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Trading For Dummies®

To view this book's Cheat Sheet, simply go to www.dummies.com and search for “Trading For Dummies Cheat Sheet” in the Search box.

Introduction

Trading used to be the purview of institutional and corporate entities that had direct access to closed securities trading systems. Technical advances leveled the playing field, making securities trading much more accessible to individuals. After the stock market crash of 2000, when many people lost large sums of money because professional advisors or mutual fund managers didn’t protect their portfolio principal, investors chose one of two options — getting out of the market altogether and seeking safety or finding out more about how to manage their own portfolios. Many who came back into the market ran from it again in late 2008, when the market saw its worst year since the Great Depression. In 2017, the stock market roared to a high of the Dow Jones Index topping 21,000, but will they be spooked again after the next correction?

The concept of buying and holding forever died after that 2000 stock crash; it saw some revival from 2004 to 2007 but then suffered another death in 2008. People today look for new ways to invest and trade. Although investors still practice careful portfolio balancing using a buy‐and‐hold strategy, they look much more critically at what they’re holding and are more likely to change their holdings now than they were before the crash. Others have gotten out of the stock market completely.

Still others have moved on to the world of trading. Many kinds of traders ply their skills in the markets. The ones who like to take on the most risk and want to trade as a full‐time business look to day trading. They never hold a position in a security overnight. Swing traders hold their positions a bit longer, sometimes for a few days or even a few weeks.

But we don’t focus on the riskier types of trading in this book; instead, we focus on position trading, which involves executing trades in and out of positions and holding positions for a few weeks or months and maybe even a year or more, depending on trends that are evident in the economy, the marketplace, and ultimately individual stocks.

About This Book

Many people have misconceptions about trading and its risks. Most people think of the riskiest type of trading — day trading — whenever they hear the word trader. We’re definitely not trying to show you how to day trade. Instead, we want to introduce you to the world of position trading, which is much safer, less risky, and yet a great way to build a significant portfolio.

Don’t get the wrong idea; trading in securities always carries risks. You should never trade with money that you can’t risk losing. That means trading with your children’s education savings isn’t a good idea. If you want to trade, set aside a portion of your savings that isn’t earmarked for any specific use and that you believe you can put at risk without ruining your lifestyle.

Obviously, we plan to show you ways to minimize risk, but we can’t promise that you won’t take a loss. Even the most experienced traders, the ones who put together the best trading systems, don’t have a crystal ball and periodically get hit by a market shock and accompanying loss. By using the basics of fundamental and technical analyses, we show you how to minimize your risk, how to recognize when the market is ripe for a trade, how to identify which specific sectors in the market are the right places to be, how to figure out which phases economic and market cycles are in, and how to make the best use of all that knowledge.

As you dip into and out of this book, feel free to skip the sidebars (shaded boxes). They contain interesting information but aren’t essential to understanding important points of trading.

Within this book, some web addresses may break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e‐book, you’ve got it easy — just click the web address to be taken directly to the web page.

Foolish Assumptions

We’ve made a number of assumptions about your basic knowledge and stock‐trading abilities. We assume that you’re not completely new to the world of investing in stocks and that you’re familiar with the stock market and its basic language. Although we review many key terms and phrases as we explore the basics of trading, if everything you read sounds totally new to you, you probably need to read a basic book on investing in stocks before trying to move on to the more technical world of trading.

We also assume that you know how to operate a computer and use the Internet. If you don’t have high‐speed access to the Internet now, be sure you have it before trying to trade. Many of the resources we recommend in this book are available online, but you need high‐speed access to be able to work with many of these valuable tools.

Icons Used in This Book

For Dummies books use little pictures, called icons, to flag certain chunks of text. Here’s what they actually mean:

tip Watch for these little flags to get ideas on how to improve your trading skills or where to find other useful resources.

remember If there’s something that’s particularly important for you to remember, we mark it with this icon.

warning The trading world is wrought with many dangers and perils. A minor mistake can cost you a bunch of money, so we use this icon to point out particularly perilous areas.

Beyond the Book

In addition to the material in the print book or e‐book you’re reading right now, this product also comes with some access‐anywhere goodies on the web. When you just want a quick reminder of trading basics, check out the free Cheat Sheet at www.dummies.com; just search for “Trading For Dummies Cheat Sheet.” There you’ll find explanations on how to identify the beginning of bull and bear markets, how to trade in those types of markets, and how to develop your own trading system. We also recommend websites that offer trading information, analysis, and advice.

