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TUTORIALS IN APPLIED TECHNICAL ANALYSIS

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Weekly for Monday March 27, 2000 Based on Thursdays Close 24 pages With contributions from P Rak, S Nicholas and J Poulos

e-mail 100035.406@compuserve.com

S Nicholas and J Poulos e-mail 100035.406@compuserve.com CONTENTS Section 1 STARTING POINTS FOR TRADE SELECTION
S Nicholas and J Poulos e-mail 100035.406@compuserve.com CONTENTS Section 1 STARTING POINTS FOR TRADE SELECTION

CONTENTS

Section 1

STARTING POINTS FOR TRADE SELECTION

Section 2

INITIAL TRADE ANALYSIS

Section 3

TRADE MANAGEMENT

Section 4

TURNOVER ANALYSIS - NEW TOOLS

Section 5

CLOSING THE TRADE

Section 6

INDICATOR BRIEFS - WILLIAMS %R

Section 7

ELLIOTT WAVE AND STOP LOSS

Section 8

PORTFOLIO RISK AND CASH ALLOCATION

LOSS Section 8 PORTFOLIO RISK AND CASH ALLOCATION DO WE NEED TO RE-INVENT THE WHEEL? The

DO WE NEED TO RE-INVENT THE WHEEL?

The pace of change in the market and in the analysis of the market continues to develop rapidly. Techniques and approaches that were laborious and time consuming as little as 12 months ago, are now quite simple. One of the appeals of Metastock, Supercharts and other advanced programs is the ability to be able to scan the market fairly easily and find stocks that meet your criteria. One of the disadvantages of this, is that they throw up all the stocks that meet your criteria but of which are not necessarily good trading candidates. This is an important distinction. Just because a stock meets our theoretical criteria doesn’t necessarily mean that it’s going to actually provide a good trading opportunity. Sometimes the potential return may be too small to be worth pursuing. At other times, you may identify the stock too late and the opportunity has already largely disappeared. The ability to construct your own scans and to use your own criteria for selecting stocks really delivers a mechanical style trading system into the hands of individuals. In some ways, instead of paying $8000 or $9000 for a trading system, you can now buy Metastock, Supercharts or Omnitrader and develop a similar system for a much lower cost. But just like any mechanical trading system, the problem is at the end of the day they turn up 8, 9, 10, or 12 possible selections and the trader is still left with the task of deciding which one of those 10 or 12 is the best one to trade and which one is worth allocating his trading capital to. One of the differences between a mechanical trading system and a tool box charting program that will allow to develop your own trading system, is the amount of time that’s involved.

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A starting point for analysis Small stock selections culled from web sites, newsletters and magazines

ABG AUD DCI
ABG
AUD
DCI

With a tool box system such as Metastock or Omnitrader, essentially you’re re-inventing the wheel. In the past we have consistently argued that mechanical trading systems are not particularly useful. This has been on two grounds. The first is the excessive cost associated with these types of system. It really does take a lot of trading success to be able to justify both the initial purchase cost and the ongoing cost of these sorts of trading systems. Our second objection has been the lack of adaptability in these trading approaches. They tend to work fairly successfully in strong trending markets, they are less successful in volatile and choppy markets such as we have experienced in the last six months or so. Additionally, the risk profile of these mechanical trading systems does not necessarily match the risk profile of you as a trader. Some of the opportunities thrown up are really not suited for instance, the novice or for people who are uncomfortable in trading breakout trades or momentum trades. The industry is changing and there is now a good argument to say that we do not necessarily have to re-invent the wheel every time we want to trade the market. Research that used to be available only to selected clients or which was generally unavailable to most people, is now fairly easily accessible via the internet. Some of this research is of doubtful quality but if you take it from reliable sources, then it can provide an excellent starting point for analysis of trading opportunities. This is the distinction that’s increasingly becoming important. For quite a while our focus was on finding potential trading opportunities as a precondition to being able to analyse those trading opportunities. Now, it is comparatively easy to buy the research that has identified potential trading opportunities. Alternatively just collect it free from a number of web sites that have gone through the process of identifying trading opportunities. This is a significant change. For a few hundred dollars a year for a subscription to Huntley’s Money Weekly or Renee Rivkin’s Newsletter or a publication put out by Dean Witter- Morgan, we can now have a starting list of opportunities that we may wish to explore further. It does take some time to find a group or an organisation that produces this research that comes up with the sorts of stocks that we would normally be fairly interested on a personal level. Some will come up with momentum and volatility driven stocks. If that suits our trading style, it’s a good place to start. Others will come up with more investment style stocks. If that suits our trading style, then that’s a good place to start. If we accept that the research done by others is a good starting point for further analysis, then we are able to concentrate on the analysis of just a few trading opportunities. For a very small

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annual cost we have a starting point provided each week. Instead of re-inventing the wheel, we can concentrate on making the wheel turn in our direction. That’s part of the focus that we are going to consider in the next couple of weeks in the newsletter. As a starting point, we’re going to take recommendations made by a variety of stock tipping or stock analysis newsletters. I’m not too sure what our final conclusion is likely to be and we’ll work through this process with newsletter readers. But it may well turn out the most cost effective approach, is to pay a small price for the research so we can save time and spend our time more profitably on the analysis of a few stocks that are likely to deliver trading success. We know from the newsletter feedback that we get, that there are quite a few trial readers who come to the weekly tutorial in technical analysis in the hope that we will provide tips or stock recommendations. As long term readers know, our focus is on showing you how to trade rather than what to trade. Attached this week is our starting point. This is a list of eight stocks taken from a variety of sources The analysis is primarily fundamentally based and often also taken from information derived from company notices to the exchange and perhaps some market gossip. We should not discount this. This is the starting point and our first step in the analysis is to turn to the daily bar chart.

step in the analysis is to turn to the daily bar chart. Culling Trading Opportunities The

Culling Trading Opportunities The trader cuts the mass of market data down to size using Metastock Explorer or Ezy Charts Analyser to look for specific relationships. The charts are also eyeballed, flicking quickly through them looking for chart patterns which are not detected by software scans. The chart patterns, or trading opportunities, include trading bands, breakouts and triangles. The trader usually only eyeballs for one type of pattern in each scan. This preliminary list is then narrowed down on financial and technical grounds. Traders develop their own techniques for cutting the data overload so there is enough time for thorough analysis.

