Think, Buy, Sell... Repeat As Needed
Generally, a trader should meet buying with selling and vice
versa when it comes to the stock market. Typically, stocks
(especially when considered on an intra-day basis) will only go
so high, or so low, before tending to attract the next group of
contrarian thinkers and switch direction. Often times crowds
(such as the markets) are wrong in their actions and over react
to the up or down side. When the "markets" as a whole are moving
up dramatically or down dramatically, there is a strong case to
be made that these actions ultimately will be wrong or will tend
to reverse simply as the contrary views of things builds on each
side of the fence.
If you can train yourself to go against your natural emotions,
you'll tend to be able to keep a clearer outlook on the markets.
When stocks are being bought, you have to train yourself to
think, "These stocks are buying bid up too high - maybe I should
sit back and wait". By the same token, when there is a great
deal of panic selling in the market, you need to train yourself
to think, "Wow, look at all these prices falling - I may find
good deals here soon". It's more difficult than you think to be
"happy" when the markets are falling and "cautious" when the
markets are rising. However, normally taking this view of things
will help improve your trading over the long haul. The old
saying, "Buy when there is blood in the streets" stems from this
basic idea of going against the masses on Wall Street.
People tend to have a desire to buy at the bottom and sell at
the top. Not just near the top, but the "exact" top. It's simply
human nature to want to be the best at something, and trading is
no different. Most people that take up daytrading want to be the
best they can be. However, aiming for exact tops and bottoms
when buying stocks can be very detrimental to your overall
trading.
I would much rather give away 10% at the top and 10% at the
bottom. You will drive yourself crazy if you punish yourself for
not selling at the high or buying at the low, as it's almost
impossible for most people to do on any sort of consistent
basis. Far more often than not, you'll simply end up missing the
trade. Even missing a top or bottom by 20% is nothing to worry
about. As many a successful trader has said, "You can worry
about the tops and bottoms, and I'll worry about the remaining
60%". In fact, it's often much safer to wait until a stock
clearly signals a move either up or down before taking up your
position.
Some people use stop orders quite often, some people hardly use
them at all. In my view, stops are best used to protect a nice
profit and/or limit down side risk in a trade that isn't acting
as you think it should. How a stop is used (or placed) is
largely dependent on the individual stock and how the overall
market is behaving at any given time as well.
Often times using stops also helps to remove some of the
emotions from trading. It's far easier to place a stop on a
trade than watch it trade tick-by-tick and try to decide the
exact moment to get out.
What about taking profits at big gains? At some point, just like
experiencing a large loss, you are likely to hit a really big
winner. When this happens, consider taking 1/2 your gains off
the table right away to reduce risk to the profit you have just
made. This allows you to continue to profit, but protects a
large amount of the money you have just made. Additionally, you
may wish to consider selling enough of the position to recoup
your original investment. This results in the remaining shares
effectively being "free" and allows you to hold them
indefinitely without any fear of a "loss" to your original
capital (which has now been removed completely).
When shorting stocks, there are several points to always keep in
mind. Never short a stock simply based on the stock price. To
really be successful as a short player (i.e. someone that shorts
stocks), you need to locate stocks that are extended with a
significant void of fundamental reasons. There must be some
reason for the stock to decline in the near term (e.g. declining
profits, lack of direction, etc.). Simply shorting a stock
"because it has a high share price" is just inviting danger.
Additionally, keep in mind that shorting stocks exposes you to
additional risks that are not present when buying or going
"long" a stock. These include having the stock called away from
you, as well as being caught in a short squeeze. Also keep in
mind that the very act of shorting a stock increases the pent up
demand for the stock - namely the number of people that will
ultimately have to repurchase the security down the road to
cover.
Finally, a good rule of thumb is to never short a stock which
may end up on the front page of the Wall Street Journal or some
other major financial publication. Typically, the best short
candidates are stocks that have moved up rapidly on little or
not fundamental changes and which are generally not well know to
the investment public at large. While it's true you can make
money shorting well known, large cap stocks, it tends to expose
you to additional risks not associated with smaller and less
well known companies.
Good luck in the markets!
No permission is needed to reproduce an unedited copy of this
article as long the About The Author tag is left in tact and hot
links included. Questions and comments can be sent to Ray at
articles@daytraders.com.