Trade Within Your Comfort Level

by Ray Johns

Stock prices fall into two basic categories; penny stocks (a.k.a. stocks trading under $1.00) and pretty much everything else. To some degree, you can lump stocks under $5.00 into the penny stock category as well. However, keep in mind that this will not always be a fair representation.

Lower priced stocks have a very seductive allure. Not only can you buy large numbers of shares, but also when the stock does move, it typically moves in larger percentage steps. However, that works both ways and there are additional risks with lower prices stocks (typically they are lower volume and this can negatively impact your trading).

Personally, I feel much more comfortable trading a stock that is above $20 if at all possible. Generally, stocks that carry low share prices tend to be more risky. They also tend to be lower priced due to lack of interest from both the public as well as professional investment community. This is not to suggest that there are not good quality low priced stocks - certainly there are. However, especially when you are first beginning, we feel its best to avoid stocks that trade under $5.00 unless you really know what you are doing. In the end, you usually stand about the same chance of seeing a higher priced stock move 10% as you would seeing a lower priced stock move 10%. Since this is usually (but not always) the case, there tends to be a little more safety in trading in the higher dollar stocks. Penny stocks can and do sometimes produce amazing short term gains, but unless you really understand the risks associated with these lower priced and often more thinly traded securities, we suggest you stick to more "name brand" stocks which tend to trade at higher per share prices.

Some people really enjoy owning Gold stocks or stocks related to oil drilling or diamond mining. I personally do not. Stocks of these types lack some of the inflation fighting components that traditional businesses provide. As a general rule of thumb, if the stock doesnt produce a product or provide a service, then its generally best to limit your trading in them, at least in my opinion. Stick to companies that produce a product or provide a service and you never have to worry about hitting a "dry hole" or a sudden drop in the price of Gold or Silver.

It is important not to "chase" stocks. Stocks go up because people (usually large numbers of people) are buying the stock. As a trader, this is usually not a good time to also be buying. As such, be very cautious about buying stocks that are rapidly moving away from you; he true money in stocks is made by buying stocks prior to a sudden move, not during a sudden move. The one possible exception to this may be if there is some very positive news that has caught the markets off guard and/or if the news is so outstanding that there is a high probability that the stock may benefit for multiple days. Keeping in mind, however, that a sudden move in a stock is often quite different than a change in the overall trend. Sudden moves tend to reverse and if you get into the habit of chasing stocks that are moving up, more times than not youll end up paying overly high prices and/or getting caught in a downward move shortly thereafter.

Again, generally people that buy late are buying on pure emotion (greed and fear); greed that they may make a lot of money very quickly and fear that they may miss out should they not "get on board". Those are the two worst reasons to buy anything - not just stocks. True you may miss out on the stock, however, in most all cases, its better to wait and find another stock, than to pay too much. Patience in the stock market is very important; usually youll do better by avoiding the temptation to "jump" when that impulse is largely a result of a move in the share price alone.

Dont rush into any trade. This is along the lines of the above comment. However, it is worth elaborating on. Often times stocks will give you many chances to get into them at current (or sometimes even lower) levels. Generally, there are few cases that require sudden action if you are really careful in how you trade. Sometimes the best trades are ones in which you wait patiently for the stock to come to you. If you feel the need to rush to order a stock, thats sometimes (not always, but sometimes) a warning sign that you are acting not on a well laid out plan for the trade, but an impulse to "get into a trade" regardless of whether or not the stock is trading at what is really an ideal price.

Keep in mind as well; its often not a bad idea to take up positions in a trade little by little. If you plan to own 1000 shares, consider buying 300 shares and then seeing how the stock trades. Often times this will allow you to better judge the market and take advantage of intraday weakness. If you do happen to miss purchasing the additional shares, there is almost always another trade you can put the cash to work in.

Do not let yourself get greedy. This spells danger. Two of the biggest emotions a trader has to over come are fear and greed. Many traders fall victim to greed once they see a trade become profitable - simply by not having a firm exit point in mind. Its generally best to decide at what levels you wish to sell prior to entering into a trade to avoid this. If you feel yourself trying to justify higher levels from the stock and/or ignoring the current profit "as though it were nothing", you probably need to stop and consider not only the value of your profit, but the current risk to it by holding longer.

Often times traders who are successful tend to lose respect for the actual value of a dollar. Regardless of how much money you have, you must not lose sight of what each trade produces and the value of the returns in relation to the capital used to produce those gains. An example might be someone with several million dollars. If this person put $10,000 into a position and saw it produce a gain of $2,000 they might not realize its time to take profits. While $2,000 is nothing when compared to several million, a 20% gain should always sound alarm (i.e. sell) bells in a traders head. In fact, typically a gain of 10% or perhaps even as little as 5% should do this as well. A common method to help combat this is to look at your trades strictly from a percentage standpoint of view, rather than a dollar standpoint. This allows you to always calculate gains and losses with consideration to the amount of capital at risk for any given trade.

In the movies, "greed is good", but in trading its generally an emotion that does little more than get in the way of clear and level headed thinking.

Good luck in the markets!

No permission is needed to reproduce an unedited copy of this article as long the About The Author tag is left in tact and hot links included. Questions and comments can be sent to Ray at articles@daytraders.com.

Ray Johns is the founder and Senior Market Editor of http://www.daytraders.com, since 1996. He publishes the award winning Morning Stock Market Report. Daytraders.com is also home of the Internets finest real time trading desk. Ray has appeared as a guest on a number of radio and television shows including CNBCs Market Talk. Log in for a free trial at www.daytraders.com.

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