In the former case one seeks to profit by capturing the directional moves (trends) which sometimes happen in the markets. The latter is based on the idea that markets tend to spend more time moving sideways in ranges than they do trending.

It could be said that when a market carves out a range it does so by having a series of little, shorter timeframe trends. For practical purposes, though, in a given timeframe there are the two market conditions.

In order to successfully trade trends, one must have a way to enter them near their beginning and exit them near the end. It is not realistic to expect any system to hit the exact start and conclusion of a major directional move, but it is possible to catch a large portion of one and make good profits. 

The problem with trend systems, however, is that they tend to be wrong more often than right. If markets do not trend that frequently, this is to be expected. The result is that trend systems generally take many small losses. The good ones, though, make up for that by capturing the big moves.

On the range trading side it is all about defining a range and making trades near its boundaries. One wants to sell near the top of the range and buy near the bottom to capture profits when the market moves from one end to the other. These sorts of systems tend to be the opposite of trend systems in that their success rate is higher, but they make smaller gains and are subject to larger losses when the market shifts from ranging to trending.

From the perspective of most part-time traders, trend trading offers a significant advantage over range trading. It is a simple question of time required to trade and monitor positions and the markets. Trend trading is generally less time-intensive.

Consider the difference between the two approaches.

If you are a trend trader, you wait for the market to tell you that a new trend is beginning (or underway), and when you get the signal you enter. You then hang on until the market tells you the trend is at or near its conclusion. At that point you exit. In between you just have to monitor things periodically.

If you range trade you are more active. You are constantly looking to identify ranges and see where the market is relative to the bounds of its range. You trade more frequently and have to pay closer attention to the market to spot the turning points where you need to make your trades.

Here’s the rub, though. Trend traders can be frequent traders. It’s just a question of timeframe. There are trends in all trading periods, not just long-term. Do not feel like if you want to trade more frequently that you have to be a range trader. That just is not true. You can trend trade as frequently as you like.
That is a side discussion, though. The point we are making is that trend trading is lower maintenance than range trading. For any given time frame it requires much less work and market focus. This is an important consideration for most part-time traders, why we recommend a trend-based approach, and why we will focus on it.

Do not just take our word for it, though.

Many of the most prominent traders of recent history are trend followers. You can read about them in the Market Wizards books mentioned earlier, and also in Michael Covel’s book entitled Trend Following. The latter does a very good job of outlining what trend trading is all about and how it can be done most effectively, regardless of market.

In this chapter and the next we will explore the three primary methods used to analyze the markets - fundamental, technical, and quantitative. The first two are normally seen as opposites, and their proponents often praise their own method while damning the other in turn. Many fail to include the third - quantitative analysis - in the discussion.

The well known market commentator Ralph Acampora, however, in a presentation he made to students and faculty at the University of Rhode Island, once described market analysis as a triangle. The three may be employed differently, but they are linked.

Do not read anything in to the position of any of the three in either absolute or relative terms. No implication of importance or quality is made in the positioning of the styles in the above triangle.

The remainder of this chapter and the next will cover each of the analysis types individually, and in some cases jointly. It is worth making mention of one quick thing first, though.

Market analysis is commonly thought of in one of two fashions: top-down and bottom-up. The former is when you look at the broad view, then use it to take positions in specific instruments. An example would be to determine an overall positive or negative outlook for the US Dollar, then pick a specific currency pair to trade (like EUR/USD).

The bottom-up approach is one in which you focus on specific instruments (like stocks) and do not spend too much time looking at the wider view (the indices or overall economy, for example).

Both approaches can be effective. It is a question of preference.

All of price movement in the markets comes down to the supply-demand equation. More demand equals higher prices, while weaker demand means lower prices. More supply means lower prices, while scarcity leads to higher prices.

Let’s use oil as a current example. Prices have risen dramatically in recent years. At least part of that has to do with increased demand coming from increased industrialization – and therefore increased energy demand – in places like China.
Fundamental analysis is the process by which one evaluates the supply-demand situation for a market in an attempt to determine a value or expected value – or in some cases a comparative worth. This methodology is something which can be applied to any market in one way or another.