Before you can read charts, you need to create them. To help you get started creating and reading financial charts, we have partnered with StockCharts.com, one of the web’s premier charting platforms. We’ve even arranged a 20 percent discount especially for Trading For Dummies readers toward a subscription on the website. Sign up today and get a free one‐month trial of the site’s advanced charting tools, resources, and more. The coupon code is SCC‐DUMMIES‐17. Access the trial as a Trading For Dummies reader at http://stockcharts.com/sales/index.html. If you’re already a StockCharts member, use the discount code to renew your existing subscription.

Where to Go from Here

You’re ready to enter the exciting world of trading. You can start anywhere in this book; each of the chapters is self‐contained. But if you’re totally new to trading, starting with Chapter 1 is the best way to understand the basics. If you already know the basics, understand everything about the various markets and exchanges that you care to know, have a broker picked out, and have all the tools you’ll need, you may want to start with fundamental analysis in Part 2. Remember, though, to have fun and enjoy your trip!

Part 1

Getting Started with Trading

IN THIS PART . . .

Know what you’re getting into before you begin trading stocks by reviewing the ups and downs you’ll encounter.

Get familiar with the various stock markets and the different types of market orders.

Pick an appropriate trading partner by finding a broker who’s right for your trading style.

Figure out the minimum hardware and software requirements and check out recommended websites and programs.

Chapter 1

The Ups and Downs of Trading Stocks

IN THIS CHAPTER

check Making sense of trading

check Exploring trading types

check Gathering your trading tools

check Discovering keys to success

Making lots of money is the obvious goal of most people who decide to enter the world of trading. How successful you become as a trader depends on how well you use the tools, gather the needed information, and interpret the data you have. You need to develop the discipline to apply all that you know about trading toward developing a winning trading strategy.

Discovering how to avoid getting caught up in the emotional aspects of trading — the highs of a win and the lows of a loss — is key to developing a profitable trading style. Trading is a business and needs to be approached with the same logic you’d apply to any other business decision. Setting goals, researching your options, planning and implementing your strategies, and assessing your success are just as important for trading as they are for any other business venture.

In this book, we help you traverse these hurdles, and at the same time, we introduce you to the world of trading. In this chapter, we give you an overview of trading and an introduction to the tools you need, the research skills you must use, and the basics of developing all this information into a successful trading strategy.

Distinguishing Trading from Investing

Trading is not the same thing as investing. Investors buy stocks and hold them for a long time — often too long, riding a stock all the way down and possibly even buying more along the way. Traders, on the other hand, hold stocks for as little as a few minutes or as long as several months, and sometimes possibly even a year or more. The specific amount of time depends on the type of trader you want to become.

Investors want to carefully balance an investment portfolio among growth stocks, value stocks, domestic stocks, and foreign stocks, along with long‐, short‐, and intermediate‐term bonds. A well‐balanced portfolio generally offers the investor a steady return of between 5 percent and 12 percent, depending on the type of investments and amount of risk he or she is willing to take.

For investors, an aggressive portfolio with a mix of 80 percent invested in stocks and 20 percent in bonds, if well balanced, can average as high as a 12 percent annual return during a 20‐year period; however, in some years, the portfolio will be down, and in others, it will go through periods of high growth. The opposite, a conservative portfolio with 20 percent invested in stocks and 80 percent in bonds, is likely to provide a yield on the lower end of the spectrum, closer to 4 percent. The volatility and risk associated with the latter portfolio, however, would be considerably less. Investors who have 10 or more years before they need to use their investment money tend to put together more‐aggressive portfolios, but those who need to live off the money tend to put together less‐aggressive portfolios that give them regular cash flows, which is what you get from a portfolio invested mostly in bonds.

remember As a trader, you look for the best position for your money and then set a goal of exceeding what an investor can otherwise expect from an aggressive portfolio. During certain times within the market cycle, your best option may be to sit on the sidelines and not even be active in the market. In this book, we show you how to read the signals to decide when you need to be in the market, how to find the best sectors in which to play the market, and the best stocks within those sectors.

