How to Become a Millionaire in the
Stock Market
By: Omar and Jimmy Hernández
Published by JSP Investment Group, Inc.
All rights reserved © 2005. By Jimmy and Omar Hernández.
JSP
Investment
Group Inc.
Publishing
Division
No part of this book may be reproduced or transmitted in any form or by any means, graphic,
electronic or mechanical, including photocopying, recording, taping, or by an information storage
or retrieval system-except by a reviewer who may quote brief passages in a review to be printed in
a magazine or newspaper-without permission in writing from the publisher.
For more information or for special discounts on bulk purchases, please contact JSP Investment
Group, Inc.: [email protected].
First Edition: August 2005
Library of Congress Cataloging-in-publication data: LCCN#2005930158
Jimmy and Omar Hernández
“How to Become a Millionaire in the Stock Market”
ISBN: 0-9766387-2-x
“Education makes the diﬀerence between success and failure”
The Ameritrade “A” Logo, and Streamer Trademarks, as well as the contents of the Ameritrade.com
web site, are the property of TD Ameritrade Holdings Corporation and/or Ameritrade IP Company,
Inc. JSP Investment Group, Inc.’s use of the Trademarks and web site content does not imply or
constitute sponsorship or approval of this publication by Ameritrade.
Table of Contents
About the Authors ................................................................................................................. ix
Acknowledgments .................................................................................................................. xi
Introduction ........................................................................................................................ xiii
Part I
Chapter 1.............................................................................................................................. 19
Welcome to the Fascinating World of the Stock Exchange Market
What Is a Share? ................................................................................................................. 19
Classiﬁcation of Companies ................................................................................................ 20
Where Are Shares Traded? ................................................................................................... 20
What Is a Company Symbol? .............................................................................................. 21
Chapter 2.............................................................................................................................. 23
How to Open an Account in a Brokerage Firm to Be Able to Start Investing
Ameritrade .......................................................................................................................... 24
E*TRADE ......................................................................................................................... 26
Chapter 3.............................................................................................................................. 29
How to Start Investing and Ways to Protect Your Investments
How to Create a Watch List of Companies to Be Followed ................................................. 29
How to Interpret This List .................................................................................................. 31
Level II and Its Advantages ................................................................................................. 33
Diﬀerent Types of Orders to Make Your Investments and Their Applications...................... 35
How to Invest to the Down Side (Short Sell) ...................................................................... 45
What Is a Mutual Fund? ..................................................................................................... 46
Chapter 4.............................................................................................................................. 49
Parameters to Keep in Mind When Investing
General Market Indexes, Sectors and Industries .................................................................. 49
Dow Jones (INDU) ............................................................................................................ 50
S & P 500 (SPX) ................................................................................................................ 50
NASDAQ (COMP) ......................................................................................................... 50
Economic Calendars, Earning Reports, Dividends, Splits and News ................................... 52
Economic Calendars ........................................................................................................... 52
Earning Report Calendars ................................................................................................... 54
Split Calendars.................................................................................................................... 54
News .................................................................................................................................. 55
Chapter: 5............................................................................................................................. 57
Analysis to Be Considered When Making a Long Term Investment
Fundamental Analysis ......................................................................................................... 57
EPS: Earnings per Share...................................................................................................... 58
P/E Ratio: Price/Earning Ratio ........................................................................................... 58
ROE: Return on Equity ...................................................................................................... 59
Float ................................................................................................................................... 59
Upgrades/Downgrades ........................................................................................................ 60
Chapter 6.............................................................................................................................. 63
How to Predict a Company’s Short Term Movement
How to Conﬁgure a Company’s Chart ................................................................................ 63
Technical Analysis ............................................................................................................... 68
Volume Increase or Accumulation at the Support Point ...................................................... 72
Volume Decrease At Its Resistance Point or Close to It ....................................................... 75
Companies at Their Resistance Point or Close to It, While Experiencing High Volume ...... 78
Descending Movement With High Volume ........................................................................ 79
Support Point With Low Volume ....................................................................................... 81
How Do Companies React to Splits and Dividends? ........................................................... 89
A List of Most Market Industries, Indexes, and the Companies Conforming Them ............ 93
Chapter 7.............................................................................................................................. 97
Discover The Secret of Penny Stocks
What Is a Penny Stock? ....................................................................................................... 97
Learn How to Invest in Penny Stocks and How to Select the Best Ones.............................. 98
Parameters to Bear in Mind When Choosing a Good Penny Stock Candidate .................... 99
Short-Term Investment Examples ..................................................................................... 102
Long-Term Investment Examples...................................................................................... 109
How to Turn $1,000 into $30,000, $40,000 or More in a Very Short Term, by Investing
in Penny Stocks Whose Prices Are Below One Cent (A List of Over 25 of These
Companies Is Included) .................................................................................................... 113
How to Select the Right Ones? ......................................................................................... 114
Part II
Chapter 8............................................................................................................................ 129
The Interesting World of Options
What Is an Option? .......................................................................................................... 129
Types of Options, Objectives and Advantages ................................................................... 130
How to Select the Right Strike Price for Our Option Contracts........................................ 139
Chapter 9............................................................................................................................ 149
Advanced Option Strategies
Long Term Option Contracts (Leaps) ............................................................................... 149
How to Buy a Put and a Call Simultaneously on the Same Company ............................... 152
How to Protect Your Shares With the Purchase of Options ............................................... 156
How to Invest With a Fraction of a Share’s Value and Get the Same Proﬁt As If You Had
Paid Its Full Price, Even With Less Risk ***(Inedit Subject)*** ......................................... 158
How to Choose the Right In-The-Money Option Contracts ............................................. 167
Chapter 10.......................................................................................................................... 175
How to Open an Account in a Brokerage Firm to Be Able to Trade Option Contracts
How to Place Buy/Sell Orders........................................................................................... 176
Advantages of One of the Best Brokerage Firms for Option Trading ................................. 180
Conclusion ......................................................................................................................... 185
Glossary .............................................................................................................................. 187
About the Authors
immy and Omar Hernández, father and son, were born in Cuba, came to the United States in
the early 90’s and have been actively involved in the stock market for more than seven years,
during this time, they have carried out over 5000 transactions, traded options, stocks, & penny
stocks.
They have also attended several seminars and courses about this subject, not to mention the study
of a substantial bibliography related to the matter.
They are the founders of J S P Investment Group, Inc., where they have the support of a talented
professional team, fully devoted to the study and research of the diﬀerent events that inﬂuence market behavior. There they have helped many people become successful investors in the stock market.
They are the creators of the popular bilingual web site: www.number1stockpick.com , which is 100%
dedicated to the service of investors.
Some of the other activities they conduct consist of organizing seminars and conferences throughout the world. These events have helped people of all walks of life to get educated in this fascinating
career. Many of which have expressed their gratitude for the results obtained by using their diverse
How to Become a Millionaire in the Stock Market
investment techniques, which have been fully covered in this fascinating material in a very easy to
understand manner.
-x-
Acknowledgments
e wish to express our gratitude to some people that in one way or another, with their contribution, made possible the completion of this material. First to Tania Varona, attorney at
law (Jimmy Hernandez’s mother), graphic designers and friends, Sandor and Franco Valdez,
Alexis Bellido- web developer, Fernando Varela-linguist and above all, we want to thank God for
allowing us to make this dream come true.
How to Become a Millionaire in the Stock Market
-xii-
Introduction
ur main objective when we started writing this book was to oﬀer a guide for those who are
planning to start their journey into the wonderful world of the stock exchange market, as well
as for those already experienced investors.
Here, we’ll teach from how to open an account in a brokerage ﬁrm, how to predict a company’s
short term movement, to the use of advanced strategies with diﬀerent types of investments. It is so
easy that the new investor will realize that even when starting with a small amount of capital, by studying this book, and having access to the Internet, it will be possible for anyone to build a fortune in
a relatively short period of time.
In our personal experience throughout the years, we have studied a lot of literature on this subject,
realizing that there is not a single book that, by itself, covers all of the information and knowledge
presented here. Furthermore, we will describe, very clearly, a type of investment that has never been
covered in any publication.
We are sure that this technique will revolutionize the way in which most people invest their money,
How to Become a Millionaire in the Stock Market
regardless of the amount of capital they may have. We speak so categorically because in our personal
case, using the strategies exposed here, we have obtained big proﬁts while investing minimal amounts
of money.
“Doing the easy when you have the ability to try the diﬃcult is like depriving talent of its dignity”
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Part I
How to Become a Millionaire in the Stock Market
-16-
n this ﬁrst part, we will cover stocks in great detail. We will show you all the tools you will need
to be able to start investing right away. Here you’ll learn in a very simple way, how to open an
account in a brokerage ﬁrm, the basic concepts of the stock exchange market, its terminology,
how and where stocks are traded, the diﬀerent types of orders and their application, how to interpret
the companies’ ﬁnancial reports, and how to predict with a very high percentage of accuracy the
movement of a company. You’ll also learn how to invest to the down side (short sell), how to protect
your proﬁt without having to close your position, and how to read a stock’s price list including Level
II. To conclude Part I, we will dedicate a full chapter to the wonderful world of penny stocks where
you will realize that by investing small amounts of money in these companies it is very easy to obtain
great returns in a short period of time.
How to Become a Millionaire in the Stock Market
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Chapter 1
Welcome to the Fascinating World of the Stock Exchange Market
n this ﬁrst chapter we will learn about the basic concepts related to investing in the Stock Market.
What Is a Share?
The operation carried out by companies making the ﬁrst sale of shares to the public is referred to as
the Initial Public Oﬀering or IPO. The main purpose of such an operation is for companies to raise
funds for the purpose of expanding their business. They accomplish this by selling shares of stock to
the public. In other words, it is the process of bringing a stock issue to the market for the ﬁrst time.
Thus, by buying these shares you can become an owner of a portion of the company you have invested in, and in many cases, receive dividends from its quarterly net earnings in addition to the proﬁt
you may get if the value of this company’s shares increase.
For example: you buy 1000 shares of company X worth $3.00 each, (or $3,000.00) and let’s say
they reach a price of $10.00 each. If at this moment you were willing to sell, you would get a net proﬁt of $7,000. We want to point out that shares can be sold at any time after their purchase. In fact,
How to Become a Millionaire in the Stock Market
when a company goes public for the ﬁrst time, their shares keep on exchanging hands everyday.
This was just a brief explanation for you to understand what a share of a company is, and the purpose of investing in it.
Classiﬁcation of Companies
Companies are classiﬁed in three categories according to their size or capitalization, as follows:
1.
Big Companies (Big Caps): These companies are known as big-capitalization companies,
with a net worth of $10 billion or more. Some examples include: Intel, IBM, Home Depot, Ford Motor Co., among others.
2.
Medium Sized Companies (Mid Caps): These companies are known as medium capitalization companies, whose market capitalization ﬂuctuates somewhere between $1.5 and
$10 billion.
3.
Small Companies (Small Caps): The capital of these companies is $1.5 Billion or less.
Historically, the investors of these companies get far greater proﬁts for their investment,
since smaller companies tend to grow much faster than the bigger ones. Penny Stock
companies also belong to this category, and are known as micro capitalization companies,
which require less money to invest, in order to obtain good proﬁts. A whole chapter will
be dedicated to these companies.
Where Are Shares Traded?
Shares are bought and sold in a market place referred to as the Stock Exchange Market. Here is
where all transactions take place.
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Chapter 1: Welcome to the Fascinating World of the Stock Exchange Market
There are diﬀerent stock exchanges, but here we will mention the three most important ones:
•
New York Stock Exchange (NYSE): This is commonly known as Wall Street. This is
the place wherein outstanding companies like Bank of America, General Motors, Home
Depot, Sears and many others carry on their trading activities.
•
American Stock Exchange (AMEX): Like NYSE it has a physical address where stock
brokers meet for negotiating the price of stocks. As an investor you are not going to be
present at this place. Instead a broker will be in charge of these transactions, since he
represents the brokerage ﬁrm where you have your account.
•
Nasdaq (Over the Counter Market): This is also a place where stocks are traded but
unlike the other two major markets, transactions are carried out through a computer’s
network. In this place, technological stocks prevail, such as Microsoft, Intel, Cisco, etc.
What Is a Company Symbol?
To simplify transactions, each company is identiﬁed with a symbol. For example: Microsoft
(MSFT), Home Depot (HD), Sears (S), Intel Corporation (INTC). This is known in market jargon
as the “Ticker Symbol.” They are the symbols we see on TV, in ﬁnancial publications, and in other
ﬁnance-related media.
When the symbol of a company has three letters or less, it means that this company is traded at the
NYSE or AMEX. The symbols of companies trading at the NASDAQ have at least four letters.
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How to Become a Millionaire in the Stock Market
-22-
Chapter 2
How to Open an Account in a Brokerage Firm to Be Able to Start
Investing
fter this general introduction explaining the stock market mechanism, we will teach you, step
by step, how to open an account in a brokerage ﬁrm to be able to start investing. These ﬁrms
are the only ones authorized by the government to carry out transactions on your behalf, of
course, following your indications. These transactions can be performed either through the phone or
via the Internet.
These brokerage ﬁrms work like a regular bank, meaning that opening an account with them is
like having your money in a bank. You get an account number and a password that only you know,
with which, you can at any time access your account, carry out your transactions, check your account
balances, and check your investments’ development. Most of them even give you a checkbook and
an ATM card, so that you can access your money whenever you want.
Once you open an account, your money will still be earning interest in a money market account,
even without making any investment whatsoever. This amount is higher than the interest earned in
a regular bank account. The Security Investor Protection Corporation (SIPC) protects all of these
accounts. In other words, it is impossible to be a victim of fraud by one of these ﬁrms.
How to Become a Millionaire in the Stock Market
There are full and discount service brokers. A few years ago, the full service brokerage ﬁrms were
the only ones around. They oﬀered buy and sell recommendations, as well as transaction execution.
Back then such services were very expensive, because it was the only choice available; they were the
only ones who had access to some market information. That made this service reserved for a selected
group of people.
We want to point out that there are still full service brokers rendering a complete service to investors. In some cases they even make decisions on the management of their clients’ accounts. Nevertheless, we do not recommend any of them at all, because in addition to what they charge for such
services, the fact of the matter is that no one can invest your money better than yourself; especially
when you have the necessary knowledge to do it. That is precisely the objective of this book. After
studying it, you’ll be able to use a discount service broker, which will save you a lot of money and
empower you to make your own decisions.
Now we will oﬀer you information about two of these discount brokerage ﬁrms that, in our personal opinion, are among the best in the market, not only because of their low commissions, but also
for the tools they give you. Through their web sites, you will be able to perform a correct analysis
before proceeding to invest.
Ameritrade
Opening an account with this brokerage ﬁrm is very simple. It can be done either through their
web page www.ameritrade.com, or over the telephone at: 1-800-454-9272 (within the United States), and 402-970-5805 (internationally).
If you choose the Internet option to open your account, all you have to do is go to their web address
as given above, and click on Open an Account. There you will ﬁnd an application to be ﬁlled out.
Once you have completed it, sign it, and mail or fax it to:
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Chapter 2: How to Open an Account in a Brokerage Firm to Be Able to Start Investing
1005 North Ameritrade Place
Bellevue NE 68005 (Overnight mail)
Fax: (816) 243-3769
Ameritrade Inc.
P.O.Box 2760
Omaha NE 68103-2760 (Regular mail)
Once this application has been processed and approved, you must deposit your funds in the account you have just opened. This can be done by sending a check to any of the given addresses or
through a wire transfer. In order to open an account with Ameritrade you should deposit at least
$2000. If you deposit less than $2,000, you will be charged $15.00, quarterly. After opening an
account with this ﬁrm, you will get the following beneﬁts:
•
The ﬁrst 30 transactions are free.
•
A ﬂat $10.99 commission to buy or sell any number of shares, as long as you do it via the
Internet. You will pay $14.99 if you do it over the phone.
•
Order execution is guaranteed in ﬁve seconds.
•
They provide very useful tools to help you perform your analyses.
•
By paying a monthly subscription of $9.99, you will have access to Level II (which is very
important as you’ll see later on).
•
They allow you to create several watch lists of shares, in order for you to follow their daily
activity.
•
You also have access to the companies’ charts, so that you can see their price movements,
dating back to their initial public oﬀering (IPO). This is very important for performing
the technical analysis.
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How to Become a Millionaire in the Stock Market
E*TRADE
The steps you need to follow to open an account with this brokerage ﬁrm are the same as those
you followed when doing so with Ameritrade. Addresses and telephone numbers are the only things
that vary.
www.etrade.com
Telephone within the United States 1 800 387 2331
International (916) 636-2510
(Regular mail) Etrade Securities LLC
P.O.Box 9206
Boston, MA 02205-9206
(Overnight mail) Etrade Securities LLC
200 Brickston Square 5th ﬂoor
Andover MA 01810
Etrade also oﬀers great beneﬁts when opening an account with them. They include:
•
50 free transactions.
