Zercatto-The Basics of the Stockmarket

An introduction to

The Stock Market How the stock market works and how you can profit from it

Prepared by Zercatto

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Table of Contents What is a stock, what is the stockmarket and why do investors buy stocks -4What are exchanges and indices, and how is the stockmarket structured? -6What is a bull and a bear market? - 10 How do investors analyse stocks? - 14 The stock itself - 18 Using a stop that makes sense - 30 Types of trading orders - 22 How to start investing - 37 -

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CHAPTER ONE What is a stock, what is the stockmarket and why do investors buy stocks?

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What is a stock, what is the stockmarket and why do investors buy stocks Stocks or shares represent the ownership of a small part of a company (the term “stock” is mainly used in the US and "share" is used in the UK).

When an investor buys a stock or a share, he or she becomes a shareholder in the company. For example, if a company's ownership is divided into 500 stocks and an investor buys 100 stocks, he would own 20 percent of the company.

This ownership does not necessarily imply that the investor has the right to vote or influence the decision making process. But a shareholder is entitled

to

receive

dividends,

if

these

are

distributed

by

the

company.

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What is the Stockmarket and why do Investors buy stocks? The financial market allows anyone to participate in the financial

achievements of companies that are publicly traded on the market.

Investors (people that who own shares or stocks in a company) earn money (or make a profit) when a company’s shares go up in value, so they buy them in the expectation that they will increase in value. When the stock goes up

in

value,

the

investor

profits

from

the

investment.

A profit can be achieved through the payment of dividends and/or by selling stocks to other investors. This profit is called a capital gain.

The downside occurs when the company incurs a loss and loses value; stock prices go down in value and investors sell the stocks at a lower price, hence, at a loss.

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CHAPTER TWO What are exchanges and indices, and how is the stockmarket structured?

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What are Exchanges and Indices, and how is the Stockmarket structured? A Family Episode Last week during my nephew’s 14th birthday dinner he asked me, since he knows Zercatto operates around the stock market, “what the hell is the Nasdaq?” He had already figured out what a stock is, but he was a bit confused about all the other fancy terms, such as Dow Jones, S&P, NY Stock Exchange and so forth, that are reported on in the news every day.

This made me think back to when I first started investing, as all of these terms also seemed like a foreign language to me. So, I figured that many beginner investors might also have the same issue when it comes to understanding these terms.

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Exchanges and Indices

Investors trade stocks through exchanges, which essentially create a market where people who want to buy stocks can meet others that are willing to sell stocks (just like in any other market, such as your local fruit market). Nowadays these exchanges are mostly electronic so, people aren’t physically present, and trading is processed by computers. In today’s market there are almost no physical “shares” (the exact term is “certificates”). The most wellknown exchanges are the New York Stock Exchange (NYSE), the EURONEXT and the London Stock Exchange (LSE).

Since these exchanges trade hundreds or even thousands of different stocks, it is useful to be able to gauge the overall direction of the market (whether it is going up or down). That’s why the indices were created.

An index is an average of a certain number of different stocks, and refers either to the whole market or to a market segment. The indices change in value over time and are used as a benchmark against which investors can compare their own portfolio returns. For example, the S&P500, the DAX and the CAC40 are general market indices often aggregating the largest companies trading in a certain country. On the other hand, indices like the NASDAQ, AMEX and GICS refer to a specific segment (for example the electronics or the automotive sector).

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How is the market structured? Daniel (my nephew) also didn’t quite understand why the news kept referring to the “financial sector” or the “tech industry” when talking about the biggest gainers or losers of the day.

To make it easier to understand, the market (and the overall global economy) is organized, segmented and analyzed in sectors and industries. The aim is to better understand which parts of the economy are rising in value (or essentially doing well) and which ones are not.

A sector is a group of companies that share common characteristics, such as technology, healthcare or energy.

An industry is a group of companies that share a primary activity. For example, a company whose main activity is to produce cars operates in the automotive industry. Other common industries would be the electric utilities or the beverages industry.

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CHAPTER THREE What is a Bull and a Bear Market?

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What is a Bull and a Bear Market?

