Usenet 1993 July/InfoMagic USENET CD-ROM July 1993.ISO/answers/investment-faq/general/part3

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From: [e-mail] (Christopher Lott)
Subject: misc.invest FAQ on general investment topics (part 3 of 3)
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Summary: Answers to frequently asked questions about investments.
         Should be read by anyone who wishes to post to misc.invest.
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Archive-name: investment-faq/general/part3
Version: $Id: faq-p3,v 1.6 1993/05/21 09:56:38 lott Exp lott $
Compiler: Christopher Lott, [e-mail]

This is the general FAQ for misc.invest, part 3 of 3.

-----------------------------------------------------------------------------

Subject: Shorting Stocks
From: [e-mail]

Shorting means to sell something you don't own.

If I do not own shares of IBM stock but I ask my broker to sell short
100 shares of IBM I have committed shorting.  In broker's lingo, I
have established a short position in IBM of 100 shares.  Or, to really
confuse the language, I hold 100 shares of IBM short.

Why would you want to short?

Because you believe the price of that stock will go down, and you can
soon buy it back at a lower price than you sold it at.  When you buy
back your short position, you "close your short position."

The broker will effectively borrow those shares from another client's
account or from the broker's own account, and effectively lend you
the shares to sell short.  This is all done with mirrors; no stock
certificates are issued, no paper changes hands, no lender is identified
by name.

My account will be credited with the sales  price of 100 shares of IBM
less broker's commission.  But the broker has actually lent me the stock
to sell; no way is he going to pay interest on the funds from the short
sale. (Exception:  Really big spenders sometimes negotiate a full or
partial payment of interest on short sales funds provided sufficient
collateral exists in the account and the broker doesn't want to lose
the client.  If you're not a really big spender, don't expect to receive
any interest on the funds obtained from the short sale.)  Also expect
the broker to make you put up additional collateral.  Why?

Well, what happens if the stock price goes way up?  You will have to
assure the broker that if he needs to return the shares whence he got
them (see "mirrors" above) you will be able to purchase them and "close
your short position."  If the price has doubled, you will have to spend
twice as much as you received. So your broker will insist you have
enough collateral in your account which can be sold if needed to close
your short position.  More lingo: Having sufficient collateral in your
account that the broker can glom onto at will, means you have "cover"
for your short position. As the price goes up you must provide more cover.

Since you borrowed these shares, if dividends are declared, you will be
responsible for paying those dividends to the fictitious person from
whom you borrowed.  Too bad.

Even if you hold you short position for over a year, your capital
gains are short term.

A short squeeze can result when the price of the stock goes up.  When
the people who have gone short buy the stock to cover their previous
short-sales, this can cause the price to rise further.  It's a death
spiral - as the price goes higher, more shorts feel driven to cover
themselves, and so on.

You can short other securities besides stock.  For example, every time
I write (sell) an option I don't already own long, I am establishing a
short position in that option. The collateral position I must hold in
my account generally tracks the price of the underlying stock and not
the price of the option itself.  So if I write a naked call option on
IBM November 70s and receive a mere $100 after commissions, I may be
asked to put up collateral in my account of $3,500 or more!  And if
in November IBM has regained ground and is at $90 [ I should be so
lucky ], I would be forced to buy back (close my short position in
the call option) at a cost of about $2000, for a big loss.

Selling short is seductively simple.  Brokers get commissions by
showing you how easy it is to generate short term funds for your
account, but you really can't do much with them.  My personal advice
is if you are strongly convinced a stock will be going down, buy the
out-of-the-money put instead, if such a put is available.

A put's value increases as the stock price falls (but decreases sort
of linearly over time) and is strongly leveraged, so a small fall in
price of the stock translates to a large increase in value of the put.

Let's return to our IBM, market price of 66 (yuck.) Let's say I strongly
believe that IBM will fall to, oh,  58 by mid-November.  I could short
IBM stock at 66, sell it at 58 in mid-November if I'm right, and make
about net $660.  If instead it goes to 70, and I have to sell then I
lose net $500 or so.  That's a 10% gain or an 8% loss or so.

Now, I could buy the IBM November 65 put for maybe net $200.  If it
goes down to 58 in mid November, I sell (close my position) for about
$600, for a 300% gain.  If it doesn't go below 65, I lose my entire
200 investment. But if you strongly believe IBM will go way way down,
you should shoot for the 300% gain with the put and not the 10% gain
by shorting the stock itself.  Depends on how convinced you are.

Having said this, I add a strong caution:  Puts are very risky, and
depend very much on odd market behavior beyond your control, and you
can easily lose your entire purchase price fast.  If you short options,
you can lose even more than your purchase price!

One more word of advice.  Start simply.  If you never bought stock
start by buying some stock.  When you feel like you sort of understand
what you are doing, when you have followed several stocks in the
financial section of the paper and watched what happens over the course
of a few months, when you have read a bit more and perhaps seriously
tracked some important financials of several companies, you might --
might -- want to expand your investing choices beyond buying stock.
If you want to get into options (see FAQ on options) start with writing
covered calls.  I would place selling stock short or writing or buying
other options lower on the list -- later in time.

