DAY TRADER · (day trad·er), noun - A person whose goal
is to make his or her profits from a security in the shortest
amount of time [preferably during a single day].
Following is an updated version of our original daytrading strategies page which
we published in 1996 when DayTraders.com went on line. In the years since that
time, we have updated and refined this section of our site to include additional
information on trading. These updates and refinements have largely been based
on our past experiences with the markets, as well as the changes in the markets
and the global economies themselves.
Keep in mind, the stock market is not your friend. Much like war, in daytrading
and/or short-term investing, you are pitting your wits against every other
person in the market. Every dollar you make is on the back of someone
else's losses. Your goal is to win with your investments and your trading and
that requires someone else to lose - try to make sure it's not you. Never
forget that and you'll be off to a much better start in the markets.
How risky is daytrading? Well, before you read this page any further, imagine
taking about $10,000 in crisp, brand new one hundred dollars bills out into the
back yard. Put them on the ground and douse them in lighter fluid. Then strike
a match. Don't burn your money just yet, but just stand there.
That's about how risky.
Always remember: at any given time, when you are daytrading for a living, you
are risking probably that much money (if not quite a bit more) and your money is
in perhaps just as much risk. And while we are not suggesting that you actually set fire to your money in
the backyard, our analogy is fairly accurate. If that bothers you, then
perhaps you might consider another line of work, or a good mutual fund, because I don't
know any good day traders that haven't seen at least $10,000 go up in a puff of
smoke during market hours. It's simply unrealistic to expect to be able to trade
professionally and profitably from day one. Mistakes will be made; lessons will
be learned; money will be lost as you learn. It's a never ending process to a large degree. In fact, the day you feel you
have mastered the markets, that's the day you get your head handed to you.
In the years I have traded, I have seen many people come and go. I've seen
people make and lose large sums of money very quickly. I have made and lost
large sums of money very quickly! I've seen stocks go from pennies to hundreds
of dollars and back again, taking traders and investors for a ride both
directions. And yet, still, in all the years I have been in this business, I am
sure of only one thing about the stock market: that I have not seen it all yet.
If anyone claims to have all the answers about the stock market, or claims to be
the only person you should listen to - run, don't walk away from them and/or
their services. While we don't claim to know everything, our site and staff
does have a tremendous amount of combined experience when it comes to trading
and investing. Our goal is to help educate and provide a cost effective service
that you can use along side your own trading. Are we perfect? No.
Certainly, not perfect. But I do feel DayTraders.com and our staff can
do an excellent job of helping traders profit in the markets while mitigating
risk as much as possible.
So, before going any further, put away the match and let us try to help you
save a few dollars on your daytrading education. In the following text we will
try to impart some of the knowledge we have acquired while day trading for a
living. While these are not always hard and fast rules that can be applied to
every situation, we do feel that they are helpful and represent a good starting point. In
addition, we strongly suggest you closely review our book list for additional reading material.
· DAYTRADING STRATEGIES ·
HOW MUCH CAPITAL DO YOU NEED? - This is a very
common question and one we receive quite often. By the same token, it's
also somewhat difficult to answer. How much do you really need in order to start day
trading. How big a "stake" (a term used to refer to your starting capital) is
required to get going?
The only answer is that it's different for each person and it's something you
must consider for yourself before you start. However, I personally feel that,
generally speaking, you should have enough trading capital to purchase between
500 to 1000 shares of any given stock. Ideally, without having to use margin.
So, if you are in the habit of trading $40 to $80 stocks, this could mean you
need as much as $40,000 to start. At the same time, one can trade with as
little as $10,000 and get their feet wet. It also doesn't hurt to have enough
capital to diversify into several different positions (two to five generally) at
one time - each with say 300 to 500 shares. Just remember, if you are starting
small, keep your expectations realistic. Certainly, someone trading with
$10,000 to $20,000 is going to have a much more difficult time generating $1,000
per day than someone using $100,000 or more. As long as you keep this in
perspective, it will help keep you grounded as you begin learning.
When you get into the bigger leagues of day trading, then it's nice to be able
to "step on" (i.e. purchase or short) a "block" or two of stock. This would be
generally defined as 10,000 shares of stock. This typically is going to require
$500,000 or more of trading capital, plus some use of margin in limited
situations and for a limited time. When you reach this level, it's easy to see
how daytrading can become quite profitable (and quite risky!). A few points (or even a few
fractions) across 10,000 shares can return quite a bit of money quite rapidly.
