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Trading for Dummies® 2nd Edition

Book Description

Now updated — your guide to trading success regardless of the market!

Want to make smarter trading decisions? This strategy-packed, no-nonsense guide presents a proven system for analyzing stocks, trends, and indicators and setting a buy-and-sell range beforehand to decrease your risk in both up and down markets. You'll discover the benefits of position trading, conduct technical analysis, and research your entry and exit points before you even purchase your stock.

  • Build your trading toolbox — know the markets and exchanges, find a broker, set up your brokerage account, and determine your computer/Internet needs

  • Explore position trading — discover the benefit of executing trades in and out of positions and holding positions for various lengths of time, depending on trends

  • Find value in fundamental analysis — observe market behavior, understand economic indicators, find critical information in financial statements, and make the most of analysts

  • Take on technical analysis — build and read charts, identify trends, recognize bull and bear patterns, and differentiate between stocks that are range bound and ones that are trending

  • Develop strategies for buying and selling — know your risks, gather key info through analysis to build your optimum trading strategy, and develop your own powerful trading system

  • Jump into the deep end — from swing and day trading to derivatives and foreign currency, get the basics of these riskier forms of trading

Open the book and find:

  • The ins and outs of trading stocks

  • Fresh ways to analyze trends and indicators

  • Updated stock charts and Web sites

  • Position trading tips and techniques

  • Step-by-step instructions for building and reading charts

  • Key money management techniques

  • Warnings about frauds and scams

  • Top ten trading survival techniques

  • Huge trading mistakes to avoid at all costs

Table of Contents

  1. Copyright
  2. About the Authors
  3. Acknowledgments
  4. Publisher's Acknowledgments
  5. Introduction
    1. About This Book
    2. Foolish Assumptions
    3. How the Book Is Organized
      1. Part I: So You Want to Be a Trader: Gathering Your Tools
      2. Part II: Reading the Fundamentals: Fundamental Analysis
      3. Part III: Reading the Charts: Technical Analysis
      4. Part IV: Developing Strategies for When to Buy and Sell Stocks
      5. Part V: Risk-Taker's Paradise
      6. Part VI: The Part of Tens
    4. Icons Used in This Book
    5. Where to Go from Here
  6. I. So You Want to Be a Trader: Gathering Your Tools
    1. 1. The Ups and Downs of Trading Stocks
      1. 1.1. Trading versus Investing
      2. 1.2. Why Trade?
      3. 1.3. Successful Trading Characteristics
      4. 1.4. Tools of the Trade
      5. 1.5. Taking Time to Trade More than Just Stocks
        1. 1.5.1. Position trading
        2. 1.5.2. Short-term swing trading
        3. 1.5.3. Day trading
      6. 1.6. Going Long or Short
      7. 1.7. Managing Your Money
      8. 1.8. Understanding Fundamental Analysis
      9. 1.9. Getting a Grip on Technical Analysis
      10. 1.10. Putting Trading Strategy into Practice
      11. 1.11. Trading at Higher Risk
      12. 1.12. Remember: Have Fun!
    2. 2. Exploring the Markets and the Stock Exchanges
      1. 2.1. Introducing the Broad Markets
        1. 2.1.1. Stock markets
        2. 2.1.2. Futures markets
        3. 2.1.3. Bond markets
        4. 2.1.4. Options markets
      2. 2.2. Reviewing Stock Exchanges
        1. 2.2.1. New York Stock Exchange (NYSE)
          1. 2.2.1.1. The specialist
          2. 2.2.1.2. The floor trader
          3. 2.2.1.3. The specialist's book
          4. 2.2.1.4. Open outcry
          5. 2.2.1.5. NYSE Hybrid Market
        2. 2.2.2. NASDAQ
