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If you're new to investing, where to start can be a stressful process. When I first started investing in stocks, I had no clue what I was doing. I would buy a stock based on the dumbest things, like if it was mentioned in an investment magazine as one of the hottest stocks of the year. I'd also buy stock in companies that I liked, doing no formal analysis. Overall, I was largely unsuccessful in the beginning with stocks.
Well there’s a better way. If you’re new to investing or just want to improve your skill in investing, you’ll find benefit from these tips. Dr. Alexander Elder wrote a book called The New Trading for a Living, in which he gives sound investment advice to new investors. Here are 7 of the tactics he suggests using when starting off as a new investor:
1. Never pay more than you should
A common mistake that new investors make is paying too much to make trades. Every time you make a trade, your broker is going to charge you some type of commission – that's how they make money. If you're an active trader paying $7 per trade, that can really add up to a lot of money wasted. To avoid this, do some research on different brokers to find the best one for you. Lowest cost doesn't always mean it's the best, though. Money Under 30 has a great comparison of online brokers, which might be a good place to start.
Another thing you'll want to avoid is slippage. This basically means you could have paid less for your trade. The best way to avoid slippage is to do a limit order instead of a market order. Just to clarify, a market order means you're buying the stock at whatever the current market price is when your trade is executed. A limit order, however, allows you to specify the most you'll pay for the stock.
Here are some pros and cons of placing limit orders:
2. Don't gamble
In his book, Dr. Elder states that professional traders don't get emotional. The moments you let emotions come into play when you're trading, you're gambling. This means rises in the stock market get you jacked up while drops in the market make you pissed off. Leave emotions out of it if you want to be a successful investor. As Dr. Elder says, professionals know that investing is just a way to make money – you shouldn't feel a personal connection to any of your investments.
Professionals know that investing is just a way to make money – you shouldn't feel a personal connection to any of your investments.
Unfortunately, most of us tend to think of investing like gambling. Probably because both seem like risky ways to make money. Poor trading might be like gambling, but good trading is nothing like it. If you can't resist the urge to invest, or feel the need to invest, you're probably on track to be a gambler, not an investor. If you're getting this sense, take a break and let your investments chill for a month or so. Take responsibility for your investment decisions, don't become reckless.
3. Avoid following the crowd
One of my professors in college always used to say “if you're reading about it in the news, it's already too late to invest.” It's so true. By the time your favorite blog or magazine writes about the next hottest stock, it's probably too late to get in, at least at the best price. Always do you own independent research. Make investment choices that you feel are best for you, not because you read about them in some magazine. To do this, though, you'll need at least some high-level knowledge on how to analyze a stock.
4. Don't invest without proper analysis
It's easy to pick a stock you think looks good based on a product they've recently released or some good news you've heard. But that's just a stupid way to invest, and you'll get burned in the long run for it. Dr. Elder suggests having a strong understanding of bar charts and the 5 key elements within them:
- opening prices
- closing prices
- the high of a bar
- the low of a bar
- the distances between the highs and lows
He says that opening prices will show amateurs' opinion of the stock's value, while closing prices will reflect the decisions of professional traders. If opening prices are higher than closing prices, it suggests that the amateurs are more bullish than the professional traders (and vice versa). The low of each bar will show the maximum power of the bears, while the high of each bar will show the maximum power of the bulls. Lastly, the distance between the highs and lows shows the intensity of conflict between bears and bulls.
Personally, I think a better place to start is a strong understanding of fundamental analysis. Investopedia has an entire section on learning fundamental analysis, which is a great place to start. Another option is to review some of the resources in my article on how to become an investment banker, such as the courses you can take.
5. Look at liquidity and volatility
First, make sure you have what you can handle in your portfolio. Dr. Elder talks about managing only a single digit amount of stocks, because it's easiest for him. He has friends, however, that manage far more than that. Do what's comfortable for you. Remember, you need to know your stocks inside and out, and be able to dedicate time to managing them. So if 5 stocks is too many, stick with 1 or 2 (though at that point I'd probably suggest an ETF or index fund).
Next you'll want to ensure the stock is liquid enough. Meaning that enough shares are traded on a daily basis that you'll have no issue selling when you need to. It sounds crazy, but the author talks about owning 6,000 shares of a stock that had a daily trading volume of only 9,000 . This caused a huge headache when he was trying to sell it and added a bunch of extra costs, too. Shoot for stocks that have a trading volume of over a million per day.
You'll also want to focus on the stock's volatility. That is, how frequent the price of the stock rises and falls. A stock that's very volatile gives you a great chance to make money, but also a great chance to lose your ass. Know your limits and your comfort zone. If you're someone who panics when the stock's value falls, stay away from volatile stocks. If you're someone who has a stomach for volatility, though, and your retirement horizon is further out, you can probably manage it.
6. Use two simple rules
Ahh simple rules. Remember when I taught you about the power of simple rules? Well here they are again. Dr. Elder suggest using two simple rules when you're investing:
- The 2% rule
- The 6% rule
The 2% rule says that you should never invest more than 2% of your available trading equity on a single trade. For example, if you have $100,000 in trading equity, your limit per trade would be:
100,000 x .02 = $2,000
According to the math above, the most you should invest on a single trade is $2,000. This includes any fees and commissions as well. So say the price of the stock you want to invest in is $40. Not including fees and commissions, you'd be able to grab 50 shares ($2,000 / $40 = 50). To ensure you don't go over your budget, you can set up a limit order, which tells your broker the most you'll pay per share.
Now the 6% rule on the other hand dictates how you handle losses. According to the 6% rule, you prohibit yourself from making any new trades for the rest of the month if your total losses plus any risk from open trades equals 6% or more of your trading capital. So using the example from above, we'll say your stocks are down $4,000 in total value this month. Here's how it looks:
6% rule = total losses + open trade risk:
$4,000 (total monthly losses) + $2,000 (open trade risk) = $6,000
- With total losses at $4,000 and open trade risk at $2,000, our total “risk” is $6,000.
Now we take that $6,000 and divide it by our total trading equity, which we established earlier as $100,000:
$6,000 (total “risk) / $100,000 (total trading equity) = .06 or 6%
- In this case, we've met 6%, and according to the rule, must halt any further investment for the month.
7. Keep a trade journal
Most people will track their performance in their online brokerage account, and that's fine. But a trade journal adds another element – it helps prevent emotional trading. Just like someone on a diet would keep a food journal, keep a detailed trade journal of every trade you make – buy or sell. This way you can look back over the course of a few months (or years) and see every trade you've made. Sometimes it even helps to jot down notes as to why you made the trade. This may come in handy later.
- Further reading: How To Keep a Trade Journal (via Yahoo! Finance)
Whether you’re a new or seasoned investor, following the tips Dr. Elder gives us in [easyazon_link identifier=”1118443926″ locale=”US” nw=”y” nf=”y” tag=”monemoza0c-20″ cart=”n” cloak=”y” localize=”y” popups=”n”]The New Trading for a Living[/easyazon_link] will help you become a much better investor in the long-run. Don’t forget that success in the stock market is largely based on focus and discipline. You also need to know the ins and outs of your company. With a strong understanding of fundamental analysis and a little bit of psychology, you’ll be making money in the stock market in no time.
What tips do you have for new investors? Please share below!