Just remember it goes both ways; you can quickly lose quite a bit as well.
There's no right or wrong answer with regard to how much you need to start.
Simply keep your objectives in perspective and reasonable. This will go a long
way to giving you a good start in the markets. Also understand that if you are
starting small, factoring in things such as equipment fees and transaction costs
may become much more important.
REDUCING RISK AND PROTECTING CAPITAL -
Reducing risk to your money and protecting your trading capital must come before
making money in the stock market; it must always be put first in your mind when
trading. You must learn and become comfortable with this being your first
priority when trading. I know that sounds a little strange, but it's 100% true
and a very important mind set to get into. After all, you can't play the game
if you don't have the dollars. You should always be willing to give up a trade
in order to reduce risk and save capital.
You absolutely must seek to reduce risk and protect yourself at every turn
in the stock market, even before making a profit. Don't get me wrong, you are
here to make a profit, but never at the expense of taking silly risks.
Always consider the risk to reward ratio of any trade you plan to take up. What
is the risk? What is the reward? Keep that ratio in your favor and you'll be
well on your way to making a good start in the trade and protecting your trading
capital. I would rather miss 10 trades, than make 10 bad ones. Any trader
would. Reduce risk, reduce risk! Bad trades, mistakes, and large risks are like
leaks in a dam. Forget about everything until you correct the leaks, then worry
about increasing the water level.
GET YOUR FINANCIAL HOUSE IN ORDER FIRST -
Trading and speculation in stocks (more commonly called 'Daytrading') has been
around as long as the stock market has been in existence. Whether it's the days
of the Buttonwood tree on Wall Street, or the Bucket Shops of the 1920's, or the
electronic trading that takes place every day across the Internet, there are and
there always will be "traders".
It's certainly not difficult to imagine that the first time a person bought a
stock and saw it go up, they had the urge to sell and take a quick profit.
Daytrading is nothing new - it's simply human nature to want to take a quick
profit and then repeat the process.
Some people would like you to believe daytrading is something new and that
therefore it must somehow be "bad". However, when you really stop and think about it,
daytrading is really no more risky than any type of investing or financial
speculation. Any investment or trade can go bad, just like any trade or
investment can go well. Just talk to anyone that has owned large amounts of
real estate for any extended period of time. There have been times in the
economy when interest rates sky rocketed and suddenly exposure to a large mortgage
has been quite risky. No matter what the situation, speculation with any
financial instrument brings some amount of risk - especially if done incorrectly
or unwisely. Daytrading is no different.
Certainly, daytrading, like anything else, can be risky if you don't know what
you are doing. I've known of people making one silly mistake and getting wiped out
over night. Since daytrading does come with a certain amount of risks, it's
only wise to get your financial "house" in order before you begin. As such, a
few basic guidelines are in order.
First, we should understand that there are two basic categories of people that
tend to seek out daytrading and that these two categories are drastically
different in their approachs to the markets.
The first (and more historically typical) category is made up of people who are
basically pretty financially well off. These include individuals who have solid
financial worth from other means. They also tend to have homes which are paid
for (or largely paid for) as well as being relatively high net worth individuals,
particularly in the liquid assets category. For individuals in this category,
daytrading most likely is only a small part of an overall (and diversified)
investment strategies or portfolio - and typically it's only used to further an
already solid net worth without exposing a high percentage of the individuals
assets to undo risks. Basically, these are individuals that can "afford" to do
a little day trading and typically don't go over board in "only" stock speculation.
The second (and not only more recent, but more dangerous) category tends to be
people who are attempting to build their net worth strictly from daytrading.
These are individuals who view daytrading not so much as simply one small aspect
of an overall financial investment landscape, but more as the major
way to generate and build their entire financial worth. This tends to also be the
category of people who take larger risks and sometimes generate a bit of negative press
regarding daytrading. This negative press would be along the lines of people that
daytrade using funds from a credit card and/or home equity mortgage of some
form or another. When things don't go well in the markets, typically the losses
tend to have a more dramatic impact on the individual's net worth and life style.
It's pretty clear that these are two radically different approaches to
daytrading. If you are in the first category, then as long as you do not expose
more than around 10% to 20% of your overall liquid net worth to stock speculation, you
probably won't get into too much trouble. However, if you fall into the second
category - where you are trying to create wealth through daytrading and/or you
are using daytrading as your only means of addressing stocks - then some
guidelines are in order. Of course, at the end of the day, no one can force you
to follow these guidelines. However, if nothing else, you should strongly
consider the following information as it relates to your individual case.
