Tips & Tools
INTRODUCTION
In 'I'm New To TRADING - Where Do I Start?' you will - hopefully - have gained some insight as to what trading is all about. In this thread we will drill down further and provide specific tips and tools to set you on your way.
HOW DO I TRADE?
In practical terms, you need a
trading platform to enable you to buy and sell the ‘instrument’ you wish to trade. (Instrument is a generic term and is applied to any share, index or commodity etc. that is traded on the open market.) This is usually supplied by your
broker, of which there are many different types, offering different trading vehicles. By far the most common trading vehicle for new traders is
Spread Betting, followed by
Contracts for Difference (CFD's),
Options and
Futures. Each has advantages and disadvantages, depending on your capital, your experience and knowledge of the industry. You can find out more about all of these trading vehicles by clicking on them to take you to the relevant forum.
You’ll then need to select an instrument to trade – or instruments plural – of which there’s a huge variety. To start with, stick with one market, e.g. indices, stocks or forex. Mixing and matching is best left to those with experience!
WHAT DO I NEED TO GET STARTED?
Typically, you'll need a fairly good PC - a lot of Spread Betting (SB) companies and certainly
direct market access (DMA) brokers will recommend a dual core processor e.g. Pentium or AMD, 2Gb RAM, Windows XP (or later) and probably a fairly decent graphics capability - especially if you want to have a dual monitor configuration. It can be done with less than the above, of course, but newer and faster is almost always better.
You will also need either a
charting package, some form of
data supplier (often but not always supplied with the charting package), and of course an account with a broker of some sort.
On the broker note, most people recommend that a
margin account is better than a
credit account. The reason behind this is that you should only trade with money you can afford to lose. When you start out, it’s more than likely that you will have some losses, and it’s best not to be in a situation in which your broker is in a position to continue lending you money - you don’t want to let it get out of control! Margin accounts simply stop operating once your capital falls below a certain level, and it’s up to you to fund it again. Hence, you are in control, not your broker.
WHERE DO I GO FROM HERE?
What follows is adapted from a post by a long standing T2W member called firewalker99, in the FAQ entitled: ‘
How Do I Start Trading?’ . . .
Before you start out, you need to:
1) Determine what you want out of trading: are you doing it for beer money or as a career to earn a full time living?
2) Determine a suitable timeframe for your trading style. Broadly speaking, traders fall into three categories: day traders – opening and closing all trades intraday, swing traders – holding trades for 1 – 5 days and position traders – holding trades for weeks at a time.
3) Determine your short and long term goals. (Small consistent profits or large gains accompanied with equally large
drawdowns?)
4) Analyze yourself (SWOT analysis: strengths, weaknesses, opportunities and threats.) The point here is that many newbies are attracted to very short term day trading. However, not many of them are really very suited to it. Be brutally honest with yourself. If you’re a balding middle aged man with a pot belly, in spite of what you might wish or believe, chances are that you don’t look good on a dance floor. In fact, chances are that women don’t fancy you, if anything they pity you. You can figure out the analogy with the market – and why you have to be so brutally honest with yourself – by yourself! Keep in mind that the market won’t show you any pity at all; it will fleece you for every penny.
Next, you need to know what kind of trading suits you best:
5) A mechanical or discretionary approach (This topic is expanded on in the ‘
Essentials Of 'Forex Strategies & Systems' Sticky)
6) Using fundamental or technical analysis of the markets – or a combination of the two? If the latter, will you focus on price,
volume, price patterns, indicators (e.g. Bollinger Bands),
pivot points,
candlestick analysis or a combination of any of the above?
After you determine that, you need to:
7) Formulate a hypothesis. An example would be that price typically moves up X number of points if it breaches yesterday’s high. To get some ideas about what other traders do on this front, check out the threads in the ‘Best Threads’ Stickies, pinned to the top of each forum index.
8) Refine the hypothesis into a strategy to take advantage of what you think you've found. To use trader’s jargon – this is called a '
set up'.
