Monday, August 20, 2012

How To Trade Stocks

If you either are a beginner or have yet to trade successfully, this post on how to trade stocks is for you.
Trading stocks is as much of a mentality as it is a science. You have to be able to have a ystem that you can obey, and if you are compusively buying or selling stocks or if you are responding by emotion, you are already in serious trouble. If you don't have the mentality for buying a stock lower, you shouldn't be a value investor. If you don't have the patience you shouldn't be either. If your mentality isn't one of careful management and following your signals, you shouldn't be a swing trader with exact rules and one who depends on piece for action, but instead one that has say a system that buys with the plan of selling after 3 days regardless of price and if so, you must be right more often than not more so than making sure when you are right it produces a huge win.
But do not get into a single stock (and if you are, get out now), if you don't first have actual rules on what to do. You need a good money management system first and foremost. The exit plan and how you are going to sell.

So what types of money management system can you have?
Lets start with the basics on how you might sell.
You can use a:

hard stop (when prices fall below a certain price threshold, your broker account is programed to sell immediately at whatever price it can get).
Mental stop (same as hard stop, only performed manually)
Trailing stop (If you have a 5% trailing stop, you would sell anytime that the stock comes down 5% from it's "high" since you bought it. If it went up 30% you would stop out at a 25% profit if it dropped 5% or more intraday for the first time.
Time Stop - (This can be as simple as selling regardless of price after a certain amount of days or regardless of conditions, or more complex such as "sell IF conditions (such as a new high is not made, or a break below a certain point is made)
Limit sell- (The price breaking above a certain point results in a sell automatically. If you buy at $30 and put in a $40 limit sell order it will exit automatically as price crosses $40)
Multiple stops - A combination of two or more stops either the same or different in type.
No stop: suitable in 10 year investments which your downside is 100% of your investment, and as a result, your upside must be great to compensate and you must really understand the model. (see Warren Buffett Style Investing)

All that is only one aspect of investing. But do not buy without knowing first how you are going to sell. That covers SELLING, but what about buying? And what about the actual prices for action or criteria for identifying which stocks to buy?

People have names for different kinds of trading or investing. Swing trading, day trading, position trading, investing,etc. You don't need to get caught up in all of this, but you do need to know what your plan s before you even find out which stock you want to buy.
I will have to make this into more than one post because I already am getting long winded (or long-fingered, or whatever you call someone who has typed for a long time and now his fingers are sore)

But let's start it out with a few examples. Johnny wants to trade according to certain patterns, you can call him a technical trader if you like. He wants to hold for an average of 5 days. As a result price patterns are perhaps not best, but candlestick patterns are. He should get a book on candlestick patterns for starters. He should identify or develop a system that assists in his identification of a small group of the best and somewhat common candlestick patterns. Once he understands them, he will identify the candlestick, set a stop buy order at a few cents above the breakout price, and perhaps an alert just below the breakdown price (so he can take off the buy order and move on). He will have to repeat this on a bunch of stocks as many of the patterns will not confirm. Once he gets a notification that a purchase has been made, he then sets some sort of alert 5 days from the purchase price that it's his day to sell. Now based upon history he has an idea of average amount earned per trade and based upon how much he has committed to each trade and how many trades he expects to make in a year, he can determine a certain expectation of profit.  He should be conservative and estimate that his trades may not work out as well, commission happens, lag period and times when he is not invested may occur, but that way he can come up with a conservative estimate on an excel spreadsheet just by crunching a few numbers. This way, he can determine the annualized rate of return for his strategy. His next plan is to find anything that might boost the strategy and add it. Perhaps one particular trade makes 4% per trade and another only makes 3% but the 3% trade occurs 5 times as often and as a result there are more trades within a year and overall a better result. Either way there should be systems that one can implement to enhance your results.