First and foremost, you should never trade using money you cannot honestly
afford to lose should some catastrophic event wipe you out in the markets.
These funds should be largely similar to funds you would ear mark for Vegas or
other forms of higher risk speculation. In the event you lost these funds in
total, they should not have any dramatic impact on your life whatsoever.
Generally speaking, these funds should represent no more than 10% to 20% of your
overall liquid net worth. Beyond this, you should strongly take into account
areas of your financial picture such as home ownership, outstanding short and
long term debts, as well as future responsibilities such as college for your
kids, etc. You should also take into consideration your age as it relates to
your future retirement. Daytrading at age 20 or 30 is one thing, daytrading
your retirement funds at age 65 or 70 is a whole different situation and very
unwise unless you limit the amount of funds at risk.
Again, before you undertake anything but causal daytrading, you should seriously
consider such things as paying down all of your short term debt. This would
include paying off all credit card balances and any loans which may be near
maturity. You should also consider allocating funds for and/or paying off
longer term debts such as car notes and/or home mortgages. Additionally, if you
have a family to provide for, you should not only consult with your wife,
husband, etc. before attempting any sort of daytrading, but you should take into
account what impact large and unexpected losses could have on your current as
well as future living situation.
Generally speaking, unless you have tremendous earning power, you should have
very little debt and a stable housing situation before using much capital in the
markets for day trading.
KNOW YOUR LIMITATIONS - What did Clint
Eastwood say? "A man's got to know his limitations" (of course, this goes for a
woman as well). You've simply got to be realistic about what you are capable
of. I hate to say it, but some people are just not cut out for trading.
However, self evaluation can sometimes be very difficult. It kind of falls into
the category of "nobody thinks they are a bad driver". Obviously, if you didn't
think you were able to be successful at daytrading, then you probably wouldn't
be reading this page :-) However, just because you think you will be successful
at trading, doesn't make it so.
So for those of you that are unsure if you are cut out for it or have difficulty
with self evaluations, here's my sure fire way to determine if you are a good
daytrader: look at your bank account.
If your account goes up, then you are doing well. If it goes down, you are not
doing well. If in a couple of years you have more money than you started with
(without adding more funds), then you are off to a good start. If you have
less, then you are making mistakes. If in five or ten years you are
consistently making money and/or have enter the big leagues of trading, then you
probably are cut out for it. If in five or ten years you are broke or having to
fund your trading from other profitable areas of your life, then you probably
aren't cut out for it. At the same time, you are only a failure if you quit.
My philosophy has always been never give up. If the person that became
successful on the 20th attempt had stopped at the 15th attempt, then they would
have been a failure.
Daytrading can be a very hard road; you don't learn this stuff over night - it
takes months, even years to become even a half way decent and savvy trader. No
one walks into this business and learns it over night. It's like anything else
in life - it takes time, it takes practice and it take the ability to learn from
your mistakes. If you find you tend to blame your mistakes on everyone else -
forget it - stop while you still have some money and get a day job. I've never
met a good trader that pointed a finger at someone else. At the end of the day,
no body forces you to enter the trade. No matter what advice you follow, what
service you use - the buck ultimately stops with you - as it's your decision to
follow through with the trade in the end. One thing you will never hear a successful
trader say is "I lost money, but it wasn't my fault". Every good trader I know
takes full responsibility for every trade they make and every action they take.
If you cannot say to yourself "I messed up that trade big time and I'll
never make that mistake again!" then you have selected the wrong business
to be in. You simply have to be able to stand back, look over what you
are doing and honestly evaluate what is working and what is not working.
If something you are doing is not working, then you must make changes.
Trading is a highly fluid type of business, it's always changing and you
must adapt and change with it. What you must do, ultimately, is learn
what works for you - not what works for everyone else - what works for
you. Part of that is knowing your limitations.
BE CONFIDENT IN YOUR TRADING - Taking up
a position in a stock when you are less than 100% confident is just a
disaster waiting to happen. Being confident doesn't mean being right.
You can't always be right. However, based on the facts
you have available to you regarding the stock and/or company, you can be
100% confident that you have done your homework based on what information
you have available to you. Anything less than this will tend to induce
uncertainty into your trading. This will often times undermine your
confidence and ultimately your ability to stand firm when others are
selling.
