Tips for Making your first Trade on a Stock Market

Contrary to popular opinion, it actually is possible to find low risk/high reward trades. However, picking options positions and/or stocks is akin to picking mushrooms. There are tasty ones and poisonous ones that look similar, and a mistake can be disastrous.

The types of trades you should do when starting out are not necessarily the kind of trading you want to do indefinitely. However, as someone who has paid her share of tuition in the school of hard knocks, I can give you some pointers on good “beginner” trading.

1. Beware buying power effect and guard your margin.

A margin account allows you to “borrow” money from your broker. No, you didn’t fill out a loan application, but by opening a margin account you in essence took out a loan.

If you use all your buying power opening positions, then a change in the market could mean that you now have to write a check and deposit additional funds in order to keep from borrowing more than your allotted margin. Keep some cash in the account that is not tied up in positions, and have a wire transfer agreement set up so you can wire emergency funds if you need to.

2. Ride the storm.

People panic. It’s stupid. Don’t do it. When investors heard the Ambac news this week, they dumped the stock like last week’s garbage. (I am deeply, deeply ashamed to say I bought back some puts.) Now, it has rebounded significantly, and all those who lost money are kicking themselves. Luckily, my position was such that I didn’t “lose” I just made less than I could have.

Why did I buy back those *&^% puts? Because I was out of buying power.

How should I have handled the situation? By sending a check to increase my buying power, at least until the panic subsided.

3. Read the charts, and don’t get intimidated.

I could make myself sound smart and sophisticated by saying something along the lines of, “Yeah, I knew it was a good trade when the stochastic and the moving average agreed with Bolinger bands.”

Just between you and me though, there is a lot you can learn from looking at the chart and using a little common sense. While I do use technical analysis, you shouldn’t feel like you have to know everything about indicators to make good chart based decisions.

4. Look for support/resistance.

These are the flatter parts of the chart. When a stock reaches a flat area on the way up, it is called “resistance” and the price will often drop, or at the very least slow it’s climb. A falling stock will also stop at a price where the chart went previously flat. In that case, it’s called resistance, and the stock will often slow it’s fall or turn back up.

5. Read the news.

Technical analysis tells you what investors are thinking. News tells you whether or not investors are thinking correctly.

I have a watch list feature on my trading software, and I keep an eye on all my underlyings (stocks) that way. When something starts changing in price, I read the news about that underlying on Yahoo. If there is no good reason for the price to be moving, I shrug, chalk it up to “investors are idiots” and leave the position alone. Idiocy is ontological, so it’s common that a price fluctuates for no good reason.

Notice I said “good reason”.

Don’t stop at the healine. Read the whole article. Maybe a company got sued, but if they lawsuit is small or if it isn’t likely to succeed, then there is no reason to think the stock will plummet in the long run. There may be a downward spike as the news hits, but if the news isn’t a big deal, the price will drift back up over the next few hours or days.

6. Know the importance of the company.

Ambac and MBIA together comprise the bond insurance industry. That’s why I could sleep soundly with a naked 5 Ambac put in my trade account. The company is stabilized by the fact that they provide a needed service and have little competition.

Starbucks, on the other hand, is another story.

There are plenty of places to go for coffee. Even McDonalds is serving cappuccino these days. While buyer of bond insurance would be devastated by Ambac going bankrupt, coffee drinkers would be only slightly inconvenienced if Starbucks went under.

Small technology companies are well known for going bankrupt since they can sell their intellectual property to a larger company and abandon ship at the first sign of trouble. Their disappearance has little effect of their industry, so no one cares enough to offer financial help.

Because of the issues described above, you need to take charts with a grain of salt. Stocks with similar prices and short-term chart behavior can have very different levels of stability in the long run.

7. Even if you are starting out with little capital, you need some diversity. Invest enough in the account that you can have at least three different positions on three different underlyings, preferably in three different sectors. Whether you are trading options or simply buying stocks, the need for diversity is the same.

8. Think rationally and keep your ego out of the equation (wait! I’m not like the other financial jerks, don’t stop reading.)

You’ll be told over and over again not to get overconfident. You’ll hear about how you have to just cut your losses when things go wrong. They’ll tell you that you’re swimming in the shark pit, or running with the cheetahs, or doing something else unwise with some dangerous animal.

That’s all bologna, of course.

In reality, you are wallowing with the pigs. We’re all just people, and we can all be stupid sometimes, and brilliant on occasion. Those “professional investors,” the proverbial sharks of the shark pit, are now exposed for the big time losers they are. I just read about a bank getting a margin call, which is funny since I get them when I run out of buying power. The only difference is, my position is such that it is improving over time. Theirs is getting worse.

If you get scared and start doubting yourself, you will fail. Period.

You need to consider your trades based on the indicators, the news, common sense, and principles of finance. Sometimes, you will say, “I screwed up” and be right. That’s ok. Learn from it and move on. Try not to do it again.

When a position looks bad, don’t immediately assume it was a bonehead trade. Do not exit in a panic. Do not, say, “Oh, dear me, they were right! The sharks and cheetahs will soon be fighting over the dead remains of my assets!”

If you did the trade, you did it for a reason. What was that reason? What information made you want to do that trade? Has that information changed significantly? Do you think this change is going to last? Why? Why not?

Once you have rationally analyzed the trade, think of ways you can improve your position. Maybe you could buy a hedge, or perhaps exit only part of the position. (If you only trade stocks, that makes life very difficult. Start reading about options so that when you need to handle a sticky situation you will have more, er, alternatives.)

Sometimes you really do need to get out and cut your losses. Sometimes you were right in the first place and you should stick to your guns. (Stupid Ambac puts I knew better than to buy those back) It’s not about your ego and whether or not you were right. It’s about doing what makes sense now, because you can’t control the past.

9. Expect to lose some money.

Everyone does, especially starting out. You don’t want to know how much I screwed up, and even if you did I wouldn’t tell you. (To give you a hint though, the very mention of the index TNY sends me into a cold sweat and twists my stomach like wet dish rag.)

I learned a lot from my mistakes, and although I will always win some and lose some, I am doing well overall with my current trades. It will take a while to recoup my losses, but it will be well worth it. It would have been easy for me to give up if I had anything else to keep me going. Because I refuse to live my life in corporate hell, I had no choice but to continue and have faith in myself.

Faith isn’t easy, but it is what you need to be a good trader. “Luck” will average out over time, but faith and insight make the difference in the long run.