

The most basic information a short-term trader needs is immediate price data as orders are entered and executed. Most direct access brokers offer price quotes as part of their package, but not all quotes are equal. Depending on the system, prices may be just a skip behind the market. For short-term traders this can be a disaster. Pricing information is so important that some traders will buy it from a vendor even if it is available as part of their direct access account. The world of scalping is measured in fractions of seconds at times. Traders who are behind the market will soon be out of the market.
As we’ll see in coming chapters, comprehensive price and volume information is essential for short-term traders. It is this information that tells traders which way the market is moving and if prices are building up on the buy or sell side. Nasdaq Level II reporting (as opposed to Nasdaq Level I or summary quotes, discussed next) shows traders not only the price of the security but, equally important, the unfilled orders on both the bid and ask side. This information helps traders form a picture of where the market is going and which side they should be on to profit. You can’t reasonably expect to succeed as a short-term trader without this level of detailed information.
def·i·in·tion
Nasdaq Level I prices are the best current price in the market. These are the quotes you’ll see on site offering “live quotes.” They tell you the price, but that’s all. Nasdaq Level II quotes show all the bid orders that are lower than the best bid price and ask orders higher than the current best ask price so that you can see orders stacking up on the bid or ask side, which may help you determine whether the market is bearish or bullish on the security.

What Do You Need to Know?

Short-term traders can be paralyzed by too much information, but position or trend traders must have much more information to establish and know how long to hold a position in a security. Your first task is to define your information needs. If you are going to do more than one type of trading, each strategy will have its own set of information requirements. In subsequent chapters, we’ll go over each of the four major active trading strategies (short term, momentum, swing, and position) as we have defined them. Part of that discussion will focus on minimum information needs to be successful. However, experienced traders soon develop their own information requirements that work best for them and their trading style.

When Do You Need It?

Active traders by definition are in the market in real time. They grab small profits multiple times during a trading day or larger profits multiple times during a trading week. This type of trading strategy requires real time price and volume information. Don’t confuse this requirement with the “free live quotes“ you see offered through many online brokers. These quotes are “inside” quotes, meaning you are seeing the best bid and ask prices available on the market—also known as Nasdaq Level I quotes or summary quotes.
Level I quotes are fine if you simply want to know where a security is trading at a given moment. However, they do not provide enough information to traders. For that information, traders turn to Level II Nasdaq quotes. Level II quotes show all the bids and ask quotes and the order size that are away from the market—that is, not at the current best bid and ask price. In other words, bid orders that are lower than the best bid price and ask orders higher than the current best ask price. Here is where you will see orders stacking up on the bid or ask side (or spread evenly), which may help you determine whether the market is bearish or bullish on the security.
def·i·in·tion
Away from the market means the bid or the ask price on a stock is not the best order available at that moment. There are lower bids or higher asks currently available.

