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I recently received a question from a reader asking about some of the terms we use when writing about investing. I'll bet the questioner isn't the only reader who's confused about some of our investing terminology. So today I'm going to rundown a list of terms that appear frequently in our writing. More definitions and educational information can be found on our Web site.
Gaps -- Gaps occur when a stock begins a new trading day at a price that's vastly different from the previous day's closing price. In effect, there is no trading at prices between the closing price and the opening price. This appears as a "gap" on a price chart. Generally speaking, gaps up are considered positive and gaps down are considered negative. However, in many (but not all) cases, price gaps get filled. So if a stock gaps up, you might expect that at some time in the future (from minutes to months later) the stock will drift back down into the gap. Conversely, if a stock gaps down, it's likely to bounce back up to fill or partially fill the gap. Gaps typically offer support or resistance. If a stock gaps down, the gap will offer resistance if it attempts to recover. A gap up will provide support when the stock corrects.
Relative Performance -- Momentum analysis of a stock's relative performance (RP) is one of our favorite ways to measure a stock's health. RP measures how a stock is performing relative to a specific market or index. A stock that holds its value during a declining market often soars once the market turns higher. In a strong bull market, most stocks will rise, even the stocks of weak companies. But you should concentrate your efforts on the best companies with the strongest stocks, the market's leaders. The way to find them is by analyzing RP lines. Specifically, RP is calculated by dividing the Friday closing price of a stock by the Friday close of an index. (We use the broad Wilshire 5000.) The weekly changes are then plotted on a line graph, using a log scale. When an RP line is moving upward, the stock is outperforming the market. When it's moving downward, the stock is underperforming the market. A flat RP line indicates the stock's performance is equal to the market's performance.
Market timing indicators -- Cabot has three proprietary market timing indicators that we employ to determine when to get in and out of the market, the Two-Second Indicator, Cabot Tides and Cabot Trend Lines.
Two-Second Indicator -- The Two-Second Indicator is so named because that's how long it takes to read: Just two seconds, every day. Specifically, this indicator measures the number of securities on the NYSE reaching new annual (52-week) price lows on any given day. This data is readily available in most major newspapers, though we use the data from The Wall Street Journal.
Cabot Tides -- For the Cabot Tides, we use five different market indexes to help us determine the overall intermediate-term direction of the stock market. They are: S&P 500, NYSE Composite, Nasdaq Composite, S&P 600 Small Cap and the Merrill Lynch Tech Index, an index that equally weights 100 of the leading technology stocks in the market. The market is considered to be advancing on an intermediate-term basis if at least three of these five indexes are advancing. And contrarily, the market is deemed to be declining if at least three of these five are declining.
Cabot Trend Lines -- The Cabot Trend Lines are our unique way of determining the long-term trend of the stock market. As long as both the S&P 500 Index and the Merrill Lynch 100 Technology Index fluctuate above their respective trend lines, we consider the market to be bullish. If both indexes are below their trend lines, we are in a bear market.
BRIC -- The BRIC countries are Brazil, Russia, India and China, and we often refer to the acronym when writing about the emerging markets.
ADRs -- Cabot China & Emerging Markets Report recommends stocks that trade on U.S. exchanges as American Depositary Receipts (ADRs), which are dollar-denominated stock equivalents. This avoids any currency risk and gives investors the protection of knowing that the listed companies have met U.S. accounting and reporting requirements.
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SNaC -- SnaC is Paul Goodwin's unique way of determining whether a stock is a good buy. Story includes the basic market proposition of a company, including its products, its target consumers, its potential for huge sales growth, its barriers to entry, its competition, its intellectual property, its management and all the other stuff that you can put into words.
But a good story isn't enough. A stock also must have good numbers, which are a factual record of a company's (and thus, management's) success. Paul looks for stocks that have been growing revenues and earnings for a number of quarters, ideally with earnings (profits) rising faster than revenues (sales). Paul likes to see the rate of growth for both categories accelerating. It's also nice to have an increasing number of institutional investors and an after-tax profit margin that's high and rising. And finally, Paul wants a stock that's liquid--trading at 400,000 shares a day or more--so Cabot subscribers can trade without being worried that the stock will get deep-sixed by one money manager who wants out.
Charts are where the rubber meets the road in growth stock investing. Some highly technical investors don't even care what a company's product is or how much money it's been making. They think they can tell everything they need just from a stock's chart. Paul isn't that confident, but he knows that a stock with a rising price and good volume support must be doing something right.
OptiMo -- Our proprietary stock picking system that helps Editor Michael Cintolo determine which stocks will be chosen for Cabot Top Ten Report. It screens for the strongest momentum charts out of more than 8,000 each week.
Benjamin Graham -- The father of value investing, his system is used in Cabot Benjamin Graham Value Letter to determine the best undervalued stocks in the market. Graham wrote "Security Analysis" and "The Intelligent Investor," which laid out his value investing system and have become the go-to books for value investors in the decades since their publication. He also taught Warren Buffett at Columbia University.
Jesse L. Livermore -- A quote from Livermore ("Markets are never wrong; opinions are.") adorns our fireplace at the Cabot office and he has been written about previously in Cabot Wealth Advisory. Livermore is one of the most colorful, flamboyant and respected market speculators of all time. Livermore wrote the book, "How to Trade in Stocks," in 1940, which gives step-by-step guidance on reading market and stock behaviors, analyzing market sectors, market timing, money management and emotional control. Livermore is the subject of the book, "Reminiscences of a Stock Operator" by Edwin Lefevre.
The list could go on forever, but that's a basic rundown of terms and people we write about frequently. Send us an email or leave a comment on our blog, http://www.iconoclast-investor.com with any questions, comments or suggestions.
In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, we have links below to each issue.
Cabot Wealth Advisory 10/20/08 - The Sage Speaks
On Monday, Paul Goodwin wrote about Warren Buffett's recent New York Times op-ed piece detailing his philosophy to "be greedy when others are fearful" and his plan to buy U.S. stocks while they are cheap. Paul also wrote about a China company that's gotten tangled up in the Lehman Brothers bankruptcy mess and a company that's both Green and from the emerging markets. Featured Stocks: Aluminum Corporation of China (ACH) and ReneSola (SOL).
Cabot Wealth Advisory 10/23/08 - A Steady Hand Amid the Tumult
On Thursday, Brendan Coffey wrote about the economic crisis and what lead to where we are today. Brendan also wrote about where he sees the future of growth in the stock market--in the Green sector-because of rising oil costs, rising consumer consciousness and technology keeping up with the hype. He detailed how Cabot's system has kept subscribers out of the market during the crash and saved them from horrific losses.
Cabot Wealth Advisory 10/24/08 - How to Invest Like a Pro
On Friday, J. Royden Ward wrote about his recent trip to the Value Investing Congress in New York City, where he met many of value investors and got the chance to learn their value investing methods and share his system with others. Roy wrote about investing for the long-term and about two companies he thinks fit into that outlook. Featured Stocks: Colgate-Palmolive (CL) and International Business Machines (IBM).
Until next time,
Editor of Cabot Wealth Advisory
Editor's Note: Are you new to investing? Cabot Stock of the Month Report can help you figure out which investing style is right for you. The Report looks across the spectrum of Cabot publications to select the best stock for current market conditions. It might be a Green stock, emerging markets stock, value stock, growth stock or momentum stock, but it will always be the best for right now. Click the link below to get started investing today.