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Precautionary Words from an Independent Trader

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Stock Market GameThis is the third and final part of a three part series discussing life as an independent trader. In this final post, Matt offers some precautionary words if you’ve considered becoming an independent trader. If you haven’t been dissuaded after reading about A Typical Day in Life as an Independent Trader or the bevy of Tools of an Independent Trader, it would be wise if you took heed of his words of warning.

Precautionary Words of Wisdom

Now that I feel like a pawn shop salesman sending you away with a handgun, please let me give you a few words of advice:

  1. Practice, Practice, Practice. Many websites are available for you to test your active trading skills. My favorites would be WallStreetSurvivor.com where you can compete in weekly tournaments (maybe even win a prize) and Marketocracy.com where you are a mutual fund manager. Think of it like Fantasy Baseball.
  2. Be Patient. My trading style is a “buy on the dips” methodology where I will only buy companies after taking a huge dip in price, and wait for them to become fairly valued. This means I might make as few as five trades all week.
  3. Don’t Gamble. The minute that making a trade becomes a 50/50 chance, it’s time to rethink your motives. This isn’t monopoly money after all.
  4. Trading Can Be Addictive. Just like gambling, the adrenaline rush can override your common sense. I’ve done it, and the results can be less than positive. Walk away, go for a jog, lift weights, or play fetch with the dog. Whatever you do, get out of the chair and away from your screen.
  5. Analyze, Analyze, Analyze. No matter how bad you screw up, learn from your mistakes. My best trades have resulted from lessons learned from past mistakes. It hurts your pride to rehash them, but suck it up and deal with it.

Let me close by saying you will lose money as a trader.

It’s inevitable, and an immutable universal truth.

And if you’re learned one thing from these posts, I hope that you learn that active trading is not for everyone. But if you must do it, practice your trading skills in a virtual environment rather than the real thing.

This concludes the three part series taking a peek into the life of an independent trader. If you haven’t read the first two parts, I invite you to do so as they put this one in a little bit of context. Part one is titled, A Typical Day in Life as an Independent Trader and part two discusses the Tools of an Independent Trader.

This guest post was written by Matt of SteadfastFinances.com. He is a full time, independent trader with some extra time on my hands!

(Photo: photophonic)

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10 Responses to “Precautionary Words from an Independent Trader”

  1. Good post!

    There is no substitution for due diligence no matter what investment you are looking at.

  2. George says:

    Matt,

    Thanks for the great posts!

    I’d love to hear more about your “buy on the dips” strategy. While I’ve employed a similar strategy myself on occasion, there is always the fear that the dip is a precursor to a bad piece of news that will send the stock tumbling further. You’ve rightfully stressed real-time news sources and diligent research, but do you also have a technical component to your analysis?

    Also, what if a dip continues after your initial buy-in? Do you ever view this as an opportunity to double-up?

    I don’t want you to give away all your secrets, but perhaps you can tell what kinds of rules you use? Here are the kind of rules that I consider, perhaps you have more:
    - Filtering Strategy – How do you find new buy candidates? A few key indicators or sophisticated technical analysis using one of the indicated tools?
    - Buy Strategy – You’ve already indicated that you buy in the dips. Any other triggers?
    - Sell Strategy – What triggers your profit taking and stop-loss? What positions do you keep open overnight or over weekends?
    - Diversification Strategy – By company, industry?
    - Cash Strategy – Do you try to keep a certain percentage in cash for hot opportunities that may arise?
    - Dividends Strategy – Are they a consideration?
    - Others?

  3. jay says:

    I’d be interested to hear more about taxes in this situation. When I was young and immature (I pretend I’m not anymore) I had some success with a few IPO shares at a company I worked at. I made a few thousand and decided to try my hand at day trading….

    What whacked me was the capital gains taxes on all the trades I made. I wasn’t aware I would be hit at the higher tax rate for these trades. It was enough to turn me off of day trading forever.

    I’ve always wondered how much $$ it would take to really make day trading profitable.

  4. Fred says:

    Excellent articles… With the writing style and interesting tone, worthy of a blog all to itself.

    Thanks for bringing this guy in, Jim.

  5. thomas says:

    Nice hat trick of posts. thanks for the great information

  6. TStrump says:

    I only just recently opened up a discount brokerage account.
    Before, I just bought mutual funds from the bank and parked my money.
    I will definitely be heeding your advice!