9) Backtest and
paper trade the hypothesis (set up). Does the set up appear a sufficient number of times in the backtest to produce enough trades? Does price move sufficiently far in your favour to produce enough profit to meet your objectives in 1-3, above?
10) Define the tactics you are going to employ to enter and exit the trade. This requires an entry ‘
trigger’ and a point to exit the trade with a loss if it goes against you or, hopefully, with a profit if it goes in your favour. Remember, you’ll always have losing trades as well as wining ones. But this is to be expected and doesn’t matter at all, so long as you have a ‘positive expectancy’. (If you don’t know what this is, read post
#2 of this Sticky entitled: ‘
What is the First Steps Forum?’)
11) Define the idea and the specifics surrounding it. In other words, pan out. Does the set up and entry trigger only appear at a certain time of day or in conjunction with a news release? Does the success ratio improve if the higher timeframes are trending in the same direction as the proposed trade etc.?
12) Go back to 9 and go through the process again to see what the performance of your system is. In other words, what is your win:loss ratio, profit ratio, maximum consecutive losses, maximum drawdown, average % gain per week / month etc.
After you have written down your trading plan, you can:
13) Switch to a live account trading small size (i.e. with very small amounts of money)
14) Analyze yourself and your ability to follow the trading plan . . . This is an area where many traders come unstuck because they’ve not done a thorough self assessment (SWOT analysis) as outlined in 4) above. It often comes down to a lack of discipline to only take the trades specified in your trading plan. By breaking your own rules, you’re undoing all the constructive work you’ve done so far. It will skew your results which will make analysis of them difficult because you won’t know if your profits or, more likely your losses, are the result of trades executed in accordance with your plan or
AWOL trades.
15) Make your first million. Then your second million just in case the first was a fluke and then write the book!
The next section discusses some popular ways of trading the markets, regardless of the instrument(s) you trade. For example, suppose you decide to trade UK shares. There are lots of trading vehicles that allow you to trade them in one form or another, including: Spread Betting, Contracts for Difference (CFDs), Options, Warrants, Single Stock Futures, Direct Market Access and conventional share dealing. The first five in the list above are known as derivatives, as you are not trading the stock itself but, rather, a financial product based on – and ‘derived’ from – the underlying share. Discussed next will be some of the most common methods.
WHAT IS SPREAD BETTING?
Spreadbets are the simplest form of trading. The most commonly traded spreadbets are probably those relating to the major market indices - in the UK, this is of course the FTSE100. Other major American indices are the Standard and Poors 500 (S&P 500), the Dow Jones and the Nasdaq. Popular European indices include the German DAX and the French CAC.
Spreadbets are not limited to indices by any stretch of the imagination. They can also be applied to stocks, sports - you name it, you can bet on it. However they tend to be less popular for stocks because there are better ways to trade stocks - using a DMA broker, for example. Stocks tend to have a wide
spread, whereas, indices tend to be much narrower on account of their popularity, forcing Spread Betting companies to maintain a competitive advantage by offering ever tighter spreads.
So, how does a spreadbet work? Well, at the time of writing, the Dow Jones, for example, is trading around 10,100. A typical spreadbet company would offer a spread of, say 5 points: 10143-10148, (i.e.
bid 10143 and
offer 10148). These are the prices THEY sell to you and buy from you – not the other way around, unfortunately! Essentially, all spreads comprise two prices, you will buy at the HIGHER price and sell at the LOWER price.
How this works is simple. If you think the market will rise, you ‘buy’ the market, or go ‘long’. Suppose you’re long the Dow, once the bid price rises above the 10148 level, you will begin to make money. Likewise, if you think the index will fall, you ‘sell’ the market or go ‘short’ and, once the offer falls below the 10143 level, you will start to make money.