At the top level, when looking at broad measures we often hear of fundamental analysis being referred to as economic analysis. Those folks who do so sometimes reserve the actual “fundamental analysis” term to application in terms of stocks. The same ideas are put in to play, though, so we won’t get too caught up in the differentiation.

That sounds an awful lot like trend trading, doesn’t it?

On one level it is. If you apply fundamental analysis properly you can see the big trends. The information will tell you where prices are likely to go. This is especially true in the stock market where it has been repeatedly shown that in the long-term stock prices track earnings. As a company’s earnings increase, its stock price is going to follow. That is why stocks have a generally positive bias.

There is a limitation to fundamental analysis, though. Even the supporters and active users of fundamentals admit that it is nearly useless in short-term trading. While fundamental influences will tend to win out over time, in the near term there are a great many other forces at play in the movement of prices.

What this all means is that you can get everything right, have your analysis absolutely nailed, but watch the market do nothing, or just maybe go in the opposite direction of what you expected. It may be that eventually prices go the right way (at least as far as you are concerned), but that could take time and requires patience, and potentially deep pockets to sit through large drawdowns.

For most time crunched traders, fundamental analysis alone is not a good way to go. It takes a lot of time to do properly, especially when you are just starting out, and even more so when dealing with individual stocks. There is a lot of information to keep track of, and you often have to wait for things to happen.

More than the time required to do and maintain the analysis is the time involved in trading from a fundamental perspective, though. Part-time trading requires time maximization. By itself, trading fundamentally might not produce enough actual trades during your window of opportunity to make it worthwhile – at least by itself. We will talk in the next chapter about other methods we can bring in to play to help in that regard.

We are not denouncing fundamental analysis here. It can be a very powerful tool. If you have the time and inclination, it could really be something worth exploring.

We are looking at things from a time perspective, though. That means we are after the best ways for you to maximize the time you have available. To that end we need to find methods to make sure you trade sufficiently often during your windows of opportunity to make trading worthwhile. To that end will also look at other forms of market analysis.

To be quite blunt, technical analysis does not care a bit about all the fundamental information and analysis presented in the last chapter. It takes the view that it is all accounted for in price and/or the movement of price over time. The technician instead focuses on price as the market determined measure of value since any given transaction is an agreement between buyer and seller as to value at a given point in time.

To take it all a step further, the technical analyst is concerned with price movement, or the lack thereof. A technician, through the application of one or more methods, attempts to determine future price direction in the market.
There are a number of different techniques for applying technical analysis that can readily be applied in part-time trading.

Charting

The foundation of technical analysis is in price charts and the interpretation of them. Charts, of course, are simply price plotted over time. The so-called “chartist” believes that patterns can be identified in the price action depicted by the charts which repeat with a measure of predictability. As such, they provide the opportunity for profit, and of course that is the name of the game.

These price charts come in many varieties from the very simple line charts in which price is plotted at given intervals, usually from the end of one period (the “close”) to the end of the next, to bar charts, to Japanese Candlesticks and others (see the Wheat futures line, bar, and candlestick chart examples below).

Each technician has his or her own preference, and some styles of charting, such as candlesticks, actually come with their own set of  terminology and analytic rules. The charting packages of most trading platforms these days offer a variety of chart types from which to choose. It all really boils down to observing price changes over time.

Chart patterns are the starting point of analysis if you are chartist. This is where the idea of technical analysis as an attempt to observe and anticipate behavior begins. We humans tend to fall into patterns of behavior, especially when considered in the group context (mass behavior). Charts show how the collection of market participants acted in the past. You then look for the kinds of price patterns this creates and attempt to profit by identifying the direction those patterns suggest for future market action.

There is not the space for an exhaustive study of chart patterns here. We will, however, cover a few key points, concepts which even the non-technician can come across as part of normal involvement in the markets.

The biggest of these ideas is that of support and resistance. In short, it is believed that specific prices or price regions can be barriers to future price movement. Support is a point below the current level at which it is expected price will cease to decline. Resistance is a point above the current price where an advance is expected to stall. Refer to the gold chart below.