data overload so there is enough time for thorough analysis. DEVELOP START POINTS - INITIAL ANALYSIS

DEVELOP START POINTS - INITIAL ANALYSIS

The first starting point in every analysis is the daily bar chart. This provides a way to rapidly identify both the potential trading candidates and the style of trading that may be appropriate for the stock. By identifying the style of trading we may also provide ourselves with a filter that takes out those trading styles which we are not comfortable with. In this first step we want to get rid of those that are clearly not good trading opportunities and then list those that may provide good opportunities and further subdivide these into those trading styles that are consistent with our approach to the market. Over the week or two we will follow the steps in this analysis. Some readers using series of fundamental recommendations will already have made an initial selection on the basis of fundamental factors or perhaps news related information. This will already have shortened their list and they will move now to these steps. We start with CEY which some analysts list as a buy recommendation because the fall in price has been extreme. The dominant feature on the chart is the resistance level around $0.65. The current breakout is likely to have trouble moving past the $0.65 level. While clearly there has been a break on the downtrend line in place since September 1999, it will not necessarily lead to the establishment of a new trend. This is the only level of analysis that needs to be applied at this stage. If we decide that CEY does provide a trading opportunity, then we will come back to it and examine it more closely with a variety of analysis tools with an eye to more precisely defining the best way to

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trade it.

Resistance CEY Centennial Coal Daily bar chart Resistance Support AUD Ausdoc Daily bar chart Tentative
Resistance
CEY
Centennial Coal
Daily bar chart
Resistance
Support
AUD
Ausdoc
Daily bar chart
Tentative trend

Turning to AUD we see a breakout of the downtrend in November 1999. This up trend that developed after this breakout did not establish a new trend. Price pull backs from January into March has the potential to establish channel trading conditions. The base of the channel trade is established around $2.50 with a potential upper limit around $2.95. It is unlikely that the current rally from $2.50 is likely to establish a new up trend. We would need to see a very good price move above $2.95. If this happens then we can look towards the establishment of a new up trend but given the current structure, a channel trading solution appears most appropriate. While we don’t want to buy at the top of the channel, we might add AUD to a watch list as prices re-test the bottom levels of the channel. The ABG chart shows price action taking place within the context of a well established long term downtrend. Unless we are looking for a reversal of trend based on very sound fundamental information, then it is most likely the trading activity here is going to be squashed by the long term downtrend. At best the trading opportunity may exist around $1.80 and at current levels be limited around the downtrend line at $2.00. This is not sufficient

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return for the risk involved in this type of rally trading. There is little suggestion on the chart that a reversal of the trend is developing. This particular stock would be eliminated very quickly as a trading candidate. Some analysts recommend it as a hold but the chart would suggest that this would mean holding onto a stock that shows little sign of halting its fall. When strong downtrends are in place traders usually sell to cut losses rather than hold on in hope that the fall will stop and that a price rise will deliver lost profits.

ABG Abigroup Daily bar chart BDL Brandrill Daily bar chart C A B
ABG
Abigroup
Daily bar chart
BDL
Brandrill
Daily bar chart
C
A
B

In contrast the BDL chart shows much greater potential. It is characterised by two volume spikes at point A and point B, which also are associated with significant increases in the price. This looks to be most suited to momentum trading and some analysts suggest buying on price pullbacks because it is cheap in terms of its fundamentals. As prices fall back towards the trend line that is established using the lows of the most recent activity, aggressive traders might take positions in anticipation of new momentum trades. While it may be possible that they up trend may stabilise, the surge in price and volume activity would suggest that it is most suited to momentum based trading approaches. If this suits our trading style, it goes on our watch list. The other point of note is the large price day at point C.

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Here price increased dramatically on virtually no volume. When this happens it tells us two things. First, that the general market was caught unawares so that they buyer had to go searching for sellers. The second, is that the buyers on this day were confident that the information they had was accurate and that they knew it in advance of the rest of the market. After all, it has to be an exceptionally confident person who pushes price up to $0.50 when patience would have allowed him to buy stock at $0.40. If we were taking on this stock as a potential momentum trade, it may pay to watch the news closely. Not all stocks are moving upwards and DCI is a good example of a stock stuck in a prolonged sideways movement. Normally these are considered to provide unexciting trading opportunities. The chart shows a strong support level around $0.06 with a minor resistance level above it at $0.08 and a resistance level based on previous highs at $0.09. Movement between this lower and upper band is fairly consistent and returns between 25% and 33%. For those traders looking for good returns without the risk associated with the volatility of stocks like BDL, these types of channel trades become attractive.

DCI DC International Daily bar chart A ADA Adcel Tech Daily bar chart First warning
DCI
DC International
Daily bar chart
A
ADA
Adcel Tech
Daily bar chart
First
warning

