Introduction to technicalanalysis and the Active

Investing strategyby Alan Hull

Disclaimer

This document was prepared by Alan Hull an authorised representative of Gryphon Learning, holder of AustralianFinancial Services License No. 246606. It is published in good faith based on the facts known at the time ofpreparation and does not purport to contain all relevant information in respect of the securities to which it relates(Securities).

Alan Hull has prepared this document for multiple distribution and without consideration to the investment objectives,financial situation or particular needs (Objectives) of any individual investor. Accordingly, any advice given is not arecommendation that a particular course of action is suitable for any particular person and is not suitable to be acted onas investment advice. Readers must assess whether the advice is appropriate to their Objectives before making aninvestment decision on the basis of this document.

Neither Gryphon Learning Pty Ltd nor Alan Hull warrant or represent the accuracy of the contents of the document.Any persons relying on the information do so at their own risk. Except to the extent that liability under any law cannotbe excluded, Gryphon Learning Pty Ltd and Alan Hull disclaim liability for all loss or damage arising as a result of anopinion, advice, recommendation, representation or information expressly or impliedly published in or in relation tothis document notwithstanding any error or omission including negligence.

None of Gryphon Learning Pty Ltd, its Authorised Representatives, the “Gryphon System”, “Gryphon MultiMedia”,and “Gryphon Scanner” take into account the investment objectives, financial situation and particular needs of anyparticular person and before making an investment decision on the basis of the “Gryphon System”, “GryphonMultiMedia” and “Gryphon Scanner” or any of its authorised representatives, a prospective investor needs to considerwith or without the assistance of a securities adviser, whether the advice is appropriate in the light of the particularinvestment needs, objectives and financial circumstances of the prospective investor.

©Copyright Alan Hull 2011This document is copyright. This document, in part or whole, may not be reproduced or transmitted in any form or byany means, electronic, mechanical, photocopying, recording, scanning or otherwise without prior written permission.Further enquiries can be made to Alan Hull, the author, on 061-03-9778 7061.

Correspondence can be forwarded to ActVest Pty. Ltd. ABN 44 101 040 939 at 53 Grange Drive, Lysterfield, Victoria,3156, Australia or via our website at http://www.alanhull.com

2

In the beginning

To really understand what share trading is, we should start right back at the very beginningand look at what the Stockmarket is and how it came about. I am actually a secondgeneration share trader and before I was even a teenager my father sat me down andexplained to me what a Stockmarket is. So here’s the story as it was told to me as a child...

Along time ago before the Stockmarket ever existed, there was a man whom we’ll call Mr A.One day Mr A had an idea…a great idea.

An idea about how to build a better ship.

3

But it was an idea about a big ship and Mr A didn’t have enough money to build his ship. SoMr A got depressed…

In fact there were lots of men and women with lots of great ideas about lots of things...

But none of their ideas ever became a reality until one day Mr A had an idea about money.His money idea was to break up his ship idea and find other people to share in it...

4

So Mr A formed a Company and went to Mr B who was a good salesman and got him to sell‘Shares’ in his new ship building Company. Mr A paid Mr B well and so Mr B worked veryhard and managed to sell all of the shares. This made Mr A very happy.

In fact Mr B made so much money selling Mr A’s idea that he then went and brokered dealsbetween the other people who had ideas and members of the public who wanted to invest.And when Mr A’s Company began to make money, he divided the profits among theshareholders. He sent money every year he made a profit.

But one of his investors, Mr C, had an idea of his own and wanted to sell his holdings in MrA’s Company to pursue his own clever idea...

5

But it was very hard for Mr C to sell his shares because Mr A didn’t want to buy them backand there was no marketplace for shares. So Mr C started one and called it a Stockmarket.

And that’s the ABC of how the Stockmarket began!

Of course this is a very simple but conceptually accurate explanation of how Stockmarketscame into existence and why we have them. Thus they serve the very serious functions ofraising venture capital and facilitating the transferring of interests in Companies from oneinvestor to another. Here are some additional key points worth noting...

• Mr A and people like him are Entrepreneurs.• Mr B brokers deals between entrepreneurs and investors and is called a Stockbroker.• Furthermore, thanks to Mr C and the creation of the Stockmarket, Mr B also brokers deals

between investors, transferring Company interests from one party to another.• When Stockbrokers initially place shares with investors it is called the primary market.• When shares are bought and sold in the Stockmarket it’s called the secondary market.• Company profits are split up and distributed regularly to shareholders as dividends.• Stockmarkets also regulate publicly listed Companies to protect investors interests.

So that pretty much explains what a Stockmarket is and now we can move to the really bigquestion; what is share trading?

Share Trading – a simple explanation

This is a very common point of confusion for many Stockmarket participants (newcomersand even the more experienced) and therefore I’m going to come at it from several directions,in order to provide you with as much clarity as possible. Again, let’s start with a very simpleexplanation (with pictures of course)...

6

Because the fortunes of a Company will inevitably change over time, the price of the sharesthat represent a company will increase and decrease in sympathy with these changes...

Share price rising and falling over time

Thus it’s possible to make money from buying and selling shares...providing you sell theshare for more money than you paid for it. So while you own the share, the share’s pricemust increase…

Rising share price

In investment circles this is given the fancy name of ‘capital growth’. It all sounds simpleenough but so often people will confuse ‘trading’ with ‘investing’. So now I’m going toclarify the difference between these two distinctly different ways of dealing in shares.

7

Share Trading – as distinct from investing

The word 'Trade' means, 'Buying and selling for profit' which does make for a usefuldefinition. If I say I am a share trader then I am stating that I buy and sell shares for a profitwhich seems simple enough but there are deeper implications to this statement. For instance,if I am buying shares with the intention to sell them at a future date for a profit then I wouldhave to be expecting them to rise in value.

Here’s the confusing bit…the word 'Invest' means to, 'use money to make a profit' whichincludes any money making endeavour which requires money. So a share trader qualif ies as atype of investor because they are applying money to the Stockmarket in order to generate aprofit. Contrary to popular belief, a person who deals in shares is not defined as a 'Trader' bythe number of trades they perform each year. This definition was created by a certainGovernment department and, whilst it may serve their purposes well, it is very misleading forthe rest of us.

The reality is; if you purchase a share with the intention to sell it at anytime in the future for aprofit then you are a share trader. The value of the share must obviously go up whilst it is inyour possession but you could sell it after 1 week, 1 year, 10 years or even longer. An starkexample of a long-term trader is someone who purchases art and holds onto it across severalgenerations before selling it. They may hold it for 100 years but they are still trading.

Warren Buffett is an Investor

So if we define a share investor as someone other than a share trader then I think it would bereasonable to take the world renowned Investor, Warren Buffet's, definition of an investor asbeing an 'Asset manager'. Warren Buffett's company, Berkshire Hathaway, is an assetmanagement company which buys interests in companies that are undervalued, improvestheir operation over time and then derives a return from them via the company’s increasedprofits.