          1. 2.2.2.1. Market makers
          2. 2.2.2.2. Over-the-counter and bulletin-board stocks
        3. 2.2.3. Amex
        4. 2.2.4. Electronic communications networks (ECNs)
      3. 2.3. Understanding Order Types
        1. 2.3.1. Market order
        2. 2.3.2. Limit order
        3. 2.3.3. Stop order
        4. 2.3.4. Stop-limit order
        5. 2.3.5. Good 'til canceled orders
        6. 2.3.6. Other order types
    3. 3. Going for Broke(r): Discovering Your Brokerage Options
      1. 3.1. Why You Need a Broker
      2. 3.2. Exploring Types of Brokers and Brokerage Services
        1. 3.2.1. Full-service brokers
        2. 3.2.2. Discount brokers
        3. 3.2.3. Direct-access brokers
        4. 3.2.4. Proprietary trading firms
        5. 3.2.5. Futures brokers
      3. 3.3. Services You Should Consider When Choosing Your Broker
        1. 3.3.1. Types of orders supported
        2. 3.3.2. Data feed
        3. 3.3.3. Charts
        4. 3.3.4. ECN access
      4. 3.4. Understanding the Types of Brokerage Accounts
        1. 3.4.1. Cash accounts
        2. 3.4.2. Margin accounts
        3. 3.4.3. Options
        4. 3.4.4. IRAs and other retirement accounts
      5. 3.5. Choosing the Right Broker for You
        1. 3.5.1. Considering more than price
        2. 3.5.2. Doing a little research
        3. 3.5.3. Understanding how you'll be paying
      6. 3.6. Getting to Know the Rules
        1. 3.6.1. Margin requirements
        2. 3.6.2. Settling trades
        3. 3.6.3. Free riding
    4. 4. Putting Your Computer to Work: Your Key Business Tool
      1. 4.1. Making Use of Your Computer
        1. 4.1.1. Identifying trading candidates
        2. 4.1.2. Managing your account
        3. 4.1.3. Improving your trades
      2. 4.2. Finding Price Charts
        1. 4.2.1. Internet charts, delayed prices
        2. 4.2.2. Internet charts, real-time prices
        3. 4.2.3. Charting software
      3. 4.3. Finding Fundamental Information
      4. 4.4. Finding Analyst Reports
      5. 4.5. Selecting a Trading Platform
        1. 4.5.1. Browser-based trading environment
          1. 4.5.1.1. Pros
          2. 4.5.1.2. Cons
        2. 4.5.2. Integrated trading platforms
          1. 4.5.2.1. Pros
          2. 4.5.2.2. Cons
      6. 4.6. Determining Computer Requirements
        1. 4.6.1. Decisions, decisions . . .
        2. 4.6.2. Configuring your computer system
      7. 4.7. Accessing the Internet
        1. 4.7.1. Connecting to the Internet
        2. 4.7.2. Picking a browser
        3. 4.7.3. Securing your computer
  7. II. Reading the Fundamentals: Fundamental Analysis
    1. 5. Fundamentals 101: Observing Market Behavior
      1. 5.1. The Basics of the Business Cycle
        1. 5.1.1. Identifying periods of economic growth and recession
        2. 5.1.2. Relating bull markets and bear markets to the economy
      2. 5.2. Sector Rotation
        1. 5.2.1. Early recovery
        2. 5.2.2. Full recovery
        3. 5.2.3. Early recession
        4. 5.2.4. Full recession
      3. 5.3. Understanding Economic Indicators
        1. 5.3.1. Fed watch: Understanding how interest rates affect markets
        2. 5.3.2. Money supply
        3. 5.3.3. Inflation rate
        4. 5.3.4. Deflation
        5. 5.3.5. Jobless claims
        6. 5.3.6. Consumer confidence
        7. 5.3.7. Business activity
      4. 5.4. Using the Data
    2. 6. Digging Into the Critical Parts of Fundamental Analysis
      1. 6.1. Checking Out the Income Statement
        1. 6.1.1. Revenues
        2. 6.1.2. Cost of goods sold
        3. 6.1.3. Gross margins
        4. 6.1.4. Expenses
        5. 6.1.5. Interest payments
        6. 6.1.6. Tax payments
        7. 6.1.7. Dividend payments
        8. 6.1.8. Testing profitability
      2. 6.2. Looking at Cash Flow
        1. 6.2.1. Operating activities
        2. 6.2.2. Depreciation
        3. 6.2.3. Financing activities