-----------------------------------------------------------------------------

Subject: Stock Index Types
From: [e-mail]

There are three major classes of indices in use today in the US.  They are:

A - equally weighted price index
    (an example is the Dow Jones Industrial Average)
B - market-capitalization-weighted index
        (an example is the S&P Industrial Average)
C - equally-weighted returns index
        (the only one of its kind is the Value-Line index)

Of these, A and B are widely used.  All my profs in the business school
claim that C is very weird and don't emphasize it too much.

+ Type A index:  As the name suggests, the index is calculated by taking the
average of the prices of a set of companies:

            Index =  Sum(Prices of N companies) / divisor

In this calculation, two questions crop up:

1. What is "N"?  The DJIA takes the 30 large "blue-chip" companies.  Why 30?
I think it's more a historical hangover than any thing else.  One rationale
for 30 might be that a large fraction of market capitalization is often
clustered in largest 50 companies or so.

Does the set of N companies change across time?  If so, how often is the
list updated (wrt companies)?  I suspect these decisions are quite
judgemental and hence not readily replicable.

If the DJIA only has 30 companies, how do we select these 30?  Why should
they have equal weights?  These are real criticisms of the DJIA type index.

2. The divisor is not always equal to N for N companies.  What happens to
the index when there is a stock issue by one of the companies in the set?
The price drops, but the number of shares have increased to leave the market
capitalization of the shares the same. Since the index does not take the
latter into account, it has to compensate for the drop in price by tweaking
the divisor.  For examples on this, look at pg. 61 of Bodie, Kane, & Marcus,
_Investments_ (henceforth, BKM).

Historically, this index format was computationally convenient.  It doesn't
have a very sound economic basis to justify it's existence today.  The DJIA
is widely cited on the evening news, but not used by real finance folks.

I have an intuition that the DJIA type index will actually be BAD if the
number of companies is very large.  If it's to make any sense at all, it
should be very few "brilliantly" chosen companies.

+ Type B index:  In this index, each of the N company's price is weighted by
the market capitalization of the company.

        Sum (Company market capitalization * Price) over N companies
Index = ------------------------------------------------------------
        Market capitalisation for these N companies

Here you do not take into account the dividend data, so effectively you're
tracking the short-run capital gains of the market.

Practical questions regarding this index:

1. What is "N"?  I would use the largest N possible to get as close to the
"full" market as possible.   BTW in the US there are companies who make a
living on only calculating extremely complete value-weighted indexes for
the NYSE and foreign markets.  CMIE should sell a very-complete value-weighted
index to some such folks.

Why does S&P use 500? Once again, I'm guessing that it's for historical
reasons when computation over 20,000 companies every day was difficult and
because of the concentration of market capitalization in the largest lot
of companies.  Today, computation over 20k companies for a Sun workstation
is no problem, so the S&P idea is obsolete.

2.  How to deal with companies entering and exiting the index?  If we're
doing an index containing "every single company possible" then the answer
to this question is easy -- each time a company enters or exits we recalculate
all weights.  But if we're a value-weighted index like the S&P500 (where there
are only 500 companies) it's a problem.  Recently Wang went bankrupt and S&P
decided to replace them by Sun -- how do you justify such choices?

The value weighted index is superior to the DJIA type index for deep reasons.
Anyone doing modern finance will not use the DJIA type index.  A glimmer of
the reasoning for this is as follows:  If I held a portfolio with equal number
of shares of each of the 30 DJIA companies then the DJIA index would accurately
reflect my capital gains.  BUT we know that it is possible to find a portfolio
which has the same returns as the DJIA portfolio but at a smaller risk.
(This is a mathematical fact).

Thus, by definition, nobody is ever going to own a DJIA portfolio.  In
contrast, there is a extremely good interpretation for the value weighted
portfolio -- it's the highest returns you can get for it's level of risk.
Thus you would have good reason for owning a value-weighted market portfolio,
thus justifying it's index.

Yet another intuition about the value-weighted index -- a smart investor is
not going to ever buy equal number of shares of a given set of companies,
which is what index type a. tracks.  If you take into consideration that the
price movements of companies are correlated with others, you are going to
hedge your returns by buying different proportions of company shares.  This
is in effect what the index type B does and this is why it is a smarter index
to follow.

One very neat property of this kind of index is that it is readily applied to
industry indices.  Thus you can simply apply the above formula to all machine
tool companies, and you get a machine tool index.  This industry-index is
conceptually sound, with excellent interpretations.  Thus on a day when the
market index goes up 6%, if machine tools goes up 10%, you know the market
found some good news on machine tools.

+ Type C index:  Here the index is the average of the returns of a certain
set of companies. Value Line publishes two versions of it:

  * the arithmetic index :  (VLAI/N) =  1  * Sum(N returns)
  * the geometric index :  VLGI  = {Product(1 + return) over N}^{1/n},
    which is just the geometric mean of the N returns.

