Building Abundance: The Stock Market – Leverage and Margin

“Bucks + Steroids = Leverage” – Gordan Gekko

As a stock trader and professional programmer I love stock market movies. I also love action movies. One thing I hate in those types of movies is when they obviously oversimplify a concept so everyone in the audience can understand it, but in doing so they flat out lie about how it works.

For example I was watching a show and the “tech nerd” fixed an electrical circuit in a matter of  a few seconds that ended up saving a life. Another character asked how they did it and the tech nerd answered “I’ve been around computers since I was 7. Wires are wires.” … No wires are not wires. Just because you use computers a lot doesn’t mean you know a damn thing about circuit boards.

Anyway I’m getting off topic.

In this quote Mr. Gekko was simplifying, but he was 100% on the money. (haha you see what I did there?) Leverage really is taking the money you have and putting it on steroids.

The general idea when using leverage is that you use debt as capital in hopes that the return you’ll get on that debt is higher than the interest you would pay. So for example if John Investor had $100 in his stock portfolio but he wanted to buy $200 in stock XYZ. This means that he had to borrow money and is using 2:1 leverage in his XYZ stock position.

The pro to using leverage is that it can greatly magnify your gains. For example if you were leveraged at 10:1 you would gain $10 for every $1 you would normally gain.

The cons are that you could also lose money at that rate. The other issue is that you have to pay interest on that leveraged debt. That means if you have $100,000 in a position where you are leveraged at 100:1 then you have to pay interest on that $99,000 you are borrowing. That’s pretty irrelevant if you make any type of decent gain in a short time, but if you’re in a stock that doesn’t make big moves or you like to trade for the longer term then it is a VERY valid concern.

There are also a few more things to consider. You may want to use different amounts of leverage for different kinds of trades. Nicolas Darvas for example was known as a “plunger”, because he would take positions where half of his position was leveraged debt and in some cases it was an even higher ratio than that. This is where a position would be called “highly leveraged.”

Margin on the other hand is a type of collateral. It is there to cover the assets or securities you are going to borrow in case there are fluctuations in the price of whatever you may be trading. This is why you need a margin account to short a stock. You are putting your own money down as collateral on the shares that you borrow from the broker.

Building Abundance: The Stock Market – The Darvas Box

There are an unccountable number of patterns in technical trading. Flags, pennants, head and shoulders, cup and handle, double top, triple top, double bottom, triple bottom, ascending triangle, descending triangle, etc. I could literally go on for days. It’s insane the amount of granularity you can get when it comes to analyzing a chart and categorizing the price movements in it.

Today though I’m only going to talk about one pattern specifically and try and cover all of the trading details around it. In fact, what I’ll be talking about is not just a pattern. It’s a full trading strategy. The Darvas box is a pattern utilized in a strategy created by Nicolas Darvas in the mid 50s.

The general claim to fame is that Mr. Darvas used this strategy to turn $10,000 into $2 million over 18 months while travelling as a ballet dancer.

Before we continue I want to make it clear that there are definitely negative arguments  against this trading strategy as well. One of the largest criticisms being that some traders will argue this strategy doesn’t work well in a bear market (a market where the overall price of securities are falling). With that being said there is no reason you can’t use this strategy in reverse if you believe the current trading environment to be bearish.

Also before I start explaining the strategy as a whole I’d like to point out that Nicolas Darvas himself wrote a book on him making the $2 million. I think it can give you a lot of extra insight on how all of the components work in conjunction. Just click on the book image if you want to check it out.

Ok, so now that we have the warnings out of the way, let’s breakdown how this thing works.

The overall strategy is fairly simple. You look only at stocks that are trading at all time highs and also have proportionally high trading volumes. Once a stock breaks a new high it is in a new box. If the new high does not get broken for x amount of days (the exact number depends on the volatility of the stock. For some it can be 2-3 days. For some it can be a week or even 2 weeks) then you have found the top of the new box.