  7. Matt_SF says:

    @ George

    I’m a user of “everything” analysis: technical, fundamental and investor psychology analysis.

    For example, shorting the market last October was a great example of a fear trade since everyone was panicking with the “sell sell sell” mentality. Figuring out the emotions of traders is one of the best tricks you can learn and I write about that frequently.

    A few of your questions can be answered with the use of stop loss orders. Ex) If you buy at $50, but your technical analysis says that $45 is the breakdown of support, then you can set an stop order at $45. Takes the emotion out of trading a losing position. Trailing stops work well also if you’re a momentum trader.

    Filtering – don’t really use anything but I do checkout the most active stocks list (price and volume). Although one trick I like to use is buying stocks trading on the out of their lower bollinger band and about to form a hammer formation just before the 4pm close.

    Sell Strategies – My stop losses are usually very tight. Somewhere around 2.5% loss. I don’t like to daytrade stocks so I’ll keep positions open as long as I possibly can before selling them, but I do have a tendency to sell stocks that have had a great run and will sell into strength with high volume. It really depends on what strategy you’re using… some of my best trades are stocks I bought in January and I’m still holding.

    Diversification – This is a pure trading system so I really don’t diversify. I keep a separate portfolio of longer term trend trades (reflation trade, the “short America” trade, etc). I also keep a smaller portfolio of index funds believe it or not.

    Dividends – I keep a few dividend stocks around. Late last year I was buying oil MLPs paying >10% dividends when oil was <$50.

    Hope that helps… I’d be happy to answer further questions for a future blog if you like.

    • George says:

      Hmmm,

      Interesting comments about investor psychology. My heart wants the market to be logical, but that’s clearly not the case. I’m sure I could learn a lot on this subject. I’m also glad you mentioned your ability to resist profit taking since January. Good to get the message out that all trades don’t have to turnaround immedately

      Thanks again, I’ll be checking out your blogs on SF and here.

      Regards,
      George

  8. Matt_SF says:

    @ Jay

    Daytrading is a tough animal and I would only advise it when the market is trading in > 2% swings. For example, last fall when the Dow was trading in intraday swings of 900 points or more. That was prime daytrader hunting grounds. But remember, daytrading (in my opinion) only works if the market is very volatile.

    As you found out, you will be hit with a higher short term capital gains tax. Any time I make a trade, I record the profit or loss in an old fashioned pencil and paper logbook. I know the idea sounds archaic, but it helps me keep track of what I will pay each quarter. The trick is not to reinvest at least 35% of your profits so you can pay your taxes. It also helps to get an experienced, and ultra patient, CPA to guide you through the process.

  9. DB says:

    What so few realize when starting on the path to trading, part or full time, is that no amount of learning (book, seminars, camps, mentors) can or will prepare you for the actual endeavor.

    Many of us are not accustomed to being WRONG so often and losing money along with it. Moreover, not only does trading often prove you wrong on a daily basis but interday traders are often wrong countless times within the span of 5 minutes. Without a doubt trading will suck you in and then promptly punch you in the face and guess what, for reasons that are beyond me some of us (myself included) keep coming back.

    By far what I so greatly underestimated in the beginning, no outright ignored, is the one true bit of advice that the real traders tell you but newbies just ignore. The hardest part of trading is the psychological aspect. What appears simple and even straightforward in a book, i.e. set your stops, cut your losers short and let your winners run HA! IT NEVER works out that easily.

    If you have never gambled or lost any serious amount of money based on your own decisions be prepared for a gut kick unlike anything you have ever experienced. And yes, the evolution of a trader means that you WILL do all the unwise things the books tell you not to due, trust me. And lucky me, I am cutting my teeth so to say in the worst market / financial environment in decades.

    I am a generally calm person but in the last five years trading has brought me unbelievable elation (windfall), despair (I actually broke down crying), paralyzing fear (watching the markets drop like a rock), full blown bang my fists on the table, slam doors, storm out the house and drive around for an hour ANGER.

    In the end I am still coming back, each hard lesson learned etched into my brain making it less difficult next time around. Even if tradings beats me and I stop I can most assuredly state that in the act of trying to learn how to trade I have learned more about financial markets and the world as a whole. Looking for data to help make decisions made me ask questions, read and research things I have never even given one iota of thought about in the past.

    Best of luck to all trying their hand at this. hang in there.


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