Trading For Dummies E-Book

Michael Griffis

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 639

Veröffentlichungsjahr: 2013

Beschreibung

Make informed trading decisions regardless of the market's condition Savvy traders can make money in both up and down markets. Trading For Dummies is for investors at all levels who are looking for a clear guide to successfully trading stocks in any type of market. It is also for investors who have experience trading and who are looking for new, proven methods to enhance the profitability of their investments. This no-nonsense guide presents a proven system for analyzing stocks, trends, and indicators and setting a buy-and-sell range beforehand to decrease risk in any type of market. It stresses the practice of position trading, conducting technical analysis on a company and its performance, and utilizing research methods that enable the trader to strategically select both an entry and exit point before a stock is even purchased. This updated guide features updated stock charts, position trading tips and techniques, and fresh ways to analyze trends and indicators. * Shows you how to take your portfolio to a higher level * Explains how to assume more risk, reap more benefits, and build a portfolio * This edition includes a new chapter on High Frequency Trading Trading For Dummies gives experienced and novice traders and investors alike the most-up-to-date information on trading wisely in any market.

Leseprobe

Trading For Dummies®, 3rd Edition

Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com

Copyright © 2014 by John Wiley & Sons, Inc., Hoboken, New Jersey

Published simultaneously in Canada

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Library of Congress Control Number: 2013948025

ISBN 978-1-118-68118-3 (pbk); ISBN 978-1-118-80500-8 (ebk); ISBN 978-1-118-80503-9 (ebk)

Manufactured in the United States of America

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Trading For Dummies®, 3rd Edition

Visit www.dummies.com/cheatsheet/trading to view this book's cheat sheet.

Table of Contents

Introduction

About This Book

Foolish Assumptions

Icons Used in This Book

Beyond the Book

Where to Go from Here

Part I: Getting Started with Trading

Chapter 1: The Ups and Downs of Trading Stocks

Distinguishing Trading from Investing

Seeing Why Traders Do What They Do

Successful Trading Characteristics

Tools of the Trade

Taking Time to Trade More Than Just Stocks

Position trading

Short-term swing trading

Day trading

Going Long or Short

Managing Your Money

Understanding Fundamental Analysis

Getting a Grip on Technical Analysis

Putting Trading Strategy into Practice

Trading at Higher Risk

Remembering to Have Fun!

Chapter 2: Exploring Markets and Stock Exchanges

Introducing the Broad Markets

Stock markets

Futures markets

Bond markets

Options markets

Reviewing Stock Exchanges

New York Stock Exchange Euronext (NYSE)

NASDAQ

Amex (now NYSE MKT LLC)

Electronic communications networks (ECNs)

Understanding Order Types

Market order

Limit order

Stop order

Stop-limit order

Good-’til-canceled orders

Other order types

Chapter 3: Going for Broke(r): Discovering Brokerage Options

Why You Need a Broker

Exploring Types of Brokers and Brokerage Services

Full-service brokers

Discount brokers

Direct-access brokers

Proprietary trading firms

Futures brokers

Services to Consider When Choosing a Broker

Types of orders supported

Data feed

Charts

ECN access

Knowing the Types of Brokerage Accounts

Cash accounts

Margin accounts

Options

IRAs and other retirement accounts

Choosing the Right Broker for You

Considering more than price

Doing a little research

Understanding how you’ll be paying

Getting to Know the Rules

Margin requirements

Settling trades

Free riding

Chapter 4: Putting Your Key Business Tool to Work: The Computer

Making Use of Your Computer

Identifying trading candidates

Managing your account

Improving your trades

Finding Price Charts

Checking out Internet charts with delayed prices

Considering Internet charts with real-time prices

Looking into charting software

Digging Up Fundamental Data

Accessing Analyst Reports

Selecting a Trading Platform

Browser-based trading environment

Integrated trading platforms

Features to consider

Determining Computer Requirements

Weighing Windows versus Mac versus Linux

Configuring your computer system

Accessing the Internet

Picking a browser

Securing your computer

Part II: Reading the Fundamentals: Fundamental Analysis

Chapter 5: Fundamentals 101: Observing Market Behavior

The Basics of the Business Cycle

Understanding how periods of economic growth and recession are determined

Using economic indicators to determine the strength of the economy

Relating bull markets and bear markets to the economy

Employing a Sector Rotation Strategy

Early recovery

Full recovery

Early recession

Full recession

Dissecting sector rotation

Understanding Economic Indicators

Interest rates

Money supply

Inflation rate

Deflation

Jobless claims

Consumer confidence

Business activity

Using Data from Economic Indicators

Chapter 6: Digging Into Fundamental Analysis

Checking Out the Income Statement

Revenues

Cost of goods sold

Gross margins

Expenses

Interest payments

Tax payments

Dividend payments

Testing profitability

Looking at Cash Flow

Operating activities

Depreciation

Financing activities

Investment activity

Scouring the Balance Sheet

Analyzing assets

Looking at debt

Reviewing goodwill

Determining Stock Valuations

Earnings

Earnings growth rate

Figuring Your Ratios: Comparing One Company’s Stock to Another

Price/earnings ratio

Price/book ratio

Return on assets

Return on equity

Chapter 7: Listening to Analyst Calls

Getting to Know Your Analysts

Buy-side analysts: You won’t see them

Sell-side analysts: Watch for conflicts

Independent analysts: Where are they?

The Importance of Analysts

Tracking how a company’s doing

Providing access to analyst calls

Listening to Analyst Calls

Understanding the analysts’ language

Developing your listening skills

Locating Company Calls

Identifying Trends in the Stock-Analyst Community

Part III: Reading the Charts: Technical Analysis

Chapter 8: Reading the Tea Leaves: Does Technical Analysis Work?

