Hi everyone,

I’ve been away for a while so haven’t had a chance to post anything new but am back now and decided it’s Chart of the Week time. Lots of interesting stuff going on in the US which I was going to cover like AIG and Boeing taking a hammering recently and Goldman getting upgraded late last week but I decided to go for one of our own guys today, and sure who better to pick than the country’s largest publicly quoted company, CRH. I knew CRH had a large market cap but was a little surprised to read last week that it now accounts for over 30% of the total value of the ISEQ Index! I wonder what percentage all our banks together now account for??
Founded in 1970, CRH has grown consistently over the last 30 years to a position where today it has operations in 35 countries, over 93,000 staff and with a market cap of over €11 billion it has a firm grip on it’s position as Ireland’s one and only true global company.

H1 Results Disappoint But Some Room For Optimism

On Tuesday CRH provided a trading update on it’s H1 (or first half) results which was a lot more downbeat than analysts were expecting. Following a very tough first half of the year CRH is now guiding profits of €100m, down from approx €600m for the same period last year. As global construction markets remain weak (particularly residential and non-residential sectors in the US) and the various stimulus packages on the go struggle to give ailing markets the boost they need it should come as no surprise that CRH’s profits are going to be down over 80% in the first half of the year on the same period last year. On going restructuring costs are also hitting the bottom line but at least these will deliver significant savings going forward so the hits will more than pay for themselves. On the restructuring front, presumably in an effort to soften the blow of the disappointing guidance, CEO Myles Lee did announced a second round of cost cutting measures which the company expect will contribute an extra €555m in cost savings to the almost €900m in savings announced in January.

While the trading update was certainly worse than analysts and investors had hoped for there are a few positives which should form the basis of a silver lining for H2 and into 2010. First up is the fact that H2 is traditionally CRH’s stronger half of the year. That combined with the news last week that of the proportion of the $787 billion US Stimulus Package earmarked for infrastructure, almost 50% will be spent on repaving existing roads. As the largest supplier of asphalt in the US this is great news for CRH and should see the company get more than it’s fair share of Barack’s Billions over the coming 12 to 18 months. Other good news for CRH comes in the form of lower energy prices as oil continues to trade well below last years $147 a barrel high. In fact over the last week or so we have seen a steady fall in the price of crude from over $70 a barrel back to around $60 in line with the pull-back in equity markets and fears the it might take longer than first thought for the US to pull itself out of this recession. Investors seem to be thinking the green shoots might need a bit more than a dart of miracle-gro before they start flowering! And going hand in hand with lower oil prices and jittery equity markets is of course a stronger dollar, as the greenback’s safe haven qualities kick-in once more. A strong dollar is more good news for CRH as about 40% of it’s revenue’s come from the US.

War Chest Ready To Be Spent

One of the other positives for CRH going forward is that it is not burdened with massive debt that is currently weighing on many of it’s competitors. While several of it’s rivals are struggling to negotiate debt refinancing deals with their bankers or are being forced to see off assets in order to pay down their debt, CRH on the other is sitting back on a very sizable war chest. Following on from an impressive (if more than a tad complex for existing shareholders to figure out…) round of funding earlier this year it is now estimated than CRH is sitting on a cash pile in the region of €4 billion. That’s a tidy sum to have on hand to spend on expansion and moves into new markets.

And there is no better firm at getting value on the acquisition front than CRH. Over the last few years spending on acquisitions have being running at close to €2 billion a year! Lots of things impress me with how CRH conduct their business but none more so than how they manage their acquisitions, from identification to valuation to negotiation and deal closure there is in my view no better company than CRH. I remember reading a few years back about how rather than engaging the major investment banks and finance houses to complete acquisitions on it’s behalf CRH instead decided to setup it’s own Mergers and Acquisitions team. This group now completes the purchases of dozens of companies each year and saves the company millions every year in professional fees it doesn’t have to pay. And they are very good at their jobs also, basing all their new deals on valuation and always willing to walk away from the table if they feel the price being asked for is too steep. They never like to pay more than 12 times earnings for any company they buy and regularly make purchases at single digit multiples. As Cemex and Lafarge are forced into asset sales over the coming months expect CRH to be there with cheque book open and ready to benefit, but only on their terms…

Dollar, Energy Prices, Weather and Peers All Impact CRH’s Share Price

CRH is a share I have followed for years and it is a company I admire a lot even if at times it’s share price has struggled to perform as well as one might have expected. In watching the company’s share price closely over the last few years I have learned that it certainly is a volatile stock. I have found that it’s often not news coming directly from CRH itself that can cause the share price to rise or fall 5% on any given day but any number of other factors, many completely outside the company’s control:

• As mentioned above the strength of weakness of the dollar can directly impact the share price as investors worry about the impact on the approx 40% of revenues that come from the US. In H1 last year for example, CRH took a €80m hit due to the weak dollar. Already easily Ireland’s most global and diversified company CRH continue to look for new markets to expand into. In the last couple of years a big push was made into Eastern Europe as the company hoped to capitalise on the construction booms hitting those countries. More recently China is on the radar with the first stakes taken in Chinese firms last year and more expected throughout this year and next. These moves into new markets will help reduce the company’s dependency on dollar revenue.
• Given the nature of CRH’s business energy prices also directly impact profitability and were one of the big factors in the share price taking a battering last summer as it fell from approx €24 a share in April to €14 a share in July. It was during this period last year that oil prices really started flying up, moving from $100 a barrel to almost $150 a barrel by mid July (see oil chart below).
• Then there is the weather, a nasty hurricane season in the States can result in construction projects being put on hold or delayed and reduced spending on construction materials. This is particularly magnified in Texas and Florida, two of CRH’s biggest markets in the US, but also two of the States hit hardest when hurricane season comes along…
• And of course there are CRH’s competitors, nothing like a disappointing set of results or trading update from Lafarge, Heidelberg or Cemex to know 7 or 8% off CRH’s share price in one fowl swoop. Of course the opposite is also true, an unexpected upgrade to earnings will also see CRH benefit. The scale and global nature of CRH’s business means it is playing with some really big fish out there, and investors clearly watch all of these big boys very closely for signs of how the others are performing.

High Oil Prices Hit CRH’s Profits - Click to Enlarge

Chart A Difficult One To Call

I wanted to mention the above factors that can impact CRH’s share price so that you were aware of them because from personal experience I have found CRH a tricky share to trade at times, especially in comparison to some of the other Irish shares. It seems to me there is always something going on out there which is having either a positive or negative effect on the share price, and unless you are fully up-to-date on all these factors it can lead to some nasty surprises on the share price front. And while volatility can be great for spread trading, sometimes having a fairly clear idea on how that volatility is going to play out can be a good thing.

CRH Chart - Click to Enlarge

If we take a look at CRH’s chart over the last 12 months this volatility becomes fairly apparent. It has traded as high as €20.50 and as low as €13 and at pretty much every price in between….I suppose one could argue that it is in a bit of a trading range with €14 or there abouts acting as support and €20 acting as resistance. At either of these extremes a trade might be worth considering but when it’s in the middle of the range, say €16-18, then I think it’s a very hard one to call and you are really taking on a risky trade should you decide to go either long or short at these levels. CRH is a share that tends to move quite a bit on any given day, and regularly sees it’s price either up 70 or 80 cent or down that amount. It’s currently not that far off the bottom of the range, closing at €16.00 today and might be worth a small long trade (€1/2 a tick) with a stop 200 points below and a target profit level of €18.00. It’s not a great risk / reward ratio really and given the way this one moves about traders might be best to leave this one be for now and look at something that offers a clearer idea of where it’s going next…

Until next time,
Happy Trading,
SpreadTrader.ie : -)

Hi everyone,

In response to two recent emails from readers asking about approaches to setting stop-loss orders today I am going to cover off a couple of different strategies often used by traders when deciding where abouts to set their stop loss. I’m guessing the recent market reversal (the DOW is down over 600 pts in the last week and a bit) may have led to a fair few people getting stopped out of long positions and has left many wondering if they set their stop correctly, should they have had it tighter, perhaps allowed a bit more room for movement, maybe considered moving it so as not to get stopped out…
Nobody wants to ever see their stop get triggered, especially when the market (as it loves to do) reverses sharply, after minutes after hitting your stop to leave you nursing a nasty loss on your trade. But losing trades are part and parcel of spread trading, you are never going to call every trade correctly. So that’s way it is important that you plan for trades going against you by putting in place a stop-loss order that gives your trade time to work while still limiting your losses to an acceptable level should it go wrong. Here are some approaches to consider when setting your stop-loss.

