Adventures in Trading

For some time now, I’ve been fascinated by money. It opens up doors, it enriches your life, hell…it just makes you happy. Who can argue with that? Now I have no desire to be super rich (not in the slightest), but I think we can all agree that, with all the uncertainties that life puts forth, wouldn’t it be nice to be comfortable financially? Yeah, well how? There are plenty of illegal means that may net you some money (and jail time…), but assuming you’re made up of a high moral caliber, the next best thing is…the stock market. Make no mistake, it’s a pretty corrupt place. I sometimes feel dirty playing in it, but it is what it is. You can make a lot of money really fast here. You can also lose it all. I’ve been on both ends, I know.

I’ve always, always wanted to “play” in the stock market. Watching the DOW on the nightly news as a kid made it feel like it was “adult game”, and I wanted to be apart of it someday. I knew I wanted a shot at it when I grew up. Two years ago, I finally had a decent chunk of capital to dedicate just to “investing” and gave it a shot. After many highs and lows, I’m sharing my experiences. If you’re interested in trying your hand at the game (or have done it awhile), here are some helpful hints and observations I’ve learned along the way.

Without question, the entire thing is legalized gambling. Some forms of investing seem more like gambling than others, but it’s all a gamble in the end. It’s a psychological experiment on human emotions. Greed and fear. It is fascinating. It is thrilling. It is deadly. You may be able to make some gains here and there not knowing what you’re doing, but if you’re an amateur, you will eventually get slaughtered. Here are some general topics that can get you started on your way. I may use jargon below that you’re unaware of. There is a lot of it to go around, so if you’re unclear of the terminology, I would highly suggest checking out the very informative website Investopedia. It’s just like it sounds; an encyclopedia on investing. Highly recommended and a very good place to get started.

With that, here are the things I’ve learned after a few years of playing:

  • Emotion

The entire stock market is manipulated. It is run by people with a lot more money than you have. They have fancy computers that trade for them and react to changes in the market instantly. They will do things that take money from you. Things will appear to go up or down for no reason. They are the ones that control the price of a stock. Always be aware of this fact! Unless you’re a millionaire, you aren’t going to be able to sway price action, you’re just trying to get a small piece of that money pie. The best advice is to know that this is a fixed game and how to learn the signs of what’s to come.

The easiest way to lose it all in the stock market is to lose control of your emotions. This is how the “big boys” make lots of money. I’m sure you’ve heard this before: “buy low, sell high”. If you follow this one rule, you’ll probably be OK. But, trust me…fear (low) and greed (high) are powerful things to overcome. We’re not machines after all, but to be successful, you have to become more like one.

Most of the trades that have devastated my balance (there have been a few) have normally come from getting greedy after a big gain. Know when enough is enough because there’s always a time to walk away. Conversely, know when it’s time to panic and get out. Normally when you start panicking, that’s probably the best time to buy (or sell) more (ironic huh?). I would suggest taking emotion out of this and setting a 20% stop loss (a way to automatically trade when you’re in the red).

Finally, one last comment that ties in with emotion: endless watching. Minute after minute. Did it go up? Did it go down?! Aww crap! Go up! Go up! Gahh…it’s tanking….holy crap, there it goes! Trust me. It will happen. Sometimes it’s fun. Sometimes it’s necessary. But mostly it’s counter productive. When you first start out, you will absolutely be glued to your monitor watching price movement. It’s fine as a start, but you will destroy yourself if you continue to do this long-term (it’s still hard for me). This depends on what your investment goals are (we’ll talk about this later), but in general, don’t do this. It will exhaust you mentally. You will have anxiety. For your health and your mind, take a position, set a floor and a ceiling on when you will get out and stick by it (unless something changes to upset your initial prediction). If you are able to master this, you will make a lot of money.

  • Research

I will admit, I don’t do this nearly as much as I should and I’ve paid for it. Buy on fundamentals, you will not regret it. I’ve bought a lot of “crappy” stocks because they were cheap and appeared undervalued. This can make you money, but it’s more risk than it’s worth. Buy solid companies, buy market sectors that have growth opportunity, move on when a different sector gets hot. Just be aware that “popular” stocks normally won’t make outrageous gains. Buy stocks that are “under the radar”, but still have good fundamentals. Once they become “popular” it’s probably time to move on. Hey, it’s like music…once the masses get ahold of a band, it’s normally lost its luster. It’s the same thing in the stock market. Small and mid-cap stocks are more fun to play in than large cap stocks. They have better price movement and can make you more money.

