December 14, 2010
In the past we have discussed on this site a paper trade in the company called Agco Corporation (AGCO) that closed today at $48.17 on the New York Stock Exchange. It might be now be interesting to revisit that paper trading position that we initiated in early September of this year and was last summarized in our post on October 27 here: A New Update.

Stock and options made good gains in a short time
On October 27 the stock had reached our preliminary target of $45, up from the purchase price of  $36.50 and our comment on our Update post said, with the article sub-head, that “Earnings indicate AGCO to be a stock worth holding for greater gains” so we therefore made no move to sell the stock in our paper trade process.

Also, at the time of taking the paper trade stock position we made a paper trade to buy 2 call option contracts on which we had made a gain of about 186% at the time we closed the position on October 22 in accordance with our pre-established guidelines, mentioned elsewhere on this website. We would like to draw attention to a way in which we could have captured a greater profit on the call options.

Implement the “Roll Out and Up” strategy
Since we had already expressed our belief that the underlying AGCO stock could move much higher, there was a way that we could have achieved a greater gain from the options we had just sold. They had been sold in keeping with our pre-established sell-routine. But, after selling the two option contracts we could have re-purchased new call option contracts with a higher strike price and farther away expiry date. To be a little more conservative and guarantee some profit from the prior option sale, we could have only re-purchased just one new options contract. The strategy is called “rolling” and is a commonly used trading strategy.

An explanation of the above process can be found in our post titled Rolling an Option.

By rolling up the option to a later expiry date, we would be able to take advantage of the subsequent gain that has occurred since October 22.

“Rolling” refers to a way to initiate a change in an option position’s strike price, or its expiry date, or both. The usual purpose of doing this is to hold on to an option position that is reaching the date when it would normally be sold, which, under my own guidelines for trading mentioned elsewhere on this website, is about one month prior to its actual expiry date. This method of “rolling” is sometimes referred to as a continuation technique, obviously a way to continue to hold a position and allow participation in the entire range of movement that a stock may achieve.

There are at least 3 ways to roll a position depending on the objectives
There are various names applied to the rolling techniques, for instance, Roll Up and Roll Down are versions of a Vertical Roll — and a Roll Out is a Horizontal Roll. A Roll Out and Up or Roll Out and Down are versions of the Diagonal Roll.

• Roll up, or Vertical Roll refers to changing an option strike price to a higher strike price in the same month.
• Roll down, also a Vertical Roll, refers to changing an option strike price to a lower strike price in the same month.When implementing a Vertical Roll, the trader sells the contracts of the existing position and buys the same number of contracts for the same expiry date but at a different strike price, either higher or lower, depending on the direction that the underlying stock is moving.With a call position in a stock moving up, the trader closes the existing call and replaces it with a call at a higher strike price. With a put position in a stock that continues to move down, the existing put is sold and replaced by a put at a lower strike price.As stated, the vertical roll allows you to lock in profits and lower risk, while maintaining the same position size. By addressing the concerns of profit and risk, you’ll have a much easier and better opportunity to follow the full run of the stock without risking the profits already built up in the option.
• Roll Out, or Horizontal Roll refers to changing to an expiration at a later date while maintaining the same strike price.
• Roll Up and Out, or Diagonal Roll refers to a combination of the above, changing both the strike price and the expiry date. And a Roll Down and Out accomplishes the same to the downside.

An example paper trading play on this website, referring to rolling an option, can be found for reference at A Better Exit Strategy.

In our post of December 07, 2010, we reviewed the paper trading stock candidates that we have been discussing in recent posts since November 22^nd in our series on stock market paper trading, namely: ASYS, F, and QQQQ, and for overall market reference, the S&P 500.

It is time to again review those stocks to see where they stand now, so here goes:

As of the Friday December 10 close:

We have good gains on ASYS, in which, as our earlier posts detailed, we initiated a paper trade to Buy long on November 24 at $18.84 per share has now closed at $25.04, that’s up about 33 %.

The 2011 May $17.50 strike call options for ASYS that we purchased at $3.90 closed at $8.50, that’s up about 118% with a new delta of 84, so plenty of room left on that option play if ASYS continues to move up.

The targets
At the time of choosing this stock for paper trading as part of our learning process of stock market basics, we said: “The target for this stock, for the time being and subject to a reappraisal shortly, is $25.” So we have now reached that target and will have to make that reappraisal — in keeping with our guideline to always know our target exit and entry points. So how should we do that ?

