The first step in the trading process is to identify your trading vehicle. But finding a good stock in which to risk your capital is just a small part of the battle. What will determine your level of success is how effectively you trade it. As I've discussed previously, the issue isn't whether it is a good pick or not. The issue is how much money do you make owning it if it works and how much you lose if it turns out to be a dud.
There are basically two ways to approach a trade - passive and active. A passive trade is one in which you make a single buy, set a sell stop, and then sit and hope it goes up and makes you money. Your work is basically finished once you make your purchase and have some parameters in mind on what to do as it moves around.
The other approach to trading is what I call 'stalking'. Identifying a good trading candidate is just the first step in the process and is not necessarily the most important step. Even a poorly chosen stock can turn out to be a good trade if you stalk it in the right manner as it develops.
The first step is choosing your target. You should have a general style and methodology that you use. Maybe you prefer more liquid big caps or maybe you focus on highly volatile smaller stocks. This will impact how you actually go about the stalking process but the basics are eventually the same:
- Establish a position and become familiar with it. When you are actively trading your initial entry point isn't that important. The main goal is to put it on the screen and become intimately familiar with the way it acts. What does it like to do in the morning? Does it have some upcoming event that it might celebrate? Are there shorts that are antagonistic toward it? Is the overall market impacting its mood? As you become familiar with the stock you will have a better understanding of whether the price movement is just normal volatility or whether it is indicating that maybe there is something more significant developing. I often will take a small position in a stock that seems wildly extended just so I can put it on the screen and learn more about it. Your view of the stock will change tremendously once you own it and watch it. A stock you don't own never seems to look as good.
- Look for additional entry points. One of the problems with a passive approach to trading is that there is a tendency to quickly dump a stock that doesn't go straight up. If the stock pulls back it is easy to conclude that it is a failure so you sell it and move on. If you are using an active approach to trading then that same pullback may look quite different. Rather than a loss, it is an opportunity to improve your entry. As long as there are no major changes in the story or the market, you are in a position to take advantage of normal volatility. Instead of cringing when a stock immediately drops after you buy it, you welcome the lower price and take advantage.
- Watch the chart and the news flow. It is important to watch the price action in the context of the news flow. Many trades will have some sort of future catalyst that you look to trigger a move. It might just be the anticipation of positive earnings or a move over a key technical level. Both news and charts need to be monitored closely and the volatility that they create used as opportunities to make additional increment buys or sells.
- Ramp up the position or cut it back as conditions develop. The primary goal of stalking a trade is to be in position with the maximum size at the right time. Few things are more frustrating than identifying a good stock but then not trading it aggressively enough to produce a sizable gain. This is the area that separates good traders from great traders. Great trades press when the feel that the odds are in their favor. They take on a higher level of risk and then manage it actively as the trade develops.
- Watch for the next setup. The best stocks will offer a serious of good opportunities as it develops over time. There will be a natural ebb and flow in its movement and will likely be impacted by overall market conditions. Even after you have harvested a hefty gain it is often a good idea to maintain a small position and watch for the next opportunity. Good stocks will reward you many times over the course of months or years.
- Cut the losers. One of the big benefits of the active approach to trading is that you can take on some higher risk trades that you are uncertain about. Since your initial buy is small, the risk is limited and if it doesn't work you just cut it and move on. If you don't have a fair number of losing trades along the way then you probably aren't taking enough risk. Trading is a game of odds. If you strive too hard to find the perfect stock you are going to miss out on numerous good trades. It just isn't possible to predict in advance what stocks will work the best.
The most important issue here is the mindset. You need to think about a trade as an ongoing process that you control rather than just a passive activity that you sit and watch. Nothing will help you trade better than actually owning a stock, learning how it moves and why, and buying and selling it numerous times.
Stalking in other contexts in criminal behavior but stalking stocks is the secret to profits.