        4. 6.2.4. Investment activity
      3. 6.3. Scouring the Balance Sheet
        1. 6.3.1. Analyzing assets
        2. 6.3.2. Looking at debt
        3. 6.3.3. Reviewing goodwill
      4. 6.4. Determining Stock Valuations
        1. 6.4.1. Earnings
        2. 6.4.2. Earnings growth rate
      5. 6.5. Figuring Your Ratios: Comparing One Company's Stock to Another
        1. 6.5.1. Price/earnings ratio
        2. 6.5.2. Price/book ratio
        3. 6.5.3. Return on assets
        4. 6.5.4. Return on equity
    3. 7. Listening to Analyst Calls
      1. 7.1. Getting to Know Your Analysts
        1. 7.1.1. Buy-side analysts: You won't see them
        2. 7.1.2. Sell-side analysts: Watch for conflicts
        3. 7.1.3. Independent analysts: Where are they?
      2. 7.2. The Importance of Analysts
        1. 7.2.1. Tracking how a company's doing
        2. 7.2.2. Providing access to analyst calls
          1. 7.2.2.1. Company-sponsored calls
          2. 7.2.2.2. Independent analyst–sponsored calls
      3. 7.3. Listening to Analyst Calls
        1. 7.3.1. Understanding the analysts' language
        2. 7.3.2. Developing your listening skills
          1. 7.3.2.1. Earnings expectations
          2. 7.3.2.2. Revenue growth
          3. 7.3.2.3. Analysts' moods
          4. 7.3.2.4. Just the facts, ma'am
          5. 7.3.2.5. The future
          6. 7.3.2.6. Employee satisfaction
      4. 7.4. Locating Company Calls
      5. 7.5. Identifying Trends in the Stock Analyst Community
  8. III. Reading the Charts: Technical Analysis
    1. 8. Reading the Tea Leaves: Does Technical Analysis Work?
      1. 8.1. Understanding the Mythology
      2. 8.2. Understanding the Methodology
        1. 8.2.1. Finding everything in the price
        2. 8.2.2. Price movements are not always random
        3. 8.2.3. Balancing supply and demand
        4. 8.2.4. Understanding where you've been
        5. 8.2.5. Understanding where you're headed
      3. 8.3. Answering the Detractors
        1. 8.3.1. Walking randomly
        2. 8.3.2. Trading signals known to all
      4. 8.4. Telling Fortunes or Planning Trades
    2. 9. Reading Bar Charts Is Easy (Really)
      1. 9.1. Creating a Price Chart
        1. 9.1.1. Creating a single price bar
        2. 9.1.2. Measuring volume
        3. 9.1.3. Coloring charts
      2. 9.2. Identifying Simple Single-Day Patterns
        1. 9.2.1. Single-bar patterns
        2. 9.2.2. Reversal patterns
      3. 9.3. Identifying Trends and Trading Ranges
        1. 9.3.1. Identifying a trading range
        2. 9.3.2. Spotting a trend
        3. 9.3.3. Time frame matters
      4. 9.4. Searching for Transitions
        1. 9.4.1. Support and resistance: Not just for undergarments
        2. 9.4.2. Finding a breakout
          1. 9.4.2.1. Waiting patiently for winning patterns
          2. 9.4.2.2. Fine-tuning your trading-range breakout strategy
        3. 9.4.3. Sipping from a cup and saucer
        4. 9.4.4. Deciding what to do with a double bottom
        5. 9.4.5. An alternative double-bottom strategy
        6. 9.4.6. Looking at other patterns
    3. 10. Following Trends for Fun and Profit
      1. 10.1. Identifying Trends
      2. 10.2. Supporting and Resisting Trends
        1. 10.2.1. Drawing trend lines to show support
        2. 10.2.2. Surfing channels
        3. 10.2.3. Trending and channeling strategies
      3. 10.3. Seeing Gaps
        1. 10.3.1. Common gap
        2. 10.3.2. Breakout or breakaway gap
        3. 10.3.3. Continuation gap
        4. 10.3.4. Exhaustion gap
        5. 10.3.5. Island gap
      4. 10.4. Waving Flags and Pennants
      5. 10.5. Withstanding Retracements
        1. 10.5.1. Three-step and five-step retracements
        2. 10.5.2. Dealing with subsequent trading ranges
      6. 10.6. Dealing with Failed Signals
        1. 10.6.1. Trapping bulls and bears
        2. 10.6.2. Filling the gaps