The other day while at the barbershop, I heard someone say: “I think it is silly to have a bull in front of the Stock exchange in New York, they could have chosen something a bit more appealing. I am sure the statue is there so that people get afraid and don’t even attempt to go in.”

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I go to the same barbershop every month, so Richard, my barber, knows that my job is related to the stock markets. After the comment he immediately asked if there was a particular reason for the statue. I laughed and explained that the statue is just a symbol. It is common to state that “we are in a Bull or in a Bear market” when referring to how the stock market is performing.

Referring to the market as a Bull market means that the market is going up in value, or trending up; referring to it as a Bear market means that the market is going down in value, or trending down.

The use of the Bull and the Bear as a metaphor exists due to the way these two animals attack in the animal kingdom. The Bull uses his horns and pushes them into the air, that is, it attacks from the bottom up (and therefore the expression is used for when the market is trending upwards – “we’re in a Bull market” or “the market is on a Bullish trend”). On the other hand, the Bear attacks by swiping its’ paws down, i.e. by attacking from the top down (and therefore the expression is used for when the market is trending downwards – “we’re in a Bear market” or “the market is on a Bearish trend”).

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Richard does not invest in the stock market yet, but his curiosity for these kinds of interesting particularities (even though they’re insignificant) makes him closer to the financial world. Every time I go for a haircut, he has interesting questions about stocks and everything related. I suggested he took a look at Zercatto, because what we’re trying to do is make it easier for people like Richard, who don’t have time or the market knowledge to invest successfully.

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CHAPTER FOUR How do investors analyze stocks?

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How do Investors analyse stocks? I grew up in a family who took a keen interest in the stock market. We are not a

large family but one of the main discussions was always the way they analysed the market. My father was investing in the stock market long before the computer era so he is not used to complex trading platforms. Nowadays we got used to them, but every

time I am watching what he is doing it looks simple; he does not use most of the features that the trading platforms provide, he basically buys and sells according to the news or how well a company is performing.

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“Why do you do it like that? You’re always the last one to find out a company’s numbers that way!”, my older brother told my father. He uses online trading platforms that look extremely complex; he uses charts, and these are always supported by moving averages, volume graphs and Fibonacci analysis. “Why do you need all those flashy lights and graphs? If you can’t see it in the company’s raw numbers, you can’t see it anywhere else”, my father usually replies.

As I am relatively new in this stock market world, I decided to do some research about how these two ways of analysing the market work. Everything I found was extremely interesting. I found that investors usually follow two main philosophies when analysing stocks and the market in general: Fundamental and Technical Analysis.

Fundamental Analysis, the one my father adopts, is a technique based on economic factors such as interest rates, earnings, company reports, company income and cash flow statements, its future growth prospects, the political environment that might influence a particular sector or industry, credit ratings, and economic stability, etc. This practice works for almost any type of security or stock. Due to the fact that new data is only released quarterly, this type of analysis is often used for medium to long-term investments.

My older brother uses Technical Analysis. He believes that all the information is reflected in the price of the security.

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The stock price reflects the consensus of the market and how healthy the company is and how well it is performing. Technical analysis is enhanced by the use of charts and market indicators.

I did more research in order to clearly understand how he could analyse the market from graphs. First, I discovered that they are not called graphs but charts, and that a chart is a graphical representation of all prices over a specific period of time. This is a simple way to see the price movements of the company’s share, as well as patterns, such as a head and shoulders or a double top or bottom, which have been proved to be extremely accurate ways to “predict future behaviour of a stock”.

Technical Analysis is also based on indicators. An indicator is a mathematical calculation based on the stocks’ past prices and volume. These tools are used to predict futures prices. The most “famous” indicators are moving averages, relative strength index (RSI), MACD and Bollinger Bands, but there are hundreds of different indicators. This analysis is usually most useful in the short to medium term.

One is not better than the other; they are just different and investors should adopt the one that better suits their profile and their beliefs the best.

