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Investopedia
============
Copyright © 2011 Remy Noulin.
Introduction
===============
The document contains notes on pdfs from Investopedia.
Economic Indicators
======================
- <http://www.federalreserve.gov/FOMC/BeigeBook/2009/>
- Consumer Confidence :
<http://www.conference-board.org/economics/consumerConfidence.cfm>
- Consumer credit :
<http://www.federalreserve.gov/releases/g19/current/default.htm>
- Consumer Price Index : <http://www.numbeo.com/common/>
- US <http://www.bls.gov/news.release/cpi.toc.htm>
- France
<http://www.insee.fr/en/themes/indicateur.asp?id=29&type=1&page=indic_cons.asp>
- Sweden <http://www.riksbank.com/templates/Page.aspx?id=27404>
- Existing-Home Sales
<http://www.realtor.org/research/research/ehsdata>
- GDP
<http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm>
- Industrial Production
<http://www.federalreserve.gov/releases/g17/current/default.htm>
- Jobless Claims <http://www.dol.gov/opa/media/press/eta/main.htm>
- Money Supply <http://www.federalreserve.gov/>
- Mutual fund flows <http://www.ici.org/research#statistics>
- PERSONAL INCOME AND OUTLAYS
<http://bea.gov/newsreleases/national/pi/pinewsrelease.htm>
- Purchasing Managers Index (PMI) <http://www.ism.ws/ISMReport/>
- Retail Sales Report <http://www.census.gov/retail/>
- Trade Balance Report (nominal trade deficit)
<http://www.bea.gov/international/index.htm>
Financial Ratios
===================
- Share Price/Earning ratio
- Price/Earning to growth ratio
- Price/Sales ratio
- Dividend Yield
- Enterprise value multiple
Conference board
===================
- <http://www.conference-board.org/> indicators and research in press
releases
- <http://www.businesscycle.com/>
- University of Michigan Consumer Sentiment Index
- The Consumer Internet Barometer
Dow Theory
=============
Technical analysis - chart patterns.\
Trends in the market: up, down, side ways, primary, secondary
Exploring Oscillators and Indicators
=======================================
MACD
--------
The moving average convergence divergence (MACD) is one of the most well
known and used indicators in technical analysis. It is used to signal
both the trend and momentum behind a security.\
The MACD indicator is comprised of two exponential moving averages
(EMA), covering two different time periods, which help to measure
momentum in the security. The MACD is simply the difference between
these two moving averages, which in practice are generally a 12-period
and 26-period EMA. The MACD is plotted against a centerline along with a
nine-period EMA, which is referred to as the \"signal line\".\
The idea behind this momentum indicator is to measure short-term
momentum compared to long-term momentum to help determine the future
direction of the asset.\
Calculation\
MACD = Short-term EMA - Long-term EMA\
\
The most commonly used moving average values are 26-day and 12-day EMAs
for the MACD calculation and a nine-day EMA of the MACD for the signal
line. These values can be adjusted to meet the needs of the technician
and the security. For more volatile securities shorter term averages are
used while less volatile securities should have longer averages. Another
aspect to the MACD indicator that is often found on charts is the MACD
histogram. The histogram is plotted on the centerline and represented by
bars. Each bar is the difference between the MACD and the signal line
or, in most cases, the nine-day EMA. The higher the bars are in either
direction the more momentum behind the direction the bars point.\
\
Buy-and-Sell Signals\
The buy-and-sell signals in regard to the MACD are formed either because
of crossovers or divergence. The first signal that is formed by the MACD
is when the MACD line crosses the signal line, which is the EMA of the
MACD. When the MACD crosses the signal line in an upward direction it is
a bullish sign as the asset is gaining upward momentum. When the MACD is
gaining upward momentum it reflects that the shorter term moving average
(12-day) is increasing at a faster rate than the (26- day) and that the
trend is starting to strengthen in the upward direction. When the MACD
crosses below the signal line it suggests that upward momentum is
weakening with downward pressure increasing. It is signals that the
shorter term momentum is falling faster than the longer term average,
signaling an increase in short-term selling. The second signal, which
also deals with crossovers, occurs when the MACD crosses the centerline.
If the MACD line crosses the centerline in an upward direction it
signals upward momentum. This upward crossover can also be seen on the
price chart at the exact movement when the 12-day moving average is
crossing the 26-day in an upward direction. Downward momentum is
signaled when the MACD falls below the centerline. This is the point in
which the 12-day moving average falls below the 26-day moving average -
a sign of increased downward momentum. The third signal that is formed
by the MACD line is when it diverges from the price movement in the
security. This signals that the momentum in the security is moving in
the opposite direction of the true trend and suggests a future weakening
in the price trend. If the MACD line is moving in an upward direction
while the price is moving downward it is a bullish sign. The opposite is
true if the MACD line is moving downward while the price is moving
upward. The MACD indicator is by far one of the most well known and
commonly used in technical analysis. It is important that anyone using
technical analysis become well versed in this momentum indicator.