Adopt a Tight Stop but be Prepared for Regular Stop-outs

Ok first up we have the approach of putting a very tight stop in place. When adopting this approach what you are basically doing is hoping you have called a bottom or a turn in the stock. You are going to put a stop in place just under the most recent level of established support, often based on a short term timeframe (10 or 30 mins). With this type of trade you should be looking for any of the following before opening the trade:

• A significant reversal on large volume, increasing the likelihood that you have caught the bottom.
• A bounce off previous support (if going long) or resistance (if going short). See last weeks Dollar Tree example.
• Stock is very close to a moving average or trend line that has acted as support of resistance in the past.

In each of these scenarios you will be putting your stop as close as possible to the key decision point which in turn keeps any potential losses, should the trade not hold up as expected, to a minimum.
Traders who go with these types of tight stops tend to have many losing trades (often a lot more than the number of winning trades they have) but each loss is only a very small fraction of their trading portfolio. When the trades go as planned they often result in significant winning returns and thus provide the trader with an excellent risk / reward ratio. E.g. Having a stop-loss set at a level where the risk is maybe only €100 but the their target profit is 5 times that.

A Loose Stop Gives Your Trade Time to Work

The opposite approach can also be taken where you apply a much looser stop-loss, thus giving your trade more room and time to work in your favour. In today’s volatile markets where 100 point swings are not uncommon this strategy can often pay-off. Many traders refer to “noise” in the market and how you should discount this and focus on the overall trend when making your trading decisions. Putting wide or loose stops in place helps off-set the risk of market noise leading to your position getting stopped out despite the fact that in the longer run you called it right. Have a look at the Morgan Stanley chart since the start of the year below. The trend has certainly been up but not without plenty of volatility and short-term pullbacks along the way. A loose stop here would have paid off where as a tight stop would have seen you stopped out of the trade very quickly.

Morgan Stanley Stop-Loss Example (Click to Enlarge)

The downsides of this approach to setting your stops are fairly obvious:

1. If you are stopped out you are going to be hit for a bigger loss than in the first approach we discussed above. And those bigger losses are going to be a bigger percentage of your trading portfolio, meaning you’ll be able to sustain less trades going against you over time.
2. Your risk / reward ratio on these types of trades is not going to be great. You could be getting into trades where you are risking a €300 loss for perhaps a targeted profit of €400, a little over 1 to 1 which is not what we typically look for.

A Percentage Stop Can Lack Flexibility

Another approach often used is to set your stop based on a percentage of your portfolio you are willing to risk on each trade, let’s say 3% of your portfolio. So if you had a €10K trading account you would risk no more than €300 on any trade and you would set your stop-loss accordingly. A variation on this approach is to set your stop-loss based on a percentage of the current price of the stock, currency or commodity you are trading. So lets say you are trading Microsoft at $20.00 want to go short. You decide to deploy a stop 10% above the current price, so you put your stop at $22.00. If the stock hits that well it is 10% off where you traded so it is pretty clear you called the trade wrong and it’s time to get out.

While I like the idea of quantifying your potential loss as a percentage of your overall portfolio (it’s good to know if you are risking 2, 5 or potentially 10% of your portfolio on a single trade…it might make you think twice about putting it on), having such a rigid approach to setting your stop-loss mean you don’t get the flexibility you need when choosing where to put your stop. It could result in you putting too wide a stop in place or not a large enough one in other cases. Likewise while knowing the percentage a stock needs to move to hit your stop is very useful (e.g. are we talking a mere 1% move and you are out…not a lot of room for error there), again using a set rule of X% from the current price to set you stop may not give you the flexibility you need. Also, because you will most likely be trading stocks of various prices and volatility, a 10% move can mean vastly different amounts of risk, e.g. A 10% move on a €1 a tick trade on Microsoft at 2000 would see you risk a max of €200, however the same 10% move on a €1 a tick trade on Apple trading at 14000 would see you risking €1,400!

Using Gaps to Set Your Stop

One less common approach to setting your stop is specific to stocks that either gap significantly lower or higher on a given day. These scenarios don’t happen that often but when they do it’s worth adopting a strategy specific to them if you are going to join the action. Stocks that gap significantly tend to do one of two things, either fill (close) the gap or carry on moving in the direction of the gap. If you think the latter is more likely and decide to open a trade on a stock that has gapped, then the logical place to put you stock is just below the gap up or above the gap down as the case may be. The RIMM chart below is a classic example of such a trade. Back at the start of April the Blackberry maker gapped up significantly (over 20%) on the open after they announced results that blew the market away after the market close the previous day. From there the stock rallied another 50% to peak at $85 a share last week. The thing to notice is that if you went long on the gap up you could have put a stop just below the day’s low and stayed in that trade for a long time, resulting in a very successful trade. In this example the gap held. Of course in many cases gaps like these are filled because that’s what the market likes to do. In such a scenario you would have had your stop perfectly placed to limit your loss as far as possible.

RIMM’s Gap-up in April Held (Click to Enlarge)

No Stop-Loss is Not A Strategy

I’m not going to dwell on this one as I don’t really consider it a viable trading strategy but I am aware of traders who have tried to adopt this “strategy” so I thought I’d throw it in for completeness… The idea behind not setting a stop-loss is that well you can never get stopped out and therefore can wait as long as it takes for your trade to be proven right (unless of course you were long Anglo and it suddenly got Nationalised!). I’ve mentioned many times in various posts that becoming a successful spread trader is all about managing your risk, keeping your losses to a minimum and letting your winners run. I’ve also spoken about knowing when you are wrong, never catching a falling knife, risk / reward ratios, etc, etc..the 10 Golden Rules sums up most of these. Not having a stop-loss in place on a trade goes completely against all of these well known trading rules. No one can make you use a stop-loss but if you don’t you are asking for trouble.

Some Final Thoughts On Stop-Losses

Whatever strategy you decide to adopt when it comes to setting your stop-loss, be it one of the above or some other approach I believe you should always set some sort of stop-loss. As mentioned above it’s not a good feeling when your stop-loss is triggered but trust me, more often than not it is for the better. Yes there will be the nasty reversals which serve to multiply the pain of the loss you have just taken but if you have set your stop loss at a particular level for a particular reason you are better off accepting the loss if the stock ends up reaching that level. Moving your stop order is very tempting, and can on occasion pay off (just like averaging down works the odd time too) but in most cases moving your stop order means one thing and one thing only, accepting a bigger loss. It may take a few hrs longer, a few days or even a week or more, but moving your stop-loss generally only puts off the inevitable.

