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How to lose money when trading. A trader is born.

StockInvest.us
05:27am, Tuesday, Feb 22, 2022

Introduction

The idea of these articles is not to make you the ultimate trading machine. Only a few are and will ever be. The idea and intention are to help you avoid the most common mistakes that either make you lose some or all of your savings. In the worst case, trading may put you into debt. Becoming a winner is like evolution in nature - learning by mistakes.

The stock market is full of predators just waiting for newbies they can feed on. Stocks may be subject of pump and dump where news is pushed to press the stock up while major players sell, or the other way around. Some stocks are played where professional traders fire up a rally, which makes small traders lose as they get in too late and get out even later. Lack of knowledge and access to information is also a major pitfall for most minor traders.

I will bit by bit introduce technical analysis in this text as I believe this is a tool any trader should know. Technical Analysis (TA) will help to improve your timing and ultimately help you make better overall trading decisions. In the end, it all comes down to decisions, and in the stock market, there is very little room for error unless you have proper stop-loss strategies.

Chapter 1 - A trader is born.

Getting into stock trading is easy.

Most new traders start because somebody tells how easy it is to make money in this market. It may be a class friend, a news article, or an "expert" advice on TV or radio. Usually, most new traders enter markets in the late stages of a long upturn when newspapers write how much you could have made if you played the markets. To me, the ultimate sell signal has always been when "trading and stocks" appear in knitting magazines.

Lately, Bitcoin and other cryptocurrencies have been booming. Some people have been lucky as they were hitting the uptrend. Their profit was caused not because of the insight or skills but by pure luck being at the right place at the right time. Because of this, tons of "experts" appear. They can explain and assure that the only way for cryptocurrencies is up. The fact is that a true "expert" has been in volatile markets or even seen the dreadful bear market where people lose their homes, businesses are going bankrupt, and fortunes are lost overnight. These are tough lessons, but the best of the best make even more money in falling markets.

Since most traders enter the market looking for the easy money promised, the disappointment is enormous when first losses are a fact. There are always many excuses for the losses, but everybody blames others and not themselves in most cases. From this point and forward in your trading, there are no excuses. You and only you are the one making decisions. If you manage to accept this simple yet powerful fact, you will be ready to move on and become a better trader. It is all about decisions, whether investing into a fund where professionals handle your money or day trading.

Take responsibility for your actions and learn from them.

Accepting the facts.

Nature is cruel, and it is not soft like humans. It doesn't spare the weak, and only the strongest survive. Nature is as close to perfection as it is possible to get to, and it has taken billions of years to achieve it. To make you a "perfect" trader in 5 minutes or two months is wishful thinking, but while nature learned it the hard way, step by step, humans can learn from history and each other.

Given that nature doesn't have options as humans have, it is, per definition, easier for nature. Nature is a beautiful 0 or 1 algorithm. Nature is the divine script all programmers dream to create. In fact, as a trader, you should strive to become more like nature is. Weak stocks do not belong in your portfolio. Weak decisions should not exist. Words like "maybe" should not be in your vocabulary. There is no such thing as "maybe a good buy" or "maybe I should sell." Having a weak stock, making a weak decision, or having a "maybe" in your vocabulary is a guaranteed way to lose money.

Some long-timers may tell stories about stocks doing marvelous turnarounds. Yes, even I have sold stocks to see them re-bounce to the sky. However, most people fail to see is that for every one stock doing it, nine will fail. In trading, you want to be more than 50% correct. This is where you're making money. Not by being lucky.

But let us jump back for a second. I started by saying that most traders enter the market in the late stages of an up-trend when even the knitting magazines recommend stocks. I then said that your first decision is to be responsible for your actions, and you are the only person to blame. Furthermore, I said that you should strive to become more like nature as a trader. I pointed out that weakness will make you lose money. If you have invested in stocks or Bitcoin, you need to understand that you're in the predator's market, and only the strongest will survive. I will now try to give examples for the first two parts of this text before moving on.

Know where you're from to know where you're going.

Market situation

You have entered the market, and you are making trades. But do you really know anything about the market you have entered? Do you know in what part of the market cycle you are? At the beginning of a bull market, you can put your money on almost anything and hit a bull's eye. Cryptocurrencies are the most recent example of this. But in the end, it is nearly impossible to win, and losses will be more common than profit. Everything moves in short, medium, and long-term cycles, and bear markets have been as certain as bull markets. If you are new to trading: the bear market is falling while the bull market is a rising market. All you need to know is that whatever goes up, in most cases, comes down. Plenty of Bitcoin owners have seen a super profit on paper reduced by 50% in less than one month (Dec 2017, Bitcoin fell from $19.900 to $10.000 in just a week).