The downside, of course, is the spread. Let’s say you’re trading at £2 per point, so that for every point the index moves, you make or lose £2. Using the above 5 point spread as an example, you will lose £10 if you close your position at exactly the same price as you opened it. In other words, the Dow has to move up 5 points (assuming you’re long) simply in order to break even. If it moves up 6 points, and you close out the trade, you’ll only make a £2 profit for your trouble. But of course if you get it right, and the market races up 20 points, you'll be up £30. (20 x £2 = £40.
Less the spread 5 x £2 = -£10.)
This is how a ‘spread’ works on any instrument. The only thing that differs from broker to broker and stock to stock is the spread itself. Some brokers might offer a 4 point spread on the Daily Dow, others might offer a 6 point spread. Some brokers offer very competitive spreads on some instruments and less competitive ones on others. The trick is to find the right broker for you.
There is no tax to pay on spreadbets, because under current UK tax legislation, they are classed as gambling and therefore exempt from Income tax and CGT.
WHAT ARE OPTIONS?
To view the
T2W Guide to Options, click the link.
WHAT ARE FUTURES?
Futures are a commonly used way of profiting from moves in the markets, normally traded by those who have some degree of experience. They are not really suitable for beginners.
A ‘future’ is a contract which contains an agreement to buy or sell a specific amount of a commodity (for example - corn, crude oil, silver) or a financial instrument (for example, emini S&P500, Eurodollar, US T-bonds) at a particular price on a particular date. It obligates the buyer to purchase and the seller to sell, unless the contract is offset before settlement date (which it is, 99% of the time!). They are sometimes called ‘commodities’, but with the introduction of financial futures in addition to physical commodities, futures is the preferred term nowadays.
The advantage of futures over, say, a spreadbet, is that the spread is often only one point. In the above example for the spreadbet, where the Dow is at 10143-10148, a futures contract would be 10145-10146. However, there is always a
commission to pay to your broker, and you will have to pay tax on any profits.
WHAT ARE CFD'S?
Many people liken CFDs to trading shares on margin - buying shares and only using a small deposit which is typically between 10% - 20%. In fact, it is an agreement between two parties agreeing to settle at the close of the contract, the difference between the opening price and closing price of the contract - multiplied by the number of shares specified in the contract.
For example, in June you might agree to buy 5000 shares of ABC Limited at, say £6.00 (total value of £30,000). You lodge a 10% margin deposit of £3,000. In September the price of ABC Limited shares moves to £8.00, and you decide to sell at this price. You receive a gross profit of £10,000 (£40,000 less £30,000) and your deposit is returned.
Using CFDs you can control up to 10 times the stock compared with an outright purchase. This higher gearing creates greater profits assuming you correctly anticipate movements in price,
but the risk of loss also increases by the same amount should the price move against you.
Again, one of the attractions of CFD's is that because no physical transaction takes place there is no stamp duty payable under current UK legislation, although this of course can change at any time.
GLOSSARY OF TERMS
Getting up to speed with trading jargon is not difficult. The glossary listed here covers the basic terms used in this Sticky and a few more for good measure. If you come across a term whilst surfing the forums that you’re unfamiliar with, copy and paste it into T2W’s very own
Traderpedia search facility. In the unlikely event that that doesn’t produce any results, try doing the same thing on
Investopedia. If you draw a blank there as well, you can ask for an explanation on forum, safe in the knowledge that the term used isn’t an everyday one and you won’t be making a fool of yourself!
AWOL
A military acronym which stands for ‘Absent Without Official Leave’. When applied to trading, it usually refers to trades that either negate the rules of a trading plan or fail to comply with them sufficiently to warrant taking the trade in the first place.
Backtest
This involves looking to see how a trading strategy would have performed in the past using historical data.
Bear
Someone who believes the market (or an individual instrument) is likely to fall in value.
Bid
The bid price is the price at which one can SELL a given size of an instrument at a given point in time, i.e. the bid is a price at which a buyer is willing to buy a security from you. This is nearly always less than the Offer or 'Ask' price
Broker
A person or firm which executes transactions on behalf of customers, generally for a commission.
