Tip 1 -Avoid buying stock with low daily volume.
Volume should be at least 200,000 shares on an average day.
* It's hard to sell fast if the volume is low.
* If the price falls, you might get stuck with a big loss before you can sell.
* Your own trades can drive the price up or down on very low volume stock.
* For example, if you buy 1,000 shares of a stock trading 2,000 per day -
* Your order could push the price much higher than you expect to pay.
* Use limit orders only if you trade such stocks.
* Limit orders tell your broker what price you'll accept.
Tip 2 - Avoid buying more if the price falls.
Winners have an exit strategy.
* Before buying stock, they know what price will make them cut their losses and get out.
Losers buy more when prices fall.
* They want to prove they weren't wrong.
* They want to lower their average cost per share.
* But the more you buy, the bigger your risk.
Market winners always try to lower their risk.
The market is always right. Fight the market at your peril.
Tip 3 - Keep risks lower than rewards.
Your risk must be smaller than your possible profit when buying stock.
* Otherwise, you risk too much for what you might gain.
Your possible profit should be at least double what you risk. Triple is even better.
* Example - you buy a stock for $50, and
* Tell your broker to sell if the price falls 10%. ($50 - 10% = $45).
* Your risk is 10%.
* If the stock might rise to $55, your possible profit is 10%.
* 10% risk and 10% profit cancel each other out.
* Your expected return is 0%.
* If the stock might rise to $65, your possible profit is 30%.
* Your expected return is 20% (30% profit - 10% risk). Congratulations!
Buying stock is a mistake when you have no idea what might happen.
Estimate your risk to reward ratio before buying.
Tip 4 - Pay attention to market trend.
Most people try buying stocks or funds that look strong. You should do that, but it's not enough.
Most stocks move with the market.
* Strong stocks fall in a down market. Weak stocks rise in an up market.
* Emotion moves the market as much as economic reports.=
The 200-Day Moving Average is the best indicator of long-term market direction.
* It is the average closing price for the 200 business days before today.
* It "moves" every day because every day there's a new closing price.
* The 200-Day Moving Average for the S&P 500 shows the over-all market trend.
* The 200-Day Moving Averages of indexes such as the NASDAQ 100 or Russell 2000 show trends of major market segments.
* An up market trades above its 200-Day Moving Average.
* A down market trades below its 200-Day Moving Average.
Be ready to buy long or sell short according to the market trend.
Tip 5 - Pay attention to total market price.
Most people try buying stocks or funds at bargain prices. They want to pay less than the stock or fund is worth. You should do that, but it's not enough.
Most stocks move with the market. (See above.)
Is the total market a bargain? Can you buy the average stock for less than it is worth? "Expensive" markets are risky.
* The more expensive the market is, the greater the risk.
* Expensive markets can have bad sell-offs or corrections.
* Sell-offs happen fast. Markets rise slowly, but fall fast.
* Ignore total market price and risk getting crushed by a sudden correction.
The S&P 500 Price to Earnings Ratio is the best indicator of over-all market price.
* The average P/E of the S&P 500 from 1881 to today is 16.4. (Note: These are the Shiller averages.)
* If the S&P 500 P/E is much above 16.4, it's expensive.
* If the S&P 500 P/E is much below 16.4, it's a bargain.
* Most stock market gains occur when the market is a bargain.
* The current (April, 2011) S&P 500 P/E is 24.04.
Be ready to buy long or sell short according to the market price.