6/3/2011 6:29 PM ET|
10 rules for rookie traders
If you're impulsive or high-strung, day trading is not for you. But if you can think fast and stay cool, it may be worth a try. Here's what you must know to start.
If you are going to day trade, it's essential to have a set of rules to manage any possible scenario. Even more important, you must have the discipline to follow the rules.
Sometimes, in the heat of battle, traders will throw out their rules and play it by ear -- usually with disastrous results.
Although there are many rules, the following are the 10 most important:
1. Know your 3 E's: enter, exit, escape
This is the first rule for a reason. Before you press the "enter" key to execute a trade, you must know at what price to get in, when to get out and what to do if the trade doesn't work out as expected.
Escaping a trade -- also known as using a stop price -- is essential if you want to minimize losses. Knowing when to get in or out will help you to lock in profits, as well as save you from potential disasters.
2. Refrain from trading until 15 minutes after the market opens
Those first 15 minutes of market action are often a time of panic trades or market orders placed the night before. Novice day traders should avoid making moves during this time, while looking for reversals. If you're looking to make quick profits, it's best to wait until you're able to spot rewarding opportunities. Even many pros avoid the market open.
3. Use limit orders, not market orders
A market order simply tells your broker to buy or sell at the best available price. Unfortunately, best price doesn't necessarily mean the trade will be profitable.
The drawback to market orders was revealed during the May 2010 "flash crash." When market orders were triggered on that day, many sell orders were filled at 10, 15 or 20 points lower than anticipated.
A limit order, however, lets you control the maximum price you'll pay or the minimum price at which you'll sell. You set the parameters.
4. Avoid using margin
When you use margin, you are borrowing money from your brokerage to finance all or part of a trade. Full-time day traders (i.e. pattern day traders) are usually allowed 4:1 intraday margin. That means a trader with a $30,000 trading account will be given enough buying power to purchase $120,000 worth of securities. Overnight, however, the margin requirement is still 2:1.
When used properly, margin can leverage, or increase, potential returns. The problem is that if a trade goes against you, margin will increase losses.
One of the reasons that day trading got a bad name a decade ago was because of margin. Some people cashed in their 401k's or borrowed bundles of money to finance their trades. When a major bull market ended in 2000, many of those traders' accounts were devastated. The bottom line for novice traders: Learn how to day trade stocks without using margin.
5. Have a selling plan
Many rookies spend most of their time thinking about stocks they want to buy without considering when to sell. Before you enter the market, you need to know in advance when to exit, hopefully with a profit.
"Playing it by ear" is not a selling strategy, nor is hope. As a day trader, you'll set a price target as well as a time target.
6. Keep a journal
Many pros swear by a journal, the place where they keep records of all of their winning and losing trades. Writing down what you did right, and what you did wrong, will help you improve as a trader, which is your primary goal.
Not surprisingly, you are likely to learn more from your losers than from your winners.
7. Hone your skills with a practice account
Although not everyone sees the value of practice trading, it can be beneficial to some traders. If you do open a practice account, be sure to trade with a realistic amount of money. It's not helpful to practice trading with $1 million if the most you have in your account is $30,000.
And if you do practice, approach your trading as an educational exercise, not a game.
8. Never act on tips from uninformed sources
Most pros know that buying stocks based on tips from uninformed acquaintances will almost always lead to bad trades. Knowing what stocks to buy is not enough. You also have to know when to sell, and by then the tipster is long gone.
Legendary trader Jesse Livermore said it best when he wrote, "I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment."
If you can't trust your own judgment, you may want to avoid day trading.
9. Cut your losses, take your profits
It's more art than science, but managing losing trades is the key to surviving as a day trader.
Also, you want to let your winners run, but you can't afford to let them run for too long.
10. Be willing to lose before you can win
Although many traders can handle winners, it's common for rookies to panic at the first hint of loss and make a series of impulsive trades that cost them money.
If you're day trading, you must be willing to accept some losses. The key -- know in advance what you'll do when confronted with losses.
Anyone can learn to day trade, but few have the discipline to make consistent profits. The main problem for most people is that they get tripped up by their emotions, which is why it's so important to create a set of flexible rules.
Your goal: Follow the rules designed to help keep you on the right side of any trade.
This article was reported by Michael Sincere for MarketWatch.
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Remember, when you are day trading, you're competing against the biggest financial houses in the industry. They have backrooms of day traders who have access to sophisticated financial data and mathematical models you likely don't have. Plus you don't know what kind of insider information they might have.
It's true that on-line brokerage accounts have levelled the playing field somewhat, but before that became mainstream, the cards were very much stacked against you. Heaven help the poor sap (me!) who had to use tele-quote via a touch-tone phone to get latest stock prices!
If you're still feeling lucky competing against the likes of Morgan Stanley and JP Morgan Chase, give it a go, but don't give up your day job.
If you're reading this article, you have no business day-trading. Period. This means you.
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