Understanding the Methodology

Finding everything in the price

Seeing that price movements are not always random

Balancing supply and demand

Understanding where you’ve been

Understanding where you’re headed

Answering the Detractors

Walking randomly

Trading signals known to all

Telling Fortunes or Planning Trades

Using StockCharts.com

Chapter 9: Reading Bar Charts Is Easy (Really)

Creating a Price Chart

Creating a single price bar

Measuring volume

Coloring charts

Identifying Simple Single-Day Patterns

Single-bar patterns

Reversal patterns

Identifying Trends and Trading Ranges

Identifying a trading range

Spotting a trend

Time frame matters

Searching for Transitions

Support and resistance: Not just for undergarments

Finding a breakout

Sipping from a cup and saucer

Deciding what to do with a double bottom

An alternative double-bottom strategy

Looking at other patterns

Chapter 10: Following Trends for Fun and Profit

Identifying Trends

Supporting and Resisting Trends

Drawing trend lines to show support

Surfing channels

Trending and channeling strategies

Seeing Gaps

Common gap

Breakout or breakaway gap

Continuation gap

Exhaustion gap

Island gap

Waving Flags and Pennants

Withstanding Retracements

Three-step and five-step retracements

Dealing with subsequent trading ranges

Dealing with Failed Signals

Trapping bulls and bears

Filling the gaps

Deciding whether to reverse directions

Chapter 11: Calculating Indicators and Oscillators

The Ins and Outs of Moving Averages

Simple moving average

Exponential moving average

Comparing SMA and EMA

Interpreting and using moving averages

Support and resistance factors

Deciding the moving average time frame

Understanding Buy and Sell Pressure through Stochastic Oscillators

Calculating stochastic oscillators

Interpreting stochastic oscillators

Tracking Momentum with MACD

Calculating MACD

Using MACD

Revealing Relative Strength

Calculating relative strength

Putting relative strength to work

Part IV: Developing Strategies for When to Buy and Sell Stocks

Chapter 12: Money Management Techniques: When to Hold ’em, When to Fold ’em

Achieving Your Trading Goals with Money Management

Managing Your Inventory

Thinking of trading as a business

Recognizing the trader’s dilemma

Finding a better plan

Protecting Your Principal

Recovering from a large loss: It ain’t easy

Setting a target price for handling losses

Determining good trading candidates

Strategies for handling profitable trades

Understanding Your Risks

Market risks

Investment risks

Trading risks

Chapter 13: Using Fundamental and Technical Analyses for Optimum Strategy

Seeing the Big Picture

Knowing when the Fed is your friend

Keeping an eye on industrial production

Watching sector rotation

Finding the dominant trend

Selecting Your Trading Stock

Trading Strategies

Trading the bullish transition

Trading in a bull market

Trading the bullish pullback

Trading the bearish transition

Trading in a bear market

Trading the bearish pullback

A hypothetical trading example

Chapter 14: Minimizing Trading Risks Using Exchange-Traded Funds

What Is an ETF?

Examining the advantages

Avoiding the flaws

Does Family Matter?

Market-weighted ETFs

Equal-weighted ETFs

Fundamentally weighted ETFs

Sector Rotation Strategies

Early recovery

Full recovery

Early recession

Full recession

Analyzing ETFs

Portfolio Construction

International trading with ETFs

Commodities and ETFs

Currency trading and ETFs

Leveraged ETFs

Inverse ETFs

Chapter 15: Executing Your Trades

Entering and Exiting Your Trade

Keeping straight the bid and ask

Understanding the spread

Devising an effective order-entry strategy

Gaining insight through Level I, Level II, and TotalView data

Entering orders after the market closes: Be careful

Reviewing a week in the life of a trader

Selling Stocks Short

Avoiding Regulatory Pitfalls

Understanding trade-settlement dates

Avoiding free riding

Avoiding margin calls and forced sales

Avoiding pattern-day-trader restrictions

The Tax Man Cometh

Chapter 16: Developing Your Own Powerful Trading System

Understanding Trading Systems

Discretionary systems

Mechanical systems

Trend-following systems

Countertrend systems

Selecting System-Development Tools

Choosing system-development hardware

Selecting system-development software

Finding historical data for system testing

Developing and Testing Trading Systems

Working with trend-following systems

Working with breakout trading systems

Accounting for slippage

Keeping a Trading Journal

Evaluating Trading Systems for Hire

Part V: Risk-Taker’s Paradise

Chapter 17: The Basics of Swing Trading

Selecting Stocks Carefully

Looking at Swing-Trading Strategies

Trading trending stocks

Trading range-bound stocks

Trading volatility

Money-management issues

Using Options for Swing Trading

Getting a Grip on Swing-Trading Risks

Taxes (of course)

Pattern-day-trading rules apply

Chapter 18: The Basics of Day Trading

What Day Trading Is All About

Institutional day traders (market makers)

Retail day traders

Understanding Account Restrictions

The Fed’s Regulation T: Margin requirements

Settlement: No free rides

Strategies for Successful Day Trading

Technical needs

Trading patterns

Scalping

Trend traders

Risks Are High

Liquidity

Slippage

Trading costs

Taxes (of course)

Avoiding the Most Common Mistakes

Chapter 19: Doing It by Derivatives

Types of Derivatives: Futures and Options

Buy now, pay later: Futures

Wait and see: Options

Buying Options and Futures Contracts

Opening an account

Calculating the price and making a buy

Options for Getting Out of Options

Offsetting the option

Holding the option

Exercising the option

The Risks of Trading Options and Futures

Minimizing Risks

Chapter 20: Going Foreign (Forex)

