Traders want to make money from changes in stock prices. As a sole trader, you trade strictly on your own behalf — you don't trade or invest for others. Making money is the ultimate goal, and some short-term steps can help make that happen. Those include understanding one or more markets, developing a trading strategy, establishing how much risk to take and mastering money management.
Traders can choose from many types of markets, including those for stocks, bond, futures, options, commodities and currencies. You can trade in as many of these as you like, but gaining a thorough understanding of how each market and type of trade works is an objective required to consistently earn profits. This is because trading is a "zero-sum game" — that is, every trade has a winner and a loser. The better-informed trader is more likely to be the winner. Although luck sometimes plays a role, you can't depend on it for consistent profits. An expert trader understands the mechanics of how a market operates, what drives price movements within a market, and what risks will be encountered by trading securities, commodities or contracts within the market.
Developing a Strategy
A trading strategy is a set of rules you follow to guide your buying and selling. The two broad classes of strategy are fundamental and technical analysis. Traders who adopt fundamental analysis buy and sell based upon the financial and economic characteristics of a particular company or market, such as a company's profit outlook or the demand for and supply of a particular commodity. In contrast, technical analysts rely on past prices and trading volumes to predict future prices. A trader can meld the two approaches by using fundamental analyses to pick securities, but also timing purchases and sales based upon technical analysis.
An important objective for traders is to understand the risk of losing money on a trade. Each market has its own set of general risks, and each asset within a market adds unique risks. Some risks involve sudden economic or political events that move entire markets. Other risks pertain to a particular company, such as the announcement of a product recall. Traders must expose themselves to risk in order to reap a profit, which is the ultimate goal. You can use various techniques, such as hedging, to control the amount of risk you undertake. Hedging means making two or more related trades with risks that partially offset each other. Diversifying your trades over many assets and types of assets helps to lower risks, because some asset prices may go up when others go down.
Managing Your Money
Money management involves establishing a disciplined approach to each trade that describes buying price, selling price, size of trade and how much margin to use. Margin is money you borrow from your broker to help pay for your trades. It magnifies both risk and potential reward since it increases the size or number of your trades. By establishing your money management rules before you enter into a trade, you remove the emotional aspect of trading decisions and cut short your losses at a predetermined level. In other words, you control your risks so that your losses don't overwhelm your profits — an important objective.
- TD Waterhouse: Calculating Margins
- New York Attorney General: How to Choose an Investment; Pyramid of Investment Risk
- Charles Schwab: How to Pick Stocks Using Fundamental & Technical Analysis
- Encyclopedia Brittanica: Hedging
- Investor.gov: What is Diversification?
- Key West Investments: An Introduction To Day Trading