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How to Cash in on Temporary Inefficiencies in the Equities Market

Contributed by Dr. Stephen Cooper

One of the debates that have been carried out in certain financial circles is the idea of "market efficiency" as it relates to the Stock Market. It goes something like this: Are the current prices of stocks and other instruments representative of realistic value? It is argued that by the time an individual investor considers the purchase of a particular stock, future expectations or concerns for example, all the reports (good or bad) have already been factored into the current share price.

If this "efficient market" theory is correct then it becomes challenging for a stock market speculator to find under priced stocks to buy. Viewed on the whole, the stock market certainly does display price efficiency over time. But there is an important dynamic involved that opens windows of opportunity if you know how to find them.

There are in fact brief periods of clear inefficiency in pricing that allow individuals chances to cash in. Because of over-reactions to news or world events, whether good or bad security prices may swing wildly and exceed reasonable short-term valuation changes. These over-exuberant buying or selling sprees pull prices into a condition of imbalance. The market will soon pull these inefficient prices back toward a more normal range and thus return them to relative efficiency.

One of the best ways that I know of to make consistent profits in the stock market is to capitalize on these brief departures from normal/efficient territory by opening positions that benefit from their return to efficiency. I'll show you what I mean.


Figure 1

Share prices of CAH dropped about $10 in one single day in July. This was an enormous percentage loss for CAH. When you see this kind of price change in one day the first question to be asked and answered is, "Why?" What could be so terrible as to cause this kind of carnage? Here is the interesting thing in all this. Quite often the bad news just isn't so bad. Here is an example of the overreaction I mentioned earlier. Market participants both professional and novice very frequently hear some bad or good news and then just go crazy! As price begins to move in reaction to the news a snowball effect can set in where the buying or selling frenzy pulls in more and more traders, exacerbating the situation. When this happens we have a prime opportunity to make some money. What if we were to buy some shares of CAH after we checked the news and decided that the bad news wasn't really so bad after all and that CAH is not going belly up tomorrow morning as the selling might indicate? On the next chart we'll add the price action that took place on the very next day after this incredible selling fit.


Figure 2

In spite of the incredible amount of selling and resultant price loss of CAH during one trading session the very next session showed a good amount of buying and price increase. Enough people had woken up the next morning and said to themselves, "Hey, it's not that bad. CAH is actually a bargain at this price. I think I'll buy me some!" And buy they did.

In fact the buying was not restricted to the day immediately after the plunge but continued on through a number of trading sessions as shown in the third chart, below.


Figure 3

There are a number of trading techniques that take advantage of temporary market pricing inefficiency. Until you become accustomed to using them it does take a bit of courage to go against the stampede of other investors and traders but if you do, the pay-offs can make it well worth the effort.

I suggest that you try this simple technique as explained here with paper trading first. Here is how to do it step by step. I call this "Slamming".

1. Find stocks that have been hammered by 15% or more in one day. You can find these listed at www.OnlineOption.com under RESOURCES/SLAMS.
2. Choose only strong, well known companies to do this with such as those listed on the NYSE.
3. On the day following the slam enter a long position provided that price is rebounding.
4. As with all trades, immediately place a trailing stop order after the position has been opened. With stocks use a dollar amount equal to 10% of the share price paid.
5. If the stock immediately rebounds after the slam day tighten your trailing stop or sell your shares for 10% or more gain.

Conclusion

Though the stock market retains general price efficiency over time there exist brief periods of distinct price inefficiency which can provide highly profitable opportunities for anyone willing to capitalize on them. By following a clear plan of action you can make excellent short-term gains with high probability trades. Open these positions with a small number of shares or contracts, especially if you are a beginning trader. Be sure to first paper trade to gain experience and confidence before committing your dollars to the markets.

About Dr. Stephen Cooper

Dr. Stephen Cooper began studying the stock market in 1985 while in private chiropractic practice. He started his trading experience in the commodities market. This practical experience was followed by stock and option trading. This interest became a passion and Dr. Cooper continued studying the markets and chart along with actively trading over the next 13 years while continuing practice. In 1998, Dr. Cooper retired from his chiropractic practice to become a full-time trader.