Some analysts suggest buying near the support levels in anticipation of a trend

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change. This is likely to be a low probability outcome, and traders with a trend in mind run the risk of missing out of good returns available from channel trading strategies. The first step is identifying the opportunity. With DCI there is a trading opportunity and on first examination the returns are quite attractive. Whether we pursue this opportunity further depends on our comfort level and style of trading. For many traders this reduced volatility coupled with good returns is a much better trading opportunity than BDL. On the first assessment of DCI some people may be inclined to sideline the opportunity on the basis of volume. At this stage of the analysis, volume is not an appropriate tool for exclusion of opportunities. Perhaps at the next step we may include this but suffice to say, at the moment that the scale of volume with DCI is distorted by the very large volume day at point A. Zoom the chart to include trading after point A and the volume display becomes much more encouraging. For some traders, stocks like ABG are attractive because they potentially provide breakout opportunities. They appeal to the bargain hunter in us all. Others like ADA appeal to a different group. We could call them the nostalgia group because they want to buy stock hoping that it will repeat the performance of the past. Perhaps this is why some recommendations are for a speculative buy. ADA started its up trend from September 1999. It can be readily defined by a straight edge trend line. In December 1999 we saw the first break below this trend line and this delivered a warning of trend weakness. We could probably confirm this very quickly by looking at a multiple moving average chart and as trading experience grows it becomes easier to visualise what an indicator display might look like when you’re looking just at the bar chart. However, with the benefit of hindsight we can see that just the application of a straight edge trend line analysis was enough to make good trading decisions. In the current environment we need very sound information to persuade us that ADA is heading for the resumption of this up trend. On the current chart display it’s trapped in a short term downtrend starting in January 2000. The support level at $3.00 provides the base for a downwards sloping triangle. This sort of chart display suggests that on the balance of probability the price targets for ADA are well under $2.00. When we turn to CDO we see a different type of trading opportunity. As a new listing we cannot draw on extended technical analysis or extended chart patterns to confirm what has happened. While we can say that prices have spent a lot of time moving in a $0.05 range between $1.05 and $1.10, this doesn’t really help us to decide whether it is a trading opportunity. In trading this type of chart, we would ideally apply risk management techniques alone. The most useful of these is the Count back line because it is designed to identify the short term risk and resistance levels of price action itself. Applying just this technique would have provided a successful solution when the stock listed and would have kept us out of this stock until recent days. From the most recent low in the current trend the Count back line level is set at $1.04. The close above the Count back line was delivered Thursday last week. Careful trading makes an entry at $1.05 quite achievable and for tutorial purposes we will add this. In terms of managing trade, the Count back line as a stop loss point is set at $1.03. The CDO chart moves very quickly into our trading candidate list because there is really only one technique that can be used to manage trades in stocks where there is not a long period of price history. Although all the grid that we’ve considered so far are small companies and many people would consider them to be speculative, they do exhibit a range of different trading opportunities. The CDO chart is the most speculative of these because of its lack of previous price history. This makes it an ideal candidate for techniques that use risk and money management alone. The ADM chart looks at first glance to be similar to the ADA chart but it has some

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important differences. The collapse below the trend line in February did signal an end to the current up trend. Subsequent price action has moved up and has continued to use the trend line as a resistance level. While it is too early at this stage to tell if a new up trend is in place, we can say that any new up trend is most likely to continue to find resistance being established by this trend line. This type of development suggests a continuation of the existing trend but at adjusted values. In trading this we would tentatively place a parallel trend line starting at point A. As prices pulled back to the lower parallel trend line we may be confident enough to buy at these levels. Conservative traders will wait until there is proof that this theoretical trend line will hold. While ADM does not present a trading opportunity immediately, it is worth putting on a watch list for potential development. We started with 8 stocks which had been preselected on the basis of someone else’s initial analysis. With this as a starting point our task is to verify the conclusions of the people who first made the analysis. Our second task is to identify those that may provide trading opportunities. These included, BDL, DCI, CDO and ADM. In selecting these potential candidates we also made some initial judgments about the type of trading opportunity that was available. From here our next step is to subject these selected opportunities to closer analysis using a range of technical indicators. The indicators selected are designed to assist us in assessing the type of trading opportunity. We will look at these in detail next week.

opportunity. We will look at these in detail next week. The Bar chart This is the

The Bar chart This is the most common price plot. A horizontal mark is made to the left to show the opening price. The vertical bar is drawn from the very low of the day to the very high of the day. A small horizontal mark is made to the right of the bar showing where the price closed. The open is set mainly by amateurs. They read the paper, ring their broker in the morning and place an order before the open of trade. The close tends to be set by professionals. They monitor prices during the day, and exit rather than carry open positions overnight. The low is set by the most pessimistic seller, and the high by the most optimistic buyer.

seller, and the high by the most optimistic buyer. TRADE MANAGEMENT While the trade is open

TRADE MANAGEMENT

While the trade is open - that is, we have bought shares but not yet sold them -

the trader is subject to an emotional roller coaster.

good high points that generate sound theoretical profits. Then he has the opportunity to take a heart stopping plunge as prices pull back perhaps even to the stage where his paper profits disappear entirely. These are not the most comfortable of times and many new traders find that this emotional roller coaster impacts dramatically on their ability to manage the trade. There are no easy solutions. The only one I know of is to plan in advance so that you are prepared for every contingency. This means that when prices do fall or rise that you know exactly what you should be doing. The next step, which is the most difficult of all, is to develop the discipline to act on these points. The sample trade with BEN is an example of this roller coaster ride. When the trade was established it was decided that using the Count back line was the most appropriate method of handling an exit in the developing trend. When prices shot through to $5.75 the trade looked pretty comfortable. The collapse back to $5.32 made life a little more interesting.

He has the opportunity to see prices lift to

Our emotional roller coaster took a dive, then just like any other roller coaster we marvelled at the view as prices tore back to $5.70. It takes discipline to continue with a trade when faced with such volatility. The trade

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remains in place until the exit conditions are met. We’re using a Count back line trailing stop loss approach. It is calculated from point A because point A is the highest point in the current trend. Point B is still within the current trend and because it is not higher than point A, it is not used as the basis for the calculation of a new Count back line.

as the basis for the calculation of a new Count back line. A B CBL Stop

A

B

CBL Stop loss

BEN Bendigo Bank Daily bar chart

In applying the Count back line, we do not take action until there is a close below the stop loss level. In this case $5.32. As soon as there is a close below the stop loss level, then we immediately shift to using the Count back line as a breakout tool. While the current trend remains in place - also defined by the lack of a close below the Count back line trailing stop loss - then we continue to make the calculation from the highest high in the current trend.

It may take weeks before a new high is established and before a new Count back line calculation can be made. Our trading techniques are designed to put the balance of probability in our favour. Very rarely do they accurately put the balance of time in our favour. If we can get the direction of the breakout right we can make money, irrespective of whether our timing is slightly out. For example in my own trading I recently took an entry into a stock based on Count back line techniques. For the next 10 days price hovered around my entry level but did not break my Count back line trailing stop loss conditions. In the last 3 days the breakout trend has developed as suggested by the balance of probability and the trade is currently showing a 25% return. The technique is designed to get the price action correct but not necessarily the timing exact. The BEN trade is a clear example of these problems.

exact. The BEN trade is a clear example of these problems. CBL Stop Loss This stop

CBL Stop Loss This stop loss rule uses the range activity of the stock to set a stop loss point. The range is the distance between the high and the low for the day It is calculated using the Count

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back Line approach. Taking the most recent highest high in the intermediate term trend the stop loss point is calculated by counting back three lower bars. The horizontal line drawn at the bottom of the third bar is the stop loss point. This stop loss is not related to the 2% rule. The line suggests the conditions where the trend may be weakening. When used with open profits, it provides an exit signal to protect those profits.