An objective to keep in mind
In this Stock Market Basics series we have assumed the beginning trader is starting out with only a small trading stake, possibly of a few thousand dollars, maybe five thousand but less than ten thousand. Because of this, the trader must follow a different and even more disciplined path than would a trader of greater means. The objective for the small trader who has limited working capital is to make as many short term gains as possible so that the trading stake can more quickly grow to a more substantial amount which would give many more alternatives and opportunities to diversify, among other things.

A short-term gain of about 35% in less than a month, as in the case of the ASYS paper trade, is very good – but look at the chart, there is nothing to indicate a correction (a fall back in price) at this time even though it is reasonable to think that there may be some profit taking at around this level. I also check the Yahoo.Finance summary data, and that shows the stock was trading up towards the day’s high into the close on increasing volume, usually a good sign. So for now we will increase the target to $28, based on the prior gain of about $10 from August to mid-October followed by a sideways move until mid-November when it again accelerated into an up-trend from about $18 after its earnings announcement — so we are considering another $10 up leg here. We can again review later and, as of now, we will certainly exit before the next earning announcement that is February 07, 2011 according to the Yahoo Finance Earnings Calendar.

Part of the learning process
As far as the ASYS options are concerned, we have 2 contracts and could sell one contract now to capture the more than 100% gain there. To have to make a decision on when and whether to take a profit is part of the learning process that stock market paper trading provides, exactly what we want in order to learn about stock market basic. My choice in this instance is to hold the positions and see what the outcome will be and then judge later whether the risk of holding instead of taking the 100% gain was warranted. The pre-established guidelines mentioned in earlier posts will help make the eventual decision.

The other previously chosen issues to watch: F, QQQQ, and the S&P 500:
In our previous review, we were waiting for F and QQQQ to break through their previous highs before committing to Buy positions for those stocks. A look at the charts shows that QQQQ has broken out so on Monday, subject to how the market is performing, we should stay with our plan and make the buys. However, F is not moving so we will reserve judgement on whether to take a position recognizing that that it may not happen.

The S&P 500 has also broken out, we hope that is confirming the anticipated rally from here to the year end and on into 2011.

Summary:

Continuing with the paper trading process as a way of learning stock market basics, we will make a simulated buy into QQQQ and its options, hold off on F, be ready to take a position in HD with a buy long at $34.50 and watch IPG and buy if it breaks above $11.25.

More on options trading
I have written elsewhere of my personal preference to always buy options on the underlying stocks. The amount of money at risk when buying call or put options is fixed and when successful, the gains are many times higher in terms of percentages than they are compared to the stock position only, but it is important to follow the 4 Rules of Trading Options. Some of my other views on Stocks and Options can be found here: Stock or Option? A check of those links provides additional viewpoints, written for the beginning trader, about trading in the stock market. Other articles concerning options trading can be found in the List of Topics for this site under the sub-heading “Stock Options.”

And a review of our paper trading stock positions and progress

In our earlier posts on paper trading for this series on stock market basics, we initiated a buy for ASYS on November 24 and we are also tracking our other candidates, QQQQ and F (Ford Motor Co.), awaiting to take positions if and when they meet our pre-established criteria, mainly that they break out in price above their previous highs. We also look at the S&P 500 as the main source for assessing how the market is performing.

Why use stock charts?
The purpose of frequently referring to stock charts, as I do on this website, is to encourage beginners who are learning the stock market basics to become familiar with them and use them as a tool to help in the decision making process. Many traders will not commit to action without first checking a relevant stock chart for reassurance and many traders depend on what the charts show at the end of each trading day.

In following the market action shown on these charts, and making decisions based on what I see, I am looking at them in my own individual way, trying to keep things as simple as possible from my own perspective — which is probably significantly different from the ways that others examine charts and analyze chart patterns.

The beginning trader or the person wishing to learn something about the basics of stock market trading, can benefit by developing their own approach to chart interpretation. For me, the simple and basic routine is to:

1. look at the chart pattern emerging after each day’s close, and determine whether it is maintaining the trend
2. look at the volume and check for any significant change, especially whether it is increasing
3. look at the lines of the moving averages and where the stock closes in relation to them
4. look for any apparent levels of resistance or support that the stock may need to break through
5. especially look for breakouts from existing constraining stock patterns, either up or down
6. look for any other well known patterns that may be developing, for instance a measured move or a saucer formation
7. check the MACD and the RSI mini charts that appear below and above the main stock chart to see whether they indicate a changing pattern

There are several other things to look for but the above list gives the general idea.