•
A ﬂat $9.99 commission to trade as many shares as you wish, as long as it is done through
the Internet.
•
A quick order execution.
•
It allows you to make watch lists of shares, to follow their daily behavior.
•
We also have access to charts and graphs of the companies’ price movements from their
beginning.
When you have decided where to open your account, proceed by ﬁlling out the application. You
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Chapter 2: How to Open an Account in a Brokerage Firm to Be Able to Start Investing
will need to specify if you will be opening an individual or a joint account. Another important decision to make when ﬁlling out this application is to indicate whether you want it to be a cash or a
margin account.
A cash account means that you are only going to be able to invest your money. On the other hand,
with a margin account you have the advantage that the brokerage ﬁrm allows you to invest twice as
much as you have deposited in the account. In other words, if you had $2000, your buying power
would be $4000. This gives you great leverage and a greater advantage. For this reason we highly
recommend that you open a margin account. Moreover, with this account you’ll always have the
availability of your money right after closing any position.
Note: Neither penny stocks nor options are “marginable,” so you cannot use this leverage when
investing in them. Even some of the big companies are not marginable, but don’t worry about that
because your brokerage ﬁrm will automatically let you know which ones are or are not marginable,
when placing your order.
Hint: One of the beneﬁts new investors have nowadays is that they can use an investing simulator where they can practice their strategies with actual stock and option quotes. They invest with
make-believe money, until they get the ability to do it with real money. If you are a beginner, we
recommend that you learn and test our strategies using one of these simulators. One of the web sites
that oﬀer this service for free is www.investopedia.com, there, all you have to do is, open your fake
account, and start practicing and having fun at the same time. You can also access them through
our web site. If after concluding this chapter, you still have any question or doubt, please visit us at:
www.number1stockpick.com.
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How to Become a Millionaire in the Stock Market
-28-
Chapter 3
How to Start Investing and Ways to Protect Your Investments
n this chapter we will teach you step by step, how to utilize all of the necessary tools to make proﬁtable investments whether you are buying long or selling short. We will also expose techniques
to protect yourself from big losses and to protect your proﬁts regardless of the market’s ﬂuctuations.
How to Create a Watch List of Companies to Be Followed
Let’s say you have opened an account with Ameritrade, the ﬁrst thing you have to do is create
a list of companies that you will follow as possible candidates for your investments. Most of the
brokerage ﬁrms’ web sites give you the option of creating these lists. Keeping up with the Ameritrade
example,when you enter the members’ section on their web site, you will see several function bars
appearing at the top. In order for you to create your list, you have to click on Streamer Suite and then
an array of several options will appear which will look like this:
How to Become a Millionaire in the Stock Market
There, if you click on Ameritrade Streamer, it will take you to the place where you can create your
lists. You’ll see a button on the upper section showing you this symbol:
You’ll have to click on it to start creating your list. After giving it a name, you’ll see a space to enter
the companies’ symbols that will comprise your list.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
A comma should be placed between each symbol. After this is done, you should save the changes
that have been made, and ﬁnally, you’ll click on Close. Now, your list is complete. You can create
more than twenty lists, which contain more than twenty symbols each. Let’s see an example of one
of these lists.
How to Interpret This List
These lists portray several parameters, but the ones we are interested in, are the following:
•
Symbol: This is the company’s symbol.
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How to Become a Millionaire in the Stock Market
•
Description: Name of the company.
•
Bid: This is the best price buyers are oﬀering to buy shares of a given company. For
example: if you are holding shares of Company X, and you would like to sell them right
away, this is the price you would get. It represents the Supply side.
•
Ask: This is the best price share holders are willing to sell their shares. In other words, if
you would like to buy shares of a given company right away, this is the price you would
have to pay. It represents the Demand side.
As you already know, the bid represents the buyers, and the ask represents the sellers. These prices
are continuously changing depending upon the ascending or descending trend line a company is experiencing. The diﬀerence between bid and ask is known as the “Spread”. The smaller the spread, the
better. As a matter of fact, a small spread is a good indication of the liquidity of a company. Usually,
companies with a small spread have a good volume of transactions, which facilitates the buying and
selling of their shares. Some companies have a big diﬀerence between their bid and ask. Such companies are referred to as “illiquid.”
Because of this, their daily volume of transactions is very low. We recommend you not to invest
in these companies.
•
Last: This is the last price at which these shares have been traded.
•
High: This is the highest price these shares have been traded at for the day.
•
Low: This is the lowest price these shares have been traded at for the day.
•
Net Change: This is the net change of a share’s price related to the previous day’s closing
price. It tells us how much a company is going up or down.
•
Volumen: This tells us the amount of shares that have been traded at a certain time, and
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
it indicates the degree of liquidity a company has. This is a very important parameter. As
we already mentioned, a fair volume is a positive sign.
Now that you are familiar with this terminology, you will be able to read and understand any price
list found in newspapers, ﬁnancial publications, or web sites. At this moment you might be asking
yourself, “From what source do I get the best candidates for my list?” It is very simple. All you need
to do is look up in ﬁnancial newspapers (Wall Street Journal, Investor Daily, etc.), TV channels
(Bloomberg, CNBC, etc), or many Internet sites. A list of key companies of every industry will be
found at the end of Chapter 6. Also, at the end of Chapter 7 you will ﬁnd a list of more than 50 good
penny stocks whose prices are below $1, and another list with over 25 companies whose prices are
below one cent.
Level II and Its Advantages
Let’s go back to the Ameritrade example, click on Streamer Suite. On the list of possible options
you will see a bar that says Level II. Click on it and this is what you will see:
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How to Become a Millionaire in the Stock Market
Bid Size: In this space that in this example appears number 17, we can see the
amount of shares buyers are willing to buy
at the best bid price at a particular moment. We always have to add two zeros to
this number, therefore in this example it
would be 1,700 shares at $28.17.
Ask Size: This is the amount of shares sellers are willing to sell at the best ask price at a given time. We also have to add
two zeros to this number, so in this case it
would be 1,800 shares at $28.18.
In this particular example demand and supply are equal. Sometimes there is a big
diﬀerence between them, giving us the
possibility of knowing exactly how they
are in a given company, being able to have
a better idea of where its share’s movement
is going to be heading to momentarily,
so, by knowing how to read level II, we’ll
always have the advantage of improving
the purchasing price in case we are buying
or the sale price in case we are selling.
In this section we ﬁnd the
diﬀerent market makers
and ECNs in charge of these transactions.
-34-
Best price on
the bid side.
Best price on
the ask side.
Chapter 3: How to Start Investing and Ways to Protect Your Investments
This is the most advanced quote system available. It has the same parameters as the other list we
created. Besides showing the best bid and ask, it also shows the number of shares that buyers and
sellers are willing to trade at those prices at a certain time, as well as the market makers in charge of
the transactions. This is very important, as it helps us to see more clearly the movement tendency of
a company at a given time. Thus, you may have a better idea of the current supply and demand relationship, enabling you to get a better price in case you wish to buy these shares. This understanding
will help you get a better sale price in the event that you have shares and want to sell them.
As you can imagine, if the number of shares reﬂected on the bid side is greater than the one reﬂected on the ask side, the movement tendency of this company must be an ascending one, or vice versa.
With this knowledge you can decide more accurately, the price you want to place your orders at.
Thus, you will be in a much better position than those investors who do not have Level II, especially
when investing in penny stocks.
Diﬀerent Types of Orders to Make Your Investments and Their Applications
Now that you know how to create a list and how the quote system and prices operate, including
Level II, you are now ready to learn how to place the diﬀerent types of orders to make your investments. Continuing with the Ameritrade example, let’s go back to their home page, and look in the
upper section, where the main function bars are found. This time you have to click on Trade, it is
located on the top left side. Then click on Stocks (for stock trading) or Options (for option trading),
in this case click on Stocks.
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How to Become a Millionaire in the Stock Market
This will take you to the site where you will be able to place the diﬀerent types of orders. Next is
an example of this page.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
step 1
step 2
step 3
step 4
step 5
step 6
step 7
step 8
step 9
Order Type
Expiration
Special Instructions
Routing
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How to Become a Millionaire in the Stock Market
Now we will explain to you, step by step, how to conﬁgure the diﬀerent types of orders, and the
application of each one of them.
Step 1
•
Buy: This means you want to buy shares of a company because you expect their price to
climb. This is also known as taking a “long position”.
•
Sell: This is when you have shares of a company and want to sell them.
•
Buy to Cover: This type of order is used when you have previously short-sold shares of a
company and you want to close your position.
•
Sell Short: This means investing to the down side. This will be fully covered at the end
of this chapter.
Step 2
Quantity: Here you will indicate the amount of shares to be traded, preferably using hundred
multiples (round lots).
Step 3
Symbol: In this space you will place the symbol of the company you want to trade.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
Step 4
Order Type: There are many types of orders, and it is very important to know how each one of
them works.
•
Market Order: As you know, all companies have a bid and an ask. For instance, if you
want to buy shares of a company using this order, the transaction will be executed instantaneously at the price reﬂected on the Ask at that moment, which is the best price sellers
are willing to sell their shares at. Also, if you want to sell shares of a company using this
order, such an operation will be performed instantaneously as well, at the price reﬂected
on the bid side, since it is the best price buyers are oﬀering.
Brieﬂy stated, the execution of this order is guaranteed almost instantaneously. We recommend this order to be used in companies whose spreads are not too large.
•
Limit Order: As its name implies, this type of order is used when you want to trade shares
of a company at a speciﬁc price. Unlike the market order, this one is not executed until
the speciﬁed price has been reached. For example, let’s suppose you want to place an
order to buy 100 shares of Company X, who’s bid and ask prices are $2.45 and $2.55. If
you were to buy using a market order, you would pay $2.55 and if you were interested
in selling, you would get $2.45. On the contrary, if you think that at that moment, the
company might experience a downtrend (which can be seen on Level II), by placing a
limit order, you could probably buy these shares at $2.45 (Bid), or even at a better price,
compared with the $2.55, you would have had to pay if a market order would have been
used.
By the same token, using the same example, if you had these shares and wanted to sell
them while the company was having an up trend, you could have placed a sell limit order
for $2.55 (Ask) and have sold them easily at this price or even better, compared with the
$2.45 you would have obtained by using a market order. This is why it is so important
to know how to interpret Level II correctly. It gives you an idea about the companies’
direction at the moment of placing the order.
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How to Become a Millionaire in the Stock Market
•
Stop Market o Stop Loss: This is an order used to protect yourself from great losses in
case your investment turns out against your predictions. Or, it can protect part of the
proﬁts if there has been a previously favorable movement, and you still want to stay in
this position without risking all the proﬁts. Thus, by using this order you will neither risk
all that you have earned, nor will the proﬁts be cut down. For example, let’s assume that
you bought one thousand shares of company X at $3.00 each ($3,000), and let’s say you
cannot risk more than $300 in this investment ($0.30 per share, because you have 1000
shares). To attain this, you should place a $2.70 stop market order. This means that if
this company experiences a decline, down to $2.70, your order will automatically become a market order, getting executed at that price or close to it. So, your loss wouldn’t be
greater than $300, regardless of whether this company’s shares keep on declining even all
the way down to $1.00, in such a case if this order had not been used, your losses would
have been $2000. Conversely, let’s pretend you bought these same 1000 shares at $3.00
each, and a couple of days later they reached a price of $4.30, bringing you a proﬁt of
$1,300. At this point, you still think this company can continue its upside movement,
but at the same time you don’t want to risk all the proﬁt earned up to this moment, in
case the price goes down again. In this situation you should use a stop market order at
$4.00. This would secure a proﬁt of $1,000, regardless of what may happen. Now, if the
share’s value continues to increase, so will your proﬁts, but if the share’s price comes back
to $4.00, your shares will sell immediately. This allows you to keep a proﬁt of $1,000.
This demonstrates how an investment can be fairly protected against losses without having to limit its potential of proﬁt.
•
Stop Limit: This order operates just like a stop market. It gives you protection to minimize losses without having to limit the proﬁts. The only diﬀerence is that the stop market
becomes a market order, once the previously speciﬁed price has been reached. However,
the stop limit order when reaching this price becomes a limit order. In other words, the
stop limit order will be executed only at the price that you specify. On the other hand,
the stop market order will generally be executed instantaneously at the market price.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
•
Trailing Stop: This order is similar to the stop market order with the exception that, if
we assign a loss of $0.30 per share, and the company goes one point in our favor, if we
still want to keep the same $0.30 loss margin, a trailing stop order adjusts the loss margin
automatically. For example, let’s assume you have the same thousand shares you had
previously purchased at $3.00, you place a stop market order at $2.70, and the share’s
price goes up to $4.00. If at this point you’d like to continue keeping the same $0.30 loss
margin, as it was initially set when the price was $3.00, you would have to place a new
stop market order at $3.70. Otherwise, you might have the risk of having the shares price
down again, and therefore your old $2.70 stop market order may be executed if the price
reached this point, in which case you would have gone from a $1,000 proﬁt to a $300
loss. On the other hand, if you place a $2.70 trailing stop order on your 1000 shares,
and their price goes down to this level, it gets executed just like the stop market, but if
the share’s price reaches $4.00, this order will automatically adjust itself to $3.70, and so
on, for as long as the company’s price continues to increase. In other words, the price of
your trailing stop order is always going to be $0.30 below the highest price these shares
reach.
This way you can insure the greatest level of proﬁt from your investments, without having
to constantly watch them.
Note: This is good for investors who have other daily activities, but still want to invest in
the stock market and have their investment well protected.
Note 2: You can also specify this loss margin using percantages using the trailing stop
%.
Step 5
Price: Here you will indicate the price you want to place your orders at.
Note: When placing a market order, you do not have to specify the price. This order is executed
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How to Become a Millionaire in the Stock Market
immediately at the Bid or Ask price, depending on whether you are buying or selling.
Step 6
Expiration: This is the time period you want your order to remain open for. Market orders are
placed only for the day, because they are executed instantaneously. All other types of orders can be
placed either for the day (9:30 A.M. to 4:00 P.M.) or GTC (good till cancelled). This order will
remain open until you cancel it or it gets executed.
Note: The regular market is opened from 9:30 A.M. to 4:00 P.M. ET, Monday through Friday. We
want to point out that before the regular market opens, many shares start trading at 7:30 A.M. This
is known as “Pre-market.” Also, after the regular market closes many companies continue trading
until 7:00 P.M. This is referred to as “After-Hour Market” or “Extended-hour Market.” We recommend that you avoid trading during such time periods, especially when you are a beginner. This is
because at these times there is a low transaction volume, and, the spread between the bid and ask is
much greater as compared to that during regular market hours. These daytime and GTC orders may
be combined with these pre-market and after market periods. For example:
•
Day + Ext.: This order will last, for the regular market day, plus the extended hours of
that day.
•
GTC + Ext.: This order will remain opened until you cancel it, but unlike the regular
GTC it will comprise the regular market period plus the pre-market and after market
hours.
Step 7
Special Instructions: Here you can make some speciﬁcations regarding how you want your order
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
to be executed, for example:
•
None: As it implies, it means that you don’t want to make any speciﬁcations.
•
AON, All or None: This means that you want your order to be executed in its entirety
at the indicated price, because sometimes orders can be partially executed. For example
if you want to buy 100 shares of Company X at a limit price using this speciﬁcation,
such order won’t be executed until the 100 shares are bought at the same time. We recommend using this option because many times orders start getting executed partially,
especially when you are trying to trade shares with a low volume of transaction.
•
FOK (Fill or Kill): It means that if your order hasn’t been fully executed at the end of the
day, it will be automatically cancelled.
Step 8
Routing: These are the diﬀerent routes you can send your orders through. As you can see in the
example, we chose Auto Routing, meaning that our order is going to be sent automatically through
a computerized program, to be executed at the best available price. You may observe that there are
many other routes available to send these orders, but based upon our own personal experience, we
recommend that you always use Auto Routing
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How to Become a Millionaire in the Stock Market
Step 9
Review Order: So far, you have ﬁlled out all of your order speciﬁcations. Now you are ready to
send it. All you have to do is click on Review Order. After making sure that everything in your order
is correct, you can send it by clicking on Place Order.
To verify the status of your orders all you have to do is go to the Order Status section and check on
your open orders. There you will be able to see whether it was executed or if it is still pending. If it
is still pending and for some reason you want to cancel or change it, this is the place to make such a
change (This is only in the case of a limit order, because remember, market orders are executed immediately). All you have to do is specify the order you want to change or cancel, and continue with
the indicated steps.
Next to Open Orders, you will ﬁnd Order Activity and Trades. There you will be able to see the
transactions you have performed during the day.
To check how your investments are doing and the balance of your account, click on Portfolio located on the left side of the central page and then click on Balance & Positions.