Bull
The exact opposite of a bear. A bullish market is a rising market and bullish news is expected to result in the market or individual instrument to increase in value.
CAC40
The leading French stock index.
Candlesticks
Candlesticks originate from Japan and, like price bars, they show the open, high, low and close of price. The body or ‘candle’ is either filled white (or green) indicating a price rise, or filled black (or red) indicating a price fall.
Charting package/software
Traders who use Technical Analysis (TA) require price charts of the instruments they trade. There are a huge variety of charting packages available, ranging from basic free end of day charts (EoD), which are often sufficient for swing traders, to real time ‘tick’ data charts required by day traders, which can cost upwards of US$100 per month.
Commission
A transaction fee charged to a trader or investor when dealing through an intermediary. Commission is the charge a financial intermediary charges to execute a transaction on a customer's behalf. The most commonly thought of type of commission is that of a broker in the stock or other markets. Equity, option, and futures generally all incur commissions. A standard commission is one charged per transaction. In that case, the trader pays both to buy and sell when making a trade. A ‘round-turn’ commission is one which the broker only charges one fee when a position is closed out.
Credit account
This type of account does not require you to deposit funds with your broker in order to trade, other than perhaps a small opening balance. It is not recommended that new traders open credit accounts as a large debt could accumulate very quickly!
Data Supplier
Essentially, ‘data’ refers to the prices of instruments and the number of them traded, e.g. shares or contracts. If you want, you can get your market data from one supplier and your charting software from someone else. Some people don’t utilise TA at all to trade, so they only require market data and a trading platform.
DAX
The German stock index.
For more information on the Dax, click
here.
Direct Market Access (DMA)
Direct Access or Direct Market Access (DMA). DA allows a trader to trade directly with another trader, for example, a
market maker on NASDAQ, or a ‘specialist’ on the floor of an
exchange without broker interference. DA is the preferred trading system for day traders, where success is, in part, dependent upon speed of execution.
Discretionary trader
This type of trader has complete control over all the decisions about when and where to enter and exit their trades. Benefits are maximum flexibility, while drawbacks are that as humans; we are emotional beings that are prone to making poor decisions motivated by fear and greed.
DOW
A common abbreviation for the Dow Jones Industrial Average - one of the major US indices, comprising 30 blue chip stocks in the USA. Also known as DJIA, US30 or Dow30. Futures traders refer to the
e-mini Dow as ‘YM’.
For more information on the Dow, click
here.
Drawdown
The difference in the equity in one’s trading account today, relative to a previous high. E.g. if one has $900 in one’s account today but, at some point in the past, it had had $1,000 in it, then the account has a drawdown of $100.
Elliot Wave Theory
A well known and fairly commonly used method of anticipating the way the market moves. Further information on Elliot is available
here.
E-mini
An electronically traded futures contract (the ‘e’ in e-mini) that represents a portion of the normal full sized futures contracs (the ‘mini’ in e-mini). E-mini contracts are available on a wide range of indices such as the Nasdaq 100, S&P 500, S&P MidCap 400 and Russell 2000. For more information about e-minis, click
here.
Eurostoxx
A Dow Jones index of the top European stocks.
For more information on Eurostoxx, click
here.
Exchange
A marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange. Exchanges give companies, governments and other groups a platform to sell securities to the investing public. An exchange may be a physical location where traders meet to conduct business or an electronic platform.
Fibonacci
A method of determining likely turning points within the market based on a series of Fibonacci numbers. For some basic details, click
here.
Flag
A chart pattern, useful for determining either continuation or reversal of price.
FTSE
The index of the UK’s top 100 companies. When traders refer to the FTSE, they are normally talking about the FTSE100 Index, but there are other FTSE indices also – FTSE250, FTSE350, FTSE All-Share etc
For more information on the FTSE, click
here.
