Stock Trading 101

Adam Hamilton     November 23, 2007     6568 Words

 

Are you interested in trading in the stock markets?  Do you have questions about getting started?  You are certainly not alone.  Almost weekly I hear from ordinary folks with basic questions about trading stocks.  After addressing these on a consulting basis for years, I’ll outline some of the basics in this essay.

 

The Rewards of Stock Trading

 

Trading stocks is an incredibly rewarding journey.  Everyone is intrigued by the stock markets because traders can make big money there.  This is certainly true.  But the potentially extraordinary financial winnings are not the most gratifying part of trading stocks.  The best part is really the endless learning and personal growth that trading naturally generates.  Trading is a most-fascinating voyage of discovery.

 

When you buy stocks, you can’t help but grow interested in what the companies you own are actually doing.  You learn about their businesses, their markets, their competitors, and the economy in general.  Everything in the markets is interconnected to some degree.  So every piece of knowledge you glean, no matter how trivial it may seem at the time, helps you grow smarter and make better decisions in the future.

 

Learning is always fun and fulfilling.  And trading stocks doesn’t just teach you about the business world around us, it illuminates your inner self like few other endeavors.  To become successful in the stock markets, you have to master your own emotions.  Trading stocks brings all of your emotional and character traits, both good and bad, to the surface where you are forced to deal with them.  You can’t hide here.

 

Through trading stocks you’ll learn more about yourself than you ever thought possible.  You’ll learn to recognize your unique God-given strengths and utilize them in the markets as well as other areas of your life.  You’ll learn to work around your weaknesses too, and gain priceless emotional control that will greatly improve your life beyond trading.  Curiously, stock trading is more of a mirror inward to your heart than a window outward to the world.

 

Stock trading is one of the last true meritocracies.  All that matters for your success is your own decisions.  If you make good decisions on balance, you will win on balance.  It doesn’t matter what anyone else thinks of you.  Anything in your life that others have used to classify or judge you is totally irrelevant in the markets.  The markets are truly blind to everything but merit.  Regardless of the hand you’ve been dealt in life, you can become an excellent stock trader if you apply yourself.

 

The stock markets also free us from the tyranny of time.  Most of our lives we trade our time for money in the form of salaries and wages.  But in the markets, instead of us working for our money our money works for us!  Unlike everyday life, time on task is irrelevant in the stock markets.  If you pick the right stocks, your capital will grow regardless of how your time is spent.  So stock trading is incredibly liberating.

 

Who Can Trade Stocks?

 

And you are never too young or old to start trading stocks.  My father opened a brokerage account for me when I was 12.  I had a little money from a summer of mowing lawns and retrieving golf balls from water traps, and he thought I might be interested in investing.  Boy was he right!  His seemingly tiny decision to help me start investing changed my life forever.  So parents, consider getting your kids started young and their odds of being very successful as adults will multiply dramatically.

 

I also know investors who never bought a single individual stock before they formally retired.  Yet even starting in their later years they’ve grown to become excellent traders and have been blessed with great success.  If you are closer to this end of the age spectrum, your hard-won life wisdom will greatly aid your journey as a trader.  And a big side benefit of trading stocks is it will help keep your mind razor-sharp.

 

All the usual factors that the world unjustly uses to limit people, such as age, sex, complexion, attractiveness, nationality, faith, and station in life are totally meaningless in the stock markets.  To get started only one thing is necessary, a little bit of surplus capital.  This is money you have saved by consuming less than you earn.  Saving is hard work, no doubt.  But you can do it.  By cutting back a little in your entertainment budget, odds are it won’t take you too long to save enough to open a stock-trading account.

 

Opening Your Stock-Trading Account

 

And you really don’t need much.  Minimum opening balances for new online brokerage accounts are typically just $1000 to $2000.  In some cases, no minimum is required at all.  And you definitely do want to start trading even if it is on a small scale.  The reason is stock-trading knowledge scales beautifully.  If you can successfully grow $1k in the stock markets, then you can do the same thing with $1m later.  All the priceless lessons you learn starting small will prevent you from losing big later as your capital grows.