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CHAPTER FIVE The stock itself

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The stock itself I was born in Portugal, but for the past 10 years I have been living abroad. I decided to move out of my country because although Portugal is amazing, it is not one of the European financial centres. I always wanted to pursue a career as a stock market investor, so I understood that I had to be where the action is. Every time the opportunity comes, I take some vacations and spend some time with

my family. I have two younger brothers, António 15 and Pedro 21 that are currently finishing college. Together with the help of my father, Pedro decided to open a restaurant in Porto (Portugal). Although the restaurant is keeping him extremely busy, I noticed that he is developing an interest in the financial markets. I believe that this curiosity comes from the fact that he is the one going to the fish market every morning to buy fresh fish that just came from the sea; he really enjoys this trading market environment, where you can always spot an opportunity to buy a good product.

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The other day Pedro asked me: “how does the buying and selling of stocks work? Is It like in the street market?” As he does not have a lot of experience in this matter, I answered his question by using the fish market example; it might sound weird, but the stock market and a fish market are more similar then you think.

I started my explanation by saying: “First you have to understand the ticker. Imagine that you are in a fish market that sells every single type of fish known to man. If you wanted to call all of them by name it would be extremely difficult; pronunciation problems, spelling mistakes, etc.” In the financial market, as you have access to companies around the world, to simplify the trading process a “common language” is used; every company has a unique symbol that is called a ticker. When companies enter the stock market they trade under a specific ticker. Apple, Inc. trades under “AAPL”; Facebook trades under “FB” for example. The ticker is usually a conjugation off letters, although sometimes numbers might also be used.

My brother is impatient and always wants to know everything, so before letting me continue my explanation he asked “and the prices? How can you know the price if there are so many people involved?”

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Like in a fish market, when a deal is done there are always two parts, the buyer and the seller. Most commonly the seller wants to sell for a higher price and the buyer want to buy for a lower price. The stockmarket operates

in exactly the same way. If you want to buy or sell a stock you have a BID and an ASK price. The BID represents the best price a buyer is willing to pay for that specific security. On the other hand, the ASK is the best price a seller is willing to receive for a particular security. It is also important to note, that the difference between these two prices is called the Spread. The gap between the BID and the ASK price also indicates the liquidity of the

security; the smaller the spread, the higher the liquidity. Translating this to the fish market example it means the quantity of fish that is available for trading.

With Zercatto, investing in the stock market has never been easier. By following the world’s best trading experts, you can learn how it’s done and

replicate their strategy and before you know it, you’ll be the expert.

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CHAPTER SIX Types of Trading Orders

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Types of Trading Orders My name is Jack, I am 49 years old and I have been a portfolio manager for

the past 20 years. In the last four years I have dedicated my life to teach investors the basic concepts of the financial markets. Two months ago I was invited to speak to recent MBA graduates on the different types of market orders. Most people only know the basic orders an investor can do in the market; Buy and Sell. However, there is a specific terminology associated with it and there are several other types of orders an investor can give.

What is a Market Order? When a trade is placed on the market with immediate execution it is called a market order; if an investor makes a “buy at market” order it means he or she wants to buy that particular security immediately, at whichever price it is trading at right now.

What is a Stop or a Limit order? Investors also want to have the option to place trades without having to be stuck to the computer. If their analysis indicates that a stock will fall or that it will start to rise after a certain point, they want to take part in these movements. In order not to lose this opportunity, investors can use a Stop

and a Limit (or sometimes also called Take Profit).

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These are automatic orders that you place that tell your broker to “Buy X amount of stock Y if it reaches a price of Z” (so that I can guarantee a certain profit and don’t miss out) or “Sell X amount of stock Y if it falls to a price of Z” (to guarantee that I never lose more than what I plan). An important thing to understand is that Stops and Limits are not guaranteed in abnormal market conditions. For example, if the stock you hold is trading at $50 today, you place a Sell Stop at $45 and tomorrow the market opens at $40, then your Stop will be hit at $40 and not at $45 as initially placed.

These types of orders work differently depending whether the investor is buying or selling a position.

