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Basic Rules of Trading

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When an investor decides he or she wants to start trading (buy and sell securities more frequently), there are more risks involved.  These risks can turn your profits into losses in the matter of seconds.  There are a few basic rules of trading that I have come up with:

  • Know when to exit

Knowing when to exit a position is just as essential if not more essential as entering the trade.  It can be the difference of making and losing money.  You should develop a strategy that your comfortable with and set the limits prior to entering your new position.  Some people don't like this idea because the limits might be hard to change when the market is moving at a fast paste.  What I usually do is recognize my strategy and set up alerts, and depending on my current situation I can determine if I want to set my stops and limits to a new higher point.

Setting up a strategy doesn't always in-tale adding stops and limit orders on a security after you have bought it.  I sometimes create very complicated formulas that I have my trading software track for me.  With any good trading software you should be able to customize your own indicators and setup alerts on them.

  • Understand Risk

Understanding risk is a key factor in trading.  First, if you’re trading securities, you want have a basic understand of what that security is and why you think it’s going to move in your favor?  There has to be some reason why you want to trade the security.

Second, usually, the more complicated it is to price a security the more risky it is.  This means if you’re trading things like futures and options which the price is based off of some other product (derivatives) than you should understand the risk with that contract.  For example, I have got into positions where I didn't understand the full contract specifications.  I shorted some call options near the market close of the expiration week.  What I didn't realize is that these options could be executed later then the market-close.  I ended up with 10,000 shares of something that I couldn't afford, but luckily it ended up in my favor the following day when I sold the shares.

  • Talk about your trades with someone

This one that I take for granted.  My brother and I do all our trades together.  We formed a partnership and all our trades go through the partnership.  So it’s kind of like a small investment group.  Talking about your trades with someone else can be really helpful because they might see things that you’re not seeing.  The hard part is finding people that are just as interested in what you’re doing as you are.  One way you can do this is by (you'll never guess) joining an investment group.

First, figure out the right investment group for you.  Don't just join one because I said so.  Do your research on the group and understand what their stipulations and goals are.  Many investment groups require you to invest so much money into the group every month, and it will have a common goal and strategy it’s trying to attain.

If you end up trading with someone you know make sure you have a contract on how the trades will be executed.  For example, my brother and I trade a lot of options and discuss our strategies among each other.  If I come up with a trade that I think is looking good then I will discuss it with my brother and he will tell me to go ahead and enter the trade or push it to the curb.

One thing we make sure is to not get mad at each other.  Some trades that one of us wanted to get into and the other didn’t might have turned into a winning trade, or on the flip side of the coin we could’ve got into a trade that turned sour.  This will happen.  Just understand your risk and know who you’re working with.  Don't allow it to affect your relationship outside of this company.  My brother and I don’t get mad at each other about trades because we know it was both of our decisions together.

  • Do your own research

I would like to repeat this one, "Do your own research!"  To start off with, I bartend on the weekends and hear a lot of people talking about the next 'hot thing'.  I always will listen to what people have to say and figure out why they think this investment will be profitable.  Then, if it still sounds appealing, I will go home and do my own research.  In the past, I have spent hours researching data about strategies that initially sounded like a good idea but didn’t look as hot when I was done.

In addition, I read a lot of articles and newsletters that recommend different stocks and investment ideas.  Good newsletters will tell you why they are recommending one investment over another.  It will also go into detail on when they think you should enter and exit.  All in all, I like reading the articles and newsletters to understand what other people think is happening.

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