Here’s an example from close to home… I got stopped out of a long position on Yahoo trade myself late last week. Yahoo was in what I considered to be a nice trading range for over two weeks, moving between 1610 and 1670. It had also received a number of analyst upgrades with price targets of $20 plus on the back of an improved online advertising market and a new CEO who has impressed so far. So when it came back down towards 1620 two weeks ago I decided to go long for €5 a tick, putting my stop 50 pts below (risking €250 on the trade). I considered going even tighter with my stop, just under 1600 but decided to give a little more room for movement plus at 1570 I was just below the gap up on 1st June. After an initial rise back up towards 1650 the stock price started to reverse and soon I was in negative territory. Three days after opening my trade I was stopped out at 1570 as planned (well not really but you know what I mean!). 2 days later it jumped up 3% and I was going “Oh here we go…back up to 1670 within a few days I bet…should have moved my stop…”. However if I now look back at the price action since then my stop-loss was a blessing in disguise. As you will see from the chart below the very next trading day (Monday of this week) Yahoo fell almost 7% (about 100 pts), followed by another 20 point drop at one point yesterday to hit 1450, that’s 120 pts (€600 at 5 a tick) below my stop that was only hit last week. While I was disappointed with how the trade went I’m happy enough with the approach I took, both from an entry point and from a stop-loss setting point of view.

Yahoo Stop-Loss Example (Click to Enlarge)

All trades are different and you should set your stop-loss based on the particular set-up you are considering but hopefully the approaches discussed above will give you some options to consider.

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

For this week’s Chart of the Week I thought I’d go back to the US and take

Dollar Tree

a look at a company called Dollar Tree (DLTR). Probably not one of the better known companies out there, Dollar Tree are a discount store chain, similar to Pound World or Euro Saver in Ireland. The reason I choose them for this week’s Chart of the Week was mainly down to the fact that I think their chart provides us with a great example of a stock in a trading range and how it has bounced off a key support level on numerous occasions. But I’ll come back to the chart later, lets start with a look at the company’s fundamentals.

A Big Player in the Cheap Stuff World

While perhaps not well known over here in the US Dollar Tree is a very big player in the discount store game. Trading under the names Dollar Tree, Deal$ and Dollar Bills, the company has over 3,600 stores across 48 States in the US and has a market cap of almost $4 billion. Its main rival is Family Dollar Stores (ticker FDO) which operates over 6,500 stores and also has a market cap of about $4 billion. Of the two big players in the discount store market, Dollar Tree has being growing the faster in recent years with its most recent quarterly revenue growth of 14.2% well ahead of Family Dollar’s 8.7% growth. Dollar Tree’s operating margins are also significantly higher at 8.2% compared to 5.7% for Family Dollar. Both companies trade at an almost identical P/E of 15.5 but Dollar Tree’s higher growth rate means its Forward PE is slightly more compelling.

Recessionary Times Open the Door to New Customers

Just like here in Ireland, the US is smack bang in the middle of its own recession and just like here consumers are looking at ways to cut back their spending. So while us Irish shoppers become more familiar with our local Aldi or Lidl, Americans are nipping down to their local Dollar Tree for their groceries. It’s this shift in consumer spending that has seen Dollar Tree’s share price double since January 2008 from $21 a share to last night’s close of just over $42. While most businesses are coming under increased pressure to meet their profit targets companies like Dollar Tree are actually beating analyst’s expectations. When we have major equity sell-off’s such as what we saw last year and earlier this year not all the money moves into cash, a lot goes into what analysts see as safe havens or recession proof stocks, the likes of McDonalds, Wal-Mart and companies in the healthcare space such as Johnson and Johnson. It is this move towards more defensive plays that has seen Dollar Tree experience its huge share price increase at a time when most markets were falling.

Lower Cost Base Helps Increase Profitability

One of the other knock-on impacts of the current economic climate that is working in favour of rapidly expanding companies like Dollar Tree is falling rents. On the one side we have stores (particularly those selling luxury items) closing all over the place as they move into liquidation. But on the other as vacancy rates continue to rise in the US, most recently hitting 9% in Q1 of this year and expected to rise as high as 15% next year, landlords have no option but to drastically cut rents in the hope of finding new tenants. This plays into the hands of strong retail chains such as Family Dollar and Dollar Tree who have the cash to finance expansion. Not only are they benefiting from lower rents but they are also in a position to take up new store rentals in better locations to what they could have afforded in the past. Reports suggest that dollar chains are now negotiating rental agreements at prices in the $2-$5 a square foot range compared with paying over $10 a square foot when times were good.

Stock Is Range Bound for Last 3 Months

So now to the Dollar Tree chart, the real reason why I wanted to talk about this stock this week. Early in the year the chart was choppy, with the share price falling almost 25% at over a few days in early February. Following that fall, the stock recovered steadily to make its way back to the $43 mark by early April. But it is the price action since then that I want to focus on. Since then the share has traded in a range from approx $41 on the low side to $45 on the high side (with the odd exception on the high side along the way). This has offered traders some excellent trading opportunities, with traders going long anywhere between $41.50 and $42.00 and then quickly changing their disposition to go short as soon as the stock reaches $45 again.

What is even more significant is the strong support developing on the low end of this range. As you will see from the chart below on no less than 4 occasions over the last few months DLTR has bounced off the $41.20 mark (4116, 4116, 4120 and 4120 to be exact). This has turned out to be a level where on each pull-back in the stock the buyers come in again. What is great about this type of setup is that it allows you to easily frame your trade without having to put too much thought into it. Wait for the stock to fall towards $41.20 and as soon as you see a reversal in the price jump in to go long. Because you know where your support level is you can use a very tight stop on your trade, you need to give a little room for error (it won’t always be as well behaved as it has being to-date) but you can still deploy a stop lets say just below 4100. If the stock does break below the current support level well then you don’t want to be involved any longer. Or if you are you want to be short if anything!

Dollar Tree Chart - Click to Enlarge

I love trades like this, I know it won’t last forever and sooner or later the stock is going to make up it’s mind and make a more decisive move one way or the other, but in the mean time I can go long again at around 4140 or there abouts for a couple of euro per tick and when the stock moves back to 4400-4500 I take my profits and potentially look for a shorting opportunity.

Until next time,
Happy Trading,
SpreadTrader.ie  : -)

Hi everyone,

Following on from my post on the Importance of Volume as a Technical Indicator a couple of weeks back today I thought I’d carry on the technical analysis theme and take a closer look at another commonly used technical indicator – the Relative Strength Index or RSI for short. So starting with a little bit of the boring background…the RSI was developed by J. Welles Wilder in his book “New Concepts in Technical Trading Systems” all the way back in 1978. Ok that’s enough of the history lesson, lets move on to what the RSI is, how it works and a couple of examples.

RSI – A Momentum Indicator Worth Keeping an Eye On

The RSI is a momentum indicator that attempts to identify markets or assets which are either overbought or oversold. It does this by comparing the magnitude of recent gains against the magnitude of recent losses over a certain time period. The time period is the only variable used in the calculation with the most commonly used being 14, meaning the calculation is comparing over the last 14 trading periods for the market or stock in question. Charting software allows you to enter any time period you want but Wilder recommends using 14 and who are we to argue with the man who came up with this indicator in the first place!

Now most charting software has the RSI as an option which you can just turn on so you never have to go off trying to calculate this thing for yourself….but for those interested the formula for calculating RSI is as follows (never let it be said we cut corners here at SpreadTrader.ie!!):

                                100_
   RSI = 100 -    1+RS
      
RS = (Total Gains / N) / (Total Losses / N)
N = Number of Periods Used (normally 14)

The results of an RSI calculation will always give you a value of somewhere between 0 and 100. Most technical analysts or chartists or whatever you want to call them see 30 and 70 as the key readings. When an index or stock has an RSI of 30 or less it is considered to be oversold. Obviously the closer to zero the RSI the more oversold the index or stock is and the more likely it is for a rebound in the near future. Alternatively when an index or stock has an RSI of 70 or above then it is considered to be in overbought territory. The closer the RSI is to 100 then the more likely a reversal or pullback in the index or stock in question.

Some technical analysts look for crossovers of the 50 reading (the centerline RSI reading) to confirm bullish or bearish trends. When a stock or market’s RSI crosses 50 to the upper side this signals that there in the recent timeframe the stock has had more up days than down days and that may signal a bullish sentiment towards the stock. Conversely an RSI move to the lower side of 50 may signal bearish sentiment towards a stock or market.