Seeing Why Traders Do What They Do

Improving your potential profit from stock transactions is obviously the key reason most people decide to trade. People who want to grow their portfolios rather than merely maintain them hope that the way they invest in them does better than the market averages. Regardless of whether traders invest through mutual funds or stocks, they hope the portfolio of securities they select gives them superior returns — and they’re willing to work at it.

People who decide to trade make a conscious decision to take a more active role in increasing their profit potential. Rather than just riding the market up and down, they search for opportunities to find the best times and places to be in the market based on economic conditions and market cycles.

Traders who successfully watched the technical signals before the stock crash of 2008 either shorted stocks or moved into cash positions before stocks tumbled and then carefully jumped back in as they saw opportunities for profits. Some position traders simply stayed on the sidelines, waiting for the right time to jump back in. Even though they were waiting, they also carefully researched their opportunities, selected stocks for their watch lists, and then let technical signals from the charts they kept tell them when to get in or out of a position.

Successful Trading Characteristics

To succeed at trading, you have to be hard on yourself and, more than likely, work against your natural tendencies, fighting the urge to prove yourself right and accepting the fact that you’re going to make mistakes. As a trader, you must develop separate strategies for when you want to make a trade to enter a position and for when you want to make a trade and exit that position, all the while not allowing emotional considerations to affect the decisions you make on the basis of the successful trading strategy you’ve designed.

tip You want to manage your money, but in doing so, you don’t have to prove whether your particular buying or selling decision was right or wrong. Setting up stop‐loss points for every position you establish and adhering to them is the right course of action, even though you may later have to admit that you were wrong. Your portfolio will survive, and you can always reenter a position whenever trends indicate the time is right again.

You need to make stock trends your master, ignoring any emotional ties that you have to any stocks. Although you may, indeed, miss the lowest entry price or the highest exit price, you nevertheless will be able to sleep at night, knowing that your money is safe and your trading business is alive and well.

remember Traders find out how to ride a trend and when to get off the train before it jumps the tracks and heads toward monetary disaster. Enjoy the ride, but know which stop you’re getting off at so you don’t turn profits into losses.

Tools of the Trade

The first step you need to take in becoming a trader is gathering all the right tools so you can open and operate your business successfully. Your computer needs to meet the hardware requirements and other computer specifics we describe in Chapter 4, including processor speed, memory storage, and screen size. You may even want more than one screen, depending on your trading style. High‐speed Internet access is a must; otherwise, you may as well never open up shop.

We also introduce you to the various types of software in Chapter 4, showing you what can help your trading business ride the wave to success. Traders’ charting favorites such as MetaStock and TradeStation are evaluated, along with Internet‐based charting and data‐feed services. We also talk about the various trading platforms that are available and how to work with brokers.

After you have all the hardware and software in place, you need to hone your analytical skills. Many traders advocate using only technical analysis, but we show you how using both technical and fundamental analyses can help you excel as a trader. (Part 2 covers fundamental analysis, and Part 3 discusses technical analysis.)

Taking Time to Trade More Than Just Stocks

The ways traders trade are varied. Some are day traders, while others are swing traders and position traders. Although many of the tools they use are the same or similar, each variety of trader works within differing time frames to reach goals that are specific to the type of trades they’re making.

Position trading

Position traders use technical analysis to find the most promising stock trends and enter and exit positions in the market based on those trends. They can hold positions for just a few days, a few months, or possibly as long as a year or more. Position trading is the type of trading that we discuss the most in this book. After introducing you to the stock markets, the types of brokers and market makers with whom you’ll be dealing, and the tools you need, we discuss the basics of fundamental analysis and technical analysis to help you become a better position trader.

Short‐term swing trading

Swing traders work within much shorter time frames than position traders, rarely holding stocks for more than a few days and looking for sharp moves that technical analysis uncovers. Even though we don’t show you the specifics of how to become a swing trader, we nevertheless discuss the basics of swing trading and its strategies in Chapter 17. You can also read about the basics of technical analysis and money‐management strategies, both of which are useful topics to check out if you plan to become a swing trader. However, you definitely need to seek additional training before deciding to pursue this style of trading — reading Swing Trading For Dummies by Omar Bassal, CFA (Wiley), would be a good start.

