Planning a Successful Stock Trade

for Dummies

Secrets of a Successful Trader Revealed

CONTENTS
Trading Psychology .................................................................................................................................................................................................. 3 Discipline .............................................................................................................................................................................................................. 3 Managing Your Emotions During a Trade ............................................................................................................................................................ 3 Hope ................................................................................................................................................................................................................. 3 Fear .................................................................................................................................................................................................................. 3 Greed ............................................................................................................................................................................................................... 3 Trading Styles ........................................................................................................................................................................................................... 4 Day Trading ...................................................................................................................................................................................................... 4 Swing Trading .................................................................................................................................................................................................. 4 Long Term Investing ........................................................................................................................................................................................ 4 Step 1: Building a Focus List of Stocks ...................................................................................................................................................................... 5 Patterns ............................................................................................................................................................................................................... 5 Stochastics ........................................................................................................................................................................................................... 5 Price ..................................................................................................................................................................................................................... 5 Volume ................................................................................................................................................................................................................. 5 Moving Averages ................................................................................................................................................................................................. 5 Step 2: Analyzing the Results ................................................................................................................................................................................... 6 Step 3: Planning the Trade ....................................................................................................................................................................................... 7 Step 4: Managing The Trade .................................................................................................................................................................................... 8 Scaling In and Out of Positions ......................................................................................................................................................................... 8 Mechanical Stops vs. Mental Stops .................................................................................................................................................................. 8 Taking Profits ................................................................................................................................................................................................... 8 Step 5: Reviewing Your Performance ....................................................................................................................................................................... 9 How To Obtain The Software In This Article .......................................................................................................................................................... 10

TRADING PSYCHOLOGY
Please do not skip this topic. It may be the most important topic in this entire article. You should not underestimate how important trading psychology is to your ultimate success in trading. If you cant manage your emotions during the trade, then you will soon learn a very valuable (and expensive) lesson.

DISCIPLINE
It is important to take the time to develop a plan before you enter a trade. Once you are in a trade emotions can override your normal decision process. Therefore, it is crucial to know where youre getting in and where you are getting out beforehand. Ive watched many traders crash and burn because they skipped this crucial step and decided to play it by ear. Unfortunately, there normal rational mind didnt react so well once the pressure mounted during the trade. When you see signs of reversal in the price action, get out, no questions asked. No one knows for sure what a stock will do. Stick to your plan. If you dont, it can quickly deplete your investment account. The Market Makers have a vast amount of capital at their disposal, and can manipulate the price of stocks. It is best to take your cut from the middle. Never try to pick a top or a bottom.

MANAGING YOUR EMOTIONS DURING A TRADE

One of the things that paper trading will never prepare you for is the emotional rollercoaster that you will experience when you enter a trade. When you have real money at stake it can cause you to get very emotional as the price of the stock goes up and down. The primary emotions that cause mistakes in trading are fear, hope and greed. There is no room in trading for either of these emotions. Lets discuss further how they can prevent you from effectively executing your trade:

HOPE

There is no room in trading for hope. Hope is simply a rationalization of a mistake. If you find yourself hoping that a stock price will go up, you probably missed your exit along the way.

FEAR

The fear of losing money can cause you to exit a profitable trade too early. You should wait for signs of reversal before exiting a profitable trade.

GREED This emotion has blown up more trading accounts than any other. Many people enter a trade with a
preconceived notion of how much money they would like to make, irrespective of what the market is telling them they should do. As a result, they ignore signs that would normally cause them to exit a position, only to find that the gains they could have realized have dissipated. Only to be replaced by massive losses.

TRADING STYLES
There are various styles of trading based on time horizons:

DAY TRADING

The time frame is within a given day. A purest day trader will enter and exit multiple trades within a given day scalping gains from the price action that occurs in the stock. I would not suggest this style for the novice trader. Many people devote their entire life to learning this skill. These will be the people on the other side of the trades you make if you decide to go with this style.

SWING TRADING

A swing trader will buy a stock on one day and sell it a few days or weeks later. This is often based on technical analysis and the ability to spot predefined patterns in the market place. This is where I feel most comfortable as a trader.

