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Dr. Market Edge Says Back to Education Institute

Trading Tips
Seventeen, time-honored rules to help improve your trading results.

There are many approaches to the stock market and over time, most will result in positive results simply because the stock market is a favorable game. No matter what approach you use, the following tips will save you a lot of money and should become part of your overall trading strategy.

1) If a company that you are interested in reports bad news and the stock rallies, buy the stock. If a company reports good news and the stock declines, sell the stock. Typically, news is reflected in the stock's price prior to its release. If there is an opposite reaction to the actual event, the news is not what it seems to be on the surface and the odds are that the stock will continue going in the new direction.

2) Invest the same percentage of your investment pool in each stock selection. Don't make the mistake of falling in love with a stock and "loading up" on it. If you are using a disciplined approach, the odds are that each stock has the same probabilities of success. If you fall in love with a particular stock, your judgement and actions will be jeopardized.

3) Use Stop - market orders not Stop - limit orders. A Stop - market order causes your order to be executed at the market once the stop price has been violated. A Stop - limit order is activated once the price violates the stop price but can only be executed at the limit price. If a stop is activated, the market is telling you that you are wrong. When you're wrong, you want to get out now.

4) When the ship is sinking, don't pray, jump. If you don't have the discipline to dump your losers, use Stop - market orders, GTC (Good To Cancel) to get you out. Recognize the fact that you aren't going to be right 100% of the time. If you were that good, you would own the stock exchange and if praying worked, everyone would be rich.

5) There is nothing wrong with trading on margin provided that you use protective stops. Trading on margin increases your leverage. Leverage can be a two edged sword if not properly managed. By using stops, the risk is lowered during adverse times while your profit potential is greatly enhanced.

6) Understand that a stock's price is based on the perception of what the company's earnings will be, not necessarily on what the company reports. When the company actually reports their quarterly earnings, things can really start happening especially when a growth stock misses its mark. The problem with growth stocks is that their prices are usually predicated on a combination of earnings and the perceived growth rate of their earnings and sales. Traders don't forgive even an insignificant earnings disappointment since it destroys their estimates and they dump the stock on the spot. This can cause havoc for the stock, especially if it is a thinly traded stock that trades on the NASDAQ.

7) Shorting stocks should be an integral part of your investment strategy. Assuming that you become proficient at timing the market, you will either be out of the market or on the short side 30% - 40% of the time. In a bear market, shorting stocks can be a very profitable endeavor.

8) Never short a stock in a dull market environment. A dull market is defined as a market that trades in a sluggish, trendless fashion on decreasing volume over a period of time. It doesn't matter if the prior move was up or down. If the move was up, the sluggish activity is typically a consolidation phase which occurs prior to an extension of the move. If the move was down, the consolodation occurs usually before a reversal to the up side. In either case, the lack of interest (dull market) can be a death trap for short sellers.

9) Never reverse a position from long to short or vice versa. When you initiate a position, the stock should meet the criteria that you have concluded has predictive value. If the position goes against you, the odds are slim that all of these conditions have reversed. Therefore it is best to close out the position and look for another stock that meets your criteria instead of trying to get even with the loser.

10) Don't trade against the prevailing trend of a stock or the market. The stock market is like the ocean. When the tide comes in, 80% of the boats will follow the tide. The same is true with the stock market. When the market is in an up trend, the vast majority of stocks will follow the trend. Stronger stocks will obviously outperform their weaker compatriots but even the dogs will usually go up. Conversely, when the market heads south, few are spared the ensuing carnage with the fundamentally weak stocks taking the brunt of the damage. If you don't believe me, check out the number of advancing issues versus declining issues on the NYSE over a thirty day period when the market as measured by Dow Jones Industrial Averages (DJIA) experiences either a 10% up or down move. You want to have the odds on your side so stay with the trend.

11) Don't use limit orders unless you are using charts to determine your entry and exit points. If you are trading large cap listed stocks, the spread between the bid and the ask should be very narrow so there shouldn't be much difference in the long run. Placing buy limit orders under the market will usually result in missed opportunities. Sell limit orders are completely ridiculous. When you want out of a position, get out at the market.

12) Don't think that the market will always come back after a decline. Despite the amazing bull market in the 1990s, the stock market doesn't always go up. Down years will occur and can be devastating to a portfolio. Those that think they can't lose by buying on market dips or corrections will get their heads handed to them in a severe bear market.

13) Don't fall for the myth that seasonality or the Super Bowl winner has anything to do with the direction of the stock market. The media makes a big deal of year end rallies, favorable months of the year, etc. but the facts don't support the argument.

14) Stay away from story or rumored stocks, especially those that are promoted on the Internet. These stocks are the work of promoters and con men and should be disregarded. Odds are that the stocks are worthless and are trading at artificially inflated prices. Once the boys have run up the price to a desired level, they unload their stock and leave guys like you holding the bag.

15) Just because a company splits its stock, there is no evidence to support the fact the stock is going to go up. This misconception has more to do with the state of the market than with the mechanics of a split. Companies typically split their stock when it becomes too high priced to attract the average investor. The stock is typically too high because the market has been in an extended bull phase. After the split, if the bull market persists, odds are that the stock will continue to go up. However, should a bear market ensue, split or no split, the stock will in all probability decline.

16) Stocks and bonds don't always move in concert with each other. Decoupling of the two securities usually occurs during periods of explosive economic growth which historically prelude inflation, a no-no for bonds. The best example of this occurrence happened in 1987 as the yield on the 30 year treasury bond soared from 7% to 10% between February and August. The stock market continued to make new highs during this period, topped out in late August and then crashed in October.

17) Don't expect miraculous returns. Despite the fact that the stock market is a favorable game, you are not going to double your money every year. Remember, historical returns from the stock market have averaged less than 10% a year and the vast majority of professional money managers don't beat the market averages.

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