where the trend may be weakening. When used with open profits, it provides an exit signal

TURNOVER ANALYSIS

No matter how hard we try to ignore it, it seems that there just should be a relationship between volume and price. In previous weeks we’ve looked at these relationships and seen that they are fairly tenuous. Sometimes they are there, sometimes they are not. This is not a good basis on which to construct a trading or investment strategy. Another approach to the relationship between price and volume was taken by Gann. I do not use Gann trading techniques. However, as in every trading technique there is always the possibility that there is something there that may help us to improve our own trading. Gann is no exception. Part of Gann’s work was what he termed ‘float analysis’. To avoid confusion with the Australian term ‘float’, which is used to describe an IPO, we call it ‘turnover analysis’. The theory of turnover analysis is fairly simple. Essentially is says that when all the first group of shareholders have sold their share holdings, then the stock is owned by a new group of shareholders. This new group of shareholders will have made buying and selling decisions based on the level at which they bought these new shares. We can infer this relationship when we look at the way support and resistance lines are created. A support line for instance, often starts where there are a large number of buyers who have become new shareholders in the company at around about the same price level. When prices move above the level and then pull back to that level, these new buyers are not sellers. They don’t wish to sell because they’re not going to make a profit, at best it will be a break even situation. Many of these buyers are inclined to buy again on the grounds that maybe the stock is starting to look good value again.

We can move beyond the relationship between volume buying at a particular level and support and resistance lines to establish a relationship between accumulation and distribution patterns. Looking purely at a chart, there a number of patterns that show us when smart traders and investors are busy selling stocks to less experienced people. These are the classic top patterns that develop in rising markets. They include the head and shoulders pattern and long term rounding tops. They are called distribution patterns because smart traders are distributing shares, getting rid of them. The opposite are accumulation patterns. These form at the bottom of downtrends. Again, this is where smart traders and smart investors are coming into the market and buying shares off people who are absolutely disgusted with the way the stock has performed. These long term investors have finally given up hope and when the last of them sells, low and behold, the stocks begins to rise. Accumulation patterns are very useful in falling markets, they let us know when the stock is about to resume an up trend. Although we talk about these accumulation and distribution patterns occurring at the top and bottom of markets, they also occur at mid markets points. You know the words, there may be a rising trend and then a period of consolidation or pause and then the trend resumes it’s upward direction again. We need to be aware also of these

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mid point accumulation or distribution patterns. The third factor that comes into the relationship between volume and price, is the number of shares that are available at any one time for trading. This is important because the number of shares that are on issue is not the same as the number of shares which may be actually traded. Typically mid cap and speculative companies, only 50% of the total shares on issue may be available for trading. The other 50% are held by the top 20 shareholders. We make an assumption here, and that is that in most circumstances the top 10 shareholders are unlikely to be sellers. The top 10 shareholders are likely to be the long term investors or perhaps even the founders of the company. These are issues that we looked at in Bear Trading and also in Trading Tactics. What we need to know, is the total number of shares that are available for trading. This could be significantly different from the number of shares on issue. Many shares are issued as options, increasingly so in modern companies. These options are in escrow, they cannot be traded for maybe 3,5,10 or 15 years. So although they come out as being shown on issue, they’re not actually available for trading. In extreme circumstances, as with some small mining companies for instance, sometimes the top 20 shareholders own 98% of the total number of shares on issue. This figure is reduced even further when we realise that the company only has 866 shareholders who are trading the remaining 2% of shares. This is a tightly held company and it becomes extremely difficult to either get a large position in the company or to actually buy shares. This has a significant impact on volatility and the way price behaves.

Intuitively we think that a large company, perhaps as Great Central Mines for instance with over 2000 shareholders, may be much more open. In fact, the top 20 hold 84% of the shares. This means that only 16% of the total number of shares on issue are available for trading, and they are traded amongst 2000 people. If we want to buy shares in Great Central Mines, we are really effectively going to be buying from one of those 2000 people. As a final example, we can look at a company where the top 20 shareholders own 56% of the total shares on issue.

Our objective is to use some of Gann’s thoughts to bring together these three factors as a means of understanding the accumulation and distribution processes that are taking place in the market. If we can identify when the shareholder register has largely completely turned over, then we can also assume that there is likely to be a significant change or acceleration in the direction of the trend. To do this, we need to be able to add up the total number of shares traded each day until we reach the same figure that coincides with the total number of shares that are available on the market. First, a caution. We are assuming that if there are 100,000 shares available for trading and 100,000 shares have changed hands, that there has been a complete or almost complete change in the share ownership. That the people who owned the first 100,000 are no longer owners of those 100,000. This assumption may be flawed, but there is no specific way to identify whether the existing shareholders originally held shares in the company or whether they are adding to existing positions or whether they are new shareholders. This makes the application of turnover analysis imprecise. If we decide to apply this tool, we need to be aware that it is an indication of what is happening rather than a specific answer about what is happening. It is one tool amongst many. We would certainly be looking for other tools to verify the accumulation or distribution patterns that appear.

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It is our intention over the next few newsletters to explore turnover analysis and to determine the extent to which it can be effectively applied, both to new floats - such as IPO’s - to speculative companies, to mid cap companies and perhaps to well established blue chip companies with a very high and consistent trading turnover. The objective is to see the extent to which it assists us define accumulation and distribution patterns and to confirm the way these patterns are likely to develop. This is based on some initial research done in America. Supercharts users can program Supercharts and Tradestation to do similar processes. We are going to apply the new tool that will be available in Ezycharts called turnover analysis.

SPP Southern Pacific Petroleum Daily bar chart Fast distribution Slow distribution Fast accumulation 33,696,697
SPP
Southern Pacific
Petroleum
Daily bar chart
Fast
distribution
Slow distribution
Fast accumulation
33,696,697 shares
traded
33,696,697
shares
33,696,697 shares
traded
traded

Slow

accumulation

12% of

shares

traded

We start with SPP and we shift first of all to a weekly chart, because this gives us enough room to be able to look back and see the impact of the trading. When we select tools and then turnover analysis, we come up with sub screen. It automatically included the total number of shares on issue. This is a starting figure but is not the figure that we need. Instead, we turn to a reference book - in this case the register of Australian Mining - to establish the number of shares held by the top 20 shareholders. We could also use the Australian Financial Review publication, the Australian shareholders guide which also gives a percentage held by the top 20 shareholders.

