Chapter 1: The Ups and Downs of Trading Stocks
6. Testing your trading systems and understanding their limitations before making a major financial commitment to your new system
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Chapter 1: The Ups and Downs of Trading Stocks
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 of these alternatives are valid trading options, we steer clear of explaining even the basics of how to use these high-risk trading alternatives, and instead, 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.
Remember: 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 for you 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 the Markets and the 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, 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, and none of the money involved in these trades goes directly into the companies being traded. Today numerous local 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 chose not to sell shares on the public market. Forbes magazine’s top privately held corporations are Cargill, Koch Industries, Chrysler, GMAC, Price Waterhouse Coopers, and Mars. 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 of public versus 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 invest- ments rise in price, so that those stocks can be sold at a profit some time in the future.
For the majority of this chapter, we focus on the three top stock exchanges in the United States: the New York Stock Exchange (NYSE), NASDAQ (the National Association of Securities Dealers Automated Quotation system), and the American Stock Exchange (Amex). 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 financial contract in which you try to predict the future value of a commodity that must be delivered at a specific time in the future.
Yup, 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.
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