        3. 10.6.3. Deciding whether to reverse directions
    4. 11. Calculating Indicators and Oscillators
      1. 11.1. The Ins and Outs of Moving Averages
        1. 11.1.1. Simple moving average
        2. 11.1.2. Exponential moving average
        3. 11.1.3. Comparing SMA and EMA
          1. 11.1.3.1. Consistency
          2. 11.1.3.2. Reaction time
          3. 11.1.3.3. Sensitivity
        4. 11.1.4. Interpreting and using moving averages
        5. 11.1.5. Support and resistance factors
        6. 11.1.6. Deciding the moving average time frame
      2. 11.2. Understanding Stochastic Oscillators
        1. 11.2.1. Calculating stochastic oscillators
        2. 11.2.2. Interpreting stochastic oscillators
      3. 11.3. Discovering MACD
        1. 11.3.1. Calculating MACD
        2. 11.3.2. Using MACD
      4. 11.4. Revealing Relative Strength
        1. 11.4.1. Calculating relative strength
        2. 11.4.2. Putting relative strength to work
  9. IV. Developing Strategies for When to Buy and Sell Stocks
    1. 12. Money Management Techniques: When to Hold 'em, When to Fold 'em
      1. 12.1. Identifying Important Characteristics of a Successful Trader
      2. 12.2. Opening the Door to Successful Trading
      3. 12.3. Managing Your Inventory
        1. 12.3.1. Thinking of trading as a business
        2. 12.3.2. Recognizing the trader's dilemma
          1. 12.3.2.1. Falling in love
          2. 12.3.2.2. Breaking up is hard to do
        3. 12.3.3. Finding a better plan
          1. 12.3.3.1. Picking stock for the seasons
          2. 12.3.3.2. Cleaning out the stock
          3. 12.3.3.3. Keeping your inventory current
      4. 12.4. Protecting Your Principal
        1. 12.4.1. Recovering from a large loss: It ain't easy
        2. 12.4.2. Setting a target price for handling losses
        3. 12.4.3. Determining good trading candidates
        4. 12.4.4. Strategies for handling profitable trades
          1. 12.4.4.1. Breaking the pattern of higher highs and higher lows
          2. 12.4.4.2. Using trailing stops
          3. 12.4.4.3. Tracking market indexes
      5. 12.5. Understanding Your Risks
        1. 12.5.1. Market risks
        2. 12.5.2. Investment risks
        3. 12.5.3. Trading risks
    2. 13. Using Fundamental and Technical Analyses for Optimum Strategy
      1. 13.1. Seeing the Big Picture
        1. 13.1.1. Knowing when the Fed is your friend
        2. 13.1.2. Keeping an eye on industrial production
        3. 13.1.3. Watching sector rotation
          1. 13.1.3.1. Anticipating a new bull market
          2. 13.1.3.2. Watching the economy rebound
          3. 13.1.3.3. Approaching a market top
          4. 13.1.3.4. Weathering a bear market
        4. 13.1.4. Finding the dominant trend
          1. 13.1.4.1. Looking at weekly index charts
          2. 13.1.4.2. Using the bullish percent index
      2. 13.2. Selecting Your Trading Stock
      3. 13.3. Trading Strategies
        1. 13.3.1. Trading the bullish transition
        2. 13.3.2. Trading in a bull market
        3. 13.3.3. Trading the bullish pullback
        4. 13.3.4. Trading the bearish transition
        5. 13.3.5. Trading in a bear market
        6. 13.3.6. Trading the bearish pullback
        7. 13.3.7. A hypothetical trading example
    3. 14. Executing Your Trades
      1. 14.1. Entering and Exiting Your Trade
        1. 14.1.1. Understanding bid and ask
        2. 14.1.2. Understanding the spread
        3. 14.1.3. Devising an effective order-entry strategy
          1. 14.1.3.1. Using limit orders
          2. 14.1.3.2. Using stop orders and stop-limit orders to enter a trade
          3. 14.1.3.3. Using stop orders to exit positions
        4. 14.1.4. Level I, Level II, and TotalView data
        5. 14.1.5. Entering orders after the market closes: Be careful
        6. 14.1.6. Reviewing a week in the life of a trader