Is Oil’s RSI Reading Signalling a Pullback is Due?

So lets take a look at an example of RSI in action. Now there are no shortage of overbought stocks and indices out there at the moment that are well into overbought territory. Given all the press its getting recently I decided to take Oil as an example this time round. If we take a look at the chart below you will notice the RSI indicator is turned on and appears in it’s own box underneath the main chart for US Light Crude. As you can see I am using an RSI setting of 14 (highlighted in red box). You can also see how there are lines along the key 30 and 70 readings which make it easy to spot oversold and overbought conditions.

I have highlighted a couple of good examples (late December and early February) when oil was oversold and at the time had an RSI reading of 30. In both examples in the following days oil rallied strongly. In the late December example it went from $35 a barrel to $50 a barrel 2 weeks later and in the February example it went from just under $35 to $55 over the next month or so.

Recent RSI of Oil - Click to Enlarge

Looking at where oil currently is we can see the RSI is up at 75 which would signal very overbought conditions and that a pullback may not be far off. We can see how as oil started rising from the end of April through to now the RSI has moved up steadily from a rating of 50 to its current level. In recent days we can see a the RSI just start to turn down again. I would not be jumping in right away to go short oil (the trend is still up after all) but it would certainly be worth keeping an eye on this reading over the coming days and if it starts to fall back below 70 in conjunction with a fall in the price of crude then we could well be at the beginning of a more significant fall in the price of crude. Remember we should never be trying to catch the top or bottom with our trades, instead we follow the trends and to that end RSI can certainly help point the way towards reversals in trends.

Some Final Takeaways On RSI

One of the aims I had when setting up SpreadTrader.ie was to try provide a site where people could get information about financial spread betting simply explained to them without a lot of the technical jargon that other sites, books, etc tend to have in them. On some of the more technical indicators like RSI that can be a little harder to do but I hope I have at least got someway there with this post. After going through all the info above I now have to be honest and say that from my own trading perspective I don’t really use RSI that much at all, the odd time I’ll take a look at it to see what it’s up to, see if it will give me any indications as to what the market or a particular stock I’m interested in might be up to, but in general I base most of my technical decisions on trend lines, moving averages and support and resistance lines. But still just because I don’t use it too much should not be a reason for me not to cover it on the site. And sure worst case scenario, next time you are down in the pub and one of your mates is babbling on about quantum physics or something you can quieten them by asking for their thoughts on the Relative Strength Index as a momentum indicator when trading stocks!!

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

Staying at home for our “Chart of the Week” post up this week is good ole Ryanair, the airline we all love to hate! It’s amazing how one company can frustrate so many people just at the mere mention of it’s name, how within seconds it can lead to story after story of different experiences  relayed covering everything from cancelled flights to excessive baggage fees to online charges for paying with your laser card! But that’s Ryanair for you, in many ways that is what Michael O’Leary has spent the last 15 plus years at the helm building up and that’s the image he wants us to have, but more of that later. Ryanair announced their annual results on Tuesday of this week so I have decided now is probably as good a time as any to take a closer look at what Europe’s Largest Airline has to offer.

The Man Behind The Airline

So just like you can’t mention Manchester United without talking about Alex Ferguson or American politics without Barrack Obama’s name cropping up, it’s very hard to have a conversation about Ryanair without Mickey

Michael O'Leary

O’Leary’s name making an appearance. Few companies have a CEO whose reputation is larger than that of the company itself, perhaps Steve Jobs at Apple or Bill Gates back in the day when he was the main man at Microsoft. We all know that O’Leary courts controversy, from his continuous swipes at government policy to the controversial ad campaigns and publicity stunts he gets involved in to his regular use of foul language. But I think deep down most people sort of have to respect O’Leary for who he is and what he has achieved. He has taken what was effectively a loss making regional airline and turned it into one of the most famous brands globally. Ryanair is now the largest airline in Europe in terms of passenger numbers with over 58m people carried last year. We may not always agree with everything he says but from an ability to run (and grow) a business and manage to keep that business continuously in the public spotlight then there are few better than O’Leary. Only last Tuesday morning I saw him interviewed on the BBC’s Breakfast show following their results announcement and he was brilliant in how he controlled the interview. He got the message across on how Ryanair would continue to drive down average fares, glossed over the fact that they were ditching check-in desks and you’d now have to pay for the pleasure of checking in online and of course got in his bit of controversy in saying that while they would like to charge fat people more it probably wasn’t practical but they would be seriously looking at charging passengers to use the toilet! The interview was probably no more than 6 or 7 minutes long but that’s all O’Leary needs to get his message across. The big question of course is what do Ryanair do when O’Leary finally decides to call it a day and hand the reins over to some other poor sod….just like whoever takes over at United when Ferguson eventually decides he has won enough trophies, whoever takes over at Ryanair will have big boots to fill!

Driving Lower Fares Means Driving Down Costs

We all know Ryanair is all about driving down costs right across the airline. One of the main reasons for getting rid of all it’s check-in desks from later this year is to further reduce it’s cost base. Analysts estimate that no more check-in desks could save the airline as much as €30m a year. Of course the additional €5 online check-in charge won’t do it’s revenues any harm either, potentially increasing them by up to €300 mil… Fuel continues to be Ryanair’s biggest cost and after a couple of years of poor calls when not hedging when prices were low in 2007 to then hedging at very high prices last year just before oil crashed back down to earth, it looks like Ryanair has got it right this time round and is now 90% hedged on it’s fuel requirements for Q1-3 this year at pretty good prices. Given the current environment that all companies are operating in one of the amazing things on Ryanair is that it has no intention of slowing down it’s expansion plans. And in fact this is not the first time that Ryanair has used a tough market for the airline industry to it’s advantage in recently completing the purchase of 45 new plans for delivery later this year and throughout 2010 at very competitive prices. Ryanair did something similar after 911 in 2001 when it was effectively the only airline in the market looking to purchase new aircraft.

Low costs and efficiency is what Ryanair is all about and will continue to be about. Fast turn-around times ensure it’s planes spend more hours in the air than any other airline, no pockets on the back of it’s seats mean the planes can be cleaned faster, deals with regional airlines for the lowest possible landing charges, new wing design to ensure maximum fuel efficiency (and not to be cynical here but it’s not out of concern for the environment…), the list goes on and on.

Ancillary Revenues Continue to Point the Way

Reducing costs is obviously massively important for Ryanair but you can only reduce them so far and ultimately it is new revenue streams that Ryanair need if it is to continue to grow profits. It started with the baggage fees, soon followed by the check-in fees, then there was paying for priority boarding, the selling of lottery tickets, the Ryanair credit card, etc, etc… and most recently Mickey has introduced onboard mobile phone service on 40 of his planes. And it won’t stop there, already there is plenty of talk of what might be the next charge to be added to Ryanair’s ancillary revenue streams, will it be the obesity charge or the “pay to pee” charge that have being getting plenty of press coverage recently?? Whatever it is Ryanair have come to the conclusion that ancillary revenues along with increased passenger numbers and cutting costs wherever possible is the way to go. It’s easy to charge a Euro or whatever for a flight when all the extra bits and pieces are going to bring it up to 20 or 30 quid and load factors of average 80% or there abouts ensure that’s enough to make each flight profitable.

In it’s most recent results ancillary revenues were up 23% year on year to almost €600m and now account for 20% of Ryanair’s total revenues. One thing I spotted recently which I thought was a great idea was that Ryanair were running a competition a couple of months back for people to suggest their “best new charge” that Ryanair could introduce, with the winner for the best idea getting €1,000. Brilliant, aside from the usual free publicity that this brought they also get hundreds if not thousands of ideas for potential new revenue streams. Now many may be rubbish and many more Ryanair may already have thought of themselves and either have already planned to introduce or discarded for whatever reasons but there has to be at least a few great ideas that will come in that Michael and his buddies hadn’t thought of yet. And the total cost to our low fares airline, a thousand quid, shouldn’t take too long for that investment to cover itself!