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This information is also available from company offices and in company reports. With SPP 89% of the shares on issue are held by the top 20 shareholders. This leaves just 11% of shares available for trading. Currently there are 306,333,612 shares on issue. At just 11% of shares available for trading, the number we are looking for is 33,696,697. Our assumption is when this number of shares has changed hands, then the entire existing shareholder base is most likely to have been transferred to entirely new shareholder base. We use SPP as an example of the way this analysis might be applied. The first stage of a new up trend is characterised by fast accumulation. Prices rise fairly consistently in a strong trend, there are some pullbacks but there is a good volume of trading. The figure of significance that we’re looking for is that 11% of shares that are available, which is 33,696,697. The first fast accumulation period shows that traders are still jumping on board this stock. Once that total number of shares changed hands, we find there is a distribution takes place. Prices begin to move sideways, there is volatility but is not as great. The other significant feature of this fast distribution - where smart traders are unloading stock to less skilled people - is the shortened time frame. The accumulation can take some time, the distribution tends to be done fairly rapidly. This is the smart traders getting rid of stock. The downtrend that follows is a slow distribution pattern. It includes some of those that bought in the preceding period, who realised that they are sitting on a loss and who are selling in disappointment and desperation. People are gradually getting rid of shares because they don’t believe the stock is going to increase in price. This slow distribution of shares takes quite an extended period. It takes much longer than the accumulation period. When people are excited about shares, they move on them quickly. When they’re disappointed there is a natural reluctance to sell them quickly, so the distribution period is much longer. Another feature of the turnover analysis display in Ezycharts is from the last line, marked as A. It also generates for us the percentage of shares which have been traded in terms of the figure of significance and the chart display shown, to the right of the last line, only 12% of the 33,696,697 significant figure have been traded. One trading strategy may be to wait until this percentage figure starts to reach towards 90%, then to look more closely at the stock for a change of this slow accumulation pattern to a fast accumulation pattern. It is important to understand that this is not a precise technique, there are many assumptions involved. But perhaps once we’ve identified a stock using a range of other indicator techniques, by applying this turnover analysis we may get some further confirmation of the stage of trading that the stock is in. In next weeks issue we will apply turnover analysis to a variety of different stocks. Part of the challenge will be to decide whether what we are looking at is a correlated relationship or a coincidental relationship. With the turnover analysis tool and Ezycharts, this is going to be a much easier process than it has been in the past where these calculations had to be made laboriously by hand.

where these calculations had to be made laboriously by hand. TURNOVER ANALYSIS Turnover analysis is called

TURNOVER ANALYSIS Turnover analysis is called float analysis in the US. Major up turns or continuation points in market trends occur when all the old shareholders have been replaced with new shareholders. When the entire available share register has been turned over then buyers must bid higher to get stock because the new shareholders are reluctant to sell at a loss. It is

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a useful tool for trading Initial Public Offerings.

The shares available for trading are different from the number of shares on issue. Of the shares on issue some may be locked up under escrow conditions. Others are held by major shareholders and are effectively not available for trading. If the top 10 shareholders own 60% of the shares on issue then effectively only 40% of shares are available for trading. This would be the turnover figure, or figure of significance, used for the analysis. Some judgment is required in determining the appropriate turnover value. A starting point is provided by the number of shares on issue - available by right clicking on any Ezy Chart display.

Modify this with company information about the level of ownership by the top 10 shareholders. This is available from company reports and some annual publications including the Register of Australian Mining and The Australian Shareholders guide. This technique is most useful in identifying bottom reversals and continuation patterns in up trends. Turnover analysis is used as a guide as we cannot be certain that the shares which have changed hands all belong to just one group of old shareholders. It is used to verify other analysis. It is less useful in identifying distribution patterns developing at the top of up trends.

distribution patterns developing at the top of up trends. CLOSING THE TRADE This week, we complete

CLOSING THE TRADE

This week, we complete the description of the MBC trade in the past two newsletters with a discussion of exiting the trade. To recap, MBC broke out from a consolidation pattern, formed a strong bullish flag pattern, and broke upward from this pattern on 7 December 99.

The initial upper target, set at entry, was the long term support level at $14.50. This target was lower than the probable target indicated by the bullish flag. As the bullish flag signals a strong probability of an upward movement with a similar magnitude as the flagpole, the price target was revised to $15.38, calculated on the basis of the bullish flag. A sell order was placed at $15.29 just after the breakout from the bullish flag. The lower price was chosen to give the order a greater chance to be filled if the price spiked to price spiked to $15.38.

The upward trend after breakout from the flag was more sedate than the run-up that created the initial flagpole. The upward trend conforms to a straight edge trend-line (see chart). This trend-line was used as a backup, to monitor the stock and give an early indication of a break in the trend.

The $15.29 order was filled on 22 December 1999 during an intra-day spike to $15.50 on relatively low volume. The profit made on this three week trade was 26.01%. If the order had not been set, or filled, the clear breach of the trend-line on 29 December 1999 would have provided a precise exit signal without surrendering a great deal of profit.

MBC has now moved back into a consolidation pattern, with good support from a well separated set of long-term multiple moving averages. The stock is still in an upward trend. Upon the completion of this consolidation, it may continue to rise: the stock has a history of moving upward in a step-like manner, with rallies following consolidation periods. As a result, the stock goes back on the watch list.

