Thursday, July 31, 2008

Why keep a stock watch list?

Keeping a stock watch list can be a critical for a trader. There are many different reasons why that statement is true.

First things first, what exactly is a stock watch list? This is a list of stocks that you feel are good strong companies for whatever reason. It may be that these companies have strong earnings and the company itself is a good investment. It could also be because the company is in a strong bullish trend and is likely to keep going up as long as buying pressure stays.

The idea behind keeping a watch list is that you are able to follow these stocks and buy when they give off a good technical signal. In this case you would have the best of both worlds, a fundamentally strong company with a great technical analysis entry.

Another reason why someone would want to keep a watch list is because it is easy. It is far easier to keep a watch list and check it every day then to go out and look for new stocks every single day that just gave off a buy signal. Even more than that, it is harder to look up any fundamentals, if you are so inclined, on all stocks that give off technical signals.

The third and final reason why it is important to develop a watch list is that if you keep trading a few stocks you will learn the patterns of those stocks. Yes, all stocks follow the rules of technical analysis but they all follow them in their own way. The long you trade a given stock the better you will get better at predicting how that given stock acts and you will get better at trading it. The better you trade it the higher returns you can make, which is always good.

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Monday, July 28, 2008

Why use option greeks

Most traders have heard something about the importance of the Greeks, but why use option Greeks? What benefit do they actually give you? They give you a lot more then you think.

Most people believe that the price of an option has a 1 to 1 relationship with a stock. If the stock goes up $1 the option also should go up $1. After all, the price of the option is based upon the price of the stock.

While this seems to make sense it is not true. There are many factors that come into the price of an option that you want to understand in order to make targets for your option. These factors are given to us through the Greeks.

This is a list of the most widely used Greeks.

1. Delta measures the amount an option should move for every 1 point move in the price of the stock. For instance if the delta is $.5 then the option will move approximately $.5 for every 1 point move in the stock.

2. Gamma measures the change in delta. Even though delta measures how much an option will move for every $1 move in the stock the delta also changes on a regular bases. The gamma takes care of this. The gamma tells you how much the delta will move for every $1 move in the stock. If the gamma is $.1 then the delta will move up $.1 for every $1 move in the stock.

3. Theta is a very important Greek. It measures the effect of time decay on an option. Because options have an expiration date they are depreciating assets. The theta measures how much value an option will lose for every day that passes. If the theta is $.05 then the option will lose $.05 of time value for every 1 day that passes.

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Friday, July 25, 2008

Selling long vs. short term options

It is often a wise idea to sell short term options in the stock market. There are many reasons for this.

Short term gives you more control. No one knows what will happen to a stock 3 months down the road. It is easier to predict which way the stock will be heading in just a few weeks as opposed to a few months.

Selling short term options also allow you to capture the more premium over a longer time frame. For example the stock XYZ has a front month $30 put selling for $2 it also has a $30 put 3 months out selling for $4. At first glance it seems like you would get more money selling the $4 option 3 months out but that is not necessarily true.

If you sold the front month option for $2 and it expired at the end of the month you could sell it again next month or a higher option if the stock moved up. You could sell 3 puts each for $2 totaling $6 before the $4 put would have expired, if you were right.

The longer term option seller does however have some good advantages over the short term seller. First of all you can sell farther out of the money. Because the future is uncertain the farther out you go the higher the options will be selling for. A stock probably will not go from $50 to $70 in two weeks but it might in two months.

The other advantage long term sellers will have is that strong stocks go up on average. If you find a strong stock there is a good chance that over a longer time period the stock could head up which may not be true in a shorter term period.

Every trade has their own opinion on which method is better, which is what makes the stock market what it is.

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Wednesday, July 23, 2008

Calculating Risk Reward on short term options

It is very important to calculate the risk reward on short term options. This is the amount you would risk if you were wrong and the amount you would make if you were right. If you don’t figure this number out you may find that the stock may go in your favor but the option goes against you.

There are many reasons why the option can lose value if the stock goes in the same direction you are predicting. The market volatility could be heading down causing the option to fall. Volatility makes up a big part of the option. The higher the volatility, the higher the price of the option will be. If it falls the option will be affected.

Time value can also be a reason why you can lose money on options. As time passes the time value of an option will start to erode. This is especially true for short term options which are set to expire in just a few weeks.

If you wanted to calculate the option risk to reward you must first understand that the bare minimum an option would be worth is called the intrinsic value. This is the difference between the stock price and the strike price of the option.