Exploring the World of Foreign Currency Exchange

Types of currency traders

Why currency changes in value

What traders do

Understanding Money Jargon

Spot transactions

Forward transactions

Options

Looking at How Money Markets Work

Different countries, different rules

The almighty (U.S.) dollar

Organized exchanges

Taking Necessary Risks in the World Money Market

Understanding the types of risks

Seeking risk protection

Getting Ready to Trade Money

Chapter 21: Trading for Others: Obtaining Trading Licenses and Certifications

Getting to Know the FINRA Series

Becoming a registered representative

Becoming a registered principal

The ABCs of Financial Advisors

Accredited Asset Management Specialist

Chartered Financial Analyst

Certified Financial Planner

Certified Fund Specialist

Chartered Financial Consultant

Chartered Life Underwriter

Chartered Market Technician

Chartered Mutual Fund Counselor

Personal Financial Specialist

Registered Financial Consultant

The Licenses and Certifications You Need When Trading for Others

Part VI: The Part of Tens

Chapter 22: More Than Ten Huge Trading Mistakes

Fishing for Bottoms

Timing the Top

Trading against the Dominant Trend

Winging It

Taking Trading Personally

Falling in Love

Using After-Hours Market Orders

Chasing a Runaway Trend

Averaging Down

Ignoring Your Stops

Diversifying Badly

Enduring Large Losses

Chapter 23: Ten Trading Survival Techniques

Build Your Trading Tool Chest

Choose and Use Your Favorite Tools Wisely

Use Both Technical and Fundamental Analyses

Count on the Averages to Make Your Moves

Develop and Manage Your Trading System

Know Your Costs

Have an Exit Strategy

Watch for Signals, Don’t Anticipate Them

Buy on Strength, Sell on Weakness

Keep a Trading Journal and Review It Often

About the Authors

Cheat Sheet

Connect with Dummies

Introduction

Trading used to be the purview of institutional and corporate entities that had direct access to closed securities trading systems. Technical advances leveled the playing field, making securities trading much more accessible to individuals. After the stock market crash of 2000, when many people lost large sums of money because professional advisors or mutual fund managers didn’t protect their portfolio principal, investors chose one of two options — getting out of the market altogether and seeking safety or finding out more about how to manage their own portfolios. Many who came back into the market ran from it again in late 2008 when the market saw its worst year since the Great Depression. In 2012, more people were coming back into the market as the Dow reached an all-time high, but will they be spooked again after the next correction?

The concept of buying and holding forever died after that 2000 stock crash; it saw some revival from 2004 to 2007 but then suffered another death in 2008. People today look for new ways to invest and trade. Although investors still practice careful portfolio balancing using a buy-and-hold strategy, they look much more critically at what they are holding and are more likely to change their holdings now than they were before the crash. Others have gotten out of the stock market completely.

Still others have moved on to the world of trading. Many kinds of traders ply their skills in the markets. The ones who like to take on the most risk and want to trade as a full-time business look to day trading. They never hold a position in a security overnight. Swing traders hold their positions a bit longer, sometimes for a few days or even a few weeks.

But we don’t focus on the riskier types of trading in this book; instead, we focus on position trading, which involves executing trades in and out of positions and holding positions for a few weeks or months and maybe even a year or more, depending on trends that are evident in the economy, the marketplace, and ultimately individual stocks.

About This Book

Many people have misconceptions about trading and its risks. Most people think of the riskiest type of trading — day trading — whenever they hear the word trader. We’re definitely not trying to show you how to day trade. Instead, we want to introduce you to the world of position trading, which is much safer, less risky, and yet a great way to build a significant portfolio.

Don’t get the wrong idea; trading in securities always carries risks. You should never trade with money that you can’t risk losing. That means trading with your children’s education savings isn’t a good idea. If you want to trade, set aside a portion of your savings that isn’t earmarked for any specific use and that you believe you can put at risk without ruining your lifestyle.

Obviously, we plan to show you ways to minimize risk, but we can’t promise that you won’t take a loss. Even the most experienced traders, the ones who put together the best trading systems, don’t have a crystal ball and periodically get hit by a market shock and accompanying loss. By using the basics of fundamental and technical analyses, we show you how to minimize your risk, how to recognize when the market is ripe for a trade, how to identify which specific sectors in the market are the right places to be, how to figure out which phases economic and market cycles are in, and how to make the best use of all that knowledge.

Within this book, some web addresses may break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page.

Foolish Assumptions

We’ve made a number of assumptions about your basic knowledge and stock-trading abilities. We assume that you’re not completely new to the world of investing in stocks and that you’re familiar with the stock market and its basic language. Although we review many key terms and phrases as we explore the basics of trading, if everything you read sounds totally new to you, you probably need to read a basic book on investing in stocks before trying to move on to the more technical world of trading.

We also assume that you know how to operate a computer and use the Internet. If you don’t have high-speed access to the Internet now, be sure you have it before trying to trade. Many of the resources we recommend in this book are available online, but you need high-speed access to be able to work with many of these valuable tools.

Icons Used in This Book

For Dummies books use little pictures, called icons, to flag certain chunks of text. Here’s what they actually mean:

Watch for these little flags to get ideas on how to improve your trading skills or where to find other useful resources.

If there is something that is particularly important for you to remember, we mark it with this icon.

The trading world is wrought with many dangers and perils. A minor mistake can cost you a bunch of money, so we use this icon to point out particularly perilous areas.

When you see this icon, we’re discussing higher-end, more technical material for the experienced trader.

When you see this icon, we’re describing how to re-create a chart at our online partner, StockCharts.com.

Beyond the Book

In addition to the material in the print or e-book you're reading right now, this product also comes with some access-anywhere goodies on the web. When you just want a quick reminder of trading basics, check out the free Cheat Sheet at www.dummies.com/cheatsheet/trading. There you'll find explanations on how to identify the beginning of bull and bear markets, how to trade in those types of markets, and how to develop your own trading system. We also recommend ten websites that offer trading information, analysis, and advice.

You can find additional information about trading in a couple of articles that supplement this book. Head to www.dummies.com/extras/trading for more information about

Tracking important fundamental market movers

Identifying trading chart patterns

Applying momentum to trading decisions

Trading on the foreign exchange market

Checking out ten mobile apps for traders

Where to Go from Here

You’re ready to enter the exciting world of trading. You can start anywhere in the book. Each of the chapters is self-contained. But if you’re totally new to trading, starting with Chapter 1 is the best way to understand the basics. If you already know the basics, understand everything about the various markets and exchanges that you care to know, have a broker picked out, and have all the tools you’ll need, you may want to start with fundamental analysis in Part II. Remember, though, to have fun and enjoy your trip.