Hang Seng
The Hong Kong index. Referred to by futures traders as either HSI or MHI, depending on the size of the contract.
For more information on the Hang Seng, click
here.
Head & Shoulders (H&S)
Another chart pattern. H&S can signify either a market top or bottom, or a continuation of the current price action, depending upon where it occurs.
Hedging
The practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. Hedgers use the futures markets to protect their businesses from adverse price changes. E.g. airlines will do this to protect themselves from future increases in the cost of fuel.
Hedge Fund
This has nothing to do with hedging as described above. Hedge funds are unregulated and cater for private investors with a high net worth. The fund manager(s) use advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns.
Indicators
Customisable displays on a chart that indicate where possible turning points may occur within the market. They can be based on price action, momentum and moving average prices, amongst others.
Long
If you are ‘long’ the market, it means that you have bought an instrument in the expectation that it will rise in value so that you can sell it later on for a profit.
Margin Account
This account type is where the brokerage firm lends you money based on a multiple of the amount you have in your account, enabling you to purchase more shares / contracts etc. than you would otherwise be able to do with your own funds alone. However, there is no obligation to use the margin facility if you don’t want to although it will be impossible to trade some markets without it – most notably Forex. This type of account is favoured by the majority of traders.
Market Maker
Market makers are individuals or financial institutions who literally ‘make a market’ by maintaining a bid and ask price in a given instrument by always being available to buy or sell at publicly quoted prices. The role of the market maker is to maintain liquidity within an instrument, typically by buying when there is an abundance of sell orders, and selling when there is an abundance of buy orders.
Mechanical trader
Unlike the discretionary trader, this type of trader produces computer code to make some or all of the decisions about when and where to enter and exit trades. The main benefit is the objectivity of a computer, while drawbacks are a lack of flexibility.
MIB
The Italian market of leading shares.
For more information on the MIB, click
here.
NASDAQ
The third of the most commonly traded indices in the US. Also known as the Nas, and known by futures traders as NQ.
For more information on the NASDAQ, click
here.
Nikkei
The Japanese stock index.
For more information on the Nikkei, click
here.
Offer
The offer price (also referred to as the 'Ask' price) is the price at which one can purchase a given size of an instrument at any moment. It is nearly always greater than the Bid price.
Paper trade
All brokers offer some kind of simulated trading, using ‘paper’ in order to test the effectiveness of a trading strategy before switching to a live account and trading with real money.
Pennant
A chart pattern that is similar to a flag and is sometimes referred to as a hinge which normally suggests continuation of a trend.
Pivot Points
A level at which previous support or resistance is broken which results in price breaking out to higher levels or breaking down to lower ones. Particular emphasis is placed on the previous day’s price high, low and close.
Proprietary ('prop') trading
This involves a bank, brokerage or prop’ ‘house’ trading their own accounts speculatively, as opposed to trading those of their clients. Prop’ traders benefit from the best hardware, software and more favorable commission structures. Typically, such traders will have a share in any profits they make.
Pullback
A pullback is an area of consolidation within an established trend. It’s where price makes a temporary retreat from the highs (in an uptrend) and catches its breath before continuing on its merry way. (Also see ‘Flag’ and ‘Pennant’, above.)
Resistance
The price level at which sellers are expected to enter the market in sufficient numbers to take control from buyers. When price makes a new high and then retreats, sellers who missed the previous peak will be inclined to sell when price returns to that level. Afraid of missing out a second time, they may enter the market in numbers sufficient to overwhelm buyers. The resulting correction will reinforce market perceptions that price is unlikely to move higher and establish a ‘resistance’ level.
S&P
Another common abbreviation, this time for the Standard & Poors 500 Stock Index. Also known by some as "Spoos" or "Spooz", and by e-mini futures traders as ES.
For more information on the S&P, click
here.
Spread Betting (SB)
A form of trading where you bet on £ per point moves, outlined above.