For instance, if a stock is trading at $40 the intrinsic value or the bare minimum that the $35 call would be worth is $5. Knowing this can be extremely helpful. Here is how you can use it.

We will say the $35 option is worth $8 for the same stock. We are expecting the stock to run up from $40 to $51. $51-$35 is $16 making the option at least worth $16 if we are right. In this case the reward for this trade would be at least $16-$8 or $8.

Now say we wanted to set the option with a $4 stop. This means if the option goes down to $4 we would exit the trade. That would give you a 2/1 risk reward ratio on the stock. Which means you would make $2 if you are right and only lose $1 if you are wrong.

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Monday, July 21, 2008

Playing the Downside vs. upside

The stock market is a constant struggle between bulls and bears. Most people prefer to play the upside of a stock rather than the downside. That strategy may work well in rising bull markets but often gets crumbled when stocks crash.

There are advantages to shorting just like there are advantages of buying every trader needs to figure out which strategy works best for them.

The advantages of being a bear

1. Stocks often go down faster then they go up. This means it is possible for you to make faster and bigger gains by playing the downside of the market.

2. Playing the downside can help you make money when there is a bears market. This could be a good alternative to watching your bullish positions lose money. Remember bear markets make millionaires too.

3. Jessie Livermore who was considered the best trader of all times was considered a bear. He made fortunes when the markets were heading down and would be a billionaire by todayĆ¢€™s standards.

The advantages of being a bull

1. The market is bullish much more then it is bearish. Buying strong stocks can help you to take advantage of this type of market.

2. Bulls do not have to sell. If you have a stock that you are bullish on you can buy it and hold it forever. This is different from shorting in which at some point you have to buy the stock back and return it.

3. The majority of traders and investors are bullish. If the majority of the people are playing the upside it is more likely that over a longer term timeframe the market should go up.

4. Warren Buffets made Billions by being a long term bull in the stock market. If you have plenty of time to let your money grow it could be a good thing to become a bull.

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Sunday, July 20, 2008

Keeping a good risk to reward ratio

Keeping a good risk to reward ratio is critical to the success of a stock market trader. This is something that most new traders will ignore.

In fact there are people who will take a trade that offers them a $2 risk in order to make a $1 reward. The main reason for this is that new traders do not expect to be wrong. They believe that it is possible to be right all if not most of the time when trading.

This thinking is more of a daydreaming philosophy. Anyone who is serious about stock market trading should remember that no matter how much homework you do on a stock you will always have trades that make you money, and trades that lose you money.

The way someone becomes good in the stock market is by managing their risk and only taking trades in which they can control the amount they can lose.

So what is a good risk to reward ratio? Well, that depends on what system you trade. Many swing traders who make big speculations will only take trades with a $2 reward for a $1 risk.

This philosophy is definitely common but it is not the only one. Options sellers who have a larger risk to reward but a greater probability of success feel different. It is impossible to find a trade that offers a 2/1 risk reward if you are an option seller.

But options sellers also have to manage their risk. It is generally a good rule for an option seller to exit there trade if they lose any more than $1.5 of the premium they make.

Trend traders also have a differently philosophy about risk to reward ratios. They may take trades in which you have an infinite reward for a given risk. That is simply because there is no target when trend trading.

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Saturday, July 19, 2008

When the VIX is high so is the premium

When the vix is high the premium of stock options tends to be much higher as well. It is important to understand this concept.

What does that really mean? When you buy a call you pay the difference between the stock price and the strike price of the option you bought. You also pay an added fee made up of factors like time decay and volatility. All these factors are figured into the price of a given option.

When the VIX goes up it signals volatility is rising. This means so is the premium of the options that you are paying for. Which also means that if volatility goes down so will the price of your option.

So, what can you do when volatility is high in the market? There are a couple different answers to this question. The first and most obvious is selling options to collect the premium. If you sell options using the covered calls or a spreads you can take advantage of the higher prices of options.

But selling options can only give you a limited return on your money. If you like buying options because they give you an unlimited reward potential you may want to simply buy stocks. Stocks will not move as fast as the options will but they will give you a potential return that has no cap on it.

Still, you can buy basic calls and puts during this time. Many traders don’t care too much about rising volatility. Just remember if you are buying options during highly volatile times you are taking a bigger risk then during regular times.

Every trader should make their own decisions on what to do in a situation like this one. Not all traders agree but that is how the market is set up after all.

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Friday, July 18, 2008

Top 4 challenges facing option buyers

There are 4 top challenges facing option buyers in the stock market. Anyone looking to gain long term success with options should have these questions answered before they use them.