Understanding what part of the cycle you have entered the market makes it easier to make good decisions and understand why good trades go bad. Anyone entering the US stock market now is entering a market that is overbought in the short to medium term. In fact, the market is now defying gravity, making the fall harder. In euphoric markets, volatility is high, and stocks behave erratically - with solid gains and strong falls, often within the same day. It is a perfect market for a very disciplined trader, but it is a rollercoaster ending with huge losses for most.

Below is the chart of the Nasdaq index as it is right now when these articles are being written (Jan 2018). The red coloring in the line at the end indicates that the index is overbought on the relative strength index. (RSI). But for simplicity, just imagine there are 100 available traders. When more than 70% is positive, you should be warned that too many are positive, and at Stockinvest.us, we color our charts red when RSI passes 70%. And green when it falls below 30. The logic is that when everyone is positive, the next person will be negative. All credit cards are maxed out at the very end of overbought, and all are in. There are simply no more buyers to push it further up.

Any investment made now has a higher risk than investments made at the beginning of 2017. And extremely riskier than investments made in 2011. This does not mean you should not invest. It just tells you that you need to treat your trades differently. "Personally, I have more than 50% of my trades invested in shorts, which is a bet that the market will fall. Due to the high volatility, I also keep a higher stop-loss on my stocks. My trading horizon is also way shorter as I don't want to get stuck in bad positions. I avoid investment into ill-liquid stocks as these can fall drastically from one day to the other. Neither do I sit 100% in the market overnight or on weekends. I always keep some cash available, so am I ready to act on good trades. It also lowers my general risk. "

To better understand why it is important to know what part of the market cycle you have entered, it is better to look at the Nasdaq history from a longer perspective.

Data from: www.macrotrends.net/1320/nasdaq-historical-chart

Looking at everything in perspective makes it easy to imagine that the next step ahead will probably be a fall. But remember that "experts" promised a huge stock fall back in 2015, and for sure when Mr. Trump won the election. I still have to see a perfect algorithm or a perfect "expert" with perfect timing. The Nasdaq exchange may quickly go up to 10.000 points because at this stage, anything can happen, and it will happen fast. Up as well as down. This volatile part of the market cycle is perfect for the disciplined trader.

If we look at the Bitcoin chart, the huge fall lately is almost logical, and I am not sure the worst part is over yet. The reason for this is the lack of real support before the $5.000 range. But that is another discussion.

To sum up, you are responsible for your decisions. You need to know where you are in all trades and all markets in the cycle. This will put you on top of the situation and not leave you in darkness. I have said it is a predator's market but not explained it in detail, for we will get to all that in a minute. If you still believe others are to blame for your trades, then you have just wasted your time reading all this. In the next part, I will be looking at some basics.

If you hesitate, you will be eaten alive.

Start with getting a proper broker.

As earlier mentioned, most new traders get late into the game and are usually driven by a desire to join the train to riches. In many cases establishing the trading account is done on impulse without doing proper homework first. Often it is done by following a link from a web commercial or by referrals from a friend. Setting up a trading account is easy, and first trades are often made without knowing what was done exactly. Getting an account usually requires some online forms, a copy of a certificate, and then cash to the account. Once the account is established, a blue or green button will let you buy. With a single click, you're in the game, and instantly you have affected your future.

I don't know how many people approached me after losing huge amounts of their savings, but they have all made classic mistakes. I am no exception.

There is a massive variety of brokers out there. As a beginner or professional, you should always seek brokers that offer you to trade directly from the exchange trading books (the broker is directly connected to the main exchange). This will make sure you are trading on the actual market price and can take advantage of the entire trading range (also known as spread or difference between highs and lows). It is essential, especially if you are day trading. When day trading - minutes and often seconds matter. You do not want a broker that provides delayed prices. You want to get in and out of trades in real-time.

Another important thing is to keep in mind that the fees are related to trading. You should make a $20.000 trade for as little as $2-3 in total fees at serious brokers. Some brokers will tell you that you can trade for as little as $0.50, but they fail to mention in the headlines, keeping in small notes at the bottom, that you're not getting a market price on your trade. It is a huge difference buying, for instance, Apple at $177,50 and $178.20. The $0.70 difference may be the entire spread of the day in many cases.

These days, you would prefer to use an online broker that offers trading both from the web and from applications. Proper online brokers derive from banks or well-known trading houses in many countries. Most banks offer trading from your bank account, but often with a bad interface, high fees, and lousy market coverage (number of shares you can trade). Ideally, you want a broker that offers several markets to get a better population to trade from. There are, for instance, only a few hundred companies listed on the Oslo Stock Exchange (OSE), while there are almost 2.800 stocks on New York Stock Exchange (NYSE).

