Trading for Beginners

Trading is a process of buying and selling assets. You buy the asset if the price is a relative value, and sell it when it has appreciated. If the price of the asset has appreciated too much, you may sell it short (sell it at the high price). When prices decline to a lower price, you buy it back.

That is trading in a nutshell. Now you have to crack the nut open and get to the meat. How do you trade? While there are several methods to choose from, there are 2 main schools of thought, fundamental analysis and technical analysis.

Security Analysis

Fundamentalists look at the market fundamentals, which involves evaluating a company’s financial statements, including their revenues, profit margins and earnings, future growth potential, research, new products. Other factors considered would be interest rates, and the overall economic state of the country and world.

Technicians are not concerned with the financial status of the company offering the security, as much as they are looking at the way the security behaved in the past. Technical analysis studies volume, patterns, moving average, support and resistance, and a plethora of other indicators. Elliot Wave Theory, Candlesticks, and Dow Theory are only a few of the methods out there that teach you how to use indicators to trade.

Relative Value Versus Trade Style

Now, how do you determine the relative value of the asset in question? There are so many ways to evaluate an asset’s relative price that it is easy to get lost in the hype. Whether it is fundamental analysis or technical analysis, is relative to your trade style.

Are you a short term trader, a medium term trader (swing trader), or a long term trader (investor)? The relative value of a company is based on how long you will have money invested or at risk. Knowing how long you will hold the asset is more important than your method of analysis. In fact, knowing how long you will hold the asset can help you decide which one of these techniques to use.

A short term trader cares very little about fundamental analysis. How often can fundamentals change? Fundamentals may be a broad guideline for a short term trader, but mean very little in day to day trading.

A medium term trader or swing trader and or a long term trader and investor care more about the the fundamentals. Since they will be holding the security/stock for days or weeks, they could be at a risk if fundamentals change.

Most people adopt one of these methods and go back and look at a security historically to “observe” if it is viable.

This is called back testing and is a systematic approach. They program their computer to run through historical data to see how the market performed. After observing the market for a time, the trader begins to trade virtually.

Trading virtually involves a process called paper trading. Many websites allow users to set up a free account that allows them to practice trading. This is an important step in learning to trade because it helps a trader refine their method of trading without financial risk.

Once a trader is comfortable trading virtually, they are ready to begin live trading. This is where the process of trading changes somehow.

Live Trading

Introducing real money into the trade brings out emotions and doubts that were not present in the hypothetical situations. This is where new traders begin to get scared. They started out with the intention to be a swing trader or investor, but when real money is on the line they quickly change, due to the pressure of live trading activity.

Imagine the trader having observed a systematic approach that worked historically 6 times in 10, or 60% of the time. In the virtual test, it maintains a performance of 60%. Then comes the live trade. The first four trades are losers. Immediately the trader becomes worried. The next 36 trades are losers.

They quit, resigned to the fact that their process is faulty despite all the testing, and begin the process anew with another approach. All this happens just before a run of 60 winning trades begins.

I know getting 36 losers in a row is as likely as winning the lottery without buying a ticket, and almost as likely as 60 winning trades in a row. This may seem like an extreme example, but it illustrates the vicious cycle too many traders eventually find themselves lost in. These traders approach each new system as if it contains the magic bullet that will discipline them, help them know when to buy and sell, and make them more money than they could ever dream of.

This is one path to becoming a professional trader; but there is another way.

In this approach, trading is more successful, and it saves money, emotional distress and time. These traders stick with the first approach they learn. They discover the pros and cons of their system of market analysis, they choose and they employ it at the appropriate time. They choose one way and do it the same way for a long period of time, consistently. These traders know that the more consistent they are, the better they will get at spotting when their approach works and when it does not.

The relative value is an arbitrary number. It is based on your trade style and your tolerance for risk. Having real money on the line. Take some time to understand how you will evaluate the market before you ever take a trade. See the pro’s and con’s of the system and prepare yourself for the fall backs emotionally. They will come. If you are prepared it will be a non event.