Buy and Sell Stock Not Because Simon Says
The ultimate amateur watches CNBC and follows Cramer religiously. He or she will buy or sell stocks solely on the media's recommendation. Alternatively the trader may buy solely on rumors or recommendations from a stock trading subscription site that promises a return of 10x on your cash within a year.
Amateur Trader Experience
In my early days, there was a time when I bought a stock based on a friend's recommendation. One of my friends had successfully called a number of stocks week after week. Of course this was just before the 2009 financial crisis and stocks were still healthy.
One day, I decided to follow his stock pick. I figured he knew what he was doing since he was able to "predict" the movement of several stocks prior. As an amateur, I didn't have an exit plan. I didn't have any stock plan for that matter. I didn't even bother asking him when he would exit the stock.
Sure enough, the stock began to trade lower after a couple of days. After it traded lower for three or four days, there was a bounce and I thought this would take us to new highs. Unfortunately, it was a dead cat bounce and ended up tanking.
While my friend had already cut his losses by then, I stupidly held on. The only thing I had going for me was that it was a very small position at the time. Had it not been, I would've lost a good portion of my portfolio. This is a classic example of what can go wrong when you blindly following another trader's recommendation.
If you follow another trader's recommendation, you may not know when to get out of the trade. Suppose he tells you that he plans to get out at the break of support at $5. Well, the stock is at $10 right now, will you have the guts to still hold the stock if it falls 50%? He has a small position in that stock and is very willing to ride out any storm that hits the stock. But you are a short term trader, losing 50% in paper money and waiting for it to recover means your capital is tied down. Suppose the market takes a huge plunge and you are long a stock. The trader doesn't tweet out what he is going to do. Because you have no plan, and no idea what you are doing, you decide to hold. While you are holding, the stock keeps falling. Finally, it reaches its low for the day/week/month. You are in too deep. You decide to hold and hope it goes back to your purchasing price so you can sell at break-even. Good luck!
Pro Trader's Recommendation
Before you enter a trade, determine your risk and reward. This also means you define your stop loss and your target levels. Your stop loss is the point at which you will get out of the position if it goes against you. If the reward to risk ratio is favorable, you take the trade. When you are wrong, exit the trade immediately and move on to the next trade.
Have a trading plan of action. Don't just sit there and blindly follow another trader's recommendation. No matter how tempting it might be.
There is a lot of noise out there about which stocks and where the market is going to go. The bottom line is everyone has their own opinions and nobody can predict the market with 100% certainty all the time.
Labels: Finances, Pro Stock Trading Tips