Note: Ameritrade’s web site has another section where you can send your orders through as well,
the speciﬁcations to be ﬁlled out are the same ones we just explained, the only diﬀerence is that this
section is always showing up at the bottom of the web site, giving you the possibility of placing your
orders without having to go to the Trade section. Here’s what that looks like.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
For option
tradings
For stock
trading
In this section you can see what the company you want to invest in is doing before
placing the order. Just put the company
symbol and click “Go”
How to Invest to the Down Side (Short Sell)
Because of lack of knowledge, many people have told us that the market is diﬃcult to invest in,
because it goes down more than it goes up. What people don’t realize is that it is possible to make
money investing to the down side as well. We will now teach you how to do it.
Short Sell: Brokerage ﬁrms have shares from many companies. We say “many” because not all of
them can be short sold. This operation consists of selling borrowed shares from the ﬁrm where you
have your account, and selling them at the current market price, expecting to buy them back later
at a lower price, then returning them to the brokerage ﬁrm who lent them to you. For example,
shares of Company X are trading at $10.00 each. Through the analysis you will learn in the following
chapters, you conclude that the price of these shares will go down. This is where a sell short operation
comes in. Like a regular sell order, as explained in the beginning of this chapter, this one can be a
limit or a market order and for the DAY or GTC. Of course, funds must be available to cover these
transactions. To short sell one thousand of these shares, you would need $10,000. Finishing the
example, let’s assume you short sold these thousand shares at $10.00, and two days later their price
went down to $7.00. At this point, you have a proﬁt of $3000. You might ask, “How can I get my
proﬁt?” Very simple. Don’t forget you owe one thousand shares to the brokerage ﬁrm that initially
lent them to you. All you have to do is buy back one thousand shares at $7.00 each or $7000, and
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How to Become a Millionaire in the Stock Market
give them back to the brokerage ﬁrm. Thus, settling your debt and keeping the diﬀerence, which in
this case is $3000. This is done by placing a Buy-to-Cover order which is similar to a regular buying
order, the only diﬀerence is, that when you place it, the brokerage ﬁrm automatically knows that it is
to close your short position, and the $3000 proﬁt will be immediately reﬂected in your account.
As we explained earlier, there are ways to protect yourself from big losses when buying shares by
using certain orders. When short selling, you can also be protected. For example, if you short sold
1000 shares at $10.00 each, and the maximum amount of money you are willing to lose is $500 or
$0.50 per share, you would have to use any of these three orders: stop market, stop limit, or trailing
stop. To ﬁnish our example, let’s say you chose the stop market order. You would then have to place a
Buy-to-Cover stop market order at $10.50. Thus, if the share’s price goes up to that point, this order
will be executed and your short position will be closed. So, you will end up losing only the $500
you were willing to risk. This way your losses will always be limited.
Note: This buy to cover order can also be a market or a limit order and good for the day or good
till cancelled (GTC).
What Is a Mutual Fund?
A Mutual Fund is made up of capital from many investors, and it is managed by the administrator
of the company in charge of operating the fund. Their function is to diversify the pooled capital by
investing it in shares of diﬀerent companies. This is nothing more than a conglomerate of shares that
according to the law should have shares of at least 20 diﬀerent companies, in order to reduce the investment risk. Every fund’s family must follow the rules as established by the Security and Exchange
Commission (SEC), set up to protect the public. The SEC limits the amount of money the administrator may invest in a given industry or company. As you may have observed, the objective of mutual
funds is to diversify the investments for protection. The administrators decide where your money is
going to be invested. For a long time many mutual funds have had good returns. Nevertheless, some
of them have incurred substantial losses.
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Chapter 3: How to Start Investing and Ways to Protect Your Investments
Practice has demonstrated that nobody can manage your money better than you can, as long as
you have the knowledge and ability to do it. This is precisely the main objective of this book. We are
100% sure that when you ﬁnish reading it, with your dedication and our guidance, you will be able
to manage your own funds very successfully..
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How to Become a Millionaire in the Stock Market
-48-
Chapter 4
Parameters to Keep in Mind When Investing
n this chapter we will be covering certain parameters that should be taken into consideration
before making an investment. It is very important to know how the stock market is comprised,
understand the economic calendars, know how to read ﬁnancial reports, dividends, splits and
follow news that relates not only to the diﬀerent companies, but also the stock market in general, in
order to evaluate how to proceed before investing.
General Market Indexes, Sectors and Industries
The ﬁrst part of this subchapter will be devoted to something very important: the general market
indexes. These are ﬁnancial indicators that follow a group of companies; they measure the general
sentiment of the Stock Exchange Market. Here we’ll mention the three most important ones, those
we see on TV and many other ﬁnancial sites.
Note: We will mention the main indexes, there are many more.
How to Become a Millionaire in the Stock Market
Dow Jones (INDU)
This index is the most popular and the oldest one of all. It dates back to 1896, and it is comprised
of 30 big companies, known as Blue Chips. Most of these companies are traded on the NYSE and
belong to a variety of industries that represent a big portion of the United States’ economy. This is an
average calculated according to the share’s price of each one of these 30 companies, and the result is
expressed in points, that is, if it goes up 100, it means that during that day it went up 100 points. In
spite of the fact that this index is comprised of only 30 companies, it has been historically considered
as the greatest measurer of the general market sentiment.
S & P 500 (SPX)
This index, as its name implies, is made up of 500 companies. 400 of which are industrial, 40 are
ﬁnancial and 60 are from the service and transportation sector. It measures, with great accuracy, the
general state of the stock exchange market, since it includes companies of various sizes.
NASDAQ (COMP)
This index is comprised of more than 5400 companies, and like the S&P 500, it is measured according to the valuation of its companies, meaning that bigger corporations weight more than the
smaller ones. Unlike the Dow Jones and the S&P 500, most of the NASDAQ companies belong to
the technology sector. Therefore, this index is the best measurer of the sentiment within this sector.
Having concluded with the indexes. Let’s see what sectors and industries are:
A sector is a segment of a country’s economy. For example: technology, energy, ﬁnancial, health,
etc.
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Chapter 4: Parameters to Keep in Mind When Investing
An industry is a subdivision of a sector. For example, the banking industry belongs to the ﬁnancial
sector as does the insurance industry and the like. The semiconductor industry, software and hardware, among others, belong to the technological sector. Each one of these industries and sectors has
its own index that measures its individual behavior within the general market.
Now, we will illustrate below, how the stock exchange market is structured:
STOCK MARKET: DOW - NASDAQ
SECTOR
COMPANY
SP500 AND OTHERS
INDUSTRY
The subchapter you just ﬁnished is very important; as it is necessary to understand what industry
the company you are planning to invest in belongs to. In order to perform a deeper analysis, it is also
useful to know how the general market sentiment is. In Chapter VII, you’ll learn how to apply all of
this when predicting a company’s movement.
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How to Become a Millionaire in the Stock Market
Economic Calendars, Earning Reports, Dividends, Splits and News
Economic Calendars
It is a calendar that shows the diﬀerent events and economic reports that are going to be taking
place every day. This is very important because of its direct inﬂuence upon the general market movement, as well as on the industries and sectors involved in such reports. Therefore, it will aﬀect the
movement of the companies conforming them, which is mostly what we are interested in.
Here’s an example of an economic calendar:
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Chapter 4: Parameters to Keep in Mind When Investing
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How to Become a Millionaire in the Stock Market
Earning Report Calendars
As we already know, all public companies report their earning per share (EPS) every three months;
this is known as a quarterly report. In this report an outlook of the company is also presented, which
is a forecast of future business operations, along with the way it will inﬂuence the ﬁnancial future of
this company. Besides this, at the end of the year, companies add up the proﬁts earned in the four
quarters. This is known as the annual report. That’s why you will ﬁnd ﬁve EPS numbers, namely,
four quarterly reports, plus the annual one. It is important to be aware of these earning report calendars, for you will be able to know the exact day that companies will be reporting their earnings, which
is a must, before making an investment. On that day, companies generally have great movements, but
we obviously do not know in which direction.
Split Calendars
In these calendars we can see, when the diﬀerent splits are going to be taking place. There are two
types of splits:
Split: As its name indicates, it consists of dividing the price of a company’s shares. It can be (2:1),
(3:1), (4:1), etc. Companies usually do this when the price of their shares have reached a very high
value and in order to make them more attractive to investors, they divide their price. For example,
you have 1000 shares of Company X, worth $60 each, and this company decides to make a 2:1 split.
Right after it takes place, the new price of the shares will be $30, which means that now you have
2000 shares instead of the 1000 you previously had. As you can see, this does not aﬀect the invested
money. Generally when a company carries out a split, the price of its shares tends to rise. By executing
a split their shares become more accessible to a greater number of investors because of their lower
price.
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Chapter 4: Parameters to Keep in Mind When Investing
Reverse Split: This is the other type of split. As its name implies, it is quite the opposite of the regular one. Sometimes companies reverse their share’s price because it is so low, that it is no longer attractive to some investors. Besides, in some cases it is done to meet price requirements of some stock
exchanges like NASDAQ. For instance, let’s suppose we have 4000 shares of Company X, whose
price is $1.00 each, and the company wants to make a 4:1 reverse split. This means that after it takes
place, the new share’s price will be $4.00, but now we will only have 1000 shares. Remember, the
invested money will always be the same, regardless of the split the company decides to carry out.
News
It is very important to keep updated with the news about both the general market, and the speciﬁc
companies. By doing so, you will be able to make better decisions when investing, either to the upside (buy long) or the down side (sell short). Some real-time services oﬀer this news almost immediately after being released, but they charge for it. Such a service is required only for day-traders (those
buying and selling within the same day). If you are planning to hold your investments for more than
a day, you can use a non-instantaneous news service, available for free on many web sites.
All of the calendars and news studied in this subchapter can be obtained on many websites. One of
the most important sites iswww.brieﬁng.com.
Also through our website www.number1stockpick.com you will have direct access to these sites,
where you’ll see all the calendars and news, at no charge.
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How to Become a Millionaire in the Stock Market
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Chapter: 5
Analysis to Be Considered When Making a Long Term
Investment
ow we will address the diﬀerent parameters that need to be analyzed before making a longterm investment. This is known as fundamental analysis or the analysis of the ﬁnancial statement and business projections of a company.
Fundamental Analysis
So far, you have learned that you can invest either to the upside or the downside, among other
things. Now, we will teach you techniques to predict, with a high percentage of certainty, the longterm movement of a company. This can be accomplished by making a fundamental analysis of the
company, which is nothing more than the study of its diﬀerent economic reports. In other words, it
is the analysis of its ﬁnancial statements and projections of business operations.
In this chapter, we’ll study those parameters which, in our judgment, stand out as the most important ones. We’ll look at: Earning Per Share (EPS), P/E Ratio, Return on Equity (ROE), Float, and
Upgrades/Downgrades.
How to Become a Millionaire in the Stock Market
EPS: Earnings per Share
This is the net income per share reported by a company and is one of the best indications of its
good or bad health. As we already know, all companies report their earnings quarterly. If you want
to measure how healthy the company’s ﬁnances are, all you have to do is compare the earnings of
the most recent quarter, with the ones of the previous year’s same quarter. Also, compare its current
annual EPS with the previous year’s EPS.
Once this comparison has been made, if the company’s earnings of this quarter increased in relation
to its previous year’s counterpart, it indicates that one of the parameters you are analyzing is positive,
which is a good sign if you are planning to invest to the upside. On the other hand, if this comparison
turns out to be negative, this is nothing more than a bad sign for buying long. Conversely it can be
a good candidate for short selling.
P/E Ratio: Price/Earning Ratio
This is the outcome of a formula in which the share price is divided by the company’s previous
year’s net earnings. Of course, as an investor you don’t need to calculate it, because the P/E Ratio is
reported in the company’s ﬁnancial statements. However, we will give you an example, so you can see
where this number comes from.
If the price of a share is $20.00, and the last year’s earning per share was $2.00, its P/E Ratio is 10,
see how simple it was. The lower the P/E Ratio, the better. These companies are prone to increase
their value much quicker than those having a higher one. Besides, when the market drops, these companies suﬀer much less than the others. Every industry has its own P/E Ratio, which is formed by the
average P/E Ratios of all the companies that comprise that industry. If you choose a company within
a given industry, you need to compare its P/E Ratio with the industry’s P/E Ratio. If the company’s
P/E Ratio is smaller that the industry’s, this means that such a company is doing better than the
average company in its industry.
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Chapter 5: Analysis to Be Considered When Making a Long Term Investment
ROE: Return on Equity
ROE is referred to as the return obtained from the average invested capital. It shows you the performance of the company’s directors, as far as managing the investors’ money is concerned. If a company is getting a good income for each dollar invested, you are in the presence of a good prospect to
buy long. In our perception, 12% or more is a positive indicator for investing to the upside. A ROE
of less than 10% is a sign of weakness in a company; therefore, it makes it a good candidate for investing to the downside. This parameter can also be found in the company’s quarterly ﬁnancial reports.
Float
This is the number of shares in circulation available to the public. There are some shares held by the
companies’ managers and chief executives, known as Insider Ownership. These shares, plus the ones
available to the public (Float) comprise the total shares that a company has, also referred to as Shares
Outstanding. For instance, if Company X has a total of 100 million shares outstanding and its insider
ownership is 25% (25 million shares), we may say that this company’s ﬂoat is 75%. So, in this case
we know that the number of shares in circulation available to the public is 75 million.
For a long-term investment, we recommend companies having less than 200 million shares in circulation (ﬂoat). The smaller the number, the more rapidly their value tends to increase, compared to
those having a bigger number. This is due to the fact that when a company has fewer shares available
for investors and the demand for these shares increases, their price tends to rise rapidly.
We want to point out that this doesn’t mean that companies with a big number of shares in circulation don’t make a good candidate for a long-term investment, at a certain time.
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How to Become a Millionaire in the Stock Market
Upgrades/Downgrades
This is a qualiﬁcation given by ﬁnancial analysts based on the company’s ﬁnancial statements and
business projections. It is important to be aware of these qualiﬁcations because when this information
is released to the public, it generally provokes a movement in the company’s shares. In the case of an
upgrade, which is a good qualiﬁcation, the company’s share usually tends to go up. On the contrary,
if the company is downgraded, its shares tend to go down. This information can be obtained in the
same websites, where the diﬀerent calendars and news are found.
There are several other parameters taken into consideration by analysts when performing a fundamental analysis on a company, but the ones studied in this chapter, in our judgment, are the best
indicators of the ﬁnancial state of a company. Next, we’ll show you an example of a company’s ﬁnancial report.
One of our favorite web sites to get these reports from is www.cnbc.com.
Earnings Estimates
Qtr (9/04) EPS Estimate
1.81
FY (12/04) EPS Estimate
7.37
Current P/E
FY (12/05) EPS Estimate
Forward P/E
This quarter’s estimated
earnings.
11.40
8.06
11.50
Anual estimated earnings.
Next Earnings Release: N/A
Current P/E Ratio.
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Chapter 5: Analysis to Be Considered When Making a Long Term Investment
Ownership Information
Shares Outstanding (Bil)
2.03
Institutional Ownership (%)
65.70
Top 10 Institutions (%)
27.71
Mutual Fund Ownership (%)
18.93
5% / Insider Ownership
Float (%)
1.68
Total of shares this company has in the market.
Shares in circulation.
98.33
Financial Highlights (All data for latest 12 months)
Sales
54.80 Bil
Income
12.18 Bil
Net Proﬁt Margin
22.20%
Return on Equity
12.80%
Debt / Equity Ratio
ROE
1.03
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How to Become a Millionaire in the Stock Market
Earnings Per Share - Quarterly Results
FY (12/04)
FY (12/03)
FY (12/02)
1st Qtr
$ 1.83
$ 1.59
$ 1.38
2nd Qtr
$ 1.86
$ 1.80
$ 1.40
3rd Qtr
N/A
$ 1.92
$ 1.45
4th Qtr
N/A
$ 1.82
$ 1.69
Total
$ 3.69
$ 7.13
$ 5.92
These are the four quarters’ earning per share reports for the last
three years, including the current
one, from which two quarters
have not been reported. The total
is the sum of all four. This helps
signiﬁcantly in evaluating the ﬁnancial state of a company, as explained earlier.
Before concluding this chapter, we want to avoid confusion by making it clear that these fundamental analyses must be deeply examined only when planning to make a long-term investment. As
you’ll see in the next chapter of technical or chart analysis, to predict the movement of a company
on a short-term basis, it is not necessary to deeply examine its fundamental analysis. With this, we
are not saying that it won’t be good to take a look at them, for if both align, it would be an ideal
investment.
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Chapter 6
How to Predict a Company’s Short Term Movement
n the previous chapter we covered the fundamental parameters that needed to be analyzed in
order to make good long-term investments. In this chapter we will teach you the best prediction
techniques that we have developed. This will help you predict the movement of a company on a
short-term basis, whether up or down. By analyzing a company’s graph, you will be able to detect the
company’s next move, this is known as “Technical Analysis”.