      2. 14.2. Selling Stocks Short
      3. 14.3. Avoiding Regulatory Pitfalls
        1. 14.3.1. Understanding trade settlement dates
        2. 14.3.2. Avoiding free riding
        3. 14.3.3. Avoiding margin calls and forced sales
          1. 14.3.3.1. Understanding margin fees
          2. 14.3.3.2. Understanding margin collateral
        4. 14.3.4. Avoiding pattern day trader restrictions
      4. 14.4. The Tax Man Cometh
    4. 15. Developing Your Own Powerful Trading System
      1. 15.1. Understanding Trading Systems
        1. 15.1.1. Discretionary systems
        2. 15.1.2. Mechanical systems
        3. 15.1.3. Trend-following systems
        4. 15.1.4. Countertrend systems
      2. 15.2. Selecting System-Development Tools
        1. 15.2.1. Choosing system-development hardware
        2. 15.2.2. Selecting system-development software
          1. 15.2.2.1. Trading system–development and testing software
          2. 15.2.2.2. Spreadsheet software
        3. 15.2.3. Finding historical data for system testing
      3. 15.3. Developing and Testing Trading Systems
        1. 15.3.1. Working with trend-following systems
          1. 15.3.1.1. Identifying system optimization pitfalls
          2. 15.3.1.2. Testing with blind simulation
        2. 15.3.2. Working with breakout trading systems
        3. 15.3.3. Accounting for slippage
      4. 15.4. Keeping a Trading Journal
      5. 15.5. Evaluating Trading Systems for Hire
  10. V. Risk-Taker's Paradise
    1. 16. The Basics of Swing Trading
      1. 16.1. Stock Selection Is Key
      2. 16.2. Swing-Trading Strategies
        1. 16.2.1. Trading trending stocks
          1. 16.2.1.1. Trading pullbacks
          2. 16.2.1.2. Surfing channels
        2. 16.2.2. Trading range-bound stocks
        3. 16.2.3. Trading volatility
        4. 16.2.4. Money management issues
      3. 16.3. Using Options for Swing Trading
      4. 16.4. Getting a Grip on Swing-Trading Risks
        1. 16.4.1. Taxes (of course)
        2. 16.4.2. Pattern day-trading rules apply
    2. 17. The Basics of Day Trading
      1. 17.1. What Day Trading Is All About
        1. 17.1.1. Institutional day traders (market makers and specialists)
        2. 17.1.2. Retail day traders
          1. 17.1.2.1. It's all about access
          2. 17.1.2.2. Day-trading firms
      2. 17.2. Understanding Account Restrictions
        1. 17.2.1. The Fed's Regulation T: Margin requirements
        2. 17.2.2. Settlement: No free rides
      3. 17.3. Strategies for Successful Day Trading
        1. 17.3.1. Technical needs
        2. 17.3.2. Trading patterns
        3. 17.3.3. Scalping
        4. 17.3.4. Trend traders
      4. 17.4. Risks Are High; Rewards Can Be Too
        1. 17.4.1. Liquidity
        2. 17.4.2. Slippage
        3. 17.4.3. Trading costs
        4. 17.4.4. Taxes (of course)
      5. 17.5. Avoiding the Most Common Mistakes
    3. 18. Doing It by Derivatives
      1. 18.1. Types of Derivatives: Futures and Options
        1. 18.1.1. Futures
          1. 18.1.1.1. What's your position?
          2. 18.1.1.2. Making money using futures
          3. 18.1.1.3. Commodities futures
          4. 18.1.1.4. Index futures
          5. 18.1.1.5. Bond futures
          6. 18.1.1.6. Stock futures
          7. 18.1.1.7. Foreign currency futures
        2. 18.1.2. Options
          1. 18.1.2.1. Options lingo
          2. 18.1.2.2. Option pricing
      2. 18.2. Buying Options and Futures Contracts
        1. 18.2.1. Opening an account
        2. 18.2.2. Calculating the price and making a buy
      3. 18.3. Options for Getting Out of Options
        1. 18.3.1. Offsetting the option
        2. 18.3.2. Holding the option
        3. 18.3.3. Exercising the option
      4. 18.4. The Risks of Trading Options and Futures
      5. 18.5. Minimizing Risks
    4. 19. Going Foreign (Forex)
      1. 19.1. Exploring the World of Foreign Currency Exchange