It takes only a minute or two to examine each chart of the stocks in play or the stocks of interest.

————————————————————————————————

Review of current paper trading stock candidates

ASYS
So now let us look at our stocks of interest shown on the charts below, we will see that we are making gains in our first paper trade choice of ASYS after our entry on November 24, 2010 at $18.84 per share. After Monday’s close we will review the ASYS position and its paper gains to date and suggest how to proceed from that point. The two option contracts we hold will show about 100% gains to date if there is no correction in the market.

We will check the charts below to see the progress of FORD and the Q’s that we are waiting to move into if and when the chart provides the confirmation we seek.

F, QQQQ, S&P 500
Both Ford (F) and the Q’s (QQQQ) are edging up to the breakout levels we established in our earlier posts in this series but until those are breeched we will hold back from entering a paper trade. The S&P 500 seems to be testing the previous high around 1225, we need to see it break through that level on good volume to confirm that we are at the start of the rally into the end of the year that we hope will materialize.

When a breakout occurs
Let us also look at a couple of other stock charts to show what can happen when a breakout above a resistance level does occur, for that let us examine CAM and HAL, showing recent breakouts to new highs, the gains are small so far, but it illustrates the point about breakouts.
The charts can be enlarged by clicking on them.

Stock Chart of ASYS Dec 03

Stock Chart FORD Dec 03

Stock Chart of QQQQ Dec 03

Stock Chart of S&P 500 Dec 03

Stock Chart of CAM Dec 0

Stock Chart of HAL Dec 03

Opinions differ on the merits of using a paper trading approach to learning the stock market basics. A frequent criticism is that paper trading lacks the emotional aspects connected to actually having real money at risk and having to deal with the need to make decisions under real stress when the market suddenly turns without warning.

Another criticism is that paper trading, also referred to as virtual trading or simulated trading or even just pretend trading, typically provides too large a trading stake to start out with, often tens of thousands of imaginary dollars. In doing so, that removes the need to learn discipline at the stock market basics level in how to carefully allocate proportions of the limited real-life trading stake that is likely to be available to the beginning trader who chooses to check into websites like this at Stock Market Basics Guide.

A common sense response
I do agree that real trading in the stock market has an emotional component for the beginner, especially when faced with a decision on what to do when the market moves without warning and it does require experience in learning how to deal with reverses and also, on the plus side, what to do when sudden and perhaps unexpected gains occur. The decision required in the latter case is whether to capture the quick gain by selling the stock or holding it through a peak and watch it fall-back, as it often does. This situation can occur when a flurry of additional buy orders (or sell orders) are prompted by some news release or other positive or negative information that becomes public knowledge. Earnings and pre-earnings announcements often cause such trading “spikes”  – and there are strategies, among our personal favorites, to take advantage of those typical reactions. Other episodes of quick moves in the stock market have occurred in recent times when international financial or political events have made the headlines.

Why paper trade?
Paper trading with real stocks in real time provides opportunities to practice making decisions based on the day-to-day activity of the stocks and the stock market in general. Decisions that require interpretation and assessment of data that comes to light over a period of time and that may require specific action on the part of the trader. It helps if many aspects of stock movement and what causes them are revealed when paper trading.

The system of paper trading is merely an opportunity to gain some experience and understanding of both the processes of obtaining quotes, placing orders and getting to know the requirements of the stockbroker, and then following the market action related to particular selected trades. Such trades require preliminary research and then decisions to commit to action followed by a period of monitoring and assessment of the performance of the stocks under consideration until the time to exit.

Trading usually involves a short-term approach to buying and selling that can be accomplished in a few months. By following several stocks at a time, up to about ten should be sufficient, the person learning stock market basics should be able to observe and react to a lot of typical patterns of stock market activity, gain some experience and perhaps identify the areas of weakness that need to be addressed. It does require effort and careful thought.

Have a plan. Follow the plan, trade according to the guidelines
You have to start somewhere, even with a small stake. This is when the serious learning begins and it will take many more trades to gain experience and develop a personal routine and slowly gain some experience and understanding. The objective is to avoid unnecessary risks – such as entering a trade too soon, before a confirmed technical stock-chart signal occurs or exiting a losing trade too late and taking too big a loss. Or on the winning side, exiting a trade too soon, leaving “money on the table” as they say. How often have you heard or read the advice to “cut the losses and let the profits run”? In the early days of trading, take small positions while still learning to trade, don’t worry about the commissions, which with on-line stockbrokers are modest anyway.