How to Conﬁgure a Company’s Chart
In this chapter we will cover the graph or chart analysis of a company. These charts reﬂect the movements of a stock during a given time, from the moment it went public (IPO), to the present time.
These charts can be obtained from the brokerage ﬁrm’s website where you open your account and
many other sites related to the matter.
Now we will show you how to conﬁgure them, again using the Ameritrade example. As you know,
their central page has several bars in the upper section. This time click on Research and then click on
Charts. NASDAQ’s chart (COMP) will automatically appear, as you’ll see next.
How to Become a Millionaire in the Stock Market
Indice del NASDAQ
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Chapter 6: How to Predict a Company’s Short Term Movement
Several parameters will appear on the right-hand side. They must be conﬁgured to get the desired
chart, in order to perform the technical analysis:
1.
Enter Symbol: Here you have to enter the symbol of the company or index to be analyzed.
2.
Time Period: This is the time period to analyze. For our analysis we generally use one or
three months intervals, sometimes even six, depending on the analysis we want to perform.
3.
This indicates the time frequency of each bar in the graph. For example, if you choose
weekly, each bar will represent one week. In our studies we use daily, which means that
each bar in the graph stands for one day.
4.
Upper Indicator: In this space we generally indicate All Events. It shows us in the graph
the events that have occurred in the company. For example: earnings, dividends, split,
etc.
5.
Lower Indicator: Here we always choose Volume which allows us to see the volume of
transactions of the company in a given time period. Since in this case we are using the
Daily frequency, one bar represents the volume of one day. This is a very important indicator for our analysis.
6.
Price Control: This is where you indicate how you want the price bars of your graph to
appear. We always use Candlestick, simply because it shows the bars very clearly in red (or
blue) and white.
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How to Become a Millionaire in the Stock Market
Highest price of the day.
White Bar
Closing price.
Lowest price of the day.
Highest price of the day.
Red Bar
Closing price.
Lowest price of the day.
7.
Once these parameters are conﬁgured, click on Draw Chart, to get the desired chart.
Here’s a graph with all these parameters conﬁgured.
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Chapter 6: How to Predict a Company’s Short Term Movement
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How to Become a Millionaire in the Stock Market
Technical Analysis
Now that we know how to conﬁgure a chart, let’s analyze the elements found within it. There are
several of them, but for the prediction technique we have developed, the ones we’ll be focusing on,
are the following:
Volume: This parameter tells us the number of shares that have been traded in a speciﬁc period of time, in accordance with the way we have conﬁgured our chart (daily or
weekly). Later on we’ll show you how this indicator inﬂuences the price movement of a
share.
Support Point: This is the lowest point, or close to it, that a company’s shares have reached during a given period of time.
Resistance Point: This is the highest point or close to it, that a share has reached in a given period of time. The diﬀerence between the support and resistance points is simply the
Range of Movement that a company has had during a speciﬁc period of time. To make
our predictions, we generally determine these parameters in time periods of one or three
months, although they can be determined in any other period.
Note: If you are planning to make a long-term investment, you can determine these parameters
in a longer period of time, depending upon the time you are willing to keep the investment for. For
example, if you are going to make an investment for one year you can determine them in a 1-year
period chart.
These parameters are the same ones to be analyzed in the charts of the diﬀerent general market
indexes as well as in the industry’s indexes.
Now, we’ll show you an example of how these parameters are determined in the two time periods
we generally use.
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Chapter 6: How to Predict a Company’s Short Term Movement
One-Month Period
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How to Become a Millionaire in the Stock Market
Three-Months Period
Now that you know how to determine the parameters you need to perform your technical analysis,
you’ll see how each one of them can show you with great accuracy, where the short-term movement
of a company is heading, either to the upside or downside. Once you know how to do this, you’ll
have an advantage over most investors since you will know when to enter or exit a position before the
movement occurs. This way you will be able to get the greatest return on your investments.
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Chapter 6: How to Predict a Company’s Short Term Movement
As we all know, this is not an exact science, but our experience has taught us that by making these
analyses correctly, we can have great accuracy when making a prediction.
That’s why we have decided to share this knowledge with you. If we would have had this knowledge
when we ﬁrst started investing in the stock market, we could have avoided many drawbacks. We don’t
want you to have the same experience.
To be able to perform these analyses, you must understand that the stock exchange market is cyclical. In other words, it goes up and down during certain periods of time. When we are in the presence
of an ascending cycle, the general market goes up more than it goes down; this is known as a Bull
Market. On the other hand, when the market is found in a descending cycle, general market goes
down more than it goes up; this is known as a Bear Market.
Like the overall market, the movements of both, companies and industry indexes, are cyclical as
well. Being aware of this, our objective is to detect in which cycle these companies and indexes are
found, in order to be able to predict where their next movement will be leading. If we combine this
with the support and resistance parameters, it will be much easier to predict such movement.
If a company’s chart is at its resistance point, the highest point or close to it in a given period of
time, combined with the volume parameter, which we will cover next, it would indicate that a descending cycle is about to occur. This gives you the opportunity to invest to the down side or to sell in
case you had previously bought these shares and have a proﬁt. On the contrary, if a company’s chart
is found at its support point or close to it, also combined with the volume, this would indicate that
an ascending cycle is about to occur giving you a good opportunity to invest to the upside, or take
your proﬁt in case you had previously made a short sell.
At this moment you might be asking yourself, “If a company is not found near its support or resistance point, namely, in the middle of its range of movement, how can I make a good prediction?”.
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How to Become a Millionaire in the Stock Market
That is, precisely the most diﬃcult point to perform an accurate prediction. What you can do in a
case like that, if you like the company, is to follow-up on it, until it gets as close as possible to either
its support or resistance point. That is why we recommend that you create a list with a wide number
of companies to follow, from diﬀerent sectors and industries, so you’ll always have a candidate that is
close to its optimal point to invest in. By doing this, you’ll always have a permanent source to make
money from with a high percentage of safety.
Now, let’s study in detail the volume parameter, which will be a key factor in your analysis. The
volume parameter, combined with those covered above, make up the formula we use to make highly
accurate predictions.
How does volume inﬂuence the movement of a company? As you already know, the volume represents the amount of transactions that a company has had during a speciﬁc period of time. When
analyzing this parameter in a chart, our objective is to detect if there has been an increase or decrease
in volume.
Volume Increase or Accumulation at the Support Point
When analyzing a company’s chart, if you observe that it is found at its support point or close to it,
with a volume increase or accumulation, it is an indication that at this point, this company’s shares
have become attractive to buyers. Therefore, the descending cycle has come to an end. Meaning that
in a very short time, a rise will take place, as shown in the following examples.
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Chapter 6: How to Predict a Company’s Short Term Movement
This particular example was of an investment we made. Following our analysis, we bought one
thousand shares at $45.00 each, and as you can see, its price reached $49.00 a few days later. We then
sold them at $48.50, right after we saw the ﬁrst sign of weakness, obtaining a good proﬁt.
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How to Become a Millionaire in the Stock Market
This next example is similar to the previous one. The only diﬀerence is that here we did not notice
a great volume increase on any given day. But using our common sense, we realized that the sum (accumulation) of all of the daily volumes in this time period, close to its support point, was a good sign.
This allowed us to conclude that this company’s shares were about to have an ascending movement:
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Chapter 6: How to Predict a Company’s Short Term Movement
Volume Decrease At Its Resistance Point or Close to It
This is quite the opposite of the two previous examples. When analyzing a company’s chart, if you
ﬁnd that it is at its resistance point or close to it, and you also observe that its volume is starting to decrease, it is a clear indication that the number of buyers for these shares at this price is also decreasing.
When this happens, a company’s shares will start to fall. In view of this negative sign, those who had
bought them before and have a proﬁt will begin to sell, pushing the price even lower. And if to all of
this we add the investors who bought these shares without making a good analysis but only because
they saw some previous ascending movements; realizing now the big mistake they made, they start to
sell their shares to cut their losses, thus contributing even more to this fall.
Now we’ll see two examples where this is clearly demonstrated:
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How to Become a Millionaire in the Stock Market
As shown in this example, at the beginning of April, this company was at its resistance point. We
looked at its volume and saw that during those days it decreased. This gave us a clear sign of an imminent fall. A great opportunity to make money investing to the down side.
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Chapter 6: How to Predict a Company’s Short Term Movement
In this example, two days after this company reported better than expected earnings, its shares
reached their resistance point and experienced a decrease in volume at the same time. This paved the
way to a great fall in their price, demonstrating that when a good technical analysis has been performed, predictions almost never fail.
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How to Become a Millionaire in the Stock Market
Companies at Their Resistance Point or Close to It, While Experiencing High Volume
This means that although a company is found at its resistance point, or close to it, while still having
good volume, you must wait. Since this indicates that there are still many investors who are interested
in buying these shares at this price. Generally, as long as this situation continues, the share’s price can
keep going up. Of course, this company is very close to becoming a good candidate for a downside
investment. All you need to do is just wait until its ascending movement stops and its volume decreases a little. Here’s an example:
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Chapter 6: How to Predict a Company’s Short Term Movement
As seen in the graph, this company has surpassed its three-month resistance point. This generally
happens when a company is going up while experiencing high volume.
Descending Movement With High Volume
When you analyze that a company’s chart is having a descending movement, but experiencing high
volume, even though it is close to its support point, we do not consider such a volume as a clear sign
for an up trend. Rather we see this, as the outcome of a panic sale, for it is nothing more than a great
number of investors selling their shares. In this case, the number of sellers is greater than the number
of buyers. Therefore, this share’s price may continue to drop.
In a situation like this, you should follow this company until its price stabilizes at a point, maintaining a good volume at the same time, indicating that its price is being supported; therefore the
descending cycle is over. Thus, this company becomes a good candidate for investing to the upside.
Here’s an example:
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How to Become a Millionaire in the Stock Market
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Chapter 6: How to Predict a Company’s Short Term Movement
Support Point With Low Volume
When a company is at its support point, but is experiencing low volume, let’s not get confused,
because its price can keep falling. Despite of being at the support point for this period, it still remains
unattractive to buyers. Its low volume demonstrates this. Here’s an example:
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How to Become a Millionaire in the Stock Market
At the end of April, this company was at the support point for this period. If we were not aware of
the signiﬁcance of the volume, we could have gotten confused and had invested to the upside. But as
you can see, its volume even decreased, provoking a big price downfall.
So far, we have covered the diﬀerent types of technical analyses we use in order to make an accurate
prediction. But, as we stated earlier, these analyses can be performed on both the general market and
industries’ indexes. As we have previously stated, it is very important to have an idea where the speciﬁc company’s industry index as well as the main market indexes are heading.
Summing up, before making an investment, we recommend that you perform a technical analysis
on both, the main market indexes’ charts, and especially on the speciﬁc company’s industry index.
Now we’ll show you examples of charts that belong to the main market indexes, the semiconductor
industry (SOX), and of the company Maxim Integrated Products Inc. (MXIM), which belongs to
this industry.
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Chapter 6: How to Predict a Company’s Short Term Movement
Dow Jones
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How to Become a Millionaire in the Stock Market
Nasdaq
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Chapter 6: How to Predict a Company’s Short Term Movement
SP 500
Like the industry indexes, the S&P 500 does not show its volume. So we can only analyze its
resistance point, support point, and its range of movement. Remember that when we perform the
analysis to these general indexes, we do it just to get a general idea of how the market sentiment is, in
order to better support the company’s prediction.
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How to Become a Millionaire in the Stock Market
Semiconductor Index
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Chapter 6: How to Predict a Company’s Short Term Movement
Company: MXIM
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How to Become a Millionaire in the Stock Market
If we create a small table with the charts to be checked, it would appear like this:
Company
MXIM
Industry Index
SOX
General Market
Dow, Nasdaq, SP500
By applying the studied technical analysis to these charts, on the ﬁrst few days of April, we noticed
that the company, the index to which it belongs, as well as the main market indexes, were at their
resistance point. We also noticed that there was a decrease in their volume, especially in the company,
where this indicator has the greatest inﬂuence. In other words, at that moment all the indicators were
lined up, giving us an extremely accurate sign that this company was going to fall. Therefore, this
one was an ideal candidate for investing to the downside.
Using these same graphs and applying the same technical analysis, we saw that on the ﬁrst days of
May, all of these indicators lined up again. But this time at their support point and the company had
a good volume accumulation. This once again, gave us a great opportunity to invest to the upside,
with a high level of certainty. As you can see in the graphs, we showed you a few more times where
all these elements lined up again during the specify time period. These alignments do not happen too
often. In this case, we detected ﬁve in a three-month period.
You may be asking yourself, “Do I have to wait solely for these optimum moments to make my investments?” The answer is No! Although these are the best opportunities, not all of these parameters
have to line up for us to be able to make a correct prediction. The company’s technical analysis is the
most important one. Therefore, we will use the analysis of the other indexes previously studied only
as a reference, or a secondary indicator, especially the industry’s index.
We tell you this because in our personal experience, we have seen that when the company’s chart
analysis gives us a solid indication to where its movement is heading, it can even go against the movement of both the general market and its industry. In such a case, if we had been waiting for all of
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Chapter 6: How to Predict a Company’s Short Term Movement
them to be lined up, which is, of course, the ideal investment situation, we would have lost a good
opportunity.
Note 1: We want to point out that even though a good prediction has been made, sometimes it can
go a little bit against us. If this happens, don’t be alarmed. As long as the technical analysis we have
shown you has been well applied, this prediction will be fulﬁlled at some point.
Note 2: It is very important for you to know, that the only factor that may aﬀect these predictions
are the unexpected, surprise news about the company, or about the market in general. For example:
the catastrophic terrorist act of September 11, 2001, provoked a great downturn in the general market. If on that day we’d made a good prediction to the upside, it would have most likely gone against
us. We also want to point out, that we do not recommend making a prediction for a company the
day before its earnings report.
How Do Companies React to Splits and Dividends?
In our studies of the stock market we have analyzed certain events that inﬂuence the short-term
movement of a company. Such events are: dividends and splits.
Dividends: Before this event takes place, the company’s shares usually tend to go up. This is due to
the fact, that in order for anyone to be entitled to collect these dividends, the corresponding shares
should have been bought before the ex dividend date. Therefore, if the demand for these shares increases, their price tends to rise. Likewise, a few days after dividends have been collected, these share’s
price tends to go down. Next is an example where this is clearly illustrated.
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How to Become a Millionaire in the Stock Market
As you may notice, on the ﬁrst few days of March, this company reported dividends. A few days before the dividends were reported its price started to go up, despite being near the resistant point. You
may also observe that after dividends were reported, the share’s price started to drop. In other words,
this parameter was lined up with our technical analysis. On that day, these shares were at their highest
point, and without much volume, giving us a perfect opportunity for a downside investment.
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Chapter 6: How to Predict a Company’s Short Term Movement
Splits: Generally, when a company makes a split, its price tends to rise. As we remember, companies
do this in order to make their share’s price more attractive to investors. Here’s an example:
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How to Become a Millionaire in the Stock Market
In this example, after the split took place, the share’s price went up more than six points in a couple
of weeks. This is due to the fact that after the 2:1 split, the new price of these shares was $26.50, as
compared to the $53.00 they were trading at before the split took place. Besides, we noticed that
there was a big volume increase at this point as well.
Note: We use these two indicators (Splits and Dividends) only as additional support to our technical analysis.
We hope that you have understood this chapter very well, because it is going to be very important
in your investing career.
On our website, www.number1stockpick.com , we oﬀer a minimum of 10 predictions every week,
using the techniques exposed here, so you may prove the accuracy of our analyses, for a modest monthly subscription.