Your Pre-Game Preparation

Athletes prepare for a game by studying the opposition and playing field. They plan a strategy based on the strengths and weaknesses of their opponents. For active traders, this means studying the market before it opens to decide whether it will open with a positive or negative bias. You’ll want to decide, based on observation and analysis, if the market looks like it will rise or fall this session, and plan your strategy around that conclusion.
Most traders develop a routine they do each morning before the market opens. This process touches the various areas they need to check before deciding if the market looks like it will open up or down. While short-term traders react to price and volume changes when the market is open, they also make themselves aware of any important news that might affect the market’s direction or velocity. Traders can make money on down markets as well as up markets, although many prefer a rising market for purely psychological reasons.
Here are some news sources that traders use to gauge where the market might be headed in the coming trading session:
News broadcasts. Early morning news from CNN or another credible news source can give you the headlines concerning any big news stories that may affect the market today. Remember, the stock market prices events in advance. If something is scheduled to happen, it is priced into the market immediately, so most of the impact is already absorbed before the event happens. What moves the market are surprises—a sudden jump in the price of oil, an unexpected ruling from a federal agency or by a court, and so on.
Stock index futures. Your broker likely provides this, but if they don’t or your want to check them before logging in, you can find them at cnnmoney.com in the “markets” section. There you’ll find futures quotes for all the major stock indexes. You’ll see two figures, the index and the fair value. The fair value is the relationship between the futures contract and the value of the index. If the futures contract is higher, the difference will be a positive number; if it is lower, a negative number. You will often hear early morning newscast talking about stock futures opening higher or lower. These are the figures they are looking at, and they are a good indicator of where the market will open, but not necessarily the direction it will maintain all day.
Market Place
Stock index futures are great indicators of where the market may open, but once the bell rings all manner of things may happen to change price direction. Count on the futures for starting guidance, but forget them after the market opens.
Economic reports. What major economic reports are due today and will any of them hold potential surprises? The market anticipates what reports are going to say and if the reports are on target or very close, you won’t see much reaction.
However, if the numbers are a surprise—good or bad—the market may have a strong reaction. Depending on the report, some sector may react more sharply than others do. If you trade in a specific industry group, learn what economic reports affect that sector the most and stay on top of that news. You can find economic report calendars on a number of websites—www.breifing.com has one of the better reports.
Sector reports. Develop a short list of websites you can scan for industry and sector news. Look for headlines that may be market movers or stories that you may want to come back to after trading hours.
Your trading targets. If you trade a specific group of stocks or securities, focus on any news about what has happened overnight that may move prices today. This could include upgrades or downgrades from stock analysts, regulatory news, key personnel changes, and so on. Remember, if you trade derivatives, you must follow the underlying security.
It is helpful to many traders to have a more or less set routine of information gathering before the markets open or before you begin trading. The routine gets traders in the proper mindset to do business. This can be helpful since most work out of their homes that are filled with distractions. The routine also assures you that all information bases are covered each day. The longer you work at active trading, the more refined your routine will become. You can alter it as you add new products to trade.

Short-Term Traders’ Needs

In addition to the information traders gather from the sources above, short-term traders prepare for the market opening by having potential trades set up on securities they follow. The overall market information gives them an idea of whether the market will trend up or down for the day. Now they begin focusing on specific securities they plan to trade. Traders will have their charts set up and the specific indicators in place so they can focus on the action once trading begins.
Once trading begins, short-term traders focus on their charts to give them the immediate information they need. However, their initial plan for the day was established based on the information gathered before the market opened. As trading continues, things change and short-term traders must be able to adapt. Since traders will close their position before the end of the day, the only concern is how prices and volume are changing right now and what does that mean for the traders’ strategies.
Beginners who jump into trading without any preparation seldom get past the beginner designation before they run out of money. Experienced traders have a trading plan of what they want to trade today and under what conditions. Experienced traders don’t guess. If there are no good trades in the securities, they prepared for, they either switch to another security they are prepared for or they go play golf and try again tomorrow.
076
Margin Call
The market moves too quickly for short-term traders to make up a plan as they go. If your plan isn’t working, close out your positions and find out why. Trying to repair your plan while trading is a recipe for disaster.

