Archive-name: investment-faq/general/part3ãVersion: $Id: faq-p3,v 1.4 1993/03/27 09:28:33 lott Exp lott $ãCompiler: Christopher Lott, lott@informatik.uni-kl.deããThis is the general FAQ for misc.invest, part 3 of 3.ãã-----------------------------------------------------------------------------ããSubject: Shorting StocksãFrom: ask@cblph.att.comããShorting means to sell something you don't own.ããIf I do not own shares of IBM stock but I ask my broker to sell shortã100 shares of IBM I have committed shorting.  In broker's lingo, Iãhave established a short position in IBM of 100 shares.  Or, to reallyãconfuse the language, I hold 100 shares of IBM short.ããWhy would you want to short?ããBecause you believe the price of that stock will go down, and you canãsoon buy it back at a lower price than you sold it at.  When you buyãback your short position, you "close your short position."ããThe broker will effectively borrow those shares from another client'sãaccount or from the broker's own account, and effectively lend youãthe shares to sell short.  This is all done with mirrors; no stockãcertificates are issued, no paper changes hands, no lender is identifiedãby name.ããMy account will be credited with the sales  price of 100 shares of IBMãless broker's commission.  But the broker has actually lent me the stockãto sell; no way is he going to pay interest on the funds from the shortãsale. (Exception:  Really big spenders sometimes negotiate a full orãpartial payment of interest on short sales funds provided sufficientãcollateral exists in the account and the broker doesn't want to loseãthe client.  If you're not a really big spender, don't expect to receiveãany interest on the funds obtained from the short sale.)  Also expectãthe broker to make you put up additional collateral.  Why?ããWell, what happens if the stock price goes way up?  You will have toãassure the broker that if he needs to return the shares whence he gotãthem (see "mirrors" above) you will be able to purchase them and "closeãyour short position."  If the price has doubled, you will have to spendãtwice as much as you received. So your broker will insist you haveãenough collateral in your account which can be sold if needed to closeãyour short position.  More lingo: Having sufficient collateral in yourãaccount that the broker can glom onto at will, means you have "cover"ãfor your short position. As the price goes up you must provide more cover.ããSince you borrowed these shares, if dividends are declared, you will beãresponsible for paying those dividends to the fictitious person fromãwhom you borrowed.  Too bad.ããEven if you hold you short position for over a year, your capitalãgains are short term.ããA short squeeze can result when the price of the stock goes up.  Whenãthe people who have gone short buy the stock to cover their previousãshort-sales, this can cause the price to rise further.  It's a deathãspiral - as the price goes higher, more shorts feel driven to coverãthemselves, and so on.ããYou can short other securities besides stock.  For example, every timeãI write (sell) an option I don't already own long, I am establishing aãshort position in that option. The collateral position I must hold inãmy account generally tracks the price of the underlying stock and notãthe price of the option itself.  So if I write a naked call option onãIBM November 70s and receive a mere $100 after commissions, I may beãasked to put up collateral in my account of $3,500 or more!  And ifãin November IBM has regained ground and is at $90 [ I should be soãlucky ], I would be forced to buy back (close my short position inãthe call option) at a cost of about $2000, for a big loss.ããSelling short is seductively simple.  Brokers get commissions byãshowing you how easy it is to generate short term funds for yourãaccount, but you really can't do much with them.  My personal adviceãis if you are strongly convinced a stock will be going down, buy theãout-of-the-money put instead, if such a put is available.ããA put's value increases as the stock price falls (but decreases sortãof linearly over time) and is strongly leveraged, so a small fall inãprice of the stock translates to a large increase in value of the put.ããLet's return to our IBM, market price of 66 (yuck.) Let's say I stronglyãbelieve that IBM will fall to, oh,  58 by mid-November.  I could shortãIBM stock at 66, sell it at 58 in mid-November if I'm right, and makeãabout net $660.  If instead it goes to 70, and I have to sell then Iãlose net $500 or so.  That's a 10% gain or an 8% loss or so.ããNow, I could buy the IBM November 65 put for maybe net $200.  If itãgoes down to 58 in mid November, I sell (close my position) for aboutã$600, for a 300% gain.  If it doesn't go below 65, I lose my entireã200 investment. But if you strongly believe IBM will go way way down,ãyou should shoot for the 300% gain with the put and not the 10% gainãby shorting the stock itself.  Depends on how convinced you are.ããHaving said this, I add a strong caution:  Puts are very risky, andãdepend very much on odd market behavior beyond your control, and youãcan easily lose your entire purchase price fast.  If you short options,ãyou can lose even more than your purchase price!ããOne more word of advice.  Start simply.  If you never bought stockãstart by buying some stock.  