Many find the slow and steady approach of investing to be too boring for them.
A return of 10% a year, while considered good by most accounts, doesn’t exactly ooze excitement…
This often leads people to research “day trading”.
When most people look the term up though, what they are really interested in is the broader topic of “trading”.
Day Trading is a specific type of trading that focuses on buying and selling a position within the span of a single day. There are many other styles of trading that can potentially generate huge gainers without becoming investments.
Picking a Broker
In order to be able to trade, you need to have a broker to execute those transactions!
There are a list of factors to consider when it comes to a good broker…..we will go through each of them:
Execution Speed- It is important for a broker to execute on a trade as quickly as possible. The stock market is dynamic, with prices moving constantly, so every minute changes the price at which a trader can get for the opening/closing of a position. The best way to test this is to spend some time using the broker and seeing how long it take from the time the orders are placed, to when they are filled. Long execution times can be especially detrimental in high volatility conditions.
Slippage- Brokers like to scrape some profits off the top and bottom of orders, and unfortunately that money is coming out of your pocket! Like with execution speed, you will have to test out the broker to get a good read on how close the broker executes the orders to the desired ones.
Commissions- Most brokers have gone commission free, so this doesn’t apply in most situations, however it something to watch out for. It’s important to mention that if a broker charges commissions, then it’s possible that the executions themselves could have smaller slippage.
Minimum Deposit- Some brokers have a requirement for a minimum account deposit needed to open an account with them. Depending on how much disposal income one has to trade with, this may be a relevant factor.
Platform Features- The different trading platforms used by brokers offer different levels of customizability and features.
Ease of Use- This factor tends to tie in heavily with the last one. Having a highly customizable platform usually means that it is more difficult to use and has a steeper learning curve. For newcomers usability tends to be a more important factor then having lots of features, but this differs from individual to individual.
Generally, it’s preferable to have more than one brokerage account, as it is very common for a given broker to have an issue at one point or another…
If this happens, it could mean potentially missing out on great trading opportunities!
Cash vs. Margin Account
When you go to open an account with a broker, you will be asked whether you want to open a cash account or margin account.
Cash accounts allow you to trade with only the capital that you deposit.
Margin accounts on the other hand allow for the trading of both your deposited money as well as money that the broker loans to you on top of that.
While the capital that can be leveraged through margin accounts can seem alluring to the unexperienced, it is a double edged sword…
You see, the money that the broker lends out is not free money…..folks who don’t know what they are doing often blowup their bank accounts very quickly if they are not careful!
Margin accounts with under $25,000 also have to adhere to the PDT rule, which adds another layer of complexity.
Cash accounts do have problem of their own however…
All trades have a settlement period that one has to deal with. This is currently T+2 for most equities, meaning that it takes 2 business days for the cash to be useable again once an existing position is closed.
While this may seem like an inconvenience for an experienced trader, it may be a useful hurdle for someone just starting out!
It will teach a novice the valuable skill of capital management in a way that will not be detrimental to their account.
The Foundation
When first starting out, most traders are so eager to start learning and executing on strategies that they get completely lost in the weeds. We need to first understand the essence of the forest before it makes sense to examine the trees…
There are two main building blocks that apply to all aspects of trading:
- Technical Analysis
- Fundamental Analysis
While both of these are almost always present, their level of importance will vary depending on the length of the position one takes.
If we like to day trade (hold positions less then a day) for example, the majority of our focus will be on the technical components.
On the other hand, if we are into long term position trading (holding positions for months) we would be putting more of our focus on fundamentals.
Why is that?
In order to answer that question, we have to delve into what each is and what purpose it serves for us as traders.
Technical analysis is all about using the price action history of the stock to try to predict future movement. In addition, since it is completely numerical and objective in nature, it allows us to create certain metrics or cutoff points that will help us manage the potential downside (more on that in a bit).
It is important to keep in mind that technical analysis is all about the charts, which means that it does not take into account what is going on at the company or broader market.
This is where fundamental analysis comes into play…
The charts (at least in theory) are meant to be a reflection of what is going on in the company, which is obviously connected to the sector and market in which it operates.
As a company grows its business, and improves metrics such as revenue and profits, investors will likely take notice.
Eventually this will boost the stock price to a level that is perceived to accurately reflect the value of the business.
This assumption tends to hold up better the longer the position length…..however under short timespans, these types of fundamentals have very little relevance.
Over the span of days and even weeks, we enter the domain of speculation. Buyer’s and seller’s move the price trying to profit off the short term fluctuations. There is no fundamental reason for this a lot of the time, so we turn our attention to technical analysis.
That’s not to say that there is no place for fundamentals over a short time horizon…
There are certain events around a company that cause more attention and speculation to be created around it. If the event turns out to be substantial then it can cause further intrigue.
An example of this is company earnings. The days and weeks leading up to this type of event will tend to cause more interest in the stock and therefore more volatility. The ultimate result of the earnings report, will have an impact on the stock price as well.
A fundamental event that can impact the price action of a stock is known as a catalyst.
Applying the Basics
Theory is helpful, however it does us no good if we don’t know how to use it to actually execute on trades!
It can get quite jarring trying to figure out what affect different technical or fundamental factors can have on a position. If we break it down though, a factor can only have have one of two effects on a stock:
- It can be good for the stock
- It can be bad for the stock
If the factor is good then we consider this an elevating factor, if it is bad we consider it a deprecating factor.
Our goal is to stack as many elevating factors as possible, while simultaneously reducing the amount of deprecating ones.
It is important to keep in mind that this is not an exact science.
While elevating factors increase the likelihood of stock going up, and deprecating factors increase the likelihood of stocks going down…..there are no guarantees.