Warren Buffett's favourite holding time is forever because he buys into companies in order toderive an ongoing interest in their operation and not to sell their stock at some point in thefuture for capital growth. Believe me, Warren Buffett is very clear on what he’s doing!

In other words, he's primarily after a share of the ongoing profits and he views any capitalgrowth largely as a bonus. Furthermore, in order to make use of any capital growth he willborrow against it rather than sell his holdings which will attract capital gains tax. Unlike ashare trader who will sell shares that start to fall in value, Warren will buy more sharesbecause they represent a cheaper income stream.

So a share trader wants to buy a rising share price and an Investor (read asset manager) wantsto buy a high income yield which occurs when the share price falls…perfectly opposedobjectives!

And so share traders are pre-occupied with share price behaviour whilst investors are moreinterested in the underlying business. Thus technical analys is or charitng is very much therealm of share traders as oposed to investors. So now we’ll move on to the subject of charting

8

Introduction to Technical AnalysisCharting analysis can be split into 2 schools. The oldest form of analysis is patternrecognition which is based upon human behaviour and history repeating itself. The newerschool of charting is based upon probability and statistics. With mathematical and graphicalanalys is a chartist can calculate the most probable behaviour of the Stockmarket. These 2forms of analysis overlap each other and most chartists use both methods. All charts arebased on 3 basic elements;

Price, Volume and Time

Different types of charts

There are many different types of charts in use throughout the world. All of the followingexamples are in common use today. The type of chart used is not a right or wrong decisionbut rather a question of personal choice. Different types of charts have their own strengthsand weaknesses but it is never a good idea to use a type of chart that you do not feelcomfortable with or confident in using.

Candlestick Charts

The height of the body of the candlestick is set by the opening and closing prices of the day.The spike at the top of the candlestick depicts the highest price achieved on the day.Similarly, the lower spike identif ies the lowest price of the day.

The candlestick chart is of Japanese origin and is believed to have been in use for centuries.Each candle shape has a particular name and the candlestick chart is used primarily for dailyor short term trading. Its main strength is pattern recognition.

9

Candlestick charting is gaining in popularity with chartists around the world. Candlestickcharts are being used in conjunction with modern technical indicators. Books on candlestickcharting are usually expens ive and hard to find due to a low demand. However this situationis changing with their increasing popularity.

Line on Close Chart

This is the simplest form of chart available and is widely used by the print media.

The OHLC Bar Chart & Volume Histogram

The OHLC bar chart & volume histogram, known henceforth as ‘The Bar Chart’ is the mostcommonly used chart today. The abbreviation OHLC stands for Open, High, Low and Close.

10

In a bar chart each trading period is represented by a bar that has a tick to the left of the barand another tick to the right. At the bottom of the chart the volume is shown for each tradingperiod in the form of a histogram. The top of the bar and the bottom of the bar represent theprice range of trading period in question (ie. the high and the low). The tick to the left of thebar represents the opening price and the tick to the right represents the closing price.

Volume and its Significance

The histogram is highly suited to showing the ‘Rate of Change’ of volume. Chartists aremore interested in the rise or fall in the trading volume than they are in the actual amount ofshares that are traded during a particular day or week.

Rising volume & rising price => Strong Bullish signalFalling volume & rising price => Weak Bullish signalRising volume & falling price => Strong bearish signalFalling volume & falling price => Weak bearish signal

Timeframe

Charts can be made using different time scales. An intraday trader who buys and sells on thesame day can use an intraday chart that has a bar for every 5 minutes. They can adjust theirtime scale from a 1 minute to 30 minutes tick, or even 2 hours if they wish. A long terminvestor would typically use a weekly or monthly chart to monitor their investments. Mostshare traders use daily and weekly charts.

Daily Chart

11

Weekly Chart

Monthly Chart

12

Basic Pattern Recognition

The range, or distance from the high to the low, indicates the volatility or difference betweenthe bulls and the bears. An inside day suggests that the bulls and the bears are movingtowards agreement on value. This pattern suggests a shift in price is coming but does notindicate in which direction.

The position of the close near the top suggests the smart money agrees with the bulls (Bullishsignal). The position of the close near the bottom suggests the smart money agrees with thebears (Bearish signal).

13

The close near the open and low volatility suggests general agreement and usually indicates ashift in price is about to occur. Candlestick chartists refer to this pattern as a Doji Star.

A bear shakeout is a bar that has its open, close and high nearly or completely equal with along tail attached. A bear shakeout indicates that a bullish movement is about to occurbecause the market has exhausted its supply of bears or sellers. Candlestick Chartists call thisbar a dragon tail or hammer.

14

A bull shakeout is an upside down version of a bear shakeout. A bull shakeout indicates thata bearish movement is about to occur. Candlestick Chartists refer to this pattern as a hangingman.

A bull or bear shakeout can occur over several days.

15

When bull and bear shakeouts occur next to one another it indicates a ‘Point of Agreement’.This pattern can occur during trends and is a warning sign of a possible change in directionor weakening of the underlying trend.

When the market moves into a ‘Point of Agreement’, market participants signal theiracceptance of the current price by refraining from buying or selling the share. This causes adrop in volume during the period leading up to and during the ‘POA’.

16

The classic reversal bar indicates the weakening of a rally. When a market is rising it istypical for the close of the day to be higher than the open. When a daily close is lower thanthe open it indicates a weakening of the underlying trend or rally.

The exact opposite can occur in a falling market where the classic reversal bar will have theclose of the day higher than the open.

17

Triangles

Triangles are one of the most common patterns that occur in charts. Triangles are anotherpattern that indicates a ‘Point of Agreement’ with the shape of the triangle indicating theprobable direction of the forthcoming breakout.

A downward sloping triangle indicates a likely downward breakout at or near the point wherethe hypotenuse meets the bottom. Each time the bulls attempt to move the price away from aparticular level the bears bring it back. Each time this occurs there are less and less bulls.When there are no bulls left a downward breakout occurs.

In late 1998 and early 1999 Telstra’s share price enjoyed a meteoric rise that lasted fromOctober 1998 to the beginning of February 1999. This trend saw the price of Telstra risefrom a low of $5.80 to a high of $9.20.

The downward sloping triangle gave the earliest warning that the trend was about to end.Note how the price was unable to break away from the $8.80 level. As the market began torun out of Bulls the price made a series of lower highs.

The tip of the triangle is a ‘Point of Agreement’ and from this point the Bears took control ofthe market and drove the price downwards. Triangle patterns can usually be spotted beforethe tip has occurred making them very useful patterns for Traders.

18

An upward sloping triangle indicates a likely upward breakout at or near the point where thehypotenuse meets the top. Each time the bears attempt to move the price away from aparticular price level the bulls bring it back. Each time this occurs there are less and lessbears. When there are no bears left an upward breakout occurs.

An Equilateral triangle gives no indication as to the direction of the forthcoming breakout butdoes indicate a point of market agreement and hence a breakout. Market sentiment is notdominant in either direction.

19

A double top or bottom is where the market takes the price up or down to the same leveltwice. When the price pulls away for the second time it is usually a strong move.