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Chapter 6: How to Predict a Company’s Short Term Movement
A List of Most Market Industries, Indexes, and the Companies Conforming Them
Semiconductor - SOX
ALTR
AMAT
BRCM
INTC
KLAC
LLTC
LSI
MOT
MU
MXIM
NSM
NVLS
TER
TXN
XLNX
PMCS
Software - GSO
ADBE
ADSK
ADVS
ATVI
BEAS
BMC
BORL
CA
CDN
CHKP
COGN
CPWR
CTXS
INFA
PSFT
VRTS
MSFT
ERTS
NOVL
ISSX
ORCL
PMTC
MERQ
MENT
KRON
ITWO
Networking - NWX
ADCT
TLAB
ADTN
AFCI
ALA
AXE
CIEN
CMVT
COMS
CSCO
ECIL
JNPR
LU
SCMR
Telecom - XTC
T
BLS
NOK
QCOM
SBC
VZ
S
ERICY
EK
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How to Become a Millionaire in the Stock Market
Biotech - BTK
BIIB
AFFX
AMGN
CEPH
CHIR
CRA
DNA
ENZN
GENZ
GILD
HGSI
IVGN
MEDI
MLNM
PDLI
IMCL
Internet - GIN
EBAY
AMZN
YHOO
PCLN
TIBX
RNWK
INSP
GOOG
IACID
Internet China
NTES
CHINA
SOHU
SINA
EWEB
PCNTF
Defense - DFX
ATK
BA
DRS
GD
GE
GY
ITT
LLL
LMT
NOC
RTN
TDY
UTX
EASI
Gold - XAU
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ABX
AEM
AU
FCX
GFI
GG
HMY
MDG
NEM
PDG
SIL
Chapter 6: How to Predict a Company’s Short Term Movement
Utility - UTIL
AEP
AES
CNP
D
DUK
ED
EIX
WMB
FE
NI
PCG
PEG
SO
TXU
Brokers - XPD
AGE
AMTD
BSC
ET
GS
JEF
LEH
MER
MWD
RJE
SCH
Oil Service - OSX
BHI
BJS
CAM
GLBL
GSF
HAL
NBR
NE
RDC
RIG
SII
SLB
TDW
VRC
WFT
Retail - RLX
GPS
HD
LOW
BBY
SHLD
ANN
COST
BJ
ROST
BEBE
TJX
TGT
JCP
TIF
WMT
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How to Become a Millionaire in the Stock Market
Housing - HGX
ASD
USG
VMC
BZH
CTX
DHI
KBH
LEN
MAS
PHM
PMI
RDN
RYL
TIN
TOL
Bank - BKX
BAC
BBT
BK
C
JPM
KEY
KRB
FITB
MEL
NCC
NTRS
WFC
WM
STI
USB
WB
Drug - DRG
ABT
AMGN
AZN
BMY
FRX
GSK
IVX
JNJ
KG
LLY
MRK
PFE
SGP
WYE
Hardware - GHA
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AAPL
QLGC
ADPT
RIMM
BRCDE
STK
DELL
SUNW
DSS
WDC
ELK
NTAP
EMC
PALM
GTW
HPQ
MXO
IBM
LXK
MCDT
Chapter 7
Discover The Secret of Penny Stocks
n this chapter you will learn how to make good investments with very little capital, whether on
a short or long-term basis, in companies whose price is in the range of pennies, thus the name
Penny Stocks. As you will soon ﬁnd out, little money invested in these companies can realize huge
proﬁts.
What Is a Penny Stock?
As we mentioned in chapter 1, there are companies known as Penny Stocks. This term means
that the share’s price is quoted below $5.00. They are very good companies to invest in, because by
investing a small amount of capital in them we can realize great proﬁts. One of the objectives of this
chapter is to learn how to choose the right candidates, which are analyzed by performing the same
technical analysis previously learned, in addition to other parameters we need to consider when selecting them.
In our personal experience we have obtained great results in this type of investment, therefore, we
recommend them to investors that have limited start-up capital. Of course, it does not mean that it
How to Become a Millionaire in the Stock Market
isn’t also good for investors holding a large amount of capital.
Learn How to Invest in Penny Stocks and How to Select the Best Ones
Within this category of companies, we are going to place emphasis on those whose shares are trading below $1.00, since the lower their price, the greater the number of shares we will be able to buy,
and the less movement we’ll require to obtain good proﬁts.
These companies are only bought to the upside, which means that the possibility of making money in this type of investment is only if their shares go up. Therefore, our technical analysis will be
focused only on looking for the candidates to rise, although after an investment has been made and
proﬁts have been obtained, it is going to be necessary for you to make use of these technical analyses
to the down side, in order for you to know when to get out of the position.
We want to point out that when analyzing these companies, we will have to perform a study only
on their charts, since these cent-priced shares can go up or down independently of the market behavior.
Summing up, to get good results in this type of investment we only have to analyze the company’s
graph, in the case of a short-term investment. If you are planning to make a long-term investment
in these kinds of companies, it is necessary to take a look at their fundamentals in order to have an
idea about their ﬁnancial state and future projections.
Note: These companies are traded at the NYSE, AMEX, NASDAQ and OTCBB.
Personally, we make this type of investment on a short-term period, although sometimes we have
made it on a long-term basis as well, obtaining great returns.
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Chapter 7: Discover The Secret of Penny Stocks
Parameters to Bear in Mind When Choosing a Good Penny Stock Candidate
Something you must keep in mind, is that these companies must have liquidity. In other words, a
good volume of transaction, and, above all, their “Bid” and “Ask” must be as close as possible, that
is, they must have a small spread. It is extremely important to keep this in mind: since these shares
are worth pennies, when investing in them on a short term basis, all you’ll need is a few cents movement to obtain good proﬁts. These companies’ shares are bought and sold the same way as the other
companies’ shares are.
According to our experience, it is necessary to have access to Level II when trading them, to be able
to have a better reference.
Here’s an example of a penny stock Level II:
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How to Become a Millionaire in the Stock Market
As you can see in this example, the number of shares to be sold is greater than the number of
shares to be bought. This tells us that the immediate movement tendency of this company will be a
descending one.
In this book we have used Ameritrade for our examples, because it is one of our favorites for trading
penny stocks; ﬁrst, for their low commissions, and above all, for the Level II they oﬀer.
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Chapter 7: Discover The Secret of Penny Stocks
Now, we’ll show you some penny stock examples, where you can see the eﬀectiveness of our technical analysis on both, short and long term.
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How to Become a Millionaire in the Stock Market
Short-Term Investment Examples
In this example, we saw that in May we got a clear sign of an increase in volume, that when combined with the accumulation (in millions) of previous days, turned out to be a perfect indication to
the upside. If you had bought 100,000 shares at $0.01, they would have cost $1000, and six days
later, you could have sold them at $0.15 each, obtaining $15,000, a 1500% return (we made this
investment).
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Chapter 7: Discover The Secret of Penny Stocks
This example clearly shows the result of our technical analysis. If we had bought 2000 shares at
$1.10, investing $2,200, four days later we could have sold them at $1.60 each, getting a proﬁt of
$0.50 per share or $1000, approximately a 45% return for the whole investment.
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How to Become a Millionaire in the Stock Market
This is another example of our analysis. If we had bought 20,000 shares at $0.13 each, investing
$2,600. Ten days later these shares could have been sold at $0.16. If, at that moment, we had decided
to sell them, we could have netted $600, approximately a 25% return. This example demonstrates
that with a three-cent movement, we could have been able to obtain a good proﬁt. This can be accomplished with a company, which like the one in this example has a very close bid and ask (small
spread). In this type of investment, a single cent that you may save when buying them, makes the
diﬀerence. According to our perception, this company can still continue to rise.
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Chapter 7: Discover The Secret of Penny Stocks
Here we observe a volume accumulation at the support point. Buying 2000 shares at $1.00, would
have allowed us to get a $0.25 per share proﬁt or $500, a few days later.
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How to Become a Millionaire in the Stock Market
This chart shows us the volume increase (in millions) this company had at $0.17 (support point).
If we had bought 10,000 shares at this price, investing $1,700, six days later we could have sold them
very easily at $0.25 each, getting a proﬁt of $800, approximately a 50% return. Chances are that this
company may, keep going up. In fact, if we take a look at its three-month chart, we’ll see that it is still
close to its support point, and still keeping a good volume.
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Chapter 7: Discover The Secret of Penny Stocks
In this example, you can also see the result of our technical analysis. If we had bought 10,000 shares
at $0.26 each, investing $2,600, three days later those same shares were being sold at $0.39, which
represents a $0.13 per share proﬁt or $1,300, a 50% return.
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How to Become a Millionaire in the Stock Market
This is another one of our many examples. At the beginning of May, this company was found at its
support point with an increase in volume, giving us a good sign to the upside. If we had bought 2000
shares at $0.70 each, investing $1,400, a few days later, we could have sold them at $1.00 per share,
receiving a net proﬁt of $600.00, a 43% return.
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Chapter 7: Discover The Secret of Penny Stocks
Long-Term Investment Examples
This is an example of a penny stock long-term investment. At the end of September the company
experienced a great increase in its volume (in millions), combined with the accumulation that had
been taking place during the last three months, it gave us the perfect sign that this company was
about to take-oﬀ. If you look at it a little closer, you may notice that its price was $0.001 per share.
If we had bought one million shares they would have cost $1000.00, and six months later, at the end
of March, we could have sold them for $0.15 each or 150 times what we had previously invested,
that is, $150,000, which represents a whopping 15000% rate of return. For those who are planning
to invest on a long-term basis and don’t have much capital, we recommend them to make this type
of investment as a sort of mutual fund. Stated otherwise, you may want to invest small amounts of
money in companies like this one, every month, and you will see that the results will be surprising.
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This one was another good long-term investment. On October 2002, these shares were being traded in the $0.40 range, with a big volume accumulation. A year and a half later, their price reached
$9.00. If you had bought 5000 of them at $0.40 each, investing $2,000, you could have sold them
at $9.00 each, making a huge $43,000 proﬁt, approximately a 2,200% return.
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Chapter 7: Discover The Secret of Penny Stocks
In this other long-term investment example, you can see that on October 2002, these shares
could have been purchased at $0.20 each, which was the lowest point of this company’s history,
while also having a good volume accumulation. At that point 10,000 shares would have cost
$2000, on January 2004, less than a year and a half later, these shares reached a price of $10.00
each, in other words, your $2000, would have turned into $100,000.
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How to Become a Millionaire in the Stock Market
On October 2002, this company’s shares were trading at $0.60 each, their lowest price ever,
and notice the volume accumulation. If back then, we had bought 5000 shares worth $3000, on
February 2004, almost a year and a half later they could have been sold at $16.00 each. Our initial
investment of $3000 would have become $80,000.
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Chapter 7: Discover The Secret of Penny Stocks
These are just some of the many examples seen in the stock market everyday. Our purpose has
been to demonstrate to you that these companies, with a correct analysis, can be a great opportunity to invest in, on a long term as well as on a short-term basis, thereby increasing your ﬁnancial
standing.
How to Turn $1,000 into $30,000, $40,000 or More in a Very Short Term, by
Investing in Penny Stocks Whose Prices Are Below One Cent (A List of Over 25 of
These Companies Is Included)
Before we conclude this chapter on penny stocks, we want to show you a type of investment that
in our personal case has brought us huge returns, using very small amounts of capital.
These companies are also found in the penny stock category. But, unlike those we have already
analyzed, their share’s price is below one cent. These are very small capitalization companies. That’s
why they are not traded in the main stock exchanges. As you can see, their price is extremely low,
giving you a perfect opportunity to obtain great returns, while only investing small amounts of money.
There are several stock exchanges where these companies are traded, but we’ll be focusing mainly on
those trading on the OTC-BB. They are the only ones which, at such a low price, their Level II can
be seen. This is extremely important, since we’ll always be able to see their Bid and Ask.
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How to Become a Millionaire in the Stock Market
How to Select the Right Ones?
For this type of investment, only companies having a high daily volume of transactions, in the
range of millions, are qualiﬁed. As you already know, this provides liquidity. Therefore, their spread
will be tiny, this is the most important factor to keep in mind whenever choosing a candidate, since
many times, with just a hundredth of a cent movement, good proﬁts can be obtained.
As said earlier, in this type of company, you can only invest to the upside, so we’ll be focused on
the technical analysis that indicates an upside sign. That is to say, the objective is to detect a volume
increase or accumulation at the company’s support point.
Something else you must do before investing in these companies is to check their most recent news,
because you don’t want to invest in candidates, whose news is negative. Remember: the more positive
indicators that are lined up, the greater the success your investment will have.
These news articles can be accessed through the research center located on our website: www.number1stockpick.com.
Now, we’ll show you a few examples, so you can understand this more clearly.
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Chapter 7: Discover The Secret of Penny Stocks
As you can see, at the end of August, our technical analysis gave us a clear upside sign. At that moment, 100,000 shares would have cost $1000 ($0.01 per share), and two days later they could have
been sold for over $40,000, a 4000% return.
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How to Become a Millionaire in the Stock Market
In this case, when our analysis gave us the sign, this share’s price was $0.005, or half a cent. With
$2500, you could have bought 500,000 shares, and as the chart shows, a few days later they could
have been sold at $0.12 each, or 24 times the original investment. In other words, the $2500 would
have turned into $60,000 (A good proﬁt in only a few days).
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Chapter 7: Discover The Secret of Penny Stocks
In this example, at the end of August, our analysis gave us a good up trend sign, at that moment,
the share’s price was $0.0005, or half a 10th of a cent each. 1,000,000 shares would have cost $500,
and a few days later they could have been sold for $10,000, or 20 times the invested capital. As you
can notice, to get this great proﬁt, this share’s price only had to reach one cent.
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At the end of August, our analysis gave us a clear sign to the upside. At that point the price of these
shares was $0.001 each, or a tenth of a cent. $1000 would have bought 1,000,000 shares, and again,
a few days later they could have been easily sold at $0.015 each, which is equal to 15 times of what
was initially invested.
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Chapter 7: Discover The Secret of Penny Stocks
As the chart shows, this company was at its support point during mid-July, and the it was experiencing a great increase in volume, giving us a perfect sign to the upside. In other words, it told us that
this company was going to go up, as it actually happened a few days later, reaching a price of almost
$0.06 per share. When this company was at its support point, 500,000 shares were worth $1,600.
These same shares, if sold at $0.05, would have produced a proﬁt of $23,400.
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To conclude, we’ll show you a list of over 25 good candidates for your database and a Level II of
one of these companies.
List of Companies Whose Prices Are Below One Cent
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BTOR
ZWLL
CYOS
TSBI
ITCV
AXAG
CRHM
GAWY
USXP
SNNW
APPI
EWMD
RNKE
PHXL
UNCN
RNVO
FGWC
DNAP
BTOO
CNEXE
HEXS
CNES
MDGN
BIBO
CYBT
TNGOE
PCOR
Chapter 7: Discover The Secret of Penny Stocks
Note: If at any time, one of these predictions goes a little to the opposite direction, please do not
be alarm, in such a case what we do is apply a technique called averaging, which is nothing more
than, if for example, we buy 10,000 shares of a company at $0.20 each, investing $2,000, and for
any reason, these shares’ price falls temporally down to $0.10, creating a new support point at this
level, we buy another 10000 shares (of course after having performed a new analysis at this point),
averaging our total cost at $0.15 ($0.20+$0.10) divided by 2=$0.15. If these shares’ price comes back
to $0.15, we would recover our losses, and if it comes back to $0.20, price originally paid for the
ﬁrst ten thousand, we would have obtained a proﬁt of $1,000. If in this example this strategy hadn’t
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How to Become a Millionaire in the Stock Market
been used, when the shares’ price came back to $0.20, we would have just recovered our losses. In
other words, when entering in a loss, by using this strategy we will be requiring smaller movements,
to get out of such a loss. This technique can be applied to options, stocks, penny stock or any other
type of investment
Now, we’ll oﬀer you a list of 50-penny stocks, whose prices are below $1.00 and they all meet the
requirements previously analyzed. This list will serve you as a good database that, by applying to them
the prediction techniques learned in this book, you can always have good candidates to invest in and
make lots of money.
On our web site www.number1stockpick.com, you will ﬁnd predictions of penny stocks every
week that are ready to make a move.
List of Good Penny Stock Companies Whose Prices Are Below One Dollar
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NASDAQ
AMEX
OTCBB
POSO
PMU
GZEX
CRDM
SOS
PWLX
TMAR
ONT
BPTR
VRSO
AAC
FRCP
MCLD
VRA
LPLHA
ECGI
ISO
KNOS
FTGX
WBR
PKCY
GNLB
HEC
IMDS
ASTM
EAG
MDGN
DYTK
IIP
SCRH
LOUD
DOR
RMSG
HOFF
HIV
SDNA
CLTK
AMW
MSSI
Chapter 7: Discover The Secret of Penny Stocks
List of Good Penny Stock Companies Whose Prices Are Below One Dollar
BCON
AGT
PMED
ANCC
AND
SEVI
FMDAY
FNT
MBTT
GLGS
IBD
ONEV
SCON
IAO
ISME
NXXI
ANX
SISI
AETC
AVR
TSRG
EDEN
PRG
PWLS
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Part II
How to Become a Millionaire in the Stock Market
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p to this point, we have covered how to open an account, how to predict, with a high percentage of accuracy, a company’s movement, what penny stocks are, and diﬀerent types of stockrelated investments.
In this second part, we will teach you all about stock options, which is a ﬁnancial instrument that
gives you the possibility of making money, while only investing a fraction of the capital needed to
invest in stocks as such. As you may have observed in the previous chapters, penny stocks are the
only type of investment that allows you to obtain good proﬁts by investing small amounts of money.
So you may be wondering if only by having large amounts of capital it is possible to invest in stocks
with a higher price ($20 to, in many cases over $100) in order to obtain good proﬁts. The answer is
no. That is precisely what you’ll learn in this interesting second part.
Chapter 8
The Interesting World of Options
ere you will learn, in the simplest of ways, the basic concepts of options, the diﬀerent types of
options that are available, their advantages and objectives. You will also learn how to select the
best option contracts to invest in.
What Is an Option?