 

From a practical standpoint, I would recommend starting with at least $1000.  While you can trade with less, commissions become more onerous with smaller amounts.  If it costs $10 flat each time you trade, and you are only trading $100, you are effectively paying your broker 10% for trading a stock which is far too high.  But if you are trading $1000, and still paying the same $10 commission, then it works out to 1%.  The bigger your initial balance you can save to start, the lower your effective commissions will become.  Regardless of your starting capital, make sure it is money you can afford to lose as stock trading is risky!

 

Once you have saved some money to start trading stocks, you need to open a brokerage account.  I highly recommend an online trading account that you can access over the Internet from your computer.  Online trading is inexpensive, fast, and efficient.  From the time you decide to buy a stock to when you actually own it is measured in seconds.  And you never have to talk to a pushy broker on the telephone who will second-guess your trading decisions and try to steer you into stocks his firm wants to get rid of.

 

As far as picking a particular broker, all the top-tier online names are great. These include Charles Schwab, Fidelity, TDAmeritrade, and E*Trade among others.  All brokers are federally-insured through the SIPC to $500k per customer, and many carry additional private umbrella insurance beyond this that takes their per-customer insurance limits in excess of $100m.  So you don’t have to worry about your money.  My personal favorite online broker, and the one I have the most experience trading with, is TDAmeritrade.

 

To open your account, just visit these brokers’ websites and find one that will work for you.  Then you can click on the appropriate new account link and print out the necessary forms to complete.  Then just mail in your forms along with your check to fund your account, and you are good to go.  Realize that this process can take a couple weeks, so don’t expect to be trading the first morning that you try to open your account.  Also, if you think you may want to trade stock options at some point, it is easiest to specify this up front in your initial forms.

 

Buying and Selling Stocks

 

Once your stock-trading account is open and funded, the actual mechanics of trading are very easy.  To trade any stock, all you have to do is go to your broker’s website and log in to your account.  Logging in will take you to a screen where you can actually execute trades.  The screenshots in the exhibit below show TDAmeritrade’s interface, but most of the online brokers’ interfaces are very similar and easy to use.

 

 

First you have to tell your broker whether you want to buy or sell a stock, which is done with the buttons on the left side of this interface.  Then you have to enter the quantity of shares you want to trade as well as the stock’s symbol.  In these examples I am using the stock of BHP Billiton, the world’s largest mining company.  Both orders above, one buy and one sell example, use 10 shares of BHP.

 

Now in order to keep the stock markets running, we need market makers.  These are specialized financial companies that buy and sell shares of particular stocks whenever sell and buy orders come in from traders.  Even if no other traders want to trade at a particular moment, market makers will always buy and sell the stocks in which they make markets.  Their service guarantees liquidity, that you can trade anytime you want.  Market makers are compensated for this service through the bid-ask spreads.

 

Bid-ask spreads are different from commissions.  When you trade a stock, you’ll probably have to pay your broker around $10 for the trade.  The bid-ask spreads are an entirely different beast than these brokerage commissions.  The bid price for a stock is the price at which the market maker is currently willing to buy, or is bidding for, shares.  The ask price is where the market maker is currently willing to sell, or is asking for, shares.  The bid price is always lower than the ask price so the market maker can earn a living on this spread.

 

Today these prices are determined instantly by computer.  If traders are offering to sell 1000 shares of a particular company in a given second but other traders only want to buy 500, computers lower the bid and ask prices until supply meets demand.  Maybe if the prices are lowered $0.05, for example, 750 shares will be offered for sale by some traders and simultaneously bid on by others.  The slightly lower price reduces incentives to sell so supply drops and it increases incentives to buy so demand rises and they meet in the middle.  This sell-side imbalance lowers real-time prices, while a buy-side imbalance raises them.

 

These relative supply-and-demand imbalances on a moment-by-moment basis are what drive stock prices.  The bid and ask move higher or lower in lockstep, with the spread between remaining intact to compensate the market makers.  So as a trader, when you want to buy a stock the higher “ask” price is what you will pay.  It is what the market maker is asking (demanding) per share in order to do business with you.

 

And of course the lower “bid” price is what the market maker is willing to pay you for your own shares of a company.  The market maker buys at his bid price and sells at his ask, earning the spread for this service.  This means that you as a trader buy at the ask and sell at the bid, effectively paying the spread to the market maker.  Many new traders get confused on bid and ask prices, but they make perfect sense if you remember they are from the market-maker’s perspective, not yours.