By the same token, you must also be confident enough to exit a position
when you realize you have made a mistake in a trade. No one is suggesting
you hold a stock that is in trouble. Rather, you base your trading on
facts, not fluctuations in the markets. Once you have made your decision
to buy or sell, if you are right, ultimately the markets will come to you
with a profit. Others may sell because they see someone next to them
sell, but that is not, and never has been, the road to success on Wall
Street. Don't follow the crowd - follow your brain, follow facts. Be
confident in your trading and thinking and you will generally (if you are
smart and use all the facts at hand) come out on top a large percentage of
the time.
HAVE A COMPLETE PLAN BEFORE ENTERING ANY TRADE
- This is so critical to successful trading, yet so rarely do I see people do
it. Before you ever place a trade, you must - absolutely must - have a plan of
action for how you are going to handle the trade. What price you are going to
pay, what price you are going to sell at, how many shares you will buy, what
price you will cut your losses at, etc. This is critical. You must have a
strategy to handle not only the upside, but also the down side. The good and
the bad of the trade. Where will you sell the stock should it move up and what
price will you exit the trade should it move south. How long will you hold the
stock if it doesn't move at all? These are all questions that should be asked
and answered before you purchase any stock for a trade. This goes hand in hand
with being 100% confident. You must have a plan of attack.
Think of each stock you buy like a battle to be fought on the battle field. You
are the 4 star General of the trade. Do you think a General would direct his
troops onto the battle field without a full plan of attack? Without thinking
out every possible scenario or what could go right or wrong? This is exactly
how you must approach each trade you make.
Just as important: once you develop a plan, adhere to it. If the stock hits
your sell price, sell and move on; if the stock hits your stop, get out. Don't
change your strategies because of your emotions - change only because of
additional facts which you did not have when you formulated your plan, or if you
clearly identify an error. Never change your plan to try to justify your
actions or justify the movement of the stock.
Remember the old saying: the market is always right. To be successful, you need
to understand the only mistakes that are made in trading are your own. As soon
as you identify a mistake, take action to correct it, not justify it.
DIVERSIFY, DIVERSIFY, DIVERSIFY -
Diversification, even in trading, is very important for risk reduction. Since
you aren't going to be correct in every trade you make, diversification is
necessary and important as a means to risk reduction and capital preservation.
The simple fact is this: if you put all your trading capital in one or a very
limited number of stocks, you are just asking for trouble and increasing the
risk you are exposing your money to. At some point, if you trade long enough,
you will undergo owning a stock that drops like a rock for one reason or
another. Most people who have traded for any length of time have been there
and it's no fun at all.
Avoiding putting all of your eggs in one basket is the first step in
limiting risk when it comes to both investing and trading.
AVOID INVESTING TOO MUCH IN A POSITION -
There is an old story on Wall Street where one trader asks another trader
for advice. He says, "I've bought so much of this stock that I can't get
any sleep at night... what should I do?" His friend says, "Reduce your
position in the stock down to the sleepling point. This is not only very
good advice, but very true. The smart trader takes up no position in such
large quantities that it makes him overly nervous or subjects him to loss
of sleep.
Trade at levels which you can afford and you will generally feel much more
comfortable in your trading. This will generally result in much clearer
thinking and smarter decisions on your part. Too much risk will result in
too much fear and that will cloud your thinking and judgement.
TRADE STOCKS YOU KNOW - Part of being
confident about a position you take up relates to having some
understanding of the company behind the stock. Clearly it is impossible
to know every little detail about the day to day operation of every
business you buy stock in. However, it does help if you have a basic
understanding of the type of business they are in and how news (positive
or negative) may relate to and/or impact a company and their stock. This
will not only help you feel more comfortable about the position you take
up, but it will allow you to more quickly evaluate news which may be
released regarding the company.
Trade stocks you know or that are in areas you may have experience in. Warren
Buffett is a good example of this philosophy. He has no problem telling share
holders in his investment companies that he doesn't understand much about
technology related companies and therefore steers clear of buying such stocks.
Sticking to what you know is not only a good way to start out investing and
trading stocks, but it can help you feel more confident and make better
decisions along the way.
TRADE POPULAR/LIQUID STOCKS - Stocks
that are "popular" with the public and investment community have a very
real benefit to your trading - specifically, they tend to be very liquid.
Liquidity is a measure of how much volume changes hands on a specific
stock (typically on a daily basis). The more liquid the stock is (i.e.
the more shares it trades) the more likely you'll get a fair price when
buying or selling the stock. Also, the more likely it is that there will
be a market to buy from or sell into.