However, to better understand these types of orders, we have to divide it into two moments: BEFORE you enter a trade and AFTER you are in a trade. Let’s start with the second part, as it is somewhat easier to understand:

AFTER you enter a trade Imagine you have a long position on a stock trading at $80, and you initially bought the stock at $75. Your goal is to make a profit, obviously, on this trade. Now, let’s say that your goal for this position is for it to rise to $82. What could you do to guarantee that you don’t miss this goal in case it touches it? And how do you make sure that the stock does not drop below $78, leaving you with less profit, but still something to hold on to in case it continues falling? So what are your options:

Place a Market order Simply sell at whatever price is trading. On our example, it means you would sell today at around $80. 24

Place a Limit order To guarantee the first part, you would place a Limit order (or sometimes called a Takeprofit) where you would state that you would like to automatically close the position when the stock price hits your $82 target.

Place a Stop On the other hand, to guarantee that the price doesn’t go below $78, you would place a Stop order (usually named a Stoploss for easiness) at that price value, and your broker would automatically close the position if the price of the stock hits this level, guaranteeing that your position yields at least some profit (remember: you never know what tomorrow brings).

That is, AFTER you entered a position, the Limit order is an order where you will have a BENEFIT on. The Stoploss order is an order where you will exit the position at a situation worse than what you currently are in (but because you want to, as it fits your strategy!).

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BEFORE you enter a trade. Now let’s make the case for when you don’t yet own the stock. Again, if we are talking about a stock X that is trading at $80, our strategy may tell us a bunch of things about the long position we want to be in.

Place a Market Order Our strategy may tell us that the price is right for me to buy right now. In this case, I’ll put in a market order, and I’ll buy the stock at around $80, the value it is currently trading at. Or it might tell us I should buy only when the trend is confirmed and the stock hit $84 (Stop order).

Place a Limit order The Limit, as we saw above, is an order at which you will have a benefit. So, if you do not hold the stock yet, but want to, you will want to buy it at a price BELOW what it is today (because it will be better for you, right?). So our strategy may tell us that I should only buy if it drops to $75, and this is the price at which I’ll place my Limit. So, if the stock comes down to $75, I’ll buy it.

Place a Stop order The Stop order is an order at which you will leave you at a worse but controlled situation. So, if you do not hold the stock yet, but want to because you believe it will rise, but are expecting the price to drop a bit so that you can buy it at a better value (using the limit above). However, you don’t know what tomorrow brings! So the stock

might just start going up! And you don’t want to miss the trend, or at least part of it. So you place a Stop at $84 because you think “What the heck! I expect it to go to $100, so what are $4 in the midst of this?” So, if the stock rises to $84, I’ll buy it. 26

You can always place a Stop AND a Limit for any given position – they often work in a “one cancels other” basis, meaning that if your Stop is hit, your Limit will be cancelled, and so vice-versa.

Long vs Short positions The Stop and Limits Order work independently if you enter the market Long or Short. Entering the market Long, means you buy a stock with the expectancy that its price will go up. For example, you buy a stock at $75 expecting that the price will go higher than the $75. On the other hand if you go Short you are expecting the price to fall; i.e. if you buy at $75 you expect that the price will go lower than $75.

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In this situation the Stop and Limit order also work differently if you already have a position in the market or not.

Already holding a Short position on the market:

Not holding any position on the market, but wanting to go Short:

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As you can see it can get better than just buy or sell. These different types of orders exist to give the possibility to investors to always be on top of the market, even when they are not in front a computer or near their phone, and guarantee profits when they’re away.

But remember the golden rule: Markets can make you rich, but they can also be cruel. When you are starting, the best thing you can do is to follow an Expert on Zercatto. You will be able to control your own portfolio and at the same time you will have direct access to a trader’s knowledge, including when to place Stops and Limits. You will have access and see how an Expert reacts to the different market signs and when he enters and exits the market. Zercatto gives you the ability to invest, have positive returns and at the same time learn from the best.