Part I

Getting Started with Trading

Visit www.dummies.com for free access to great Dummies content online.

In this part . . .

Know what you’re getting into before you begin trading stocks by reviewing the ups and downs you’ll encounter.

Get familiar with the various stock markets and the different types of market orders.

Pick an appropriate trading partner by finding a broker who’s right for your trading style.

Figure out the minimum hardware and software requirements and check out recommended websites and programs.

Chapter 1

The Ups and Downs of Trading Stocks

In This Chapter

Making sense of trading

Exploring trading types

Gathering your trading tools

Discovering keys to success

Making lots of money is the obvious goal of most people who decide to enter the world of trading. How successful you become as a trader depends on how well you use the tools, gather the needed information, and interpret the data you have. You need to develop the discipline to apply all that you know about trading toward developing a winning trading strategy.

Discovering how to avoid getting caught up in the emotional aspects of trading — the highs of a win and the lows of a loss — is key to developing a profitable trading style. Trading is a business and needs to be approached with the same logic you’d apply to any other business decision. Setting goals, researching your options, planning and implementing your strategies, and assessing your success are just as important for trading as they are for any other business venture.

In this book, we help you traverse these hurdles, and at the same time, we introduce you to the world of trading. In this chapter, we give you an overview of trading and an introduction to the tools you need, the research skills you must use, and the basics of developing all this information into a successful trading strategy.

Distinguishing Trading from Investing

Trading is not the same thing as investing. Investors buy stocks and hold them for a long time — often too long, riding a stock all the way down and possibly even buying more along the way. Traders, on the other hand, hold stocks for as little as a few minutes or as long as several months, and sometimes possibly even a year or more. The specific amount of time depends on the type of trader you want to become.

Investors want to carefully balance an investment portfolio among growth stocks, value stocks, domestic stocks, and foreign stocks, along with long-, short-, and intermediate-term bonds. A well-balanced portfolio generally offers the investor a steady return of between 5 percent and 12 percent, depending on the type of investments and amount of risk he or she is willing to take.

For investors, an aggressive portfolio with a mix of 80 percent invested in stocks and 20 percent in bonds, if well balanced, can average as high as a 12 percent annual return during a 20-year period; however, in some years, the portfolio will be down, and in others, it will go through periods of high growth. The opposite, a conservative portfolio with 20 percent invested in stocks and 80 percent in bonds, is likely to provide a yield on the lower end of the spectrum, closer to 4 percent. The volatility and risk associated with the latter portfolio, however, would be considerably less. Investors who have 10 or more years before they need to use their investment money tend to put together more-aggressive portfolios, but those who need to live off the money tend to put together less-aggressive portfolios that give them regular cash flows, which is what you get from a portfolio invested mostly in bonds.

As a trader, you look for the best position for your money and then set a goal of exceeding what an investor can otherwise expect from an aggressive portfolio. During certain times within the market cycle, your best option may be to sit on the sidelines and not even be active in the market. In this book, we show you how to read the signals to decide when you need to be in the market, how to find the best sectors in which to play the market, and the best stocks within those sectors.

Seeing Why Traders Do What They Do

Improving your potential profit from stock transactions is obviously the key reason most people decide to trade. People who want to grow their portfolios rather than merely maintain them hope that the way they invest in them does better than the market averages. Regardless of whether traders invest through mutual funds or stocks, they hope the portfolio of securities they select gives them superior returns — and they’re willing to work at it.

People who decide to trade make a conscious decision to take a more active role in increasing their profit potential. Rather than just riding the market up and down, they search for opportunities to find the best times and places to be in the market based on economic conditions and market cycles.

Traders who successfully watched the technical signals before the stock crash of 2008 either shorted stocks or moved into cash positions before stocks tumbled and then carefully jumped back in as they saw opportunities for profits. Some position traders simply stayed on the sidelines, waiting for the right time to jump back in. Even though they were waiting, they also carefully researched their opportunities, selected stocks for their watch lists, and then let technical signals from the charts they kept tell them when to get in or out of a position.

Successful Trading Characteristics

To succeed at trading, you have to be hard on yourself and, more than likely, work against your natural tendencies, fighting the urge to prove yourself right and accepting the fact that you’re going to make mistakes. As a trader, you must develop separate strategies for when you want to make a trade to enter a position and for when you want to make a trade and exit that position, all the while not allowing emotional considerations to affect the decisions you make on the basis of the successful trading strategy you’ve designed.

You want to manage your money, but in doing so, you don’t have to prove whether your particular buying or selling decision was right or wrong. Setting up stop-loss points for every position you establish and adhering to them is the right course of action, even though you may later have to admit that you were wrong. Your portfolio will survive, and you can always reenter a position whenever trends indicate the time is right again.

You need to make stock trends your master, ignoring any emotional ties that you have to any stocks. Although you may, indeed, miss the lowest entry price or the highest exit price, you nevertheless will be able to sleep at night, knowing that your money is safe and your trading business is alive and well.

Traders find out how to ride a trend and when to get off the train before it jumps the tracks and heads toward monetary disaster. Enjoy the ride, but know which stop you’re getting off at so you don’t turn profits into losses.

Tools of the Trade

The first step you need to take in becoming a trader is gathering all the right tools so you can open and operate your business successfully. Your computer needs to meet the hardware requirements and other computer specifics we describe in Chapter 4, including processor speed, memory storage, and screen size. You may even want more than one screen, depending on your trading style. High-speed Internet access is a must; otherwise, you may as well never open up shop.

We also introduce you to the various types of software in Chapter 4, showing you what can help your trading business ride the wave to success. Traders’ charting favorites such as Metastock and Trade Station are evaluated along with Internet-based charting and data-feed services. We also talk about the various trading platforms that are available and how to work with brokers.