A head & shoulders occurs when the market moves price from one level up to another. Theprice breaks back to the original level and then breaks down from this level. This is anextremely bearish signal as shown with the correction of 1997.

20

Support & Resistance Lines

Imagine a share that trends up in price to 72 cents and then remains around 72 cents for aperiod of time. From this behaviour it can be deduced that most of the recent buyers acquiredtheir shares at or near a price of 72 cents.

If the price of the share rises from this level and then falls back to 72 cents, the large group ofbuyers at 72 cents will have enjoyed paper profits. Human greed will motivate them not tosell at or below 72 cents because of their recent profitable experience. In doing so theyprovide support for the share at 72 cents. They do this by reducing the supply of availableshares when the price is at or below 72 cents.

If the price of the share falls and then rises back to 72 cents, the 72 cent buyers typicallybecome sellers at 72 cents. Fear motivates them to sell at the point where they can breakeven. In this instance the 72 cent buyers, turned sellers, provide resistance to the share priceat 72 cents.

The price at which a share remains for an extended period of time takes on specialsignif icance. The price of 72 cents is said to be a level of support and resistance. On a barchart you can position a horizontal line to represent the price level of support & resistance.Placement of these lines is subjective and a chartist could position the S/R line on thefollowing chart anywhere from 71 cents to 74 cents.

21

Support and resistance lines are projected forward into the future and the older the line theless significant it becomes. The longer the price action remains at the same price; the moresignif icant the support and resistance line becomes. Support and resistance lines, knownhenceforth as S/R lines, are a primary tool for chartists.

Market psychology can project S/R levels such as the All Ordinaries Index at 3000.

22

Linear Regression

If a group of traders & investors believed $7.50 to be the true value for a share it is logical toassume that they would be buyers if the price fell below $7.50. Conversely, if the price risesabove $7.50 they would become sellers. This causes the price of the share to return to $7.50whenever it try’s to move away.

A horizontal line at $7.50 is called a line of linear regression or the line of best fit. A line oflinear regression is similar to a support and resistance line but of different significance. Asthe volatility of price activity diminishes and settles at the line of linear regression,agreement is being reached by the bulls and bears.

From this point there will be a breakout and the chartist will use other indicators and methodsto determine the direction of the breakout. If the price activity remains around the line oflinear regression for a prolonged period the price will develop support and resistancecharacteristics as well.

The above chart shows the price activity oscillating around $7.50 and how this price activitygradually narrows down before breaking away from $7.50. Towards the right hand side ofthe chart, the price activity comes down and bounces off $7.50 before continuing on itsupward trend.

Lines of linear regression are of less importance than lines of support and resistance. Theyare characterised by price activity oscillating around a particular price level rather thanbouncing off it as would be the case with a line of Support and Resistance.

23

Trendlines

There are actually 3 types of trends in the Stockmarket. A sideways trend, as represented by asupport and resistance line, is where the price activity moves horizontally across a chart. Anupward trend occurs when price activity moves upward from the left of a chart to the right. Adownward trend is where price activity moves downward from left to right.

When analys ing an upward or downward trend a chartist uses trendlines. Trend trading iswidely considered to be the most reliable method of trading financial markets. There is acommon cliché that states ‘The Trend is your Friend’. There are traders and investors whotrade against prevailing trends and they are referred to as ‘Contrarians’.

Special Note

The construction/placement of trendlines is subjective and chartists can have differingopinions on how they should be positioned on a chart. The method described below is themost conventional approach employed by chartists around the world.

In an upward trend, a trendline is constructed by drawing a line that touches two or more ofthe most significant lows. This line provides support to the price action and, when broken bythe price activity, indicates that the trend is weakening or may be over.

This trend ended when it ran into resistance at $5.00. The chartist would place an S/R line at$5.00 knowing that this level will be of significance in the future.

24

In a downward trend, a trendline is constructed by drawing a line that touches two or more ofthe most significant highs. This line provides resistance to the price activity and, whenbroken by the price activity, indicates that the downward trend is weakening or may be over.

The above chart of AMP shows a very significant downward trend with the price activitytouching the trendline on 4 separate occasions. When the price activity broke out of thedownward trend it began to rise until it almost reached $18.00. Note the sideways movementof price activity just below $18.00 during April and May 1999. As the price rose back to thislevel, the buyers from April and May probably came into the market and sold their holdingsat the break even price.

General Rule 1

The more often a trendline touches the price activity; the more significant the trendline. AChartist will position trendlines so they are touching the price activity as many times aspossible. This can lead to a loss of objectivity by the chartist.

General Rule 2

A break in an upward trend signals an exit as the price activity begins to move sideways ordownwards. A break in a downward trend does not signal an entry as it does notnecessarily mean that the price will go into an upward trend.

25

Trendlines have two signif icant characteristics. The gradient and time duration of thetrendline tell the chartist the strength of the trend. An upward trend requires a constant supplyof new bulls or buyers to continue.

A trend with a steep gradient, ie. 50 degrees or more, is likely to exhaust its supply of bullsmore quickly than a trend with a gradient of only 30 degrees. In understanding thischaracteristic the chartist knows that the steeper the trendline the shorter the time duration.

The above chart of NAB is a good illustration of how a steep trend is short lived. The supplyof buyers is rapidly exhausted in a period of only 4 weeks. The price of NAB sharescontinues to rise but with a more gradual rate of climb. The more sustainable trend lasted fora period of approximately 5 months.

A common technique used for trend trading is to exit a position when the price activity closesconsecutively lower two times in a row below the trendline. The success of this techniquedepends on the chartists ability to position trendlines.

Special Note

As price activity trends for a long period of time with the same rate of climb, the marketbuilds acceptance in the gradient of the trend. Because of this market acceptance, it isharder to break a long lasting trend than it is to break a short lived trend.

26

Simple Moving Average (SMA)

Because price activity is not linear in nature it is more helpful to use moving averages tosmooth out the price activity rather than a series of straight lines. A moving averagesmoothes out the price activity on a chart by adding together the prices of ‘X’ number ofdays and dividing it by ‘X’ number of days. Each day this average is recalculated and all theaverages are connected using a single unbroken line.

A moving average can be used in the same way as a trendline to detect a change in thedirection of price activity. Some traders use moving averages instead of trendlines. Thismethod takes the guess work out of the placement of trendlines.

The ‘2 consecutively lower closes below the trendline’ exit signal can be applied withmoving averages as well as trendlines. Remember not to invert this rule as 2 consecutivelyhigher closes above the line does not indicate that the price activity is in an upward trend.

General Rule

When calculating a moving average it is the convention to use the closing price of eachday as this is considered to be the smart money. All commercially available chartingprograms use the closing price to calculate moving averages.

27

To calculate a simple 5 day moving average the following formula would be applied. Thename ‘Simple Moving Average’ is used because it is calculated using the formula forcalculating a ‘Simple Average’. This type of moving average has been in use by chartistssince the early 1900s.