Here’s  an example as to what I’m in right now. Casino stocks: LVS, WYNN. China is exploding. These companies are setting up operations in China to build casinos and hotels. Huge growth opportunity. This is where I’m playing right now in early 2011. Always be on the look out for things that “make sense” like this. Do *not* solely buy a company on the brand or your experience with them. It may help you in some regard, but never buy based on company loyalty. Just because you like a company, doesn’t mean it’s a good idea to buy their stock.

Google finance and Yahoo finance are both very good tools for watching stock news and up-to-date price changes. Yahoo message boards are a good source of up-to-the-minute changes. Just be aware that most people posting are idiots. It’s normally a good idea to sell when people are getting super excited on an up move. It’s normally a good idea to buy if people are predicting doom and gloom! You’d be amazed at how often this works, I’m not kidding…

  • Trading style

This is a big topic because it can mean a few different things. One of them is just exactly “how” you want to trade. Do you want to buy and hold for a long time (long-term investing)? Do you want to trade as a job (day trading)? Do you want to look for patterns in the market and trade at specific times (swing trading)? Take a guess at what I think the best is. If the story of Goldilocks told us anything, it’s probably best to go with the middle of the extremes.

Buy and holding is stupid (sorry). Yes, it’s easier, you may get some dividends from it, you may save a little on taxes, but…it’s not going to maximize your money. Day trading, on the other extreme, is expensive (will eat you alive in broker fees), generally nerve-racking, a full-time job, and you need to have a special status on your brokerage account to even do it! Most people can’t fall into this category even if they wanted to. So, what do I suggest? Trading on the highs and lows. I normally have a day to a month time window when I trade. It’s agressive (I’m impatient), it can be dangerous, but it has the potential for high reward. The downside is that it can get expensive with trading fees, is still pretty nerve-racking, but it has high reward potential, and it will make you learn a lot.

Another topic of trading style is “which side you’re on”. This may come as a surprise to you, but you don’t have to be on the “buying” side to trade. You can actually predict a downfall and make money by selling short a stock or selling puts (options term). This is a powerful tool and you shouldn’t ignore it. To make a lot of money, you really should play both sides, and you shouldn’t get attached to either. You should trade based on how the market is trending. To prepare for this, I wouldn’t suggest holding large positions for very long. This will allow you to react faster to market changes. There is nothing worse than being stuck holding something you don’t want to while the tides change. Sometimes it’s hard to cut and run when you’re down (even though you should).

Then there’s the matter of  “what” you should be in. Should you diversify or hold just a few stocks? Most people say focusing on one stock is a huge no-no, and can severely damage your capital. Yes, that’s very true. But, if you pick the “right” stock or sector it does have the highest reward potential. I don’t diversify. I pick one sector and one or two stocks I’m interested in. It’s easier to manage and lets you feel like you “know” a stock.

Finally, there’s “how” you should play. There’s two choices, purchasing shares or options. Small potential, less risk. Enormous potential, huge risk. That’s the difference. Options are time bounded, straight up shares  are not. You buy a stock, and you own it. You buy an option and you “might” get a chance to own it if it reaches a certain price by a certain day. I’ve pretty much gone exclusively into options trading. The same change in price normally equates to about five to ten times more for your dollar with options (but it works both ways; hence the risk). Options are a *huge* topic that I’m not going to go into here. Just know that you really need to know what you’re doing to play in this realm. I feel like I’m at this point now, and I have made a decent amount, but it is very risky. It probably doesn’t help that I’m very impatient though…

  • Entry and Exit points

Emotion will get the better of you if you don’t set clearly defined points where you want to enter and exit a position. Like I mentioned before, “buy low, sell high”. There are two main kinds of traders: technical analysis and event (news). I fall in the former. I love math and statistics. Stocks are like a giant math problem that you can solve. There are enormous topics on technical trading. Search the Internet, you can find it. From Bollinger Bands, to MACD, to candle stick analysis, there are ways to “know” when something is about to happen by looking at the past. Others just like to trade on “events”, news. Earnings are coming up, company A is planning on building Y. Company C is parterning with Company D. This is nice to know, but is normally reflected in the technical charts too.