Day trading

Day traders never leave their money in stocks overnight. They always cash out. They can trade into and out of a stock position in a matter of hours, minutes, or even seconds. Many outsiders watch day traders in action and describe it as more like playing a video game than trading stocks. We discuss this high‐risk type of trading in Chapter 18, but we don’t show you the specifics of how to do it. If day trading is your goal, this book will only take you part of the way there. You discover the basics of technical analysis, but you need to seek out additional training before engaging in this risky trading style — check out Day Trading For Dummies by Ann C. Logue, MBA (Wiley).

Going Long or Short

Before you start trading, you absolutely have to know what stocks you want to buy and hold for a while, which is called going long, or holding a long stock position. You likewise have to know at what point holding that stock is no longer worthwhile. Similarly, you need to know at what price you want to enter or trade into a position and at what price you want to exit or trade out of a position. You may be surprised to find out that you can even profit by selling a stock without ever owning it, in a process called shorting. We discuss these vital trading strategies in Chapter 15.

You can even make money buying and selling options on stocks to simulate long or short stock positions. Buying an option known as a call enables you to simulate a long stock position, in much the same way that buying an option known as a put enables you to simulate a short stock position. You make money on calls when the option‐related stock rises in price, and you make money on puts when the option‐related stock falls in price.

When placing orders for puts and calls, you’re never guaranteed to make money, even when you’re right about the direction a stock will take. The values of options are affected by how volatile stock prices are in relationship to the overall direction (up or down) in which they’re headed. We discuss options and how they work in greater detail in Chapter 19.

Managing Your Money

Managing your trades so you don’t lose a bunch of money is critical. Although we can’t guarantee that you’ll never lose money, we can provide you with useful strategies for minimizing your losses and getting out before your stock portfolio takes a huge hit. The key is knowing when to hold ’em and when to fold ’em, and we cover that in great detail in Chapter 12.

warning One thing that we can’t emphasize enough is that you must think of your trading as a business and the stocks that you hold as its inventory. You can’t allow yourself to fall in love with and thereby hang on to a stock out of loyalty. You’ll find it especially hard to admit you’ve made a mistake; nevertheless, you have to bite the bullet and exit the position before you take a huge hit. You’ll discover that housecleaning and developing successful strategies for keeping your inventory current are important parts of managing a trading portfolio.

Setting a target price for exiting a position before ever trading into it is the best way to protect your business from major losses. Stick with those predetermined exit prices and you’ll avoid a major pitfall that many traders face — holding a position too long and losing everything. You obviously don’t want to turn a profit into a loss, so as your position in a stock produces a profit, you can periodically raise your target exit price while continuing to hold the position to ensure that you keep most of that profit.

Understanding your risks — market risks, investment risks, and trading risks — helps you make better trading decisions. We review the different kinds of risks as they relate to specific situations at several points throughout the book.

Understanding Fundamental Analysis

You’ve probably heard the phrase “It’s the economy, stupid.” Well that’s true, and we show you how understanding the basics of the business cycle can help you improve your trading successes. In Chapter 5, you find out how to identify periods of economic growth and recession and how these differing periods impact bull and bear stock markets. We also explore sector rotation and how to use it to pick the right sectors for your trading activities.

You can also discover plenty of information about how money supply, inflation rates, deflation, joblessness, and consumer confidence impact the mood of the market and stock prices and how the economy can be driven by how confidently (or not) political and monetary leaders speak out about it. We discuss the role of the Federal Reserve (Fed) and how when the Fed Chairman speaks, the markets listen.

Essentially fundamental analysis looks at company financial performance, as well as the performance of the economy, to analyze the future profit potential of a stock or other equity purchase. Understanding how the economy works isn’t the only fundamental analysis tool that’s important to you. You also need to read financial statements to understand the financial status of the companies you want to buy. We delve into financial statements in Chapter 6.

A company’s income statements, on the other hand, give you a look at the results of the most recent period and provide a basis for comparison with prior years and periods. You can use these statements to look at whether revenues are growing, and if they are, by what percentage. You also can see how much profit the company is keeping from the revenue it generates. The cash‐flow statement shows you how efficiently a company is using its cash and whether it’s having problems meeting its current obligations. The balance sheet gives you a snapshot of a company’s assets and liabilities and stockholder’s equity.