After the top has been found the price will drop some and eventually find a bottom. If that bottom holds for x amount of time (can vary just like the top) you now have the top and bottom of your box.

What Mr. Darvas would do is draw these boxes and as a price broke through the top of a box he would buy into the stock and set his stop loss at the bottom of that box. Then as a new box formed and the price broke through the top of the new box he would increase his stop loss to the bottom of the just broken box.

This way he would never lose more than a single box worth of profits (excluding some catastrophe where a stock for whatever reason may lose a large percentage in after hours).

Mr. Darvas would also scale into his trades as new boxes formed. A perfect example of this is his trade with E. L. Bruce.  He bought 500 shares of E.L. Bruce (a hardwood flooring company) at $50.75 . He bought another 500 shares at $51.125, another 500 at $51.75 another 500 at $52.75 and a final 500 shares at 53.625.

The real key to the entire system is his stop loss. He may not win every trade, but because his stop loss is fairly tight he doesn’t lose much every time he is wrong. This can allow a couple winners to heavily outweigh a larger quantity of losers.

Building Abundance: The Stock Market – The Trend Is Your Friend

Before we begin a little bit of housekeeping is in order. If you don’t understand trend lines and you haven’t read my article about support and resistance I suggest you check it out here before you continue reading. Also, if you aren’t sure what it means to be long or short you can get a better understanding of those terms in this article.

Ok now that I know you’re up to speed, let’s get this thing rolling.

Trend lines do a few obvious things and a few not so obvious things. Almost all of these will help us figure out where to get into and out of trades, so the first thing we’ll want to do is start to draw trend lines. Remember that the more points a chart touches on a trend line without crossing it the stronger the trend is.

Unless your stock price is at an all time high or all time low you should be able to draw trend lines both above and below the current price. The closest line below the current price and the closest line above the price will make what looks like a tunnel. This is known as a trading range.

Here is where trend lines can be extremely helpful. We know that a trend line is a point of either high supply or high demand. If a stock drops to a point of support there is a good chance the price will bounce up, because there are enough people at that level which believe that the stock is a good deal at that price. With this in mind we can actually enter a trade with a hard set stop loss price.

As an example let’s say John Investor has drawn some trend lines and sees the current trading range of stock XYZ is support at $52 and resistance at $56. This means that as the stock gets extremely close to $52 he can buy in long (if his other indicators show a bounce is probable) and set a stop loss at a little below $52.00. In this case we’ll say he buys in at $52.25 and set’s a stop loss at $51.80 (finding the exact stop loss point is a bit of an art and takes some practice but following this strategy you can get pretty close). That means he has about $0.45 of risk and because the resistance is at $56 he has about $3.75 of possible gain.

This works extremely well for figuring out where you should buy in, but where should you sell at? Well there are TONS of options. I think the most common strategy with this one is selling half of your position off when you’re halfway to your target, so in this case it would be after you see a $1.63 gain. The other half you let ride. This is known as taking profit or “taking some money off the table.”

There are lots of other strategies that are far more precise when it comes to setting entry and exit points. In the next article I’ll talk about an extremely precise system known as Darvas boxes.

Building Abundance: The Stock Market – Trend Lines

In technical analysis the most fundamental skill a trader can learn is drawing trend lines. Almost every technical analysis trading strategy utilizes them in some way so today I’m going to talk about the basics of resistance and support levels which are the points where a stock price touches a trend line.

I think the first thing we need to get out of the way is what exactly are resistance and support. It’s fairly simple actually. Both are price points where a stock that is moving in a certain direction needs a large amount of momentum to continue its current trend no matter whether it is up or down.

If  a price is falling and it is nearing a trend line that point is known as support. If the price is rising to a trend line that point is known as resistance.

So to be a little more specific a support level is an area where demand for stock shares is great enough to not allow the price of the share to fall any lower. All sellers should find a buyer at this level.

