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Introduction

 

What does a trader need for success in trading?

I personally believe that there are three things which affect trading success:

1. Analytical skills, and a trading strategy, to find -- what to buy and when to buy.
   Most trading books are about this part of trading. However every book on trading is likely to have its own unique approach/strategy. This will be enough to confuse any new trader.
   
   Mostly, stock trading involves valuing a stock and there are three major approaches for stock price analysis. Writing about these three topics itself can be a content for one stock trading book! So I am just going to highlight them briefly.
   
   (i) Fundamental Analysis (FA)- This is where you study the ***company***, its ***Business model*** and its ***industry***. This is time consuming and it asks for professional skills/education. The results of good fundamental analysis are seen over medium to long-term time period. So fundamental analysis is suitable more for investors than for traders.
   
   If you are a trader or want to be one, un-learn all fundamentals or learn how to not let fundamentals come in your trading decisions. I am not against fundamental analysis of stocks but I want to highlight that FA is more successful when applied over long term. For short-term trading, many times the fundamentals stay the same but you will the stock move up or down significantly. See how Google dropped down from 450 to 350 and then come back to 450 and then drop back down to 350 over last three months (Around Mar to May 20060? Was there any abrupt changes in fundamentals that would justify such roller coaster movement in stock prices? Do you get my point? Fundamentals remain more or less the same but the stock can move up and/or down significantly. So if you want to be a trader- learn to neglect EPS, Book Value, ROI etc. Otherwise, trading a stock with using weapons meant for investors can kill yourself.
   
   (ii) Technical Analysis (TA)- This is where you study ***stock price of the company***. You look at the recent movement in stock price and then try to predict future stock price movement. This is the approach where most traders are interested because TA is more successful for short-term price prediction. So it is more for traders than for investors.
   
   This TA can be further divided in few groups/segments.
   First, some stock trading books use the price information itself- the raw prices- without any math or computation on them. One such book, probably the best stock trading book on this approach is PROFIT FROM PRICES. It uses just the prices of few days, compares them and then extracts tons of valuable information for finding stocks for trading. This group of Technical Analysis uses stock prices, price charts and patterns on stock price charts.
   Second, most Technical Analyst books will apply some math on prices. They use the first or second derivative (rate of change in prices), average prices (moving and exponential price, and variety of stastitical models on prices. Their indicators can be sub-divided into two groups- leading indicators and lagging indicators. Leading indicators are more proactive and they try to predict something before it happens. On the other hand, lagging indicators wait for some confirmations and then they make their assessments. The problem with leading indicators is that they often occur too-soon and the problem with lagging indicators is that they are often too-late.
   
   (iii) Contrarian Approach: This is one less popular method of stock price analysis. The followers of this sect usually neglect fundaments or technicals of the stock. Their trading strategy is to stand against the crowd. So if ****most people**** are thinking that the stock prices are going to go high, a contrarian will sell/short the stock. On the other hand, if ****most people**** are afraid that the stock market is going to go further down, a contrarion thinks that it is the best time to buy stock. As you know the keyword for contrarion is **most people**. Such times, when ***most people*** are thinking in one direction, take place very rarely- may be once in every few years or once in a decade! So for traders, this is the approach they need to save themselves from. *******Most losses in trading stocks can be attributed to application of contrarian thinking. Many trading positions are taken based on thinking like, "The stock prices has gone up too high", or "the price has fallen too much". However in reality, there are cases when a stock has gone up 100% or even 500% from this 'too high' price level. So avoid being contrarian in trading. It can work well once in few years for investors but for traders, this approach usually brings in losses.
   
   Here is one nice example of a stock trading strategy/indicator/signal. Don't forget to read it.
   
   Let us now go to the second important requirement for success in stock trading.
   
   
2. Trading Discipline and Money Management: Every trader in the marketplace has just one objective- to make money. However very few people are able to consistently make money in the market. When markets are rising, it seems easy to make money. However when they are trending down, they take away most of the profit or capital of many, if not most, individuals. Trading is a tough game with many traps. If a trader is not watching himself, his actions, his behavior or his emotions, he is likely to fall into some of these traps. To avoid such falls, it is imperative to be rational in trading decisions and to control emotions. This seems easy but as a matter of fact, emotions like greed, fear, hope, overconfidence, regret, etc., are very difficult to manage. If there is a trading position with profit, should it be held a little longer or should it be closed to book profit? If a trade is going into loss, should one wait for the prices to recover or cut the losses? Such decisions are tough to make without getting emotional. To be rational, and free our mind from emotions, is a tough job.
   
   So how should a trader trade stocks then? He should constantly strive for trading discipline; and, trading discipline can be achieved with strict money management rules. Every prospective trader should lay down a framework of policies and rules by creating a formal, well-defined trading plan. The plan should contain trading objectives and trading rules/guidelines based on one's financial situation, trading objectives and risk preferences. There should be rules or guidelines about how much fund to commit to trading, how to identify stocks for trading, how much fund to commit to each trade, when to close a position, how to control risk in trading and how to monitor trading progress. Such rules should be strictly adhered to. This can save a trader from taking large positions at high prices which seem to ruin most of the investors when market stages sudden reversals.
   So it is must for a trader to "Plan your trades and Trade as per Plans"
   
   
   
3. Luck: Despite of having excellent analytical skills and trading plans, there are millions of factors outside an individual's influence or control. As an example, there is no way to know for sure what Alan Greenspan will do about interest rates in the next Fed meeting. One has no idea what the next Unemployment, GDP or Inflation report will be, or how good eBay or Amazon's earnings will be! I label such uncontrollable, unpredictable events as LUCK. Certain events can cause a sudden change in the mood of the market and the direction of the stock prices. Though one might have entered into a correct trade at the correct time, it may go sour in the next moment for any reason. So what should one do when something unexpected happens that causes the stock price to move contrary to one's expectations/position? One can, and should, use a Stop-loss.
   
   Here is one of the best webpages about stoploss on the Internet.