5 Day SMA = Price for day1+day2+day3+day4+day55

The number of days used in calculating a moving average depends upon which timeframe theChartist is trading. A short term Trader would typically use a 5 or 9 day moving averagewhereas a ‘Trend Trader’ would use a 21 or 30 day moving average. The less number of daysused in a moving average the closer in nature it is to the current price activity. This can beseen by comparing the following chart of a 5 day simple moving average to the chart of a 21Day SMA on the previous page.

Points to Note

As equity markets do not operate on weekends; five days equals one week and twenty onedays is equal to one calendar month. 260 days is equivalent to 1 year.

A moving average using up to 10 days is considered to be a fast moving average whereas20 days or more is considered to be a slow moving average.

28

Weighted Moving Average (WMA)

A modern innovation to technical analysis is the use of weighted moving averages inpreference to simple moving averages. A weighted moving average is designed to give moresignif icance to the recent price activity and less signif icance to the older price activity. Thisis achieved by weighting each days price in the moving average calculation.

5 Day WMA = 1xday5+2xday4+3xday3+4xday2+5xday1 1+2+3+4+5

Where day5 is the oldest price data and day1 is the most recent price data.

Some chartists will create their own formulas for calculating a weighted moving average.Note that the Weighted moving average follows price activity closer than the simple movingaverage.

Weighted moving averages use complex calculations that are time consuming and tedious.The technological evolution means that the chartist can create these averages with the push ofa button.

Prior to the advent of ‘Computer Aided Drawing’, chartists only used simple movingaverages. SMAs and WMAs are both in use today because each type of moving average hasown its strengths & weaknesses.

29

Exponential Moving Average (EMA)

The most commonly used type of weighted moving average is the exponential movingaverage. The calculation for an exponential moving average is so complex that it only cameinto existence after chartists began using computers and charting software.

EMA = Today’s Price x K + Yesterdays EMA x (1-K)

Where K = 2 / (Total Number of Days + 1)

The exponential moving average is very similar to the WMA as can be seen in the followingchart.

Exponential moving averages are extremely popular and are used in many modern indicatorssuch as the MACD indicator. Chartists have a tendency to over use this type of movingaverage in the belief that it is superior to all other types of moving averages.

It is not important for the chartist to comprehend the formula for calculating an EMA but tounderstand that it is simply a type of weighted moving average. It provides less weightingthan the conventional weighted moving average as can be seen in the above chart of Telstra.

30

Crossover Signals

A common method of generating buy & sell signals is to compare a fast moving average witha slow moving average. These two lines will crossover each other when the price activitychanges direction. The choice of the values of the fast & slow moving averages is subjective;common values for SMAs is 9 and 21 whereas for EMA’s they are 10 and 30.

Crossover methods work by responding to changes in price and therefore lag the immediateprice activity. If a chartist ‘Shortens’ the value of the averages to make them more responsivehe or she will encounter whipsawing. Whipsawing is when the two averages run almostparallel to one another and constantly touch or crossover generating false buy and sellsignals.

Special Note

Exponential moving averages are more responsive to current price activity than simplemoving averages but slower to generate crossover signals. Similarly, the MACD generatesbuy and sell signals faster than the SMA crossover method.

It is never a good idea to use any single method when charting. The best approach is toemploy several techniques that compliment each other. The weakness of one indicator can becounteracted by the strength of another indicator.

31

MACD Indicator

MACD stands for ‘Moving Average Convergence Divergence’ and works by measuring thedifference between a fast and a slow exponential moving average. The 3 components thatmake up the MACD Indicator are constructed in the following way. The values used in thefollowing formulae are the default values for virtually all modern charting programs.

• MACD Line = 12 Day EMA - 26 Day EMA• Signal Line = 9 Period EMA of the MACD Line• Histogram = Signal Line - Reference Line

A buy signal is generated when the MACD line crosses upwards through the signal line and asell signal is generated when the MACD line crosses downwards through the signal line. Thehistogram indicates the strength of the underlying rally. The MACD is probably the mostpopular indicator in use by chartists today.

Special Note

The Designer of the MACD Indicator, Gerald Appel, claims that the MACD works betterin a rising market than a falling market. It is also universally accepted that a buy signal ismore reliable if the crossover occurs below the histogram and similarly for a sell signalthat occurs above the histogram.

32

MACD - Wrong Application

The MACD cannot be used to monitor a trend for an exit signal. This is because the referenceline is an average of the signal line and it will collapse into the signal line under constanttrending conditions. This occurs when the value of the signal line remains constant for anylength of time, ie. 12day EMA - 26day EMA = constant.

MACD - Correct Application

Having located a point of agreement using Daryl Guppy's MMAs, the MACD is used todetect the direction & timing of an anticipated breakout and, hence, an entry signal.

33

Multiple Moving Averages (MMAs)

A 3 day moving average will reflect the behaviour of short term traders who buy & sell on anintra-week basis. Similarly, a 60 day moving average will reflect the sentiment of longer termtraders. If these two averages touch each other on a chart it can be inferred that the short termtraders agree on value with the long term traders.

To expand on this concept a group of short term averages can be compared on a chart to agroup of long term averages. The purpose of this technique is to determine the mood of themarket and identify moments of general market agreement. This type of analysis is bestsuited to EMA’s as they are more responsive to current market sentiment.

The recommended short term values are 3,5,8,10,12 & 15

The recommended long term values are 30,35,40,45,50 & 60

34

When all these averages converge there is general market agreement and therefore a breakoutis likely to occur. The direction of the breakout is usually in the same direction as the longterm group of averages are pointing.

As the prevailing trend sets in, the long term group of averages will compress and thenspread apart in a parallel pattern. The further apart the averages are; the stronger the trend.Conversely, when the long term averages begin to compress it indicates a weakening of thetrend.

In either an upward or downward trend the short term averages will bounce around above orbelow the long term group and periodically pull back towards the long term group. Thesepullbacks are normal and occur because price activity, when trending either up or down,moves in a saw tooth pattern rather than a straight line progression. This is caused by forcesin the market that are non-linear in behaviour. (ie. Profit-taking, etc.)

If the short term averages move towards the long term averages then the long term averagesshould be observed closely for any compression or change in gradient. Whilst price pullbacksare normal, they are a danger signal that should be monitored closely. Daryl Guppy is theinventor of the MMA behavioural indicator.

The Guppy MMAs are categorised as a pro-active indicator. Even though it is constructedusing exponential moving averages which are ‘Reactive’ to price activity, the Guppy MMAdoesn’t suffer from lag when identifying ‘Points of market agreement’.

35

The Range Indicator

The Range indicator provides us with a series of price ranges that tell us when to buy, sell,hold or profit take. Although simple in construction, it tells us when the price activity ispulling back, rallying up or the trend is reversing.

Its construction is based on an electronically generated line that tracks price activity, knownhenceforth as the central cord. A function called 'Average true range' that measures pricevolatility is then used to position upper and lower lines based on the central cord.