RSI
-------
The relative strength index (RSI) is another one of the most frequently
used and well known momentum indicators in technical analysis. It is
used to signal overbought and oversold conditions in a security. The
indicator is plotted between a range of zero to 100 where 100 is the
highest overbought condition and zero is the highest oversold condition.
The RSI helps to measure the strength of a security's recent up moves
compared to the strength of its recent down moves. This helps to
indicate whether a security has seen more buying or selling pressure
over the trading period. The standard calculation uses 14 trading
periods as the basis for the calculation which can be adjusted to meet
the needs of the user. If the trading periods used is lowered then the
RSI will be more volatile and is used for shorter term trades.\
Calculation\
\
How the RSI is used\
Like most indicators there are two general ways in which the indicator
is used to generate signals - crossovers and divergence. In the case of
the RSI, the indicator uses crossovers of its overbought, oversold and
centerline. The first technique is to use overbought and sold lines to
generate buy-and-sell signals. In the RSI, the overbought line is
typically set at 70 and when the RSI is above this level the security is
considered to be overbought. The security is seen as oversold when the
RSI is below 30. These values can be adjusted to either increase or
decrease the amount of signals that are formed by the RSI. A buy signal
is generated when the RSI breaks the oversold line in an upward
direction, which means that it goes from below the oversold line to
moving above it. A sell signal is formed when the RSI breaks the
overbought line in a downward direction crossing from above the line to
below the line. A more conservative approach can be used by setting the
overbought and oversold levels at 80 and 20, respectively.\
Another crossover technique used in formulating signals is using the
centerline (50). This technique is exactly the same as using the
overbought and oversold lines to formulate signals. This technique will
often form signals after a movement in the direction they are predicting
but are used more as a confirmation then a signal compared to the other
techniques. A downward trend is confirmed when the RSI crosses from
above 50 to below 50. An upward trend is confirmed when the RSI crosses
above 50.\
Divergence can be used to form signals as well. If the RSI is moving in
an upward direction and the security is moving in a downward direction
it signals to technical traders that buying pressure is increasing and
the downtrend may be coming to an end. Divergence can also be used to
signal a reversal in an upward trend where the RSI is decreasing
signaling increasing selling pressure in an upward trend.\
The RSI is a standard component on any basic technical chart. The
relative strength indicator focuses on the momentum underlying the
security and is a great secondary measure to be used by traders. It is
important to note that the RSI is often not used as the sole generation
of buy-and-sell signals but used in conjunction with other indicators
and chart patterns.
Option greeks
================
- When IV falls, Delta falls and it falls faster for out of the money
options.
- When time passes, Delta falls amd it falls more for out of the money
options.
Option volatility
====================
Historical volatility
-------------------------
When a big cap stock is having a bearish cycle, the daily price swings
typically will expand, generating higher historical volatility.
Implied volatility
----------------------
Let's say that an option trader is interested in buying high beta tech
stock call options because he or she is bullish on the stock. Because
high beta stocks have the potential to make big moves, the trader thinks
that the potential for profit is higher when buying call options.
However, options on these stocks, especially around pending news, can
experience a change in the price even without movement of the
underlying. Prices may move higher (again even without a stock price
move) simply because there is a big move expected. And this will
typically occur on the puts and calls. In this case, IV is going to be
high. When the news comes out and the stock moves higher as expected by
the trader, the results are often disappointing in terms of changes in
the option price and what Delta implies the price should actually be.
The reason is that the reverse movement in IV occurs, IV falls after the
news (like letting the air out of a balloon) and the IV (and with it
lots of extrinsic value) deflates quickly. With this drop in IV, the
call buyer is often left miffed as to why he or she did not make much,
if anything, on his or her speculative purchase of calls.\
Now, when it comes to put buying, there can be both good and bad
surprises. The same process outlined above will operate when buying
puts, especially if puts are purchased during bearish cycles in the
stock (IV typically for most large cap stocks will be pumped up at this
point). If the puts are purchased when they are \"cheap\" in terms of IV
levels (this occurs when you buy the puts when the trend has been upward
and price action relatively uniform (and assuming no big pending news
outcome), then it is possible for IV to rise if the stock enters a
bearish cycle. This can lead to a positive surprise in the change of the
option price, provided you purchased the option when the IV was low near
the market top. Here, the price would increase more than that which is
suggested by Delta (leaving any significant changes due to Theta or the
rate of time value decay aside for now).