 

So to buy a stock, type in its symbol to get a price quote.  Then look at the market-maker’s ask price.  This is what you’ll have to pay.  Then enter the stock symbol again if necessary in the actual buy interface (as opposed to the quotation one) and the number of shares you want to buy.  Then you decide on “order type”, which is generally “market” or “limit”.  This is a very important distinction that can save traders much angst.

 

The conventional type of order is a market order.  This means you are willing to buy X number of shares of XYZ at whatever price the market maker happens to be asking when he receives your order.  This sounds fine, and it is 99% of the time.  But sometimes prices can move fast or even worse trading anomalies can happen that lead to bad fills on market orders.  For example, what if you placed a market buy order when a stock traded at $70 but then it rocketed to $80 just before your order hit?  You’d be stuck paying $80 a share when you thought you’d pay around $70.  While very rare, there is still no need to accept this price risk.

 

It is far more prudent to use limit orders.  A limit order is a conditional order to buy stock but only at or under a certain price.  In the example above, BHP’s ask price is $70.50.  So I put in a limit-buy order slightly over this at $70.65.  This means, no matter what, I will not pay more than $70.65 for this stock.  If it happens to run over this price before my order hits, then it simply won’t be executed and I can cancel it.  And there is no charge for orders that aren’t executed.  And since computers fill my order, if the ask is still $70.50 when it hits it will still fill at $70.50 despite my $70.65 limit.  A limit buy order caps your buy price on the topside but you can still get a lower price if the ask is lower when your order is executed.

 

Limit orders work similarly on the sell side.  If I want to sell 10 shares of BHP like in this example, the market maker is currently bidding $70.45 per share for my stock.  But since I don’t want to get caught in some price anomaly and sell out at a way lower price than I intend, I can put in a limit sell order.  In this case I went slightly under the bid, offering to sell my BHP at $70.30 or higher while the market maker is offering to pay $70.45.  In practice I will still get $70.45 or whatever the current bid is when I execute my order, but I won’t get stuck selling my shares for $60 if some weird spike happens.

 

Now I don’t want to make you paranoid here, price anomalies are virtually nonexistent in major stocks and extremely rare in little stocks.  Despite this, it is very prudent to protect yourself with limit orders.  Limit orders allow you to specify the highest price at which you are willing to buy or the lowest at which you are willing to sell.  So by setting limits on buys slightly above asks and limits on sells slightly below bids, you ensure that those are indeed the prices you will get.  I always use limit orders for every single stock trade.

 

In the old days, limit orders could take longer to execute.  This is no longer the case in our computerized markets.  As long as your limit order is “marketable”, which means it is above the ask for a buy order or below the bid for a sell order, it will still execute instantly just like a market order.  Although limit orders used to cost more than market orders in brokerage commissions, today they are usually all the same price.  So use “marketable” limit orders to protect yourself whenever buying or selling stocks.

 

As you can see, actually buying and selling stocks is very easy mechanically.  All you need to know is the symbol of the company you want to trade and the number of shares.  You type this symbol into your trading account to get the current bid and ask prices from the market maker.  Then you enter a buy or sell limit order with limit prices slightly outside the current ask or bid.  Then hit the appropriate “finished” button to execute the trade, and within a second or two you will have bought or sold a real stock!  Congratulations.

 

Picking Stocks - Fundamentals

 

Stock trading is a lot like the classic game of chess.  You can learn the basic moves in an hour, but it can take a lifetime to master all the strategies and nuances.  So funding a trading account and learning how to buy and sell mechanically is the easy part.  The hard part, which you will continue learning about as long as you trade, is picking the individual stocks to trade and deciding when to buy and sell them. 

 

This is the entire mission of mutual funds, which are the vehicle in which most people choose to invest.  The mutual-fund managers research stocks, pick their favorites, and try to buy and sell them at optimal times to make profitable trades.  But the problem with mutual funds is the vast majority fail to even equal, let alone beat, general stock-market returns.  You can do the same thing fund managers do, and often do it better, since no one cares more about growing your capital than you do.

 

The first thing to consider when picking stocks to trade is fundamentals.  They are the underlying supply-and-demand dynamics affecting a particular company or sector, which is a group of companies in the same business.  You want to pick stocks in a sector with strong fundamentals, where demand for their goods or services is growing faster than they are able to supply it.  Demand outstripping supply means higher prices, which translates into higher profits for producers and ultimately higher stock prices.