The paper trading approach establishes procedures to be followed that cope with the above eventualities. Maybe it’s an individual’s personal attitude and response to risk-taking that affects a trader in moments of decision-making, helpful to some but not to others. The advantage of building a set of rules and guidelines to follow is that it helps eliminate times of indecision and avoid costly delays or impetuous moves that can cause regret later in the day.

And real trading involves dozens of trades over the course of a year, and eventually possibly hundreds of trades, where each one requires a decision to buy and a decision to sell. There will be losing trades and my own experience is that with proper risk management and a general set of guidelines to follow, the trader accepts the losses without flinching and moves on to the next trade, accepting any loss that occurs and knowing that by following the guidelines, the loss is limited to the approximate amount that could be tolerated, established before entering the trade.

For an example of some of the guidelines that aided our earlier paper trade of a  stock and options, check out AGCO Paper Trade.

Also, some of the articles listed in the Related Posts, shown below, make reference to guidelines, for instance the post No. 2 titled Finding Stocks for Stock Market Basics Paper Trading.

December 02, 2010
For us chart watchers and Stock Market Basics followers, a look at the charts after the market’s close today gives a nice indication of how promising thing’s can look after just a couple of good up-trading days, looking the way they do now — and on decent volume that shows some conviction from the buyers.

So what should we look for next – to back up our earlier expressed opinion, given elsewhere on this website, that the market could be higher by year-end and possibly continue upward after that, for a preliminary target of 1360 maybe?

The brief and simple answer to that is given after the chart shown below – but I hope the answer is becoming more apparent to the beginning trader who is learning stock market basics and who has read earlier posts in this series under the general title “Starting Anew”. At the end of this article, many are listed under the sub-head “Related Posts”, and others can be found in the List of Topics.

Those recent posts mentioned what I personally would prefer to see before making a commitment to enter a paper trade for such stock issues as Amtech Systems (ASYS),  Ford (F), and the Q’s (QQQQ), the paper trades we are currently following on this site. And also Agco Corp (AGCO), our September successful stock and options trades for which full details are available on this website.

——————————————————————————————————

Caution
Please remember we are pursuing a routine of paper trading based on a simple level of stock chart interpretation and analysis, suitable to introduce the beginning trader and person learning the basics of stock market trading to some facets of trading that can help guide the making of decisions to enter or exit a stock position. Charts and paper trading are useful tools for the beginning trader, let us see how we can make out in this specific series of possible paper trade commitments, some may win, some lose, but the objective is to learn something for future use and to gain an understanding of “the market”.
——————————————————————————————————

Here is the chart of the S&P 500 stock Index, our preferred index to watch because it represents a broader market that includes a good range of typical widely traded stocks. Click on the chart to enlarge and make clearer.

Stock Index Chart of S&P 500 Dec 2, 2010

The simple answer to the question posed above is:
Now that the S&P 500 has confirmed a move above the 20 day moving average, I would like to see it take out the previous high at about 1225. In other words, a break out above 1225 on good volume could be the signal for the beginning of a new uptrend of whatever length, yet to be determined.

An additional positive indicator can be seen on the MACD, the smaller graph below the main chart, where there is a strong crossover about to occur of the black line above the red line. The previous similar crossover took place last September and from where the market has moved to its present high levels, a gain of about 160 points.

Importance of resistance and support levels
We are always looking for a breakout of a support or resistance level that might tip off the next continued move and 1225 is just one of those possible resistance levels to be considered as such.

While we are looking at the chart, the observation could also be made that the recent series of lows around 1181 represent a support level and we should be aware of the possibility, probably less likely, that a correction could again occur and a move back to the 1181 level is possible. Further, a break through below the 1181 levels might indicate a bigger correction that could take the market down to around the 200 day moving average, shown as a red line on the above S&P 500 chart.

Something to keep in mind about support and resistance levels
The support and resistance levels are not backed by science or mathematics, they are “mental constructs”, sort of psychological levels that because they are observed and followed in the way that I am suggesting here, may have some small validity because we and many others do make trading decisions based on them and it is the decisions to buy or sell that are creating demand or supply, and affect the level at which a stock is trading. That might cause a small and minor blip when a lot of people make a move after seeing a chart pattern that can be commonly interpreted as a signal to enter or exit a position.

But . . .
However, it should also be kept in mind that individual traders have a very small affect on the stock market action that takes place every day. Most of the trading is done by mutual funds and large institutions, I’m not sure how much but I have read and heard that it is about 80% of all trading.