Trading in the stock market and what you should know about it

Specifics of Stock Market Trading

15-11-2019

I recall dealing with a curious psychological aspect back in the day. When I was asked about what I was doing for a living, I used to feel uneasy and even embarrassed to tell about FOREX trading. So, I would simply say that I was engaged in the financial markets, and involved in stock trading in order to mention this specific market only.

Now I see the reasons behind it. Back in 2011-2012, there were a lot of negative articles on dealer manipulations and complaints about forex brokers’ operation. Even the providers of access to the U.S. market used to say that Forex wasn’t something serious and you couldn't make money there. Only the stock market was seen as reliable.

Due to questionable results at the time, I myself somehow started doubting the Forex industry which made me wander around the markets in search of the best.

Obviously, there are certain differences in trading platforms. Forex is more of a range-bound market, whereas the stock market is more trend-oriented. The nature of the movement and volatility may vary as well.

All of this is true. The changes of 0,2-0,3 % in the stock market have to be taken with leverage in order for the profit to become substantial. In the U.S. stock market, the size of own capital is, more often than not, enough.

However, there is also a difference in liquidity, where you get an exit price on currency pairs, whereas when it comes to stocks you may encounter a gap or a squeeze i.e. when the price is slipping past the stop-loss order. The so-called cleanliness of the movement in the U.S. market in contrast to Forex which is often talked about is nothing but a myth.

Just take a look at these charts of the currency pair and the stocks, and you will see with half an eye that the level is unstable and there are several false breakouts.

Stock market trading: example 1

On top of that, there is a huge temptation to trade stocks. Just like you are itching to mention in chats that you’ve become a proud owner of McDonald’s, Coca-Cola or Visa Inc. stock, having made good money.

But the bottom line is that by getting involved in the unknown and jumping on the bandwagon, we get ourselves in an information vacuum. We trade what we have no understanding of and what we haven’t even properly examined. The majority mistakenly believes that by simply drawing a horizontal line which is often subjective, they will tackle all the issues, and the price will, for whatever reason, generate profit.

Let’s recall a book by Edwin Lefevre called «Reminiscences of a Stock Operator» where an experienced speculator realizes that he is trading probability, and nothing else. Having gotten his hands on insider information, he is in no hurry to buy shares, but starts selling, thus testing the market depth and checking out whether there is anybody willing to buy the stocks.

After getting a confirmation that the price is not dropping and someone is actually buying, he closes his short position and starts buying.

Obviously, we do not have the resources to check the market depth in terms of each stock. However, simply trading based on a subjective slanting or horizontal line with a short stop-loss order leads to its hunting and a low percentage of winning trades when exiting.


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So, what does the trader need and what should happen for the level to become truly functional and be close to positive mathematics in terms of probability?

There should be a fight, a consolidation. You need to be able to understand the nature of the instrument’s movement and its volatility, and how high the chances are that there will be a significant movement in relation to the stop-loss order, and the stop will be adequate and relatively harmless i.e. placed at the point where scenario changes.

Just like in the example of the DOW trade, where there would have been an obvious change in the scenario above 27 271.

Stock market trading: example 2

Now let’s get back to the stock trading. By applying the same logic, we often come across situations where the level seems strong, there are holding and solid consolidation, yet the level fails to hold out. It seems that we are headed towards the buy by following the index, but the stock may lag behind, and the level gets broken out in case of the slightest stop of the index.

Here’s another situation: the index is going up, while the stock has already gone far from the level, being significantly ahead of the market.

When attempting to buy the stock during the stock market correction, we often find ourselves in a situation where the market tilts towards the loss, and as a result the stock also fails to hold the price indicated by the level. This is what trading blue-chip stocks or stocks that are influenced by the news background often looks like. In other words, 70–80 % of the stocks follow the market or it follows them.

In today’s financial world, it’s hard to tell what follows what, since both individual stocks that lead the market and index ETFs and sectors, which pull the included securities along, are being purchased.

In other words, in order to trade such stocks (which are typically the most popular ones), you need to understand the index itself, the nature of its movement and be able to trade it, understand the sector and only then the stock itself.

If statistics demonstrates that index trading isn’t quite working for you, you can be sure that trading individual stocks won’t work for you either.

This means that in this case the trader bears all three types of risks: market risk, sectoral risk and risk per stock itself, where the size of an average gap, slippage - and a swap if it is a CFD - should also be factored in.

By no means am I trying to dissuade you from trading stock CFDs or stock overall. What I mean is that each instrument needs to be thoroughly examined before you put your funds at risk.

There are obviously some things such as news releases and quarterly reports that knock the stocks out of the market trends which then leads to an imbalance. In such cases, the issuer may ignore the market background. That said, the trader should have a clear approach and risk management rules in place and not act as an artist who is creating and improvising.

Experience shows that temptations and improvisation never lead even the greatest of traders to anything good.



Author: Viktor Makeeu


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