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Trade management (3) Trades have multiple exit conditions. On entry, the first exit conditions is
Trade management (3) Trades have multiple exit conditions. On entry, the first exit conditions is

Trade management (3) Trades have multiple exit conditions. On entry, the first exit conditions is based on the stop loss. This is designed to minimise loss should our entry be inappropriate. Once the trade starts to show a profit, our exit conditions focus on preserving that profit. We use a trailing stop loss to monitor this. A close below this levels gets us out, protecting some, but not all of the profits possible from the trade. Sometimes an interim profit level is set, particularly if we expect prices to pause briefly at a level before moving on. If the move fails to develop, the pause allows us to collect some profits. The final exit condition is based on the initial profit calculations for the trade. This is the best outcome. It is also based on specific indicator signals decided upon before the trade is entered

indicator signals decided upon before the trade is entered INDICATOR BRIEFS - WILLIAMS %R The Williams

INDICATOR BRIEFS - WILLIAMS %R

The Williams %R indicator generates three types of trading signals: the all important price indicator divergence, 'failure swings' and the more basic and perhaps less useful

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overbought / oversold indications. All three are illustrated in the accompanying price chart of National Foods (NFD).

in the accompanying price chart of National Foods (NFD). Divergence: This is a relatively unusual occurrence

Divergence: This is a relatively unusual occurrence in the case of the Williams %R indicator, but powerful and important when it does happen. A bearish divergence is shown on the NFD chart at area 'A/A1'. The indicator rose above the upper (20%) reference level during a price rally then dropped below that line but could not pull back above it again. The price chart did not immediately follow this declining pattern, therefore a (bearish) price / indicator divergence occurs. This is a strong exit signal, confirmed by the subsequent price movements. A bullish divergence occurs if the indicator drops below the lower (80%) reference line, rises above it, falls back but is not able to cross into the oversold area before rising again, while the price chart pattern diverges relative to the Williams %R plot by either remaining level or declining. This is a strong entry signal.

Failure swings: A 'failure swing' occurs when the indicator plot reverses direction in mid-flight while swinging from one extreme to the other and hence fails to reach the opposite reference line. That is, when swinging from either the overbought area to the oversold area or vice versa, it is unable to reach the other extreme and turns back to the extreme from which it started. If during a decline, the Williams %R indicator stops falling and turns back to the overbought level without reaching the lower reference line, it shows the bears are weak and indicates an entry signal - see F1 on the chart. Similarly, if the Williams %R does not reach

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the upper reference level during a rally, it shows the bulls are weak and can be interpreted as an exit signal - see F2 on the chart. Next week we look at how the over bought and oversold signals are used, along with a summary of the strengths and weaknesses of this indicator.

how the over bought and oversold signals are used, along with a summary of the strengths

Williams %R This is an oscillator style indicator designed to help identify market turning points. The upper and lower limits are defined by 0 and 100%. It measures the position of the closing price in relation to user selected time period - usually 7 or 14 days -of recent highs and recent lows. When prices close near the high for the day, then the bulls are in charge. When they close near the low for the day, the bears are winning. This indicator is most effective when used together with a good trend indicator because it will continue to give overbought signals in a strong trend and this is normally an exit signal.

in a strong trend and this is normally an exit signal. ELLIOTT WAVE AND STOP LOSS

ELLIOTT WAVE AND STOP LOSS

While this trade used Elliot wave techniques to assess the opportunity, the trader turns to a variety of other confirming indicators and trade management methods to manage the trade and to control the risk. The stop loss conditions are vital to the success. This trade does not use Elliot wave as a predictive tool. It is used as a starting point.

Looking at stop loss first, the count back stop loss calculated from the high of $11.20 on 09 Feb, would be $10.70, the low of 07 Feb. The Elliott Wave stop, on the other hand would depend on our current wave count. If we view the $11.60 high as a wave (3?), then our stop is the wave (1?) high, all the way back at $10.32, or if we regard this as a wave (5?) high, then our stop would be the low of the wave (4?), at a slightly more respectable $10.37, bearing in mind that we entered this trade at $10.35. For the first time in the trade, the count back stop loss is giving us a significantly higher stop of $10.70 compared to the higher Elliott Wave stop of $10.37. The count back sell signal is given 3 trading days later on 14 Feb, when the close for that day is $10.67. But what else happens on 14 Feb that convinces us to exercise the count back stop loss? We must not forget our other technical tools -firstly, the 5/35 oscillator histogram has definitely peaked at the $11.60 high and is now heading for the zero line, and secondly, the stock has closed below the 6/4 DMA for the first time since we entered our trade. It is clearly time to take the count back signal and get out, which we do at the open of $10.68 on 14 Feb. This trade made us a very small profit of $0.33 cents, or a little over 3% in one month. Depending on our account size and brokerage rate, in reality, this may have been a break even, or small loss trade. While not an extremely profitable trade, it is an excellent example of trade management, and shows how we can come within one cent of our stop loss, and still be in the trade. For those readers interested in time and price, and waves of similar degree relating to each other. The larger degree Wave 5 (blue label) related to the previous larger degree Wave 3 in the following way - 34 calendar days for Wave 5 and 33 calendar days for Wave 3 (very close to 1.00 is to 1.00) and the price range of Wave 5 was $1.19 compared to the Wave 3 range of $1.90, which was very close to 0.618, a Fibonacci ratio.

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ELLIOTT WAVE This is a pattern recognition technique published in 1939. It holds that the

ELLIOTT WAVE This is a pattern recognition technique published in 1939. It holds that the stock market follows a rhythm or pattern of five waves up and three waves down. This forms a complete cycle of eight waves. The three down waves are referred to as a correction of the preceding five up waves. The application of this technique requires accurate identification of the waves. Specialised software such as Advanced GET is designed to work with this trading approach. Elliott waves can also be plotted automatically with Ezy Chart. The success depends on the accurate identification of the initial starting points and the completed leg of the first wave.

starting points and the completed leg of the first wave. READERS QUESTIONS - RISK AND CASH