An option is the right, but not the obligation, to buy or sell shares of stock (in case of a stock option), at a speciﬁc price, within a speciﬁed date. Now, we’ll give you a simpliﬁed example, which we
think is similar to the way options work.
If you were to buy a house during pre-construction, you would sign a pre-construction contract.
Suppose that, at that moment, your future house has a value of $100,000. If you pay $5,000 in advance as a guarantee to buy this house, after one year (duration of the contract), you will be entitled
to buy it for the price previously agreed upon in the contract, regardless of its market price once the
construction has been completed. For example, let’s assume that this price will be $120,000. As you
may see, by doing this, you could have obtained a $20,000 proﬁt, investing only $5,000, which re-
How to Become a Millionaire in the Stock Market
presents a 400% return.
On the other hand, If you had paid the house in full ($100,000.00) from the beginning, you
would have obtained the same $20,000 proﬁt, but investing a bigger amount of money. In other
words, you would have obtained only a 20% return. This is just a hypothetical example, aiming at
making you more familiar with the option mechanism. In the exchange market, the house is nothing
more than the shares of a company.
Getting back to the options. If an upside or downside movement of a company is predicted, all
you have to do is buy an option contract for a fraction of the value of the company’s shares, instead
of buying them, just as we did in the example with the house. The only diﬀerence is that option contracts are traded in the Option Exchange Market, and like stocks, they can be sold at any time after
their purchase.
An option contract is equivalent to 100 shares; in other words, with each contract we will manage
100 shares.
These option contracts are bought and sold in option exchange markets which operate like stock
exchange markets. There are several of them. The main one is CBOE (Chicago Board Option Exchange), followed by AMEX, BOX, MIBSX, BHL, and IPSE.
Types of Options, Objectives and Advantages
There are two types of options, Calls and Puts:
Calls: A Call option contract is the right to buy one hundred shares of a company at a spe-130-
Chapter 8: The Interesting World of Options
ciﬁc price, within a speciﬁed time. This contract is used when we think that a company’s
share’s price is going to go up, in other words, it is the equivalent of buying the shares
(buy long), but with a fraction of the money they would cost.
Puts: A Put option contract is the right to sell one hundred shares at a speciﬁc price,
within a speciﬁed time. This contract is used when we believe that the share’s price of a
company is going to go down. Stated another way, it is like selling short, but investing a
fraction of the money this would cost.
Now that we know the two types of options that exist, and the purpose of buying them, let’s start
shaping the puzzle. When we were talking about a pre-determined price, we were referring to what
in the option world is known as Strike Price. When we mentioned a speciﬁed time, we were talking
about the Expiration Date, or in other words, when the option contract expires.
Regular options may have a duration time of up to nine months, and they expire the third Friday
of each month. For instance, if you buy a July option contract, it will expire on the third Friday of
July. Let’s see the following example for a better illustration:
1 INTC 04/June 30 Call
•
1: This stands for the number of option contracts we want to trade. In this case, 1, so we
will be managing 100 shares.
•
INTC: This is the company’s symbol we are buying this option contract for.
•
04/June: This is the month when the option contract will expire. In this example, it’ll be
the third Friday of June 2004 (sometimes in the option chains, instead of the year and
month you are going to see the option contract symbol, don’t get confused because it is
the same thing, in such a case the expiration month and year will be on the upper section
of the chain).
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•
30: This is the Strike Price or the price at which these shares can be bought, at any time,
until this contract expires. We say ‘to be bought’ because in this example it is a Call.
•
Call: This is the type of option we are going to trade.
Let’s say that this company’s shares have a price of $30 each. In this particular case, since it is a call,
even though the share’s price goes up to $40.00, if you exercise your option, the person who sold
this call (known as the option writer) has the obligation to sell these shares to you at $30.00 (strike
price). From there you can sell them if you wish, at $40.00 (market price at this moment) and obtain
your proﬁt. We want to point out that almost nobody carries out this operation, for option contracts
can be sold in the option exchange market and the same proﬁts can be obtained without having to
exercise them.
In the case of a put, it is the opposite. You have the right to sell these shares at a pre-determined
price, regardless of the price they reach. For example: if a company’s shares are trading at $30.00 each,
you buy a put with a 27.5 strike price, and seven days later, the share’s price goes down to $20.00, at
that moment you can exercise your option if you want. Let’s assume you do, meaning that whoever
sold this put (the writer) has the obligation to buy these shares from you at $27.50, regardless of their
new price. In other words, you can buy them at $20.00 in the market and sell them to the option
writer at $27.50 and obtain your proﬁts. But, as we said in the example of the call, almost nobody
does this because you can get the same proﬁts by selling the put as such, which is simpler.
The objective of this explanation is only for you to have a better idea of how money is made with
options, because we are sure that you are never going to exercise one. In our personal case, we have
never done it.
Note 1: If by any chance you happen to buy either a put or a call, and on the expiration day
this contract is in the money (it has intrinsic value) and for whatever reason you forgot to
sell it (something hard to believe). Don’t worry, you won’t loose your money, since in such
a case, your brokerage ﬁrm will automatically exercise it on your behalf and the money
will go to your account.
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Chapter 8: The Interesting World of Options
Note 2: We want to make clear that these transactions are not carried out from person to
person, but through the option clearing corporation. This ﬁrm is in charge of connecting
the option writers with the buyers electronically.
These option contracts, like stocks, have their own symbol. Now, let’s see what an option price table
(option chain) looks like.
Company’s symbol.
This is the expiration month
of these contracts.
These are the diﬀerent strike prices.
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It is necessary to know the price of the company’s shares before choosing the right strike price for
your option contract, since, as we can see in the table, these options have several strike prices, which
can be at the Money, Out of the Money, or In the Money, in relation to the stock’s price.
At the Money: This means that the option’s Strike Price is equal or close to the share’s
price. For instance, if shares of Company X are being quoted at $25.00 and you buy a Put
or a Call with a 25 Strike Price, this option contract is known to be At the Money.
Out of the Money: In the case of a Call, this is when the strike price is greater than the
share’s price. For example, if the price of a share is $25.00, and you buy a call option contract for this company with a strike price of 27.5, then this is an Out of the Money call.
In the case of a Put it is the opposite, namely, if the strike price is below the share’s price,
such contracts are Out of the Money. For example: if the price of a share is $25, and the
Put’s strike price is 22.5, we are in the presence of an Out of the Money Put.
In the Money: In the case of a Call, this means that its strike price is below the share’s
price. For example, if the price of a company’s share is $25.00 each, and the option’s strike
price is 22.5, this contract is In the Money by $2.50. In the case of a Put, it is the opposite. If the option’s strike price is greater than the share’s price, it is an In the Money put.
For example: if you buy a Put option contract for Company X , whose shares are trading
at $25.00, and the strike price of your Put is 27.5, this contract is $2.50 in the money.
The value, for which a contract is in the money, is known as Intrinsic Value.
Our purpose in mentioning the Intrinsic Value in the previous example, is because we want you to
know what the price of an option contract is comprised of. In the case of an In the Money option,
its price is comprised of its intrinsic value + time value. For example, in the previous case, that the
Put was $2.50 in the money, if this contract were selling for $3.00, we would know that its price was
comprised of 2.50 intrinsic value + 0.50 time value.
The intrinsic value increases or decreases, depending upon the company’s share movement, whereas
an option’s time value decreases as it gets closer to its expiration date. Therefore, the longer the time
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Chapter 8: The Interesting World of Options
a contract has to expire, the greater its time value will be. Knowing this, your objective is to pay as
least as possible for the time value, for this value starts getting consumed or aﬀected as time goes by.
We’ll further explain this in more detail.
The price of At the Money and Out of the Money contracts are comprised only of time value, because, remember, they have no intrinsic value at all.
Note: When an option contract is in the money or out of the money by a great margin of points, it
is known as a Deep Out of the Money or Deep in the Money contract. So, if you see this terminology
somewhere, you’ll know what it means.
Now, we will explain to you two parameters to keep in mind when buying an option contract:
Volatility: This is the average daily movement a company has experienced during a certain period of time. The more a company moves, regardless of its direction, the greater
its volatility will be. It is very important to be aware of this when buying an option, since
they depend on the shares’ movement, which means that we must stay away from companies with a low volatility. This can be known simply by looking at the company’s chart,
and determining its range of movement.
Delta: This is referred to as the percentage of the price increase of an option in relation
to the share’s movement. For example, an option contract having a 60% Delta means
that for each dollar the share’s price increases, this contract will approximately increase by
$0.60. Knowing this, we arrive at the conclusion that the more in the money a contract
happens to be, the greater its Delta will be. Sometimes earning even as much as the share,
in other words, they have a Delta of almost 100%. Later on, in chapter 9, we will teach
you the beneﬁts of using these kind of contracts. You’ll be amazed.
Well, so far, we have covered the terminology, types of options, and the way they work. Now, you
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How to Become a Millionaire in the Stock Market
are ready to study some of the diﬀerent strategies you can use.
This ﬁnancial instrument (called Options) is not only used on stocks. They can also be used on
bonds, future contracts, etc. In this book, we are covering only stock options, since we have the
advantage of knowing how to predict the companies’ movements. We want to point out that the
option’s mechanism is the same, in any kind of investment, the only thing that changes, is the underling (stocks, bonds, future contracts, etc).
There are diﬀerent techniques available to make money with the use of options, some of which are
very risky and complicated. For this reason we will only be focusing on buying and selling techniques, which, according to our experience, are the most proﬁtable and less risky ones.
Let’s put theory aside, and see how this works in the real world. For example, let’s say we are at the
beginning of July 2004, and we perform a technical analysis on INTC’s chart, whose shares are being
traded at $29.00 each. This analysis tells us that this company’s shares are going to go up. If we were
going to buy one thousand shares, we would need to invest $29,000. Now, let’s analyze this same
investment, but using option contracts instead.
We already know that to manage the same 1,000 shares, we would need 10 contracts. Suppose we
chose the one with a strike price at 30.00, so, the order would look like this, 10 INTC 04 / July 30
Calls, whose price is $0.25 each, which means that this would cost us 10 x 100 (every option contract
represents 100 shares) x $0.25 (option price) = $250.00, and their expiration date would be the third
Friday of July. Let’s pretend that a week later INTC’s share’s price went up to $33.00. Our option
contracts are now “in-the-money” by three points (intrinsic value). Therefore, we would be able to
sell them at $3.20 each ($3.00 intrinsic value + $0.20 time value), since they still have a week before
expiring. This is how the numbers would look like: 10x100 x $3.20 =$3,200, giving us a net proﬁt of
$2,950, almost a 1200% return, only having invested $250.00. Meanwhile the person who bought
the 1000 shares, investing $29,000 got a proﬁt of $4,000, which represents a return of only 15% (a
huge diﬀerence in the rate of return).
Let’s be a little more pessimistic, and assume that this prediction went against us, and on the expira-136-
Chapter 8: The Interesting World of Options
tion day the share’s price had fallen to $24.00. Because we bought the options, we lost only $250.00,
since these contracts expired out-of-the-money or worthless as commonly referred to, (When investing in options the maximum amount of money you can loose is what you pay initially for their
purchase: ‘premium’). Whereas, the investor who bought the 1000 shares, invested $29,000 and lost
$5,000 (big diﬀerence).
Many of those who are familiar with the subject would say, yes, but the investor holding the shares,
has the possibility that their price could come back to $29, and recover his losses, while you can’t recover yours because your option already expired. The solution we oﬀer to this so-called disadvantage
is very simple. On the day your contracts expire buy 10 new calls of the following month, in this case
with a strike price of 25, which, based on our experience, would cost approximately $350 or $0.35
each, a little more than those previously purchased, because these ones have 4 weeks of life, and the
others had only three. If during these 4 weeks INTC share’s price comes back to $29, the person
holding the 1000 shares will recover his losses, while you can sell your contracts for at least $4 each,
getting $4,000 for their sale, a net proﬁt of $3,400 out of an initial $250 loss.
$ 250.00
Initial Loss
$ 350.00
Second Investment
____________________________
$ 600.00
Total Investment
$ 4000.00
Sale of Second Investment
$ 3400.00
Net Proﬁt (550 % of return)
This works the same way when we make a down side prediction, only that this time, instead of
buying calls, we have to buy puts. Again, suppose that on July 1st, our analysis indicates that Dell
Corporation’s shares (DELL) are about to go down; at that moment they are trading at $36.00 each.
If we were to short sell 1000 of them, we would need $36,000. Let’s examine the option contracts, in
this case the puts. Now for our example let’s choose the ones with a strike price of 35, so your order
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How to Become a Millionaire in the Stock Market
would look like this: 10 Dell 04/July 35 Put. As you can see, these contracts expire on the third Friday of July, giving you two and a half weeks for your prediction to be fulﬁlled. Based on experience
we’d say they cost $0.30 each. So, managing the same 1000 shares would cost us $300.00. If a week
later, this share’s price actually goes down to $32.00, our contracts would cost approximately $3.20
($3.00 intrinsic value + $0.20 time value). If you decided to sell them at this moment, you’d get
$3,200, a net proﬁt of $2900, almost a 1000% return. While the investor who short sold the 1000
shares, obtained a $4000.00 proﬁt, investing approximately $36,000.00, so all he received was an
11% return.
On the other hand, if your prediction had gone, let’s say 5 points against you, and this company’s
share reached a price of $41, on the expiration day; your contracts would expire worthless, so you
would lose the $300.00 initially paid for them. The investor, who short sold the same 1,000 shares,
would be losing $5000, but as we mentioned in the INTC calls example, many people think that
despite of him having this loss, he would be able to recover it some day, because shares never expire,
and options do. In this case you would need to use the same strategy used in the calls example, in
other words, you would have to buy 10 new puts of the next month with strike price 40, which have
four weeks to expire and a cost of $0.40 per contract (10= $400.00). If, within this time, Dell’s share’s
price comes back to $36.00, these contracts would be worth at least $4000.00, since they would be
$4.00 in the money, rendering a net proﬁt of $3,300.00.
$ 300.00
Initial Investment
$ 400.00
Second Investment
_____________________________
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$ 700.00
Total Investment
$ 4000.00
Sale of Second Investment
$ 3300.00
Net Proﬁt (aprox. 500 % of return)
Chapter 8: The Interesting World of Options
While the person who short sold the 1000 shares, investing $36,000.00 just recovered his losses,
or broke even, (0% return).
After having analyzed the same investment with both, shares and options, you may draw your own
conclusions about the advantages and disadvantages of each one of them.
Option prices vary from one company to another, depending upon their volatility; you do not
necessarily have to buy an option of the current month. Obviously, the longer the life of an option,
the more expensive its time value will be, but of course, it will give you more time for your prediction
to be fulﬁlled. In our personal case, we generally buy options of the current month, and sometimes
with two months, depending on how imminent our prediction turns out to be, because remember,
if, by any chance, our options expire worthless, we still have the possibility to buy the right contracts
of the following month, without having to have much capital invested in a single position. Do not
worry, as you may have observed, our predictions are generally fulﬁlled in a matter of days, and their
percentage of accuracy is extremely high.
How to Select the Right Strike Price for Our Option Contracts
You now know how the option mechanism works and how to predict the movement of a company.
Now, you’ll need to learn how to choose the right strike prices for your option contracts (strike price
intervals usually are 2.5 and 5. For example: 20, 22.5, 25). A common error made by those who
invest in options is that they don’t know which strike price to choose, and they tend to select the deep
out of the money ones because they are the cheapest, but at the same time they are also the riskiest.
How do you select the right ones? It is simple. You need to know exactly the range of movement that
the company you want to buy these option contracts for has had in the last period of time, as you’ll
see clearly in the following example.
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As this Sears’ chart shows, on Friday June 4th, our technical analysis gave us a clear sign of an imminent upside movement, at that moment this share’s price was $36.90. Let’s suppose we want to buy
options. We already know we have to buy calls, either of June, expiring on the 18th (two weeks from
now), or July’s, which have six weeks of life. Now, let’s choose the strike price, if we were to choose
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the June ones, which are cheaper, due to fact that they have a smaller time value, we would have to
go back to the chart, to analyze the range of movement this company has had lately. As it indicates,
the highest point reached by Sears in the last month was around 41; therefore, it would be unreasonable to buy an option contract with a 42.5 strike price, and much less with 45, because it is hard to
believe that in such a short period of time this share’s price is going to reach or surpass these points.
There would be a good chance that these options would expire worthless. And if it did surpass these
points, your proﬁt would be lesser than if you had bought the contract with the right strike price. As
you’ll see next, the correct contracts to buy for June were the SP 37.5 and 40, preferably the 37.5,
which at that moment was worth $0.40 (10 contracts $400). The one with SP 40 cost $0.05 each
(10 contracts $50).