After you have all the hardware and software in place, you need to hone your analytical skills. Many traders advocate using only technical analysis, but we show you how using both technical and fundamental analyses can help you excel as a trader.

Taking Time to Trade More Than Just Stocks

The ways traders trade are varied. Some are day traders, while others are swing traders and position traders. Although many of the tools they use are the same or similar, each variety of trader works within differing time frames to reach goals that are specific to the type of trades they’re making.

Position trading

Position traders use technical analysis to find the most promising stock trends and enter and exit positions in the market based on those trends. They can hold positions for just a few days, a few months, or possibly as long as a year or more. Position trading is the type of trading that we discuss the most in this book. After introducing you to the stock markets, the types of brokers and market makers with whom you’ll be dealing, and the tools you need, we discuss the basics of fundamental analysis and technical analysis to help you become a better position trader.

Short-term swing trading

Swing traders work within much shorter time frames than position traders, rarely holding stocks for more than a few days and looking for sharp moves that technical analysis uncovers. Even though we don’t show you the specif ics of how to become a swing trader, we nevertheless discuss the basics of swing trading and its strategies in Chapter 17. You can also read about the basics of technical analysis and money-management strategies, both of which are useful topics to check out if you plan to become a swing trader. However, you definitely need to seek additional training before deciding to pursue this style of trading — reading Swing Trading For Dummies by Omar Bassal (Wiley) would be a good start.

Day trading

Day traders never leave their money in stocks overnight. They always cash out. They can trade into and out of a stock position in a matter of hours, minutes, or even seconds. Many outsiders watch day traders in action and describe it as more like playing a video game than trading stocks. We discuss this high-risk type of trading in Chapter 18, but we won’t be showing you the specifics of how to do it. If day trading is your goal, this book will only take you part of the way there. You’ll discover the basics of technical analysis, but you need to seek out additional training before engaging in this risky trading style — check out Day Trading For Dummies by Ann C. Logue (Wiley).

Weathering a changing market

Housing stocks crumbled in the housing crunch. Financials were crushed in the credit crisis.

We can’t claim any special foresight or knowledge to know when a stock is about to take a big plunge or a company is going to be taken over by the Fed. We don’t have a crystal ball. But we were able to keep most of our money safe from the ravages of the down market since 2008. By using strategies that we discuss throughout this book, we can exit positions before giving back most of our accumulated profits — while many others unfortunately do just that.

An impending pullback is not illuminated with flashing beacons. There is no instant indicator telling us that it is time to sell everything. Instead, we close individual positions as each stock’s technical conditions deteriorate. The tools we describe in this book enable us to recognize when risk levels have changed, when few stocks are attractive, and when simply leaving most of our trading capital in cash is the best course of action.

Tight credit was still a major problem in 2012, but it is easing. Yet stock prices climbed in late 2012 and early 2013. Many traders and analysts expect another correction. We will weather this market with the majority of our trading capital intact as we take profits. Then we may make a little money by shorting a few stocks or buying some short or double-short exchange-traded funds. Thanks to the tools we show you in this book, we will be ready to trade aggressively when the technical condition of stocks begins improving again.

Going Long or Short

Before you start trading, you absolutely have to know what stocks you want to buy and hold for a while, which is called going long, or holding a long stock position. You likewise have to know at what point holding that stock is no longer worthwhile. Similarly, you need to know at what price you want to enter or trade into a position and at what price you want to exit or trade out of a position. You may be surprised to find out that you can even profit by selling a stock without ever owning it, in a process called shorting. We discuss these vital trading strategies in Chapter 13.

You can even make money buying and selling options on stocks to simulate long or short stock positions. Buying an option known as a call enables you to simulate a long stock position, in much the same way that buying an option known as a put enables you to simulate a short stock position. You make money on calls when the option-related stock rises in price, and you make money on a put when the option-related stock falls in price.

When placing orders for puts and calls, you’re never guaranteed to make money, even when you’re right about the direction a stock will take. The values of options are affected by how volatile stock prices are in relationship to the overall direction (up or down) in which they are headed. We discuss options and how they work in greater detail in Chapter 19.

Managing Your Money

Managing your trades so you don’t lose a bunch of money is critical. Although we can’t guarantee that you’ll never lose money, we can provide you with useful strategies for minimizing your losses and getting out before your stock portfolio takes a huge hit. The key is knowing when to hold ’em and when to fold ’em, and we cover that in great detail in Chapter 12.

One thing that we can’t emphasize enough is that you must think of your trading as a business and the stocks that you hold as its inventory. You can’t allow yourself to fall in love with and thereby hang on to a stock out of loyalty. You’ll find it especially hard to admit you’ve made a mistake; nevertheless, you have to bite the bullet and exit the position before you take a huge hit. You’ll discover that housecleaning and developing successful strategies for keeping your inventory current are important parts of managing a trading portfolio.

Setting a target price for exiting a position before ever trading into it is the best way to protect your business from major losses. Stick with those predetermined exit prices and you’ll avoid a major pitfall that many traders face — holding a position too long and losing everything. You obviously don’t want to turn a profit into a loss, so as your position in a stock produces a profit, you can periodically raise your target exit price while continuing to hold the position to ensure that you keep most of that profit.

Understanding your risks — market risks, investment risks, and trading risks — helps you to make better trading decisions. We review the different kinds of risks as they relate to specific situations at several points throughout the book.

Understanding Fundamental Analysis

You’ve probably heard the phrase “It’s the economy, stupid.” Well that’s true, and we show you how understanding the basics of the business cycle can help you improve your trading successes. In Chapter 5, you find out how to identify periods of economic growth and recession and how these differing periods impact bull and bear stock markets. We also explore sector rotation and how to use it to pick the right sectors for your trading activities.

You can also discover plenty of information about how money supply, inflation rates, deflation, joblessness, and consumer confidence impact the mood of the market and stock prices and how the economy can be driven by how confidently (or not) political and monetary leaders speak out about it. We discuss the role of the Federal Reserve (Fed) and how when the Fed Chairman speaks, the markets listen.

