Trading vs. Investing Investing is defined as taking a stake in a company in hopes of benefiting from their prosperity through price appreciation and dividend payouts. Fundamental Analysis is the study of Financial Statements and Ratios which help evaluate a company s overall Value and Growth potential. Trading is often focused more on taking advantage of the short-term fluctuations in price than investing in the actual success and failures of the company. Technical Analysis is the study of price and volume patterns on a chart. It essentially tracks the Supply and Demand for the stock itself. There is the underlying assumption that the Fundamentals are discounted or reflected in price action. Briefing Trader s Note: Combining both forms of analysis can give a trader a distinct edge. Fundamentals help to answer the question of WHAT to trade, whereas Technicals help answer the question of WHEN to trade. Different Styles of Trading There are a variety of styles and strategies to make money in trading, so it s critical to take a good look at one s personality and capital to determine which one best suits your comfort zone. SCALPING: Focus is on very short intraday timeframes. Often associated with taking many Large-Sized trades and locking in a Small profit for nickels, dimes and quarters. DAY-TRADING: Focus is on intraday price action. Position Size and profit objectives vary, but there is no intention of holding a trade overnight. SWING-TRADING: Focus is on more of a 3 Day to 3-week timeframe. Position Size and profit objectives vary, but the intent is to stick with the prevailing momentum until it ends. Briefing Trader s Note: Jumping between different Styles of trading can be hazardous to your wealth if you don t know what you are doing. Are you trading Part-Time? Then Swing Trading may be a better fit for you. Can you sit in front of a screen tracking each tick throughout the day? Scalping may be your calling. Do you have the patience to sit with a position, but don t want to carry overnight risk? Daytrading is the answer. 1
What it means to be BULLISH Reference to a Bull, means one expects prices to RISE. A trader will enter an order to BUY (also known as Long ) with the intent of price moving higher so it can be sold for a profit. Other Bullish terms or phrases to know include Bidding for stock, Getting Long, and Lifting the Offer What it means to be BEARISH Reference to a Bear, means one expects prices to FALL. A trader will enter an order to SELL an existing Long position when expectations are prices will be moving lower. Either a Gain or a Loss will be recognized, dependent on where the stock price was sold in relation to where it was initially bought. Sometimes a trader may want to take advantage of an expected drop in prices, without an existing position, and can do so by entering an order to SELL SHORT. In this instance, a trader will borrow stock from his/her broker and then Sell it to the market. The trader hopes to later re-purchase the borrowed stock (which is subsequently returned to the broker) at a Lower price for a profit. If the trader re-purchases, or Buys back, the stock at a Higher price than where it was borrowed (or Shorted), then a Loss will be recognized. Other Bearish terms or phrases include Offering Stock, Getting Short, and Hitting the Bid Briefing Trader s Note: A LONG POSITION is closed out or offset with an opposing order to SELL. SHORT POSITION is closed out or offset with an opposing order to BUY or COVER. i.e. Cover your Shorts. Brokers charge interest for borrowing stock known as margin. Therefore a Margin Account (as opposed to Cash Account) is needed in order to Short stocks. 2
Understanding Different Order Types MARKET ORDERS: Used when traders are willing to pay the current bid or offer at the time of entry. In more liquid (heavily traded stocks with high daily volume), most Market orders are filled or executed within relatively close proximity of the current bid or offer. In more illiquid or less traded stocks with low daily volume, a Market order is susceptible to slippage. Slippage is often the result of a Wide Spread between the Bid- Ask prices, along with little to no size behind those bids and asks. Remember the Stock Market is an auction market where Buyers and Sellers come together to trade at a particular price. 3
A Market order to Buy 1,000 shares can be filled at different prices based upon how much size there is being offered to Sell. If only 500 shares are offered, say at $50.25, then the Buyer will be filled on 500 shares at 50.25 and the remaining 500 shares will match up with the next Higher offer. If the next best offer is 300 shares at $50.40, then 300 shares will be filled there. The remaining 200 shares will continue to match up with the next best offer, which could be with 1,000 shares at $50.50. In this case, the original Market order to Buy 1,000 shares was filled at 3 separate prices (500 at 50.25; 300 at 50.40; and 200 at 50.50), all which represented the Best Offer at the time. Bottom line: Be prepared to have different execution prices, especially when using Market orders on more illiquid or fast-moving stocks. LIMIT ORDERS: An order that states you are willing to pay up to a specific price or sell down to a specific price. You will NOT be filled beyond that specified price level. In fast-moving (headline-driven) stocks or stocks with low liquidity (less frequently traded), it is quite possible to receive only a partial fill or even nothing at all. STOP ORDERS: An order that becomes activated only when a specified price is reached. When the market trades at that predetermined price, (known as the stop price, ) either a Market or Limit order will be triggered for execution. Stop orders are frequently used for both Entering or Exiting a position. By default, a Stop order will automatically convert to a Market order when a specific price is met. To protect oneself from slippage or poor execution prices, a Stop Limit order may be used. With a Stop Limit order, when price trades at the specific Stop price, the order will automatically convert to a Limit order (See above for Limit Order definition). Buy Stops must be placed ABOVE the Current Offer price or Resistance. Sell Stops must be placed BELOW the Current Bid price or Support. Otherwise, the order will become triggered immediately for execution. 4