The time frame can be several months to years for a long term investor. They dont monitor the price action LONG on a daily basis. Instead, they check the stock every couple weeks or months. This type of investing is better TERM INVESTING for well-known stocks such as IBM or Microsoft. Im not saying pick up either of these stocks, Im just giving an example of stocks that dont have as much volatility associated with them compared to high yield stocks such as pharmaceutical stocks.

STEP 1: BUILDING A FOCUS LIST OF STOCKS

The first step is to identify a focus list based on specific filter criteria. This will narrow the list of 6,700+ stocks down to a handful of candidates that you can effectively manage. My preferred style is swing trading bottom reversal patterns. I find that Eye In The Sky Screener contains the best tools available to develop a narrowed focus list of stocks.

PATTERNS
I like to focus in on stocks that have the following patterns: Channel Down Channel Down (Strong) Double Bottom Head & Shoulders Inverse Multiple Bottom Triangle Descending Triangle Descending (Strong) Wedge Down Wedge Down (Strong)

STOCHASTICS
I look for stocks with a Full Stochastics (14, 3, 3) %K indicator less than 30%. This indicates that the stock is in oversold territory.

PRICE
I like to trade stocks with a Price Range between $5 and $200. I avoid low price stocks because there is a lot of manipulation surrounding those stocks. I tend to buy stocks over $10 or $15 a share. But, I leave my criteria set a little lower, just in case there is a high quality company that has an undervalued stock price. I have to be very familiar with the company to consider purchasing a stock under $10.

VOLUME
I specify a Minimum Daily Volume of at least 50,000 shares. I avoid stocks in non-liquid markets. You always want to be able to sell your shares when you need to.

MOVING AVERAGES
I specify an Exponential Moving Average that is within 3% of the current price. Often times a stock will bounce off the moving averages. The more indicators that line up increases your probability of success in the trade!

STEP 2: ANALYZING THE RESULTS

Determine if the stocks fall within predefined patterns. Look for major support and resistance levels. All of this information is necessary to plan out a methodical trade. I visually scan the resulting list, looking at where the current price is in relation to the patterns that are playing out. Im looking for stocks that are ready to bounce off major support levels. This will limit our risk when we enter the trade. If the stock breaks that major support level it would indicate that we should exit the trade and take the loss. Otherwise, the reversal pattern will play out, and we can stay in the trade until our first target is met. This usually is just below the nearest resistance level. I will run through an example of how you would do this. Lets consider the following chart for WMGI:

Ive drawn the trend lines on this chart. This is important to determine where to place the stop loss order. In addition, it will be used to determine our price targets. Heres what I observe when I examine this daily chart: The current price is just above the nearest major support level. There is in an upward trending channel playing out. There is consolidation occurring in the last 6 days. The volume is at a good level with the most recent day higher than the previous days. Price can fall with no volume. But, increased volume is required for price to increase. The full stochastics (14, 3, 3) are %K indicator is at 27.7894. This puts the stock in oversold territory. Of course, a value below 20 is the preferred level, but this is within the acceptable range. Anything below 30 is considered oversold. The full stochastics %K indicator is above the %D indicator. The ideal scenario would be a %K below %D that is just about to crossover at an angle of %45 or greater. The angle of accent is important. The steeper the accent the more momentum that exists. For large price movements the momentum is necessary. If you look 8 days back you can see that the price quickly moved up when the crossover occurred between the %K and %D indicators. It was accompanied by heavy trading volume. This is the optimum setup. I have the 20 (green), 50 (yellow) and 200 (red) day exponential moving averages on my chart. I notice that the 20 day is above the 50 day. Sometimes it is good to look for a crossover between these indicators. In addition, looking for a price level that is getting ready to bounce off one of these moving averages can be very beneficial for momentum.

Remember, the more indicators that line-up the higher probability that the trade is going to be successful.