1. Time decay. When you buy an option there is both time value and intrinsic value in that option price. Intrinsic value moves the option based on the price of the stock. Time value goes down slowly as the option price gets closer to expiration. Because of this an option buyer needs to have the intrinsic value go up faster than the time value to make any money.

If they intrinsic value doesn’t go up fast enough have this the stock could do what they wanted it to do and they still lose money. The best way to combat this problem is to buy more time value. If you have an option 3 months out the time value will decay at a much slower rate than an option that is 1 month away from expiration.

2. The Bid and ask price also pose a problem for option buyers. When buying options there are two prices the bid and ask. The ask price is the price that you can buy it for and the bid price is the price that you can sell it for. The difference between these numbers is called the spread.

The price you can buy an option for is always higher than the price you can sell an option for. You need the option to go up above this gap in order to make money. This problem is lessened by not trading options with stocks that have a high spread. Obviously if you find a stock that has an ask price of $8 and a bid price of $6 that might not be a good buy regardless of the stock.

3. The implied volatility. This is very important to understand. The IV measures how volatile the stock is at a given time. It is also used to measure the volatility of an option. This can affect the price because if you buy a call with high volatility the stock can go up but if volatility drops your option’s price will be affected. Now on the same note if you buy a call when volatility is low and the stock price goes down you might still be able to make money if the volatility goes up.

Generally volatility goes down when stocks goes up and it goes up when stock prices fall. You may also want to check the VIX which shows the volatility of the SPY. In addition if you can go to a website like which will give you the volatility of individual stocks.

4. Delta. Many option traders believe that if a stock moves $1 the option should also move $1. Nope. This is one of the biggest misconceptions new traders have about options. They will not move up exactly the same amount as the stock. In fact there is an option greek called the Delta that is designed to determine how fast an option should move. If the Delta is $.5 then it will move $.5 for every $1 the stock moves.
The farther in the money you buy a stock option at the higher the delta will be. But it will also result in a higher option price as well.

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Thursday, July 17, 2008

Buying vs. Selling options

Buying vs. selling options, which one is better? Each strategy has its own strengths and weaknesses.

If you are Selling options you have the benefit of time. As time goes by the option you sold will lose its value. This way even if the stock goes against you, you can still make money on the trade. With option buyers time works against them.

If you are a buyer of an option the stock has to go in the direction you want it to go faster than time value goes down. This means that the stock can do what you expected it to and you can still lose money as a buyer. Another advantage of option sellers is that they tend to have a higher winning ratio.

On average 80% of options expire worthless so selling them can indeed be a powerful way to make money. Being an option seller is like being the person who sells lottery tickets to people who want to get rich quick, the odds are in your favor.

But there are still reasons in which someone would want to be an option buyer. The first reason is also the most powerful. Buying options can give you an unlimited profit potential while giving you a limited loss potential. That sounds pretty good and has convinced many traders to go after the option buying part of trading.

Option selling does not give you an unlimited reward. If you sell a put the maximum you can make off of that trade is the amount the put was worth.

The second advantage that option buying gives you is the ability to have a limited loss. If you have a controlled limited loss it is easier to control your trade and to only take trades that give you a small loss if you are wrong and a large profit if you are right.

Option selling does not have this. While there are ways in which you can keep your losses small by being a seller your potential loss will always be greater than your potential reward for any 1 trade. Still if you are right the majority of the time that becomes less important.

Both these strategies contain strengths and weaknesses it is up to the individual investor to decide which strategy is best for them.

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Wednesday, July 16, 2008

Don't fight the trend

Don’t fight the trend of a given security. It can be very painful to bottom pick or top pick. Even though it is dangerous there are still a huge group of investors tend to keep doing it.

When a stock is trending upward it is more likely that the stock will keep trending up then start trending down all of a sudden. But the mentality seems to be the other way around. When oil went to $100 it was all over the net. You could hundreds of blogs that said oil was too high and it is time to short. Well a couple months later oil was in the $140s.

People seem to forget that there is no level that a stock has to top out on. It is not necessarily that the stock hits the top of the graph you have it on so it must go down. No the stock will continue to go up until it stops.

This rule applies to down trending stocks. Trying to buy a down trending stock is like catching a falling knife, it’s going to hurt. This can be true even if you think the company is a great long term company. There are a number of instances were companies that were thought of as strong crashed and then went bankrupt in a bears market.