These lines are referred to as the upper deviation line and lower deviation line. These twolines create an envelope that defines our tolerance towards price activity. The central cord,upper deviation and lower deviation lines create four distinct price zones that tell us when tobuy, hold, take profit or sell. The following chart illustrates how the Range indicator is usedto set buy, hold & sell zones.

When price trends either up or down it moves in a sawtooth pattern and not a straight line. Inan upward trend this behaviour is caused by the repetition of a rally/profit-take cycle. As longas the buying force behind the rallies is greater than the selling force behind the profit-takingthe trend will continue. Upward trends end when the buying force is exhausted which is aninevitable occurrence. Market participants often forget that all trends must come to an end.

By using the Range indicator to control our entry and exits we can avoid buying overpricedshares and we can identify and sell when a trend reversal occurs.

If price rallies beyond the upper deviation then there is a heightened probability that it willthen fall past the lower deviation line. At this point it is sensible to take profit.

36

The Count Back Line

The ‘Count back line’ (CBL) method was developed by Daryl Guppy and is used to fine tunemarket entries and exits. For an entry, the CBL is applied by drawing a line, towards the left,from the high of the bar with the lowest low.

The first bar that the line hits is used to set up the second line to the left by starting from thehigh again. From the next bar in the sequence, a line is drawn from the high towards theright. A close above this level indicates an entry point.

The reverse procedure from an entry is used to calculate the CBL exit. The CBL exit can berecalculated daily to provide a new exit everytime a new high is made. This use of a CBL isreferred to as a moving stop loss.

The above chart shows the CBL method being used for an entry and exit on NationalAustralia Bank. The CBL method responds to recent price volatility and adjusts the entry orexit point accordingly. The use of the CBL on the above chart gives an approximate entry of$26.50 and an exit of $29.00. This is a return of just over 9% for a trade lasting 10 weeks.The CBL method is a completely mechanical approach that can help traders to overcome anyindecis ion at the moment of entering or exiting trades.

Further Reading Share Trading by Daryl GuppyTrading Tactics by Daryl Guppy

37

'Price/Volume Breakout' Searches

Probably the greatest advantage afforded to modern Traders, thanks to the advent of chartingsoftware, is the ability to conduct daily, weekly or even monthly searches of the Stockmarketfor potential trading opportunities.

Daily and Weekly Searches

'Price/Volume Breakout' searches can be performed on either a daily or weekly basis wheredaily searches would be the most commonplace. The following chart shows a sharply risingshare price accompanied by a sharp rise in volume.

Imagine if you owned a widget store and you raised the price of widgets by 10% and thensales increased by 100%. Retailers would say this is highly unlikely but it is a regularoccurrence in the Stockmarket.

The above chart pattern indicates positive market sentiment and is commonly referred to as a‘Price/Volume Breakout’. Charting programs can locate this type of pattern using automatedsearch routines that will save the trader hours of manual scanning.

Although charting programs have this search capability; it is left to the user to set the criteriafor the search. But in addition to searching for sharp increases in both price and volume, it isalso necessary to filter out shares that move rapidly because of low liquidity.

In other words we don't want to detect a 1 cent share that has jumped to 2 cents in valuebecause of several relatively small purchases. This is done by checking ‘Money Flow’ whichis calculated by multiplying the volume by the median price of the same period, ie. Volume x[(high+low)/2].

38

The following search criteria should return a handful of trading opportunities for each tradingperiod. But as market conditions change over time, the search criteria should be adjustedaccordingly. The following settings can be used for both daily and weekly searches. Weeklysearches should be done at the end of the week, ie. after Fridays close. Of course it is highlyunlikely that the following criteria will pick up any Blue Chip shares. Which is a good thingbecause 'Price/Volume Breakout' searches are designed to pick up only speculative shares.

• Price increase of 10% or more over the previous days closing price.• Volume increase of 100% or more over the previous 10 day average.• Daily Money-Flow of $250,000 (Weekly Money-Flow of $500,000)

The following chart shows a ‘Price/Volume Breakout’ Indicator triggering an alert whenprice activity increases by at least 15% in a single day. (Note the horizontal bar set at 15)

If the criteria are set lower then a larger number of possibilities will be found and lesspossibilities if the criteria is set higher. After conducting a daily or weekly search the traderwill have a short list of possibilities that must be examined individually.

Search formulas for Metastock (Volume units must be given in 100s)

colA = VOLUME*CLOSE colB = VOLUME/2colC = Ref(mov(VOLUME,10,S),-1) colD = Ref(CLOSE,-1)*1.1

Filter colA>=2500 AND colB>=colC AND CLOSE>=colD

These formulas will be explained in detail when we look at doing searches in Metastock.

39

'Rate of Return' Searches

If 'Price/Volume Breakout' searches can't locate Blue Chip trading opportunities then weneed to employ a different approach for large capitalisation shares. 'Rate of Return' searcheswill identify rising Blue Chip shares, provided we limit our searches to a predeterminedpopulation of Blue Chip shares such as those listed in Top Stocks by Martin Roth.

Example

• Lets assume that a share is climbing at a rate of $2 per year.

• The current price of the share is $5.

• The annual ‘Rate of Return’ would be 0.4 ($2 divided by $5).

• Converting this to a percentage we get 0.4 x 100 = 40%.

Therefore, based on its current trend & current share price, the rate of return is 40%pa.

The 'Rate of Return' Indicator

The Rate of Return indicator performs its calculations using a computer generated line oflinear regression. The following chart of Lang Corporation shows a line of linear regressionthat is generated using 1 year of price activity. In other words it is a line of best fit over thepast year.

We can measure the change in price over any given period of a 52 week line of linearregression, which is indicative of the overall trend, to calculate the annual rate of return.

40

Example

• Value of the 52 week line of Linear Regression today = 11.67• Value of the 52 week line of Linear Regression 6 Months ago = 9.06• Current share price = 12.37• Rate of return over the past 6 Months = (11.67 - 9.06) / 12.37 = 0.21• Annualize and convert to a percentage = 0.21 x 2 x 100 = 42%

In the above example we have taken the change in price over a 6 month period and thenmultiplied the answer by 2 to determine the annual rate of return. By taking a 6 month'Snapshot' of the change in price instead of using the change in price over the past year, wehave made the rate of return indicator more responsive, ie. the shorter the period underexamination; the more responsive the indicator is. The rate of return indicator is shown at thebottom of the following chart. It employs the mathematical approach described above.

The RoR indicator is returning a figure of 42.43%, which coincides with our calculations.Although we can achieve different results by sampling the change in price over differentperiods, it is only imperative that we adhere to our original concept of rate of return and thatwe are consistent in our approach. We are interested in comparing different trends rather thantrying to come up with a perfect method that gives us an absolute set of results.

The MetaStock formula for the RoR indicator is:

Weekly Charts 200*(LinearReg(C,52)-Ref(LinearReg(C,52),-26))/C

This formula is designed to return annualized results when applied to weekly charts. As it isdesigned to locate established long term trends it is typically only used on weekly charts.