When you feel like you sort of understandãwhat you are doing, when you have followed several stocks in theãfinancial section of the paper and watched what happens over the courseãof a few months, when you have read a bit more and perhaps seriouslyãtracked some important financials of several companies, you might --ãmight -- want to expand your investing choices beyond buying stock. ãIf you want to get into options (see FAQ on options) start with writingãcovered calls.  I would place selling stock short or writing or buyingãother options lower on the list -- later in time.ãã-----------------------------------------------------------------------------ããSubject: Stock Index TypesãFrom: susant@usc.eduããThere are three major classes of indices in use today in the US.  They are:ããA - equally weighted price indexã (an example is the Dow Jones Industrial Average)ãB - market-capitalization-weighted indexã        (an example is the S&P Industrial Average)ãC - equally-weighted returns indexã        (the only one of its kind is the Value-Line index)ããOf these, A and B are widely used.  All my profs in the business schoolãclaim that C is very weird and don't emphasize it too much.ãã+ Type A index:  As the name suggests, the index is calculated by taking theãaverage of the prices of a set of companies:ãã            Index =  Sum(Prices of N companies) / divisorããIn this calculation, two questions crop up:ãã1. What is "N"?  The DJIA takes the 30 large "blue-chip" companies.  Why 30? ãI think it's more a historical hangover than any thing else.  One rationaleãfor 30 might be that a large fraction of market capitalization is oftenãclustered in largest 50 companies or so.ããDoes the set of N companies change across time?  If so, how often is theãlist updated (wrt companies)?  I suspect these decisions are quiteãjudgemental and hence not readily replicable.ããIf the DJIA only has 30 companies, how do we select these 30?  Why shouldãthey have equal weights?  These are real criticisms of the DJIA type index.ãã2. The divisor is not always equal to N for N companies.  What happens toãthe index when there is a stock issue by one of the companies in the set? ãThe price drops, but the number of shares have increased to leave the marketãcapitalization of the shares the same. Since the index does not take theãlatter into account, it has to compensate for the drop in price by tweakingãthe divisor.  For examples on this, look at pg. 61 of Bodie, Kane, & Marcus,ã_Investments_ (henceforth, BKM).ããHistorically, this index format was computationally convenient.  It doesn'tãhave a very sound economic basis to justify it's existence today.  The DJIAãis widely cited on the evening news, but not used by real finance folks.ããI have an intuition that the DJIA type index will actually be BAD if theãnumber of companies is very large.  If it's to make any sense at all, itãshould be very few "brilliantly" chosen companies.ãã+ Type B index:  In this index, each of the N company's price is weighted byãthe market capitalization of the company.ãã        Sum (Company market capitalization * Price) over N companiesãIndex = ------------------------------------------------------------ã     Market capitalisation for these N companiesããHere you do not take into account the dividend data, so effectively you'reãtracking the short-run capital gains of the market.ããPractical questions regarding this index:ãã1. What is "N"?  I would use the largest N possible to get as close to theã"full" market as possible.   BTW in the US there are companies who make aãliving on only calculating extremely complete value-weighted indexes forãthe NYSE and foreign markets.  CMIE should sell a very-complete value-weightedãindex to some such folks.ããWhy does S&P use 500? Once again, I'm guessing that it's for historicalãreasons when computation over 20,000 companies every day was difficult andãbecause of the concentration of market capitalization in the largest lotãof companies.  Today, computation over 20k companies for a Sun workstationãis no problem, so the S&P idea is obsolete.ãã2.  How to deal with companies entering and exiting the index?  If we'reãdoing an index containing "every single company possible" then the answerãto this question is easy -- each time a company enters or exits we recalculateãall weights.  But if we're a value-weighted index like the S&P500 (where thereãare only 500 companies) it's a problem.  Recently Wang went bankrupt and S&Pãdecided to replace them by Sun -- how do you justify such choices?ããThe value weighted index is superior to the DJIA type index for deep reasons. ãAnyone doing modern finance will not use the DJIA type index.  A glimmer ofãthe reasoning for this is as follows:  If I held a portfolio with equal numberãof shares of each of the 30 DJIA companies then the DJIA index would accuratelyãreflect my capital gains.  BUT we know that it is possible to find a portfolioãwhich has the same returns as the DJIA portfolio but at a smaller risk. ã(This is a mathematical fact).ããThus, by definition, nobody is ever going to own a DJIA portfolio.  Inãcontrast, there is a extremely good interpretation for the value weightedãportfolio -- it's the highest returns you can get for it's level of risk. ãThus you would have good reason for owning a value-weighted market portfolio,ãthus justifying it's index.ããYet another intuition about the value-weighted index -- a smart investor isãnot going to ever buy equal number of shares of a given set of companies,ãwhich is what index type a. tracks.  