Jessie Livermore who was considered the best trader who ever lived believed that there was no level at which a stock was too low to short and no level at which a stock was too high to buy. He stood by that mentality by buying stocks when the market was going up and shorting stocks when the market was going down.
Basically it can be very risky to go against the trend of a given security. Stocks at a discount offer a high risk way of trading.

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Tuesday, July 15, 2008

Investing vs trading

Everyone always says that the safest way to make money in the stock market is by investing for the long term. I don’t believe it. In fact long term investors might have the disadvantage.

There are a number of reasons why trading can be a safer strategy then investing in the long term.

1. Traders can make money in all markets. Unlike a long term investor who only makes money in bulls market and loses money in a bears market, traders can take advantage of whatever the market does.

2. Strong companies don’t have to go up. People seem to have a false image in their mine that if you own Disney stock and they make a sale your stock goes up. That is not necessarily true. You could buy a stock that makes loads of money with great fundamentals and still lose money. In fact Wal-Mart, Disney, Microsoft, and coke are all stocks that have huge earning but have not done anything except go down a little in the last 10 years.

3. Successful traders base their conclusion off of price, the trends and patterns of it. This is a much better way to grow your money because what you make money off of is ultimately what the stock does not what the company does.

4. The idea of holding onto a stock forever can actually hurt you. I have seen people with a long term prospective ride a $40 stock to a $10 stock because they are in it for the long term. As far as I am considered it not a good idea to hold a stock through a 75% decline in hopes that it might one day go up no matter what your time frame is.

5. Actively trading is a can give you higher returns. Think about it like this, if you are actively trading in the stock market you will be able to learn from your past trades. The more you learn the better a trader you will become. Where as someone who invest in the long term cannot use what they learned from their last trades into their new trades because your last trades lasted 40 years.

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Monday, July 14, 2008

Protecting yourself with leaps

One of the most common techniques in the stock market is buying leaps to protect you from the downside of the market. This can be used like sort of a long term insurance policy.

Let us look at how this works. Let us say you own a stock that is trading at $107. The markets have been a little volatile lately and you are worried that the market might crash along with your position.

To protect yourself you buy a $100 leap for $30. This gives you the right to sell the stock at $100 for 1 year. Now if the markets crash and your stock goes down to $40 you can still sell it at $100 because you bought the right to sell it at $100.

Now let us say that the market didn’t crash but instead started to stabilize and head up. Your stock went to $120. Now your leap is only worth $15. You would have two choices in this case. You can either leave the put alone and continue to have a protection level at $100, or if you feel like the markets are heading higher you can sell your $100 put for $15. This allows you to receive back some of the premium you spent on protection.

Buying leaps is definitely a helpful way to protect yourself from the downside but why would you buy them over short term put options they do the same thing and cost less. Let’s look at that.

Now let us say that you did not want to buy the $100 leap but the $100 put instead. The $100 put only cost $5 but only gives you protection for one month. If after that month is over the market is still scaring you, you would have to buy another $100 put for the next month.

So, you can wind up paying $5 a month per share for protection as long as you feel the market is uncertain. With the leap you would only pay $2.5 a month because $30/12= $2.5. This could be helpful if you want to protect yourself over a longer period of time.

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Sunday, July 13, 2008

Options Aren't Risky People Are Risky

Every time someone says something about option trading the majority of people automatically think, aren’t options risky? The answer to that is no, options aren’t risky people are risky. Options can give a trader a great advantage in the market if used correctly. If they are used incorrectly they can give you accelerated loss.

Let’s do some comparisons. There is a $40 stock that we would expect to go up in the short term. If we bought the stock and it went up we can make money. But if it goes down we can lose up to $40.

Now suppose we buy a $40 call for $5. Now we still have the ability to profit from this trade if it goes up, but now if the stock goes down we can only lose $5. I would rather risk $5 then $40 for the same trade.

This makes sense because it can limit your risk without limiting your upside. However many people still consider option trading riskier then stock trading. Perhaps the biggest reason for this is that most people trade options the wrong way.

Most people will make one of these mistakes when trading options

1. They buy an option based on long term prospective. Options are not built for the long term. If you like a company because you believe the stock will be worth a lot more in 10 years do not buy an option.

2. Some people try and hold onto an option if it turns against them. Most new traders will buy a stock and if it goes against them they will just hold it forever and hope it goes up and they break even. You cannot do this with options. They all have an expiration date and will expire worthless if you try and hold onto it forever waiting to break even.

