As you all probably know, I think technical indicators are often self-fulfilling prophecies. If a lot of traders, especially high frequency traders, think that an indicator works, then they’ll make trades when they see the indicator. If enough of them do it, as is the case when it’s all computers, then the indicators work more often than they don’t. If all signs point to buy and lots of people buy, then the stock goes up and we can look back and say that the indicator worked.

Bearish indicators will lead them to sell. Bullish indicators will lead them to buy. When they look back at how their trades performed against the indicator, they’ll be validated as long enough other traders join them. These traders do a lot of trading, so just a few ticks upward means a profit to them and they just need to be right more often than they’re wrong.

Most technical indicators have boring names, like cup and handle, but I discovered one that actually has an interesting name – it’s called the DEATH CROSS. (it’s made more ominous because I put it in all caps and I bolded it!)

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The Dow Jones Industrial Average is one of our stock market’s most venerable indicies. Every single business day, financial news outlets will report how the Dow, Nasdaq, and S&P 500 performed as a barometer for the overall market. We can dispute whether or not it’s an accurate barometer but we can’t dispute it’s age and it’s place in our financial market’s history.

The Dow Jones was created by Charles Dow in 1896 when he took the dollar average of 12 stocks. Of those twelve companies, only General Electric remains. The rest are either gone, live on as subsidiaries of other companies or have been renamed. The original twelve were American Cotton Oil Company, American Sugar Company, American Tobacco Company, Chicago Gas Company, Distilling & Cattle Feeding Company, General Electric, Laclede Gas Company, National Lead Company, National American Company, Tennessee Coal, Iron and Railroad Company, U.S. Leather Company, and United States Rubber Company.

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Until a few years ago, the stock market was a mystery to me. I understood how it worked but I was always concerned about taxes, not getting ripped off, and the sums of money it seemed to take to “make” anything in the market. This was way before the huge market gyrations of the last few years, especially the pops and drops during the “Great Recession,” and I didn’t commit myself to learning until a few years into personal finance blogging.

I thought it would be valuable to put together an article on the basics of stock market investing. This won’t explain everything about the market, that’s just too difficult, but hopefully it’s a good start that will be the basis for additional research. Let me know if you see anything missing and I can add it.

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The Facebook IPO, one of the biggest and most publicized in the last few years, hurt “retail” investor confidence in the stock market. There was the hard sell by brokers (think Boiler Room style). Then investors not actually knowing, for a few hours, whether their brokers executed trades and at what price, which led to the $40 million fund to pay for the glitches (which probably isn’t enough).

For a lot of regular people, it was the last straw and I don’t blame them. There was the freak out flash crash in 2010, when, in five minutes, the Dow dropped 600 points only to recover most of that 20 minutes later. The investigation later revealed that high frequency trading, while not the cause, contributed to the crash and brought HFT into the spotlight. I read one BusinessWeek article that said about 70% of the transactions in the stock market come from these traders.

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When Prosper and Lending Club emerged a couple years ago, I was skeptical. Back then, they promised above market returns on investment in very small loans with the added bonus of helping people out, even if on a small level. The idea was that you could make small investment, like $25, with others to fund someone’s goal. Even today, Lending Club suggests that you can earn 9.43% on C Grade creditors, 8.26% on B Grade creditors, and 5.81% on A Grade creditors. By diversifying, the thought is that you could get pretty close to these returns even with defaults, since a default would cost you very little relative to your investment. I never got involved because, at least years ago, residents of Maryland couldn’t invest in these securities.

With a few years of history, you can finally see if those promises are true and a site like Lendstats.com puts it all out there for you. It turns out that the yields aren’t as high as the sites promise but they’re fairly close. If you want to see a real time experiment, Jonathan at My Money Blog is putting $5,000 into 200 loans at $25 each to compare them as investments. I’m interested to hear his take on it as he goes. (My friend Nickel just wrote about the results of his three year investment – not that impressive)

Have you done any investing with Lending Club or Prosper?

In the first article of this series we learned how to read a chart. We looked at only three parts: The price action of the stock, (or index, commodity, etc.) the moving averages, and the volume. Although there are plenty of other layers complexity that we could apply, many of the best technicians don’t go far beyond this. William O’Neil, in his book, How to Make Money in Stocks: A Winning System in Good Times and Bad, doesn’t go much beyond these indicators either. Don’t get yourself bogged down in indicators like Bollinger bands, stochastics, or the many other overlays to a chart. They will do little to help.

With that in mind, let’s take a look at two chart patterns that  indicate bad times may be ahead. It’s important to note that trying to time the market is largely a fool’s game but if you see these chart patterns emerge, increasing your hedging is well advised. Hedging is simply insurance. When bearish trends emerge, you might short a stock or buy a put option as insurance. Let’s check these out.
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When you buy or sell stocks, do you use technical analysis as a way to affirm or disprove your thesis of where the stock is going in the short term? The world’s stock exchanges have seen drastic change in recent years since high frequency trading came to the market. If you’re unfamiliar with high frequency trading, simply put, computers are able to buy and sell stocks at a very rapid rate based on certain technical indicators.

Since computers can’t evaluate the quality of management, the future customer demand, or other less objective metrics, computers can only relay on the technicals of a stock. In other words, the chart. This is why learning some basic chart patterns is another tool in your stock evaluation toolbox but beware of one important fact about chart reading: Things don’t always work out the way the chart says they should.

Although we can find plenty of examples of the chart accurately predicting the future direction of a stock, there are just as many instances where a chart pattern emerged and didn’t do what the pattern predicted. With that in mind, let’s look at two patterns that may indicate a move to the upside.
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Before the Facebook IPO, I wrote about how I wasn’t going to buy any shares. Then 11 AM rolls around, the NASDAQ opening cross on the stock put it at around $45 (that’s where the bids and asks meet, the NASDAQ gives you a general idea of where that is), and I thought why not play a little. I put in a limit order at $42 once the cross slipped to $43. I figured that there was a 99% chance my order wouldn’t get filled because I still thought the stock was going up (at least day 1). Then the IPO was delayed for about thirty minutes and I thought – “this is stupid, cancel that order.” Fortunately I did!

Looking back, I had no idea the underwriters were pimping out shares to their clients. I had no idea NASDAQ was having trouble processing orders. All the chaos that’s coming out in the news now was not known in real time, certainly not as well known anyway. I knew that things were not going in an orderly fashion and that almost always spells trouble.

Here are five lessons I learned from the Facebook IPO:

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