If you take into consideration that theãprice movements of companies are correlated with others, you are going toãhedge your returns by buying different proportions of company shares.  Thisãis in effect what the index type B does and this is why it is a smarter indexãto follow.ããOne very neat property of this kind of index is that it is readily applied toãindustry indices.  Thus you can simply apply the above formula to all machineãtool companies, and you get a machine tool index.  This industry-index isãconceptually sound, with excellent interpretations.  Thus on a day when theãmarket index goes up 6%, if machine tools goes up 10%, you know the marketãfound some good news on machine tools.ãã+ Type C index:  Here the index is the average of the returns of a certainãset of companies. Value Line publishes two versions of it: ãã  * the arithmetic index :  (VLAI/N) =  1  * Sum(N returns)ã  * the geometric index :  VLGI  = {Product(1 + return) over N}^{1/n},ã    which is just the geometric mean of the N returns.ããNotice that these indices imply that the dollar value on each company hasãto be the same.  Discussed further in BKM, pg 66.ãã-----------------------------------------------------------------------------ããSubject: Stock Index - The DowãFrom: vision@cup.portal.com, nfs@princeton.eduããThe Dow Jones Industrial Average is computed from the following stocks:ããTicker  Nameã------  ----ãAA AlcoaãALD Allied SignalãAXP American ExpressãBA BoeingãBS Bethlehem SteelãCAT CaterpillarãCHV ChevronãDD Du PontãDIS DisneyãEK Eastman KodakãGE General ElectricãGM General MotorsãGT Goodyear TireãIBM International Business MachinesãIP International PaperãJPM JP Morgan BankãKO Coca ColaãMCD McDonaldsãMMM Minnesota Mining and Manufacturing (3M)ãMO Philip MorrisãMRK MerckãPG Procter and GambleãS Sears, RoebuckãT AT&TãTX TexacoãUK Union CarbideãUTX United TechnologiesãWX WestinghouseãXON ExxonãZ WoolworthããThe Dow Jones averages are computed by summing the prices of the stocksãin the average and then dividing by a constant called the "divisor".  Theãdivisor for the industrial average is adjusted periodically to reflectãsplits in the stocks making up the average; the divisor was originally 30ãbut has been reduced over the years to 0.462685 (as of 92-10-31).  Theãcurrent value of the divisor can be found in the Wall Street Journalãand Barron's.ãã-----------------------------------------------------------------------------ããSubject: Stock Indexes - OthersãFrom: jld1@ihlpm.att.com, pearson_steven@tandem.com, jordan@imsi.com,ã rajiv@bongo.cc.utexas.eduããStandard & Poor's 500: 500 of the biggest US corporations.ã    This is a very popular institutional index, and recently becoming ã    more popular among individuals.  Most often used measure of broad ã    stock market results.ãWilshire 5000ã    Includes most publicly traded shares.  Considered by some a betterã    measure of market as a whole, becuase it includes smaller companies. ãWilshire 4500 ã    These are all firms *except* the S&P 500.ãValue Line Compositeã    See Martin Zweig's Winning on Wall Street for a good description.ã    It is a price-weighted index as opposed to a capitalization index.ã    Zweig (and others) think this gives better tracking of investmentã    results, since it is not over-weighted in IBM, for example, andã    most individuals are likewise not weighted by market cap in theirã    portfolios (unless they buy index funds). ãNikkei Dow (Japan)ã    I believe "Dow" is a misnomer.  It is called the Nikkei index (orã    the Nikkei-xx, where xx is the number of shares in it, which Iã    can't quote to you out of my head).  "Dow" comes from Dow Jones &ã    Company, which publishes DJIA numbers.  Nikkei is considered theã    "Japanese Dow," in that it is the most popular and commonly quotedã    Japanese market index, but I don't think Dow Jones owns it. ãS&P 100 (and OEX)ã    The S&P 100 is an index of 100 stocks.  The "OEX" is the option on ã    this index, one of the most heavily traded options around.  ãS&P MidCap 400 ã    Medium capitalization firms.ãCAC-40 (France)ã    This is 40 stocks on the Paris Stock Exchange formed into anã    index.  The futures contract on this index is probably the mostã    heavily traded futures contract in the world. ãEurope, Australia, and Far-East (EAFE)ã    Compiled by Morgan Stanley.ãRussell 1000ãRussell 2000ã    A small cap stock index.ãRussell 3000ãNYSE Composite              [options on index]ãGold & Silver Index         [options on index]ãAMEX CompositeãNASDAQ CompositeãTopix (Japan)ãDAX (Germany)ãFTSE 100 (Great Britain)ãMajor Market Index (MMI)ãã [ Compiler's note: a few explanations are still missing.ã   Can anyone supply a few? ]ãã-----------------------------------------------------------------------------ããSubject: Stock SplitsãFrom: egreen@east.sun.com, schindler@csa2.lbl.gov, ask@cblph.att.comããOrdinary splits occur when the company distributes more stock to holdersãof existing stock.  A stock split, say 2-for-1, is when a company simplyãissues one additional share for every one outstanding.  After the split,ãthere will be two shares for every one pre-split share. (So it is calledãa "2-for-1 split.")  If the stock was at $50 per share, after the split,ãeach share is worth $25, because the company's net assets didn't increase,ãonly the number of outstanding shares.ããSometimes an ordinary split is referred to as a percent.  