The Iconoclast Investor

I recently received a question from a reader asking about some of the terms we use when writing about investing. I’ll bet the questioner isn’t the only reader who’s confused about some of our investing terminology. So today I’m going to rundown a list of terms that appear frequently in our writing. I’ll post some more in the next couple of days. More definitions and educational information can be found at Cabot.

Gaps – Gaps occur when a stock begins a new trading day at a price that’s vastly different from the previous day’s closing price. In effect, there is no trading at prices between the closing price and the opening price. This appears as a “gap” on a price chart. Generally speaking, gaps up are considered positive and gaps down are considered negative. However, in many (but not all) cases, price gaps get filled. So if a stock gaps up, you might expect that at some time in the future (from minutes to months later) the stock will drift back down into the gap. Conversely, if a stock gaps down, it’s likely to bounce back up to fill or partially fill the gap. Gaps typically offer support or resistance. If a stock gaps down, the gap will offer resistance if it attempts to recover. A gap up will provide support when the stock corrects.

Relative Performance – Momentum analysis of a stock’s relative performance (RP) is one of our favorite ways to measure a stock’s health. RP measures how a stock is performing relative to a specific market or index. A stock that holds its value during a declining market often soars once the market turns higher. In a strong bull market, most stocks will rise, even the stocks of weak companies. But you should concentrate your efforts on the best companies with the strongest stocks, the market’s leaders. The way to find them is by analyzing RP lines. Specifically, RP is calculated by dividing the Friday closing price of a stock by the Friday close of an index. (We use the broad Wilshire 5000.) The weekly changes are then plotted on a line graph, using a log scale. When an RP line is moving upward, the stock is outperforming the market. When it’s moving downward, the stock is underperforming the market. A flat RP line indicates the stock’s performance is equal to the market’s performance.

Market timing indicators — Cabot has three proprietary market timing indicators that we employ to determine when to get in and out of the market, the Two-Second Indicator, Cabot Tides and Cabot Trend Lines.

Two-Second Indicator – The Two-Second Indicator is so named because that’s how long it takes to read: Just two seconds, every day. Specifically, this indicator measures the number of securities on the NYSE reaching new annual (52-week) price lows on any given day. This data is readily available in most major newspapers, though we use the data from The Wall Street Journal.

Cabot Tides – For the Cabot Tides, we use five different market indexes to help us determine the overall intermediate-term direction of the stock market. They are: S&P 500, NYSE Composite, Nasdaq Composite, S&P 600 Small Cap and the Merrill Lynch Tech Index, an index that equally weights 100 of the leading technology stocks in the market. The market is considered to be advancing on an intermediate-term basis if at least three of these five indexes are advancing. And contrarily, the market is deemed to be declining if at least three of these five are declining.

Cabot Trend Lines – The Cabot Trend Lines are our unique way of determining the long-term trend of the stock market. As long as both the S&P 500 Index and the Merrill Lynch 100 Technology Index fluctuate above their respective trend lines, we consider the market to be bullish. If both indexes are below their trend lines, we are in a bear market.

OptiMo – Our proprietary stock picking system that helps Editor Michael Cintolo determine which stocks will be chosen for Cabot Top Ten Report. It screens for the strongest momentum charts out of more than 8,000 each week.

Leave a comment here with any other terms you’d like us to define.