Understanding how the economy works isn’t the only fundamental analysis tool that’s important to you. You also need to read financial statements to understand the financial status of the companies you want to buy. We delve into financial statements in Chapter 6.

A company’s income statements, on the other hand, give you a look at the results of the most recent period and provide a basis for comparison with prior years and periods. You can use these statements to look at whether revenues are growing, and if they are, by what percentage. You also can see how much profit the company is keeping from the revenue it generates. The cash-flow statement shows you how efficiently a company is using its cash and whether it’s having problems meeting its current obligations. The balance sheet gives you a snapshot of a company’s assets and liabilities and stockholder’s equity.

You can use this information to develop your own estimate of a company’s growth and profit potential. In Chapter 6, we show you how to do a few basic ratio calculations that you can use to compare similar stocks and then choose the one with the best potential.

Analysts use this information to project a company’s financial growth and profits. You never should depend entirely on what analysts say, but you always should do your own research and collect the opinions of numerous analysts. One of the best ways to find out what analysts are saying and what aspects of the financial statements may raise a red flag is the analyst call. In Chapter 7, we explain how you can listen in on these calls and understand the unique language used in them to make better choices when selecting stocks. We also discuss the pros and cons of using analyst reports.

Getting a Grip on Technical Analysis

You use fundamental analysis to determine what part of the business cycle the economy is in and what industries offer the best growth potential. Then you use that information to select the best target companies and identify prices at which you’d want to buy their stocks.

After choosing your targets, you then use technical analysis to follow trends in the prices of the target stocks so you can find the right time to get in and ultimately to get out of a stock position. These targets become part of your stock-watch list. After you’ve established that list, you then use the tools of technical analysis to make your trades.

In Chapter 8, we introduce you to the basics of technical analysis, how it works, and how it needs to be used. Although some people think of technical analysis as no more than fortune-telling, others believe it yields significant information that can help you make successful trades. We believe that technical analysis provides you with extensive tools for your trading success, and we show you how to use those tools to be profitable.

Your first step in technical analysis is finding out how to create a chart. We focus on the most popular type — bar charting. In Chapter 9, you discover the art of deciphering simple visual stock patterns and how to distinguish between trends and trading ranges, all so you’re able to spot when a stock moves from a trading range into either an upward or downward trend and know when you need to act.

In Chapter 10, we show you how to use your newfound skill of identifying trends to locate areas of support and resistance within a trend that ultimately help you find the right times to make your move. You find out how to read the patterns in the charts to identify trading signals and what to do whenever you’ve acted on a failed trading signal.

Chapter 11 fills you in on moving averages and how to use them to identify trends. You also find out about oscillators and other indicators that traders use for recognizing trading signals. As a newbie trader, you’ll probably find that your greatest risk is paralysis of analysis. That’s where you may find that you’re having so much fun reading the charts or are just so confused about which chart has the right signal that you feel paralyzed by the variety of choices. We show you how to create and use a tiny subset of tools that is available in today’s charting software packages to simplify your life and make your choices easier. You’ll likewise discover how to use such odd-sounding but critical tools as an MACD indicator or a stochastic oscillator, and we help you take advantage of the powerful concept of relative strength.

Putting Trading Strategy into Practice

After you get used to using the tools, you’re ready to put your new skills into practice making money. In Chapter 13, we show you how to put your newfound affinities for fundamental analysis and technical analysis together to develop and build your trading strategy. Using fundamental analysis, you can

Determine which part of the economic cycle is driving the market.

Determine which sector makes the most sense for stock trading.

Figure out which sectors are in the best positions to go up.

Find out which stocks are leading in the ascending sectors.

Evaluate where the Fed stands on the economy and which potential moves by the Fed can impact the strength of the market.

Evaluate and hopefully anticipate potential shocks to the market. Although doing so may seem like gazing into a crystal ball, you really can pick up some signs by checking out the key economic indicators. We show you what they are.

After you complete your fundamental analysis, we show you how to use your new technical analysis skills successfully. Using them, you find out how you can

Trade within the overall technical conditions.

Confirm which economic cycle a market is in by using index charts.

Determine whether an ascending sector is stuck in a range or ready to enter a new upward trend.

Determine whether leading stocks are stuck in ranges or ready to break out in upward trends.

Finally, we show you how to use your newfound skills to manage risk, set up a stop-loss position, and choose your time frame for trading.

In Chapter 14, we introduce you to techniques for using exchange-traded funds (ETFs) to ride the trends instead of taking the risk of finding just the right company in each sector. Sector ETFs have become a major trading tool for position traders who want to take advantage of sector rotation, which we talk about in Chapter 5.

After honing your skills, you’re ready to start trading. So in Chapter 15, we focus on the actual mechanics of trading by

Discussing how to enter or trade into a position.

Explaining bid and ask prices.

Discussing the risks of market orders.

Explaining how to use limit and stop orders.

We also explore how to exit or trade out of a position and still stay unattached emotionally, when to take your profits, and how to minimize your losses, in addition to discussing potential tax hits and how to minimize them.

Now that you know how to research the fundamentals, effectively use the technical tools, and mechanically carry out a trade, the next step is developing and managing your own trading system. We explore the basic steps to developing the system, which include

1. Designing and keeping a trading log.

2. Identifying reliable trading patterns.

3. Developing an exit strategy.

4. Determining whether you’ll use discretionary trading methods or mechanical trading. We explore the pros and cons of each.

5. Deciding whether to develop your own trading system or buy one off the shelf.

6. Testing your trading systems and understanding their limitations before making a major financial commitment to your new system.

We also discuss assessing your results and fixing any problems.

After you’ve designed, built, and tested your system, you’re ready to jump in with both feet. The key to getting started: Make sure you begin with a small sum of money, examining your system and then increasing your trading activity as you gain experience and develop confidence with the system that you develop.