What is SCALING and FADING? Given the extreme difficulty with trying to pinpoint the exact highs and lows of a range, traders will often opt to slowly enter a position in separate pieces around a key price zone, usually obtaining a better average price in the process. Scaling In and Scaling Out are the opposite of trading with an All In and All Out approach. Instead, it can be thought more as, buy some buy a little more...sell some...sell a little more. Focusing on trading price Zones, Areas, and Levels will allow for traders to be more lenient with waiting for the market to react to price movements. It is very rare to see prices react to the exact penny. Always take the bigger picture into perspective. 5
Money/Risk Management According to the FINRA Rule 4210, if you plan on making more than 4 round-trip trades within a week s time frame, you are considered a Pattern Day Trader and must carry a minimum $25,000 of equity in your margin account. Failure to do so, would put an automatic restriction to trade your account, until either you add more funds to meet the minimum, or until 90 days (3-months) pass. Note this rule also applies to trading Options, but not Futures. Account Size and What Percentage of Capital to Trade As a beginner trader, it is in your best interest to start as small as possible. Only after a series of successful trades and proper money/risk management discipline, should a trader reward themselves by increasing their trade size. 6
Even then, it s best to be prudent and make only a small incremental increase. As time goes on, you can make the decision to again make a small incremental increase or possibly even decide to decrease your size to a more comfortable level. In due time, each trader will recognize their own comfort zone of how much size they can accept based on their own Risk Tolerance. As a general rule of thumb, traders should use the Sleep Test. If you can t get a good night s sleep because you re worried about a particular position, you ve over-committed yourself to the trade. The goal is to build wealth by being a consistently profitable trader. It should be viewed as a longjourney that demands planning, patience, and discipline. Trading is not a get rich quick scheme. If possible, try Paper-Trading first. Paper-trading not only builds confidence, but will aid in developing the necessary skills and discipline required for consistent success. Understanding A Stock s Volatility (Risk vs. Reward) Volatility is the price movement of a stock. As traders, we favor stocks with Higher Volatility as profits (and losses) tend to be much quicker. There are a number of ways to measure Volatility, but we ll highlight just 2 here. First, is to look at Price Ranges and Volume. It doesn t take long to look at the last few days of price Ranges (High Low) and determine an average daily range. Volume should also be looked at to determine the liquidity. Second is a technical indicator available on most Charting Software packages called Average True Range or ATR. Without getting into the specifics of its calculation, it essentially shows the recent average range of x number of periods. The default setting is typically 14 periods or about 3 weeks of trade. Most Day and Swing traders want to focus on stocks with an ATR greater than 1 or 2 points. Above 5 points, a trader is more than likely looking at stocks trading well above the $100-level. Why is this important? A trader must understand a stock s recent behavior (or the way it trades) in order to capitalize on its price action. Knowing how a stock has been trading in the past, allows for a trader to develop some expectations about how it will trade in the future. More importantly, it will allow a trade to understand the potential risk associated with the trade. 7
Keep Your Expectations in Check Whether you are trading part-time or full-time, the concept of making a lot of money and earning your way to financial freedom can often be unrealistic for those with unrealistic expectations. Be sure to understand the Risk behind each trade before assessing the Reward. The table below can be called a Profitunity table. It shows that just making as little as $50/day can add up to as much as $12,000/year! Don t get too caught up thinking that trading larger size and catching every move in the market is necessary for reaching your goals. Always stay focused on the bigger picture to achieve your long-term goals. Don t allow a bad trade, day, or even month, get in the way of remaining disciplined to your plan. PROFITUNITY TABLE Monday Tuesday Wednesday Thursday Friday WEEK MONTH YEAR 50 50 50 50 50 $250 $1,000 $12,000 100 100 100 100 100 $500 $2,000 $24,000 200 200 200 200 200 $1,000 $4,000 $48,000 300 300 300 300 300 $1,500 $6,000 $72,000 500 500 500 500 500 $2,500 $10,000 $120,000 750 750 750 750 750 $3,750 $15,000 $180,000 1,000 1,000 1,000 1,000 1,000 $5,000 $20,000 $240,000 2,000 2,000 2,000 2,000 2,000 $10,000 $40,000 $480,000 5,000 5,000 5,000 5,000 5,000 $25,000 $100,000 $1,200,000 10,000 10,000 10,000 10,000 10,000 $50,000 $200,000.00 $2,400,000 Keep Good Records and a Trading Journal Not only is keeping an accurate record of all your trades a good idea for review each day/week/month, but it will also help in organizing your activity for tax purposes. Note if you achieve significant income from which taxes aren t withheld (i.e. profits), you may need to make Estimated Tax Payments for each Quarter. If you fail to do this, there is the chance the IRS can implement a penalty for late payments. Contact your Tax Accountant for further details. When it comes to keeping a Trading Journal, you should note the current market conditions and your reasons for taking the trade. This type of detailed analysis will be very useful during market cycles that become more difficult to navigate as you will have created a reference to how you dealt with similar circumstances in the past. 8 A trading journal is critical for learning from both your Success and Failures.
Summary You are about to embark on a long journey in which the opportunity to consistently build up your wealth is fully achievable; however, there is much hard work and discipline required to do so. Seriously consider starting small and only increasing your expectations/risk after you have proven to yourself that you earned it. Educating yourself on how the mechanics of the market works is just one part of the equation. Knowing your own capability based on account size and risk tolerance, as well as keeping your expectations in context of the bigger goal is a must for success. A trading journal can become an invaluable source for analysis and reference. Use our Briefing Trader service as a tool for helping you guide your way through the markets activities. There is more than an abundance of information and analysis flowing through the site on a daily basis. Avoid analysis paralysis by focusing on what best fits your style and objectives. If you are interested in a free trial to Briefing Trader, email sales@briefing.com or call 800-752-3013. 9