Choosing a Trading Approach
If you haven’t realized it by now, elevating and deprecating factors are highly context dependent.
This means that we first have to figuring out what kind of trading we are interested in before we can know what technical and fundamental factors to pay attention to.
While trading “styles” are often segmented in all kinds of ways, the most relevant way to separate them is based on the length of the position as follows:
- Scalping- seconds to minutes
- Day Trading- less then a day
- Swing Trading- a few days to a few weeks
- Position Trading- a few weeks to a few months
While there are all kinds of trading methodologies within in each type, there are a few important characteristics to consider when deciding what type of trader you want to be.
Time commitment is probably the most important one…
Generally speaking, the shorter the position length the greater the time commitment. This means that folks who have busy schedules with a 9-5 are likely better off swing trading or position trading, as it is not as labor intensive.
Another aspect to consider is personality type…
Shorter term positions are much more dynamic and require a faster decision making process.
Whether that’s a good or bad thing will depend on the individual…..Some find it more stressful while other’s see it as more exciting, so it’s important to know yourself and what you’re looking for.
You don’t have to commit to only one style per say, but again – the elevating and deprecating factors that are relevant will vary depending on the position length, so it’s best to stick with one approach when first starting out.
Learn the In’s and Out’s
Now that you’ve narrowed the type of trading you’re interested in, it is now your job to start experimenting with different technical and fundamental toolsets, and see what work’s best for you.
Typically in this early phase, we recommend either paper trading or using a very small amount of capital.
At this point its all about learning…
You will likely experience tons of missteps and setup backs…..but don’t get discouraged!
In the words of Thomas Edison: “I have not failed. I’ve just found 10,000 ways that won’t work”.
Ideally, you should view your trading journey the same way that Edison viewed building the lightbulb!
Let’s look at both the technical and fundamental side of things, to flesh out how to approach this learning process.
From a technical analysis standpoint, a lot of the same elements can be applied to different trading styles.
The major difference is that the relevance of technical analysis will be diminished the longer the length of the positions get.
Experiment with different technical indicators, and construct some elevating and deprecating rules of your own. You can mix and match elements from other people’s trading styles and see if it works for you.
How we use fundamental analysis on the other hand will vary more depending on our style.
For shorter term positions it makes more sense to put an emphasis on catalysts, as they have the ability to generate hype and spikeability in the market.
As the time horizon extends, the focus will shift more towards the fundamental factor’s abilities to affect the company itself. Taken to the extreme, we exit the realm of trading and enter into investing, where it’s all about the fundamentals.
In addition, macro economic factors will start to play a more prominent role as well. Elements such as interest rate hikes, can affect the overall trading direction of entire sectors for months at a time.
When you are in this experimental phase, its important to get a good sample size for the different pieces that you are testing out…
Just because you don’t get a good result testing something out once or twice, doesn’t mean it is a bad methodology.
Manage Risk
While most people are interested in fancy indicators, they tend to overlook one of the most important aspects in trading…
Being able to manage your risk properly is one of the best indicators of success in the long run.
Why is this?
This is because trading is a probabilities game. It doesn’t matter how good your “strategy” is, there will always be losing trades on the horizon.
For this reason people should treat their trading accounts as if they are a casino.
Casino’s set up an environment so that they always have a small edge over their clients. This means that while they know they will frequently be on the losing end of bets, over time the house will always come out on top.
There is a problem though…
What if someone came to the casino and wanted to place a bet of $100 million on a single gamble? If the casino lost that bet, they could go out of business real fast.
This is why casinos always have table limits, or maximum amounts that can be placed for a single bet…..This isn’t to protect the clients, it’s there to protect the casino!
In the same way, our goal is to create a similar theoretical edge using technical and fundamental elements we discussed earlier.
We need to have a concrete risk management strategy in place though, in order to protect from that one crazy position that can blow up an entire trading account!
Finding Stocks
Now that we have accumulated all this knowledge, we actually need a place to experiment with and hone our skills.
That place lies in the stocks themselves…
Given the sheer number of stocks out there though, the question becomes how do we find good ones?
There are two common approaches:
- The Technical Approach
- The Fundamental Approach
The technical approach involves setting specific criteria that a stock has to meet in order for it to be relevant to us.
The “criteria” will vary depending on what technical indicators you use and how broad or specific you want to be with your search query.
Most brokers have tools called scanners that allow for traders to input specific technical parameters that they want the stock to meet, in order to appear in the search result.
The fundamental approach on the other hand is a bit different…
It involves looking for fundamental catalysts that can impact price action, and using that as a starting point to find stocks that could see movement in the future.
The types of catalysts will vary based on the companies and sectors we are looking at, but there are some universal ones as well.
For example we can look at upcoming earnings reports from different companies. Then we dig into the nitty gritty details such as analyst projections, in order to get a sense of the potential hype that can be generated. We can add some of these stocks and monitor them for price movement using our technical factors.
Keep in mind, getting an accurate read on fundamentals and how it can impact a stock will take some getting use to…
The better you understand a specific company and sector it is in, the better read you will likely have on the impact that some of these fundamental factors can have on the price of the stock.
Get Out There on the Battlefield
While everything we’ve talked about may make a lot of sense to you conceptually, reality is a far messier affair.
The stock market is like a battlefield…..you might perform well in bootcamp but there’s nothing quite like being out there on the frontlines.
Things can move in utterly chaotic ways!
However, there is a method to be found behind this madness if you are dedicated enough in your pursuit and clear minded in your intent.
Just make sure to be careful with your capital!
After all, you want to make it back home in one piece…