Trading stocks which have very low volume (typically under 100,000 shares
per day) can incur additional costs and can limit your ability to get in
and out quickly when so desired. Often times if you try to buy or sell a
large block of stock, there simply won't be a market at current prices.
This can result in the market "stepping away" from you when you go to
sell. Worse yet, you can drive the price up on yourself. While there are
times when buying a little known stock may work out, for most of your
trading, you should strongly consider sticking to actively traded stocks.
This is true of options trading as well (i.e. stick to options on stocks
which trade higher volume).
TRADE STOCKS THAT ARE MAKING MONEY - The
stock market is based largely on economics and business (with some emotion
and perception thrown in). As a result, I personally feel it's a good
idea to trade stocks on companies which are currently showing a profit, as
opposed to companies which "might show a profit someday". Great ideas are
a dime a dozen, as they say, and you don't have to look far on Wall Street
to find stock in companies that are using other peoples' money to test
out their "great" idea. In my personal opinion, I would much rather be
trading stocks in companies that are currently profitable.
Additionally, keep in mind that even companies that are "making money" on
the top line may not be "profitable" from a net (bottom line) profit
standpoint. There are many companies out there that have racked up a
tremendous amount of debt and/or have business models that, while they
bring in quite a bit of cash, are unable to actually show a profit at the
end of the year. Generally speaking, stocks which are currently showing a
profit or are very close and very likely to show a profit in the near
term, trade better and are somewhat less risky than stocks which are
either in the red or struggling to show profits on their financial
statements. Part of this is because valuations are much easier to
calculate from real earnings (i.e. using the company's P/E ratio) than
trying to base valuations on "what might happen" down the road. True,
sometimes stocks trade more actively or more wildly on news of potential
profits, but at the same time, when a company announces they may not meet
analysts' expectations or may experience an earnings short fall, it can get
quite dangerous. Consider sticking to companies with tangible, consistent
earnings when doing your trading as a further means to risk reduction.
AVOID BUYING THE "BIG EVENT" - This idea
tends to go hand in hand with the ideas presented above (regarding trading
companies that actually are able to show a profit). In the stock market,
there is always "some big event" that might take place for a company or
the market. Buying or selling based on the possibility that this event
may take place (or may not take place) or based on the how the market
might react to such an event tends to turn your trading into a gamble more
than anything else - and this is very risky.
Buying a stock ahead of what might be a "big event" can be quite risky and
often times tends to delay your trading. Very often these big events
(such as mergers, buyouts, etc.) get delayed for months and months. If
you wish to hold a stock for weeks and weeks or months and months waiting
for some big news flash, then that's perfectly okay. However, just keep
in mind that generally stocks move up on news far before the average
individual hears about even the rumor of the news. As a result, you often
see stocks trade down on positive news (due to the fact that the news was
already anticipated long in advance and largely priced into the stock
prior to the release of the actual news). Generally speaking, buying the
big event will tend to be not only risky, but also will tend to slow down
and stagnate your trading. Avoid when possible.
STOCK PRICES - Stock prices fall into
two basic categories. Penny stocks (a.k.a. stocks trading under $1.00)
and pretty much everything else. To some degree, you can lump stocks
under $5.00 into the penny stock category as well, however, keep in mind
that this will not always be a fair representation.
Lower priced stocks have a very seductive allure. Not only can you buy large
numbers of shares, but when the stock does move, it typically moves in larger
percentage steps. However, that works both ways and there are additional risks
with lower prices stocks (typically they are lower volume and this can
negatively impact your trading).
Personally, I feel much more comfortable trading a stock that is above $20
if at all possible. Generally, stocks which carry low share prices tend
to be more risky. They also tend to be lower priced due to lack of
interest from both the public as well as professional investment
community. This is not to suggest that there are not good quality low
priced stocks - certainly there are. However, especially when you are
first beginning, we feel it's best to avoid stocks which trade under $5.00
unless you really know what you are doing. In the end, you usually stand
about the same chance of seeing a higher priced stock move 10% as you
would seeing a lower priced stock move 10%. Since this is usually (but
not always) the case, there tends to be a little more safety in trading in
the higher dollar stocks. Penny stocks can and do sometimes produce
amazing short term gains, but unless you really understand the risks
associated with these lower priced and often more thinly traded
securities, we suggest you stick to more "name brand" stocks which tend to
trade at higher per share prices.