Notice that these indices imply that the dollar value on each company has
to be the same.  Discussed further in BKM, pg 66.

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Subject: Stock Index - The Dow
From: [e-mail], [e-mail]

The Dow Jones Industrial Average is computed from the following stocks:

Ticker  Name
------  ----
AA    Alcoa
ALD    Allied Signal
AXP    American Express
BA    Boeing
BS    Bethlehem Steel
CAT    Caterpillar
CHV    Chevron
DD    Du Pont
DIS    Disney
EK    Eastman Kodak
GE    General Electric
GM    General Motors
GT    Goodyear Tire
IBM    International Business Machines
IP    International Paper
JPM    JP Morgan Bank
KO    Coca Cola
MCD    McDonalds
MMM    Minnesota Mining and Manufacturing (3M)
MO    Philip Morris
MRK    Merck
PG    Procter and Gamble
S    Sears, Roebuck
T    AT&T
TX    Texaco
UK    Union Carbide
UTX    United Technologies
WX    Westinghouse
XON    Exxon
Z    Woolworth

The Dow Jones averages are computed by summing the prices of the stocks
in the average and then dividing by a constant called the "divisor".  The
divisor for the industrial average is adjusted periodically to reflect
splits in the stocks making up the average; the divisor was originally 30
but has been reduced over the years to 0.462685 (as of 92-10-31).  The
current value of the divisor can be found in the Wall Street Journal
and Barron's.

-----------------------------------------------------------------------------

Subject: Stock Indexes - Others
From: [e-mail], [e-mail], [e-mail],
    [e-mail]

Standard & Poor's 500:    500 of the biggest US corporations.
    This is a very popular institutional index, and recently becoming
    more popular among individuals.  Most often used measure of broad
    stock market results.
Wilshire 5000
    Includes most publicly traded shares.  Considered by some a better
    measure of market as a whole, becuase it includes smaller companies.
Wilshire 4500
    These are all firms *except* the S&P 500.
Value Line Composite
    See Martin Zweig's Winning on Wall Street for a good description.
    It is a price-weighted index as opposed to a capitalization index.
    Zweig (and others) think this gives better tracking of investment
    results, since it is not over-weighted in IBM, for example, and
    most individuals are likewise not weighted by market cap in their
    portfolios (unless they buy index funds).
Nikkei Dow (Japan)
    I believe "Dow" is a misnomer.  It is called the Nikkei index (or
    the Nikkei-xx, where xx is the number of shares in it, which I
    can't quote to you out of my head).  "Dow" comes from Dow Jones &
    Company, which publishes DJIA numbers.  Nikkei is considered the
    "Japanese Dow," in that it is the most popular and commonly quoted
    Japanese market index, but I don't think Dow Jones owns it.
S&P 100 (and OEX)
    The S&P 100 is an index of 100 stocks.  The "OEX" is the option on
    this index, one of the most heavily traded options around.
S&P MidCap 400
    Medium capitalization firms.
CAC-40 (France)
    This is 40 stocks on the Paris Stock Exchange formed into an
    index.  The futures contract on this index is probably the most
    heavily traded futures contract in the world.
Europe, Australia, and Far-East (EAFE)
    Compiled by Morgan Stanley.
Russell 1000
Russell 2000
    A small cap stock index.
Russell 3000
NYSE Composite              [options on index]
Gold & Silver Index         [options on index]
AMEX Composite
NASDAQ Composite
Topix (Japan)
DAX (Germany)
FTSE 100 (Great Britain)
Major Market Index (MMI)

 [ Compiler's note: a few explanations are still missing.
   Can anyone supply a few? ]

-----------------------------------------------------------------------------

Subject: Stock Splits
From: [e-mail], [e-mail], [e-mail]

Ordinary splits occur when the company distributes more stock to holders
of existing stock.  A stock split, say 2-for-1, is when a company simply
issues one additional share for every one outstanding.  After the split,
there will be two shares for every one pre-split share. (So it is called
a "2-for-1 split.")  If the stock was at $50 per share, after the split,
each share is worth $25, because the company's net assets didn't increase,
only the number of outstanding shares.

Sometimes an ordinary split is referred to as a percent.  A 2:1 split is
a 100% stock split (or 100% stock dividend).   A 50% split would be a 3:2
split (or 50% stock dividend).  You will get 1 more share of stock for
every 2 shares you owned.

Reverse splits occur when a company wants to raise the price of their
stock, so it no longer looks like a "penny stock" but looks more like a
self-respecting stock.  Or they might want to conduct a massive reverse
split to eliminate small holders.  If a $1 stock is split 1:10 the new
shares will be worth $10.  Holders will have to trade in their 10 Old
Shares to receive 1 New Share.

Often a split is announced long before the effective date of the split,
along with the "record date."   Shareholders of record on the record
date will receive the split shares on the effective date (distribution
date). Sometimes the split stock begins trading as "when issued" on or
about the record date.   The newspaper listing will show both the pre-
split stock as well as the when-issued split stock with the suffix "wi."
(Stock dividends of 10% or less will generally not trade wi.)

