A foundation for trading

Here are some general principles to digest.

It’s all about putting odds in your favor.  This is why the stock market is not like a casino, or gambling.  We’re the guppies in the big ocean, so we want to swim with the big fish.  Jump into the moving tide and let it take us for a bit until we jump off.  Each time, we grow our money a little bit by keeping losses small and letting winners be bigger winners.  The amount of money then gets steadily increased by just a bit with each new trade.  Eventually, after finding some consistency in following a plan for money/risk management and recognizable structures for entering and exiting trades, the wonder of exponential growth makes us steadily more and more profitable by just repeating the same process.  It should eventually be almost boring, like commonplace.

The one major necessity is to always be looking forward.  We cannot predict the future, but we can recognize what IS happening and PLAN accordingly.

• MIND YOUR MONEY! – Money Management is the MOST IMPORTANT part of the puzzle.  By concentrating on losing as little as possible, making money will eventually take care of itself.  The primary focus must be to keep losses small.  When times are tough, the most important reality is that we have to live to trade another day.  With each large loss, the next win has to be that much larger just to get back to break-even.  Read this bit on “Position sizing – A Free lunch.”
• Identify your goals.  What do you want from the market, how active you want to be, and what is your tolerance for risk.  The simplest measure of this for most people is, if you can’t sleep at night about the money you have at risk, it is too much.

• PRICE IS KING!  – The current price is the most up to date information about the stock.  It reflects all publicly known information and the according sentiment of the market(the rest of the world of investors, analysts, and traders).  Technical indicators like moving averages and stochastics and hundreds of others can all be helpful but are all “lagging” indicators in that they are a representation of PAST price performance.  They can be used to confirm what we are seeing in the price action.  Most indicators are just as good as any other.  It’s just a matter of knowing what they tell you and how to read them for your purpose.  They are all derived in one way or another from the price action.  They are just a tool that can be used, but are not a necessity.  Focus first on studying price movement and identifying highs and lows in any trends present.  Moving averages are the simplest way to confirm what you’re seeing in a trend of the price action for a given time period.
• TRADE WITH THE TREND – “The Trend is your Friend.”  This is one of the most commonly spoken maxims of technical analysis.   Along with trend comes the equally important SUPPORT AND RESISTANCE.  As you know, levels of support tend to become resistance when broken and vice-versa.  Support and resistance come on horizontal and diagonal planes and often border the extremes of a trend up, down or sideways.  This is called a CHANNEL.

• Candlesticks – Candlesticks were developed and have been used for hundreds of years in the far east, originating with the rice traders.  This way of looking at charts allows for quick identification of what has happened in a day, week or hour, depending on the setting of the chart.  We can identify the characteristics of each candlestick formation and in combining them into successive patterns up to two and three days in a row, we can take further confirmation of price action continuing or reversing in the context of the bigger structure and/or trend.  Here is an example of probably the most often mentioned and most likely candlestick to find at the bottom of a downswing, the HAMMER.  It comes in a down trend of successive candles and signals a potential bullish reversal.  It needs confirmation in closing higher in the next candle stick.  Here is one of many places on the internet to find a gallery of the many candlestick patterns.  It is not all that important to learn their names or even worry about the extensive lot of them.  It is important simply to understand the psychology of what they tell us about the buyers and sellers throughout the pattern and each individual candle.  They are either confirmed by finishing the pattern, or negated by not.  Candle sticks are another form of technical indicator, but unlike the lagging indicators, they show us the closest thing to current signals we can take beyond the current price itself.