What’s to Become of Aer Lingus?

The main reason Ryanair announced it’s first ever annual loss this week was due to the right down of it’s stake in Aer Lingus, a €222.5 million charge. If this was excluded Ryanair actually made a profit of €50 mil. After two failed takeover attempts over the last few years, the first at €2.80 a share and the second last year at €1.40 a share, the question is what will Ryanair decide to do with it’s Aer Lingus stake in the end. It can’t make another takeover attempt for about 18 months or so but don’t be surprised if it still has it’s 30% stake around that time if it does come back for a 3rd bite, and looking at how Aer Lingus are burning through their cash pile these days expect the bid to be under a €1 next time round. Whether we get to a 3rd Ryanair bid or not I’m not sure, something will have to happen to our national carrier and perhaps a merger or takeover from the likes of a BA or Air France might be a more likely outcome. At least that way the airline can survive in some guise without the Aer Lingus management and the Government having to accept O’Leary’s overtures.

The Challenges that Lie Ahead

Obviously it’s not all up, up and away for Ryanair, it is operating in one of the toughest and most competitive industries in the world and there are plenty of headwinds facing it in the months and years ahead. Oil prices, which these days account for 45% of Ryanair’s total operating costs, look set to continue to rise. Competition is fierce as airlines reduce fares in a desperate effort to increase load factors and stave off the threat of going into liquidation. While we may be coming towards the end of a global recession consumers are certainly still cutting back on the number of trips they are making and businesses in particular are looking for cheaper alternatives to flying their staff all over the world for training, meetings, etc with many having a ban on all non-essential travel.

Jumpy Chart Not for the Faint-hearted

So what does Ryanair’s chart tell us. Well first off, it’s certainly not one for the faint hearted with several big rises and falls over the past 12 months (click on the chart below to see larger version). That said looking at a shorter 3 month timeframe there stock has being working it’s way upwards, going from around €2.80 in March to close to €3.80 today. A 35% increase is not to be sneezed at. However it’s worth noting that the rise throughout April and May came on very low volume in comparison to what was the norm over the previous 10 months, potentially highlighting that there may not be a lot of weight behind this recent 35% rise.

But where might it go from here. Well personally Ryanair wouldn’t be the kind of share I’d like to trade, it’s just an industry and a stock that’s a bit too all over the place for me. Trends and support levels can often count for very little and leaving you scratching your head when you get stopped out of a trade from nowhere. For me there are just too many other “better behaved” stocks out there to be trading these days. But plenty of people do trade it and probably do very well on it. If I was going to trade Ryanair I’d be looking at how things have panned out since Tuesday’s results. At the open on Tuesday the markets initial reaction was to sell off on the news of Ryanair’s first ever loss, with the stock down over 7% within minutes at around €3.40 a share. But since then it has recovered nicely as the market has had more time to digest the results and as mentioned earlier is now at a 52 week high of €3.72 after breaking through resistance at €3.60 earlier in the week. Obviously the market has come around to the thinking that despite last years loss Ryanair is still best of breed in the airline industry and from here should continue to take market share from it’s rivals, increase passenger numbers and of course grow it’s ancillary revenues. While higher oil prices may hold the share price back somewhat I never believe in fighting the trend, so a long position would seem the best approach with a tight stop just below the low hit following Tuesday’s results announcement.

Ryanair’s Chart is a Choppy One (Click to Enlarge)

Final thoughts on Ryanair

So that brings another “Chart of the Week” to an end. As mentioned the Airline industry is one of the more high risk sectors to be trading but assuming at least a couple of airlines come out of the current recession in-tact and assuming people will continue to fly, then expect Ryanair to stay in the limelight and continue to expand it’s reach as Europe’s largest airline.

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

It’s “Chart of the Week” time again and this week I thought I’d take a look

Bulmers Irish Cider

at a stock a bit closer to home, this is an Irish blog after all! So after the fab weather we had this weekend I’ve decided to that a look at drinks group C&C. Back in the day C&C used to have a lot more strings to it’s bow when it also owned premium brands such as Tayto, Ballygowan and Club Orange among others. However a shift in corporate strategy in 2006 saw the company sell off a number of it’s brands to pay down the company’s debt and allow it to focus it’s resources on the Long Alcoholic Drinks (LAD) market instead, and one drink in particular, cider. Tayto was sold off in the summer of 2006 to Largo for over €60 million. That sale was followed up in the summer of 2007 by the sale of it’s soft drinks business, which included the famous bottled water brand Ballygowan, to Britvic for a whopping €250 mil, and to think back to the days when you wouldn’t dream of paying for a bottle of water!

What’s in a name?

Today C&C is left with a product stable that includes Tullamore Dew, Carolans Irish Cream and Ritz but it is it’s cider business that forms the key to the company’s performance and value. Growing the Bulmers brand in Ireland and the Magners brand in the UK and the rest of the world are now C&C’s priority as they contribute the vast majority of the groups profits. Recent results for FY09 show that the C&C had sales of almost €515m of which cider sales contributed €387m, or approx 75% of the group’s turnover. What has baffled a lot of Irish people over the years is how come it’s Bulmers in Ireland but Magners in the North and in the UK? Well a company called HP Bulmer, or better known as Bulmers cider already existed in the UK, since 1887 actually, and they owned the rights to the Bulmers brand in the UK. In 2003 the company was bought by drinks giant Scottish and Newcastle for £278m who were subsequently taken over by Heineken and Carlsberg in 2008 as part of a wave of consolidation in the drinks industry in recent years. This hasn’t worked out too well for C&C who, despite doing a great job building up the Magners brand in the UK in recent years, has seen it’s market share come under stiff competition from Bulmers who have pumped a lot of money into branding their cider, particularly at the “served over ice” market. So all this results in C&C having what must be a frustration and obvious extra expense where it has to brand it’s main product under two different names. Will we see a consolidation of the brands at some stage, similar to Jif becoming Cif and Bounty becoming Plenty, where C&C bite the apple (sorry another pun that just couldn’t be resisted!) and decide to do away with the Bulmers brand in Ireland and just go with Magners globally? Although it would no doubt be met with resistance and some negative publicity from it’s loyal customer base in Ireland it is probably not that big a step for them to make at this stage given that the Magners brand is fairly well know in Ireland at this stage anyway…

New Product Launch to Drive Profits Higher?

So what else is going on in C&C these days? Well unless you don’t have a TV you cannot have failed to miss the recent launch of Bulmers Pear Cider. The company is obviously pumping a lot of money into the launch of it’s new cider brand in Ireland and the UK but should it take off then it can expect to see it add substantially to the group’s bottom line. I have to say that I think the campaign is class, I love the way they are taking the piss out of themselves for being so slow in coming up with this initiative, with the tv ads around the lads trying to come to terms with dealing with pears instead of apples particularly humorous. With the launch of Bulmers Pear Cider C&C will be hoping to eat into the impressive market share already built up by Kopparberg over the last couple of years. I haven’t had a chance to do a taste test between the two brands yet, anyone any thoughts on how this new Bulmers Pear Cider is going down??

Promised Good Summer will be Key for C&C

Regardless of the success of it’s Pear cider one factor which will have a massive impact on C&C’s profits this year is whether or not we get a good summer. Now I am no long-term weather forecaster but by all accounts in the media we are actually supposed to have one of our better summers this year, something about the rise in ocean temperature in the Pacific, the fact that we got a harsher winter and that March and April have been significantly wetter than normal! Your guess is as a good as mine but so far so good…Anyway, why do these rising temperatures matter so much to C&C? Well it’s being proven over the years that warmer, sunnier summers have seen an increase in the amount of outdoor drinking done and in particular an increase in people’s preference for a nice pint bottle of Bulmers over ice…ah yeah, in fairness I am not a cider drinker myself, give me a pint of Guinness any day, but there is something very refreshing about Bulmers over ice on a sunny Saturday afternoon when you are out watching the rugby, the gaa or whatever. Interestingly, when announcing their recent results C&C have said that sales of Bulmers in Ireland are up 10% in the first couple of months of the year, due to the timing of Easter, good weather and the rugby success achieved by Ireland and Leinster. So the upcoming Loins tour should only serve to add to that impressive start to the year.