Now, if on June 7th, after the ﬁrst rise, when Sears’ new price was $38.30, you go back to the graph
you can see that Sears lad still had potential to continue its uptrend movement, arriving at the conclusion that those who bought these contracts on Friday don’t have to sell them yet. For those who
wanted to wait for a positive movement before jumping in (which is not necessary if you learned how
to do this technical analysis correctly), this new point that Sears was at, the correct strike prices were
the 37.5, which was still very good, but now it cost a little bit more ($1.20 each, 10 = $1200.00) and
the SP 40 one with a price of $0.15 each, concluding, that for those having little money to invest,
the best strike price for the month of June was the 40, since it cost $0.15 (10 contracts = $150.00).
Besides it had 9 days before expiring, and if you take a look at the graph, being Sears’ share’s price
at $38.30, you can see that there was a great likelihood that these shares might reach or surpass this
point (40), during those nine days. Now, we’ll show you the Sears’ option chain of June 8th, when
the second rise took place. So you can see what each contract earned.
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As you can see, in this June 8th table, the contracts of strike price 40, which were worth $0.15 each,
closed at $1.20, having a $1.05 increase. This means that if we had bought 10 contracts for $150,
the following day we could have sold them for at least $1200, we say at least because when SEARS’
shares reached their highest price of the day, such contracts were being sold for $2.00 each. If instead
of 10 contracts we had bought 100, investing $1500, we could have sold them when Sears was close
to its high of the day for $20,000. In other words, investing $1500 we could have made $18,500 in
less than 24 hours, with a single movement of a little more than $2.00. This tells us how important it
is to know the movement range that a company has had in its last period of time, in order to be able
to maximize our proﬁts and diminish the risk.
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Now we’ll show you the option chain of the same day, but for the July’s contracts, which had six
weeks of duration.
These July contracts cost a little more, because they had more time value. When Sears was at
$38.30, right after the ﬁrst price increase on June 7th, we proved to you that the best strike price
of that month was the 40. For the July contracts, besides the strike price of 40, the 42.5 was a good
choice as well.
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Looking at this option chain, we see that the contracts with strike price 40 cost $0.60 a day before.
We know this because, if the last transaction was done at $1.85 and they had a $1.25 increase, this diﬀerence was their day before closing price. At the moment this option chain was printed, these same
contracts could have been sold for at least $2.00 each. So if we had bought 10 contracts at $0.60,
investing $600, we could have sold them for at least $2000.
You may be asking yourself, “Why did the July contracts of strike price 42.5, were a good option,
unlike the June 42.5 ones?” The answer is very simple. If we go back to the movement range analysis
in the chart, we realize that this company’s shares, with a little more time, which is what the July
contracts oﬀered us, may get close to, or even surpass this strike price very easily. Therefore, for the
month of July, this contract was the best one to invest in, with little capital, as demonstrated in the
option table, since in percentage it was the one that earned the most. Being its last transaction at
$1.00, and like the other contracts, when SEARS was at its High of that day, this same contract was
being traded at $1.40 each, so, if we had bought 40 of them at $0.15, investing $600, we could have
sold them at least for $1.00, obtaining an overnight net proﬁt of $3,400.00 or approximately a 600%
return.
As you may have noticed, we had a good proﬁt in this investment without the share’s price having
surpassed or even reached our contracts’ strike price. The rationale behind this, is that, as the share’s
price gets closer to the strike price of an option, with the underlying company’s shares still having
a reasonable time to surpass it, before expiration, the demand for these contracts grow, and so does
their price. Which means that a company does not have to reach or surpass the strike price of a contract, for us to be able to make a proﬁt.
All these analyses performed thus far to determine the best strike prices for a call option, are the
same ones you should perform when determining the right strike prices for a put option, as we’ll
explain in the next example.
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In this example, on July 7th, we had a clear sign that this company was about to experience a downfall. At that moment its share’s price was $28.50 each. If we had decided to buy a June Put option,
the one with strike price 27.5, would have been the right one. Its price was $0.20 per contract and
according to the movement range analysis of this company’s chart; it was likely that its shares would
fall below this point. This actually occurred two days later. The share’s price fell to $25.35. Although
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on that day it closed at $25.90, these contracts were being traded at approximately $2.30, which
means that with a $200 investment, we could have earned $2,100. We did not recommend the contract with a strike price of 25, because it was 3.5 points away from the share’s price. Besides, it had a
very short life left, and it wasn’t worth buying, since the strike price (27.5) was very cheap.
In case we had decided to invest in the July contracts, the correct strike prices were the 27.5 and
25. In the June contracts’ example, the 25 was not recommended, for the reasons stated above. But if
you go back to the graph, at that point the company was found, for the month of July, the one with
strike price 25 was the best one to buy, since it cost $0.25. Besides, it had enough time in order for
these shares to surpass or get close to this point, as you can see in the next example, it happened a few
days later, dropping all the way to $20. At that moment, these contracts that were originally bought
at $0.25, got a price of over $5.00 each. You do the math.
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Now, after having learned the diﬀerent types of analyses performed to choose the right strike prices
for option contracts, it is necessary to know that, like stocks, options have a Bid and Ask. As you
already know, the closer they are, the better, because it is a sign of liquidity. When buying options, it
is very important to keep this in mind. You should not buy option contracts, whose bid and ask are
separated by more than $0.15, or maximum $0.20, depending on their price. For example, if you
are going to buy an option contract with a price of $0.40 or $1.00, it should not have more than a $
0.05 or $0.10 spread, and, if the option price were $3.00 or $4.00, a $0.20 spread would not aﬀect
us. Here we will show you an example of a company’s options, whose Bid and Ask have a big spread.
That is to say, these options are illiquid.
As you can see, this is a very clear example of illiquid options, if you take a look at this table, you’ll
notice the big separation that there is between the Bid and Ask. Therefore, these contracts’ volume
would be very little, or even zero. We tell you again, keep away from these types of options, because
it is very diﬃcult to make money with them.
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Advanced Option Strategies
fter having learned the options’ mechanism, now you will learn some of the best option strategies available. From investing in long-term option contracts(LEAPS), buying a “put” and a
“call” simultaneously on the same company, the use of option contracts as protection, to our
inedited subject “How to Invest With a Fraction of a Share’s Value and Get the Same Proﬁt as if You
Had Paid Its Full Price, Even With Less Risk”.
Long Term Option Contracts (Leaps)
So far, we have learned how to make investments with short-term options, but we want you to
know that there are also long-term options contracts, called Leaps, which can last for as long as 3
years. These contracts are of great beneﬁt when we want to invest in a company on a long-term basis,
for it is cheaper than investing in the stock itself. Let’s see an example of an investment using a leap.
How to Become a Millionaire in the Stock Market
This was an investment made by ourselves. During the last days of December 2003, this company’s
shares were trading at $5.00. Its chart analysis gave us a good upside sign, and its fundamental
analysis was positive as well. Once these two analyses were lined up, we proceeded to look for the
right long term option contracts. We bought 40 7.5 calls with seven months of duration, the cost
was $0.50 each ($2000.00 for the whole investment). This allowed us to manage 4000 shares of this
company. If we had bought this number of shares outright, we would have needed $20,000. For our
satisfaction, almost four months later, these shares reached a price of $25.00, and we were able to sell
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our option contracts at $17.50 each, obtaining $70,000 for our sale. Whoever invested in shares the
same $2000.00 we invested in options, could have only bought 400 shares. And if this investor had
sold them at $25.00, he would have gotten a net proﬁt of $10,000. (a huge diﬀerence).
Not all companies have long-term options. Generally, we use this type of investment in companies
which prices ﬂuctuate between $4.00 and $20.00. Due to their low prices, their leaps are much cheaper; besides, these companies tend to grow more rapidly than the bigger ones. Let’s see the following
example of a leap option chain.
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In this case the share’s price is $8.25. The leap we would choose, would be the 05 January 10 Call,
which expires on January 2005, having almost 8 months of life.
Another advantage leaps oﬀer, is that by using them you can create a sort of mutual fund, diversifying your long-term investments in several companies. You can do all of this with little investment
capital and without having to make a daily follow up.
How to Buy a Put and a Call Simultaneously on the Same Company
This strategy is generally used when an event or an economic report of a company is expected,
that may provoke a great movement in it, but we don’t know in which direction. For example: a
company’s earnings report, the approval of a new product or medication, the closure of a deal, the
outcome of a pending trial or lawsuit, etc.
These events can be found in the diﬀerent calendars and also by following the news companies are
involved in.
A recent example of this was MSO Company, which was directly related to Martha Stewart’s trial,
who is the principal shareholder of this company.
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Throughout all of the news media, it was known, the day of the trial’s decision. Which means that
on that day we were waiting for a big movement in this company’s shares, as it indeed happened,
giving us a good opportunity to use this strategy. As indicated in the graph, the right moment to
have bought this Put and Call was six or seven days before the event took place. This is something
you always have to keep in mind when using this strategy. If you wait one or two days before the
event, the company’s option contracts get inﬂated or overpriced, due to the fact that there is a great
movement expectation in the company, and many investors want to speculate with them.
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At that optimum point, this company’ shares were trading at $14.00 each, so we could have bought
10 calls with a strike price of 15 for the current month, and 15 puts with a strike price of 12.5 for the
same month, balancing out the investment on both sides. On the day of the event, this company’s
shares actually went down more than four points, so, whoever used this strategy made a great proﬁt,
as the numbers show below:
•
10 Calls cost $150.00, $0.15 per contract.
•
15 Puts cost $150.00, $0.10 per contract.
In other words, to use this strategy we had to invest $300.00, and after the trial’s decision, we
could have sold these puts at $3.00 each, getting $4,500.00 for the 15 we had, yielding a net proﬁt
of $4,200.00, a 1,400% return. Not bad for a day.
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An Example of a Company that Was About to Report Its Earnings
As we already said, the ideal point for using this strategy was ﬁve days before the report. At that
moment, this company’s share’s price was $40.00, therefore, we could have bought the 42.5 calls and
37.5 Puts or the 45 calls and 35 Puts, depending on how much we were willing to invest. The day
this report was published, this share’s price fell more than 10 points, giving a great proﬁt to those
who used this strategy.
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Note: Sometimes, you buy these contracts a few days prior to the event, and right before it actually
takes place, you already have a proﬁt, even though the company’s shares haven’t moved at all. This is
due to the fact that as the event gets closer, the expectations of the investors begin to grow, and so do
these contracts’ demand, causing them to inﬂate.
One of the great advantages of this strategy is that after using it, you can sleep peacefully, since
you will never have an adverse movement. The only thing that may aﬀect you is that this company’s
shares don’t move at all for many days, that’s why it’s so important to look for a source that provokes
movement.
How to Protect Your Shares With the Purchase of Options
This is a very beneﬁcial strategy for those who invest in stocks. Let’s think of it as an insurance
policy. This is generally used when you already have a proﬁt in your stock investment, and want to
protect it, but without having to sell your shares because you think that they still have potential to
continue their movement in your favor.
For example: Let’s suppose it is June, and a month ago you had bought 1000 shares of Company
X at $20.00 each, investing $20,000. Now these shares are trading at $25.00; at this moment you
have a $5000 proﬁt. But you think that the price can still keep going up; at the same time you don’t
want to risk your proﬁt. The only way to protect it, while keeping the shares at the same time, is
with the purchase of put option contracts. Since you want to protect 1000 shares you have to buy 10
contracts. In this particular case, with the share’s price at $25.00 and being at the beginning of June,
you need to buy 10 June 25 puts, which have almost three weeks of life, oﬀering you protection for
this time.
Let’s assume their price is $1.00 each, so, you would need, $1000 to buy the 10. Thus, no matter
what happens, you are securing $4000.00 of your proﬁt ($5000.00 initial proﬁt - $1000.00 invested
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in the puts), even if the share’s movement goes against what you had thought. For example, if during
this protection time, the share’s price goes down to $20.00 (initial purchase point), the puts you had
bought would now cost $5.00 each, because they are $5.00 in the money. You can either sell them to
get your $4000.00 proﬁt and keep the shares if you wish, or sell them as well, closing this position
completely.
If in this case, this strategy had not been used, you would have lost your $5000 initial proﬁt. On
the contrary, if this company’s shares had kept on going up, as you previously had thought, reaching
a price of $30.00, you would have obtained a $10,000.00 proﬁt with your shares. Of course, the
puts would’ve expired worthless. So, you would have had to subtract the $1000.00 paid for them
from your $10,000 proﬁt, ending up getting a net proﬁt of $9,000.00. This is much better than the
$5000.00 you had received if you had sold your shares at $25.00, for not knowing this strategy.
This can also be used when you have previously done a short sell on a stock, and have a proﬁt, but
you still think that your share’s price can keep on falling down, and you don’t want to risk that proﬁt.
In such a case you have to buy call option contracts, the strike price, the expiration month and the
amount to buy, just as in the previous example, depend on the number of shares you have short sold,
their price and the month you are in.
Many people who invest in shares, either lose their proﬁts or limit them, for ignoring this protection technique.
Another good application of this strategy is when you have shares in a company, whose earnings
report or any other important event is approaching, which may provoke a great movement in its
share’s value. To avoid great losses, all you have to do is, apply this strategy as clearly explained in
this chapter, and after the storm has ended, sell the options you bought for protection and stay with
your shares.
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How to Invest With a Fraction of a Share’s Value and Get the Same Proﬁt As If You
Had Paid Its Full Price, Even With Less Risk
***(Inedit Subject)***
This kind of investment we’re going to teach you now, we consider to be the most important discovery we have ever made throughout all the research and study of diﬀerent investment types and stock
market mechanisms. Therefore, we have the conviction that once this book is published, this issue
will have a great impact on the investment world, among investors big and small, since in spite of the
fact that this technique is available, there are parameters demonstrating, that almost nobody knows
about it. We have already learned diﬀerent types of investments using at-the-money and out-of-the
money option contracts, whose value increases a percentage of the share’s movement (Delta), for their
price is made up only of time value.
Now, we are going to learn how to invest in contracts, whose value increases almost 100%, with respect to the share’s movement. For example, if the share’s price goes up $5.00, these contracts would
earn almost $5.00 as well. This is because their value is almost entirely comprised of intrinsic value.
In other words, all its value is in the money, which means that it doesn’t depreciate as time goes by, as
it happens to the other contracts. After reading this sub-chapter, you’ll realize that investing in them
is the same as investing in the stocks themselves, but with two great advantages:
1.
You can buy these contracts with a fraction of the money you would need to buy the
shares while obtaining the same proﬁts.
2.
Your losses are limited, compared to those you could incur, if holding the shares.
Next we’ll show you several examples, so you can understand this more clearly:
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Example 1: Using a Put
On June 8th, the AMZN chart analysis gave us a clear sign to the down side. If you were going
to short sell 1000 shares, you would need $52,000.
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Now, let’s analyze the in-the-money contracts, of which we’ll show you examples of two option
chains: one from the day before the fall, and another one from the day of the fall.
From Example 1: One Day Before the Fall
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As we can notice in the previous price table, the 55 June Put could have been purchased at $3.30
each, this price was comprised of $3.06 (intrinsic value) plus $0.24 (time value). 10 contracts, to
manage the same 1000 shares, would have cost $3,300. Now, let’s take a look at the option chain of
these same contracts, from the following day, when the company dropped $1.70.
Tabla del Día de la Caída del Ejemplo 1
By analyzing the Puts we should have bought, we realize that their value increased $1.60 of the
$1.70 these shares fell, almost 100% of their movement. Let’s do some math. These 10 contracts
cost $3300, and a day after, we could have sold them for $4900, getting a proﬁt of $1600, a 48%
return. In monetary terms, we made $100.00 less than the investor who short sold these shares, while
investing 17 times less money.
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Now we’ll show you an example using call option contracts:
Example 2: Using a Call
On June 7th, our analysis indicated that this company was going to go up. That day its share’s
price closed at $24.80. To buy 1000 shares at this price, we would have had to invest $24,800. The
next day this company’s share’s price had an increase of $2.53. Thus, if we had sold our shares at this
point, we would have received a $2,530 proﬁt (10% return).
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Let’s see what we would have gotten with the calls, to establish a comparison.
From Example 2: Option Chain From the Day of the Rise
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As you can see, this 22.5 June Call increased $2.40, with respect to the $2.53 the share’s price increased, proving that this contract’s value increased almost 100% of what the share moved. The price
table shows that this contract cost $2.50 a day before. Stated another way, in order for us to manage
the same 1000 shares, we would have needed to buy 10 contracts, whose cost at that moment would
have been $2500. A day after, these same contracts could have been sold for $4,900, close to a 100%
return. By establishing a simple comparison, we realized, that the same investment made with options, yielded almost the same amount of money than buying the shares outright. Only that, to buy the
options we invested 10 times less money.
Now we will explain to you, what we meant, when we said that with this type of investment your
losses were limited, compared to those you could incur if holding the shares, in case of an adverse
movement, as you’ll see next.