As a foreigner, you can, with some hassle, get a trading account at the American broker TD Ameritrade. Once your account is established, you can enjoy the lowest fees and most accurate market prices for the US market. The point is that this will allow you to make money on even a 1% day spread in the end. And this is where the money is.

Spending extra time doing things properly is better than regretting for years.

Try to stay away from CFDs until you are ready.

In most cases, beginners join a CFD broker (Contracts For Difference), and while it looks like they are trading real stocks - they are not. CFD brokers offer margined contracts on financial products (stocks, currencies, cryptos, etc.), and according to a recent article, 74% of all CFD traders lose money. This is why it is so essential to understand what type of broker you get and be able to compare this broker to alternatives.

Some will argue that CFD brokers are very good as they offer leverage (trading where you only put in a small amount of the total trade and therefore allow small investments to take large positions). For example, you can put in $150, and the CFD broker will put in 20x, making your $150 investment worth $3.000. But there is no free lunch in the stock market, and for sure not in the world of CFDs. Usually, it will take some losses to understand. The first trap is the high spread between sell and buy when it comes to CFDs. The second trap is the deviation from the actual trading price for the security (at the exchange where stock is listed). Let us take a real example. Imagine you want to buy Apple (AAPL) and that it is traded for $ 178,25 at Nasdaq stock exchange. You, however, are using your CFD broker. In most cases, the CFD broker will do two things:

A) It will give you a very bad spread, meaning there will be a huge difference between buy and sell prices. In the case of AAPL, the CFD company will offer you to buy AAPL for $178.64 and sell it for $178.25. In this case, the spread is $0.39 or 0.22% between buy and sell, far higher than at the actual exchange. In simpler words, it means that AAPL will need to rise 0.22% before you are at breaking it even.

Yahoo Finance

You may think this is bad, but the spread is more extensive in most cases, and there may be a transaction fee. If you decide to keep position overnight, you will be subject to more fees. Forced leverage, in this case, 1:20, meaning that you put up money for one stock, and the CFD will lend you the cash for 20 more. For $1.000, you can hold AAPL stocks for $20.000. This may sound very good as you get more exposure, but it will keep you on an unwanted leash unless you have enough cash to cover sudden changes.

Most CFD companies also lag the price in the wanted direction to make it worse. If a stock goes up, the CFD broker's price moves up slower but instantly kicks in on price drop. This means you will never be able to get optimal trades hitting the exact bottom or top. I have seen the difference in lag reducing an actual trading range (bottom-top) of 7% on the exchange to be only 3.5% at the CFD broker. This simply means that you could lose 50% of the potential profit. I assure you that they will increase your loss if they can. The reason is very simple. While at proper brokers, you actual buy a share; you only buy a contract for a share at CFDs. So it is in their interest; you lose as your money then will go straight into their pockets.

B) The other major thing CFD companies do, especially for currency pairs, is flush positions. Massive algorithms keep track of how many positions can be closed by pushing or dumping prices. To avoid legal conflicts, buyers and sellers are not associated with the actual companies, but the money derives from the same sources. This is why most CFD companies are registered in Malta or similar countries. It is all about mathematics. If a position is closed, you lose your investment. If closing your position costs less than what can be gained, it will always be lucrative. This game that all major players play is known as pump and dump and comes in all varieties in any financial instrument. These actions are often followed up by news to increase the effect. The market is indeed for predators, and this should always be in the back of your head. Personally, I love to pray on the pump and dump as these can easily be detected, and the pattern is very predictable.

You may ask why I don't recommend avoiding CFDs. The answer to this question is in the huge leverage they offer. If you are willing to pay the price and know the risks, then CFDs are a way to access more capital for your trading. Nevertheless, a CFD broker should never be your main trading source.

A good start is everything.

Chapter 2 – Stock picking

Choosing the right stock to buy/sell.

I hate the word "random." It includes too much uncertainty for me. But the fact is that in a very strong bull market, you can make a random choice and, in many cases, be better off than listening to a professional.

In strong bull markets, the professionals usually underperform compared to the index. In bear markets, the situation is different. You will need both skills and luck. There is a reason why one of the most famous expressions is "let the trend be your friend." Therefore, it is important to understand "where you are" when you enter the market, and for sure, when you enter the "stock."

