Approach the stock market with the right objective
You have to know your objectives when approaching the stock market. Are you going to create wealth or income? Do you have the time to consistently monitor your shares?
If you want to create wealth then you are an investor. You should be buying a stock and ride the entire trend upwards. In this case, you should not be bothered on daily fluctuation. Besides, you do not have the time to monitor your stocks very closely.
If you want to create income then you can consider being an active trader. Your main objective is to profit from the sudden surge in share prices yet hold cash when market is doing sideway consolidations.
You have to decide this yourself. Different personality might suit different types of trading strategies.
How to choose the right stocks to trade?
First, identify the overall market trend. If the overall market trend is up, you should go long. If the overall trend is down, you should have no stocks in your portfolio. Otherwise, if you are an active trader, you should be positioning yourself for short positions.
Second, identify the sector that is moving with the market trend. Finally, zoom down to shares that belong to this strong sector. Stocks that create new highs have higher chances to continue to create higher highs. These are the shares that you should be focusing. WHY? Let’s illustrate the point by using a simple physics theory.
If you exert a force on a ball horizontally, the chances for it to move up, down, straight or no motion is 25% each. In short there is only 25% chance for the ball to move up.
exert a force upwards, you already had 50% chance that it will move up. The next 25% chance is just in case it stays horizontal.
Similarly, if a stock had been “exerted a force” upwards and is facing consolidation after the surge, you have higher chance that it will continue to make higher highs.
In summary, how to trade right depends on how you calculate the probability of winning. You only enter trades that give you higher chance of winning.
For more information on which stocks belongs to which sector, visit www.sharesinvestors.com for more details.
Money Management
Set aside a sum of money that is not “scared” money. Meaning to say this sum of money is spare cash that are not used to pay off monthly bills or cash that are for rainy days. Make sure that this amount set aside is disposable. In the world of investment, there is no 100% guarantee returns. There are times you might be hit with big losses. Thus, it is important to make sure that you are comfortable with the amount set aside.
Never risk more than 5% of your capital on each open trade. In fact, most of the fund managers only risked 1%. Alternatively, you can risk an absolute amount that you are comfortable with but remember that the absolute amount should not be more than 5%. Finally, allocate a portion for each stock that you enter. Do not hold too many positions at one time as you might find it hard to manage. Let’s look at an example so it will be clearer.
Let’s say you have prepared a sum of $10,000 to invest in the stock market and you limit yourself to open only a maximum number of 5 positions.
In calculation, every stock entered must not have a contract value that is over $2,000 ($10,000/5)
(Contract value refers to the share price multiply by the quantity that you purchased at that price)
Following the rule of maximum risk per trade capped at 5% of your capital.
Max. Risk Amount = $10,000 x 0.05 = $500
Assuming you did all your analysis and concluded that Stock C is a good buy. How do you calculate the quantity to purchase while abiding to the laid out rules? For instance, you want to buy Stock C at $1.20 and exit this position if the stock falls below $1.
Max. Quantity = $500/($1.20 - $1) = 2,500 shares.
Contract value = 2.500 x $1.20 = $3,000
In this case, you have exceeded the amount that you are supposed to allocate. How do you solve this problem?
Alternative Quantity = $2,000 / $1.20 = 1,666 shares.
So instead of risking 5% of your capital, you end up risking only 3.33% due to your allocation of shares budget.
Impact of news on stock market
Be it positive or negative news released into the market, you should always look at the reaction of all investors towards the news. Good news may not have positive impact on stock market if majority of the investors think is not good enough and vice versa. The main idea is to exploit the emotions of the majority to grasp the overall market trend.
In a nutshell, a piece of news is just information. Most importantly, the priority of being an investor/ a trader is to assess the overall market environment to decide if is logical to hold on to existing positions or to take early profit and/or to minimize losses.
Transition period of the markets
If you learn to view stock market as a human being, you will understand when to be in the market and when to stay out of the market. Stock market operates in a trend – range – trend way. After resting for a while, it will trend and after trending for a while, it has to pause to take a breather before running higher.
Let’s illustrate this analogy on a simple example.
You are running a 10km marathon. Initial start off; you will start to jog slowly to build up your momentum. When you get the hang of it, you start to pick up speed. After running half way through, you will feel exhausted and jog slowly to gain momentum again. Finally at your last 500metres, you will sprint to the finishing line and that’s when you go full speed. So, when you reach the finishing line, you will collapse on the ground grasping for air.
Similarly for stock market, the initial buying momentum is the period that attracts most professional traders or investors to lookout for a potential run up. Next, when market has gained enough momentum to trend, most professional are already in the market. Follow on, market pause again, that’s when market is doing consolidation, traders will get out locking on profits. Finally, on the final run, most investors and traders will go in again and sell off when the trend turns.
There is one key thing to take note. Never enter positions during the last stage of a trending market. This is the period when professional traders are selling their positions to you to lock on profits. Because too many sellers are hanging around, there is a high chance sellers will push down the price fast. Definitely you do not wish to be stuck with a losing trade.
Stock market takes a few days or even a few weeks to change from an upward trend to a downward trend and vice versa. During the period of transition, market will be very choppy with one day up the next day down. This always happen after the last stage of a trending market. Traders and investors should learn to avoid trading this period. You should be sitting on full cash. Come back to the market when it starts to build momentum again.
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