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Wednesday, August 22, 2012

Top 8 stock trading tips

My experience of stock trading began in 2003. I read some small book on the topic and got fascinated by the opportunities that were there for me in trading stocks. I started trading on my native (Lithuanian) stock exchange by buying and selling stocks that seemed to be cheap. Unfortunately, they got even cheaper and having reached the ‘then’ bottom stagnated for a long time. I understood that something was wrong with my approach as I saw other stocks going higher and higher. 

One day a friend of mine introduced me to his brother who had been investing in the same market for a few years. And he did have tremendous results. I looked at his portfolio and saw around 5 stocks all of which had risen more than 100 hundred percent from the time he had bought them. I was surprised to see that as 3 of the stocks were agricultural companies. For me, it seemed not a very intelligent decision to invest in those. 

When I asked him about his choice, he took out some three pages full of pros (his why’s) for investing in the companies. This shocked me even more. I was very na├»ve at the time. I believed I could just look at the prices of stocks, read a little about them and pick up the one stock that will make me a lot of money. I was wrong and results confirmed that. Understanding the market and fundamentals was necessary for profitable investing. This was confirmed again when I started trading Forex and lost my initial balance of 500 bucks in a few months. Yea, it takes some time and painful experience for dummies to become wise. 

Understanding of investing principles as well as fundamentals of a given market is a must for one to become a successful investor in any market. You will soon learn too, whether it is day trading or long term trading the statistics remains the same: 99 percent of those who trade finally fail. Why? There are a lot of reasons for that, but most fail to look at investing as a business and this light attitude causes them to fail. 

In the article I am intending to present some of the most general stock trading tips that would help one understand what one should and should not do when one starts investing. This is the first article of the series that I am going to publish once a week. Hope the posts will be useful both for newbies and for more experienced ones. So, let me start.

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  1. Do not try to predict market tops and bottoms
Some rephrase it by saying that you should not try to catch falling daggers. Those that try to guess where the market will make a bottom can start buying too early and in a severe downtrend they will experience severe losses. They same will happen if one tries to predict a possible market top and start selling too early. The top maybe formed after a year or two or even ten years. What will you do then? Keep to a losing position? So, do not try to make these predictions in the first place. Let market give signs about a possible reversal: ranges to start (prices fail to make new highs or new lows). 

I remember how in 2004 eur/usd (Forex market) pair was in range of 500 points. Finally it broke out and started running up. I used to spend a lot of time in various Forex forums at that time. I remember one trader who was always recommending selling eur/usd at the time. All on the way to the top he was opening selling positions. He used to say that all sound traders had already left ‘this insane uptrend’. However, market did not pay attention to his ramblings and continued upwards. Market does not care about your opinion. You should learn to listen to what market ‘says’ and follow it faithfully. 

  1. Do not follow too many stocks, concentrate on a few
I initially learned about the principle in the book “Reminiscences of a stock operator” that is full of insights of one of the best speculators of all times – Jesse Livermore. The problem with following a lot of stocks is that you can never know everything about each stock and if you divide your focus on two many stocks you will know enough about each one of them. You need to focus and invest all of your attention on a few stocks.
You can initially start analyzing indexes by sectors, then selecting one which you understand best and from that index choose three, maximum four stocks which you follow and trade them when opportunities occur. You will also find out that this is how professional investors and analysts study markets and pick out the best stocks for investment. 

  1. Cut losses and let your profits grow
It does not matter how great you are as a trader you will still be making mistakes and most probably half of your trades will be good and half of them will be bad. The same is valid for real professionals. They do make mistakes, but they know how to take advantage of opportunities and to maximize their profits in these situations. Cutting your losses is simply admitting that you have made a mistake and now you are ready to wait for better opportunities. 

It is pretty difficult as most traders see their losses as something personal, so they tend to sit and wait for their losing positions to turn profitable. In this way you can hold a stack of losing trades and continue closing good trades. It should be the other way round. Close the bad ones and continue holding the good ones. 

Before one opens a position one also has to decide how much he is going to risk. For some it may be 2 percent, for others 10. It depends on the nature of trading. Those who day trade should not risk more than 2 percent of their equity. Those who invest can make it as large as 20 percent. The less your risk the better! And your potential profit target should always be bigger than your potential loss.

  1. Buy the rumor and sell the fact
That is another famous axiom of Wall Street. Those who are experienced often predict that the upcoming fundamental news will be positive and they buy the stock in advance. When the news comes out they sell the stock as the positive news that comes out is already ‘priced in’. And if the news is bad they might take a ‘short position’ in the stock. 

What kind of news we are talking about? Any fundamental news connected with the company: merging, introducing new product to the market, closing some department or quarterly financial results.
However, one should also be aware of the multitude of rumors that circulate in the market daily and one should rely more on his own fundamental analysis and not on some unreliable information coming from ‘God knows where’. 

  1. Do not follow amateur tips
There is a saying in Wall Street that ‘when taxi drivers start giving tips it is time to sell shares’. Tips are abundant in financial markets. You can get a lot of those on various financial TV programs. But those people usually retell what they have heard others saying or even worse they help somebody to get rid of the shares that have exhausted their potential and are ready to fall. This also applies to the so called ‘market gurus’ that give out their tips right and left. Do not trust them. Become a pro analyst yourself. 

It is in their nature of people to tips. Most probably, it comes from our unwillingness to do serious analysis by ourselves and trust somebody else’s opinion. We also avoid personal responsibility by doing so and place it on the shoulders of others. 

  1. Take profits when the stock is still rising
We know that no stock goes up all the time. The same can be said about stock indexes and all the rest securities. Times for correction do come. And not only for correction! Companies do get into trouble and their shares collapse. So, if you want to make profits in the market learn to take get out of your position while the stocks are still going up. 

It might be difficult to do as traders often ‘fall in love with their stock’ that is doing well. If you are not simply playing for fun, but intend to make money from your trades it is better to untie yourself emotionally from the trades you make and close your most profitable positions when they show you decent profits.

  1. Get out when everybody is bullish and get in when everybody is bearish
You should always distrust the crowd. When any market becomes ‘one sided’ (everybody is a bull, or everybody is a bear) you should take the opposite direction than the majority of people take. If all newspapers, newsletters and ‘experts’ start telling that this stock, or commodity or currency will rise for years to come the days of the bullish move are counted. The same is true about bears. When everybody is bearish the days of bulls are about to start. 

  1. Buy in October and sell in May
This can be modified slightly and buying can start at the end of summer. Why is this so? Nobody could tell you exactly why this is so, but it simply works. Most money in the stock market is made from November till May. Then stocks usually start going down. Summer is often for corrections, but at the end of summer you might start looking for cheap and prospective stocks and start buying them bit by bit. 

You do not want to buy at inflated prices as this is contradicts the main rule of investing ‘buy low and sell high’. Investors do take profits and end of spring has become a traditional time to do it. You should have in mind the rule when thinking about the place of exit for your trades.

Final thoughts

Investing in stocks is not gambling. There are rules that you have to follow and important things that you have to know. The article covered some of the points that had to be in mind before one decides to take a position in stocks. Nobody becomes a profitable stock trader over a night in the same fashion as nobody becomes a good doctor over a night. Good things have a good price tag on them. Look at this occupation as a business and then decide whether it is for you to get into it. Next week I will continue the topic. Hope the article was helpful. If it was I would be grateful if you tweeted it, liked on Facebook or any other social media. Thanks for reading. 

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Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.