GOLD, OIL, PRECIOUS METAL STOCKS, ETC. -
Some people really enjoy owning Gold stocks or stocks related to oil
drilling or diamond mining. I personally do not. Stocks of these types
lack some of the inflation fighting components that traditional businesses
provide. As a general rule of thumb, if the stock doesn't produce a
product or provide a service, then it's generally best to limit your
trading in them, at least in my opinion. Stick to companies that produce a
product or provide a service and you never have to worry about hitting a
"dry hole" or a sudden drop in the price of Gold or Silver.
DON'T CHASE STOCKS - Stocks go up because
people (usually large numbers of people) are buying the stock. As a trader,
this is usually not a good time to also be buying. As such, be very cautious
about buying stocks that are rapidly moving away from you. The true money in
stocks is made by buying stocks prior to a sudden move, not during a sudden
move. The one possible exception to this may be if there is some very positive
news that has caught the markets off guard and/or if the news is so outstanding
that there is a high probability that the stock may benefit for multiple days.
Keeping in mind, however, that a sudden move in a stock is often quite different
than a change in the overall trend. Sudden moves tend to reverse and if you get
into the habit of chasing stocks that are moving up, more times than not you'll
end up paying overly high prices and/or getting caught in a downward move
shortly thereafter.
Again, generally people that buy late are buying on pure emotion (greed and
fear). Greed that they may make a lot of money very quickly and fear that they
may miss out should they not "get on board". Those are the two worst reasons to
buy anything - not just stocks. True you may miss out on the stock, however, in
most all cases, it's better to wait and find another stock, than to pay too
much. Patience in the stock market is very important; usually you'll do better
by avoiding the temptation to "jump" when that impulse is largely a result of a
move in the share price alone.
DON'T RUSH INTO ANY TRADE - This is along the
lines of the above comment, however it is worth elaborating on. Often times
stocks will give you many chances to get into them at current (or sometimes even
lower) levels. Generally, there are few cases that require sudden action if you
are really careful in how you trade. Sometimes the best trades are ones in
which you wait patiently for the stock to come to you. If you feel the need to
rush to order a stock, that's sometimes (not always, but sometimes) a warning
sign that you are acting not on a well laid out plan for the trade, but an
impulse to "get into a trade" regardless of whether or not the stock is trading
at what is really an ideal price.
Keep in mind as well, it's often not a bad idea to take up positions in a trade
little by little. If you plan to own 1000 shares, consider buying 300 shares
and then seeing how the stock trades. Often times this will allow you to better
judge the market and take advantage of intraday weakness. If you do happen to
miss purchasing the additional shares, there is almost always another trade you
can put the cash to work in.
DON'T GET GREEDY - Two of the biggest emotions
a trader has to over come are fear and greed. Many traders fall victim to greed
once they see a trade become profitable - simply by not having a firm exit point
in mind. It's generally best to decide at what levels you wish to sell prior to
entering into a trade to avoid this. If you feel yourself trying to justify
higher levels from the stock and/or ignoring the current profit "as though it
were nothing" you probably need to stop and consider not only the value of your
profit, but the current risk to it by holding longer.
Often times traders who are successful tend to lose respect for the actual value
of a dollar. Regardless of how much money you have, you must not lose sight of
what each trade produces and the value of the returns in relation to the capital
used to produce those gains. An example might be someone with several million
dollars. If this person put $10,000 into a position and saw it produce a gain
of $2,000 they might not realize it's time to take profits. While $2,000 is
nothing when compared to several million, a 20% gain should always sound alarm
(i.e. sell) bells in a trader's head. In fact, typically a gain of 10% or
perhaps even as little as 5% should do this as well. A common method to help
combat this is to look at your trades strictly from a percentage standpoint of
view, rather than a dollar standpoint. This allows you to always calculate
gains and losses with consideration to the amount of capital at risk for any
given trade.
In the movies, "greed is good", but in trading it's generally an emotion that
does little more than get in the way of clear and level headed thinking.
CONTRARIAN THINKING - Generally, a trader
should meet buying with selling and vice versa when it comes to the stock
market. Typically, stocks (especially when considered on an intra-day basis)
will only go so high, or so low, before tending to attract the next group of
contrarian thinkers and switch direction. Often times crowds (such as the
markets) are wrong in their actions and over react to the up or down side. When
the "markets" as a whole are moving up dramatically or down dramatically, there
is a strong case to be made that these actions ultimately will be wrong or will
tend to reverse simply as the contrary views of things builds on each side of
the fence.