        1. 19.1.1. Types of currency traders
        2. 19.1.2. Why currency changes in value
        3. 19.1.3. What traders do
      2. 19.2. Understanding Money Jargon
        1. 19.2.1. Spot transactions
        2. 19.2.2. Forward transactions
        3. 19.2.3. Options
      3. 19.3. How Money Markets Work
        1. 19.3.1. Different countries, different rules
        2. 19.3.2. The almighty (U.S.) dollar
        3. 19.3.3. Organized exchanges
      4. 19.4. The Risks of the World Money Market
        1. 19.4.1. Types of risks
          1. 19.4.1.1. Market risk
          2. 19.4.1.2. Exchange risk
          3. 19.4.1.3. Interest rate risk
          4. 19.4.1.4. Counterparty risk
          5. 19.4.1.5. Volatility risk
          6. 19.4.1.6. Liquidity risk
          7. 19.4.1.7. Country risk
        2. 19.4.2. Seeking risk protection
      5. 19.5. Getting Ready to Trade Money
    5. 20. Trading for Others: Obtaining Trading Licenses and Certifications
      1. 20.1. Getting to Know the FINRA Series
        1. 20.1.1. Becoming a registered representative
          1. 20.1.1.1. Series 3: National Commodity Futures
          2. 20.1.1.2. Series 6: Investment Co./Variable Contract Representative
          3. 20.1.1.3. Series 7: General Securities Representative
          4. 20.1.1.4. Series 9 and 10: General Securities Sales Supervisor
          5. 20.1.1.5. Series 22: Direct Participation Programs Limited Representative
          6. 20.1.1.6. Series 42: Registered Options Representative
          7. 20.1.1.7. Series 55: Limited Representative Equity Trader
          8. 20.1.1.8. Series 62: Corporate Securities Limited Representative
          9. 20.1.1.9. Series 63: Uniform Securities Agent State Law Examination
          10. 20.1.1.10. Series 82: Limited Representative/Private Securities Offerings
        2. 20.1.2. Becoming a registered principal
          1. 20.1.2.1. Series 23 or 24: General Securities Principal
          2. 20.1.2.2. Series 26: Investment Company Products/Variable Contracts Principal
          3. 20.1.2.3. Series 4: Registered Options Principal
          4. 20.1.2.4. Series 27: Financial and Operations Principal
      2. 20.2. The ABCs of Financial Advisors
        1. 20.2.1. Accredited Asset Management Specialist
        2. 20.2.2. Chartered Financial Analyst
        3. 20.2.3. Certified Financial Planner
        4. 20.2.4. Certified Fund Specialist
        5. 20.2.5. Chartered Financial Consultant
        6. 20.2.6. Chartered Life Underwriter
        7. 20.2.7. Chartered Market Technician
        8. 20.2.8. Chartered Mutual Fund Counselor
        9. 20.2.9. Personal Financial Specialist
        10. 20.2.10. Registered Financial Consultant
      3. 20.3. The Licenses and Certifications You Need When Trading for Others
  11. VI. The Part of Tens
    1. 21. Ten (Or More) Huge Trading Mistakes
      1. 21.1. Fishing for Bottoms
      2. 21.2. Timing the Top
      3. 21.3. Trading Against the Dominant Trend
      4. 21.4. Winging It
      5. 21.5. Taking Trading Personally
      6. 21.6. Falling In Love
      7. 21.7. Using After-Hours Market Orders
      8. 21.8. Chasing a Runaway Trend
      9. 21.9. Averaging Down
      10. 21.10. Ignoring Your Stops
      11. 21.11. Diversifying Badly
      12. 21.12. Enduring Large Losses
    2. 22. Top Ten Trading Survival Techniques
      1. 22.1. Build Your Trading Tool Chest
      2. 22.2. Use Both Technical and Fundamental Analyses
      3. 22.3. Choose and Use Your Favorite Tools Wisely
      4. 22.4. Count on the Averages to Make Your Moves
      5. 22.5. Develop and Manage Your Trading System
      6. 22.6. Know Your Costs
      7. 22.7. Know When to Hold 'Em and When to Fold 'Em
      8. 22.8. Watch for Signals, Don't Anticipate Them
      9. 22.9. Buy on Strength, Sell on Weakness
      10. 22.10. Keep a Trading Journal and Review It Often