Trading For Dummies. Lita Epstein

knowing when to hold ’em and when to fold ’em, and we cover that in great detail in Chapter 12.

      

One thing that we can’t emphasize enough is that you must think of your trading as a business and the stocks that you hold as its inventory. You can’t allow yourself to fall in love with and thereby hang on to a stock out of loyalty. You’ll find it especially hard to admit you’ve made a mistake; nevertheless, you have to bite the bullet and exit the position before you take a huge hit. You’ll discover that housecleaning and developing successful strategies for keeping your inventory current are important parts of managing a trading portfolio.

      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.

      

Analysts use this information to project a company’s financial growth and profits. You never should depend entirely on what analysts say, but you always should do your own research and collect the opinions of numerous analysts. One of the best ways to find out what analysts are saying and what aspects of the financial statements may raise a red flag is the analyst call. In Chapter 7, we explain how you can listen in on these calls and understand the unique language used in them to make better choices when selecting stocks. We also discuss the pros and cons of using analyst reports.

      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 identify trading signals and what to do whenever you’ve acted on a failed trading signal.

      Chapter 11 fills you in on moving averages and how to use them to identify trends. You also find out about oscillators and other indicators that traders use for recognizing trading signals. As a newbie trader, you’ll probably find that your greatest risk is paralysis of analysis. That’s where you may find that you’re having so much fun reading the charts or are just so confused about which chart has the right signal that you feel paralyzed by the variety of choices. We show you how to create and use a tiny subset of tools that is available in today’s charting software packages to simplify your life and make your choices easier. You’ll likewise discover how to use such odd‐sounding but critical tools as an MACD indicator or a stochastic oscillator, and we help you take advantage of the powerful concept of relative strength.

      Putting Trading Strategy into Practice

      After you get used to using the tools, you’re ready to put your new skills into practice making money. In Chapter 13, we show you how to put your newfound affinities for fundamental analysis and technical analysis together to develop and build your trading strategy. Using fundamental analysis, you can

      ❯❯ Determine which part of the economic cycle is driving the market.

      ❯❯ Determine which sector makes the most sense for stock trading.

      ❯❯ Figure out which sectors are in the best positions to go up.

      ❯❯ Find out which stocks are leading in the ascending sectors.

      ❯❯ Evaluate where the Fed stands on the economy and which potential moves by the Fed can impact the strength of the market.

      ❯❯ Evaluate and hopefully anticipate potential shocks to the market. Although doing so may seem like gazing into a crystal ball, you really can pick up some signs by checking out the key economic indicators.