Resistance is the point where the rate of selling is high enough to stop the price from rising any more. The idea behind this is that as the price rises sellers become more inclined to sell and take profits while buyers become less inclined to buy.

OK, so that seems pretty simple. Now to the part that matters. If you want to trade through technical analysis you need to be able to recognize levels of support and resistance. This generally takes time and practice to truly master, but you can get a fair idea of how it works by remember that every time a price movement stops (a rising price stops rising or a falling price stops falling) that is technically a point on a trend line. All you have to do is line up multiple trend line points to create a true trend line. The more points on the line the stronger the trend.

Here is the reason why this works a large amount of the time. Let’s say that John Investor noticed that there is a point of resistance at $50 for stock XYZ. The stock has been sitting at $49 for weeks. Every time it hits $50 it falls back down. One day it gets to $50.50 so John Investor buys in.  He knows that $50 is now a support. If there are X amount of people that want to sell at $50 and the price went beyond that point that means more than X people thought $50 was a good value. If they thought it was worth buying at $50 the first time they’ll think the same thing when it drops back to $50 again. The same is true the other way around for sellers.

Ok so now that you can find trend lines I’ll talk about how to actually utilize them in the next article.

Building Abundance: The Stock Market – Risk Management

Without question the most important skill you will ever learn when it comes to handling stock is risk management. Most people think they lose money in the market, because more trades go against them than go in their favor. They think a great trader wins a large majority of their trades. In most cases this isn’t true. While there are definitely traders that have a winning trade percentage and some are even up in the 70%+ area, the thing that makes them winning traders is their understanding of risk vs reward.

The truth is many successful traders don’t even win half of their trades. Some don’t even win one out of three, BUT when they lose the losses are tiny in comparison to their gains.

For example if I make 10 trades and I lose 7 out of those 10 it might seem like I’m doing a terrible job, but if we look closer at the gains and losses they can tell a far different story. Let’s say out of those 7 losses my average loss was $200. My average gain for the 3 wins was $900. So in the end I lost $1400 and gained $2700. That sounds pretty good to me.

Now let’s look at the opposite scenario. I win 7 and lose 3. My average gain for each of the 7 wins is still $900, but I have no loss management so each loss will probably be massive. We’ll say they are $2500 a piece on average.

Why would something like this happen? Generally the issue is that people feel that they have to be right. A perfect example is when an investor buys a stock at $55.00 and the stock drops to $54.xx then it goes up to $55.xx. Now the trader with no risk management will say “See I knew this trade was going to make me money.” Sadly the trade starts to take a dive. It hits $54. Then it drops to $53.  Now the trader is thinking “Ok so this trade was definitely going to make me money. It’s losing now and I’m getting scared so I’ll just wait for the price to go over $55.00 again and sell immedateily.” HUGE MISTAKE!

If a trade is a loser, it’s a loser. You don’t have to be right. This is generally where something called a stop loss comes in. A good trader will define the rules of their trade BEFORE they ever get into it. For example let’s say John Investor sees that company XYZ stock is at $55 and after using technical analysis he realizes that there is a good margin for stock price growth, and he sees that at $53.50 there might be a good chance for the stock to dip down due to investor fears. $53.50 is known as a resistance point and I’ll get into that more in the next article, but essentially what John Investor is looking to do is create a line in the sand. He’ll say to himself “I’m going to buy in at $55, but if the stock drops to $53.49 then I”m selling and not a second after.”

This takes all of the emotion out of trading. That mindset of “I’ll just wait until the price goes back to where I bought it” is a losing mindset. That’s an emotional mindset.

You want the emotional satisfaction of being right. Well being right is damn expensive and that’s a price no good stock trader is willing to pay. There is a great chance the stock will never go back to the price you bought it at, and even if it does it may take months or even years. That’s a period of time where you could have been reinvesting that money into winning picks.

Ok so I think you get the general point of risk management. Now let’s talk about different types of risk management. There are a ton of strategies when it comes to risk management in your trades, but I’ll just go over the major ones and that should give you a very powerful toolset for dealing with trades that go south.