Notice the two highlighted points. Both are examples of how highs can become resistance points. In each case a new high was put in by the market. It then pulled back, only to rally once more. In both cases, the rallies failed to overcome the resistance at those highs and fell back. They would eventually go on to break through, but our point is made.

Sticking with gold, we can also demonstrate an example of support.

In the case of the chart which follows, the market broke out from a period of consolidation. It rallied strongly, but then fell back. In doing so, it actually reached all the way down to the range from which it launched in the first place. Upon hitting that support point, though, gold rebounded and took off. This is an example of price area or range being the support or resistance rather than just a single price point.

 
The breach of a support or resistance level is important. In general terms, two things increase the significance of a given support or resistance level or area. One is the time frame. A weekly resistance point is thought to be more significant than a daily one, for example. The second is touches. The more a level has been tested (approached, but not broken) the stronger it is thought to be. The more important the support or resistance level (timeframe and touches), the more significant the break when it happens.

There are two ways traders use support and resistance levels in their methods. One is the range trade we mentioned at the start of the last chapter in which one sells as the market approaches resistance or buys as price reaches support expecting a turn.

The opposite is a break-out trader, which is a go-with approach where trades are taken in the direction of a break through support or resistance. As just stated, breaks are significant. If you are a break-out trader, you are making the play for the development or continuation of a trend in the direction of the break. That makes you a trend trader.

Since much support and resistance is based on consolidation, it is worth touching on that notion quickly. A consolidation is a period of primarily sideways price action. In the chart below we expand the view we had before of the consolidation area gold bounced off of to continue its rally. 

As the example shows, the consolidation came after a directional move. The market rallied considerably, then stalled out. In this case, the trend had been upward, but it works both ways. You can see an example of that on the S&P 500 chart which follows. After a sharp move lower, the market shifted in to a lengthy consolidation.

The S&P chart, in fact, shows quite clearly the two primary phases of the markets. There are clear trends where the market is moving directionally up or down. There are also periods of sideways action. In the highlighted case the range trading is very wide.

Along with support and resistance, and in conjunction with the idea of consolidation, is the continuation pattern.

As its name would suggest, a continuation pattern is one which it is expected that the market will recommence a given directional move. Continuation patterns are visible formations which appear on the charts. They have names like flag and pennant—basic descriptions of their appearance.

The weekly gold chart which follows provides a sample continuation pattern. As you can see, the market rallied up from about 380 in May of 2004 to near 460 in December. It then proceeded to move sideways in a triangular consolidation for about nine months.

In the second half of 2005 the upper part of the triangle (outlined by the two trend lines) was broken. The market then took off very rapidly in to new high territory. Thus, the consolidation became a continuation pattern.

At the same time there are reversal patterns.

As you can easily guess, a reversal pattern is a visual formation on a chart which indicates that one trend has ended and another started. They have names like head-and-shoulders.

The EUR/USD chart below shows an inverted head-and-shoulders pattern, which many traders consider a bullish reversal pattern. It comprises a low from which the market rallies but fails and then makes a lower low. The first low is the shoulder, with the lower one the head. The market then rallies again, falls back, but not to by very much, creating the second shoulder (normally at about the same area as the first shoulder).

The idea behind the head-and-shoulders (be it regular or inverted) is that once the market breaks the “neckline” a reversal from one trend to the other has taken place. In the chart example, the trend shifts from down to up. Some folks use the pattern to project future prices as well.

Continuation and reversal patterns are far from exact things, though. History rarely repeats exactly, so no two chart patterns are going to look identical. This is what chart analysis is often considered fairly subjective - more art than science.

Getting away from patterns, but keeping in the charting theme, we come to the trend line.

A trend line is an attempt to describe a directional move (a trend). Down trend lines follow a set of declining peaks, as in our USD/CAD example below. Up trend lines follow rising peaks.

There can be quite specific rules as to how they get drawn, but the final analysis is the same. The trend line is intended to give you an indication of direction. If a trend line is broken it suggests a change in the market, either to consolidation or to a slower (less steep) trend. As such, trend lines are not dissimilar to the idea of support and resistance.