 

As a student of the markets and speculator, my favorite sectors since 2000 have been in the commodities arena.  Commodities infrastructure was rusted and neglected after two decades of bear markets ending in the early 2000s, crimping supplies.  While worldwide supplies were low, Asia started demanding enormous amounts of raw materials to industrialize.  Now global demand in many commodities is at record highs while miners struggle to keep pace.  But finding and bringing new mineral deposits to market takes years or even decades, so prices tend to stay high for many years before supply growth catches up with demand growth.  In the meantime the profits for mining commodities soar, driving up producers’ stock prices.

 

Within a particular broad theme, like the industrialization of Asia’s affect on global commodities demand, there are individual sectors.  One example is gold mining.  Asians have a millennia-old traditional affinity for gold as an investment so as they get more prosperous they demand more gold.  And within specific sectors like gold mining, you can research individual miners and explorers to find the best-of-breed companies.  And it is these companies, the elite within a strong sector benefitting fundamentally from a major long-term global trend, in which you should consider trading since they will rise on balance.

 

Unfortunately there is no denying that researching individual stocks is a tremendous amount of work.  At Zeal we are constantly researching stocks looking for our favorites within given sectors.  We dig deeply into hundreds of stocks in a given sector, examining their financial statements, reading their quarterly SEC filings, and learning about their unique projects, in order to find our favorites.  Winnowing out the best-of-breed companies from all the players in a sector is a challenging and laborious task.

 

Thankfully there are specialists who can do this work for you.  At Zeal, for example, we sell comprehensive reports detailing our in-depth fundamental research into sectors of interest.  After carefully examining the greater population of stocks in a sector, we gradually narrow down the field to our favorite 20.  Then we write up profiles on these promising companies, which we believe are best-of-breed, and sell them in the form of reports.  You can get the fruits from many hundreds of hours of our research for a modest price.

 

In fact, we just completed an awesome new report on our 20 favorite gold-producing stocks.  It is now available for sale on our website.  If you are interested in trading high-potential gold stocks, you will really enjoy this report.  Buy it today!  It will bring you up to speed on the most promising gold producers on a project-by-project basis.  Our reports are a great way to learn about the fundamentally strong best-of-breed stocks within a sector, the key targets for trading.

 

Timing Stock Trades - Technicals

 

Picking fundamentally-strong stocks in fundamentally-strong sectors is very important.  You want to buy stocks that other traders will want to buy from you later at higher prices.  But the real key to profitable trading is timing.  In order to buy low and sell high, you have to have some idea of when these great stocks are relatively low or relatively high.  Stock price behavior, or technicals, offers insights here.

 

Thankfully timing stocks is a lot less arduous than researching their fundamentals.  Nevertheless, much of the art of speculation is dedicated to studying timing to make sound buying and selling decisions.  Countless trading tools and indicators have sprung up to game timing, to try to gain an idea of when the probabilities for success for a given stock trade are high or low.  Obviously you only want to buy or sell when your odds for success of executing an optimally profitable trade are high.

 

My favorite simple timing tool is based on a trading system I developed, Relativity.  In bull markets when prices are trending higher, they don’t move up in a straight line.  Instead they advance forward two steps in uplegs before retreating back one step in corrections.  The best time to buy is late in these corrections.  Interestingly these optimal buy times are fairly easy to discern on a chart because they often emerge at a common point.  This point is the 200-day moving average of the stock price itself.

 

For any given stock, you can easily and quickly see where it is trading relative to its own 200dma by visiting www.StockCharts.com and entering its symbol.  I love this website and use it many times a day, it is outstanding.  The resulting chart will look something like this example of BHP Billiton, the world’s biggest mining company.  The solid red line, labeled “MA(200)” in the chart legend, is its 200dma.

 

 

Note that BHP tended to retreat back down near or under its 200dma in corrections and then soar far above it in uplegs.  When it was down near its 200dma, odds are its price would next head higher in the coming months.  When it was stretched far over its 200dma, odds are its price would next head lower in the coming months.  This simple general bull-market tendency forms an excellent basic guideline for buy and sell timing.  So always check a stock’s price relative to its own 200dma before buying or selling.