Trading at Higher Risk

Some traders decide they want to take on a greater level of risk by practicing methods of swing trading or day trading or by delving into the areas of trading derivatives or foreign currency. Although all these alternatives are valid trading options, we steer clear of explaining even the basics of how to use these high-risk trading alternatives. Instead, in Chapters 17 through 20 we provide you with a general understanding of the ways these trading alternatives work and the risks that are unique to each of them.

If you decide, however, that you want to take on these additional risks, don’t depend on the information in this book to get started. Use the general information that we offer you here to determine what additional training you need to feel confident before moving into these trading arenas.

Remembering to Have Fun!

Although you are without question considering the work of a trader for the money you can make, you need to enjoy the game of trading. If you find that you’re having trouble sleeping at night because of the risks you’re taking, then trading may not be worth all the heartache. You may need to put off your decision to enter the world of trading until you’re more comfortable with the risks or until you’ve designed a system that better accommodates your risk tolerance.

You may find that you need to take a slower approach by putting less money into your trades. You don’t need to make huge profits with your early trades. Just trading into and out of a position without losing any money may be a good goal when you’re just starting out. If you notice your position turning toward the losing side, knowing that you can trade your way out of it before you take a big loss may help you build greater confidence in your abilities.

Remember, making a losing trade doesn’t mean that you’re a loser. Even the most experienced traders must at times face losses. The key to successful trading is knowing when to get out before your portfolio takes a serious hit. On the other side of that coin, you also need to know how to get out when you’re in a winning or profitable position. When you’re trying to ride a trend all the way to the top, it sometimes starts bottoming out so fast that you lose some or possibly even all of your profits, causing you to end up in a losing position.

Trading is a skill that takes a long time to develop and is perfected only after you make mistakes and celebrate successes. Enjoy the roller coaster ride!

Chapter 2

Exploring Markets and Stock Exchanges

In This Chapter

Discovering the markets

Understanding the exchanges

Reviewing order basics

Billions of shares of stock trade in the United States every day, and each trader is looking to get his or her small piece of that action. Before moving into the specifics of how to trade, we first want to introduce you not only to the world of stock trading but also to trading in other key markets — futures, options, and bonds. In this chapter, we also explain differences and similarities among key stock exchanges and how those factors impact your trading options. After providing you with a good overview of the key markets, we delve into the different types of orders you can place with each of the key exchanges.

Introducing the Broad Markets

You may think the foundation of the United States economy resides inside Fort Knox where the country holds its billions of dollars in gold, or possibly that it resides in our political center, Washington, D.C. But nope. The country’s true economic center is Wall Street, where billions of dollars change hands each and every day, thousands of companies are traded, and millions of people’s lives are affected.

Stocks are not the only things sold in the broad financial markets. Every day, currencies, futures, options, and bonds also are traded. Although we focus on stock exchanges in this chapter, we first need to briefly explain each type of market.

Stock markets

The stocks of almost every major U.S. corporation and many major foreign corporations are traded on a stock exchange in the United States each day. Today numerous domestic and international stock exchanges trade stocks in publicly held corporations; moreover, the only major corporations not traded are those held privately — usually by families or original founding partners that choose not to sell shares on the public market. Forbes magazine’s top privately held corporations are Cargill, Koch Industries, Mars, Price Waterhouse Coopers, and Bechtel. Many of the large private corporations that are not traded publicly do have provisions for employee ownership of stock and must report earnings to the SEC, so they straddle the line between public and private corporations.

A share of stock is actually a portion of ownership in a given company. Few stockholders own large enough stakes in a company to play a major decision-making role. Instead, stockholders purchase stocks hoping that their investments rise in price so that those stocks can be sold at a profit to someone else interested in owning a share of the company sometime in the future. Investors may hold the stock to earn dividends, as well. Traders rarely hold the stock long enough for dividends to be a primary decision factor in whether to buy a stock. Therefore, after the company’s initial sale of stock when it goes public, none of the money involved in stock trades goes directly into that company.

For the majority of this chapter, we focus on the two top stock exchanges in the United States: the New York Stock Exchange Euronext (NYSE) and NASDAQ (the National Association of Securities Dealers Automated Quotation system). We also introduce you to the evolving world of electronic communication networks (ECNs) on which you can trade stocks directly, thus bypassing brokers.

Futures markets

Futures trading actually started in Japan in the 18th century to trade rice and silk. This trading instrument was first used in the United States in the 1850s for trading grains and other agricultural entities. Basically, futures trading means establishing a price for the commodity at the time of writing the financial contract. The commodity must be delivered at a specific time in the future. If you had a working crystal ball, it would be very useful here. This type of trading is done on a commodities exchange. The largest such exchange in the United States today is the Chicago Mercantile Exchange. Commodities include any product that can be bought and sold. Oil, cotton, and minerals are just a few of the products sold on a commodities exchange.

Futures contracts must have a seller (usually the person producing the commodity — a farmer or oil refinery, for example) and a buyer (usually a company that actually uses the commodity). You also can speculate on either side of the contract, basically meaning:

When you buy a futures contract, you’re agreeing to buy a commodity that is not yet ready for sale or hasn’t yet been produced at a set price at a specific time in the future.

When you sell a futures contact, you’re agreeing to provide a commodity that is not yet ready for sale or hasn’t yet been produced at a set price at a specific time in the future.

The futures contract states the price at which you agree to pay for or sell a certain amount of this future product when it’s delivered at a specific future date. Although most futures contracts are based on a physical commodity, the highest-volume futures contracts are based on the future value of stock indexes and other financially related futures.

Unless you’re a commercial consumer who plans to use the commodity, you won’t actually take delivery of or provide the commodity for which you’re trading a futures contract. You’ll more than likely sell the futures contract you bought before you actually have to accept the commodity from a commercial customer. Futures contracts are used as financial instruments by producers, consumers, and speculators. We cover more about those players and futures contracts in much greater depth in Chapter 19.