The different options are as follows: stop loss, trailing stops, scaling in and out, and hedging. This will be a very high level look so keep in mind that there are lots of extra strategies in and around these options, but the first step is to understand what they are and how they work.

Stop Loss- This is the simplest and probably most common trading tool for managing losses. A stop loss is pretty straight forward. When you buy or sell a stock you also set a price where you would like to close your position if the trade goes the wrong way.

Example time! John Investor likes a company with a stock ticker symbol XZX. He think that the current price of $34 is a great entry point, but he is worried about possible losses. Looking at all of the information he has been given he is pretty sure if the stock goes below $32 then it will really start to tank so he sets a stop loss at $31.95. This means that the moment someone sells a share for $31.95 his stop loss will kick in and all of his shares will be sold. He doesn’t have to monitor the trade himself and let the broker know he wants to sell.

This can be a VERY powerful tool for people who get emotional in the moment and want to remove their momentary feelings from the equation or for people who don’t have the time to constantly monitor their stock portfolio.

Trailing Stops- These are very similar to a stop loss except they move up (or down depending on if you’re long or short on the stock) when the price moves up. This trailing can be done with a hard number such as $1 or by a percentage.

So if John Investor buys a stock at $20 and his trailing stop is set to $0.50 then the current stop loss is $19.50, but if the price goes up to $22 then the stop loss would trail that price by $0.50 and go up to $21.50. This is a great way to lock in profits or as many traders say “take some money off the table.”

Scaling In and Out- This method of risk management can be a little bit abstract. Essentially the idea is that you buy in with a small portion of the amount you plan on investing overall. As the trade goes your way you continually buy in more shares (Scaling in). Once the trade reaches a predetermined value that you have set for yourself you begin to sell off small portions of the trade (Scaling out). Some traders do both. Some traders only scale in. Some traders only scale out. Generally this is an extremely powerful technique if you have a large portfolio and it would be hard to buy and sell your entire position instantly.

Hedging- This is by far the most complicated of the techniques listed in this article. Generally hedging is done using options. The idea here is that once you have bought some shares of a company you buy options in the opposite direction in case the trade goes against you. This will cut into your gains, but also reduces your risk substantially.

This might be a little hard to visualize, so I’ll try and lay out a scenario that might make sense. John Investor likes the tech company TECH and thinks they have a lot of room for growth, but is worried about a competitor pushing them out of the market, so John buys 100 shares of TECH at $55. To help reduce his risk he pays $4 a contract for 100 put option contracts which give him the right, but not the obligation to sell a share of TECH at $55.

This way if the stock goes south he can exercise those options and he’ll only lose the $400 it cost him to buy the options. On the other hand if the trade goes well he must first get to $59 to offset the $4 he paid for the options, and anything after that would be profit.

Risk management is obviously a fairly complex subject and their are entire departments of trading firms that do nothing but risk management and analysis, so don’t feel like you’re going to immediately understand how you should set your loss prevention system up. When I go over things like resistance and support in the next article you should have a much better idea of where these different techniques can be applied when you look at your next stock.

Building Abundance: The Stock Market – Options Trading

There are literally hundreds of complex strategies involving options trading, but before you go down that route you want to first make sure you understand how options work. I’m not going to lie to you and say options are simple. They aren’t. While the basic idea behind them is fairly straight forward, there are so many caveats that it would be hard to list them all in one concise article. Instead I’m going to keep this topic laser targeted and short. We’re focusing specifically on what options are.

A stock option is a contract between a buyer and a seller where the buyer of the contract has the right, but not the obligation, to buy or sell an underlying asset at a set price. Ok so that probably sounds a little confusing by itself. Let me see if I can create a few examples to better illustrate what’s going on.