If you can train yourself to go against your natural emotions, you'll tend to be
able to keep a clearer outlook on the markets. When stocks are being bought,
you have to train yourself to think "These stocks are buying bid up too high -
maybe I should sit back and wait". By the same token, when there is a great
deal of panic selling in the market, you need to train yourself to think "Wow,
look at all these prices falling - I may find good deals here soon". It's more
difficult than you think to be "happy" when the markets are falling and
"cautious" when the markets are raising. However, normally taking this view of
things will help improve your trading over the long haul. The old saying, "Buy
when there is blood in the streets" stems from this basic idea of going against
the masses on Wall Street.
TRYING FOR TOPS AND BOTTOMS - People tend to
have a desire to buy at the bottom and sell at the top. Not just near the top,
but the "exact" top. It's simply human nature to want to be the best at
something and trading is no different. Most people that take up daytrading want
to be the best they can be. However, aiming for exact tops and bottoms when buying
stocks can be very detrimental to your overall trading.
I would much rather give away 10% at the top and 10% at the bottom. You
will drive yourself crazy if you punish yourself for not selling at the
high or buying at the low, as it's almost impossible for most people to do
on any sort of consistent basis. Far more often than not, you'll simply
end up missing the trade. Even missing a top or bottom by 20% is nothing
to worry about. As many a successful trader has said, "you can worry
about the tops and bottoms and I'll worry about the remaining 60%". In
fact, it's often much safer to wait until a stock clearly signals a move
either up or down before taking up your position.
STOPS - Some people use stop orders quite
often, some people hardly use them at all. In my view, stops are best used to
protect a nice profit and/or limit down side risk in a trade that isn't acting
as you think it should. How a stop is used (or placed) is largely dependant on
the individual stock and how the overall market is behaving at any given time as
well.
Often times using stops also helps to remove some of the emotions from trading.
It's far easier to place a stop on a trade than watch it trade tick-by-tick and
try to decide the exact moment to get out.
TAKING PROFITS ON BIG GAINS - At some
point, just like experiencing a large loss, you are likely to hit a really
big winner. When this happens, consider taking 1/2 your gains off the
table right away to reduce risk to the profit you have just made. This
allows you to continue to profit, but protects a large amount of the money
you have just made. Additionally, you may wish to consider selling enough
of the position to recoup your original investment. This results in the
remaining shares effectively being "free" and allows you to hold them
indefinitely without any fear of a "loss" to your original capital (which
has now been removed completely).
SHORTING STOCKS - When shorting stocks, there
are several points to always keep in mind. Never short a stock simply based on
the stock price. To really be successful as a short player (i.e. someone that
shorts stocks), you need to locate stocks which are extended with a significant
void of fundamental reasons. There must be some reason for the stock to decline
in the near term (e.g. declining profits, lack of direction, etc.). Simply
shorting a stock "because it has a high share price" is just inviting danger.
Additionally, keep in mind that shorting stocks exposes you to additional risks
which are not present when buying or going "long" a stock. These include having
the stock called away from you, as well as being caught in a short squeeze.
Also keep in mind that the very act of shorting a stock increases the pent up
demand for the stock - namely the number of people that will ultimately have to
repurchase the security down the road to cover.
Finally, a good rule of thumb is to never short a stock which may end up
on the front page of the Wall Street Journal or some other major financial
publication. Typically, the best short candidates are stocks which have
moved up rapidly on little or not fundamental changes and which are
generally not well know to the investment public at large. While it's
true you can make money shorting well known, large cap stocks, it tends to
expose you to additional risks not associated with smaller and less well
known companies.
PLACING ORDERS FOR STOCKS - Buying stocks
appears fairly straight forward at first glance, however there are several
points you should consider before blinding placing your first trade to buy or
sell a stock. Following is a brief outline of points to consider:
First and foremost, you need to understand that stocks are sold to you at
one price and bought back at a slightly lower price. This difference is
called "the spread". And while the spread has generally decreased over the
years, you are still taking a hit when you purchase a stock (assuming you
should want to turn around and sell right away). The bid price is the
price the market will pay for a stock when you go to sell it, while the
ask price is the price quoted to those who wish to purchase the stock from
the market. Nothing says you cannot try to buy at the bid and sell at the
ask, but this will generally delay your execution.