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Let’s say that on July 8th, someone who didn’t know how to perform a good technical analysis, decided to buy these shares, expecting them to go up. Suppose they bought 1000 shares at $25.50 each,
investing $25,500. Unfortunately the next day their price fell over $8.00, to $17.50, this person
would have had a paper loss of $8,000. If somebody else who also thought that this company could
go up, but instead of buying the shares, he bought 10 June 22.5 Calls, whose price was $3.00 each,
as you can see, all their value was in the money. The day this company fell, these contracts became
worthless, so this investor’s paper loss would have been $3,000. But don’t get confused, if by any
chance this company comes back to the point it was prior to the fall, before these contracts expire,
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the investor would recover his/her losses. Following with the example, the person holding the shares
lost $8,000, which is much more than the one incurred by the investor holding the contracts, because
as you already know, in options the most you can lose is what you pay for them initially (premium),
concluding that in a case like this, where the company experienced a big adverse movement, your
losses are much smaller in options than in stocks.
You may be wondering to yourself, “If I had been the person who bought the option contracts in
the previous example, what could I have done, after the share’s price dropped to recoup my losses?
Being that because the options’ strike price was a little far from the stock price, and it was a little hard
for them to recoup their value, besides, their expiration date was close, whereas the investor holding
the shares had the possibility of eventually recouping his losses for they never expire.” The answer
is very simple. This could have been oﬀset by buying 10 15 Calls of the same month, which were
$2.50 in the money, and cost $2.60 each (10 x $2.60 = $2,600), they had seven days of life. But since
they didn’t have any time value, you didn’t have to worry about the time depreciation (time decay);
because they could have been sold for all the value they were in the money, even a few minutes before expiring. So far, between the previous loss and the new investment, you would have had $5,600
invested, while the one having the shares would have had $25,500, from which there would only be
$17,500 left. If before the expiration of your option contracts, the share’s price would have gone up
to $22.00, you would’ve been able to sell your 10 contracts for at least $7000, recovering your losses,
and in addition to, obtaining a small $1400 proﬁt; whereas, the share’s owner at this point would
have still had a loss of $3,500. If you had thought that this company could have still kept going up,
all you had had to do was, sell your contracts and make the transition for the following month’s
in-the-money ones, with less time value. In this case the stock price was at $22.00, and it would
have been the July 17.5 Call, that would have cost $4.70 ($4.50 intrinsic value + $0.20 time value).
Again, if during this new month, these shares had come back to their original price of $25.50, as it
is obvious, the shareholder would have only recouped his losses, while you, with your new option
contracts, and much less capital invested, would have obtained a $3,300 proﬁt. Add the $1,400 you
had previously made with the June contracts, and your proﬁts would be $4,700.
As we already stated in chapter 8, when you buy these types of contracts with almost no time value, you’ll always be able to sell them, even on the expiration day and obtain all its intrinsic value. If
for some reason you want to continue in the same position, all you have to do is buy the following
month’s ideal in the money contracts. You could keep any position for as long as you want, with a
tiny amount of money invested, compared to what you would need to keep the shares. Thus, with
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this type of investment, even when having a small amount of capital, you have the opportunity to
invest in companies regardless of their price. And in the event that you have large amounts of capital,
you’ll only need to use a fraction of it, allowing you to use the rest for other investments.
How to Choose the Right In-The-Money Option Contracts
Here, we will show you examples of two companies with their respective June and July option contracts, with the purpose of teaching you how to choose them correctly, having the least possible time
value and still maintaining a low price.
Best Call
Best Put
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Let’s pretend you want to short sell 1000 shares of this company, which would cost $38,500. Now
let’s take a look at the prices of the in-the-money puts with the least possible time value and, at the
same time, cheaper than the other in-the-money puts. As you already know, to manage 1000 shares,
you need 10 puts. In order for a put to be in the money, its strike price has to be above the stock
price. In this case, the share’s price is $38.54, therefore, the ﬁrst one we’ll analyze is the one with a 40
strike price, whose price is $1.60, realizing that it has $1.46 in the money. So, we will be paying only
$0.14 for time value, add to this its price, which is also very attractive (10 contracts = $1600.00), it
indicates to us that this is the best contract to buy. This is because the one with the 45 strike price,
in spite of the fact that it has a few cents less of time value, we discard it, for its price is $6.50 (10
contracts $6,500), and it is not worth to invest so much money for such a small time value diﬀerence.
In order to demonstrate this, let’s say that before these contracts expire, this share’s price falls $2.00.
Here is how the numbers would look like in the diﬀerent scenarios:
1.
1.To short sell the 1000 shares, we would have needed to invest $38,540 and we would
have earned $2,000 (almost a 6% return).
2.
Buying the 10 Jun 45 puts, would have cost us $6,500, and they would have generated a
$2000 proﬁt (approximately a 30% return).
3.
Lastly, to buy the 10 Jun 40 puts which were the correct ones, we would have needed
to invest only $1,600, and they would have yielded a net proﬁt of $1,850, more than a
100% return.
As we can see, the June contracts have only 5 days left to expire, so we can either buy these June
40 puts, and in case the company has not accomplished what we expected on the expiration day, sell
them and buy the right ones for the next month, or simply, buy the July ones initially, which have 5
weeks of duration, to avoid having to make the transition at all. That’s totally up to you.
The procedure to select the correct in-the-money calls, is the same we just used to choose the right
in-the-money puts. Using the previous table, the best call contract would be the one with strike price
35, which costs $3.60 each, and practically has no time value at all.
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Now let’s see the July’s option chain:
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How to Become a Millionaire in the Stock Market
If, instead of buying the June contracts, you had initially decided to buy the July contracts, as
indicated in this table, the best put would be the July 45, that has almost no time value, and with
only $6,600 you could manage 1000 shares. Compare this to the $38,500 you would need to
short sell such an amount of shares.
The best July call, as also indicated in the table, would be the one with strike price 30, which
practically does not have any time value either. Do your own math. You might ask yourself, “Why
not the one with strike price 35?” Very simple. Because, although it costs much less, if we observe,
it has more than 50 cents of time value. Of course, the price diﬀerence is huge, compared to the
other one. So, in a case like this, we would say that, both contracts qualify, the most expensive one,
because of having less time value, would earn almost 100% with respect to the share’s movement,
while the other one would earn approximately 80%, but it cost much less. In a situation like this,
and knowing the advantages and disadvantages, you decide which one to buy.
We have previously mentioned that many people don’t know about this type of investment, for if
we see these in-the-money contracts’ volume (amount of contracts traded in a day), we realize that,
it is very light or even none. Nevertheless, if we look at the volume of the stocks, we see that it is in
the range of millions everyday.
After what you have learned in this chapter, do you think that it makes sense to invest so much
capital in stocks, when with a fraction of it, you can obtain the same proﬁts, and at the same time
keep your losses minimized compared with the ones you can have, by investing solely in stocks.
To conclude, we’ll leave you with examples of the June and July in-the-money contract prices for
IBM, whose shares have a high price.
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Chapter 9: Advanced Option Strategies
June Contracts
To buy 1000 shares of this company, we would need $90,460, while 10 June 85 calls would cost
$5,500, allowing us to manage the same number of shares. To short sell these one thousand shares,
we would also need $90,460, but 10 June 95 puts would cost us only $4,600.
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How to Become a Millionaire in the Stock Market
July Contracts
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Chapter 9: Advanced Option Strategies
To be able to manage 1000 shares of this company for ﬁve weeks, we would need 10 July 80 Calls,
which would cost $10,700, likewise, to invest to the downside, we’d need only $9,600 to buy 10 July
100 Puts. We are not going to mention what you would need to buy or short sell these shares because
you already know it.
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How to Become a Millionaire in the Stock Market
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Chapter 10
How to Open an Account in a Brokerage Firm to Be Able to
Trade Option Contracts
p to this point, you have learned diﬀerent investment strategies using option contracts. Now,
you’ll learn how and where to open an account to trade them. In most of the brokerage ﬁrms,
where you open your account to invest in stocks, you can also trade options. All you need to
do when ﬁlling out the application is specify in a section of it, that you want to trade options. The
account must be approved for option trading. Of course, that is just a formality, because everyone
gets approved, at least for buying and selling them, which is all you’ll need.
The majority of the option chain examples used in the second part of this book, were taken from
Ameritrade, since they also allow you to trade options, as we did with stocks in the ﬁrst part of this
book. Now, we’ll explain to you step by step the diﬀerent functions related to options you must know
in order to execute your transactions.
How to Become a Millionaire in the Stock Market
How to Place Buy/Sell Orders
Before placing a buy or sell order, the ﬁrst thing you need to do is get the price table or Option
Chain of the company you want to invest in, which is very easy. Once you are on Ameritrade’s central
page, click on Research, then on Option Chain, where you will see a form that needs to be completed,
in order for you to get the option chain. Now let’s see what this looks like.
Company’s symbol we
want to get the option
contracts for.
Select All, to see all the
strike prices.
Here we specify that we
want to see the puts and
the calls.
Here we specify that we
want to see all the expiration months for these
contracts.
After completing this, click on View Chain in order to get the desired information, which will
look like this:
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Chapter 10: How to Open an Account in a Brokerage Firm to Be Able to Trade Option Contracts
To trade these contracts, whether a put or a call, all you have
to do is click on their bid or ask and ﬁll out the form that
will appear.
As you may notice, the expiration month for these option contracts is found in the upper section
of the puts and calls. To buy or sell an option contract, whether a call or put, on Ameritrade’s web
site, all you have to do is click on their bid or ask price, and ﬁll out the form that appears. For instance, if in the above example you want to buy 10 INTC June 25 calls, you would have to click on
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How to Become a Millionaire in the Stock Market
their bid or ask, as you can see, their price is “$0.25 Bid x $0.30Ask,” this will take you to an order
entry form that will pop up at the bottom of the option chain, which needs to be completed with
the desired information. You are already familiar with this form from chapter 3:
As we said in chapter 3, this section can also be accessed by clicking on Trade and then on Options
or using the order entry form that is always at the bottom of the web site. Next you’ll learn how to
conﬁgure and place option orders.
As mentioned earlier, we will be focusing only on buying and selling option contracts. So, these
are the two functions you’ll be using:
•
Buy/Open: This means to buy either a Put or a Call.
•
Sell/Close: This means to sell either a Put or a Call.
Therefore, we’ll ignore the Buy/Close and Buy/Open, since they are used for other types of option
strategies not covered in this book. We do not recommend such strategies, because of the risk involved. As you can notice in our example we are trying to buy this contract at the bid price. It means
we’re using a limit order. If we had used a market order, it would have been executed immediately
at $0.30. You will also notice that in the last space we speciﬁed that this order would be for the day.
Option orders are recommendable to be placed only for the day.
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Chapter 10: How to Open an Account in a Brokerage Firm to Be Able to Trade Option Contracts
We want you to know that for options, the order types, their duration and the other speciﬁcations
are the same as for stocks (covered in chapter 3). With this previous example completely ﬁlled out,
the only thing left to do is send the order, which is done by clicking on Review Order. After this, you
will be able to access a section, where you can check if everything speciﬁed in the order is correct. If
so, send the order by clicking on: Place Order. Once sent, you will be able to see it in the Order Status / Open Order section, where you can modify it or cancel it if you want, of course in case of a limit
order that hasn’t been executed yet. Executed orders during the day, are shown in the Order Activity
and Trade section. These functions are accessed the same way we learned in chapter 3.
These steps are similar in most of the brokerage ﬁrms where you open an account to trade options.
We want to share something important with you. From our point of view, Ameritrade is one of
the best brokerage ﬁrms for investing in stocks, especially in penny stocks, and as you have seen,
they allow you to do options as well, although they are not option specialists. Meaning that there are
brokerage ﬁrms specialized in options, therefore, they can oﬀer better commissions, as well as better
tools through their web sites for the execution of your orders.
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How to Become a Millionaire in the Stock Market
Advantages of One of the Best Brokerage Firms for Option Trading
If you are seriously considering investing in options, we recommend to you a brokerage ﬁrm
called Interactive Brokers that based on our experience; we believe they are one of the best in the
market. Their commissions are the lowest ($1.00 for each bought or sold contract), and they also
have a great software program called Trader Workstation, through which you’ll be carrying out all
your transactions.
If you want to contact them, here is their information:
www.interactivebrokers.com
Telephone USA: 1(877) 442-2757 or
(312) 542-6901
FAX:(312) 765-0095
Regular Mail
Interactive Brokers LLC
ATTN: Document Processing
P O Box 5544
Chicago IL 60680-5544
Over Night Service
Interactive Brokers LLC
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Chapter 10: How to Open an Account in a Brokerage Firm to Be Able to Trade Option Contracts
ATTN: Document Processing
440 S. Lasalle ST Suite # 2601
Chicago IL 60605
Opening an account with them is very simple. All you need to do is go to their web page, click
on Open an Account, ﬁll out the application. Specify that you want to trade options, print it, sign it
and send it out, using any of the ways indicated above.
Once your account has been opened and the money you wish to deposit sent, you can download
and use their software, where you’ll be handling all your transactions. This software is very easy to
use. In the Help section, each one of its functions is explained step by step.
One of the great beneﬁts of this software is that it allows you to see the option prices simultaneously in the diﬀerent option exchanges that exist, something like an option Level II, giving you
a huge advantage over those investors who don’t have such a service. Now we’ll show you what an
option chain looks like on their software.
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How to Become a Millionaire in the Stock Market
Through this software we have access to the option prices of the diﬀerent option exchanges. More importantly, we can see the bid and ask size (amount
of contracts to be traded), which allows us to detect how the supply/demand
are in a given contract.
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Chapter 10: How to Open an Account in a Brokerage Firm to Be Able to Trade Option Contracts
Through our web site www.number1stockpick.com you will have access to this software’s help
tutorials, where every one of its functions is clearly explained.
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How to Become a Millionaire in the Stock Market
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Conclusion
inally, we are in the closing stage of this instructional material, with the hope that you have enjoyed it to your greatest satisfaction. We want you to know that our main goal was not only to
teach you, but also to inspire you, so you can feel encouraged to enter this fascinating world of
investments, and change your life style forever.
Our endeavor was also to guide you, step by step, from the simple operation of opening an account to the use of advanced investment strategies. As you may have noticed throughout the book,
everyone is entitled to use these techniques and take advantage of them, regardless of their social or
ﬁnancial status. In other words, we have tried to break the myth that only millionaires and those
mentally gifted can accomplish the American dream through the exciting career of investing in the
stock market.
Now you know, dear reader, that by learning and applying these techniques, your life can and will
positively change forever. After having said this, we feel ethically and emotionally bound to remain
in touch with you, to give you our best assistance in every doubt and concern you may have in regard
to this new challenging career.
On our web site www.number1stockpick.com we have a chat room at your disposal where we will
be exchanging ideas with you, and listening to your suggestion. Also in a near future we are going
to implement some sort of online seminars through web cams where we will have very interesting
debates and we’ll answer all the investment-related questions our readers may have. We wish you the
best of luck ... see you at the top!
¨The secret of success is in the perseverance of the purpose¨
Jimmy Hernández
How to Become a Millionaire in the Stock Market
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Glossary
Ask: This is the best price sellers are willing to sell their shares, options, etc.
Bid: It’s the best price buyers are oﬀering to buy a security or any other type of ﬁnancial instrument.
Call Option: It is the right, but not the obligation, to buy shares of a company at a predetermined
price within a speciﬁed date.
Delta: It is the value an option contract will increase with respect to the share’s movement. For
example: a 30% Delta means that this option contract would earn 30 cents for each dollar this share
moves on your favor.
EPS: Earnings per share
How to Become a Millionaire in the Stock Market
Float: The number of shares a company has available to the public.
Intrinsic Value: It is the value for which an option contract is in the money.
IPO: Initial Public Oﬀering, in other words, this is when a company goes public for the ﬁrst
time.
In The Money Option: In the case of a Call, this is when the strike price is below the share’s price,
and in the case of a Put it is when the strike price is above the share’s price.
Mutual Fund: It is a conglomerate of shares, managed by an administrator of the ﬁrm operating
such fund, and is comprised of capital from many investors.
Put Option: It is the right, but not the obligation to sell shares of a company at a predetermined
price within a speciﬁed date.
P/E Ratio: It is the relation between a company’s share’s price and its last annual EPS, for example:
if a company’s share’s price is $20 each, and its last annual EPS was $2, to know this company’s P/E
ratio, we would have to divide these two numbers, so in this case it would be 10.
ROE (Return on Equity): It is the return a company has had on the average invested capital.
Short Sell: It is when we borrow shares from the brokerage ﬁrm to sell them at the market price,
with the hope of buying them back at a lower price to return them.
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Glossary
Spread: It is the diﬀerence between the Bid and Ask.
Stock Option: It is the right, but not the obligation to buy or sell shares of a company at a predetermined price within a speciﬁed time.
Stock Split: It is when a company splits its share’s price. It can be done in the following ratios:
2:1; 3:1: etc.
Technical Analysis: It is the analysis of a company’s charts.
Volume: The number of shares or options that have been traded in a given time.
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How to Become a Millionaire in the Stock Market
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Notes
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Notes
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