John Investor thinks stock XYZ is going to raise in price from it’s current value of $105 a share. The problem is John doesn’t want to put that much money down per share right now. So instead John buys what is known as a call option contract. This means that he has a contract with another trader so that he can buy these shares for a set value for some period of time in the future. In this case we’ll say that the call option contract he bought had an expiration date 1 year from now for a price of $105 per share and he paid $12 per contract.

So let’s break this down. He has 1 year to “excercise” this contract if he so chooses. He has already paid $12 per share no matter what. If he buys the shares they will cost $105 a piece, so if we add those two values together we get $117 per share. That means if the price of that stock ever goes over $117 he will make money and rather than putting $105 down he only had to put down $12.

The opposite of this is called a put option. If John Investor bought a put option that gives him the right to sell a stock at a set price at some point in the future. Let’s say he see company ABC trading at $55 a share. He thinks that the price is going to go down so he buys some put options at $5 a piece with an expiration date 1 year from now.

Let’s assume that in some period of time before the 1 year is up that the price of the stock has dropped to $30. Now he has the right to sell shares for $55 a piece so that means for every put option he bought he can buy a share for $30 and sell it for $55 dollars. That’s a $25 dollar profit but you have to subtract the $5 he paid earlier for the option contract. So in essence John put down $5 to make $25 back. That’s called an awesome trade.

Ok so we know what a put is and what an option is. What’s with all of this “right, but not an obligation” junk? As a buyer of these contracts you don’t have to exercise them. You can just let them expire. You paid the seller money and then it didn’t go your way so you just lost your minimal down payment. On the other hand as a seller you are getting paid for this contract which puts you at risk. If you sell an option contract you MUST honor it if it gets exercised. This means as the seller you have the OBLIGATION to honor the buyer’s right.

Ok so those are the simplest options trades that a person can make. I’ll let you digest that for a bit and in the next article I’ll get into more complex options scenarios like hedging positions.

Building Abundance: The Stock Market – Practice Makes… You Better

I hate the phrase “Practice makes perfect.” The first and most obvious reason is that no one is perfect at any skill and no one ever will be. We all make mistakes, but by practicing we can reduce the regularity and severity of those mistakes.  This brings me to my second and probably more important reason for hating that phrase.

Many people user perfection as a benchmark and quit, because they come up dismally short. DON’T DO THAT. Your job is not to be perfect. Your job is to be better than you were. With that in mind, no matter how good you are at a skill, if you practice you’re going to be better.

So here are my major steps to becoming a better trader. These steps have helped me hone my abilities as a stock operator and trade profitably. If you use them then you can do the same.

Make a business plan- Owning stock is no different than a business and just like any good business you should have a plan that guides you in your decisions. This should encapsulate every aspect of your trading possible. It should outline when you’re going to trade, why you’re going to trade, how you’re going to trade, how you’ll do your research, when you’ll do your research, your goals, your improvement metrics, and any other related aspect. As you trade you’ll want to make revisions to this plan as you find flaws.

Keep a journal- This in my opinion is the most important thing you can do to increase your skills over time. In any area of life if you practice you’ll get better… to a certain point. The difference between the average person and the professional is analysis of past performance. You should be keeping track of why a trade went well or went poorly. Analyze what you did right or wrong. What weakness did you have that lead to a loss. What strength did you have that lead to a gain? Once you’ve identified your areas of needed improvement start to devise a plan to laser target those skill sets and devise a strategy to improve them.

One example is reading charts. Maybe you are an excellent judge of company future potential so you pick a lot of long term winners, but you’re terrible at timing your entry (the point when you buy shares or short them) so you always buy at the top of a huge uptick or sell at the bottom of a trough. These are skills you can definitely improve.

I place my trades into a site called <— Click the link to check it out. It’s completely free to simply track your trades and it gives lots of metrics so you can see your progress over time. There are also paid options for things like training and advanced metrics, but you can easily get major use out of the free membership, if you aren’t ready to jump head first into trading.

