stocks you want to buy and hold for a while, which is called going long, or holding a long stock position. You likewise have to know at what point holding that stock is no longer worthwhile. Similarly, you need to know at what price you want to enter or trade into a position and at what price you want to exit or trade out of a position. You may be surprised to find out that you can even profit by selling a stock without ever owning it, in a process called shorting. We discuss these vital trading strategies in Chapter 15.
You can even make money buying and selling options on stocks to simulate long or short stock positions. Buying an option known as a call enables you to simulate a long stock position, in much the same way that buying an option known as a put enables you to simulate a short stock position. You make money on calls when the option‐related stock rises in price, and you make money on puts when the option‐related stock falls in price.
When placing orders for puts and calls, you’re never guaranteed to make money, even when you’re right about the direction a stock will take. The values of options are affected by how volatile stock prices are in relationship to the overall direction (up or down) in which they’re headed. We discuss options and how they work in greater detail in Chapter 19.
Managing Your Money
Managing your trades so you don’t lose a bunch of money is critical. Although we can’t guarantee that you’ll never lose money, we can provide you with useful strategies for minimizing your losses and getting out before your stock portfolio takes a huge hit. The key is knowing when to hold ’em and when to fold ’em, and we cover that in great detail in Chapter 12.
Setting a target price for exiting a position before ever trading into it is the best way to protect your business from major losses. Stick with those predetermined exit prices and you’ll avoid a major pitfall that many traders face – holding a position too long and losing everything. You obviously don’t want to turn a profit into a loss, so as your position in a stock produces a profit, you can periodically raise your target exit price while continuing to hold the position to ensure that you keep most of that profit.
Understanding your risks – market risks, investment risks, and trading risks – helps you make better trading decisions. We review the different kinds of risks as they relate to specific situations at several points throughout the book.
Understanding Fundamental Analysis
You’ve probably heard the phrase “It’s the economy, stupid.” Well that’s true, and we show you how understanding the basics of the business cycle can help you improve your trading successes. In Chapter 5, you find out how to identify periods of economic growth and recession and how these differing periods impact bull and bear stock markets. We also explore sector rotation and how to use it to pick the right sectors for your trading activities.
You can also discover plenty of information about how money supply, inflation rates, deflation, joblessness, and consumer confidence impact the mood of the market and stock prices and how the economy can be driven by how confidently (or not) political and monetary leaders speak out about it. We discuss the role of the Federal Reserve (Fed) and how when the Fed Chairman speaks, the markets listen.
Essentially fundamental analysis looks at company financial performance, as well as the performance of the economy, to analyze the future profit potential of a stock or other equity purchase. Understanding how the economy works isn’t the only fundamental analysis tool that’s important to you. You also need to read financial statements to understand the financial status of the companies you want to buy. We delve into financial statements in Chapter 6.
A company’s income statements, on the other hand, give you a look at the results of the most recent period and provide a basis for comparison with prior years and periods. You can use these statements to look at whether revenues are growing, and if they are, by what percentage. You also can see how much profit the company is keeping from the revenue it generates. The cash‐flow statement shows you how efficiently a company is using its cash and whether it’s having problems meeting its current obligations. The balance sheet gives you a snapshot of a company’s assets and liabilities and stockholder’s equity.
You can use this information to develop your own estimate of a company’s growth and profit potential. In Chapter 6, we show you how to do a few basic ratio calculations that you can use to compare similar stocks and then choose the one with the best potential.
Getting a Grip on Technical Analysis
You use fundamental analysis to determine what part of the business cycle the economy is in and what industries offer the best growth potential. Then you use that information to select the best target companies and identify prices at which you’d want to buy their stocks.
After choosing your targets, you then use technical analysis to follow trends in the prices of the target stocks so you can find the right time to get in and ultimately to get out of a stock position. These targets become part of your stock‐watch list. After you’ve established that list, you then use the tools of technical analysis to make your trades.
In Chapter 8, we introduce you to the basics of technical analysis, how it works, and how it needs to be used. Although some people think of technical analysis as no more than fortune‐telling, others believe it yields significant information that can help you make successful trades. We believe that technical analysis provides you with extensive tools for your trading success, and we show you how to use those tools to be profitable.
Your first step in technical analysis is finding out how to create a chart. We focus on the most popular type – bar charting. In Chapter 9, you discover the art of deciphering simple visual stock patterns and how to distinguish between trends and trading ranges, all so you’re able to spot when a stock moves from a trading range into either an upward or downward trend and know when you need to act.
In Chapter 10, we show you how to use your newfound skill of identifying trends to locate areas of support and resistance within a trend that ultimately help you find the right times to make your move. You find out how to read the patterns in the charts to