Swing Traders’ Information Needs

Swing traders work at a fast pace, although not as fast as the short-term trader. Since swing traders may hold a position for several days or weeks, they are more concerned with information that can stop or reverse the upward (or downward) swings in prices. While technical indicators play a major role for the short-term traders, they play a less, although still important role, for the swing trader. Swing traders look for stocks that trade in a range or channel and may be slowly drifting up or down. This type of trading is usually difficult if the overall market is trending sharply in one direction or the other.
Swing traders need more fundamental, sector, and overall market information than short-term traders. Technical analysis traders will disagree, but many active traders find they have a large blind spot if they don’t focus attention on external indicators (other than price and volume, for example). A security that works for a swing trader can become derailed by news events, economic reports, company fundamentals (earnings reports, for example) or other factors that have nothing to do with price or trading volume.
Market Place
Swing trading seems to work best when the market indexes are not going either direction with any authority. With the overall market drifting along, certain stocks will trade within a range that makes them good swing candidates.
Technical analysis will tell swing traders the approximate range a stock is trading in using an exponential moving average to establish a baseline. The “swing” in swing trading is the price moving over this baseline and falling back below it, only to move up again. The high and low form the channel the stock trades in and swing traders can profit going both ways with the price. As the price moves up, swing traders buy or take a long position. When the price hits the top of the channel, it will typically reverse back down. Swing traders will close the long position and short the stock as it falls below the baseline. Traders will cover their short as the stock hits the bottom of the channel and begins an upward bounce.
Of course, it doesn’t always work this smoothly. However, if swing traders have done their homework, they will take a long position as the security rises and if it keeps going past the top of the channel, that’s more profit for them. By using protective market orders, they can cover their profits in the event the security reverses course (as many do). If swing traders have a position that breaks out of the channel and keeps going, they have become a position trader. Some swing traders set profit targets and close their position when those are reached even if it appears the security has more profit by holding longer.
The danger with holding is that traders are great at convincing themselves a security that was doing well, but is now falling in price, will reverse course again and continue upward. That may happen, but often undisciplined traders and investors watch profits evaporate while they wait for a security to reverse its slide.

Position Traders’ Information Needs

Position traders who may hold a trade for months are more closely aligned with investors than traders when it comes to information needs. Fundamental analysis of a company drives the decision-making for many position traders; however, the technical analysts never stop looking at their charts for answers. What both strategies look for are securities that are beginning a sustained upward (or downward) trend. It is not necessary to buy at the first tick of the trend (and you won’t know it anyway).
The position trader’s goal is to identify those securities that are suited to begin a long-term movement is some direction. The trick is identifying when price movement is a trend as opposed to a bump. Jumping in too quickly can mean you may find your trend falling out from under you. However, if you wait too long and the trend is well established, most of the gain may already be gone.
The position traders’ other dilemma is when to close out their positions. Experienced traders use protective market orders to cover much of their profits. Setting a rule about when you exit is a good idea. Some traders wait until the trend has backed off a certain amount before closing, while others cut their position at the first sign of a reversal. These traders tend to rely heavily on technical analysis of price and volume for buy and sell signals.
As you become more experienced, you will develop your own system for evaluating position trades and the information you need to trigger a trade. Whether you rely more on fundamental or technical analysis is less important than having a plan and following it. Traders who profess to have a “feel” for the market and base their trades on instinct alone usually are looking for another line of work soon. The instinct that some experienced traders talk about is the experience of having seen similar circumstances before and remembering the outcome.
077
Trading Tip
The market cliché “The trend is your friend” has a ring of truth in it. Riding a trend up or down can be very profitable, especially if the trend runs for several months.

Information Bites

Information for traders must not only be appropriate for the type of trading, but it also must be in a form that is easily digestible. Columns and columns of numbers can be difficult to understand or summarize. Even charts and graphs can be confusing and misleading if they are not constructed properly and labeled clearly. Traders need to be able to look at the information and quickly understand what it means—not just its face value, but in the broader context of how the information changes or confirms their valuation of the security.
Short-term traders are the most vulnerable to foggy information. If the data screens and charts they construct aren’t clear and concise, traders will miss opportunities trying to decipher the information. A quick glance at a chart(s) should be sufficient to tell traders what they need to know about what is happening that minute in the market.
078
Margin Call
Agony for a short-term trader is waiting for a chart to draw while the market pushes ahead. Dynamic charts that update in real time and the Internet connection to support them are money well spent.
 