 

If you want to buy a given stock low, you have a pretty good chance of achieving it when that stock is down near its 200dma.  This is because in order to get to its 200dma, the stock had to just do one of two things.  It either fell sharply back down to its 200dma in a short period of time (a correction) or it gradually ground sideways for a longer period of time (a consolidation) to give its 200dma time to catch up.  Either way, it is likely trading at a relatively low level compared to where it will be in the coming months.

 

So if you want to buy a stock that is gradually climbing higher within a bull market, you should wait until it is near its 200dma before buying.  Everything else being equal, odds are it is relatively low at that point compared to where it is going.  Sometimes it is hard to wait for a hot stock to fall far enough or drift long enough to hits its 200dma, but patience before buying is essential to make sure you have a good shot at buying relatively low.  Stalking trades well in advance, waiting for an optimal entry point, is a critical part of trading.

 

On the opposite end, your odds of selling high are greatest if you wait until a stock stretches far above its own 200dma.  As this chart shows, after soaring well above its 200dma BHP tended to correct or consolidate.  This is true of all stocks in long-term bull markets.  You have an excellent probability of achieving a near-optimal sell point in a trade if you wait to sell until your stock is stretched way over its own 200dma.

 

Now I realize this rule sounds overly simple, and it is.  And no it doesn’t always work 100% of the time, but no other trading system does either.  The markets are full of exceptions to any rule-set that traders try to impose upon them.  Nevertheless, I have personally earned a fortune trading stocks largely based on this simple principle.  The key caveat is this strategy is only valid for stocks within long-term bull markets.  This works best when a stock is likely to rise on balance for years to come for fundamental reasons.

 

Timing Stock Trades - Sentiment

 

Researching stocks fundamentally is straightforward, albeit arduous and time-consuming.  And timing stock trades based on technicals is not difficult to learn.  But the challenges of learning fundamentals and technicals are greatly eclipsed by the supreme challenge of sentiment, or emotions.  Learning to manage your own internal emotions, while simultaneously becoming hyper-sensitive to the psychological state of other traders, is crucial to your long-term success.

 

Why?  Virtually all trading is driven by two destructive human emotions, greed and fear.  The great majority of traders who choose not to study the underlying sentiment aspects of their art are never able to transcend their own emotions.  So they become trapped within them, careening from one irrational extreme to the next.  They buy stocks when they share the greed that permeates the rest of the markets.  And they sell stocks when general fear grows too great for them to bear.  But this is the recipe for failure.

 

Greed only reigns supreme after a major upleg, when a stock is stretched far above its own 200dma.  So a trader who buys stocks when he and his peers are the most greedy is going to get stuck buying high.  And soon when the inevitable correction arrives, stocks bought high will rapidly bleed into losses.  So if you want to buy low, you cannot buy stocks when everyone else is greedy and thinks it is a great idea.

 

Conversely, fear only grows intense after a major correction, when a stock falls to or under its 200dma.  After such a long or fast decline is when traders as a group are the most scared and feel the strongest urge to sell.  Yet if they succumb to temptation and sell at these times of great fear, they are selling low.  If you want to sell high, you cannot wait to sell until everyone else is scared and thinks the time to exit positions has drawn nigh.

 

Despite most traders buying greed near highs and selling fear near bottoms, and losing money as a result, you can transcend this natural human tendency.  To grow successful at stock trading, you have to learn to totally ignore your own emotions.  When everyone else is greedy and it looks like a great time to buy, odds are it is not.  In reality that is the time to sell.  And when everyone else is scared and you are really uncomfortable and want to sell, it is not the right time.  Instead that is the time to buy.

 

This is the essence of contrarianism, doing the opposite of what the majority is doing.  The best time to buy a stock is when it is the most beaten up and you least want to buy it.  And the best time to sell is when a stock is thriving and you absolutely don’t want to sell it.  Trading is so challenging, and so many people fail at it, because it demands you do your buying and selling when you least want to.  You have to be a black sheep, buying when most others are selling (fear-laden bottoms) and selling when most others are buying (greed-laden tops).  Fight the crowd to win!

