In the article last weekend, I discussed some considerations traders may want to ponder when deciding upon a vehicle to trade. We looked at the idea of using ETFs to trade whole markets or sectors as opposed to trading single stocks and noted the probable differences in relative volatilities among those choices as well as certain comparative risk issues. In this article, I am going to focus on some ideas related to choosing individual stocks to trade.
Undoubtedly there are a myriad of ways to select a stock to trade. We may have heard someone touting a particular stock at a cocktail party, or we may have received a cold call from a broker, or gotten a recommendation from our own broker. We may subscribe to a service or we might have some scan or scans of our own.
While we might establish some ranking of the various ways to select a stock, each has at least some merit. Although my general experience with cocktail party or barbershop tips is that they are rarely to be followed, there are times when they might put us onto something good. The problem with many of those is that it is already late in the move; perhaps too late to jump on board. One of the major problems I have with broker suggestions is that they are often completely unrelated to what I would consider to be a good entry, i.e. one that has a palatable reward to risk ratio. The other problem I have with many brokers and their advice is that they may call and say to buy, but it is a much rarer case when they call to suggest it is time to exit.
I edit three alert subscription services, Trend Trader, Option Trader, and $10 Trader. My publisher adds the Success Trading Group, a Covered Call service, and a Dividend Trader service. In the case of my own services, I am usually actually making the play I discuss in the alert shortly after I send the alert to subscribers and I send additional alerts when I place a stop loss order, exit the trade, or, in the case of Option Trader, when I adjust the trade. The idea with these services is definitely not to recommend a trade, but rather to draw the subscribers' attention to a particular vehicle and show how I may utilize specific strategies. The simple fact that I am making a specific trade, alone, is not a sufficient reason for someone else to make the same trade. Their goals, risk tolerance, available cash, etc. are likely to be different from my own situation so they need to make their own analysis in light of their own personal circumstances and plan.
The key for traders, in using any of these methods of selection, including their own scans, is to recognize that it is just a beginning. A trader must then make an analysis and decisions on his own about whether the candidate fits their plan. As I discuss in detail in "Trade Your Way to Wealth", once a candidate is identified the trader, among other things, must determine for himself or herself whether there is a sufficient reward to risk ratio, what their exit strategy will be if an entry is made, where a first target may lie, what capital to invest, how risk will be managed, and what strategy to employ. In "Smart Investors Money Machine", for example, I discuss a variety of strategies that might be considered, all of which are specifically designed to create a regular cash flow (sometimes weekly, sometimes monthly, or maybe quarterly). Other strategies discussed in "Trade Your Way to Wealth" may be used to attempt to capture gains in up, down, or sideways moves. The point is that merely selecting a candidate, whether through a tip, an advisory service, or one's own selection methodology is only a first step in identifying a trade. The successful trader makes several other very important decisions before ever pulling the trigger.
When I'm asked how I find a specific stock to trade I often reply that is one of the least of my worries. My first concern always is where will my initial exit be in the event I am mistaken on direction. Once the initial exit and exit strategy are determined, I want to see where the first level of potential reward appears to be. Those factors are more critical for me than what stock I use. I should hasten to add that though I am aware of fundamentals when trading, technicals form the discipline for my trades and I try to let them control my actions.
Of course, the trader can choose to trade individual stocks as many do. Movement in them may well be farther and faster than in whole market or sectors and that can be a good or a bad thing depending upon the position taken.
Issues of risk control and monitoring are critically important no matter what the investor chooses to trade. In a DVD entitled "Trading for Keeps" that I was invited to do in Chicago, I cover a number of issues related to those subjects including some important principles of disciplined trading, trend line and stop loss use, and protecting positions and portfolios. You can purchase a copy by following the link in this paragraph.
by Bill Kraft, Editor
Copyright 2009, Makin' Hay, Inc.
All Rights Reserved
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