Because of his trading success over a number of years, Dr. Cooper was urged to share his trading philosophy and techniques with others. As a result, he authored The Online Option Trader in 1999. This work is designed to take the student from little or no knowledge of the stock market to proficiency in trading stocks and options.

The popular stock and option training site www.OnlineOption.com was created in late 1999 to augment resources available to his students. Now in its 11th year OnlineOption.com has become the research and interaction hub of a vibrant community of traders from around the world.

In 2001, following numerous requests for further training and help with stock charts, Windows to Wealth was completed. This 327 page book is dedicated to the understanding and practical application of chart principals and techniques.

Dr. Cooper is also a popular speaker, writer and trainer, conducting live trading workshops, online courses, personal one-on-one coaching, and ongoing market commentary.
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Support Tip
How do I create a custom symbol list for a particular index in the QuoteCenter application?

Contributed by MetaStock Support

For QuoteCenter Only

1. Go to your computer and access the Equis International folder.



2. Open the QuoteCenter application. Once in QuoteCenter, go to file and open "New Blank Workspace".



3. Double click anywhere in the whitespace.
4. Select "Marketwatch". There is a list of pre-populated Marketwatch lists on the right hand side under "Select SymbolList". If you want to create your own, select "OK".



5. Type in the symbol field. (This is the first column on the left.)
6. In the symbol field of a MarketWatch type in "..!CountryCode!Symbol". The country code must be in lower case and the symbol must be in all caps. After entering this, you must hold shift when you hit enter.
6a. Example: ..!us!SPX then SHIFT+ENTER.



7. This will populate the marketwatch with all of the symbols contained with the given index symbol.
8. Right click onto the back ground of the MarketWatch and select "SymbolList", then "Save As...". Give it a name and hit "OK".



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MetaStock Power User Tip
How to Create a Toolbar Shortcut

Contributed by Breakaway Training Solutions
Do you find yourself always applying the same template, layout, or chart? If so, you might want to consider creating a shortcut in order to save time.

At the bottom of your screen, you'll find the existing shortcut toolbar.



Open it up by right clicking anywhere in the toolbar, and select Custom Toolbar Properties. Here you'll be able to create your own shortcut.

Begin by clicking on the New button.



Select Browse.



If you installed your MetaStock program with the default settings, you'll find your templates, layouts and charts installed under C:\Program Files\Equis\MetaStock\Charts.



At the bottom of this window under the Files of Type selection, you'll be able to choose either Template, Layout, or Chart.



Once you make your selection, click the Open button and click the Next button.

Here you'll be able to select the icon that you want to associate with your shortcut.



Once you've made your selection, click Next, Finish and, finally, OK.

If you created a shortcut to a template, you'll first need to make sure that you have a chart loaded on your screen. You should then see your shortcut icon displayed, which you can use immediately to apply your template.

To see Kevin Nelson demonstrate this lesson, just watch this three minute video.

For more MetaStock training, make sure to visit us at www.learnmetastock.com or email us at admin@learnmetastock.com.

About Kevin Nelson

Kevin Nelson is the founder of Breakaway Training Solutions, Inc. He has spent the last 17 years becoming an expert on MetaStock software and a serious student of technical while working for MetaStock. Prior to joining MetaStock in 1993, Kevin was a stockbroker for a well-known NYSE firm. In his role as Sales Manager at MetaStock, Kevin interacted extensively with MetaStock customers via phone, webinars, and public appearances. His experiences while working at MetaStock have enabled him to gain a keen understanding of the needs of technical analysts worldwide. While with MetaStock, Mr. Nelson was a featured presenter for four years. During this time, he traveled the U.S. introducing the MetaStock program to thousands of people and teaching them how to use its many features. His easy-to-understand approach is considered by many to be the best in the industry.

©Breakaway Training Solutions, Inc. 2011