Bond markets

Bonds are actually loan instruments. Companies sell bonds to borrow cash. If you buy a bond, you’re essentially holding a company’s debt or the debt of a governmental entity. The company or government entity that sells the bond agrees to pay you a certain amount of interest for a specific period of time in exchange for the use of your money. The big difference between stocks and bonds is that bonds are debt obligations and stocks are equity. Stockholders actually own a share of the corporation. Bondholders lend money to the company with no right of ownership. Bonds, however, are considered safer because if a company files bankruptcy, bondholders are paid before stockholders. Bonds are a safety net and not actually a part of the trading world for individual position traders, day traders, and swing traders. Although a greater dollar volume of bonds is traded each day, the primary traders for this venue are large institutional traders. We don’t discuss them any further in this book.

Options markets

An option is a contract that gives the buyer the right, but not the obligation, either to buy or to sell the underlying asset upon which the option is based at a specified price on or before a specified date. Sometime before the option period expires, a purchaser of an option must decide whether to exercise the option and buy (or sell) the asset (most commonly stocks) at the target price. Options also are a type of derivative. We talk more about this investment alternative in Chapter 19.

Reviewing Stock Exchanges

Most of this book covers stock trading, so we obviously concentrate on how the key exchanges — NYSE and NASDAQ — operate and how these operations impact your trading activity.

New York Stock Exchange Euronext (NYSE)

The U.S. stock market actually dates back to May 17, 1792, when 24 brokers signed an agreement under a buttonwood tree at what today is 58 Wall Street. The 24 brokers specifically agreed to sell shares of companies among themselves, charging a commission or fee to buy and sell shares for others who wanted to invest in a company. Yup, the first American stockbrokers were born that day.

A formalized exchange didn’t come into existence until March 8, 1817, when the brokers adopted a formal constitution and named their new entity the New York Stock & Exchange Board. Brokers actually operated outdoors until 1860, when the operations finally were moved inside. The first stock ticker was introduced in 1867, but it wasn’t until 1869 that the NYSE started requiring the registration of securities for companies that wanted to have their stock traded on the exchange. Registration began as a means of preventing the over-issuance (selling too many shares) of a company’s stock.

From these meager beginnings, the NYSE built itself into the largest stock exchange in the world, with many of the largest companies listed on the exchange. Trading occurs on the floor of the exchange, with specialists and floor traders running the show. Today these specialists and floor traders work electronically, which first became possible when the exchange introduced electronic capabilities for trading in 2004. For traders, the new electronic-trading capabilities are a more popular tool than working with specialists and floor traders. Electronic-trading capabilities were enhanced when the NYSE merged with Archipelago Holdings in 2006. The exchange expanded its global trading capabilities after a merger with Euronext in 2007, which made trading in European stocks much easier. European exchanges operated by NYSE Euronext include the Amsterdam Stock Exchange, Brussels Stock Exchange, Lisbon Stock Exchange, London International Financial Futures and Options Exchange (LIFFE), and the Paris Stock Exchange.

You may not realize just how much the concept of supply and demand influences the trading price of a stock. Price swings of a stock are caused by shifts in the supply of shares available for sale and the demand created by the number of buyers wanting to purchase available shares.

The designated market makers

Designated market makers buffer dramatic swings by providing liquidity when needed, such as when news about a company breaks. If news that has a major impact on a stock’s price breaks, designated market makers buy shares or sell the ones they hold in a company to make the trend toward a higher or lower stock price more orderly. For example, if good news breaks, creating more demand for the stock and overwhelming existing supply, the designated market maker becomes a seller of the stock to minimize the impact of a major price increase by increasing supply. The same is true when bad news strikes, creating a situation in which having more sellers than buyers drives the stock price down. In that situation, the designated market maker becomes a buyer of the stock, easing the impact of the drop in price. Designated market makers operate both manually and electronically to facilitate stock trading during market openings, closings, and periods of substantial trading imbalances or instability.

The floor trader

The guys you see on the floor of the stock exchange, waving their hands wildly to make trades, are the floor traders. They’re actually members of the NYSE who trade exclusively for their own accounts. Floor traders also can act as floor brokers for others and sell their services. But over 82 percent of trades take place electronically, so floor trading today is used primarily to trade a small group of extremely high-priced stocks not traded electronically.

Open outcry

The NYSE still uses what is becoming an outdated method of trading called open outcry, in which stocks are sold like a public auction with verbal bids and offers shouted at the trading post. These trading posts are centered on the specialist’s location for particular stocks. Other exchanges exclusively use computer-based network systems for trading.

The NYSE is the last big stock exchange to use open outcry, but even there it is taking a backseat to automated execution. Only a tiny fraction of trades are handled through open outcry. Except for a small group of very high-priced stocks, almost everything can be handled immediately by electronic execution.

NYSE Hybrid Market

The New York Stock Exchange uses the Hybrid Market program to integrate the best aspects of the open outcry or auction market with electronic trading. Most NYSE trades are now handled electronically, but brokers can still choose to route customer orders to the floor for open-outcry trading.

NASDAQ

NASDAQ, which stands for the National Association of Securities Dealers Automated Quotations, is the fastest-growing stock market today. The market was formed after an SEC study in the early 1960s concluded that the sale of over-the-counter (OTC) securities — in other words, securities that aren’t traded on the existing stock exchanges — was fragmented and obscure. The report called for the automation of the OTC market and gave the responsibility for implementing that system to the National Association of Securities Dealers (NASD).

The NASD began construction of the NASDAQ system in 1968, and its first trades were made beginning February 8, 1971, when NASDAQ became the world’s first electronic stock market. In 2007, NASDAQ combined forces with the Scandinavian exchange group OMX. Together, NASDAQ OMX operates 24 securities markets. It also provides trading technology to 70 exchanges in 50 countries.

Market makers

NASDAQ market makers compete with each other to buy and sell the stocks they choose to represent. More than 500 member firms act as market makers for NASDAQ. All market makers are members of the NASD. Each uses its own capital, research, and system resources to represent a stock and compete with other market makers.