Indicators

An indicator is a tool employed to make certain kinds of market assessments. They come in a wide range of varieties from those which are very simple to those which are very complex. They run the gamut of intentions from trying to measure volatility, to determining trend, to getting a read on how powerfully the market is moving in a given direction.

An indicator is derived from price and/or volume, is generally calculated on a running basis, and normally is plotted along with price on a chart. Some indicators, such as moving averages, are plotted in an overlay fashion right on top of price. Others have their own scales, and thus require a separate plot, generally positioned below the main price section.

The following weekly Cotton futures chart shows examples of both kinds of indicators.

We have several different things going on.

First, the price chart is in Candlestick format. Second, there is an overlay plot on the price chart (red line). That is the 10-week moving average, which simply shows the average price for Cotton over the last ten weekly observations on a running basis.

The plot separate from the main chart area depicts the Average Directional Index (ADX). ADX is a popular indicator for determining whether a market is trending or not.

There is an additional category of indicators which take on the important technical concept of overbought/oversold. In short, overbought means the market has rallied too much or too rapidly in a given period of time. As such, it requires some time to settle down. This could either mean retracing (pulling back part of the rally), or consolidating. Oversold means the market has moved lower too far and/or too fast.

The well-known Relative Strength Index (RSI) indicator is one of a number of overbought/oversold indicators which are intended to point out such conditions.

The Unleaded Gasoline futures chart below shows how RSI is most often plotted. It also includes in the main chart as an overlay, the Bollinger Bands study, another often used indicator.

Bollinger Bands fall in to the category of volatility-based indicators. The more volatile a market has been during the measurement period, the farther apart the bands will be. Markets move from periods of relative calm to those of intense activity. Indicators which focus on that are intended to either point out likely changes in volatility or to use it as a way to make directional interpretation (i.e. trend or consolidation continuation).

By the way, the aforementioned moving averages are not used by analysts to forecast, but rather fall in to the category of trend indicators. This group tries to identify the current trend so that the trader can take the proper directional positions. In the case of a moving average, the trend is considered to be up when price is above the average and down when it is below.

There are also momentum indicators, ones designed to measure how strongly a market is moving. The idea is that markets with high momentum will tend to continue in their current direction, while those with lower momentum are more likely to turn.

A very simple momentum indicator is Rate of Change (ROC), which is shown on the Corn futures chart following. An n-period ROC is calculated by taking the most recent period close and subtracting the close from n-periods ago. For example, a 5-day ROC would be calculated as C0 - C-5 where C is the daily closing price.

Obviously, a high positive ROC means the market has been moving aggressively higher, just as a high negative one indicates a market moving sharply lower. The ROC is about as simple as it gets. Other momentum indicators are significantly more complex, with some incorporating volume as well as price.

The collection of technical analysis tools and indicators is vast. Topics such as cycle analysis and sentiment indicators, have not yet been brought up, to name just a few. This is not a book on technical analysis, though. We will carry some basic technical methods forward with us in our discussion of part-time trading, but you are encouraged to do your own further exploration if it is an area of interest to you.

Regardless of whether you are operating in a timeframe measured in minutes or months, the same tools and techniques can be applied. It all comes back to behavior patterns. They are not timeframe dependent.

Markets can develop trends and trading ranges in minutes just as readily as months. It is just a matter of scope.

For that reason, you can use the vast majority of charts and indicators in all time frames and across all markets. This is one of the biggest reasons so many traders, especially those with a short-term timeframe, flock to technical analysis.

Those who oppose technical analysis point to several problems with the application of its methods.

Subjectivity: Certain elements of technical analysis, like chart reading, do not necessarily have objective interpretation. That is why technical analysis is sometimes referred to as more art than science. It is also where individual trader biases can come in to play. This is certainly true in some regards, but there are plenty of objective technical methods.

Self-Fulfilling: Technical analysis is said to be self-fulfilling in that the more people applying its methods, the more likely the expectation of the analysis is to come to pass.  While it would be true that if everyone used the same or similar techniques such a thing could occur (and it has been known to happen in short time spans in the absence of other influences), the subjectivity of some methods, the diversity of techniques used (non-technical included), and the fact that traders operate in different time frames means a lack of unified approach.