Theoretically a stock split is a non-event.  The fraction of the company
each of your shares represents is reduced, but you are given enough
shares so that your total fraction of the company owned remains the same.
On the day of the split, the value of the stock is also adjusted so that
the total capitalization of the company remains the same.

In practice, an ordinary split often drives the new price per share up,
as more of the public is attracted by the lower price.  A company might
split when it feels its per-share price has risen beyond what an individual
investor is willing to pay, particularly since they are usually bought
and sold in 100's.  They may wish to attract individuals to stabilize the
price, as institutional investors buy and sell more often than individuals.

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Subject: Technical Analysis
From: [e-mail]

The following material introduces technical analysis and is intended to
be educational.  If you are intrigued, do your own reading.  The answers
are brief and cannot possibly do justice to the topics.  The references
provide a substantial amount of information.  The contributions of the
reviewers is appreciated.

First, the references:

  1. Technical Analysis of the Futures Markets, by John J. Murphy.
     New York Institute of Finance.

  2. Technical Analysis Explained, by Martin Pring.
     McGraw Hill.

  3. Stan Weinstein's Secrets for Profiting in Bull and Bear Markets, by
     Stan Weinstein.  Dow Jones-Irwin.

Next, the discussion:

1.  What is technical analysis?

Technical analysis attempts to use *past* stock price and volume
information to predict *future* price movements.  Note the emphasis.
It also attempts to time the markets.

2.  Does it have any chance of working, or is it just like reading tea leaves?

There are a couple of plausibility arguments.  One is that the chart
patterns represent the past behavior of the pool of investors.  Since
that pool doesn't change rapidly, one might expect to see similar chart
patterns in the future.  Another argument is that the chart patterns
display the action inherent in an auction market.  Since not everyone
reacts to information instantly, the chart can provide some predictive
value.  A third argument is that the chart patterns appear over and over
again.  Even if I don't know why they happen, I shouldn't trade or invest
against them.  A fourth argument is that investors swing from overly
optimistic to excessively pessimistic and back again.  Technical analysis
can provide some estimates of this situation.

A contrary view is that it is just coincidence and there is little, if
any, causality present.  Or that even if there is some sort of causality
process going on, it isn't strong enough to trade off of.

A very contrary view:  The past and future performance of a stock may
be correlated, but that does not mean or imply causality. So, relying
on technical analysis to buy/sell a stock is like relying on the position
of the stars in the atmosphere or the phases of the moon to decide whether
to buy or sell.

3.  I am a fundamentalist.  Should I know anything about technical analysis?

Perhaps.  You should consider delaying purchase of stocks whose chart
patterns look bad, no matter how good the fundamentals.  The market is
telling you something is still awry.  Another argument is that the
technicians won't be buying and they will not be helping the stock move
up.  On the other hand (as the economists say), it makes it easy for
you to buy in front of them.  And, of course, you can ignore technical
analysis viewpoints and rely solely on fundamentals.

4.  What are moving averages?

Observe that a period can be a day, a week, a month, or as little as 1
minute.  Stock and mutual fund charts normally are daily postings or
weekly postings.  An N period (simple) moving average is computed by
summing the last N data points and dividing by N.  Moving averages are
normally simple unless otherwise specified.

An exponential moving average is computed slightly differently.  Let
X[i] be a series of data points.  Then the Exponential Moving Average
(EMA) is computed by

    EMA[i] = (1-sm)*EMA[i-1] + sm*(X[i]-EMA[i-1])

    where sm = 2/(N+1), and EMA[1] = X[1].

"sm" is the smoothing constant for an N period EMA.  Note that the EMA
provides more weighting to the recent data, less weighting to the old data.

4a.  What is Stage Analysis?

Stan Weinstein [Ref 3] developed a theory (based on his observations)
that stocks usually go through four stages in order.  Stage 1 is a time
period where the stock fluctuates in a relatively narrow range.  Little
or nothing seems to be happening and the stock price will wander back
and forth across the 200 day moving average.  This period is generally
called "base building".  Stage 2 is an advancing stage characterized by
the stock rising above the 200 and 50 day moving averages.  The stock
may drop below the 50 day average and still be considered in Stage 2.
Fundamentally, Stage 2 is triggered by a perception of improved conditions
with the company.  Stage 3 is a "peaking out" of the stock price action.
Typically the price will begin to cross the 200 day moving average, and
the average may begin to round over on the chart.  This is the time to
take profits.  Finally, the Stage 4 decline begins.  The stock price drops
below the 50 and 200 day moving averages, and continues down until a new
Stage 1 begins.  Take the pledge right now:  hold up your right hand and
say "I will never purchase a stock in Stage 4".  One could have avoided
the late 92-93 debacle in IBM by standing aside as it worked its way
through a Stage 4 decline.