Director Purchases A Positive Sign

One thing a lot of analysts and investors look for as an indicator of a company’s future performance is whether or not company directors are buying or selling shares in the company or if they are exercising share options. Only last week C&C non-executive director Liam Fitzgerald spent almost   €50,000 buying 21,900 shares in C&C at €2.28 per share. So while we can’t read too much into the purchase it’s always nice to see that some of the key players in a company putting their money where their mouth is so to speak.

So with C&C announcing adjusted EPS for FY09 of 25.5 cents per share recently that leaves it  trading on a PE of about 10 which is comparable with other larger players in the industry. The company also announced a final dividend of 3 cents per share bringing it’s full year dividend to 9 cents, representing a yield of around 4%. Overall these results were in line with expectations and importantly full year guidance for the coming year was maintained with profits expected to come in in between €77-88m.

C&C Chart Also Paints a Pretty Picture

So that brings us to C&C’s chart and what does that tell us about where the company’s share price might go in the coming months? Well a quick look shows us that since bottoming in late January at a around the 75 cent a share mark C&C has been in a very nice upward slope indeed. The last four months has seen the share price triple to now stand at €2.25 a share. That’s a massive run-up in a very short period of time but still sees the share price at less than half what it peaked at last summer when the share price traded at over €5.50 during the summer months.

C&C - Click to Enlarge

Talking a closer look at the chart the 20 day moving average seems to be acting as support in recent months, with the share price steading climbing just above this level. Some resistance may be hit at the €3 mark but after that a run-up to €4 is not inconceivable. Any trades to the long side should have a stop just below the 20 day moving average. Ideally any pullback to closer to the 20 day moving average would seem a good entry point.

Final thoughts on C&C’s Prospects

Overall C&C, like a number of Irish shares, is making a bit of a recovery recently. Given it’s more recent slimmed down focus on a smaller number of brands, and on Bulmers and Magners in particular, it has certainly become a more seasonal stock. Continued improvement in the share price will largely depend on whether we do get this much talked about “Good Summer” and on how successful the recent launch of it’s Pear Cider range turns out to be.

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

In my previous posts, particularly the Chart of the Week posts, I have tried to introduce different technical indicators that traders should look out for like trends, double bottoms, higher highs and higher lows, etc. Today I thought I’d take a look at another very important technical indicator that is often overlooked by traders – Volume. In this post I am going to cover a number different trading setups where volume is a key factor in giving weight to the trade you are considering.

Large Volume Adds Significance to Breakouts

For traders who look for stock breakouts (either to the upside or downside) then checking out the trading volume of shares traded on these breakout days is important. Basically if a stock has been trading in a narrow range for a number of weeks or months and then suddenly (over 1-3 days) makes a significant upward or downward movement then this is considered a breakout. The longer the stock has been trading in it’s previous range the more significant any breakout is when it eventually comes. Typically though you should be keeping an eye on stocks that have been trading in a narrow range for approx 10-12 weeks (often referred to as a consolidation pattern or period). During this time when the stock is not really moving in either direction basically we have a stand-off between the bulls and the bears, with neither having enough conviction to force the the stock in a particular direction. However as sure as the amount of money required to bailout the banks will continue to rise one thing is certain with bull / bear stand-offs, sooner or later one of them is going to win the battle and when they do the stock will move. That’s when you need to be ready to make your move. But before you get trigger happy with your trading it is important to make sure your breakout is real and not just a false breakout due to a bout of short covering or just handful of trades going through at prices outside the norm. That’s where the daily trading volume comes into play. If the stock for example has an average daily volume over the previous 3 months of lets say 1 million shares traded and on the day of a perceived breakout to the upside the volume is a mere 300K  then you have to be suspicious of it. In this scenario clearly the buyers have not suddenly come out in force to push this stock upwards. Now it may be the case that it takes a few days for whatever news is on the horizon to break and when it does come the stock will continue higher but until you see some serious volume backing up the breakout you have been waiting for then it’s best to bide your time. Regularly breakouts on low volume turn out to be false and within a few days the stock is back in its range. In fact I know many traders would use such low volume breakouts to the upside as a reason to short the stock (or they would buy low volume downside breakouts), in both cases looking for it too fall back into it’s range.

Some Pretty Charts to Look At…

To help back this up I have included a couple of charts. First up is a stock I have been aggressively trading over the last couple of weeks, (when you see the chart you’ll probably guess why!) called Potash (Ticker: POT) who are one of the world’s largest producers of fertilizers. I am not going to go too much into the company itself right now because I think it’s an ideal candidate for a future Chart of the Week post. But for now lets look at the the recent breakout above a key resistance level of approx $95 a share and the part the daily trading volume played in this. The chart below (click to enlarge) is a 3 month chart and over that period the stock had an average daily volume of just under 10.5 million shares traded a day. On the 11th May, the day before it’s significant breakout, the stock closed down about 1% at $94.96 and exactly 5.5 million shares were traded, so well below the average daily volume. Along came the 12th May and bang, POT jumps over 6% and not only breaks through the $95 mark but goes on to break the $100 mark and close at just under $101. The volume that day? 15.7 million, over 50% above the average daily volume. So even if you missed the initial breakout on 12th May given the bullish nature of the volume that accompanied it you could still have joined the POT party the next day. So what’s happened since Tuesday last week:

• Well Wednesday the stock closed up marginally at $102 with another 15 million shares traded.
• Thursday it moved up to $108 with over 12 million shares traded.
  Friday it held it’s own, closing at $107 and almost 13 million shares traded.
• Monday just gone by the stock moved on to $111.50 although volume was not as strong at under 7 million
• And last night it closed at $114.50 with almost 11m shares traded

So while volume is dropping back again I hope you can see the significance of the the big breakout on May 12th on huge volume and the follow through over the following week’s trading. Even if you only went long last Wednesday after the initial breakout on Tuesday you would still be looking at an over 1200 point rise since then, at €1 a tick that’s a pretty nice trade.

Potash Chart - Breakout on High Volume

The second chart is Crocs (CROX), you know the makers of those rather uncool shoes that you see around the place, the ones with the holes in them. Apologies to anyone who has a pair and thinks they’re the business…but we call it as we see it here on SpreadTrader.ie! Although I have heard they are supposed to be very comfortable…
I’m not going to go into as much analysis on this one but you’ll get the picture, similar to POT, this time I’ve included the Year-to-Date chart, you’ll see from the start of January to the end of March the stock was not up to much, chugging along between the $1.15 and $1.40 mark on low volume of around a million shares a day give or take a few 100K – basically a pretty boring stock and not a lot of trading opportunity in it. Then we get into April and it breaks out to the upside, it breaks through $2 a share, $2.50 a share and ends up going over $3.50 a share before pulling back a bit recently. Notice the volume over the last 6 weeks since this breakout began?? 3, 4, 5 million shares a day, even as high as 9 million shares a day for a few days at the start of this month. Clearly money is moving back into Crocs again for some reason, possibly on the back of improved market sentiment,  stronger retail figures coming out or just more people starting to think Crocs are cool!