A 2:1 split isãa 100% stock split (or 100% stock dividend).   A 50% split would be a 3:2ãsplit (or 50% stock dividend).  You will get 1 more share of stock forãevery 2 shares you owned.ããReverse splits occur when a company wants to raise the price of theirãstock, so it no longer looks like a "penny stock" but looks more like aãself-respecting stock.  Or they might want to conduct a massive reverseãsplit to eliminate small holders.  If a $1 stock is split 1:10 the newãshares will be worth $10.  Holders will have to trade in their 10 OldãShares to receive 1 New Share.ããOften a split is announced long before the effective date of the split,ãalong with the "record date."   Shareholders of record on the recordãdate will receive the split shares on the effective date (distributionãdate). Sometimes the split stock begins trading as "when issued" on orãabout the record date.   The newspaper listing will show both the pre-ãsplit stock as well as the when-issued split stock with the suffix "wi." ã(Stock dividends of 10% or less will generally not trade wi.)ããTheoretically a stock split is a non-event.  The fraction of the companyãeach of your shares represents is reduced, but you are given enoughãshares so that your total fraction of the company owned remains the same. ãOn the day of the split, the value of the stock is also adjusted so thatãthe total capitalization of the company remains the same.ããIn practice, an ordinary split often drives the new price per share up,ãas more of the public is attracted by the lower price.  A company mightãsplit when it feels its per-share price has risen beyond what an individualãinvestor is willing to pay, particularly since they are usually boughtãand sold in 100's.  They may wish to attract individuals to stabilize theãprice, as institutional investors buy and sell more often than individuals.ãã-----------------------------------------------------------------------------ããSubject: Technical AnalysisãFrom: suhre@trwrb.dsd.trw.comããThe following material introduces technical analysis and is intended toãbe educational.  If you are intrigued, do your own reading.  The answersãare brief and cannot possibly do justice to the topics.  The referencesãprovide a substantial amount of information.  The contributions of theãreviewers is appreciated.ããFirst, the references:ãã  1. Technical Analysis of the Futures Markets, by John J. Murphy. ã     New York Institute of Finance.ã  ã  2. Technical Analysis Explained, by Martin Pring. ã     McGraw Hill.ã  ã  3. Stan Weinstein's Secrets for Profiting in Bull and Bear Markets, byã     Stan Weinstein.  Dow Jones-Irwin.ããNext, the discussion:ãã1.  What is technical analysis?ããTechnical analysis attempts to use *past* stock price and volumeãinformation to predict *future* price movements.  Note the emphasis.ãIt also attempts to time the markets.ãã2.  Does it have any chance of working, or is it just like reading tea leaves?ããThere are a couple of plausibility arguments.  One is that the chartãpatterns represent the past behavior of the pool of investors.  Sinceãthat pool doesn't change rapidly, one might expect to see similar chartãpatterns in the future.  Another argument is that the chart patternsãdisplay the action inherent in an auction market.  Since not everyoneãreacts to information instantly, the chart can provide some predictiveãvalue.  A third argument is that the chart patterns appear over and overãagain.  Even if I don't know why they happen, I shouldn't trade or investãagainst them.  A fourth argument is that investors swing from overlyãoptimistic to excessively pessimistic and back again.  Technical analysisãcan provide some estimates of this situation.ããA contrary view is that it is just coincidence and there is little, ifãany, causality present.  Or that even if there is some sort of causalityãprocess going on, it isn't strong enough to trade off of.ããA very contrary view:  The past and future performance of a stock mayãbe correlated, but that does not mean or imply causality. So, relyingãon technical analysis to buy/sell a stock is like relying on the positionãof the stars in the atmosphere or the phases of the moon to decide whetherãto buy or sell.ãã3.  I am a fundamentalist.  Should I know anything about technical analysis?ããPerhaps.  You should consider delaying purchase of stocks whose chartãpatterns look bad, no matter how good the fundamentals.  The market isãtelling you something is still awry.  Another argument is that theãtechnicians won't be buying and they will not be helping the stock moveãup.  On the other hand (as the economists say), it makes it easy forãyou to buy in front of them.  And, of course, you can ignore technicalãanalysis viewpoints and rely solely on fundamentals.ãã4.  What are moving averages?ããObserve that a period can be a day, a week, a month, or as little as 1ãminute.  Stock and mutual fund charts normally are daily postings orãweekly postings.  An N period (simple) moving average is computed byãsumming the last N data points and dividing by N.  Moving averages areãnormally simple unless otherwise specified.ããAn exponential moving average is computed slightly differently.  LetãX[i] be a series of data points.  Then the Exponential Moving Averageã(EMA) is computed byãã    EMA[i] = (1-sm)*EMA[i-1] + sm*(X[i]-EMA[i-1])ãã    where sm = 2/(N+1), and EMA[1] = X[1].ãã"sm" is the smoothing constant for an N period EMA.  