5.  What is a whipsaw?

This is where you purchase based on a moving average crossing (or some
other signal) and then the price moves in the other direction giving a
sell signal shortly thereafter, frequently with a loss.  Whipsaws can
substantially increase your commissions for stocks and excessive mutual
fund switching may be prohibited by the fund manager.

5a.  Why a 200 day moving average as opposed to 190 or 210?

Moving averages are chosen as a compromise between being too late to
catch much move after a change in trend, and getting whipsawed.  The
shorter the moving average, the more fluctuations it has.  There are
considerations regarding cyclic stock patterns and which of those are
filtered out by the moving average filter.  A discussion of filters is
far beyond the scope of this FAQ.  See Hurst's book on stock
transactions for some discussion.

6.  Explain support and resistance levels, and how to use them.

Suppose a stock drops to a price, say 35, and rebounds.  And that this
happens a few more times.  Then 35 is considered a "support" level.
The concept is that there are buyers waiting to buy at that price.
Imagine someone who had planned to purchase and his broker talked him
out of it.  After seeing the price rise, he swears he's not going to
let the stock get away from him again.  Similarly, an advance to a
price, say 45, which is repeatedly followed by a pullback to lower
prices because a "resistance" level.  The notion is that there are
buyers who purchased at 45 and have watched a deterioration into a loss
position.  They are now waiting to get out even.  Or there are sellers
who consider 45 overvalued and want to take their profits.

One strategy is to attempt to purchase near support and take profits near
resistance.  Another is to wait for an "upside breakout" where the stock
penetrates a previous resistance level.  Purchase on anticipation of a
further move up.  [See references for more details.]

The support level (and subsequent support levels after rises) can provide
information for use in setting stops.  See the "About Stocks" section of
the FAQ for more details.

6a.  What would cause these levels to be penetrated?

Abrupt changes in a company's prospects will be reacted to in the stock
market almost immediately.  If the news is extreme enough, the reaction
will appear as a jump or gap in prices.  More modest changes will
result, in general, in more modest changes in price.

6b.  What is an "upside breakout"?

If a stock has traded in a narrow range for some time (i.e. built a
base) and then advances above the resistance level, this is said to be an
"upside breakout".  Breakouts are suspect if they do not occur on high
volume (compared to average daily volume).  Some traders use a "buy stop"
which calls for purchase when a stock rises above a certain price.

6c.  Is there a "downside breakout"?

Not by that name -- the opposite of upside breakout is called
"penetration of support" or "breakdown".  Corresponding to "buy stops,"
a trader can set a "sell stop" to exit a position on breakdown.

7.  Explain breadth measurements and how to use them.

A breadth measurement is something taken across a market.  For example,
looking at the number of advancing stocks compared to declining stocks
on the NYSE is a breadth measurement.  Or looking at the number of stocks
above their 200 day moving average.  Or looking at the percentage of stocks
in Stage 1 and 2 configurations.  In general, a technically healthy market
should see a lot of stocks advancing, not just the Dow 30.  If the breadth
measurements are poor in an advancing sense and the market has been
advancing for some time, then this can indicate a market turning point
(assuming that the advancing breadth is declining) and you should consider
taking profits, not entering new long positions, and/or tightening stops.
(See the divergence discussion.)

7a.  What is a divergence?  What is the significance?

In general, a divergence is said to occur when two readings are not
moving generally together when they would be expected to.  For example,
if the DJIA moves up a lot but the S&P 500 moves very little or even
declines, a divergence is created.  Divergences can signify turning
points in the market.  At a major market low, the "blue chip" stocks
tend to move up first as investors becoming willing to purchase quality.
Hence the S&P 500 may be advancing while the NYSE composite is moving
very little.  Divergences, like everything else, are not 100 per cent
reliable.  But they do provide yellow or red alerts.  And the bigger the
divergence, the stronger the signal.  Divergence and breadth are related
concepts.  (See the breadth discussion.)

8.  How much are charting services and what ones are available?

They aren't cheap.  Daily Graphs (weekly charts with daily prices) is
$465 for the NYSE edition, $432 for the AMEX/OTC edition.  Somewhat
cheaper for biweekly or monthly.  Mansfield charts are weekly with weekly
prices.  Mansfield shows about 2.5 years of action, Daily Graphs shows 1
year or 6 months for the less active stocks.

S&P Trendline Chart Guide is about $145 per year.  It provides over 4,000
charts.  These charts show one year of weekly price/volume data and do not
provide nearly the detail that Daily Graphs do.  You get what you pay for.

There are other charting services available.  These are merely representative.

9.  Can I get charts with a PC program?

Yes.  There are many programs available for various prices.  Daily quotes
run about $35 or so a month from Dial Data, for example.  Or you can
manually enter the data from the newspaper.

10.  What would a PC program do that a charting service doesn't?

Programs provide a wide range of technical analysis computations in
addition to moving averages.  RSI, MACD, Stochastics, etc., are routinely
included.  See Murphy's book [Ref 1] for definitions.  Frequently you can
change the length of the moving averages or other parameters.  As another
example, AIQ StockExpert provides an "expert rating" suggesting purchase
or short depending on the rating.  Intermediate values of the rating are
less conclusive.

