Educating an Ignorant Stock Trader

So I hopped on a plane to Chicago, eager to learn all I could about the stock market at this top-notch business school. I stayed at a very nice hotel near the lake and the Chicago Board of Options Exchange, where the course would be taught. This area of ​​Chicago was the nicest I’ve ever known in a big city. Pristine streets, lovely restaurants and cafes, friendly people. A far cry from the Chicago of today, with its appalling violent crime statistics.
The CBOE building was huge, with very high security, despite the fact that it was about three years before the horror of 9/11. I signed up for the classroom and took my place with only six other students. The instructor gave us an overview of the course and then proceeded to explain our failings and misconceptions. As he continued with many examples, we all groaned, knowing that we had all made mistakes and were clinging to foolish ideas. “Buy and hold” was important. Many of us had learned to invest in “blue chip” (highest quality) stocks and hold them indefinitely because they would always go up. While this method might have worked at times, it could also be very dangerous. Some investors may have tried to protect themselves with “sell stops,” but these are far from foolproof, as you will see.

Stock trading has been divided into three types: Long-term investing (buy and hold), where one buys stocks and forgets about them – with or without sell stops; “Position Trading”, where one bought and held shares for a few days, maybe up to two weeks, usually but not necessarily with sell stops; And finally, “Day Trading”, where one bought and sold a stock – or stock options – possibly within a few hours, but NEVER more than a day, always with sell stops. Day trading was the widely preferred method of this school, which our teaching focused on.
For one, one could never get in trouble if they exited all stocks at the end of the trading day. Let’s say you bought 1,000 shares of “XYZ” one morning and they gradually rose during the day. You win ninety cents, a profit of $900. Your personal trading rules state that you must sell before the market closes; however, you are “confident” that in this case it would be a mistake, as the stock “seems to continue to rise tomorrow”, so you own it. To play it safe, you put a sell stop at the price where you won’t earn less than, say, $0.70 per share, or $700. That evening, a huge scandal at “XYZ Corp.” is revealed on the news, where its CEO got away with millions of dollars.
You’re worried, but not worried, because you’ve set up the sell stop. But a sell stop is a “sell trigger” when a stock or option hits a certain price; however, this does not guarantee that the stock will be sold at the stop price. You, and a hundred thousand other investors, can have stops in place on “XYZ”, and all of them will trigger a sell order at the same time! “XYZ” could then open drastically lower than its closing price the day before. Your sell stop may not trigger until you lose a LOT of money! Of course, that may not happen, and “XYZ” may continue to rise the next day. Or not. Either way, if you sold at market close, you would have made $900 and slept well.
This is not to say that sell stops are unnecessary; on the contrary! Let’s say you choose to buy a stock or an option (for specific reasons I’ll explain) one morning, at say $10 per share. Your personal trading rules determine how much risk you are comfortable taking, so let’s say yours is 2%. You would then simultaneously place a sell stop at $9.80, which means that if that stock fell to $9.80 and you bought 100 shares, you would lose $20.00, or $200 if you bought 1,000 shares. . This would happen the same day you bought the stock, and that’s the most you could lose, barring an apocalyptic event. Your profit potential can be essentially unlimited, however! Let’s say your analysis tells you that this stock has a reasonable potential to rise $0.75 that day. You can also place another stop that would trigger a sell when the stock rises $0.75, earning you a profit of $750. You also have the possibility to modify your stop orders at any time. If your chosen stock is going higher and faster than you thought, you can raise the protective sell stop as the price rises, while raising the stop that will trigger a sell when you reach a certain profit . Unless you have the ability to stay glued to your computer screen all day, this is a much safer way to limit your losses AND protect your profits. I once watched a stock go up all day, but had no stops in place. A customer walked in and we chatted in the warehouse for a while. When I returned to the computer, I learned that my stock had changed direction and all my profits were gone, and more. Well-placed stops would have kept this trade profitable. The instructor then began the lengthy stock selection procedures.

“Bulls make money, bears make money, but pigs get slaughtered!” – Old Wall Street saying.

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