3. They will not manage their risk. People like options because they give them a smaller loss if they are wrong but they end up buying more because options are cheap. Instead of buying 100 shares at $40 like they wanted they buy 1000 shares with calls for $5 each. Now they actually increased the risk they would have took by buying 10 times as many shares then they would if they just bought the stock.

4. Not developing a system. When you are buying stocks most people will blindly buy random mutual funds and ETFs and hope that 30 years later you will have made money. With options you need to develop that can tell you when to buy and when to sell in the short term. Most failed option traders don’t have this. They buy when they feel the company might go up not when their trading rules tell them it will.

What you should do to trade options correctly is

1. Develop a trading strategy that gives you entry and exit signals. Without consistency you will never be able to have any long term success in the markets.

2. Always use proper risk management when trading options. The general rule when trading is never to risk any more then 2-5% of your account in any 1 trade. This rule is especially important when trading with options. If you risk anymore then that you will be kicking yourself if you lose money on the trade.
Options are not for everyone, but can definitely be helpful when trading.

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Saturday, July 12, 2008

Types of dojis

The doji is a candlestick that can be helpful tool when trying to find the tops and bottoms of a given stock. There are four major kinds of these candlesticks.

1. The first is the regular doji. This is when the stock did pretty much nothing during the day. It may have swung back and forth every now and then, but overall the security remained unchanged. If this candlestick comes after a big bull run it could mean that the bulls are losing strength. However it could also mean that the stock is just pulling back.

2. The long legged doji is pretty similar to the regular doji. The only difference is that with the long legged doji the day had a much higher swing. The stock had a pretty big high and a pretty big low but in general it still did nothing. The log legged doji can give the same signals as the regular doji, but the signal is stronger because it shows a bigger struggle between the bulls and bears.

3. The gravestone doji can be a bearish reversal pattern when it comes after a bull run. During this day the stock opens and starts to rally. Somewhere during the day however the stock starts to fall. By the end of the day the day closes flat, or close to it. This is an indicator that the bullish run is starting to lose steam.

4. The last types of doji is the dragonfly doji. This can be used as a bullish reversal indicator when it occurs after a bear run. During this day the stock market opens and starts to fall. During the middle of the day the buyers come in and start to buy. This pushes the stock up. By the end of the day the stock finishes flat. This can show that the stock is starting to strengthen.

The doji can be a helpful indicator but should never be tooken as a stand along buy or sell signal. It should be used as a way of strengthening another indicator.

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Friday, July 11, 2008

Benefits of trading in a bears markets

Everyone is talking about how terrible bears markets are. They seem to all be wondering the same thing, is it over yet? But there are many ways in which trading and especially learning to trade in a bears market can help you.

1. Stocks tend to go down faster then they go up. I know to most of you that does not seem like a good thing but think about this. If a stock is moving in either direction you can make money off of it. This is done by buying stock and calls when they go up and shorting stocks and entering puts when stocks go down.

If a stock heads down 40% in a month and you shorted it, it would be like buying a stock and having it go up 40%. It is the same thing only backwards. This is the main reason why many professional traders prefer to trade in a bears market.

2. The second reason is that bears markets along with volatile markets happen all of the time. If you are just getting into the stock market it can be to your benefit to learn in a bears or volatile market.

The reason for this is that it paints a more realistic picture of how the market behavior. There are too many people who enter the market when it is bullish and make a lot of money. Then they lose it all when the markets crash. Remember in a bulls market everyone is a genius.

3. On a related note it is very important to always use proper risk management. In a bears market you never forget that, but in a bulls market you may wonder away from that ideal causing you to pick up a very bad trading habit.
I am sure that not everyone agrees with me but bears markets are not as bad as their reputation. They are a natural cycle and come to remind people that the market isn’t just a place where you buy a stock and expect it double in a week.

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Thursday, July 10, 2008

Putting stops on options

One thing I think is critical for any option trader weather they are an option seller or a buyer is a stop. Just like stock traders everyone who trades options should have a stop that tells them when to get out of a trade.

There are a couple different ways you can go about placing a stop on an option. The first is placing a stop loss based on the price of the option itself. Many traders will feel that this is the best way to go about placing a stop.

It helps you to manage the loss that you might inquire while trading. Here is an example; if you only want to risk $1000 on a trade you could have a stop on the option to exit if the option loses $1000 or more. That can help you to keep your losses short.

Also if you are a big risk to reward trader you can more accurately control the amount of risk you are taking with this strategy.

The second way to place a stop on an option is through a contingency order. This order lets you enter or exit an option based on the price of the stock itself. In other words you can place an order to exit a trade if the stock gets to $50 or lower.

