The Basic Rules of Stock Trading

If you’re going to trade in stock, adhere to some golden rules to help you maximize your success (or at least minimize your potential losses):

  • Don’t commit all your cash at once: In a fast-moving market, opportunities come up all the time. Try to keep some cash on hand to take advantage of those opportunities.

  • Have a plan: Try to have predetermined points at which you cut losses or take profits.

  • Understand that taking profits is not a sin: Sometimes, a bird in the hand is worth two in the bush. Markets can reverse fairly quickly. If you have a stock position sitting there with a fat profit, it can’t hurt to take the profit. This action gives you cash for the next opportunity.

  • Discover hedging techniques: Just because you’re bullish doesn’t mean that you can’t also put on a bearish position. Hedging techniques protect you when the market moves against you.

  • Find out which events move markets: Research the market and discover what types of events tend to move it. Serious short-term traders keep one eye on their positions and the other on what’s going on in the world. Keep informed by regularly reading financial publications and websites.

  • Check the stock’s trading history: Charts and related data tell you how a particular stock has moved in recent weeks, months, and years. Do you see any seasonality or reliable patterns that may help you judge future movements?

  • Use stop-loss and limit orders: Using trade orders is an integral part of the trader’s overall strategy.

  • Use discipline and patience versus emotion and panic: Part of the human equation in the world of financial markets is that fear and greed can become irrational, short-term drivers of prices. Instead of joining the crowd, watch them to give you an advantage in assessing a stock’s price movements. Stick with your plan and use discipline and patience.

  • Minimize transaction costs: Keep in mind that because trading is typically active and short-term, transaction costs are significant. Active trading can mean lots of brokerage commissions, even in this age of Internet-based brokerage firms. Therefore, traders who trade frequently should shop around for brokerage firms that charge low commissions.

    In addition, short-term trading leads to short-term capital gains, which are taxed at a higher rate than long-term transactions.

  • Understand the beta of a stock: The volatility of a stock is an important consideration for traders. The more volatile a stock is, the greater its ups and downs are. Therefore, traders should regularly check the stock’s beta. Beta is a statistical measure of how volatile a particular stock is relative to a market standard.

    How is it measured? The S&P 500 (for example) is given a beta of 1. A stock with a beta of 2 is considered twice as volatile as the index. In other words, if the index falls by 10 percent, the stock in question has the potential of falling by 20 percent.

    Traders looking for fast (and hopefully profitable) movement look for high-beta opportunities. A stock’s beta can be found on various financial websites.

  • Read and learn from top traders: Last (but not least), learn from the great ones out there, such as the legendary Jesse Livermore. You can read all about his trading exploits in the book Reminiscences of a Stock Operator by Edwin Lefèvre and Jon D. Markman (Wiley).

Because trading can be very risky, you need to know as much as you can. Don’t use your rent money or retirement money, and for crying out loud, don’t break open your kid’s piggy bank. Trading should only be done with risk capital (money that, if lost, doesn’t hurt your lifestyle).

Don’t forget the advice from the immortal Will Rogers: “Don’t gamble. Take all your savings and buy some good stock and hold it till it goes up; then sell it. If it don’t go up, don’t buy it.”

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