Use simulators whenever possible- There is no substitute for real market experience, but trading simulators come decently close. Many traders will tell you that you should trade on a simulator before you ever spend a dime on a real share. The rule of thumb if you’re day trading or swing trading and you can maintain a profit after 6 months of simulated trading then you are probably ready to start trading for real. I would suggest that you continue using simulators even after you starting using real money. If your trading strategy utilizes pattern recognition in any way then this can be extremely helpful in building on that ability. (I’m looking at you technical analysis and techno-fundamentalist people out there.)

Wrong Simulator Bro!

Even if you don’t trade on technicals you can still gain from a trading simulator. There are many simulators out there specifically for fundamental analysis. They use real world company stock prices from the past and give you all of the company financials. They won’t tell you the company name, so you can’t cheat, but in a lot of cases if you know the market sector you can probably figure it out.

Building Abundance: The Stock Market – Trading Strategies

There are an uncountable number of trading strategies out there. For most people the issue isn’t figuring out whether they want to trade or not. It’s really a matter of how they are going to trade. If you haven’t read my post on trading styles I suggest you check that out first. Once you understand those you can move into the area of trading strategies.

Generally they fall into one of the following 3 main categories: Fundamental analysis, technical analysis, and techno-fundamentalism. These each have many, MANY sub strategies, but I’ll just give a general overview on each and I’ll try to link a relevant book to each that is both entertaining and informational. I personally hate super dry text book style learning, so I won’t be posting any of those.

Fundamental Analysis- These are the people that believe a company’s current economic situation and outlook will have an extremely strong correlation to their share value. I won’t get into super technical things like EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), return on equity, or even more straight forward things like profit margins. What I really want to do here is explain the idea behind fundamental analysis. When you’re looking at a company with this mind set you’re assuming that their current position will continue to compound onto itself.

For example if a company has had strong growth in previous quarters, a large positive net revenue stream, and they are in a growing market (the technology sector for example) then most fundamental analysts would consider them as having a “positive outlook.” In theory this is great, but there are some definite downsides as well. It’s very possible that the company has some major internal issues that have yet to surface.

One possibility is a company with middle or upper management issues can see rapid growth for multiple years and then quickly spontaneously combust as all the poor decisions eventually lead to a tipping point. It’s also very possible that the market you’re looking at is about to tank so even though the company is sound they are ultimately doomed anyway.

That’s not to say fundamentals don’t work in the long run. They definitely do. Take a look at the Oracle of Omaha, Warren Buffet. He has consistently beaten the market since the early 60s using only fundamental analysis (disregard 2008 and 2009….). Anyway if you want to learn the specifics of analyzing a company then I suggest you check out the following book. I linked it up to amazon, so if you click it you can check out the reviews, because who wants to spend all that time typing book names into Google. Am I right?

Technical Analysis – These guys are the exact opposite of fundamental analysts. They don’t care at all how a company is doing economically. They believe that the market is driven by emotions and patterns. When these patterns arise people will respond in a set way because they are emotional beings. This is where things like trend lines, resistance, support, and moving averages come into play. When you hear people talking about “reading the chart” they are talking about looking at the recent stock prices of a specific stock and predicting the next movement based off nothing but the chart. The company does not factor in whatsoever.

This is further proven out when you hear people say this stock is cheap, because it’s at X price. If the stock is garbage it’s garbage. Just because you can buy it for $1 doesn’t mean it’s worth it, but because so many people think this way (or think in any common way for that matter) patterns will always arise and can be capitalized on.
The book I linked for this trading strategy is the first true stock market book I ever read and to this day it is still in my opinion the best and most entertaining I have ever read. Even if you don’t care about the market I think you’ll find yourself enthralled and if you do care then it’s damn informative too.

Techno-Fundamentalism- If you couldn’t guess, this one is a mix of the first two. There are a lot of ways to mix the two strategies together to get this hybrid, but the most common is an approach I call sector/ticker. Essentially you fundamentally analyze a sector of the market like healthcare or technology to find out if they are able to foster growth. If so then you start looking at all the charts of companies in those sectors. Fundamentals picks the major sector you trade in but technical analysis picks the specific stocks.