If the stock ever gets to $50 or lower you will automatically exit the trade. Although this way of trading will make it harder to develop a proper risk to reward ratio it can help you be a little more accurate. Because options aren’t 100% priced based off of the price of the stock placing a stop solely on the price of the option can sometimes make you either stay in a trade too long or exit too early.

Every option trader must find the way that works best for them. One more thing I would like to add. Many people will place a mental stop. This means that they say they will sell if a stock gets to a certain level. This can be devastating because not many have the disciple to actually sell at that point.

These people may decide that they will just wait and see. Or they will move their stop lower which is a bad thing to do. Once you decide your stop you must place the order.

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Wednesday, July 9, 2008

Why use Bearish candlestick patterns?

It is important to know different types of candlestick patterns because they can give you signals for when a security is going to go up. But is equally important to know bearish candlestick patterns as well.

There are a couple reasons for this. The first reason is to let you know if your stock is losing strength. If you are holding a stock and get a bearish signal on it you may start thinking about possibly exiting it or watching it carefully.

The other reason you might want to know some bearish candlestick patterns is if you are possible looking for a stock to short. If you like to short or buy puts on stocks it is important to keep up to date with possible bearish indicators.
Below is an explanation of a couple different bearish patterns.

1. The evening star is a bearish pattern. It comes after a bullish rally and consists of three days. The first day is a bullish day. Here the stock rises a pretty good amount. The second day the stock does nothing.

The buying pressure is starting to weaken on this day. The third day is a bearish day. Here the buying pressure weakens so much that the short sellers are actually able to push the stock down. After this day the stock is more likely to go down then head up.

2. The bearish engulfing pattern is another bearish signal. This signal however only consists of two different days. The first day is an up day. The stock does not need to have an explosive upward movement although it can.

The second day is a bearish day. This bearish day needs to be much bigger than the bullish day. It should open higher than the close of the last day and close higher than the open of the bullish day. This also signals that selling pressure is taking over and the stock is more likely to go down then up.

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Tuesday, July 8, 2008

The components of trading

I would say that there are two different components of trading. These are the trader and the system. Each one has something that they can bring to the table to give you a successful trading system.

The system component is easy to understand. If you follow your own strict rules of what to look for before you invest your money you will come up with some sort of consistency. If you always trade by do the same thing then you will be able to get the same results, over and over again.

This makes having a trading system very important aspect when it comes to making money in the market. Develop a well tested system can be the best way to make good money. However there is one other major component when it comes to trading, and that is the trader themselves.

Some traders believe that a trading strategy should be all system and the trader should try to keep their own thoughts out of it. This can be true to an extent. The major flaw we as humans have when it comes to trading is our emotions.

Our emotions might make us sell too soon or buy too early. That can cause us to lose money. But there is a good reason that traders should not rely 100% on a system and keep some human touch in trading.

This ability that humans can bring is the ability to change and adjust to new markets. You may have a system that is working well buying calls but if you start to see that the market is crashing it can tell you that you might not want to be buying calls right now.

You might adjust that strategy by taking the same rules you learned from buying calls and reversing it to give you good put buying strategies. Or you might try something different. But our ability to adjust is what gives us an edge over a pure systematic way of trading.

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Monday, July 7, 2008

High priced stocks

Surprising buying expensive stocks does not seem to be a bad idea in the market as long as the given stock is in an uptrend. This is true even though the majority of people believe that they should buy after a stock has taken a hit.

One reason why buying high priced stocks in an uptrend is that when a stock is in an uptrend it tends to stay in it. So the bullish pressure tends to stay with the stock for a very long time. Strong up trending stocks can make big returns over and over again.

Many people seem to think that because a stock is so overpriced that it will not go up and if it does it will not go up that much. I have found this to be very untrue. Stocks in an uptrend will normally go up faster than stocks that have been crushed.

This way instead of buying low and selling high it may be better to buy high and sell higher. In fact stocks that have been going down typically keep going down for a while. Like up trends downtrends can last for a long time and trying to pick the bottom can lead to a lot of losses.

Of course knowing when to buy is only half the battle. The other equally important half is knowing when to sell. Selling at the wrong time can either leave you upset from how much profit you missed or upset of how much you let the stock go down before you sold.

Every investor and trader should develop their own ways of determining when to sell their stock. Most traders will sell strong stocks when they are starting to turn around. In other words if their stock was in a strong uptrend but had a big crash they might decide to get out of that trade before the stock crashes more.

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Sunday, July 6, 2008

What are candlestick patterns?