Unreliable: Since the past (upon which technical methods are based) does not often repeat exactly, meaning sometimes the product of the analysis turns out not to be correct, the methods can be considered inconsistent.  The question which must be asked, however, is whether that matters if the trader is able to make money.

A legitimate additional criticism of technical analysis is the ease with which it can be applied. Because technical methods are so readily used with seemingly little effort, new traders often gravitate to them as the easy solution. After all, most trading platforms these days come replete with numerous technical tools. This can actually be a major negative in that unprepared traders can experience an illusion of knowledge and control.

That isn’t to say technical analysis cannot be effectively and safely employed, though. Like any other risk-taking venture, it requires a thorough understanding of both the application of the methods and the risks involved.

Moving forward, with fundamental and technical methods covered, we are left with the third part of the market analysis triangle.

Quantitative Analysis, for the sake of this discussion, is the use of mathematical and/or statistical methods applied to market data. This is primarily done for one of two reasons: 1) To compare two or more markets or securities; 2) To develop a probability-based view of market behavior.

In this part of the chapter, we will go through some of the methods employed by the quantitative analyst and see how you can apply them to trading.

Comparison

The first quantitative application we want to explore is market and/or instrument comparison. The easiest way to describe this approach is to use an example.

Investors Business Daily (IBD) publishes two figures in its stock tables (among other things). They are the rankings for Earnings Per Share (EPS) and Relative Strength (RS). Even if you have never seen an issue of IBD, or heard of the paper, you could still be familiar with EPS and RS as many stock broker screening systems have variations of them included.

 
Source: www.investors.com

In brief, the EPS rank is an assessment of all companies in terms of their rate of earnings per share growth over a given time frame (3-5 years normally). The companies are arranged in order of their growth rates and ranked. In the IBD version the ranking is done on a percentile basis such that the top 1% of all companies would get a 99 (99th percentile) while the worst 1% would be 1 (1st percentile). In this way, companies can be compared on an equal basis, without regard to size, industry, or anything else.

This is an example of using quantitative methods in conjunction with fundamental data.

The RS ranking takes more of a technical analysis view. It ranks, in the same manner as EPS, how well a stock has performed in comparison to all other stocks. The evaluation is based on price appreciation/depreciation over a given time period, so a stock which rose 10% would outrank one that rose 9%. Likewise, a stock which fell 5% would rate higher than one which fell 7%.

The EPS and RS rankings are quite obviously and intentionally comparison statistics. They are not very complicated in their calculation, but they quite handily serve the purpose of taking a given set of data and applying it in a useful fashion.

Market Behavior Constructs

The other primary form of quantitative analysis deals with the area of probabilistic behavior—defining or approximating the odds and likelihoods of given price movements taking place.

Here’s a quick example. Using the data in the S&P 500 futures from September 1997 through November 2006, we can make the observation that 47% of the time the market moves in the same direction two days in a row. That implies the market actually goes in the opposite direction 53% of the time.

This is a fairly basic example of observational quantitative analysis. It was a simple day-to-day comparison done in a spreadsheet with no heavy math. Even still, it provides us with worthwhile information. In this case we find out that the market does not generally have a tendency one way or another in regards to day-to-day directional continuation.

You might be saying “big deal” right about now. All we have come up with the not very surprising information that the market is about equally likely to go in the same direction two days in a row as it is to go the opposite. Granted, this is a simple observation.

If nothing else, though, it allows us to eliminate certain factors from our market understanding and/or to avoid certain paths of inquiry. Beyond that, the knowledge that there is no little or no bias in the figures, and the random behavior it implies, can become part of a larger model.

Here is another example. Below is the result of a study of forex price behavior from one day of the week to the next.

Currency Pair   Mon  Tue  Wed  Thu  Fri
AUD/USD          52%  44%  52%  44%  47%
EUR/USD          49%  45%  48%  42%  44%
GBP/USD          50%  48%  46%  47%  47%
USD/CAD          50%  38%  43%  50%  53%
USD/CHF          45%  46%  48%  45%  45%
USD/JPY           51%  47%  49%  46%  50%

The percentages indicate for each day of the week how often the market went in the same direction that day as it did the previous day. For example, on Monday AUD/USD trades the same direction as it did on Friday (up Friday, up Monday or down Friday, down Monday) 52% of the time.