CROX breakout sees Stock Double

How Volume Adds Weight To A Trend

So to summarise what you should be looking for when it comes to volume, generally it should follow the trend. So if a stock is rising, this upwards trend should be supported by large volume, backing up the thesis that more and more money is moving into the stock. An interesting thing to note here is that as a stock’s price rises and it naturally becomes more expensive to buy, increased volume means even more physical money is moving into that stock. For example, in the CROX example above, early in the year approx $1m a day was been spent by investors buying Crocs shares (around 1 million shares a day at a little over a dollar a share), more recently however we have seen upwards of $15m getting spent buying up CROX stock on a daily basis (over 5m shares a day at approx $3 a share). It’s a clear sign that the demand for the stock is increasing and that more and more money is been invested in it.

The reverse is also true, if a stock starts trending downwards, for it to signal a significant sell-off again you should be looking for large volumes to back-up the downward trend, that’s the sign that tells you people are dumping this stock as fast as they can and are ready to accept whatever price they can get for it on the open market. That’s when you need to be shorting like it’s an Irish bank stock in 2008! If on the other hand you see the stock fall sharply but on much lower volume than normal, chances are it is not a significant sell-off but perhaps instead just one particular shareholder who needs to sell his holding to get his cash out quickly for whatever reason. If such a low volume breakout to the downside is not followed up with either more sustained selling or some bad company news, results or whatever then you should consider it as a false breakout and be looking for the stock to move back into it’s previous trading range.

Volume as an Indicator of Overall Market Sentiment

Looking at the part played by trading volumes from an overall market perspective the same ideas hold through. If we are in a Bull market stocks indices will continue to make new highs on larger volume. If this volume drives them up too far too quickly they may fall back as new buyers are less eager to jump in and some profit taking from those who got in early kicks in. However if these pullbacks are on lower volume that’s a bullish sign, it means there’s no big sell-off going on. If these slight pullbacks end up getting bought into (by those who missed out the last time) and result in the market getting driven on to new highs, again on large volume, that’s what gives us our overall bull market and from a charting perspective will give you the higher highs and higher lows that we look for – see Morgan Stanley Chart of the Week for a more detailed example.

In a Bear market, such as the one we are in the middle of right now, we see the reverse. Investors sell off very quickly, driving the price lower on large volume. Sometimes the sell-off will be so quick and so severe that a lot of shareholders will miss it or will decide that they are not happy to sell at the current price because it’s too low. This can lead to low volume pullbacks but in a real bear market these will be met with renewed selling once the price rises to any reasonable level, ultimately pushing it to new lows. The process continues giving us lower lows and lower highs each time.

Final Thoughts On Volume, For Now…

So to finish up, volume is something that is often overlooked by traders, they look at the chart and make their decision off price alone. I think one of the reasons this is that a lot of the trading platforms out there don’t include volume as an option in their charting software. If that is the case with whoever you are currently trading with it is still no excuse for not taking 2 minutes to log onto Yahoo Finance or whatever and having a look at the recent volume and how it compares with the average volume over the previous few weeks or months. I have no doubt I’ll touch on this topic again in the future as there are plenty of other technical setups where volume can play a part but for now hopefully the examples covered above will give you some guidelines on what you should be looking for before you pull the trigger to Buy, Buy, Buy or Sell, Sell, Sell!

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

It’s “Chart of the Week” time again and this week, following the announcement of the Stress Test results in the US last Friday I thought I’d take a look at one of the major US banking stocks which were under review as part of the Stress Tests. After take a look at the various candidates, most notably Citigroup, Bank of America, Wells Fargo and Goldman Sachs in the end I decided to take a more detailed look at Morgan Stanley.

Morgan Stanley Comes out of Tarp and Stress Tests Relatively Unscathed

As always we’ll start with the fundamentals, so where does Morgan Stanley now stand following all the turmoil in the financial markets we have had over the last 12 months? Well, following the collapse of Lehman Brothers, the acquisition of Bear Stearns by JP Morgan and the acquisition of Merill Lynch by Bank of America, probably not too bad a position…Along with Goldman Sachs, Morgan Stanley is now one of two major independent US investment banks left in the game. So assuming the recent financial crisis eventually blows over and we find ourselves back in a  more normal state of business (albeit a much more conservative and more tightly governed one) the likes of Goldman and Morgan Stanley should be able to reap the benefits of competiting for new business in a less crowded marketplace. As one of the world’s largest investment banks the company operates in three main segments, Institutional Securities, Global Wealth Management and Asset Management.

Although it’s worth clarifying that technically speaking both Morgan Stanley and Goldman Sachs are, as of last September, now bank holding companies. The decision by both companies to change their status came at the height of the banking crisis and following what were no doubt intense discussions with the US Federal reserve. What the decision did mean at the time though was that the US government was not going to allow either company to fail and has since allowed them to take part in the now famous TARP (Troubled Assets Relief Program) scheme. Under TARP Morgan Stanley received a relatively modest $10 billion in capital support to help shore up it’s balance sheet at the height of the crisis. Furthermore it is eager to pay back this $10 billion in funding “as soon as possible”. Only last Friday the company announced that it had successfully sold $4 billion in stock at $24 a share (an 11% discount to the previous day’s closing price) and had raised another $4 billion in debt (split evenly between 5 and 10 yr notes). Both the stock and debt sale were over subscribed and were mainly taken up by institutional investors – all very positive indeed. As well as paying off its TARP loans no doubt a portion of this money will be used to cover the $1.8 billion the US government said it needed to raise in fresh capital as part of the Banking Stress Test results announced last week.

Quarterly Results Fail To Impress

In it’s most recent set of quarterly results announced at the end of April Morgan Stanley reported a $578 million loss and significantly cut its dividend from 27 cents a share to 5 cents a share. Unlike most of its peers in the US banking sector the results were much worse than the market was expecting. Wall Street had penciled in a loss of 9 cent a share, so needless to say they were less than impressed with Morgan Stanley’s 57 cent a share loss. Net revenues of $3 billion were 62% down on last year. Q1 last year saw Morgan Stanley earn profits of $1.3 billion or $1.26 per share. This resulted in Morgan Stanley shares falling 16% over the following 7 days. Interestingly though, the shares remained above the key $20 mark and since reaching a low of $20.70 on April 29th have risen a very impressive 35% in the last two weeks to Friday’s close of almost $28.

Weirdly one of the main reasons for Morgan Stanley’s loss this quarter was due to a dramatic improvement in its credit rating, thus allowing it to borrow money at tighter spreads then it was previously able to. This is a very positive development for the company but also one which has a short-term negative impact on their revenues, mainly due to the way such debt is reported from an accounting perspective. Because the broader market now has more confidence in Morgan Stanley  than it did say 6 months ago, Morgan Stanley would have to pay more to buy back its debt now than it would have had to at the end of last year. Although a positive development from the company’s perspective, US accounting rules say this change must be recorded as a loss!

Management Adopt a More Conservative Approach

There is no doubt that Morgan Stanley is a company in transition. Since becoming a bank holding company just over 6 months ago it is clear that it is now well on it’s way to becoming a much more conservative (if a tad boring) bank. During this time it has begun the process of reducing risks and strengthening it’s balance sheet by reducing it’s dependency on investment banking and building up the retail side of it’s business. A recent deal with Citigroup will see it double the number of retail brokerage outlets worldwide to 1,000. The deal with Citigroup basically sees Morgan Stanley control 51% of Citi’s brokerage arm Smith Barney. Another example of Morgan Stanley’s more prudent approach to “post financial meltdown” life is that over a quarter of it’s balance sheet was kept in cash last quarter, which while leaving it in a very strong liquidity position, does have a negative impact on it’s earnings. It’s main rival Goldman on the other hand has decided to continue running it’s business as it always has, taking on similar levels of risk with it’s investments and showing better returns in it’s most recent quarterly results. That said there are still areas of Morgan Stanley’s business that are doing very well, for example in the last quarter they completed more Merger and Acquisition deals than any other investment bank during this period.

From a valuation perspective Morgan Stanley is not exactly cheap trading at a P/E of almost 20, but what is probably of more significance is that it is trading at a Forward P/E just over 10. This keeps it in line with it’s main rival Goldman who is trading at a Forward of P/E of 11. Morgan Stanley’s current market cap is $31 billion and they employ almost 47,000 employees worldwide.