11.  What does a charting service do that PC doesn't?

Charts generally contain a fair amount of fundamental information such
as sales, dividends, prior growth rates, institutional ownership.

11a.  Can I draw my own charts?

Of course.  For example, if you only want to follow a handful of mutual
funds of stocks, charting on a weekly basis is easy enough.  EMAs are
also easy enough to compute, but will take a while to overcome the lack
of a suitable starting value.

12.  What about wedges, exhaustion gaps, breakaway gaps, coils, saucer
     bottoms, and all those other weird formations?

The answer is beyond the scope of this FAQ article.  Such patterns can be
seen, particularly if you have a good imagination.  Many believe they are
not reliable.  There is some discussion in Murphy [Ref 1].

13.  Are then any aspects of technical analysis that don't seem quite
     so much like hokum or tea leaf reading?

RSI (Relative Strength Indicator) is based on the observation that a
stock which is advancing will tend to close nearer to the high of the day
than the low.  The reverse is true for declining stocks.  RSI is a formula
which attempts to provide a number which will indicate where you are in
the declining/advancing stage.

14.  Can I develop my own technical indicators?

Yes.  The problem is validating them via some sort of backtesting procedure.
This requires data and work.  One suggestion is to split the data into
two time periods.  Develop your indicator on one half and then see if it
still works on the other half.  If you aren't careful, you end up
"curve fitting" your system to the data.

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Subject: Ticker Tape Terminology
From: [e-mail], [e-mail]

Ticker tape says:        Translation (but see below):
        NIKE68 1/2            100 shares sold at 68 1/2
     10sNIKE68 1/2           1000 shares sold at   "
 10.000sNIKE68 1/2          10000 shares sold at   "

The extra zeroes for the big trades are to make them stand out.  All
trades on CNN and CNBC are delayed by 15 minutes.  CNBC once advertised
a "ticker guide pamphlet, free for the asking", back when they merged
with FNN.  It also has explanations for the futures they show.

However, the first translation is not necessarily correct.  CNBC has
a dynamic maximum size for transactions that are displayed this way.
Depending on how busy things are at any particular time, the maximum
varies from 100 to 5000 shares.  You can figure out the current maximum
by watching carefully for about five minutes.  If the smallest number
of shares you see in the second format is "10s" for any traded security,
then the first form can mean anything from 100 to 900 shares.  If the
smallest you see is "50s" (which is pretty common), the first form
means anything between 100 and 4900 shares.

Note that at busy times, a broker's ticker drops the volume figure and
then everything but the last dollar digit (e.g. on a busy day, a trade
of 25,000 IBM at 68 3/4 shows only as "IBM 8 3/4" on a broker's ticker).
That never happens on CNBC, so I don't know how they can keep up with all
trades without "forgetting" a few.

-----------------------------------------------------------------------------

Subject: Treasury Debt Instruments
From: [e-mail]

The US Treasury Department periodically borrows money and issues
IOUs in the form of bills, notes, or bonds ("Treasuries").  The
differences are in their maturities and denominations:

                    Bill             Note              Bond
  Maturity       up to 1 year     1 - 10 years     10 - 30/40 years
  Denomination     $5,000           $1,000            $1,000
                (10,000 minimum)

Treasuries are auctioned.  Short term T-bills are auctioned every Monday,
and longer term bills, notes, and bonds are auctioned at other intervals.

T-Notes and Bonds pay a stated interest rate semi-annually, and are
redeemed at face value at maturity.  Exception: Some 30 year and
longer bonds may be called (redeemed) at 25 years.

T-bills work a bit differently.  They are sold on a "discounted
basis."  This means you pay, say, $9,700 for a 1-year T-bill.  At
maturity the Treasury will pay you (via electronic transfer to your
designated bank checking account) $10,000.  The $300 discount is the
"interest."  In this example, you receive a return of $300 on a $9,700
investment, which is a simple rate of slightly more than 3%.

Treasuries can be bought through a bank or broker, but you will
usually have to pay a fee or commission to do this.  They can also
be bought with no fee using the Treasury Direct program, which is
described elsewhere in the FAQ.

In practice, the first T-bill purchase requires you to send a
certified or cashiers check for the full face value, and within a
week or so, after the auction sets the interest rate, the Treasury
will return the discount ($300 in the example above) to your checking
account.  For some reason, you can purchase notes and bonds with a
personal check.

Treasuries are negotiable.  If you own Treasuries you can sell them
at any time and there is a ready market.  The sale price depends on
market interest rates.  Since they are fully negotiable, you may also
pledge them as collateral for loans.

Treasury bills, notes, and bonds are the standard for safety.  By
definition, everything is relative to Treasuries; there is no safer
investment in the U.S. They are backed by the "Full Faith and Credit"
of the United States.

