Monday, November 30, 2009

Trading 101 Tutorial - Part 1 - Introduction


The public often confuses trading with investing, with little help from the various financial programs where these terms are constantly being mixed up. Investing implies a buy and hold strategy to buy assets such as stocks, bonds, commodities and real estate, over a substantial period of time. Trading involves the buying and selling of financial instruments over short term periods. The time frame can be days and weeks, known as swing trading, or hours, minutes and even seconds for day trading.

Regardless of the time frame, traders fall into two distinctive categories – fundamental analysis and technical analysis. Fundamental traders rely on corporate related events or financial metrics to make trading decisions. Some examples are upgrades and downgrades from brokerage firms, earnings announcements, anticipated contracts, mergers, and acquisitions. There are similar characteristics in fundamental analysis trading to investing, with the marked difference that fundamental traders are looking for short term momentum as a result of, or the anticipation of events mentioned above. An example would be “buy the rumor and sell the news”. In this case, a trader would buy stock ahead of a potential favorable earnings announcement, with the intention of selling the stock as soon as the actual announcement is made.

Technical analysis traders rely on price charts and indicators to make trading decisions. They are not interested in corporate news or event driven decision making. Technicians feel that all fundamentals are reflected in charts, and it is not necessary to monitor news or pour over statistics, because the information is represented visually for any time frame the trader wishes to trade in.

Common chart time frames for day traders are 5 minutes, 30 minutes and hourly. For swing traders, daily or weekly charts are frequently used. There are different styles of charts such as Bar, Mountain, OHLC (open, high, low, close) and Candlestick. Many feel that a chart is not usable unless it is in Candlestick form. See the 5 minute Friday November 20 2009 Dow Jones Industrials chart illustration in this article for an example. The representations on this type of chart appear as white or red candle bodies, with wicks on tops and bottoms, displayed as thin lines. Part 2 of this series will focus on Candlestick charting and the many patterns traders use in this style for their buying and selling decisions.

C. Cohn