Trading is not a game of luck

Part 1

Researching and Choosing Stock

You know possibly know more than one person who lost money with online trading. But you also know a few driving fancy cars living in lavish homes and popping champaigns for supper because of online trading. Those are the ones you look up to, so you think to yourself why not take a chance you might be lucky. If luck is all you are betting on, then you are out of luck. To some experienced traders, buying and selling stock on the Internet is a cakewalk. But for beginners, trading stocks online is a total mystery. The emergence of online brokerage accounts and software tools for the stock market has made online stock trading simpler, but it has also led to some complexities and some liabilities for the home trader. In this four part article we are going to share some simple steps to help novice investors trade stocks online. 1. Perform a technical analysis. Technical analysis is an attempt to understand market psychology or, in other words, what investors - as a whole - feel about a company as reflected in the stock price. Technical analysts are normally short-term holders, concerned about the timing of their buys and sells. If you can detect a pattern, you might be able to predict when stock prices will fall and drop. This can inform you about when to purchase or sell certain stocks. 2. Identify patterns. Patterns identified in a technical analysis include identifiable price boundaries in the market price of a stock. The high boundary, which the stock rarely surpasses, is known as the "resistance." The low boundary, which the stock rarely dips below, is called "support." Identifying these levels can let a trader know when to buy (at resistance) and when to sell (at support). Ÿ Some specific patterns are also detectable in stock charts. The most common one is known as "head and shoulders." This is a peak price then drop, followed by a taller peak then drop, and finally followed by a peak similar in height to the first. This pattern signals that an upwards price trend will end. Ÿ There are also inverse head and shoulders patterns, which signify the end to a downward price trend. 3 Understand the difference between a trader and an investor. An investor seeks to find a company with a competitive advantage in the marketplace that will provide sales and earning growth over a long period. A trader seeks to find companies with an identifiable price trend that can be exploited in the short-term. Traders typically use technical analysis to identify these price trends. In contrast, investors typically use another type of analysis, fundamental analysis, because of its focus on the long term. 4 Learn about different orders traders make. Orders are what traders use to specify the trades that they would like their brokers to make for them. There are numerous different types of orders that a trader can make. For example, the simplest type of order is a market order, which purchases or sells a set number of shares of a security at the prevailing market price. In contrast, a limit order buys or sells a security when its price reaches a certain point. Ÿ For example, placing a buy limit order on a security would instruct the broker to only purchase the security if the price fell to a certain level. This allows a trader to specify the maximum amount he or she would be willing to pay for the security. Ÿ In this way, a limit order guarantees the price the trader will pay or be paid, but not that the trade will occur. Ÿ Similarly, a stop order instructs the broker to buy or sell a security if the price rises above or falls below a certain point. However, the price that the stop order will be filled at is not guaranteed (it is the current market price). Ÿ There is also a combination of stop and limit orders called a stop-limit order. When the price of the security passes a certain threshold, this order specifies that the order become a limit order rather than a market order (as it does in a regular stop order). 5 Understand short selling. Short selling is when a trader sells shares of security that they do not yet own or have borrowed. Short selling is typically done with the hope that the market price of the security will fall, which would result in the trader having the ability to purchase the security shares for a lower price than they sold them for in the short sale. Short selling can be used to make a profit or hedge against risk, however it is very risky. Short selling should only be done by experienced traders who understand the market thoroughly. Ÿ For example, imagine that you believe that a stock currently trading at R100 per share is going to decrease in value in the coming weeks. You borrow 10 shares and sell them at the current market price. You are now "short," as you have sold shares that you didn't own and will eventually have to return them to the lender. Ÿ In a few weeks, the price of the stock has indeed fallen to R90 per share. You purchase your 10 shares back at R90 and return them to the lender. This means that you sold shares, that you didn't have, for R1,000 total and have now replaced them for R900, netting yourself R100 profit. Ÿ However, if the price rises, you are still responsible for returning the shares to the lender. This potentially unlimited risk exposure is what makes short selling so risky. “The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.” – Ed Seykota