Again, the results are not surprisingly neutral for the most part showing mostly no clear tendency. There is, however, at least one figure which points toward the potential for further research.

On Tuesdays USD/CAD tends to move in the opposite direction as it had done on Monday (since the 38% represents moving in the same direction, it would be 62% for going in the opposite direction). This would seem like tradable information. If we fade Monday’s price move (go against it) on Tuesday, we are going to be right 62% of the time.

On the surface, that seems like a workable system. The problem is while we know one thing—the tendency in absolute price behavior from one day to the next– we do not know any more than that. For example, we do not know how much price movement takes place.  That is an important piece of information. If one does not make sufficient profits on the winning trades to more than offset the losses suffered on losing trades, then it matters not one bit how often the winners happen.

The point is that statistics such as the ones we have just shown can be very useful, but you must understand the limits. Every statistical determination is done with certain constraints. In the above example, all that was considered was absolute direction, not amplitude of the moves. Constraints mean limitations. That is why such a study as we have just shown is generally just the first cut—a lead on to more comprehensive studies.

Types of Quantitative Analysis

The comparative and market price behavior analysis we have just discussed can be accomplished in a variety of ways. Some are very simple. Others are highly complex. They tend to fall in to one of the following categories:

Observation Counting
The table in the last section was generated through observation counting, which is nothing more than seeing how often something occurs. With a large enough data set you can use the results to get an idea of the tendencies of a market.

Examples of some of the types of things you can learn are:

• How often do 1% or greater moves occur?
• Does the market tend to move in one direction on a given day?
• Are high volatility periods clustered or randomly scattered?
• How long do trends and/or trading ranges persist?

Think of a question. Observation counting can probably answer it.

Statistical Evaluation
This category of market exploration includes things like regression analysis and other measures right out of most statistics text books. The most prevalent example of this kind of work is the well known Beta figure used in the stock market, which is based on the regression model. There are also commonly applied measures such as covariance which come in to play in portfolio composition.

Artificial Intelligence
The cutting edge of quantitative analysis is in the area of so-called artificial intelligence. This encompasses such things at Neural Nets and Genetic Algorithms. These are powerful tools for modeling and forecasting. Their use in the markets has been talked about for quite some time. Until recently, however, they were slow and unwieldy, making their application in actual trading difficult. Of late, however, performance improvements have begun to make them a more legitimate possibility for future use.

Words of Warning

Quantitative analysis can be a powerful tool, providing an array of avenues for research and market assessment. One thing must be kept in mind, however. The application of quantitative analysis to fundamental or technical data imparts the same limitations as seen in those methods. Using fundamental information means timing questions and lack of short-term applicability. Should technical studies be involved, lags (among other things) remain an issue. 

The bottom line, as always. is to know your tools, what exactly they are telling you, and how best to apply them.

Quantitative analysis can be a bit more difficult than straight out fundamental or technical analysis, though. As a part-time trader you may not have the time – or the inclination for that matter – to devote to collecting data and performing in-depth studies of price movement, modeling economic scenarios, and the like.

That is completely fine, though. You do not necessarily have to create your own quantitative studies to make use of quantitative analysis in your trading.

Recall the EPS and RS figures from Investor’s Business Daily we spoke of earlier. They represent quantitative analysis that you can easily use in your stock trading in a number of different ways. This type of externally available information, when applied with a full understanding of how it is derived and what it represents, can have a significant positive benefit to your part-time trading.

If you apply the results of quantitative analysis with an awareness of what they represent, you can save time in your market work and/or make better trades. You do not even have to be some kind of math whiz to do it, either.

In the next chapter we will take a look at how brining together the various forms of market analysis can help you make your part-time trading extremely effective and efficient.

We are addressing the question of which market to trade at this stage in the book because it greatly influences the decisions made later on in the process. The market you trade dictates the brokers you chose from and can weigh heavily in deciding which approach and methodology to use in your trading. That is why we want to get the market determined right off the bat.