41

Performing 'Rate of Return' Searches

Price/volume breakout searches point us in the direction of 'Hot Stocks' and are an invaluabletool when it comes to speculative share trading. But they will not identify large capitalisationBlue Chip shares that are trending up gradually over time. The elephants of the Stockmarketsuch as BHP-Billiton don't jump 10% in price and 100% in volume in a single trading period.

Blue Chip shares are ponderous in nature and we need to employ a totally different methodof identifying potential trading opportunities within this fraternity of large capitalisationshares. Rate of return searches gives us the ability to filter out shares that are trending upover time and then compare their profitability. The RoR indicator shown in the followingchart has a horizontal line positioned at 25% which can be used as a cutoff level.

Woolworths, pictured above, is currently rising at a rate of 40.54% per annum and would bepicked up by a rate of return search with a cutoff level of 25%. Unlike price/volumebreakout searches where we would scan the entire market, rate of return searches are onlyapplied to pre-selected Blue Chip shares of interest such as the S&P ASX200 Index sharesfor example. In the case of 'Active Investing', a Blue Chip share trading strategy, we onlyscan shares that have a capitalisation of at least $100 Million and are fundamentally sound.

The key factor for employing market searches successfully is to always work from afoundation of need. Success is defined as the ability to take profits from the market andtaking profits from the market depends on our ability to interpret price activity, not ourability to use computers nor the price we pay for our software. Computers are a 'Tool of theTrade' and are there to solve our problems and meet our needs. They are a means to anend…not an end within themselves.

42

Active InvestingThe simple dynamic that drives share prices either up or down is shown below in blockdiagram form. Note the use of the word 'Factors' as opposed to the word 'Facts' in the firstsquare.

This diagram summarizes the whole process that moves share prices and is the foundation ofdynamic analysis. Factors that affect opinion include fundamentals, market cycles, macroeconomics, global factors, etc. Investors who rely on fundamentals are coming at the marketdynamic from the left hand side. Chartists, on the other hand, are coming at the market fromthe opposite direction by simple measuring the output of the whole dynamic process.

As active investors we will approach the market dynamic from both ends by employingdynamic analysis. There are, in fact, Blue Chip shares with good fundamentals and risingshare prices. By testing and measuring the market dynamic we can locate these shares. Thefollowing charts show the results we can achieve with this process.

43

The Tool BoxActive investing is a strategy that uses both fundamental and technical analysis. Whilst weshould have an understanding of both methods of analysis there are shortcuts available to uswhen it comes to locating companies with good fundamentals. By allowing others to do thefundamental analysis we can focus our attention on technical analysis and observing priceactivity. Our time is better spent this way because we buy & sell price and not fundamentals.

Locating Blue Chip Shares with good FundamentalsThere are many different sources of fundamental information and company research but atthe end of the day, and to avoid endless debate, we need to hang our hat on a specific set ofcriteria. Therefore we have developed a fundamental filter for Active Investing using acombination of criteria that is in effect a subset of benchmarks from the following sources.

• 'Top Stocks' by Martin Roth, published by Wrightbooks

• StockDoctor by Lincoln Indicators Pty. Ltd.

(please visit www.stockdoctor.com.au)

44

The ‘Rate of Annual Return’ Indicator

The ‘Rate of Annual Return’ (ROAR) indicator is used to calculate the annual rate of returnof a share given its current rate of climb or fall. It achieves this by calculating the annualincrease in price activity and then dividing it by the current share price. The result is thenmultiplied by 100 to convert it to a percentage.

Example

• Lets assume that a share is climbing at a rate of $2 per year.• The current price of the share is $5.• The ‘Rate of Annual Return’ would be 0.4 ($2 divided by $5).• Converting this to a percentage we get 0.4 x 100 = 40%.

The ‘Rate of Annual Return’ (ROAR) Indicator can be seen in the chart below. The ROARindicator uses linear regression for measuring price activity as opposed to moving averages.

Unitab (formerly Qld TAB) enjoyed a rate of annual return of between 20% and 45%throughout 2002. The horizontal bar placed at 20% is a cutoff level. Searches can beperformed using the ‘Rate of Annual Return’ indicator to sift out shares that only have a rateof annual return higher than the 20% cutoff. The ROAR indicator switches itself 'On' onlywhen it detects the presence of a valid trend. It automatically switches itself 'Off' if the rateof annual return falls below 20%, the money flow drops below $10million/3 Months, thetrend reverses or price activity moves sideways for too long. It is an 'Intelligent' indicator thattests for a range of conditions simultaneously, saving us a lot of time and hard work.

45

Multiple Moving Averages

Multiple moving averages, MMAs, are a sophisticated tool that can be used in a range ofapplications. MMAs are a series of lines that track and filter the weekly price movements.They consist of 2 sets of lines that allow Technical Analysts to observe and compare theimmediate behavior of price activity with the long term behavior of the price activity.Exponential moving averages are used for this type of analysis. The price bars in thefollowing chart have been switched off to improve readability of the MMA lines.

Short term group (Grey Lines) - 3, 5, 7, 9, 11 & 13Long term group (Black Lines) - 21, 24, 27, 30, 33 & 36

Once we have found a share that has an acceptable 'Rate of return' we must make aqualitative judgement of the trend. We are looking for a strong and consistent trend that isnot likely to reverse shortly after we enter the market. The following points are critical;

- The long term group must be spreading apart or running parallel with each other.- The long term group must be pointing upwards.- The straighter the long term group of lines are; the less volatile the trend is.- The short term group can pullback (ie. compress together) but if they cross into the

long term group then the trend is weakening and may be about to break.

This type of qualitative analysis is only used when entering the market and the idea is toavoid volatility. We want to 'Buy and Hold' and not get bounced in and out of the market.Judging the quality of trends is the most subjective function we will have to perform.

46

The Range IndicatorThe Range indicator provides us with a series of price ranges that tell us when to buy, sell,hold or profit take. Although simple in construction, it tells us when the price activity ispulling back, rallying up or the trend is reversing. Its construction is based on anelectronically generated line that tracks price activity, known henceforth as the central cord.A function called 'Average true range' that measures price volatility is then used to positionupper and lower lines based on the central cord. These lines are referred to as the upperdeviation line and lower deviation line. These two lines create an envelope that defines ourtolerance towards price activity. The central cord, upper deviation and lower deviation linescreate four distinct price zones that tell us when to buy, hold, take profit or sell.

The following chart illustrates how the Range indicator is used to set buy, hold & sell zones.

When price trends either up or down it moves in a sawtooth pattern and not a straight line. Inan upward trend this behavior is caused by the repetition of a rally/profit-take cycle. As longas the buying force behind the rallies is greater than the selling force behind the profit-takingthe trend will continue. Upward trends end when the buying force is exhausted which is aninevitable occurrence. Market participants often forget that all trends must come to an end.

By using the range indicator to control our entry and exits we can avoid buying overpricedshares and sell when a trend reversal occurs. Although we are using weekly charts in ActiveInvesting, the buy and sell signals can be applied in both daily and weekly timeframes.

