Charting the right online course

Jana Schilder

Tyler Bollhorn, founder of Stockscores.com, says "traders crowd their stock charts with different indicators, hoping lines and colours will provide insight."

JANA SCHILDER PHOTO

If you're an online investor and are thinking about trying your hand at swing trading or position trading with stocks, a good place to start is with charting basics.

Stock charts provide a picture of the past trading activity of a stock. The vertical axis on the chart shows price; the horizontal axis shows time. When looking at a stock chart from left to right, you are seeing the price movement of a stock through time.

The field of technical analysis is highly complex and is a subspecialty in itself. If you crack open Technical Analysis of the Financial Markets by John Murphy, you'll learn about different types of charts that measure different things about stock markets.

At some point, you might get curious about: Bollinger bands, the Stochastic oscillator, Japanese candlestick charts, Moving Average Convergence/Difference (called MACD), the relative strength index (RSI), and the list goes on.

The quest? To find predictions, patterns, and probabilities in the behaviour of stock markets – which is behaviour of institutions and individual traders in the markets – that will make money for your investments in the future.

For those who are afflicted with analysis paralysis, the field of technical analysis can be a black hole from which they never emerge.

"Some traders crowd their stock charts with many different indicators, hoping that the lines and colours will provide them with added insight. Often, their charts end up looking like a basket weaving competition gone terribly wrong," says Kelowna-B.C.-based Tyler Bollhorn, 39, founder of Stockscores.com.

"Keep it simple. This is an approach that many stock traders forget," says Bollhorn, a self-taught 19-year veteran of online trading.

"I prefer to use `candlestick charts' because they provide more information about short-term supply and demand than a conventional line or bar chart," says Bollhorn.

Candlestick charts demonstrate the open, high, low, and close for the chart time period. The difference between the open and close makes up the fat, middle part of the candle, which is called the body. The areas above and below the body are the tails of the candle; they demonstrate the highs and lows for the time period the candle represents.

"At Stockscores.com, I differentiate between bullish and bearish candles, depending whether the stock closed above or below its open," says Bollhorn.

Bullish candles are those that close above their open; they are usually green. During a trading day, the stock will move up and down. The buyers are in control of the market when the candle has a close that is higher than the open, and is therefore optimistic.

Bearish candles are red, indicating that they closed below their open. The stock will close below its open and with pessimism when the sellers are in control.

"The approach I teach online trading students is that `message candles' have noticeably taller bodies than those before them. The price volatility over the period that the candle represents is high, indicating a strong opinion by either buyers or sellers," says Bollhorn. "If the candle is green, the buyers are giving a message of strength. If red, the sellers are expressing pessimism," says Bollhorn.

Making the trade : Market makers are important for individual online traders because they are the watchdogs

Online traders, and especially swing traders and position traders who want to trade immediately, need to be aware of organizations that function as market makers.

Here's a practical definition of market makers: they are registered traders, usually of brokerage firms, that agree to post prices on both sides of the market, buying and selling.

These are often shown in stock listings as bid and ask. Bid and ask are price tags on a stock, as it waits to be bought or sold.

"Market makers sign a contract with a stock exchange saying they will always be there to provide a market for a particular stock," says Jim Bittman, a senior instructor at the Chicago Board Options Exchange, and 30-year veteran of the trading industry.

"The responsibility of market makers is to assure liquidity on stock markets," says Francesco Pasin, CEO of Montreal-based JitneyTrade, and a 16-year veteran of the trading industry.

Market makers are important for individual online traders in two ways.

"First, if online traders want to buy stock, there is always stock to buy from market makers," says Pasin.

"Second, if online traders want to sell stock to unlock their profits, there are always market makers to sell to. That's very important; profits are theoretical until they are sitting in your cash account," says Pasin.

There are about 300 market makers altogether in Canada.

The New York Stock Exchange only has one market maker per stock, who works on the actual trading floor. He or she handles huge orders, say 100,000 shares of a stock, for a hedge fund or pension fund.

Represented by colourful jackets on the NYSE, market makers doing the big deals are still on the trading floor. They're the ones you see on CNBC interviews every day and also the ones that Hollywood likes to glamourize in movies like Trading Places. Alas, they are a dying breed as markets like the NASDAQ and the TSX have gone electronic.

Small orders from individual "retail" traders go through a computer system which is designed to match those orders. But if no other investor wants to buy your stock, or sell you more, the market maker steps in. "Online traders do not always trade with market makers. Frequently, online traders trade with market makers, but not always. There are other people participating in the market," says Bittman.

How do market makers make money?

In return for the liquidity they provide to stock markets, market makers make profits on the spread – and move on to the next trade.

Pre-1996, in the case of the TSX, the stock exchange used a fractional system of pricing. The fractional system was based on eighths of a dollar, so the smallest increment was 12 1/2 cents and spreads used to range from 12 1/2 to 50 cents on a stock. In 1996, the TSX switched to a decimal system and other stock exchanges followed. Technology and more competition have narrowed spreads.