In part 2, I talked about the definition through the eyes of an investor. In this article I go through some key definitions for traders. As I mentioned in previous articles, there are big differences between an investor and a trader. In the last article I told you that the important thing for an investor is the seek for value (I gave you Warren Buffet as an example for the value method); an investor is constantly searching for assets which trade for undervalue, discounted prices. A good trader does not care for the “real” value of the asset (it can be a stock, or any other tradable asset), the only things he cares is whether he will be able to sell it tomorrow, or at any other future time, in a higher price.
Knowing When To Trade
What makes you a good trader?
A trader looks for short-to-medium term trades, meaning that a trader looks for quick movements in the market. In order to become a good trade,r you`ve got to be cold-blooded and follow specific rules you set to yourself. You also need to understand the movements, trends and the psychology behind the market and the other investors or costumers. You need to remember that trading is all about buying cheap and selling expensive. As a trader, you don’t care about what it is that you are buying, the only thing you care about is to sell it in a higher price than you paid. It can be a stock, land, house, commodity or any other merchandise that have a market you can buy and sell at any time. Liquidity is very important for traders; the last thing you want to happen is to be stuck with an asset without the ability to sell.
The three questions that need to be answered are the same from part one and two of the article:
- What are you buying?
- Why are you buying?
- When are you selling?
What are you buying? This time, the answer is a little different from part one and two. You want to buy an asset that is tradable at any time. As I wrote in paragraph two, liquidity is one of the most important factors for traders; you cannot be a trader in an illiquid market (unless you have very high margins to cover the risk you are taking).
Why are you buying? There is a very simple answer for this question – you are buying because of the assumption that you will be able to sell it in future time for a profit, which covers up the risk you are taking. This is the first time in this article I am mentioned risk. There are two main risks I will talk about:
- Market risk – the risk that the whole market change his direction
- Specific risk – the risk that the specific asset’s price you are trading will go down.
In order to protect yourself from those risks you need to know when to sell, cut your losses short should be buried in your state of mind.
When are you selling? Different from investing, as a trader you have to have a stop loss. Without a stop loss, I can guarantee you will lose money at the long run. The stop loss is the key to success in trading. The problem most people have is they get too attached to the stock (or any other asset) they are buying, they starts say things like: “it`s got to go up”, “this is a good company”, “if I had more money I would buy more”, “they have the best management”, “I have confidence in this company” etc. but you need to remember what was the original reason you bought it first place – was it because the company has a good management or because you thought you will be able to sell it at a higher price? No one can guarantee you tomorrow’s price; the best company can go bankrupt any day. It’s not likely to happen, but it is a possibility, and as a trader you need to remember it all the times. Nothing in the market “has to happen” – because the market is built up from so many elements that affect each other, the market is constantly surprising us. So ,the best thing to do when you are in a situation which is not familiar to you, or is not going as you planned, is to sell sell sell.
Another action that I suggest is to sell small chunks of your holdings (when the asset is stocks) every time the price rises up. That will give you profit margin, and will make sure you`ll make money of the trade. It’s extremely important to do that on high volatility stocks.
Are you a trader?
In this part of the article, I discussed a small fraction of what it takes to become a good trader. People think that if they buy and sell stocks every day, they become traders, but the real test is how you react to market changes. If you cut your losses short, you are in the right lane. If not, you need to rethink your steps in the market – maybe you should let someone else invest and trade for you (just make sure this person is not Bernard Madoff).
How can The CEO Game help you?
The CEO Game will give you tools to test your investing and trading theories, methods, techniques and abilities, you will be able to trade and invest in an imaginary market, and have the ability to see how this market reacts to changes and surprises – just like a real market. This is a major breakthrough in the world of serious business games.
Feel free to ask any question,
The CEO Game.
September 14th, 2009 at 5:01 pm
[...] The Importance of the Definition – Part 3 of 3 | The CEO Game [...]