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CHAPTER SEVEN Using a Stop that makes sense

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Using a Stop that makes sense “The most important factor in determining the nature of your stop is to determine if it makes sense given your objectives, the nature of the concept you are trading, and your temperament.” Van K. Tharp

Did you ever look at a Stop in this way, or a stop for you was simply a way to guarantee that you would cut your losses? There are several different kind of stops and each one of them has a different rationale behind it. While setting a stop most investors develop a logical argument why they are setting the stop at that particular price. There is a difference between investors that actually understand the concept of Stops and the ones that “gamble” a bit while setting them. Experts Traders know the different kinds of Stops and when each one of them should be used. This Blog Post will give you insights about different types of Stops and some knowledge how to use them.

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Dollar Stops These particular stops are directly linked to a psychological advantage; you fix a limit on how much you are willing to lose and you just have to set your stop before that. It sounds simple, but if you go a bit further you will set it more accurately.

Another positive aspect occurs when Dollar Stops are beyond the Maximum Adverse Excursion (MAE); you simply have to determine which is your MAE and set the stop a little beyond that.

It is frequent for traders to confuse the Dollar Stops with Money Management. If you invest €100 000 and you are willing to lose 1 percent setting your stop at €1000 is an inexperienced move. If you are setting a stop like this, you are probably confusing money management and position sizing. The latter is the most important part of your system; position sizing is crucial for you to determine how much you want your system to trade.

The MAE is one of the metrics that is produced by most back testing systems. It measures the largest loss suffered by a single trade while it is open. For example, a trade may end up closing at a profit of (say) 14 points but while that trade was open, at one point, the trade was at a loss of 13 points. Assuming that no other trade was in such a losing position during the

back testing then this would be the MAE.

So, are you setting your Stops correctly? 32

Percent Retracement It is common practice among investors to set a Stop order based on a percentage of the Stock. For example, if you buy a stock for €100 you will set your stop at €90. This method is called Percentage Retracement. It is fine and works perfectly, if you base your method in some kind of analysis like MAE. If you do not and you are just putting Stop based on a percentage that you feel comfortable with, then you might be losing some profit. Take some time and do your analysis carefully, it is likely that your profits will increase.

Volatility Stops Volatility Stops, if properly set, are among the best Stops you can use. These kind of Stops are based on the assumption that volatility represent noise in the market. The way to set a Stop beyond this noise is to use a multiple of the Average True Range (ATR); for example three times. Are you including ATR* in your analysis?

The average true range is a moving average (generally 14-days) of the true ranges.

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Support and Resistance Stops Support and Resistance Stops are the typical stops that are placed in the areas of "support and resistance" of the chart. By this we mean, at the extreme levels of the charts. For some traders setting a stop in these

extremes might sound too obvious and evident. If you usually set your stops as a Support and Resistance Stops, then maybe the option of a trailing stop might be better option for you. This will work as a "support" on your trade. Are you using trailing stop to "guarantee" your profits?

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Time Stops

Usually Time Stops are recommended to investors who have a preference for short-term trading. Time Stops is a kind of stop where you define when to execute it, based on a time frame. Many traders have the opinion that, if the position does not go in your favour quickly, then probably it will never go.

One of the important rules a trader should remember while setting a Time Stop, is to analyse how efficient this kind of stop will be for his trading methodology. It is important to be sure the stop will not make you miss major moves, however if you believe that Time Stops only cut your loses faster, then they should be a great choice for you.

This tools are vital to cut your losses, but they might also cut your

profitable trades. Learning how to use these tools properly is essential. How much time have you spend developing your stops methodology?

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Discretionary and Psychological Stops Discretionary Stops are mainly for people that have a vaster experience and a good intuitive sense of the market. Many professional traders use this stop, but commonly it is not recommended for traders that still doing the first steps on the market.

On the other hand Psychological stops can and should be used by everyone. Unless you are aiming for a long-term position (the one that even if it goes against you, you will not sell), you should always take this stop as an option. Although you can be psychologically balanced, after a good trade (like one that makes your whole trading year) you should implement this stop. However, there are several moments in a trader’s life that will heavily affects his/her psychology “stability”. If an event of this kind occurs in your life you should consider getting out of the market: • Illness or death of a family member or close friend

• When you have to move (house or office) • When you feel mentally exhausted • Divorce or separation of an important person in your life • When a child is born • When you are so excited about the market (Ex.: you just double a position overnight)

• Vacations or business trip

It is a smart move to close your position when one of such events occurs because you will not have the possibility to follow the market in the “normal way”. To take a clear and responsible investment decision you should be “psychologically secure” 36

CHAPTER EIGHT The first small step I needed to do to start investing!

