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Friday, June 26, 2009

Stock Market Trading - How To Trade Stocks? 5 Rules For Short-Term Trading

Want to be a full-time trader? Here are some principles to bear in mind before you take the plunge.

We are witnessing tremendous public interest in equity as investment and a tool for wealth creation. However, trading as a full-time profession is relatively rare. As interest in and knowledge about markets spreads, we will see the growth of a community that will want to trade for a living, as has happened in the West. What is the key to success as a trader? In trading, as in any other field, knowledge is essential to success. An important component of that knowledge is mental preparation. As an amateur investor climbs the learning curve, losses are inevitable, but even more than the initial accumulated capital loss, what the rookie trader’s undoing is the blow to his psyche. It prevents him from building up his confidence and in most cases, results in his quitting. At this point, he will tend to justify his defeatist behaviour by blaming the market itself. And once the damage is done, very rarely can an amateur find his feet again.

People living on trading typically tend to be short-term traders. Short-term trading is essentially trading on price swings in a short time horizon, lasting anywhere between 2-10 days, sometimes a bit more.

It must be recognised at the outset that short-term trading is an altogether different game from general investment practices, and one that has to be played by an entirely different set of rules. Each of these principles is equally important and following one to the exclusion of another will not result in success. Money Management.

The first rule for making money through short-term trading is to avoid losing money.
One must calculate beforehand the amount of money one is willing to commit and lose in each trade. This helps to take some of the psychol-ogical pressure off, and keeps one from operating out of greed or fear. Losing too much means having to earn much more just to break even. Also, once the stop-loss level is reached, the trader must be willing to exit. Following this one rule itself will result in lesser depletion of capital over the long term. To sit back when the trade goes against one, in the hope that things will come back in one’s favour, is the road to ruin. This can be avoided by a mechanical system of stop loss.

What is the trading time-horizon?
This is the most important aspect of success in this game though it may seem like a basic question to answer. It is extremely difficult for any trader to answer this correctly because it requires a thorough and correct psycho-logical evaluation of oneself. Investment with longer term time horizons imparts a comfort level, which is absent in short-term trading. In longer- term trading one can sit back and wait for the stock to come back above one’s purchase price, should it have nosedived below it. Short-term trading gives traders no such margins for errors, and a small series of losses can result in substantial loss of capital. It will make sense for a trader to carry out a few short-term trades and see whether he is comfortable if the trade goes against him and how he reacts in that situation - most notably, whether he comforts himself by conveniently stretching his time-horizon.

Trading plan or a system.
Success depends on developing a plan - and following it ruthlessly. For this, the trader will need to have full confidence in the reasonable efficacy of his chosen method. He will have to repeatedly carry out back-tests on stock charts. He will also have to carry out the tests in all possible market conditions - rising, falling and range-bound, and he will have to continue doing so until he has the confidence that he can put his money on the line based on this system. Sometimes he will suffer a series of losses. He must be prepared to ride it out, confident that his system will ultimately show result. If he changes his mind frequently or in the middle of trades, he is setting himself up for certain defeat. The more mechanical he gets in his trading, the more his chances of success. It would be a good idea for the short-term trader to specialise in trading particular types of patterns. For example, suppose he is trading the market when it is essentially in a long-term uptrend. In this case, even though he is trading short-term, it is generally a good idea to trade in the direction of the larger trend. In doing this, he greatly increases his chances of success. For example, Cadila Healthcare has recently broken out of a symmetrical triangle, on the upside. It would have been most prudent to wait for Cadila to form the entire pattern and set itself up for an upside breakout, in the direction of the major trend, before pulling the trigger. One would have lost some of the initial move, but it would have been worth it.
Source: MoneyLife

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