And now it starts to get a bit more complicated because your picking strategy should be based on several factors, and these will change every day. Obviously, in bull markets (rising markets), you can allow yourself higher risks, while you must limit your risk in bear markets. The different interpretation of volume in bear and bull markets is not so obvious, which is vital to determining a good entrance and exit point in a stock. But if you understand that liquidity is flowing into the markets in a bull market, the opposite is happening in bear markets. People would seek other safer investments or simply put their money in the bank. Less volume can affect the stock price even more in a bear market.

So how to pick a stock? You don't. You let the stock be picked for you.

If you're a good trader, you have good strategies, and these strategies pick the stock(s) for you. By following a strategy, you will also identify mistakes and learn from them (nature).

Creating a strategy is much easier than you think, but it takes time to create a good one. A good strategy is shaped around your personality and trading capital. If the strategy is not aligned with your personality, it will be tough to follow it. If your God is Elon Musk, and Tesla is your dream car, you will never be able to sell or buy Tesla (TSLA) when you should. If you are not patient, you should never get involved in ill-liquid stocks. If you have limited capital, you should avoid CFDs as nobody can predict the market accurately. Only Kim Jong-Un takes 1 minute to crash all markets in the world.

Defining a strategy - the start.

Defining and making a strategy is not something to be learned in 5 minutes, but I will keep it simple. The first question you should ask yourself is: "how much money do I have?". The second question should be: "how much of it can I lose?"

Earlier I told you there are 2.800 stocks at NYSE. If the answer to question 1 is that you have $1.000 to trade, you should only trade one stock at a time. If you play more than one stock, you will need a higher return on each stock to cover trading fees. If you got $10.000, the answer is different. If you cannot lose more than 20% of your capital, there will no longer be 2.800 shares for you @ NYSE. You will have to remove all penny stocks (stocks under a dollar) since these are too volatile and unpredictable. You will also have to remove all other stocks that are considered high risk (some different parameters can define risk, and we will get to it later). After these few changes, there will be only like 500 out of 2.800 stocks left for you. Still, there is no 100% guarantee that you will not lose 20%, but you have reduced the risk according to your strategy. If it is a bull market, most of the stocks can be a good pick, but if it is a bear market - as few as 2 of the 500 will be a good pick.

The two initial questions make your base. The 3'rd question should be: "Do I want high, medium, or low risk?" If your answer is a high risk, only a few of the 500 stocks will fit your criteria because you already reduced risk in your first question. There are no penny stocks left or other highly volatile stocks, but there is a major difference between buying Boing (BA) stocks and ZIM Integrated Shipping Services Ltd. (ZIM) from both a technical analysis and fundamental point of view (Check out the gallery below). One can be considered to have more risk than the other. You can have a guess which one. Later, we will determine which parts define the risk and how this can be seen in the chart.

So far, we have defined 3 points forming your strategy and identified how this would have reduced the number of stocks to pick on NYSE from 2.800 stocks to less than 500. By now, a strategy can be vocalized:

"I will invest $1.000 for trading at NYSE. I will cut my losses at $800 and not invest in penny stocks or stocks with extreme volatility. I will invest in 1 stock at the time, and for all stocks passing my first criteria, I will select stocks with higher risk".

This is by no means a very well-defined strategy but is far better than random stock picking. It will also make many decisions for you. If you lose 20% of your capital, you are out. You will not attempt to re-gain by investing more or with higher risk. You will neither sit in 3 stocks paying $15 in fees, but instead in one stock paying $5. The difference is 1.5% profit, and the other is only 0.5%.

If you got $10.000, the situation is a bit different. The amount of cash will allow you to work your risk differently. While being in only one stock at a time, everything falls and rises within the one stock, but it is different if you have three stocks. In the case of three stocks, it is enough that one stock gets strong gains and the others don't collapse. It is simply a different ball game.

Since strategy reduces the number of stocks you can select, it will also be easier to pinpoint what went wrong if your trading does not yield. When you have been trading for some time, you will realize that stocks and whole sectors move differently. One sector may, for instance, go down or underperform in a strong bull market. This may usually be affected by fundamental news like falling oil prices or some regulations. If you work by your strategy but keep picking stocks from the underperforming sector, you may end up losing money. Your first idea will then be that trading by strategy is just bullshit. But what your strategy needs is to be tuned. If you have some cash, you can easily avoid this trap by having a rule that you will never have two stocks in the same sector. Personally, I like to add one of the most important factors in stock trading;

Know your fundamentals.

To be continued...

Jim Stromberg

Co-founder at StockInvest.us

About The Author

StockInvest.us

StockInvest.us is a stock market research tool that provides daily stock signals and technical analysis for over 25 000 tickers on 38 exchanges. The company was founded in 2016 in Vilnius, Lithuania.

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