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How to start investing “The first small step I needed to do to start

investing!”

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My name is Peter (20) and five months ago I decided to start investing in the financial markets. Due to the fact I am a newbie, instead of investing alone I decided to follow an Expert on Zercatto. The main objective is to win money (of course), but also to learn! Following one Expert will give me the real time information I need to understand what is happening in the market, why, when and how to invest.

When I first arrived in Zercatto.com I realised that before starting investing there are several step you should follow.

1. The first step before investing is to setup a Brokerage Account – The way investors have access the financial markets is through brokers. The first step you need to take in order to enter the investment world is to open an account with a broker or get access to the trading platform of your bank. 2. To be always up to date you should have access to computer & Internet – Nowadays due to the development of technology, trading is much easier than it was

before. Technology made the markets “run faster” and in order to be up to date with all the important events, the access to the internet through a laptop, phone or tablet is almost considered crucial. Above all, it will give you the comfort to trade from almost anywhere and have access to stocks from companies all over the world. 3. The method used to have a quick overview of your investments is through a Charting Software – The investment market is so vast that in order for an investor to be able to keep the pace of all of his investments, he/she needs to be able to access, interpret and understand charts. Charts are extremely useful because it is a quick way to have an overall picture of the movements of each stock: “a picture is worth 1.000 words”. 39

4. Make the most you can by using Bookmarks for useful websites – A few decades ago one of the biggest barriers for investors in the financial markets was the access to information. Having substantial, updated information could be vital for your investments. Nowadays the situation changed. With the internet sometimes investors get confused and get often “lost” in the extremely vast amount of information that exists. It is important that you keep track of the websites that you might consider useful for your investments. The bookmark tool on your web browser is extremely useful when

organising and saving important websites. 5. When you reach number 5 its time to pick a Strategy and a specific Timeframe – Before starting to invest it is important that you decide a proper strategy and its time

frame. Investments can be long, medium or short termed. Trades can be placed daily, once a week or once a month. You should also decide if you prefer a more profitable strategy, but with higher risk or on the other hand, something where you will be exposed to less risk but with less return. It is extremely important for you to understand that risk and return are not directly linked. 6. You are investing in the market but your daily live has to continues – While defining which strategy to adopt, you also have to take into consideration your availability and the type of security to invest; this should be defined with the time you have to spend analysing and following the market movements.

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7. Almost there, you just have to pick your favourite Experts on Zercatto – In Zercatto investors can find a large variety of strategies. The most important aspects to

take into consideration are the type of assets, their level of risk exposure and the frequency of investment. Certain Experts trade several times per day, and others only trade twice per month. It is important to replicate the trades as soon as the Expert inserts them on Zercatto. This is the most accurate way to achieve the same profitability of the strategy. While following an Expert on Zercatto you will significantly reduce the time you spend analysing which investment to make (the Experts are doing this for

you!) and you will also minimize your risk level as the Experts are constantly keeping track of their own investments. 8. My last point and also advice on my list is: Practise Virtual Investing – Almost every time you open an account with a broker, they offer you a DEMO version of their platform. This DEMO will allow you to get comfortable with the platform and learn how

to use it. While testing this “trial run” you can invest in whatever stock you want by using virtual money. It is also useful so you can learn how to go around the difficulties that you might find when investing your own money in the actual market. After learning how to use the platform investors understand that investing in the market does not take as much time and effort as initially thought.

After five month I can say that my experience has been great. Of course I am not an Expert yet and I am aware that it will take some year to be one. The amazing thing is that I am making money, learning and I am already (slowly) starting making my own analysis and interpretation of what is happening in the market. Zercatto helped me do the first step into something that was unknown for me. In the beginning (like everything that is unknown for us) it was scary but this guidance gave me the confidence to do the first step! 41

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