You can use this information to develop your own estimate of a company’s growth and profit potential. In Chapter 6, we show you how to do a few basic ratio calculations that you can use to compare similar stocks and then choose the one with the best potential.

tip Analysts use this information to project a company’s financial growth and profits. You never should depend entirely on what analysts say, but you always should do your own research and collect the opinions of numerous analysts. One of the best ways to find out what analysts are saying and what aspects of the financial statements may raise a red flag is the analyst call. In Chapter 7, we explain how you can listen in on these calls and understand the unique language used in them to make better choices when selecting stocks. We also discuss the pros and cons of using analyst reports.

Getting a Grip on Technical Analysis

You use fundamental analysis to determine what part of the business cycle the economy is in and what industries offer the best growth potential. Then you use that information to select the best target companies and identify prices at which you’d want to buy their stocks.

After choosing your targets, you then use technical analysis to follow trends in the prices of the target stocks so you can find the right time to get in and ultimately to get out of a stock position. These targets become part of your stock‐watch list. After you’ve established that list, you then use the tools of technical analysis to make your trades.

In Chapter 8, we introduce you to the basics of technical analysis, how it works, and how it needs to be used. Although some people think of technical analysis as no more than fortune‐telling, others believe it yields significant information that can help you make successful trades. We believe that technical analysis provides you with extensive tools for your trading success, and we show you how to use those tools to be profitable.

Your first step in technical analysis is finding out how to create a chart. We focus on the most popular type — bar charting. In Chapter 9, you discover the art of deciphering simple visual stock patterns and how to distinguish between trends and trading ranges, all so you’re able to spot when a stock moves from a trading range into either an upward or downward trend and know when you need to act.

In Chapter 10, we show you how to use your newfound skill of identifying trends to locate areas of support and resistance within a trend that ultimately help you find the right times to make your move. You find out how to read the patterns in the charts to identify trading signals and what to do whenever you’ve acted on a failed trading signal.

Chapter 11 fills you in on moving averages and how to use them to identify trends. You also find out about oscillators and other indicators that traders use for recognizing trading signals. As a newbie trader, you’ll probably find that your greatest risk is paralysis of analysis. That’s where you may find that you’re having so much fun reading the charts or are just so confused about which chart has the right signal that you feel paralyzed by the variety of choices. We show you how to create and use a tiny subset of tools that is available in today’s charting software packages to simplify your life and make your choices easier. You’ll likewise discover how to use such odd‐sounding but critical tools as an MACD indicator or a stochastic oscillator, and we help you take advantage of the powerful concept of relative strength.

Putting Trading Strategy into Practice

After you get used to using the tools, you’re ready to put your new skills into practice making money. In Chapter 13, we show you how to put your newfound affinities for fundamental analysis and technical analysis together to develop and build your trading strategy. Using fundamental analysis, you can

After you complete your fundamental analysis, we show you how to use your new technical analysis skills successfully. Using them, you find out how you can

Finally, we show you how to use your newfound skills to manage risk, set up a stop‐loss position, and choose your time frame for trading.

In Chapter 14, we introduce you to techniques for using exchange‐traded funds (ETFs) to ride the trends instead of taking the risk of finding just the right company in each sector. Sector ETFs have become a major trading tool for position traders who want to take advantage of sector rotation, which we talk about in Chapter 5.

After honing your skills, you’re ready to start trading. So in Chapter 15, we focus on the actual mechanics of trading by

We also explore how to exit or trade out of a position and still stay unattached emotionally, when to take your profits, and how to minimize your losses, in addition to discussing potential tax hits and how to minimize them.

Now that you know how to research the fundamentals, effectively use the technical tools, and mechanically carry out a trade, the next step is developing and managing your own trading system, which we discuss in Chapter 16. We explore the basic steps to developing the system, which include

  1. Designing and keeping a trading log.
  2. Identifying reliable trading patterns.
  3. Developing an exit strategy.
  4. Determining whether you’ll use discretionary trading methods or mechanical trading. We explore the pros and cons of each.
  5. Deciding whether to develop your own trading system or buy one off the shelf.
  6. Testing your trading systems and understanding their limitations before making a major financial commitment to your new system.

We also discuss assessing your results and fixing any problems.

remember 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 these alternatives are valid trading options, we steer clear of explaining even the basics of how to use these high‐risk trading alternatives. Instead, in Part 5 (Chapters 17 through 20) 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.

Remembering to 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 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 Markets and Stock Exchanges

IN THIS CHAPTER

check Explaining the different types of markets

check Surveying the major stock exchanges

check 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.