Note that the EMAãprovides more weighting to the recent data, less weighting to the old data.ãã4a.  What is Stage Analysis?ããStan Weinstein [Ref 3] developed a theory (based on his observations)ãthat stocks usually go through four stages in order.  Stage 1 is a timeãperiod where the stock fluctuates in a relatively narrow range.  Littleãor nothing seems to be happening and the stock price will wander backãand forth across the 200 day moving average.  This period is generallyãcalled "base building".  Stage 2 is an advancing stage characterized byãthe stock rising above the 200 and 50 day moving averages.  The stockãmay drop below the 50 day average and still be considered in Stage 2.ãFundamentally, Stage 2 is triggered by a perception of improved conditionsãwith the company.  Stage 3 is a "peaking out" of the stock price action. ãTypically the price will begin to cross the 200 day moving average, andãthe average may begin to round over on the chart.  This is the time toãtake profits.  Finally, the Stage 4 decline begins.  The stock price dropsãbelow the 50 and 200 day moving averages, and continues down until a newãStage 1 begins.  Take the pledge right now:  hold up your right hand andãsay "I will never purchase a stock in Stage 4".  One could have avoidedãthe late 92-93 debacle in IBM by standing aside as it worked its wayãthrough a Stage 4 decline.ãã5.  What is a whipsaw?ããThis is where you purchase based on a moving average crossing (or someãother signal) and then the price moves in the other direction giving aãsell signal shortly thereafter, frequently with a loss.  Whipsaws canãsubstantially increase your commissions for stocks and excessive mutualãfund switching may be prohibited by the fund manager.ãã5a.  Why a 200 day moving average as opposed to 190 or 210?ããMoving averages are chosen as a compromise between being too late toãcatch much move after a change in trend, and getting whipsawed.  Theãshorter the moving average, the more fluctuations it has.  There areãconsiderations regarding cyclic stock patterns and which of those areãfiltered out by the moving average filter.  A discussion of filters isãfar beyond the scope of this FAQ.  See Hurst's book on stockãtransactions for some discussion.ãã6.  Explain support and resistance levels, and how to use them.ããSuppose a stock drops to a price, say 35, and rebounds.  And that thisãhappens a few more times.  Then 35 is considered a "support" level.ãThe concept is that there are buyers waiting to buy at that price.ãImagine someone who had planned to purchase and his broker talked himãout of it.  After seeing the price rise, he swears he's not going toãlet the stock get away from him again.  Similarly, an advance to aãprice, say 45, which is repeatedly followed by a pullback to lowerãprices because a "resistance" level.  The notion is that there areãbuyers who purchased at 45 and have watched a deterioration into a lossãposition.  They are now waiting to get out even.  Or there are sellersãwho consider 45 overvalued and want to take their profits.ããOne strategy is to attempt to purchase near support and take profits nearãresistance.  Another is to wait for an "upside breakout" where the stockãpenetrates a previous resistance level.  Purchase on anticipation of aãfurther move up.  [See references for more details.]ããThe support level (and subsequent support levels after rises) can provideãinformation for use in setting stops.  See the "About Stocks" section ofãthe FAQ for more details.  ãã6a.  What would cause these levels to be penetrated?ããAbrupt changes in a company's prospects will be reacted to in the stockãmarket almost immediately.  If the news is extreme enough, the reactionãwill appear as a jump or gap in prices.  More modest changes willãresult, in general, in more modest changes in price.ãã6b.  What is an "upside breakout"?ããIf a stock has traded in a narrow range for some time (i.e. built aãbase) and then advances above the resistance level, this is said to be anã"upside breakout".  Breakouts are suspect if they do not occur on highãvolume (compared to average daily volume).  Some traders use a "buy stop"ãwhich calls for purchase when a stock rises above a certain price.ãã6c.  Is there a "downside breakout"?ããNot by that name -- the opposite of upside breakout is calledã"penetration of support" or "breakdown".  Corresponding to "buy stops,"ãa trader can set a "sell stop" to exit a position on breakdown.ãã7.  Explain breadth measurements and how to use them.ããA breadth measurement is something taken across a market.  For example,ãlooking at the number of advancing stocks compared to declining stocksãon the NYSE is a breadth measurement.  Or looking at the number of stocksãabove their 200 day moving average.  Or looking at the percentage of stocksãin Stage 1 and 2 configurations.  In general, a technically healthy marketãshould see a lot of stocks advancing, not just the Dow 30.  If the breadthãmeasurements are poor in an advancing sense and the market has beenãadvancing for some time, then this can indicate a market turning pointã(assuming that the advancing breadth is declining) and you should considerãtaking profits, not entering new long positions, and/or tightening stops. ã(See the divergence discussion.)ãã7a.  What is a divergence?  What is the significance?ããIn general, a divergence is said to occur when two readings are notãmoving generally together when they would be expected to.  