Since thousands of years ago, people have learned that buying something at a low price and selling it later at a higher price has economic benefits. Ironically, it is the same basic principle of Stock Trading in today’s financial market.
Despite such simplicity, many people, market experts and financial institution lose money in Stock Trading. This raises the question of WHY?
Insufficient Knowledge & Skills:
Many traders (both retail & institutions) lack the skills and understanding of financial knowledge to trade stocks.
1. Choose the right market to trade
An investor has to decide where he wants to trade. Is it going to be a global exchange such as Hong Kong Stock Exchange or London Stock Exchange or is it NYSE & NASDAQ in US or a regional exchange in Dubai, Mumbai, Shanghai and Singapore? Most investors have developed an affinity towards their own local exchange because they are familiar with the companies listed there, even though it may not be the best stock exchange. A smart investor would definitely choose a market with the highest trading volume and full of liquidity where all the global players are. This is none other than NYSE & NASDAQ. Both these Exchanges have a combined trading volume of 150 billion dollars on any normal trading day. Such volume and liquidity is way above the rest of the stock exchanges around the world. With a huge trading volume and a broad range of investors with different risk appetite, it is often easier to pick a profitable trade.
2. Choose the right sector to trade
An investor has to educate himself or herself on the latest global trend and thereafter identify the current or upcoming favorite trading sector of the market. It could be bio-technology and pharmaceutical corporations due to outbreak of global epidemic. It could be energy sector because global economy is picking up. It could be a certain type of commodity sector because of a drop of global output as a result of bad weather/disease outbreak in another major producing continent/country. Trading stocks in the right sector do not necessarily lead to profit but it is more likely that the price of those stocks will enjoy an upward momentum, at least in the short term. An ill-informed or ignorant investor may end up buying the wrong stocks because everyone else is already dumping those stocks and moving to the “hot” sector.
3. Choose the correct stock to trade
There are many analytical tools that can be used to decide whether to buy/trade a particular stock. Basic knowledge such as support level, resistance level, moving averages, fundamental, price/earnings (P/E) Ratio, oversold or undervalued scenarios must be considered at all time. Investors tend to trade “hot” stocks because it is among the Top 10 actively traded stocks of the day without actually knowing the reason behind it. Some investors may end up buying Top 10 biggest loser of the day, expecting it to rebound the next day. All irrational trades eventually lead to huge losses.
Invest Only in Companies You Know and Trust
4. Select the appropriate strategy to trade each stock
Every stock has its own characteristic. Some people call it the DNA of the stock. Some stocks always rise before dividend call. Some stocks rise before the launching of their new products. Some stocks rise on certain months of the year. Some top management have a history of launching Stock Buyback (Share repurchase) Scheme to prop up the share price before holding shareholder’s Annual General Meeting (AGM) in order to make their shareholders happy. Some stocks do not follow any specific trend. An investor must study a particular stock in absolute detail before trading it, which is something that 9/10 retail investors don’t do.
Timing is everything. Learn to do nothing. Doing nothing is quite often the right thing to do.
5. Investing is all about choosing the moment when things begin to go up
Timing is everything especially in stock trading. An investor needs to learn about all the market indicators so that he/she doesn’t go against market trend and force.
Wrong Trading Methodology:
Financial institutions such as brokerage firms and banks have set up a system that most traders will eventually lose money.
Three most common ways to trade stocks:
One: Capital Intensive
- No leverage
- Buy your selected stocks and pay in full
- Wait for price to go up, sell at profit and repeat the whole process all over again
- High Risk because once you choose the wrong stock, your capital is stuck for a long time. The fact that you are not given leverage means you have limited financial resources to build a large portfolio to spread your risk.
- Many investors sell stocks that make profit and keep those that are losing money. The fact remains that stock price of good companies will keep on appreciating while the price of non-promising companies will continue to drift lower. Eventually these types of investors miss the chance of huge appreciation and end up with lousy stocks with no future.
Two: Low Capital, High Risk
- Margin Account
- Deposit X Amount of money into a Margin Account and get 3-10 times of leverage
- Able to create a reasonable portfolio of stocks
- Interest charged on margin account is very high. Brokers often offer competitive margin rates, but once the stock price depreciates and money market becomes tight, margin rates can become astronomically high as margin rate calculation is never straight forward.
- Leverage is a double edge sword. During good times, a trader can make a lot of profit. During bad times, a trader can lose a substantial amount of capital and get stuck with high margin interest and low portfolio evaluation; margin trading is a very risky business.
- To compensate for margin interest & losses, investors tend to buy penny stocks in hope for miracles that usually never happen.
- Most margin accounts eventually close down with heavy losses and if the principal is linked to credit card, such losses can take years for an investor to repay.
Three: Gamble on Market Direction
- Contract for Differences (CFD) Trading
- CFD has become very popular for stocks and forex trading in the past few years
- Leverage is very high, can even be 50x of account balance
- In CFD trade, an investor does not actually buy a particular stock. In fact, he/she is making a bet whether prices will go up or down. If he/she guesses correctly, he/she will make money.
- In the United Kingdom, it is also known as Spread Betting and is in fact a form of gambling.
- This is a super risky trade because it has more gambling elements than investments.
- CFD Trading has been deemed un-religious by a number of religious scholars.
- During market turbulence, CFD traders will not be able to close their position because liquidity providers will not be willing to settle the open trade at the market price. Even if they are willing to settle, the spread or close price will cause so much loss to the account holder/trader.
- In fact, most investors who do CFD trades lose all their capital in a matter of time.
As we pointed out, the principle of stock trading is simple. Buying at low and selling at high. However, stock trading is not a gentlemen’s market. There are a lot of tricks and speculations going on at the same time. True facts, rumors and lies are all jumbled up and an investor needs to have the skills, knowledge and experience to interpret all available information and data. Even Institutional players are always looking for ways to win money from one another and retail players don’t have much of a chance to even survive, let alone making profit.
Hence, Financial.org aims to educate our members on how to become good stock market traders. There is no such thing as guaranteed winning trades but there is a winning formula for success for those who are willing to learn and put it into practice.