READERS QUESTIONS - RISK AND CASH ALLOCATION

In a broad sense the objective in managing portfolio risk is to allocate our capital consistent with the broad ratio. This allows the trader to manage portfolio risk and the probability of a sector collapse more effectively. The size of each open trade within each of these sectors takes us back to the 2% rule and our assessment of the probability of success in the individual trades within each sector. As the volatility increases the returns typically are leveraged to even greater levels, and this means an increase in impact of the risk of failure in each trade. Although we talk of a speculative sector based on high volatility and many trading opportunities, in reality this sector may draw on stocks as diverse as NCP, ETR, GHM and ECP. They might include gold stocks, Internet stocks, and oil stocks. What unites them is the level of volatility, not the industry group they are drawn from, not their capitalisation. These broad sector ratios tell us how much trading capital we can afford to allocate to individual trades within each sector. Starting with the example in Share Trading, with $21,000 the trader can earmark $7,000 for trading in the speculative area. In deciding whether to allocate the $7,000 to a single trade, or $3,500 to two separate trades within the same sector, the trader must make some realistic judgments about his trading skill. While the 2% rule is designed to limit the risk on any one of these trades to just 2% of our total trading capital we must also acknowledge that the greatest risk in any single trade is posed by our own analysis skills. Quite simply, the novice trader is more likely to get it wrong than the experienced trader. This is analysis risk. Some trader overcome it by seeking out the best brokerage advice available. In this newsletter we aim to show readers how to reduce thus risk by better understanding of charts and technical analysis. In all cases, the objective is to develop identification skills that allow us to pick the correct direction of price movements in trading opportunities with a better than 50/50 level of success. We want to put the balance of probability on our side. The novice aims for better than 50/50, while the experienced trader works on a 70/30 ratio or better. This is an important factor in deciding just how much cash e will allocate to an individual position. If the novice trader has a 50/50 success ratio then this does not man that he will get one trade right and one trade wrong. Over time this will happen on average, but in reality he may face 3 or 5 or more losing trades in a row. While in theory it does not matter if the trades all happen simultaneously, in practice the novice rarely has the skills to be able to effectively manage multiple open positions. He improves his chances of success by taking just one trade at a time in the sector. This gives him time to manage the trade, and to analyse the reasons for its failure or success before moving into the next trade. By spreading the trades out, the novice gives himself more time to learn, and to survive. The more experienced trader has a 70/30 success rate. His skill means he has a

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better probability of managing multiple open position in the one sector. It is appropriate for this trader to take several trading positions in each sector where volatility and risk are higher. In trading less volatile sectors of the market, the blue chips in terms of reduced volatility, the novice trader is able to take on additional positions. Once the decision is made to open a trade in a low volatility stock there is a reduced probability that the trader will be asked to close it quickly. There is more time for analysis of both entry and exit conditions. If the novice allocates all of his $7,000 allowable in the speculative sector to an individual stock then the most he puts at risk is 2% of his total trading capital. His exit conditions will get him out of the trade when 2% of his trading capital has been lost. This exit is irrespective of the size of the trade. This is a difficult concept to gasp as we are accustomed to under standing risk in terms of the total amount of capital my have in a trade, rather than the amount of capital e are prepared to lose. It does not matter of the single position is worth $5,000, $7,000 or $15,000. If the maximum loss is limited to 2% of total trading capital then the impact of analysis failure is limited. The novice improves his chance of survival and success by having just a few open trades and managing them carefully. It protects him against analysis risk. It has been suggested that we can also counter this by having two open positions,a and limiting the risk to 1% of trading capital in each trade. The culumative risk is still only 2%. Unfortunately, the analysis risk is doubled. As shown in the chart, using these approaches the novice may end up with a cumulative 12% of his trading capital at risk across a variety of market segments. The difference in the risk profiles of each segment effectively reduces the probability of all open trades being closed at the same time. This means his effective risk is less than the cumulative 12%, but not much greater than 2%.

High Risk

Speculative -

1 position

2%

2

positions

4%

  high volatility cumulative   cumulative
 

high volatility

cumulative

 

cumulative

risk

risk

Mid cap - mid range volatility

2 positions

4%

4

positions

8%

cumulative

 

cumulative

risk

risk

Blue Chips - low volatility

3 positions

6%

4

positions

8%

Low Risk

cumulative

 

cumulative

 

risk

risk

 

Novice

Total risk for novice portfolio 12%

Experienced

Total risk for experienced portfolio 20%

trader

trader

In contrast, the experienced trader with multiple positions in each sector may have a cumulative risk of 20%. Again, while the cumulative risk in individual sectors is likely to be greater, he also has a greater probability of being able to take an effective exit at limit the risk successfully inn each individual trade. The allocation of capital to each volatility sector - blue chip, mid cap, speculative - is a function of volatility. the allocation of capital to individual trades within each sector is a function of trading experience and analysis skill. This requires realistic judgment by the novice and the ability to ignore other potentially good opportunities. Once a trading record is established the novice should be able to determine when his analysis skills are improving. This is best

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judged after a series of winning gab and losing trades, rather than just winning trades. As analysis skill levels improve the trader can take on multiple open trades within a selected volatility sector. His increased analysis skill weights the probability of success more in his favour and reduces the likelihood of having toe exit the trade at stop loss point as a result of poor analysis. While we have no control over the market, or the probability of a systemic of sector collapse, we do have control over our analysis skills. By matching trading exposure to our level of skill we have an effective way of determining just how much capital should be allocated to individual position within each sector Portfolio allocation is pat of risk management. It includes an understanding of volatility and of the risk imposed by our analysis skills, or lack of them. When volatility expands we reduce risk by both the way we allocate cash within the portfolio, and by the number of opportunities we provide for analysis failure.

the number of opportunities we provide for analysis failure. Draw down This term applies to individual

Draw down This term applies to individual trades and to the entire portfolio. It describes the amount of money theoretically lost when a trade moves against us. If we take a trade for $10,000 and tomorrow the stock closes lower so our calculated value of the trade is now $8,000 then we have experienced a $2,000 draw down. Draw downs in equity trading are theoretical because until the trade is closed they have no actual impact on our portfolio value. Draw downs with margin trading, derivatives and futures trading do have an impact. At the end of the day each position is marked to market and the trader will be requited to put up additional money to maintain his agreed margin. In this situation the draw down is important because it results in a call to add real extra money to the position. This is the way the term is used and applied in many books on trading. Our focus is on equity trading. Here the level of draw down is used to help determine when our trade, or trading, is going bad. In individual trades the average draw down level is used as an additional exit indicator. This is sometimes called Maximum Adverse Excursion. If our portfolio is down by 1% we probably do not need to worry. If it is down by 15% then we do need to worry unless this volatility is consistent with our normal trading pattern.

volatility is consistent with our normal trading pattern. NEWSLETTER NOTICES ORDER STRUCTURE AND E-TRADING Electronic

NEWSLETTER NOTICES ORDER STRUCTURE AND E-TRADING

Electronic internet trading is changing the way we place orders in the market. Old terms such as an ‘at market’ order, are now being applied in some slightly different ways. With a full service brokerage - the one where you get to talk to a real person on the end of a telephone - an at market order means that you buy all of the stocks which are currently on offer and you continue to chase the price upwards until your order is completely filled. With some electronic trading services it is not possible to lodge an at market order because the system doesn’t have enough brains to be able to chase price upwards. In some other electronic trading systems, an at market order is treated in the same way as a set price order. It used to be treated by a full service brokerage. That is, if the buy order is at $1.00, then it stays at that level until it is completely filled. This confusion between the old order structures and the new ways that they are being interpreted to facilitate electronic trading, both causes some confusion and offers some potential for making better use of old terms to get the price that you want. We will look at this in more detail next week.