If price rallies beyond the upper deviation line then there is a heightened probability that itwill then fall past the lower deviation line. At this point investors and traders should sell andlock in profit.

47

The Trading StrategyWe want to put a minimum amount of effort into locating and trading quality shares that arein stable, upward trends. Whilst the analysis is done on a weekly basis, the trading strategycan be implemented on a day to day basis. We can spend as little as 1 hour per week asActive Investors or we can monitor our positions everyday by checking the end-of-dayprices.

‘Rate of Annual Return’ Searches

We begin by searching our group of shares to locate the most profitable tradingopportunities. We hold shares with a rate of annual return of at least 20% but we only buywhen the rate of annual return is at least 30%.

In the above chart the ROAR indicator switched 'ON' in late February 1995 after QBEInsurance began trending upwards. The best point to have entered the trend was soon afterthis time when it had a rate of return of at least 30% (Our 'Entry' level). As the trend hasworn on, the rate of return has dropped due to the rising share price (The indicator uses thecurrent price to calculate the ROAR). In early 1996 it was still acceptable to hold thisposition (Our 'Hold' level is 20%) but it is was no longer an optimal time to be entering QBE.

This 30%-plus entry criteria ensures that we are using our capital efficiently and it preventsus from entering worn out trends. But be aware that there are some shares that have trendedfor long periods of time that are still potential trading candidates. Don't judge the profitabilityof a trend by the current share price. Only when the rate of return falls below 20% or theshare moves sideways for a long time do we want to move our capital to a better position.

48

Verifying & evaluating the Trend

The next step is to ensure that the share is in a stable upward trend. In the early stages of atrend the long term set of lines will initially compress and then expand as the trend gets underway. Only enter trends where the long term set of averages has begun moving out ofcompression. Note that the quality of the trend is critical to our success and profitability.

49

Market entryOnce we have found a share with an acceptable trend and a ROAR greater than 30% we mustfine tune the entry. Although we want to jump on board a trend when the price is in a dip it isimportant not to enter the market whilst the price activity is 'Gunning the stop loss'. We needto wait for the market to reverse and show evidence of buyer support. The green light isflashing after we have witnessed a rising week with a closing price higher than the previousweeks close. When the green light is flashing we act on a daily basis and ensure that our buyprice is in the buy zone, ie. lower than the central cord. It is possible for the 'Market' to getaway. The following chart shows a point of entry into the uptrend in Aquarius Platinum.

The following is a summary of the entry criteria.

- A rate of return equal to or greater than 30%.- Buyer support as evidenced by a rise in share price during the previous week.- Price activity is in the 'Buy' zone.

We will not be able to purchase an entire portfolio of shares immediately because many ofthe shares we want to buy won't be in the 'Buy Zone'. It is quite normal to spend severalMonths buying into the market, catching each share as it dips down.

50

Holding and Profit Taking

Although holding or profit taking are often conceived by market newcomers to be the easiestaspects of trading they are in fact one of the few areas of trading that require the use ofhuman discretion. The range indicator as shown in the following chart dictates, as much aspossible, the boundaries for holding and profit taking.

Active investing is a trend following strategy and, providing price activity remains betweenthe upper and lower lines of deviation, there is no need to close a position. If, however, theprice activity overheats and closes at the end of the week in the 'Profit Take' zone then sellingis mandatory. A true cliché is 'You will never go broke by taking profit'.

The reason for selling when the price activity exceeds the upper deviation line is because thenext stop, on the balance of probability, is the 'Stop Loss' zone. As mentioned earlier, priceactivity moves in a sawtooth pattern and a weekly close outside our trading range is apowerful indication that the volatility has reached a critical level. The fact that the tradingrange has initially been breached to the upside is fortuitous as we can make a timely andprofitable exit. As with all aspects of trading our actions are driven by the balance ofprobability and if our upside exit proves to be premature then we can always re-enter theongoing trend.

Discretion can be exercised when it comes to profit taking in the upper part of the tradingrange. Whilst some will always hold, others will want to take quick profits if they aresignif icant enough. A bench mark for profit taking is, ' Am I up 10% per month or more'. Ifwe are up 10% per month or more then we are looking at an annualized profit of 120%. Ourobjective as Active Investors is to achieve a return between 20% and 50% per annum. At120% per annum we are well ahead of the curve and it is prudent to take profit at this point.

51

SellingThis is the most critical aspect of any strategy and the decision to sell must be mechanicaland carried out with total discipline. The stop loss can be monitored on either a daily orweekly basis. If the price closes at the end of the day below the lower deviation value thenyou can elect to sell. But if the price closes at the end of the week below the lower deviation,you must sell immediately. Daily monitoring of your portfolio and daily stop loss executionis not essential but it will prove more efficient when it comes to protecting your tradingcapital. Us ing daily stop loss execution as opposed to weekly stop loss execution in terms ofprofitability is insignif icant. Daily stop loss execution, whilst being superior when it comesto protecting our trading capital, can cause us to occasionally exit the market prematurely.This offsets any gains that we may achieve in terms of profitability. One factor that can helpus to decide between using daily or weekly stop losses is the state of the Broad Market. If theU.S. Stockmarkets are behaving nervously then it is a good idea to use daily stops and whenglobal markets are trending upwards we can fall back to using just weekly stop losses.

Note how the price activity bounced back up after breaking the stop loss. This 'Bounce back'is common and often leads undisciplined traders into ignoring their stop losses. Always bearin mind that this stop loss is not set arbitrarily and is designed to indicate a trend reversal. Ifit does prove to be wrong then you can always wait for a re-entry signal to rejoin the market.

The ROAR indicator can also signal an exit by switching itself 'OFF'. It is telling you thatyou are no longer trading a valid trend because the ROAR is below 20%, the market has beenmoving sideways for too long or the liquidity has dropped to an unacceptably low level.

52

The Broad Market

Active Investing assumes that sound fundamentals are the reason for share prices to be rising.But there are periods in the market cycle when other influences will control market sentimentand push factors such as good fundamentals, sound management and profit growth into thebackground. Broad market sentiment is clearly one of them and can be taken intoconsideration. If the broad market is retreating, we can refrain from opening new positions.

The following diagram shows the All Ordinaries Index and the SP500 Index. These dailycharts contain a 10 day (Grey) exponential moving average and 30 day (Black) exponentialmoving average. When the fast moving average (Grey 10 day EMA) is below the slowmoving average (Black 30 day EMA) the index is in retreat and heading downwards andwhen the fast SMA is above the slow SMA then the index is trending upwards.

A broad market decline is signaled when both of the Indexes are retreating at the same time.If you are stopped out of the market when both of the Indexes are in retreat then you shouldnot re-enter the market on the long side until the broad market retreat has ended. The reverseapplies for opening new short positions. This method tells traders and investors when toleave their money in the bank and stand aside. Global Stockmarkets often retreat in unisonduring the months of August and September. If we can see this pattern of retreat in the abovecharts then it pays to wait until the market has turned up again before opening new longpositions. If we fail to do this then we will inevitably suffer a string of straight losses. These'Crossover' charts act as a safety switch that prevent us from trading against the prevailingbroad market trend and our own desire to have our money 100% committed to the market.