 

Although extraordinarily hard at first, thankfully like everything in life this gradually gets easier with practice.  The longer you trade, the longer you suppress and ignore your own emotions, the longer you observe the emotional state of other traders, the more natural this becomes.  Eventually you will approach the point of immunity from your own greed and fear, and then you will really start multiplying your wealth.  It is a hard journey, but well worth it.  Mastering your own emotions has countless benefits outside of trading too, as it makes you much easier to get along with.

 

Other Key Principles of Stock Trading

 

The riskier a particular stock trade, the higher the probability for big gains as well as big losses.  Remember that volatile stocks that have high potential to rise are also the ones that can fall the fastest.  In general the lower the market capitalization of a stock (shares outstanding times stock price), the higher its price-to-earnings ratio (P/E), and the bigger and faster its recent gains, the riskier the stock.  If you want to shoot for big gains fast, you have to be prepared for big losses fast if you are wrong.  Risk works both ways.

 

And believe me, you will be wrong often when trading.  Losing trades are inevitable and are a normal and expected “cost of business” of trading.  Like me you are a mere mortal, neither of us can see the future.  So when we guess on the future performance of a stock, we will certainly not always be right.  The longer you trade, the better you will get at this, but you will still make bad trades.  So don’t let a losing trade or streak of them demoralize you or damage your confidence.  Every trader, no matter how elite and experienced, has losing trades.

 

Ultimately trading is an averages game.  Since it is impossible to win on all trades, you want to maximize your winning trades while minimizing your losing ones.  If you do this successfully, you will still multiply your capital rapidly despite your losses.  Most new traders fail at this because of a natural tendency we all have.  We tend to want to let our losses run in the hopes they will eventually return to break-even.  And we tend to want to sell our wins fast because a locked-in profit is a far surer thing than an unrealized one.

 

But just like buying when you are greedy and selling when you are scared is disastrous despite it being your natural instinct, so is letting losses run and cutting wins fast.  Instead, when you have a losing trade you should sell out of it as soon as possible and take the loss.  If you bet on a stock rising, but it has not risen since you bought it, then it is time to face the facts that you were wrong.  Your stock itself probably isn’t a bad choice, but your timing was clearly off.  In this case sell the stock right away and take the loss so you can redeploy this capital elsewhere.

 

And with winning trades, don’t succumb to the temptation to sell right away to realize your profits.  If a farmer plants his fields in May he doesn’t expect to harvest them in June.  Like crops, winning trades take time to mature into a bountiful harvest.  You may be tempted to sell out soon for a 10% gain, but by doing so you may miss the far bigger 100% gain you could have achieved over the next six months.  So never be in a hurry to sell a winning trade, unless of course a price stretches way over its 200dma and greed waxes extreme.  Give your winners the time they need to reach maturity and grant you a bountiful harvest.

 

The best way I have found to let my wins run and cut my losses fast is to use stop losses.  A stop loss is a conditional sell order you place with your broker.  It tells your broker that after a stock you own slides more than a certain percentage from its best price achieved during your trade, say 20%, that the broker should automatically sell the stock.  If you prudently use these trailing stop losses, you won’t even have to worry about selling.  The stops do all the work, eliminating human decisions.  Stops automatically let your wins run unmolested while cutting your losses fast.  I highly recommend you use them religiously.

 

In a winning trade, having a trailing stop eliminates your temptation to sell too early.  As long as your winner doesn’t correct by more than your stop percentage, then you’ll keep the trade in your portfolio and it will continue maturing.  And in a losing trade, having a trailing stop eliminates your temptation to hold on until you break even.  As soon as your loser falls more than your predetermined percentage, you are automatically sold out.  This is great because you can then redeploy this recovered capital in greener pastures elsewhere.

 

And since trading is an averages game and you won’t win all the time, it is critically important to be diversified.  Ideally, you should never have more than 5% to 10% of your stock-trading capital deployed in any individual stock.  Obviously if you start with $1000 this is hard, but once you get over $10k or so it gets a lot easier.  Since so much can go wrong with any individual company at any time, never put all your eggs in one basket.  Own a trading portfolio of 10 to 20 different stocks, with your capital allocated roughly equally among all, as soon as you can afford to.

