Building a Body of Trading Survival Techniques - dummies

Building a Body of Trading Survival Techniques

Trading is not a risk-free activity. Although all traders know that losses are inevitable, they want to minimize those losses and be around to trade another day. But alas, you can enter the world of trading and continue to trade for a long time to come — without losing your shirt and your mind.

Assemble your trading tool chest

Before you buy that first share of stock, that first option or futures contract, or any other security, you need to be certain that you have the right mix of trading software, hardware, and Internet access to be successful. You need the right tools to identify trading candidates; display and interpret charts; research trading opportunities; screen stocks for technical or fundamental constraints; and monitor and analyze your portfolio, open positions, market indexes, sectors, and trading statistics.

The proper tools help you evaluate your trading system and test your trading ideas. They enable you to keep trading logs to review your trading performance. You also can use tools to stay in touch with other traders and exchange ideas that ultimately may help you improve your trading skills and discover new trading opportunities.

Use both technical and fundamental analyses

You may have heard that all traders use technical analysis and believe that fundamental analysis is a waste of time. Don’t believe it. Although technical analysis is critical to finding the right entry and exit points, fundamental analysis improves your ability to make the right stock choices, given market and economic conditions.

You’ll find as a trader that knowing the current state of the economy and the state of the market is critical. You obviously want to buy stocks in the bull market and sell them, or short them, in a bear market, but do you know how to recognize when the market is entering a period of transition so you can make your moves when the opportunity for making profitable trades or minimizing potential losses is greatest?

Using a combination of fundamental and technical analyses, your chances of identifying bull and bear markets and finding phases of transition and consolidation improve dramatically. Your best trading opportunities are at the beginning of these phases of change, so be sure that you understand the six phases of the market and know which sectors offer you the best trading opportunities within each of those phases.

Count on the averages to make your moves

Traders use many different types of moving averages in hundreds of different ways. Stock closing prices are the most common data being averaged, but any value on a price chart can be smoothed for interpretation. For example, traders sometimes manipulate the moving averages by using the mid-point between the high and low prices to develop the moving average. Others look for the moving average using the open, high, or low prices. It’s all a matter of trading style and how the charts you’re developing match your trading system.

Be sure to find out how to use moving averages and what they mean. After you understand them and what goes into them, you can manipulate moving averages to your advantage and to coincide with your trading style. Moving averages are powerful indicators, but they’re not the only type of indicator you need to use in choosing your trades; use moving averages in conjunction with other indicators.

Know your costs

Trading isn’t cheap. Not only do you have to worry about commissions or transactions fees, you also must watch for any slippage in your trades. Even though you may be using stop or limit orders, you rarely end up executing trades at the exact entry or exit prices you plan. Some slippage, or the difference between the quoted price and the actual price for the security, is bound to occur, so you need to be sure that you carefully monitor your commission costs, transaction fees, and slippage costs.

In addition, don’t forget to consider the taxman. If you’re trading stocks that you hold for less than a year, any profits you make are taxed as current income rather than at lower capital gains tax rates.

Traders must also avoid being caught by wash sale rules. Most trading losses can be used to offset trading gains and thus reduce your income tax burden, but if you sell a stock for a loss and repurchase the same stock within 30 days, your trading loss for that transaction cannot be deducted. You have to wait until you sell the stock again and use any losses to reduce the cost basis of the trade, which reduces the tax owed when the position is finally closed. Full-time day traders receive special tax treatment, but you must be a bona fide day trader to qualify.

Know when to hold ’em and when to fold ’em

Knowing when to take your profits and get out and when to accept your losses and close a position before it becomes even more damaging can be among the hardest lessons any trader must learn. All too often you’re enticed by the win and want to ride it to the absolute top.

Wise traders plan their exit points at the top and bottom of each position long before they ever enter that position. And, more important, they stick to their plan. Getting caught up in the emotions of a winning trade is easy, but don’t forget you’re operating a business. Take your profits when you reach your goal and get out, so you don’t risk turning a winning position into a loss.

Buy on strength; sell on weakness

Buy on strength and sell on weakness is a mantra you’ve probably heard frequently from investment and trading gurus. The reason for its popularity is a good one. It works! And it needs to become your trading way of life.

When you see a stock showing strength and heading into an uptrend, it’s time to buy. When you see a stock falling and showing signs of entering a weakening period, it’s time to sell. If a weak stock takes a turn for the better, you can always reenter the position.