By the way I’m a techno-fundamentalist and the first book I ever read about someone using this strategy is still my second favorite stock trading book of all time right behind “Reminiscences of a Stock Operator.” It’s by Michael Darvas and I find it extremely entertaining.  Click the book to check out the amazon reviews.

Building Abundance: The Stock Market – Trading Styles

Ok so there are two main areas of focus when you look at how someone trades. There is trading strategy which makes up what stocks they trade, why they enter a trade, why they exit, and how big the trade is (along with some finer details); and then there is trading style. Strategies can get very in depth and complex, so for now I’m just going to tackle styles. There are 3 major trading styles. Day trading, swing trading, and buy and hold.

Keep in mind that you can use multiple trading styles in your trading strategy, but we’re not focusing on strategy in this article so let’s keep this thing rolling.

Day Trading - A day trade is any trade that is opened and closed in a single trading day. So for example if John Investor buys 300 shares of stock XYZ after the market opens he has to sell his shares of XYZ before the end of the trading day in order for it to be a day trade. Buying stock at 3pm on a Tuesday and selling it before 3pm on Wednesday does not count as a day trade even though the trade occurred within 24 hours.

The idea behind day trading is it allows for the greatest leverage on price fluctuations as you can trade each change in price as opposed to just trading the general up pattern or down pattern of a stock. The other major factor in day trading is it removes the risk of holding stock during non-trade floor hours. If for example John Investor has shares of car company CAR and in the 5 o’clock news people find out that all of their vehicles blow up after 20,000 miles then the price will probably fall through the floor.

When John tries to sell his stock in the morning the price could have dropped by 40% or more before the opening bell even rings and there is nothing he can do about it. Day trading completely solves this issue.

Caveat (Pattern Day Trading) – There is a rule you have to follow if you want to day trade with a margin account (an account where some of the money is loaned to you) that is worth less than $25,000. You are not allowed to commit 4 or more day trades in any rolling 5 day period. A rolling 5 day period means at any 5 day point in time. So if you make a day trade on Wednesday you cannot have 3 more day trades in the period before the next Wednesday.

Keep in mind that the pattern day trader rule ONLY applies to margin accounts under $25,000. If all the cash in your account is yours then you are free to do with it as you wish.

Swing Trading- This is any trade that is held longer than a day but shorter than 5. Generally speaking this definition is rather loose, because if you ask some traders they will say a swing trade can even be a month or more. The idea behind a swing trade is you are trading stocks that aren’t quite as volatile as day trading scenarios so you don’t have to watch them as closely. Many swing traders only adjust their buying and selling strategies outside of market hours. This allows them to have regular full time jobs as well as trade.

Buy and Hold- This is the conservative style of trading. If you watch Jim Cramer on TV this is the style he advocates. Find a company that you think will prosper in the long run and buy into. Then protect yourself from anything that might happen to it by buying into multiple other companies that you also believe in. The general idea behind a buy and hold style of trading is to keep the shares for a minimum of 12 months. This way the gains are taxed under “Long term capital gains” which has a much lower tax rate than short term capital gains.

Short term capital gains are taxed at your normal income tax rate while long term capital gains are only taxed at 15%. Keep that in mind when deciding how you want to trade.

So here is a quick breakdown of where you might want to place your style if you want to fit the stock market into your current lifestyle.

Day trading is for those who want to make a large return on a fairly small investment and have a lot of time during the day to monitor their trades. This is ABSOLUTELY NOT recommended for people who have day jobs.

Swing trading is perfect for people who want to see decently high gains (or losses) and have the determination to follow their trades daily, but don’t need to follow them intraday.

Buy and hold trading is good for anyone looking to make a respectable return in the long run and doesn’t want to pay a high tax rate on those gains. This style is ideal for people with fairly large portfolios that don’t want to watch their stocks like a hawk.