Interest on Treasuries is taxable by the Federal Government in the
year paid.  States and local municipalities do not tax Treasury
interest income.  T-bill interest is recognized at maturity, so they
offer a way to move income from one year to the next.

The US Treasury does not issue Zero Coupon Bonds (see FAQ article).
However, a number of enterprising companies and funds purchase
Treasuries, "Strip off" the "coupon" (an anachronism from the days
when new bonds had coupons attached to them) and sell the coupons
for income and the non-coupon portion (TIGeRs or Strips) as zeroes.

Other US Debt obligations that may be worth considering are US Savings
Bonds (Series E/EE and H/HH) and bonds from various US Government
agencies, including the ones that are known by cutesy names like
Freddie Mac, as well as the Mae sisters, Fannie, Ginnie and Sallie.

-----------------------------------------------------------------------------

Subject: Treasury Direct
From: [e-mail], [e-mail]

You can buy Treasury Instruments directly from the US Treasury.
Contact any Federal Reserve Bank (for example, New York: 33 Liberty
Street, New York NY 10045) and ask for forms to participate in the
Treasury Direct program.  The minimum for a Treasury Note (2 years and
up) is only $5K and in some instances (I believe 5 year notes) $1K.
There are no fees and you may elect to have interest payments made
directly to your account.  You even may pay with a personal check, no
need for a cashier's or certified check as Treasury Bills (1 year and
under) required.  In the Treasury Direct program, you can ask that you
roll over the matured Treasury towards the purchase of a new one.

AAII Journal had an article on this a couple of years ago.  Like they
said, the government service is great, they just do not advertise it well.

-----------------------------------------------------------------------------

Subject: Uniform Gifts to Minors Act (UGMA)
From: [e-mail], [e-mail]

The Uniform Gifts to Minors Act allows you to give $10,000 per year
to any minor, tax free.  You must appoint a custodian.

Some accountants advise that one person should make the gift and
that a different person should be the custoidian, but I have never
seen any IRS publication to justify this, nor any tax case ruling
which makes this a problem.  I suspect some people are just being
conservative.

To give such a gift, go to your friendly neighborhood stockbroker,
bank, mutual fund manager, or (close your eyes now: S&L), etc. and
say that you wish to open a Uniform Gifts (in some states "Transfers")
to Minors Act account.

You register it as:
  [ Name of Custodian ] as custodian for [ Name of Minor ] under the
  Uniform Gifts/Transfers to Minors Act - [ Name of State of Minor's
  residence ]

You use the minor's social security number as the taxpayer ID for this
account.  When you fill out the W-9 form for this account, it will
show this form.  The custodian should certify the W-9 form.

The money now belongs to the minor and the custodian has a legal
fiduciary responsibility to handle the money in a prudent manner for
the benefit of the minor.

So you can buy common stocks but cannot write naked options.  You
cannot "invest" the money on the horses, planning to donate the
winnings to the minor.  And when the minor reaches age of majority -
usually 18 - the minor can claim all of the funds even if that's
against your wishes.  You cannot place any conditions on those funds
once the minor becomes an adult.

Until the minor reaches 14, the first $500 earned by the minor is
tax free, the next $500 is taxed at the minor's rate, and the rest
is taxed at the higher of the minor's or the parent's rate.  After
the minor reaches 14, all earnings over $500 are taxed at the
minor's rate.

Note that if you want to continue doing your childs taxes even after
they turn 18, there is no reason they need to know about their UGMA
account that you set up for them.  They certainly can't blow their
college fund on a Trans Am if they don't know about it.

Even if your child does his/her own taxes, you can still give them
gifts through a trust without them knowing about it until they are
more mature.  Call and ask Twentieth Century Investors for information
about their GiftTrust fund.  The fund is entirely composed of trusts
like this.  The trust pays its own taxes.

-----------------------------------------------------------------------------

Subject: Warrants
From: [e-mail]

There are many meanings to the word warrant.

The marshal can show up on your doorstep with a warrant for your arrest.

Many army helicopter pilots are warrant officers, who have received
a warrant from the president of the US to serve in the Army of the
United States.

The State of California ran out of money earlier this year and
issued things that looked a lot like checks, but had no promise to
pay behind them.  If I did that I could be arrested for writing a
bad check.  When the State of California did it, they called these
thingies "warrants" and got away with it.

And a warrant is also a financial instrument which was issued with
certain conditions.  The issuer of that warrant sets those conditions.
Sometimes the warrant and common or preferred convertible stock are
issued by a startup company bundled together as "units" and at some
later date the units will split into warrants and stock.  This is a
common financing method for some startup companies.  This is the
"warrant" most readers of the misc.invest newsgroup ask about.

As an example of a "condition," there may be an exchange privilege
which lets you exchange 1 warrant plus $25 in cash (or even no cash
at all) for 100 shares of common stock in the corporation, any time
after some fixed date and before some other designated date.
(And often the issuer can extend the "expiration date.")

So there are some similarities between warrants and call options for
common stock.