Most new traders just kind of fall into a market when they first get going. Oftentimes the stock market is the one the majority of people immediately associate with trading. While stock trading does have the largest number of participants, it is not the largest.

Surprised?

Keep in mind that stock trading, even in the current global market environment, is still a very regional thing. Most trading in the U.S. stock market, for example, is done by U.S. traders. The same is true for other stock markets, and interest rate (fixed income or money markets) as well.

The foreign exchange (forex) market is the one true global market. It accounts for about $1.5-$2.0 trillion in daily transaction volume, compared to $350 billion for the combined US stock and interest rate markets.

The point we are trying to make here is that there is more out there to trade than just stocks. In this day and age, as an individual trader you have access to basically any market you like. There are no longer markets you could point to as being strictly for “professionals”, or anything like that.

Stocks/Shares

As noted before, the stock market is the one most people think of first when trading comes to mind, so we will start there. The stock market is where people buy and sell the shares of companies. These shares represent a portion of the ownership in those firms.

For the vast majority of traders that ownership will only ever be of the tiniest percentage. After all, owning 100 shares of a company with 1 billion share outstanding does not represent much. Even still, though, those shares allow you participation in the earnings and growth in value of that company.

The attraction to the stock market for most people is that we can understand what moves stock prices. When a company does well, the stock goes up. When a company does poorly, the stock goes down. It is pretty simple.

The stock market offers a wide array of potential trading vehicles. There are literally thousands of different companies you can trade across the whole spectrum of business activity. There are even ways you can make commodity types of trades buy playing gold or oil stocks, for example.

Additionally, the exchanges have been rapidly increasing what can be traded by adding a large collection of things like Exchange Traded Funds (ETFs). These are basically instruments which take their value from some basket of other securities, such as a stock index. The QQQs is an example. That is the so-called “tracking stock” for the NASDAQ index.

For those looking at leveraged trading, there are stock options traded on a number of exchanges. A fairly recent development as well is single stock futures. As their name suggests, these are futures contracts based on the value of a single company’s stock.

Trading in stocks is pretty easy and straightforward. There are plenty of very good brokerage options. In fact, competition in the business, especially online, has sharply reduced the cost of stock trading in the last decade, making it very reasonable for even the smallest trader.

The first major drawback to the stock market for the part-time trader – at least for some - is the trading day. Most stock markets are only open during a specified time each business day, a time that does not work too well for traders with day jobs and things like that. There is some electronic trading at other times of day, but the volume is much lower than during the normal trading day.
Now for many part-time traders the trading day limitation is not that big an issue. You can put your trade orders in with your broker any time you like, after all. For those who would like to be a bit more active, trade a little more in the short-term, however, there is a big limitation.

A second drawback to stock trading is the influence the general direction of the market as a whole has on the prices of individual stocks. When the market is in a bull phase, most stocks will have an upside bias, whereas when the bears are in charge, most stocks will slant lower. This can mean major boom-bust cycles. It was great to trade stocks in the late 1990s, but not so great in the early 2000s.
That rolls in to a further issue with stock trading. Companies are run by people. People sometimes break the law or act unethically. You have no doubt heard about Enron. The actions of one person, or a small group, have the ability to destroy a company and by extension, its stock value.

Something else that can be a drawback to stock market trading is the sheer size of it. As we noted, there are thousands of stocks from which to choose. That can be overwhelming to the part-time trader trying to find good opportunities with only limited time.

Don’t get us wrong. We aren’t slamming stock trading here. There is just as much potential in shares as in any other market. You just need to consider both the plusses and minuses when you pick the market you choose the focus on.

Indices

Index trading is a very popular way to go for traders of all kinds. These days you can trade the stock indices of most major industrial countries, and several other types as well.

Index trading means taking a position in the value of a basket of stocks or other instruments. For example, if you trade the popular S&P 500 Index, you are really trading the equivalent of a portfolio which includes the shares of the 500 highest market value U.S. stocks (market value being equal to the number of shares outstanding times the price of the stock).

Trading indices is favored by many because it overcomes some of the disadvantages of single stock trading. It is mostly is done through the futures markets, which have 24-hour (or nearly so) electronic trading for many index contracts. The volumes are high and the liquidity is excellent. There is also very active options trading, and we mentioned earlier the developments in ETFs.