Hopefully this gave you some idea of how you personally might want to trade. That’s it for now. Next up – Trading Strategies!

Building Abundance: The Stock Market – Penny Stocks; Pump ‘em and Dump ‘em

Penny stocks, penny stocks, penny stocks… oh penny stocks. Outside of options trading there is no faster way to get extremely rich or create an insurmountable tower of debt than trading penny stocks. In some cases there are days where you can turn a $100 investment into $1,000 when picking the right penny stock. Of course you can do exactly the opposite as well.

So what are these extremely lucrative and monstrously dangerous stocks you might ask? I can see the dollar signs in your eyes already. Well a penny stock has multiple definitions and in other countries outside the US it is also referred to as a cent stock. The most common definition and the one recognized by the SEC is any stock worth less than $5 and not traded on a national exchange.

So why are these stocks so dangerous? One of the major reasons is lack of regulation. Because these stocks are traded “over the counter” through things like the OTCBB( over the counter bulletin board) and the Pink Sheets(over the counter pink sheet stocks) they have a little extra ability to do “shady” things a big company couldn’t do.

So what do they do exactly? Well if you’ve ever heard of a boiler room or the term pump and dump they were probably in reference to a penny stock.

As a small aside before I explain what pump and dumps are I just want to be very clear that you can absolutely make money off of them, but you can also lose your shirt if you don’t know what you’re doing. What I’m saying is don’t trade penny stocks until you’re sure you understand how they work and you’re willing to take the risk for a chance at the reward.

Ok, so pump and dumps are actually not that complicated at all. Back in the old days before the internet there were these places called boiler rooms. These boiler rooms were filled with “salesmen” that would cold call random people and try to entice them to invest in company XYZ, because it’s so awesome. The only thing is that company XYZ isn’t awesome. Company XYZ is terrible.

The issue is that as these salesmen pretending to be regular stock brokers with “a tip” on great company start to get people to buy the stock price goes up. As more people buy the price goes up faster and then more people want in. It continues to grow exponentially until you have stock that go from being worth 10 cents to being worth 10 dollars in a matter of a couple days.

That part is called the pump. Now for the dump. So company XYZ paid these boiler rooms X amount of dollars to promote their stock. Then when it hit a price that they thought was sufficient they dumped all of their shares for a massive profit thus causing a massive panic and everyone was trying to sell out. The issue is that when everyone panics like that only the first people get out, but guess who the first people are… company XYZ. John Investor is screwed. He bought the stock on the way up at $2. It seemed like an awesome investment when it doubled so he put the rest of his life savings in at $4 when the “salesman” called again saying “, See I told you this company is awesome.”

Boiler Room schemes

But now John Investor doesn’t think the company is so awesome when he is still holding all of his shares that he couldn’t sell and they are only worth 3 cents a piece. Now John Investor has to sell his home. Guess what company XYZ gets to do? They take their millions, file for bankruptcy, dissolve the company, start a new one, and do it all over again. And now it’s even more lucrative than it use to be because rather than cold calling from boiler rooms these guys use giant email lists and just mass mail people their TERRIBLE stock picks.

That’s the bad news, but here’s the good news. This is actually pretty damn predictable and if you know the pattern you can make a lot of money. The catch is you don’t make the money the way you think you would. Instead of buying on the way up you short some stock at the very top or near the very top (no one knows exactly where the top will be). Once the price plummets you buy the shares back and keep the difference.

Obviously it’s not as easy as I just made it sound, but the point is it’s learnable. The biggest proponent of this method is Tim Sykes. He runs this site if you want to check it out. I use it myself. There is a free plan that allows you to track all of your trades as well as paid options that give lots of extra functionality. I highly suggest checking it out and at least trying the free version. Then again I’m a huge fan of numbers and charts.

Ok so those are the basics of penny stocks and pump and dumps. Don’t go starting a boiler room just, because I showed you how it works though. They’re illegal.