Trading Stocks: An Introduction
What is Stock Trading?
Trading stocks, or speculation as it used to be called, is the buying or selling of stocks in order to profit from price movements. Compare this to investing where stocks are held for their dividend income. Nowadays the distinction has become blurred, with many investors holding assets for both income and capital growth, especially in times of high inflation.
When we refer to trading on this website we mean the buying and selling of financial assets (as opposed to real estate or collectibles). Financial assets or securities are traded through recognized financial markets, whether formal, such as most stock and commodity exchanges, or informal as in the case of the currency market.
Buying Long or Selling Short
Traders will buy long in expectation of a price rise or sell short in expectation of a price fall. Selling short requires the trader to borrow stock from a broker (so that he can execute a sale and stock delivery) with the object of purchasing the stock at a lower price in the future. Short sales should only be attempted by experienced traders who fully understand the related risks.
Protecting your capital (or money management)
The biggest risk that any trader faces is that they will lose their capital. Often new traders will start out with a string of successful trades and their confidence grows: they never learn to apply sound money management and limit their downside risk. Sooner or later they encounter a string of losing trades that either wipes them out or wipes out a big enough portion of their capital that they quit trading.
Uncertainty
No trading system can deliver 100% accuracy. Prices can go up or down at any time: it is only the probability that varies. The best we can hope for is a probability of about 80% (that price will move in a specified direction). That means that at least one in five times you will be wrong and price will move against you. There is no such animal as a "sure thing". In fact, whenever you hear or use those words, you are at more risk of losing your capital than at any other time.
If you can't be 100% accurate, how can you make money?
In the same way that a casino makes money. If the odds are stacked in your favor (compare 80% to the house advantage of less than 55% on a roulette wheel) you will be able to gain more than you lose -- provided that you do not risk all your capital on a single trade.
| The market is a dynamic system. I often compare trading to a military operation, not because of its' oppositional nature, but because of the complexity, the continual uncertainty created by conflicting intelligence reports and the element of chance that can disrupt even the best made plans. Prepare thoroughly, but allow for the unexpected. The formula is simple: trade when probabilities are in your favor; apply proper risk (money) management; and you will succeed. |
A Simple Trading Formula
- Use stop losses to limit your losses on individual trades.
- Only risk a small portion of your capital on each trade: stick to the 2 percent rule.
- Manage your emotions.
- Avoid the pitfalls that await newcomers:
- Remember, there is no substitute for experience. Becoming an expert trader takes time.