Both allow holders to exercise the warrant/option before an
expiration date, for a certain number of shares.  But the option is
issued by independent parties, such as a member of the Chicago Board
Options Exchange, while the warrant is issued and guaranteed by the
corporate issuer itself.  The lifetime of a warrant is often
measured in years, while the lifetime of a call option is months.

Sometimes the issuer will try to establish a market for the warrant,
and even try to register it with a listed exchange.  The price can
then be obtained from any broker.  Other times the warrant will be
privately held, or not registered with an exchange, and the price
is less obvious, as is true with non-listed stocks.

-----------------------------------------------------------------------------

Subject: Wash Sale Rule (from U.S. IRS)
From: [e-mail]

From IRS publication 550, "Investment Income and Expenses" (1990).
Here is the introductory paragraph from p.37:

    Wash Sales
    You cannot deduct losses from wash sales or trades of stock or
    securities.  However, the gain from these sales is taxable.

    A wash sale occurs when you sell stock or securities at a loss and
    within 30 days before or after the sale you buy or acquire in a
    fully taxable trade, or acquire a contract or option to buy,
    substantially identical stock or securities.  If you sell stock and
    your spouse or a corporation you control buys substantially
    identical stock, you also have a wash sale.  You add the disallowed
    loss to the basis of the new stock or security.

It goes on explaining all those terms (substantially identical, stock
or security, ...).  It runs on several pages, too much to type in.  You
should definitely call IRS for the most updated ones for detail.  Phone
number:  800-TAX-FORM (800-829-3676).

-----------------------------------------------------------------------------

Subject: Zero-Coupon Bonds
From: [e-mail]

Not too many years ago every bond had coupons attached to it.  Every
so often, usually every 6 months, bond owners would take a scissors
to the bond, clip out the coupon, and present the coupon to the bond
issuer or to a bank for payment.  Those were "bearer bonds" meaning
the bearer (the person who had physical possession of the bond) owned
it.  Today, many bonds are issued as "registered" which means even if
you get to touch the actual bond at all, it will be registered in your
name and interest will be mailed to you every 6 months. It is not too
common to see such coupons. Registered bonds will not generally have
coupons, but may still pay interest each year.  It's sort of like the
issuer is clipping the coupons for you and mailing you a check.  But
if they pay interest periodically, they are still called Coupon Bonds,
just as if the coupons were attached.

When the bond matures, the issuer redeems the bond and pays you the
face amount.   You may have paid $1000 for the bond 20 years ago and
you have received interest every 6 months for the last 20 years, and
you now redeem the matured bond for $1000.

A Zero-coupon bond has no coupons and there is no interest paid.

But at maturity, the issuer promises to redeem the bond at face value.
Obviously, the original cost of a $1000 bond is much less than $1000.
The actual price depends on: a) the holding period -- the number of
years to maturity, b) the prevailing interest rates, and c) the risk
involved (with the bond issuer).

Taxes:  Even though the bond holder does not receive any interest while
holding zeroes, in the US the IRS requires that you "impute" an annual
interest income and report this income each year.  Usually, the issuer
will send you a Form 1099-OID (Original Issue Discount) which lists the
imputed interest and which should be reported like any other interest
you receive.  There is also an IRS publication covering imputed interest
on Original Issue Discount instruments.

For capital gains purposes, the imputed interest you earned between the
time you acquired and the time you sold or redeemed the bond is added to
your cost basis.  If you held the bond continually from the time it was
issued until it matured, you will generally not have any gain or loss.

Zeroes tend to be more susceptible to prevailing interest rates, and
some people buy zeroes hoping to get capital gains when interest rates
drop. There is high leverage.   If rates go up, they can always hold them.

Zeroes sometimes pay a better rate than coupon bonds (whether registered
or not).  When a zero is bought for a tax deferred account, such as an
IRA, the imputed interest does not have to be reported as income, so
the paperwork is lessened.

Both corporate and municipalities issue zeroes, and imputed interest on
municipals is tax-free in the same way coupon interest on municipals is.
(The zero could be subject to AMT).

Some marketeers have created their own zeroes, starting with coupon
bonds, by clipping all the coupons and selling the bond less the coupons
as one product -- very much like a zero -- and the coupons as another
product. Even US Treasuries can be split into two products to form a
zero US Treasury.

There are other products which are combinations of zeroes and regular
bonds.  For example, a bond may be a zero for the first five years of
its life, and pay a stated interest rate thereafter.  It will be treated
as an OID instrument while it pays no interest.

(Note:  The "no interest" must be part of the original offering; if a
cumulative instrument intends to pay interest but defaults, that does not
make this a zero and does not cause imputed interest to be calculated.)

Like other bonds, some zeroes might be callable by the issuer (they are
redeemed) prior to maturity, at a stated price.

-----------------------------------------------------------------------------

Compilation Copyright (c) 1993 by Christopher Lott, [e-mail]
--
"Christopher Lott   [e-mail]   [phone], -3331 Fax"
"Post: FB Informatik - Bau 57, Universitaet KL, 67653 Kaiserslautern, Germany"