IV and Historical Volatility Spikes
---------------------------------------
When IV is greater than historical volatility, options are thought to be
overvalued, and when IV is less than historical volatility, options are
considered to be undervalued.
Options Mispricing
----------------------
If actual prices for options are greater than historical volatility
modeled theoretical prices, IV will pick up this mispricing. The
mispricing can be above or below theoretical prices, which is perhaps
the easiest way to understand overvalued options (above theoretical) and
undervalued options (below theoretical) pricing. When the market prices
are greater than theoretical prices, IV will be greater than historical
volatility and when market prices are less than theoretical prices, IV
will be less than historical volatility.
Volatility conditions for selling and buying options High Implied
Volatility Low Implied Volatility High Historical Volatility Low
Historical Volatility
| \- |High Implied Volatility |Low Implied Volatility |High Historical Volatility |Low Historical Volatility|
| -----------------------|-------------------------|------------------------|----------------------------|---------------------------|
| Implied \> Historical |Selling Bias |Mixed |Selling Bias |Mixed|
| Implied \< Historical |Mixed |Buying Bias |Mixed |Buying Bias|
Vega and the Greeks
-----------------------
The higher the price, the larger the Vega. This means that as you go
farther out in time (imagine LEAPS options), the Vega values can get
very large and pose significant risk or reward should volatility make a
change. For example, if you buy a LEAPS call option on a stock that was
making a market bottom and the desired price rebound takes place, the
volatility levels will typically decline sharply (see Figure 11 for this
relationship on S&P 500 stock index, which reflects the same for many
big cap stocks), and with it the option premium.\
Typical of most big cap stocks that mimic the market, when price
declines, volatility rises and vice versa. This relationship is
important to incorporate into strategy analysis For example, at the
bottom of a selloff, you would not want to be establishing a long
strangle, backspread or other positive Vega trade, because a market
rebound will pose a problem resulting from collapsing volatility.
Vertical Skews
------------------
The options on stock market indexes (i.e., OEX, SPX) have a permanent
reverse IV skew. This pattern of IV variability is common to most equity
market indexes and many of the stocks that make up those indexes.\
With a reverse vertical IV skew, at lower option strikes IV is higher
and at higher option strikes IV is lower.\
The reverse forward skew exists largely in response to the possibility
of a market crash that may not be captured in the standard pricing
models. That is, risk is priced into the options to take into account
the possibility, however remote at any point in time, of a large market
decline.
Horizontal Skews
--------------------
Generally speaking, it is possible for options in any one month to
acquire higher IV levels than other months, and as with commodities, it
is true for stocks. This phenomenon is largely driven by expected price
moves surrounding an impending news event or possibly weather or supply
conditions that may impact the price of commodities. These skews can
arise and disappear as the news event approaches and then passes.
Predicting Big Price Moves
------------------------------
Implied volatility levels were shown previously to move inversely to the
price of most big cap stocks and options on major market averages. In
the previous chapter on valuation, we presented past implied volatility
(IV) and historical volatility levels for Altria Group, Inc. (NYSE:MO)
that made this relationship very clear. However, for many stocks and
commodities, this relationship does not apply. Often, high IV levels
flag an impending price explosion - moves that may be up or down and
that are accompanied by a collapse back to normal IV levels. You will
see this pattern repeat again and again, most often in biotech stocks,
but even in other tech names.\
Historical volatility may even go higher with a big price move following
the event, while IV collapses back to a normal level. In Figure 17, IV
(blue line) often begins to diverge sharply from historical volatility
levels (brown line), and in some instances, historical volatility will
move in an opposite direction to IV as the stock price volatility
dampens ahead of the explosion in price that follows a run-up in IV.\
Trading this information is difficult because the direction of the price
move is not known. While it is possible to try to see what insiders are
doing and to mimic their behavior, this is not always easy and may lead
to erroneous results. Buying out- of-the-money options is a poor
strategy even if you know which way the stock is headed. This is because
the options are trading at extreme price levels, as indicated by the
sky-high IV. When the move occurs, assuming you bought the right
options, the collapse in IV will often erase most of his gains. Selling
strategies, meanwhile, may pose a problem because the price moves can be
so big that you may find that the risk is not worth the reward.
IV as a Measure of the Investor Crowd
-----------------------------------------
When investors are fearful, and markets are bearish, VIX will rise. When
fear recedes, VIX declines. However, long-term low levels of the VIX
have been associated with bull markets, where VIX at extreme lows
signaled a major market advance, as seen in Figure 19. In 1994 and 2004,
VIX remained below 20 and the market developed significant bullish
trends.
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