For example,ãif the DJIA moves up a lot but the S&P 500 moves very little or evenãdeclines, a divergence is created.  Divergences can signify turningãpoints in the market.  At a major market low, the "blue chip" stocksãtend to move up first as investors becoming willing to purchase quality. ãHence the S&P 500 may be advancing while the NYSE composite is movingãvery little.  Divergences, like everything else, are not 100 per centãreliable.  But they do provide yellow or red alerts.  And the bigger theãdivergence, the stronger the signal.  Divergence and breadth are relatedãconcepts.  (See the breadth discussion.)ãã8.  How much are charting services and what ones are available?ããThey aren't cheap.  Daily Graphs (weekly charts with daily prices) isã$465 for the NYSE edition, $432 for the AMEX/OTC edition.  Somewhatãcheaper for biweekly or monthly.  Mansfield charts are weekly with weeklyãprices.  Mansfield shows about 2.5 years of action, Daily Graphs shows 1ãyear or 6 months for the less active stocks.ããS&P Trendline Chart Guide is about $145 per year.  It provides over 4,000ãcharts.  These charts show one year of weekly price/volume data and do notãprovide nearly the detail that Daily Graphs do.  You get what you pay for.ããThere are other charting services available.  These are merely representative.ãã9.  Can I get charts with a PC program?ããYes.  There are many programs available for various prices.  Daily quotesãrun about $35 or so a month from Dial Data, for example.  Or you canãmanually enter the data from the newspaper.ãã10.  What would a PC program do that a charting service doesn't?ããPrograms provide a wide range of technical analysis computations inãaddition to moving averages.  RSI, MACD, Stochastics, etc., are routinelyãincluded.  See Murphy's book [Ref 1] for definitions.  Frequently you canãchange the length of the moving averages or other parameters.  As anotherãexample, AIQ StockExpert provides an "expert rating" suggesting purchaseãor short depending on the rating.  Intermediate values of the rating areãless conclusive.ãã11.  What does a charting service do that PC doesn't?ããCharts generally contain a fair amount of fundamental information suchãas sales, dividends, prior growth rates, institutional ownership.ãã11a.  Can I draw my own charts?ããOf course.  For example, if you only want to follow a handful of mutualãfunds of stocks, charting on a weekly basis is easy enough.  EMAs areãalso easy enough to compute, but will take a while to overcome the lackãof a suitable starting value.ãã12.  What about wedges, exhaustion gaps, breakaway gaps, coils, saucerã     bottoms, and all those other weird formations?ããThe answer is beyond the scope of this FAQ article.  Such patterns can beãseen, particularly if you have a good imagination.  Many believe they areãnot reliable.  There is some discussion in Murphy [Ref 1].ãã13.  Are then any aspects of technical analysis that don't seem quiteã     so much like hokum or tea leaf reading?ããRSI (Relative Strength Indicator) is based on the observation that aãstock which is advancing will tend to close nearer to the high of the dayãthan the low.  The reverse is true for declining stocks.  RSI is a formulaãwhich attempts to provide a number which will indicate where you are inãthe declining/advancing stage.ãã14.  Can I develop my own technical indicators?ããYes.  The problem is validating them via some sort of backtesting procedure. ãThis requires data and work.  One suggestion is to split the data intoãtwo time periods.  Develop your indicator on one half and then see if itãstill works on the other half.  If you aren't careful, you end upã"curve fitting" your system to the data.ãã-----------------------------------------------------------------------------ããSubject: Ticker Tape TerminologyãFrom: capskb@alliant.backbone.uoknor.edu, nfs@cs.princeton.eduããTicker tape says:     Translation (but see below):ã        NIKE68 1/2            100 shares sold at 68 1/2ã     10sNIKE68 1/2           1000 shares sold at   "ã 10.000sNIKE68 1/2          10000 shares sold at   "ããThe extra zeroes for the big trades are to make them stand out.  Allãtrades on CNN and CNBC are delayed by 15 minutes.  CNBC once advertisedãa "ticker guide pamphlet, free for the asking", back when they mergedãwith FNN.  It also has explanations for the futures they show.ããHowever, the first translation is not necessarily correct.  CNBC hasãa dynamic maximum size for transactions that are displayed this way. ãDepending on how busy things are at any particular time, the maximumãvaries from 100 to 5000 shares.  You can figure out the current maximumãby watching carefully for about five minutes.  If the smallest numberãof shares you see in the second format is "10s" for any traded security,ãthen the first form can mean anything from 100 to 900 shares.  If theãsmallest you see is "50s" (which is pretty common), the first formãmeans anything between 100 and 4900 shares.ããNote that at busy times, a broker's ticker drops the volume figure andãthen everything but the last dollar digit (e.g. on a busy day, a tradeãof 25,000 IBM at 68 3/4 shows only as "IBM 8 3/4" on a broker's ticker). ãThat never happens on CNBC, so I don't know how they can keep up with allãtrades without "forgetting" a few.ãã-----------------------------------------------------------------------------ããSubject: Treasury Direct ãFrom: jberlin@falcon.aamrl.wpafb.af.milããYou can buy T-Bills directly from the US Treasury.  