STEP 3: PLANNING THE TRADE

The next step is to plan where Im getting in and out of the trade. I need to determine the Risk/Reward ratio for the trade. This will enable me to focus in on trades that are the most profitable. I enter the following values based on the observations above:

I enter $15.15 as my entry price. This is just above the current price of the stock. I plan to scale into my position, so I enter 200 as the number of shares. The software automatically calculates the market value of my position as $3,030. I enter $15.03 as my stop loss price. This is just below the nearest major support level. The software automatically calculates my potential loss as being $33.98. In addition, it calculates the percentage of that loss compared to the market value of my position. I enter $15.97 as the first price target. This is just below the nearest major resistance level. The software automatically calculates my potential profit as being $154.02. In addition, it calculates the percentage of that profit compared to the market value of my position. Risk/Reward Ratio is calculated as 5:1. This means that the potential profit is 5 times higher than the potential loss. Successful traders look for a Risk/Reward ratio of at least 3. I enter $16.99 as my second price target. This is just below the major resistance level that defined the top of the upward trending channel. The software automatically calculates the potential profit as $358.02 with a 12% gain on the market value of my position.

I can now use this information to enter my orders using my trading platform.

STEP 4: MANAGING THE TRADE

SCALING IN AND OUT OF POSITIONS
Successful traders dont buy or sell all of their shares at once. It is important that you establish a small position in a trade to test the waters. You can then add to that position over time as things move in your direction. This applies when you are exiting your trade. You can sell just a portion of your position at the first target, and then hold the rest until a reversal signal is detected in the market. That way you can let your winners run! At that point, you have all ready locked in some of the profit.

MECHANICAL STOPS VS. MENTAL STOPS

Consider a stop loss as being an insurance policy against suffering massive losses. Dont be upset if you get stopped out of your position. At least you didnt lose 100% of your investment. Disciplined loss prevention strategies are the key to not losing your hard earned investment capital. Lets discuss the two types of stops. A mechanical stop is a stop loss order placed through your brokerage. Be careful of not placing your stop orders too close to the current price. There is a force in the stock market called Market Makers. These entities exist to ensure the stock market trades in an efficient manner. However, they tend to manipulate the prices by quickly buying and selling large numbers of shares. If they spot a stop loss order that is very close to the current price, they may quickly drop the price down to stop you out of your position. Immediately, it will go right back up. Some brokerages provide a hidden stop order type. This type of order is held at the brokerage until the price specified is met. It is then sent to the market to be filled. This allows you to enter a stop order that is invisible to the Market Makers. This is preferred to prevent getting artificially stopped out of your position. A mental stop is manually placing a sell order when a predetermined stop loss price is hit. This requires that you watch the price action throughout the day, and act as if you were a machine. You cant get emotionally attached to the trade. When the price level is hit, you need to sell. There is no room for hope in this equation. Once the price has broke-down through the support level, it invalidates your reasons for entering the trade. Dont hesitate or a small loss may turn into a very large one. You will want to adjust your stop loss prices as the trade progresses. If you are following a multi-day swing trade, then you would want to reevaluate the stop loss each day to determine if it needs to be raised. That way you can lock in profit as the market makes it available. Disciplined profit taking separates the successful traders from the rest. That brings us to our next topic of taking profits.

TAKING PROFITS
The next step during a trade is to take profits. It is recommended that you scale in and scale out of your positions. So you may decide to take 50% off the table once your first price target has been met. This way realize those gains, and limit the risk of losing everything you have made. This is all part of being a disciplined trader. If the market shows signs of reversal, you need to get out. You can lose everything you have made if you dont.

STEP 5: REVIEWING YOUR PERFORMANCE

It is important to review your trades to identify areas of improvement. The most successful traders look at the worst trades they made to learn from their mistakes. The first step is identifying what mistakes you made, and then making corrections to that they do not repeat those mistakes. They can range from entering a trade too early, to exiting a trade too late. Another common mistake includes entering a trade without knowing the reason for entering the trade.

HOW TO OBTAIN THE SOFTWARE IN THIS ARTICLE

Eye In The Sky Screener is a very powerful software package that aggregates lots of useful trading information from many valuable sources. It saves me a great deal of time finding and research profitable trades. You can download a free copy of this software from the official web site at www.eyeintheskyscreener.com.