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TAX SELLING AND THE US

Having got it wrong in Australia I watched Bill Maclaren on CNBC shift his predictive analysis to America where he is now forecasting a fall on the NASDAQ of substantial proportions. The NASDAQ chart shows a strong steady fast trend that is well supported. Current trading activity can pull back substantially before the underlying trend is threatened. Predicting a pullback on the NASDAQ is like predicting rain in Darwin during the Wet season. When you also remember that in the US the tax years ends in April then it is really a no- brainer to suggest weakness in the market in this period. Just as in Australia, portfolio positions are adjusted in anticipation of tax advantages and this leads to heavier selling. The basis of this newsletter is that the market cannot be predicted, either by techniques that rely on a mystical hidden order or cycle, by fundamental analysis of new vs old economies, or by expensive trading systems. The market can be traded by assessing the balance of probabilities and by using sound trading discipline. There is no substitute.

STOCKCENTRAL AND GUPPYTRADERS.COM

Guppytraders.com do not host a chat room. However, we do actively participate in the StockCentral chatroom. We work with this chatroom because we believe it delivers a quality service. Its focus is education rather than gossip. Many of the participants are real traders who are willing to share their ideas and experiences. They are not interested in selling products or programs, although they will direct you to web sites, books and other materials which will help answer your questions in more detail. The most important aspect of StockCentral is the way beginners and novice traders are encouraged to ask questions and the way they are answered. This is a genuine community where the emphasis is on learning and helping others. We all started as novices and we all learn from others. It is important to continue learning and to help other to learn. It puts something back. This is our philosophy and it is the reason we are active participants in StockCentral. We do not participate in any other market chat room or forum. If you have questions about charting, technical analysis, or trading then e encourage you to post them on StockCentral. You get get answers, not just from us, but from a variety of other traders.

NEWSLETTER DELIVERY CHANGES

As from this week readers will be directed to different issues of the newsletter depending on their status. As a result of the new delivery methods we are able to make some changes in terminology. There are three groups of readers. They are:

Subscribers - the old pre-paid group. Their newsletter is available for collection by midday on Saturday. It is collected by clicking on the SUBSCRIBER button. Trial readers Their shortened newsletter is available by midday on Saturday. They collect only around one third of the material included in the subscriber issues. They will not have access to the free spreadsheets that are included with the newsletter from time to time. Off the shelf readers. These readers can purchase current individual copies of the full newsletter. These are available only after midday on Monday and will cost around 30% more than the subscriber issues. Individual current issues are available at $5.90 per issue.

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TUTORIAL PORTFOLIO 1 - MONEY MANAGEMENT Starting cash position $100,000 - no brokerage or slippage

TUTORIAL PORTFOLIO 1 - MONEY MANAGEMENT

Starting cash position $100,000 - no brokerage or slippage 2% of risk = $2,000

STOCK

Newsletter date entered 24/3

Cost of entry Number purchased Entry price 2% stop loss

Current closing price

1.05

CDO

19.950

19,000

1.15

.95

Exit price Trading comment

Trade managed CBL

SUMMARY MONEY MANAGEMENT Overall profit to date since July 1, 1999 $66,537 or 66.5% return on trade equity. Profit 98/99 = 102% return on trade equity. Profit 97/98 = 94% return on trade equity. Profit 96/97 = 66.5% return on trade equity.

TUTORIAL PORTFOLIO 2 - TRADING BLUE CHIPS

Starting cash position $50,000 - no brokerage or slippage 2% of risk = $1,000

STOCK

Newsletter date entered 14/2/2000

Cost of entry Number purchased Entry price 2% stop loss

BEN

20,800

4,000

5.20

4.70

Current closing price Exit price Trading comment

SUMMARY BLUE CHIPS Overall profit to date since July 1, 1999 = 56.6% or $28,289 return on trade equity. Profit 98/99 = 72% return on trade equity. Profit 97/98 = 52% return on trade equity.

SUMMARY ASEAN MARKETS

Although we do not include these examples in this newsletter as they are now all carried on asiastockwatch.com we provide this updated summary for readers.

5.33

Trade managed with price oscillator and CBL

Overall realised profit to date since July 1, 1999 = $35,603 or 59.3% return on trade equity. Profit July,1998/ June, 1999 = 54% return on trade equity. Profit July 1997/ June, 1998 = 66% return on trade equity. (Nominal trading capital, $60,000. Profits are not added to capital. Stop loss equals 2% or $1,200. No Brokerage costs)

capital. Stop loss equals 2% or $1,200. No Brokerage costs) GST From July 1 2000, GST

GST

From July 1 2000, GST will become payable on all advance payments for the newsletter. Like most other magazine publishers, guppytraders.com will charge this tax on issues collected after that date. We will send you a payment advice with several options in June/July 2000. The most likely option to collect payment will be to bring forward the end date of your prepaid period by between 1 to 3 issues. In July we will supply all readers with an amended tax invoice showing the GST details.

DISCLAIMER AND COPYRIGHT

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Guppytraders.com (ACN 089 941 560) Pty Ltd is not a licensed investment advisor. These analysis notes are based on our experience of applying technical analysis to the market and are designed to be used as a tutorial showing how technical analysis can be applied to a chart example based on recent trading data. This newsletter is a tool to assist you in your personal judgment. It is not designed to replace your Licensed Financial Consultant or your Stockbroker. It has been prepared without regard to any particular person's investment objectives, financial situation and particular needs. This information is of a general nature only so you should seek advice from your broker or other investment advisors as appropriate before taking any action. The decision to trade and the method of trading is for the reader alone to decide. The author and publisher expressly disclaim all and any liability to any person, whether the purchase of this publication or not, in respect of anything and of the consequences of any thing done or omitted to be done by any such person in reliance, whether whole or partial, upon the whole or any part of the contents of this publication. The information contained in this newsletter is for the sole use of trial and prepaid readers. It cannot be circulated to other readers without the permission of the author. Stocks held by the author are marked* and are not to be taken as a trading recommendation.

of the author. Stocks held by the author are marked* and are not to be taken

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