53

Risk ManagementTraders are able to manage the risks involved in share trading because they use clearlydefined entry and exit prices. Active Investing uses the same quantitative approach.

Position Risk

The potential loss in owning each share is referred to as position risk. Traders normally usethe 2% rule that states;

‘The total loss for any single trade must not exceed 2% of total capital’Your total capital is the current value of all shares held plus the total amount of cash on hand.By risking only 2% of our total capital on each trade it would take 194 consecutive losses tolose all of our money. Statistics from the United States indicate that 20% of Traders use riskmanagement and this proportion coincides with the fact that only 20% of Traders survive.

Example

- We are trading with $20,000 total capital and using the 2% risk rule- Assume that the closing price of a share is $12 & the stop loss is set at $10.

(It is always assumed that the closing price is the probable entry price.)- The potential loss per share is $12 - $10 = $2 and 2% of $20,000 = $400- Divide $400 by $2 to get the number of shares we can buy = 200 shares- Multiply 200 by the closing price of $12 to get the position size = $2,400- Divide $2,400 by $20,000 and multiply by 100 to get the percentage of total capital

that can be spent on this position = 12% (This is the maximum position size.)

Sector Risk (Also referred to as Industry Risk)

We want to be able to capitalize on strong sectors without being exposed to speculative risk.To limit our exposure we will only allocate a maximum of 30% of our total capital per sectorand a maximum of 6% position risk per sector, ie 3 positions per sector. (3 x 2% = 6%)

Portfolio Risk

Portfolio risk is the sum total of our position risk. Our portfolio can have a minimum of 5shares and a maximum of 10 shares. No single position can be greater than 20% of our totalcapital or less than $1,000 in value. By using the 2% position risk rule we will probably ownsomewhere between 6 and 9 different positions. Note that the more positions we have; thehigher the portfolio risk. This is why diversification is a dangerous and 'Gooey' form of riskmanagement. It is in fact the result of risk management.

54

General ConsiderationsCalculating your Total Capital

You must know at all times what your total capital is. Long positions are calculated bymultiplying the number of shares by the current share price. Each short position is calculatedin the following way and the total is added to the current ‘Short Selling’ account balance.

(Entry price - Current share price) x Number of shares being shorted

It is possible to quickly calculate an approximate value of your total capital based on theweighting and current value of your long positions.

Example

Total long positions = $90,000 & Weighting = 60% or 0.6Therefore Total Capital = $90,000 / 0.6 = $150,000

Reweighting and Optimizing your Portfolio

Optimization is not necessary but reweighting your long and short positions should be doneperiodically. Reweighting is needed because one side of the market will inevitablyoutperform the other causing a shift in your Long/Short weighting. When reweighting it isessential to calculate the exact value of your portfolio. It is recommended that reweightingand optimization be done no more than twice a year. (June & December are quiet months)

Important Tips

The following tips are based on the past experience of other Active Investors. They are givenwith the intention of helping new Active Investors to avoid some common pitfalls.

- Don't double guess your trading system. No one likes incurring losses but the reality isthat no trading system has a 100% success rate. Expect a win/lose ratio of 40 to 70%and you will be profitable from staying with the winners and selling the losers. Thesecret to success in the Stockmarket is the ability to cut your losses…not pick winners.

- Don't dabble with the strategy. Buying 'Just a couple of shares to give it a go' is likemowing just a bit of your lawn. There is no point if you don't fully commit because themathematics and logic behind the strategy are based on your 'Total Capital'. If youwant to test the system then paper trade with it until you are satisfied with the results.

- It does makes sense to diversify across different investment mediums if you have alarge amount of capital. Other investment mediums include property, bonds, termdeposits, etc. Those seeking advice in this area should consult with a licencedFinancial Advisor such as Nigel Smith at Segue Portfolio Partners on 03 9509 1599.

55

ActVest Newsletter Subscription form (AIA)DISCLAIMER

• Alan Hull is an authorised representative of Gryphon Learning, holder of Australian Financial Services LicenceNo. 246606. None of Gryphon Learning Pty Ltd, its Authorised Representatives, the “Gryphon System”,“Gryphon MultiMedia”, and “Gryphon Scanner” take into account the investment objectives, financial situationand particular needs of any particular person and before making an investment decision on the basis of the“Gryphon System”, “Gryphon MultiMedia” and “Gryphon Scanner” or any of its authorised representatives, aprospective investor needs to consider with or without the assistance of a securities adviser, whether the advice isappropriate in the light of the particular investment needs, objectives and financial circumstances of theprospective investor.

• Although every care is taken the nature and content of the education and/or training prevents the giving or makingof any representations or guarantees as to the commercial or financial suitability of any of the material,information and opinions given.

• Alan Hull and his servants and/or agents accept no liability for any reliance upon the material, information andopinion given in the course or session and no responsibility is accepted for any losses, charges, damages orexpenses which may be sustained or incurred by any participant or otherwise by reason of any reliance upon thematerials, information or opinion given.

• Participants are responsible for making his or her own assessment of the matters discussed during the course orsession and are hereby expressly advised to verify and to obtain independent advice before acting on anyrepresentations, statements, information or opinions given.

• This disclaimer is a continuing disclaimer and applies to the primary course or session and any future supportgiven (whether on-going or otherwise) following completion of the course or session.

Acknowledgment• I, the undersigned, acknowledge that I have read and understand the above advice and disclaimer.• I acknowledge that ActVest P/L ABN 44 101 040 939 must retain my credit card details, as supplied below, for

the purpose of charging me $39.50 including GST on the 1st day of each month for my ActVest Newslettersubscription and that, should I elect to discontinue my subscription, I must notify ActVest P/L in writing.

• I acknowledge that I will at all t imes in the future indemnify Alan Hull and his servants and/or agents against allactions, liabilit ies, proceedings, claims, costs and expenses which I may suffer, incur, or sustain in connectionwith, or arising in any way whatsoever in reliance upon any material, information or opinions provided by AlanHull and his servants and/or agents.

• I acknowledge that any future dealings I may undertake in any securities will be entered into freely and voluntarilyand without inducement or encouragement from Alan Hull and his servants and/or agents.

Please print all details clearly, tick where appropriate, sign, date and fax or post toActVest at 53 Grange Drive, Lysterfield, 3156. Phone-03 9513 0070 Fax-03 9778 7062

Yes, I wish to become an ActVest Newsletter Subscriber. (at a cost of $39.50 per month)

Please charge to my Credit Card: VISA MasterCard

Card No. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ EXPIRY ____ / ____

My full Name ____________________________________________________Mailing address ____________________________________________________E-mail address ____________________________________________________Daytime Phone ____________________________________________________

Where did you I’m an AIA member so I don’t pay the joining fee of $49.50hear about us ?

Please sign here x………………………………..... ....... DATED: / /