Candlesticks patterns give you buy and sell signals for a given security. They can help you determine the right time to buy a stock and the right time to short too.

These patterns like any other indicator out there are not 100% accurate but they have been known to be useful in the past. If you are going to find great stocks knowing which patterns to use can be very helpful.

Here is an example of a couple different candlestick patterns and what they mean.

1. A morning star is a stock reversal pattern. It is said to mark the bottom of a pullback. It consists of three different candlesticks. The first candlestick is a bearish day. During this day the bears take control of the stock and push it down lower.

The second candlestick is a day when the bulls and bears are evenly matched. Neither one is able to take control of the stock. So, it doesn’t go anywhere.
During the third day the stock rises. The bulls eventually take control of the stock and push it up. This candlestick should be larger than the other two. It signals that buying pressure is coming and that the sock is likely to go up.

2. The hammer is another bottoming signal. This one only consists of one candlestick. This pattern happens after the stock has been falling. The stock opens and starts to fall because there is selling pressure.

Sometime during the day however the bulls take control and push the stock up. After the day is finished the stock finishes up. This will show that buying pressure is starting to happen. But be cautious if this pattern does not occur when the stock is pulling back it could be forming a hanging man pattern which is actually a bearish signal.

If you trade candlestick patterns you should always have a plan on how you are going to exit the trade if you are right and if you are wrong.

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Saturday, July 5, 2008

Don't buy penny stocks

All over the internet I hear people trying to pick the best penny stocks. They buy stocks that are trading at $.02 and hope that they will go up.

The main reason behind this is that those stocks are cheap. It is relatively inexpensive to buy tens of thousands of shares of penny stocks. Then if the price goes up they can make a fortune. The problem with this thinking is that penny stocks probably will not go up. They are penny stocks for a reason.

If a stock makes it too low there is a reason for it, and there it is extremely unlikely that it will go up. It is just not a good buy and ‘smart money’ knows to avoid it. If the best investors do not buy these stocks there is no reason why anyone should.

Because the smart investors will not invest money in penny stocks some people try to buy a lot of the stock and sell it once it goes up. This theory seems to make sense. If you buy $100,000 of a stock trading at $.15 that stock is going to skyrocket then you can just sell it.

This is called pump and dump and is highly illegal. It can and has sent people away for a long, long time. Another form of this is the people who try and pump up this hot penny stock by telling everyone to buy it. Of course the stock goes up because everyone buys it. Then the owners sell their stock and it crashes.

It is not worth it to try and use this technique to buy and sell them. This causes legitimist investors to lose money. It is also very easy to make big money in the stock market without having to risk going to jail. It makes you wounded why anyone ever bothers doing something that will put them behind bars.

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Figuring out your trading type

All traders should try and find their particular trading type. There are many different ways of trading. Trend trading, swing trading, option selling, and day trading are the most common.

The reason for this is that everyone is different. You cannot trade someone with else’s system as efficiently as them, just like you wouldn’t put on their glove or wear their shoes the same as them. People are diverse in all areas and trading is one of those areas.

There are a few different major trading types below are an example of a couple.

1. Trend traders try to find stocks that are strongly upward trends. They buy the stock and hold onto them until the stock starts showing signs of reversing. When this happens they will get out of the stock. These traders try to buy a strong stock and ride it up all the way up until it stops going up.

2. Swing traders are normally in a trade for a short period of time, maybe 2 to 4 days. These traders try to play the short swings in the market. They are the traders who like fast action, quick gains or quick losses.

3. Option sellers sell options on a stock in attempt to gain the premium. They look for consistent profit instead of huge returns. Probability can also be on their side because they can take trades where the stock does not have to go in 1 direction for them to make money.

4. Day traders have the shortest timeframe for investing, less than 1 day. They try to play the short inner day movements of the stock market. A good day trader will be out of all of their positions by the time the day is over.

Whatever your particular trading style is you should spend your time getting used to trading with it. You may also decide that you want to trade a few different strategies. That can be fine but make sure that you can determine which ones are working and which ones are not.

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Friday, July 4, 2008

Option selling

One of the most powerful ways of trading is option selling. This is a way that you can make money without having to predict the direction that the market is heading.

The reason for this is that when you sell options you instantly make money. The bad part is you will have the liability of buying or selling the stock at a given price if you are wrong. But if it does not get to or pass that level you can keep the profits and cash out positive.

There are two different ways you can sell options

1. Selling naked options. This is when you just sell an option. You hope that it does not come down to the level of the option by expiration. The danger of this is that you have an unlimited risk with a limited reward.