Swing and position traders have the luxury of more time than the short-term trader does, but that doesn’t change the need for information to be clear and concise. These traders have more time to digest information, but there is no reason they should have to stumble through confusing and contradictory statements to learn the truth. The efficient market theory says that all knowledge is already priced into securities and no one has an edge on knowing something others don’t know.
What that means in practical terms is that it is unlikely you will uncover some important piece of information about a company that will give you an edge that no other trader or investor has. But it also means you had better know what the market knows about why a stock is priced at a certain level. For example, if a company’s stock is undervalued by the market, you should know why. Is the company in serious debt trouble? Have they lost significant market share? It may just be an overlooked company in an uninteresting industry sector, which qualifies it as a value stock. Value investors are willing to hold the right value stocks for long periods, believing the market will one day re-price them upward.
The Internet provides many sources of fundamental information for traders who want to examine companies for the inside out. You can find a great deal of free information or go to paid sources, which typically include analysis or commentary along with straight information.
Market Place
Full-service brokers used to earn their commissions by making recommendations to clients. That service still exists and many traders and investors use the advice. If you want someone to help you pick investments, you must have a sizable amount to invest.
Your broker or direct access provider may offer research as part of your account services. This information comes in several forms, including referrals to third-party providers, proprietary services, and a mix. Full-service brokers provide not only information but also recommendations to clients. If you are not interested or don’t have the time to make your own choices, this is a viable route for position traders. We’ll discuss brokers and their services and fees in Chapter 11.

Paying for Information

With all the information available free on the Internet, paying for even more may seem almost wasteful. While you must run your trading operation like a business and watch expenses, you shouldn’t cut corners on services that may mean success or failure. How much and what type of information you may need to buy is determined by the type of active trading you plan to do and what is provided by your broker or direct access provider.

Price Quotes

Short-term trading demands Level II Nasdaq quotes—there is no compromise here. Simply seeing a live quote is not nearly enough information, as we’ll see in Chapter 17. Many advance brokers and direct access providers offer Level II quotes as part of their package. However, some traders find that the process of the quotes passing from the exchange through the broker’s system before it appears on their screens is too slow. They choose to use an outside source for quotes that specializes in providing information as their main business.
A number of vendors provide this service in some form. At the top of the line are information platforms that offer a wide and deep range of information services, including price quotes. These sophisticated platforms are dynamic, meaning they push information to the screen constantly. More importantly, you can customize the display of information to suit your needs. The combination of news, analysis, charting, price quotes, and alerts make these platforms the ultimate information centers.
Of course, you can expect to pay a hefty price for what you get. The good news is many information platforms offer a basic service for a monthly fee and then let you add on only the extras you need. The tab can still run several hundred a month, but if you are an active trader and serious about succeeding, you owe it to yourself to check out what these marvels of information reporting have to offer. Many will let you try the system or parts of it for 30 days with various money-back offers. If you are considering using an expensive information portal, try before you buy.
079
This image of an eSignal. com window shows how much information the company can place on your computer. This is just one of hundreds of configurations.
(Photo courtesy of eSignal.com.)

Basic Information

Position traders may find this level of detail too much and too pricey, although many active traders practice multiple strategies and need to cover all of their information bases. However, if you plan a slower approach to trading, Level II quotes are probably not necessary. Whether you buy a stock at $25.23 or $25.24 per share will not make much difference six months from now.
You do need access to fundamental information, including all the appropriate financial ratios and comparisons to sector and market averages. Much of this information is free or can be purchased with a subscription to one of several premium services. MorningStar.com offers a premium service for a small monthly subscription that includes a stock screener and analysts’ comments on many stocks. Other similar services are sufficient for the position trader who can take time to study companies before trading.

The Cost of Information

What you pay for information is relative to its benefit to you. If you are a very active short-term trader, having access to Level II quotes presented quickly and in a manner that is clear to you is invaluable. Likewise, real-time charting software can present buy or sell signals at a glance. If these services help you make money and don’t cost more than they increase your profits, you should seriously consider employing them.
080
Trading Tip
Almost all information and price quote services offer some type of free trial. Take advantage of these offers to see which services fit your needs the best.
Of course, spending money on information that you don’t need and don’t use is unnecessary and foolish. The most expensive trap you can fall into is the one of buying bells and whistles you don’t understand, use, or need. The other expensive trap is not investing in the tools that will help you make trades that are more profitable. Active trading is difficult enough without taking advantage of all the tools at your disposal.
 
The Least You Need to Know
• Information is an active trader’s tool and is necessary for success.
• Active traders should tailor information to their trading style.
• Information should be formatted for quick delivery and retention.
• Traders should avoid paying for information they don’t need and invest in the information that will help them succeed.
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