 

When you are properly diversified like this, bad news in one company doesn’t hurt you irreparably.  If you own only one stock, and the company misses its earnings expectations so it falls 20% in a single day, you are going to take a massive 20% loss on your entire trading portfolio.  This is unacceptable.  But if you own 10 stocks, and one falls 20% in a day, you only lose 2% of your portfolio.  To thrive for a long time as a trader and survive all the curve balls the markets will throw at you, you must diversify your trading portfolio.

 

Another benefit of diversification is it greatly reduces the risk of emotional attachment to any one stock.  To be a great trader, you have to be a total mercenary with no loyalties to any particular company.  If a stock is doing well for you, that is great and you should keep it.  But if a stock isn’t performing as you expected, you should be able to sell it instantly without a second thought.  It is far easier psychologically to dump a loser that is less than 10% of your portfolio than one that is more than 10%.  Proper diversification minimizes emotional attachment that interferes with timely and prudent trading decisions.

 

Most of the risk you encounter in trading stocks, which is considerable, should be managed before you even buy a particular stock.  Managing this risk includes never allocating too much of your trading capital to any one stock, 10% max.  It also includes deciding in advance before you buy what the biggest loss you are willing to accept in any individual position is.  Then you effectively lock this in by setting your trailing stop to that level.  The less money you lose, the quicker you will multiply your capital in the markets.

 

And definitely don’t worry about a hot stock you missed out on.  There is a constant and endless parade of opportunities coming your way in the stock markets.  The markets are like a major airport.  If you miss one airplane, there is no reason to fret because another flight is always heading out shortly.  So there is no need to dwell on the past and wish you would’ve bought a particular stock.  Instead look to the future and try to figure out what the next hot stock will be.

 

Trading stocks is analogous to the great European sea trade of centuries past.  Brave entrepreneurs would finance ships, hire crews, and sail to Asia to buy spices.  If they could successfully bring the spices back to the European markets, they would earn fortunes.  Trading stocks is about supply and demand and risk too, but the oceans we sail across are time itself.  When you buy a stock today, you have to think about whether lots more traders will want to buy it from you later in the future at a higher price.  So fill your holds with stocks that, while not highly desired now, are likely to be highly desired by other traders in the future.

 

Finally, avoid the temptation to use margin.  Margin is borrowing money and using this debt to buy stocks.  Fully margined, you can double your wins or losses in a given trade.  The problem is margin greatly increases your risk and amplifies your dangerous emotions.  If you have to worry about paying back borrowed money, it is really hard to make wise real-time trading decisions.  Trading with capital you own outright, free and clear, is the way to go.  It is usually far wiser to increase your risk and potential returns by trading more volatile stocks than by borrowing money.

 

Yes, You Can Excel in Stock Trading

 

I realize this is a lot of information if you have never traded stocks before.  But you really can do it.  Every trader on the planet today started with zero knowledge of the markets.  We all start from nothing and that is totally normal.  It will seem difficult at first, but with each trade you make your experience will grow and your probability for future success will rise.  Like everything in life, the more you trade the better you will get at it.

 

If you want some help along the way, subscribe to our acclaimed monthly newsletter Zeal Intelligence.  It is essentially my ongoing personal journal as a lifelong stock trader.  In it I discuss fundamentals, technicals, and sentiment and apply all of our research to real-world stock trading.  Our primary focus since 2000 has been in commodities stocks, as commodities are in the world’s greatest bull market today and legendary profits are being won here.

 

Our newsletter will show you what specific stocks my partners and I are trading, exactly when we make these trades, and why we are doing them.  You can mirror our trades to accelerate your own intellectual, emotional, and financial growth as a trader.  Subscribe today for an ongoing profitable education in real-world stock trading!

 

The bottom line is stock trading is fantastically fulfilling and fun.  Not only can you earn big profits doing it, but it will teach you a great deal about yourself.  The emotional control that stock trading demands will help you be a more stable and less volatile person in all aspects of your life.  And the self confidence that trading naturally builds will be a boon for all your personal interactions.  The crucible of trading will gradually forge you into a better, and richer, person.

 

While there is a lot to learn, the basics are pretty straightforward.  And there is no better time to start than today.  Cut back on your entertainment expenses to save some money, open a trading account as soon as you can fund it, and start trading.  With each trade your confidence and success will grow.  And eventually, if you stick with it and practice good trading discipline, you will grow into a successful stock trader.

 

Adam Hamilton, CPA     November 23, 2007     Subscribe