Indices remove the concerns related to dealing with one single company, both in terms of the risk for corporate malfeasance and the vagaries of understanding the businesses the companies have. Many of them are basically diversified portfolios. They also take out the need for scanning through potentially thousands of stocks to find good trades.

On the negative side, price action in the major indices (as the S&P 500 chart on the previous page shows) can be very choppy. There tends to be a lot of back and forth in the trading, even when the market is primarily trending. This is especially true in the shorter-term timeframes. That can prove a big challenge for many traders.

Fixed Income/Money Markets

The fixed income and money markets are those which involve interest rates. The former is often considered to include those instruments such as bonds and notes which have initial maturities exceeding a year, while the later covers the short-term ones such as Treasury Bills, Eurocurrencies (Eurodollars, Euroyen, etc.).

The movement of these markets determines interest rates across the full spectrum from sovereign and municipal debt to mortgages to corporate debt. They also play a major part in the interest rates we pay for things like credit cards and auto loans.

There are two primary ways to play the interest rate market. One is to actually buy and sell the securities themselves. Anyone can buy government and municipal bonds, and many corporate bonds trade on exchanges. This is not where the major action is, though.

The bulk of interest rate market trading is done in the futures arena. The US Treasury Bond contract is one of the most active in the world, doing billions of dollars in transactions each day. The same is true of the Eurodollar futures. Both trade on exchanges all over the world along with similar instruments from all the major industrial countries and even the likes of the World Bank.

The great thing about the interest rate market is that it is probably the most responsive of all markets. It can react very dramatically to the release of economic data, speeches by major public officials, and news events of all kinds.
All of this action can make for very exciting trading, but it can also be scary. Longer-term instruments can be extremely volatile and thus hazardous to shorter-term traders with small accounts. They tend to be the domain of the professional trader.

That is certainly not to say that part-time traders cannot or should not trade the interest rate market. In fact, if you are in a longer-term trader, interest rates may be the best choice. Being tied, at least in part, to the interest rate policies of the countries to which they belong, they can move in nice trends, as the monthly chart of 3-month Eurodollar futures below shows.

It is hard to miss the strong, smooth trends in Eurodollars at this very long-term time scope. They can last literally for years, as has been the case in the most recent downward run representing the string of rate hikes by the U.S. Federal Reserve.

Commodities

A market that has gained a great deal of exposure in recent years is the commodity market. The biggest names there are, of course, gold and oil, which we highlighted back in Chapter 1. These two are major features of global economy, so it is no surprise that they trade very actively. That barely scratches the surface of what the commodities markets include, though.

The commodities markets can be broken up in to the following primary groups:
Agricultural—This group is pretty much anything grown by farmers including

• Corn, Wheat, Soybeans, Cocoa, Sugar, Coffee and the related goods produced from those base products.
• Live Stock—These are animals such as cattle and live hogs and the products derived from them (e.g. milk)
• Energy—The products in this category are those used for power generation such at Crude Oil and it’s distillates (Unleaded Gasoline, Heating Oil) and Natural Gas.
• Metals—Gold is the star of this group, but it also includes several other precious and non-precious elements such as silver, platinum, and copper.

Trading in commodities is done primarily via futures. There are exchanges all across the globe taking part of the action. Aside from the major international goods, however, most products trade on a primarily local scale. For example, there is active trading in Corn on the Chicago Board of Trade during the US Trading session, but not much outside that.

This mostly exchanged-based trading can be limiting for part-time traders. Electronic contracts are starting to become more readily available, though, so there definitely are opportunities to trade in the commodities markets.

There has also been a rapid move in recent years to create more small (mini) contracts. These allow smaller speculators to take part in the markets. This is particularly helpful for part-time traders as commodities can be quite volatile at times, with swings that force one to use wider stops than might be the case in other markets.

Another way the individual trader can take part in the commodity markets is through ETFs. There are an increasingly broad array of ETFs that are dedicated to specific commodities (like gold) or to groups of them (like energy products). That makes trading commodities as easy to do as trading stocks.