Tuesday, February 2, 2010

Important Stock Tips For Beginners

When it comes to stock market tips, there are all sorts of people offering you the hot tip of what to buy. However, this teaches you to be gulible and victem to the prey of people who look to exploit inexperienced investors. It's important to avoid a hot stock market tip if all it is is pumping up a stock. Certainly there may be a winner from time to time, but if you really want to become a winning investor, you have to find your own method.

The best advice anyone can give is for you to seek education, learn for yourself, read lots of books, and run the numbers and case studies yourself and see which works for you.

I have a friend that is the most patient man in the world. He would have been a perfect long term investor. But he got convinced that he could make money quickly and that making money quickly even if it was small amounts was the better route. It was so alluring to him that he invested in some training program. Another relative of his who fit that swing trading style perfectly, had success with that system. However my friend joined this system and didn't want to put stop losses. The system taught him to buy the dips when a stock was oversold, and set a stop for money management. He got caught up in the concept that this program taught which was, the more oversold it is, the better purchase it is. He thought, why would I want to sell a stock that's even cheaper? He had the classic value investor mentality, the problem was he wasn't finding value stocks. So instead he ended up spending all of his money on new stock tips and services and started swing trading. He couldn't find any stock to buy that was a good value with this method because this method was technical trading only. So he ended up losing money with this system when a few stocks traded horrendously downward, then bounced but not back to where they were. My friend was patient, but the business had been losing money and it wasn't a good choice for him.

To make a long story not any longer than it already is, he finally discovered value investing, which fit his style and he now makes about 14% per year. Now perhaps he can refine his skills and make more, but he's struggling to get back to where he was because he had such devastating loss trading a style that he's not meant to trade in.

Me personally, I'm a numbers guy. I had a similar problem following my friend into value investing because he had success. I then tried swing trading and lost a lot trading leveraged etfs and inverse ETFs. I like to know the odds of a win, the deviation, how much is safe to bet, what my risk of ruin is, what my win ratio is and all sorts of things like that. So I've finally found a style that works for me. I come from a background of playing poker, knowing money management and odds, so I always thought the transition would be easy. But in order to do treat investing similar to what I'm familiar with, I need concrete numbers. Unfortunately there isn't much information telling you how likely a stock is to win, and it isn't set in stone, unlike poker where there are always 52 cards in a deck and you always know how many cards will be dealt. There's data suggesting that Warren Buffett has made a lot value investing because he finds strong earnings, but how can you put measurements on a "long term competative advantage". You can estimate the return, but it's hard to determine the risk of a company coming along and replicating the success. Buffett is great, but he's just not for me, I can't sit on a stock for 10 years while worried about funding and other companies taking over and I don't know enough about business to do that. I need to measure risk vs reward within a single action.

That begs the question... if a stock pattern makes something that is bullish, is it bullish because when it does produce a "win" it goes up 1000% and it only needs to win once every 10 times and that's if it loses 100% when you're wrong, or once out of 100 times if you have a 10% stop loss? How do you know this? Or is it bullish because it wins 80% of the time but only will go up 5% before going back down again? These are things a number guy needs to know. I'm not intuitive I have no idea what the volume is telling me exactly.

The first step was to identify a book that would teach me plenty of information on chart patterns. It had been backtested to see what the average move upwards was, what the average win ratio was and other useful information. The book was Encyclopedia of Chart Patterns by Thomas N. Bulkowski. He also has a book about candlestick patterns, but candlestick trading isn't my cup of tea because the holding period is too short... I'd rather not spend so much buying and selling and losing fees... I want the system to work for me so I can sit back and let it work. So I read his book, I ran through the numbers, and gave myself a hypothetical investments. I wanted to see based on 1 full "kelly" of risk which gave me the best return with a 7% stop loss(using the kelly criterion). For more information on using this in investing consider this article titled "How much do you make per dollar risked per day?".

So I gained the insight needed to make intelligent investments. I now have a trading system where I trade stocks using high tight flags. Once I identified that I wanted to trade high tight flags I looked at some methods using high tight flags. I needed to read a few more books and one of them was William J O'Neil's "how to make money in stocks - in good times and in bad". That gave me a lot of solid rules but I also needed to make sure I didn't fall into compulsive decisions based on having the wrong mentality. I needed to know I was vulnerable to making mistakes so I read Alexander Edler's "Trading For a Living". That pretty much rounded out my style, but a few other books can still probably help me improve.

My most recent trade involved buying HDY at $3.2. It's now trading over twice that in less than a month over $7. However, with the 25% stoploss in place, if it were to all go south from here, I would still lock in a 82.3% gain assuming it didn't drop below the stop order overnight and sell below it, which can occasionally happen. The other stock I own is up enough where even if it traded below it's 20% trailing stop I would still have a nearly 4% gain so that means there's a very slim chance I will lose in either trade and most likely I stand to make a lot of money. I certainly can't promise you those kinds of gains, and I went through a lot of ups and downs before I found a style that works for me... and it's a constant process. There is still more stock market education that I need to get. However, if you're looking for a stock tip, ignore the noise, decide what style works for you and gain stock market information until you are satisfied and can put it into a system or methodology that works for you.

4 comments:

  1. I read your post . it was amazing.Your thought process is wonderful.The way you tell about things is awesome. They are inspiring and helpful.Thanks for sharing your information and views.
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  2. Thanks a lot for sharing all these wonderful tips that will help out all the beginners. You have mentioned all the key points to become a successful trader. I highly recommend all these points.
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  4. Great beginner tips, and great blog. Would you mind taking a look at my site and write me a few tips.

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