There are many ways to invest in the stock market. For example, you can simply buy a mutual fund that fits your needs. Or you can narrow your investments by choosing a sector of the market such as banking, home improvement or energy. You would do this by investing in an Electronically Traded Fund or ETF. Another way is to pick and choose stocks that you feel will appreciate in price.
Doing Your Research
Whatever method you choose, you must do your research. You’ve oft heard the cliché: Buy Low and Sell High. Believe it or not this is the key to your success. First, determine the overall direction of the market. Is it a bull or bear market or is it just going sideways. You can do this by looking at a chart of the Dow Jones or S & P 500 averages. Look at Gross Domestic Product (GDP) numbers. Is GDP rising quarter after quarter? Examine company profits. Here again, are they going up quarter after quarter? Study what the US Federal Reserve is doing in regard to interest rates. Are they going up or down or flat? Interest rates generally rise in a growing economy and fall in a declining period.
Bull and bear markets are the easiest to trade. Most of the money is made in the beginning and end of a bull market. This is when few want to buy but the sellers have run out of firepower to drive the market lower. At the top end, euphoria takes hold and drives prices beyond their normal valuations. A key example was during the Dot.com boom. Prices were driven to extreme heights when some companies had little revenue and no business model to support prices. When the crash hit, it drove these stocks back down to normal valuations. In many cases the companies simply went bust. This was an example of a classic bear market. To profit, you had to have been a short seller. A short seller borrows stock from a brokerage house, sells it and buys it back later at a lower price. Or another way would have been to buy a “Reverse ETF.” This ETF goes up when stocks go down.
The most difficult market to trade is a sideways one. Here you have peaks and troughs that move up and down within a trading band. We often call this support and resistance. Traders often follow the 50 day and the 200 day moving averages to determine the highs and lows of these ranges.
Stop Loss Orders
The key to success in trading stocks is to preserve capital while making a profit. To do this we use “stop loss” orders. This is an order to sell your stock when it falls below the market to a specified price. Traders often fall into the trap of believing that their stock will move up and when it goes against them they hold on. There is another adage that says: “Your first loss is your best loss.” A stop loss order will help you from letting a small loss grow into a bigger one.
Risk only a small portion of your capital at one time, perhaps only 4%. Traders often make the mistake of risking 20% of their capital. Taking a 20% loss on five trades wipes you out. With only two losses you are always trying to do “catch up” and are psychologically punishing yourself. If you follow some of these basic ideas, you will have a greater chance of success.