Clear Upward Channel Points The Way

So after looking at the fundamentals and getting a good understanding of what Morgan Stanley does and where it sits in the world of investment banking lets take a look at it’s chart and see what that tells us about what the share price might do over the coming months. Well first up, not unlike IBM last week,  we can see that since last October / November the stock is in a clear uptrend. We can see from the chart below (click to enlarge) that the stock has being trading in a channel, defined a by a series of higher highs and higher lows.

Chart 1 - Morgan Stanley

The concept of “higher highs and higher lows” is a commonly used technical trading term which I wanted to introduce this week, and one of the main reasons why I decided to pick Morgan Stanley for this week’s “Chart of the Week” post over the various other US banking stocks I looked at. Stocks whose charts are showing a series of higher highs (defined by the price reaching a new high each time it trades up - see red lines marked on chart) and higher lows (defined by the price staying above the previous low it made the last time it traded downwards - see blue lines marked on chart) are by default going to be in an uptrend. What technical traders like about these kind of trades is that:

• They can time their entry point using the channel, be that buying when the stock hits the bottom of the channel or shorting when it’s near the top. Note: Shorting stocks in an uptrend like this, even if they are in a trading channel and due a pullback, is risky as the over all direction of the stock is upwards.
• They can easily define their risk by putting their stop just below the previous higher low. If the stock falls below the previous higher low it has effectively broken out of the upward trend, at least temporarily and from a trading perspective you no longer want to be long the stock.
• Similar to defining their risk, they can also identify logical profit taking levels when the stock moves back up to the top of the range and use these levels to tighten up their stops.

Looking at some of the other technicals for the stock, it has a rising 20 and 50 day moving average and recently broke through it’s 200 day moving average. This 200 day moving average (approx 2330) may well act as support going forward. In it’s fall from over $90 a share in June 2007 the 200 day moving average acted as resistance on a number of occasions so if this breakout can hold it could turn out to be quite significant. Any pullback to the 200 day moving average holding would also see another “higher low” be put in place. Any long trades should have a stop just below this area. On the upward side, the next big area for the stock to clear would appear to be $30. A close above this point would see a new “higher high” and would keep the bullish upward trend intact.

Final Take-away on Morgan Stanley

Morgan Stanley has had a great run-up since hitting the $9 mark last November, and is now up over 200% in 6 months. It’s a huge rise but not out of line with the similar price increases seen in many of the US financial stocks over this period. Whether it can keep this upward trend going for much longer I am not so sure. As the market regains it’s appetite for risk will Morgan Stanley’s more conservative approach to its business be what the the market is looking for? Or will they be more attracted to the potentially higher earning power of a Goldman instead?

Happy Trading :-),
SpreadTrader.ie

Hi everyone,

Something I wanted to try introduce as part of my regular blog posts is a “Chart of the Week” segment. Basically this would be a post which would (no prizes for guessing this one!) focus on a particular stock. I will attempt to analyse the stock in question from both a fundamental and technical perspective and give my overall take on where I think it might go from here. So when best to start our “Chart of the Week” than today. I had a bunch of different stocks which I was thinking of selecting as our first chart to analyse such as Apple (because it’s one of my favourite stocks to trade these days), GlaxoSmithKline because of the recent Swine flu breakout and a number of others. Anyway we will come back to some of the others in the weeks ahead but for today I decided to go with “Big Blue”, yep IBM. Why you ask? Well two reasons really, one, I just opened a long trade on IBM myself yesterday (at exactly $100 for those interested) and two, IBM’s chart has a couple of nice and relatively straightforward technical analysis techniques going on right now which I think are worth discussing.

So lets start with some of the key fundamentals on IBM. “Big Blue” is the world’s largest technology services company. Last year it had revenues of $103 Billion. Just how big is IBM, well they currently employ just over 400,000 people worldwide! Puts little old SpreadTrader.ie here in his place for sure!

Technology Giant has Excellent Fundamentals

Early last week IBM announced their Q1 results for 2009 and while revenues fell 11% over Q1 2008 to just over $21 billion, their Earnings Per Share (EPS) of $1.70 still managed to beat the $1.66 per share the Wall Street Analysts were expecting. Profit for the quarter was $2.3 billion which will add to the company’s ever increasing cash pile which now stands at over $12 billion. While in some respects the Q1 results disappointed a bit the fact that the company reiterated it’s full year guidance of $9.20 per share appeared to keep the market happy enough. The stock trades at a P/E ratio of 11 times earnings which is not overly demanding for a tech stock.

These days IBM is far from just a hardware player, in-fact it may surprise some to know that the biggest component of IBM’s business is now services (Q1 revenues of $13.2 billion), followed by software ($4.5 billion in Q1) and the hardware side of the business coming in third with revenues of $3.2 billion in Q1. IBM has positioned itself as a full IT solution provider and last week announced it’s plans to start offering cloud computing services later this year, an offering that has proved very lucrative for early adopters such as Amazon and Salesforce.com and one I’d expect to further increase IBM’s bottom line going forward.

Only last week IBM missed out to Oracle on the purchase of Sun Microsystems which it now appears to be putting a brave face on…saying that Oracle and Sun were always closely aligned so it’s no big deal that Oracle now owns them. And given that Sun have just announced a Q1 loss of $200 million perhaps IBM are right!

Other news which should serve to underpin the company’s share price from a fundamental perspective is todays announcement that it is increasing it’s quarterly dividend by 10% to 55 cent per share and is also adding an extra $3 billion to its share buyback program.

Upward Trend Paints Impressive Technical Picture

Right so enough of the fundamentals, lets take a look at the technicals. Well we can’t really look at the technicals without having a chart to look at, now can we. Seeing as this is our first Chart of the Week I decided I’d spoil you with two charts!

The first chart below (click on the image to see bigger version) looks at couple of simple technicals which are often used by traders. First we can see that since it’s low last November IBM is clearly in an uptrend. And we all know how we should trade trends…if you don’t it might be worth having a read of one of my earlier posts on the “10 Golden Rules of Spread Trading”! Secondly if we look at some of the key moving averages we will see that the 20 (orange line on chart) and 50 (pink line on chart) day moving averages are in an uptrend, always a good thing. And we will also notice that the stock has just broken through the 200 day (black line on chart) moving average which currently stands at about 9890 or there abouts. As traders we would hope that the 200 day MA will now act as support for the stock. This was actually one of the key reasons behind me opening a trade on IBM yesterday, I was able to buy at 10000 and put a tight stop in place at 9850 (which I subsequently moved up to my breakeven of 10000 today).

IBM Chart 1

Chart number two looks at an interesting pattern that occurred a couple of months ago, when in mid to late February the stock formed what is referred to by chartists as a double bottom. When double bottoms complete themselves they form a “W” shape which I have highlighted on the chart below. Double bottoms such as this are considered to be bullish, mainly because the stock tested a price level twice but failed to fall through it, thus highlighting this as an area of support or an area where there are plenty of buyers of the stock. When a double bottom like this occurs and the “W” shape completes it can often lead to a stock rising higher on renewed buying pressure, as was the case in this IBM example.

IBM Chart 2

Final Take Away - Upward Trend Should Continue

So overall I’d continue to be bullish on IBM. From a fundamental position I think the company is well diversified to do well in these challenging times and the technicals don’t look too bad either. Any long trades on IBM should be framed around the 200 day moving with a tight stop just below this area. I’d expect the stock to possible hit some resistance at the $104 mark, but a break above this could see it continue to move higher.

Right that’s it from me for my first “Chart of the Week” post. I hope you found it useful. All feedback welcome and if there is any particular stock you’d like me to take a look at in a future “Chart of the Week” post use the Contact Us page to drop me a mail on it.

Happy Trading :-),

SpreadTrader.ie