Scalper
Scalpers tend to make numerous, perhaps hundreds of trades a day, accruing a number of small profits into a respectable daily total. Losses per trade tend to be minimal, from ‘scratch’ (i.e. break even) to a few
ticks at most. A scalp trade would certainly never be held overnight.
Short
Traders who believe an instrument is likely to fall in value open a trade by selling it ‘short’ in the expectation of buying it back (known as short 'covering') at a lower price. With equities, traders are able to sell shares they don’t own by borrowing them from their broker.
Size
The number of units (shares, contracts, etc.) immediately available to buy (bid) or sell (ask).
Spread
The spread on an instrument is the difference between the price you buy at known as the ‘offer’ and the price that you sell at known as the ‘bid’.
Stop Loss
A price of an instrument where a trader with an open position in that instrument would accept that s/he was wrong and/or does not wish to risk further losses and wants to exit the open trade at a loss.
Support
A level at which buyers are expected to enter the market in sufficient numbers to take control from sellers. The market has a memory. When price falls to a new low and then rallies, buyers who missed out on the first trough will be inclined to buy if price returns to that level. Afraid of missing out for a second time, they may enter the market in sufficient numbers to take control from sellers. The result is a rally, reinforcing perceptions that price is unlikely to fall further and creating a ‘support’ level.
SWX
The SIX Swiss Exchange (formerly the SWX Swiss Exchange) is the principal stock exchange in Switzerland.
For more information on the SWX, click
here.
Tick / Tic / Pip
A tick is usually the smallest increment that a price can rise or fall, typically 1p on UK stocks like CKSN and BARC. In the US it is usually one cent. However, for stocks which are only pennies each, the increments are in fractions of a penny, so the price will go from 1.9p to 2.0p to 2.1p etc. On some it can be 1.90 to 1.95 to 2.00 etc. An intraday move of one cent in the forex market is huge, so price is broken down into tiny fractions known as ‘pips’. The size of a ‘pip’ will vary from one currency to the next. The same principle applies to the futures markets. For example, on the e-mini S&P futures, it is 0.25 point, on mini Dow it is 1.0 point.
Timeframe
Traders who use TA as the basis of their trading strategy tend to use the same timeframe, or combinations of different timeframes. Day traders tend to use fast timeframes such as 1 minute or 5 minutes, whereas swing traders tend towards longer timeframes, such as one day or one week.
Trading platform
Your broker will usually provide you with a trading platform which is essentially the software that allows you to execute your trades. Trading platforms are a bit like cars in that traders will like one and hate another. It’s essential that you find one that you like and has the features you require.
Trend
The most common piece of trading advice is to ‘trade with the trend’. A trend occurs when there is momentum that propels an instrument up (in an uptrend) drawing in more and more buyers, while selling pressure is limited. Identifying when they start, when to join the trend and when to get off it before it ends is the tricky bit!
Trendline
This is a line drawn on a price chart underneath a succession of higher lows in an uptrend or on top of a succession of lower highs in a downtrend. The precise point at which a trendline is drawn will vary from one trader to the next.
Trigger
At the start of a race, athletes hear the words ‘get set’ and ‘ready’, followed by the starting pistol. Similarly, traders ‘get set’ by filtering prospective trades and then looking to see if their ‘set up’ materialises. Finally, there is a trigger to enter the trade. This is often as simple as the breach of a previous price high or low.
Volume
A measurement of how many trades are executed during a specific period of time. Volume can be useful for determining potential turning points within the market, and also for indicating if price action may continue in the same direction.
Editors’ Note on Chart Patterns and Indicators
Please be aware that no chart pattern or indicator is guaranteed to perform in either one way or another, as they depend on a variety of circumstances which can change at any moment. Hence, none of the patterns or indicators mentioned above should be considered as totally reliable. The information provided here is for educative purposes only and is not offered as advice to trade using one particular style, method or indicator in preference to another.