If sell a put for the $50 strike price for $1 you have to buy it at $50 if it goes lower than that. And if the market crashes you will have the ability to lose up to $50. So this is the most dangerous type of option selling with huge risks.

2. Credit spreads. This is different than naked puts because you do not have as big of a risk. An example of this would be if you not only sold the $50 call for $1 but bought the $45 call for $.5. You would make the difference between the amount you sold the $50 put for and the amount you bought the $45 put for or $.5. This limits your possible gain.

The benefit of this is that it also limits your maximum loss. Because you have the right to buy the stock at $45 your maximum loss is only $5. This is true no matter how far the stock may fall. This alternative produces a lower reward but also give less of a risk which might be worth it.

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Thursday, July 3, 2008

Why manage your risk?

Managing your risk can be the best way to have long term success trading in the stock market. All traders who do not have a risk management system in place will eventually lose their money.

Something that the majority of traders will do is overlook this. They will come in and start picking stocks that make them big money. They decide that position sizing isn’t for them because the more they make more money by using all of their account.

They start making the big bucks and living the good life. They get cocky because they believe that they can always make more money, it just rolls in. But then when the market turns against them they are devastated. What good is making a million dollars if you lose it all in 1 day?

Stories like that are all too common in the trading world. To get around this you must use proper risk management. There are a couple ways you can use it to prevent the markets from crushing your account.

1. Never risk more than 5% of your account in any 1 trade. If you only risk 5% of your account in every trade you can never go broke. You can never lose all of your money no matter how many times you lose.

2. Having both long and short positions at all times. This is something that I have found to be useful. When the markets are bullish then you can make huge returns with your bullish trades, when they turn bearish then you can make huge gains on your bearish trades.

3. Having cash to sit on. This is something many traders do not like to hear but you should always have some cash in reserve. It can be there for a couple reasons but the major reason is that if you lose the money you have in the markets you will always have some cash in reserve.

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Wednesday, July 2, 2008

Leaps vs Options

Leaps and options are the two best ways to gain leverage in the stock market. They each have their own advantages and disadvantages.

An option will give you a way to make huge returns on your money in the short term. They will give you a month or two to let the stock do something. If it does the returns will be greater than the returns that you will get from either a stock or a leap.

The problem is that if the stock doesn’t move in that time frame you can also lose more money than if you had either the stock or the leap. Options can also lose money if the stock does nothing. That happens because as the option gets closer to expiring the value of the option will decrease unless the stock moves enough to compensate for the loss.

Leaps on the other hand are just like options. The only difference is that they do not expire for years. That way if you are wrong you do not lose as much in the short term. You also can choose to hold onto the position for a much longer time frame if you believe that everything still looks good.

There are two drawbacks to that. The first is that if the stock does make a big move right away then you will make less money from the leap then you would have if you had just bought the option. The 2nd drawback is that you might hold onto a losing position longer just because you can. Many times it can be better to get out of a trade as soon as it goes against you rather then ride it all the way down. If you have a larger timeframe then you can hold a bad trade and lose more money than you would have if you did an option.

In other words both options and leaps have advantages and disadvantages. You should use your time frame to decide which one is right for you or if one is right for you.

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Tuesday, July 1, 2008

Trading well vs. trading to make money

Trading well and trading to make money are two completely different things. In fact trading well can make you more money in the stock market then by trading to make money. Even though this is the case the majority of new traders trade for money.

They do this and lose money, not understanding why. Well, of course you lose money. If you are in the markets for the sole purpose of making money you will always have fear and greed to deal with.

Greed can make you stay into a trade too long. It can make a great profit turn into a great loss and has happened to many people many times. Fear on the other hand might make you get out of a good trade too soon. This is where you get out of an awesome trade because you get scared that it will turn against you.

Obviously this type of trading can be very dangerous and runs on emotion. There is a better way to trade. It is trading just for the purpose of trading well. Now I don’t mean trading randomly just because you can. I mean developing a system testing it out and following it through.

The system should have strict rules that you create in order to more efficiently make money. It should be tested before you actually trade with it.

This way you develop a system that works in the long term. It may have both wins and losses but in the long term it makes money. Once you have a great system then you can follow the buy and sell signals.

This is true regardless of how the price has changed. If you bought a stock at $55 and it fell to $53 and did not hit your sell point you will not get out if you are trading well. After all it can still go up. Concentrating on making your system work will make you a lot more money then concentrating on making money.

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