The biggest piece of advice is to “get confirmation”. What do I mean by that? If you anticipate that something is about to “reverse” (about to go up from a bottom or fall from a high), you should get some confirmation (whether it be a day or a few minutes later; depending on your time threshold) that your theory is right. Yes, you will lose a chunk of potential gains, but it is much, much, much less riskier. Trust me. You will get burned if you get a signal that ends up being a fake-out. It will happen. Wait for a stronger confirmation before starting a big position.

  • Cutting Losses

Sometimes things aren’t going to work. You guessed wrong. Hopefully, it’s just the exception case. If you’re doing good, you should have a 70-90% “guessed right” ratio. Now if you’re holding shares and not options, maybe waiting is OK; you will most likely eventually get back your losses. But, if you’re tying up capital and other stocks are moving and you’re not able to buy it because you literally can’t (you have no money to do so), then in essense you’re losing money by not being able to participate. Sometimes it is more advantageous to sell at a loss and move on to something more profitable. Just don’t make this a common occurence and you’ll be OK.

  • Broker and commissions

I’ve done a lot of research on good online brokers. I’ve used two: Tradeking and thinkorswim. Tradeking has cheap rates. thinkorswim is amazing. I now only use thinkorswim. They have the best charting software out there (look it up, it’s true), and they match anyone’s options rates!! Sold. I love thinkorswim. Highly recommended brokerage firm.

For the most part $5-10 is what you’ll normally pay on average when buying shares of stock. Options are much more complicated. They can range from $5-100+ depending on what you’re doing. It goes a lot more depending on just how many option contracts you’re buying. This can quickly rack up to huge costs in fees, so if you’re playing the options game, be careful and pace yourself. thinkorswim matches anyone’s options rate though, so again, I highly recommend them. I would not recommend E-trade. They have high minimum balances and potential annual fees. No fees with ToS.

Finally, let me talk about margin accounts. A margin account is like a “loan”. Generally, if you have a margin account your broker will allow you to “borrow” 2x what you have in your account; e.g. balance is $5000; you can buy up to $10000 in stock. Granted, I would highly suggest *not* over leveraging yourself and buying that much because it’s money you DON’T OWN.

Why I would suggest getting one though is for one simple reason: the day trading rule. The SEC prohibits most traders from buying and selling a stock on the same day three times in a 72 hour period (or something like that; look it up! :)). If you DO NOT have a margin account you must wait THREE DAYS after you sell something for the funds to clear and then you can buy something else. This is debilitating. With a margin account, this restriction is lifted and whenever you sell something, as long as you have a margin account to cover it, you can buy and sell as much as you want (up to 3 times still). I know it’s confusing, and I didn’t do a good job of explaining it. Look up “day trading rule” for more information.

If you break this rule, your broker will place a 90 day trading restriction on your account. It’s happened to me. It’s easy to do. It’s not fun.

  • Tax Implications

 Aww, let’s end on a sad note. Taxes. You knew it was coming. It’s always lurking in the background. So what does buy and hold trading have over everything else? It puts you in the long-term gains tax bracket (generally 15%). You must hold shares of stock for 1 year to be in LTG; obviously, buying and selling options makes this impossible. Short term gains comes in around 25%. This means you sold stock less than one year old. Even though you take a 10% penalty, the luxury of not having to wait an entire year before selling is normally worth it. I would suggest doing this with your company stock (if you have it where you work) and dedicating an investment account solely to the pursuit of making a lot of money quickly. You can use another account to rely on steady long term gains. That’s what 401ks, IRAs, and company shares are for, in my opinion.

Last note. The wash sale rule. It is the most confusing thing I have ever read. I still don’t understand it. The IRS doesn’t even understand it. You will get different answers everywhere you go. In general though, the government allows you to write off losses on your taxes, BUT if you attempt to buy *more* shares of a stock after you have LOST money already from the same company, it’s called a wash sale, and you are unable to write off the loss on your taxes! The understanding is…”hey, you lost money on this trade, but you’re still trying to make money off it by buying more; we’re not letting you claim this as a loss now”. I think it’s stupid. Be aware of it though. I believe you can claim up to 5k in losses on your taxes. Hopefully, it won’t have to come to it though!

Well, hopefully you learend something. If you’re interested in trading, I plan on doing more indepth articles, so watch out for those. In the meantime, happy trading!

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