On the topic of bid and ask prices, you should note that there is a
corresponding "size" which relates to how deep the orders run on the bid
and/or ask size at any given price. As an example, you may have 100
people trying to buy a stock at a specific price, while only 10 are trying
to sell. This directly impacts how much stock is available at any given
bid or ask price. Once the orders to buy or sell a stock at a given price
are filled and/or cancelled, the price adjusts according to the remaining
orders - either at higher or lower prices. If there is a 'void' of orders
at any given level in the market, a stock is said to "free fall" or "gap"
to where ever there are buyers or sellers. Keep in mind as well, how this
area of pricing is handled is sometimes dependent on where your stock
trades. On the NYSE, for example, bid and ask sizes are displayed by a
market specialist who's job it is to ensure an orderly market. However,
on the Nasdaq, multiple market makers my line up at different prices
advertising to the market to buy or sell at different levels. Detailed
information regarding where a specific market maker (generally a large
brokerage firm) will buy or sell a given stock is provided via Level II
data.
Next, you should understand there are several different types of orders
that can be placed to buy or sell a stock. The most common is called a
"market order". This means buy or sell at the market price. However, keep
in mind once this type of order is placed, you are nearly powerless in
your control of the price paid should the market make a sudden move. In a
very active market, you can also run into situations where your
confirmation (showing the price you paid for the stock) is delayed
significantly. This makes it extremely difficult to judge what a "fair
and accurate" price is and/or when your order should have been executed.
It also opens you up to possible foul play when it comes to how your order
is processed and/or handled. As such, unless you are dealing with a
fairly orderly market, we suggest using what are called limit order.
A limit order works just like you might think. It is an order with a
limit price attached to its execution. When you place your order, you
specify a limit to the price you'll pay. While limit orders are usually
executed after market orders, they do provide a higher level of protection
against over paying, etc. Additionally, we feel they are a fine method to
use when trying to take up a position at a lower than the market price.
You should keep in mind, however, there are two types of limit orders. A
stop limit as well as a market limit. A stop limit order is an order
which becomes a stop (such as a stop loss) once the price is reached.
Keep in mind with this sort of order, the market can pass right by you,
where as with a normal limit order (which basically turns into a market
order once hit) you stand a better chance for not only execution, but
seeing an improvement on your execution price (this is because once your
market order is set, the market may move in your favor during execution,
but you will never pay more than your limit).
Limit, stop and market orders apply directly to both buying and selling of
stocks.
STAYING ON THE SIDELINES - Sometimes
being in cash gives you the best strategic position from which to trade -
and this is often an overlooked fact of daytrading. Remember, you can't
take advantage of market dips if you are already in the market! In my
view, it's better to be out of the market more for day trading than in the
market. This will allow you to get in and out with profits quickly and be
on the sidelines should dips occur. It also drastically reduces the risk
to your capital as compared to just sitting in stocks that aren't moving
and/or holding trades for excessively long periods of time. Try to be out
of the market more with your trades and in the market more with your
investments (as long as they are good investments of course).
ABOVE ALL ELSE - One of the most
important and most widely over looked aspects of being a successful day
trader is working on your personal life and how you conduct yourself.
Most of the personality traits required to be a successful trader are also
the traits found in someone that is said to have Character.
Rarely have I met a successful trader that I didn't like. I've found - almost
without fault - that people who are successful at the stock market are also
fairly successful at "life". These are people that show integrity in their
lives, as well as consideration and honesty. They are people that deal with
others in a generally polite and honest manner. As mentioned above, rarely have
I run into a successful trader that will "point a finger" or blame others for
their mistakes. Integrity, honor, character, fairness - these are all qualities
that not only make up general character in a person, but also are the foundation
of a successful trader.
I've often said, if you aren't naturally "humble" that the stock market
will do an excellent job of teaching you how to be :-) Always keep in
mind that the stock market is nothing more than dealings between human
beings - it's just people doing business. And how this business is done
is a reflection of all involved, as well as you yourself.
To be successful in the market, you must start by getting your house in order
when it comes to yourself and how you deal with other people. If you are a
dishonest person, or you blame others for your own mistakes or have a lack of
integrity in your character, chances are high than this will come back to haunt
you in the end - not only in life, but in the stock market.
Discipline, fairness and honesty - those are all traits I have found in
successful people and above and beyond all else, successful traders. My
simple words of advice to people entering the stock market are these:
"Take stock of yourself, before you take stock from anyone else"
:-)
Ray Johns
Senior Market Editor
DayTraders.com
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