Contact any FederalãReserve Bank and ask for information on Treasury Direct.  The minimumãfor a Treasury Note (2 years and up) is only $5K and in some instancesã(I believe 5 year notes) $1K.  There are no fees and you may elect toãhave interest payments made directly to your account.  You even may payãwith a personal check, no need for a cashier's or certified check asãTreasury Bills (1 year and under) required.  AAII Journal had an articleãon this a couple of years ago. Like they said, the government service isãgreat, they just do not advertise it well.ãã-----------------------------------------------------------------------------ããSubject: Uniform Gifts to Minors Act (UGMA)ãFrom: ask@cbnews.cb.att.com, schindler@csa1.lbl.govããThe Uniform Gifts to Minors Act allows you to give $10,000 per yearãto any minor, tax free.  You must appoint a custodian.ããSome accountants advise that one person should make the gift andãthat a different person should be the custoidian, but I have neverãseen any IRS publication to justify this, nor any tax case rulingãwhich makes this a problem.  I suspect some people are just beingãconservative.ããTo give such a gift, go to your friendly neighborhood stockbroker,ãbank, mutual fund manager, or (close your eyes now: S&L), etc. andãsay that you wish to open a Uniform Gifts (in some states "Transfers")ãto Minors Act account.ããYou register it as:ã  [ Name of Custodian ] as custodian for [ Name of Minor ] under theã  Uniform Gifts/Transfers to Minors Act - [ Name of State of Minor'sã  residence ]ããYou use the minor's social security number as the taxpayer ID for thisãaccount.  When you fill out the W-9 form for this account, it willãshow this form.  The custodian should certify the W-9 form.ããThe money now belongs to the minor and the custodian has a legalãfiduciary responsibility to handle the money in a prudent manner forãthe benefit of the minor.ããSo you can buy common stocks but cannot write naked options.  Youãcannot "invest" the money on the horses, planning to donate theãwinnings to the minor.  And when the minor reaches age of majority -ãusually 18 - the minor can claim all of the funds even if that'sãagainst your wishes.  You cannot place any conditions on those fundsãonce the minor becomes an adult.ããUntil the minor reaches 14, the first $500 earned by the minor isãtax free, the next $500 is taxed at the minor's rate, and the restãis taxed at the higher of the minor's or the parent's rate.  Afterãthe minor reaches 14, all earnings over $500 are taxed at theãminor's rate.ããNote that if you want to continue doing your childs taxes even afterãthey turn 18, there is no reason they need to know about their UGMAãaccount that you set up for them.  They certainly can't blow theirãcollege fund on a Trans Am if they don't know about it.ããEven if your child does his/her own taxes, you can still give themãgifts through a trust without them knowing about it until they areãmore mature.  Call and ask Twentieth Century Investors for informationãabout their GiftTrust fund.  The fund is entirely composed of trustsãlike this.  The trust pays its own taxes.ãã-----------------------------------------------------------------------------ããSubject: WarrantsãFrom: ask@cblph.att.comããThere are many meanings to the word warrant.ããThe marshal can show up on your doorstep with a warrant for your arrest.ããMany army helicopter pilots are warrant officers, who have receivedãa warrant from the president of the US to serve in the Army of theãUnited States.ããThe State of California ran out of money earlier this year andãissued things that looked a lot like checks, but had no promise toãpay behind them.  If I did that I could be arrested for writing aãbad check.  When the State of California did it, they called theseãthingies "warrants" and got away with it.ããAnd a warrant is also a financial instrument which was issued withãcertain conditions.  The issuer of that warrant sets those conditions. ãSometimes the warrant and common or preferred convertible stock areãissued by a startup company bundled together as "units" and at someãlater date the units will split into warrants and stock.  This is aãcommon financing method for some startup companies.  This is theã"warrant" most readers of the misc.invest newsgroup ask about.ããAs an example of a "condition," there may be an exchange privilegeãwhich lets you exchange 1 warrant plus $25 in cash (or even no cashãat all) for 100 shares of common stock in the corporation, any timeãafter some fixed date and before some other designated date.ã(And often the issuer can extend the "expiration date.")ããSo there are some similarities between warrants and call options forãcommon stock.ããBoth allow holders to exercise the warrant/option before anãexpiration date, for a certain number of shares.  But the option isãissued by independent parties, such as a member of the Chicago BoardãOptions Exchange, while the warrant is issued and guaranteed by theãcorporate issuer itself.  The lifetime of a warrant is oftenãmeasured in years, while the lifetime of a call option is months.ããSometimes the issuer will try to establish a market for the warrant,ãand even try to register it with a listed exchange.  The price canãthen be obtained from any broker.  Other times the warrant will beãprivately held, or not registered with an exchange, and the priceãis less obvious, as is true with non-listed stocks.ãã-----------------------------------------------------------------------------ããSubject: Wash Sale Rule (from U.S. IRS)ãFrom: acheng@ncsa.uiuc.eduããFrom IRS publication 550, "Investment Income and Expenses" (1990). ãHere is the introductory paragraph from p.37:ãã    Wash Salesã    You cannot deduct losses from wash sales or trades of stock orã    securities.  However, the gain from these sales is taxable.ãã    A wash sale occurs when you sell stock or securities at a loss andã    within 30 days before or after the sale you buy or acquire in aã    fully taxable trade, or acquire a contract or option to buy,ã    substantially identical stock or securities.  If you sell stock andã    your spouse or a corporation you control buys substantiallyã    identical stock, you also have a wash sale.  You add the disallowedã    loss to the basis of the new stock or security.ããIt goes on explaining all those terms (substantially identical, stockãor security, ...).  It runs on several pages, too much to type in.  Youãshould definitely call IRS for the most updated ones for detail.  Phoneãnumber:  800-TAX-FORM (800-829-3676).ãã-----------------------------------------------------------------------------ããSubject: Zero-Coupon BondsãFrom: ask@cblph.att.comããNot too many years ago every bond had coupons attached to it.  Everyãso often, usually every 6 months, bond owners would take a scissorsãto the bond, clip out the coupon, and present the coupon to the bondãissuer or to a bank for payment.  Those were "bearer bonds" meaningãthe bearer (the person who had physical possession of the bond) ownedãit.  Today, many bonds are issued as "registered" which means even ifãyou get to touch the actual bond at all, it will be registered in yourãname and interest will be mailed to you every 6 months. It is not tooãcommon to see such coupons. Registered bonds will not generally haveãcoupons, but may still pay interest each year.  It's sort of like theãissuer is clipping the coupons for you and mailing you a check.  Butãif they pay interest periodically, they are still called Coupon Bonds,ãjust as if the coupons were attached.ããWhen the bond matures, the issuer redeems the bond and pays you theãface amount.   You may have paid $1000 for the bond 20 years ago andãyou have received interest every 6 months for the last 20 years, andãyou now redeem the matured bond for $1000.ããA Zero-coupon bond has no coupons and there is no interest paid.ããBut at maturity, the issuer promises to redeem the bond at face value.  ãObviously, the original cost of a $1000 bond is much less than $1000. ãThe actual price depends on: a) the holding period -- the number ofãyears to maturity, b) the prevailing interest rates, and c) the riskãinvolved (with the bond issuer).ããTaxes:  Even though the bond holder does not receive any interest whileãholding zeroes, in the US the IRS requires that you "impute" an annualãinterest income and report this income each year.  Usually, the issuerãwill send you a Form 1099-OID (Original Issue Discount) which lists theãimputed interest and which should be reported like any other interestãyou receive.  There is also an IRS publication covering imputed interestãon Original Issue Discount instruments.ããFor capital gains purposes, the imputed interest you earned between theãtime you acquired and the time you sold or redeemed the bond is added toãyour cost basis.  If you held the bond continually from the time it wasãissued until it matured, you will generally not have any gain or loss.ããZeroes tend to be more susceptible to prevailing interest rates, andãsome people buy zeroes hoping to get capital gains when interest ratesãdrop. There is high leverage.   If rates go up, they can always hold them.ããZeroes sometimes pay a better rate than coupon bonds (whether registeredãor not).  When a zero is bought for a tax deferred account, such as anãIRA, the imputed interest does not have to be reported as income, soãthe paperwork is lessened.ããBoth corporate and municipalities issue zeroes, and imputed interest onãmunicipals is tax-free in the same way coupon interest on municipals is. ã(The zero could be subject to AMT).ããSome marketeers have created their own zeroes, starting with couponãbonds, by clipping all the coupons and selling the bond less the couponsãas one product -- very much like a zero -- and the coupons as anotherãproduct. Even US Treasuries can be split into two products to form aãzero US Treasury.ããThere are other products which are combinations of zeroes and regularãbonds.  For example, a bond may be a zero for the first five years ofãits life, and pay a stated interest rate thereafter.  It will be treatedãas an OID instrument while it pays no interest.ãã(Note:  The "no interest" must be part of the original offering; if aãcumulative instrument intends to pay interest but defaults, that does notãmake this a zero and does not cause imputed interest to be calculated.)ããLike other bonds, some zeroes might be callable by the issuer (they areãredeemed) prior to maturity, at a stated price.ãã-----------------------------------------------------------------------------ããCompilation Copyright (c) 1993 by Christopher Lott, lott@informatik.uni-kl.deã-- ãChristopher Lott    lott@informatik.uni-kl.de   +49 (631) 205-3334, -3331 FaxãPost: FB Informatik - Bau 57, Universitaet KL, W-6750 Kaiserslautern, Germanyã