Morristown, New Jersey (PressExposure) May 27, 2011 -- Rule 1
Never trade with borrowed money.
It's called "leverage" or "margin." These trading strategies use money borrowed from a broker. Some people even max out their credit cards, or take out home loans. Don't do it!
It sounds so tempting -
*Put up only a little money. The broker puts up the rest.
* Make bigger profits. Get returns on the borrowed money as well the investor's own.
Until the roof falls in -
* Losses are multiplied as much as profits. Any loss is much bigger.
* If prices go down, a stock bought with borrowed money is no longer worth enough to be collateral for the loan.
* The broker can demand more money as collateral. That's a "margin call."
* If the investor doesn't have more money, the broker can sell the stock.
* The investor loses almost everything.
* "Margin calls" can cost investors everything.
* Meanwhile, there's interest on the loan.
Buy shares without borrowing, and ride out price dips. Buy shares with borrowed money, and a price dip brings a margin call. The added profit potential is more than canceled by the added risk.
Smart trading strategies are safe trading strategies. Don't use "leverage."
Always take part of the winnings off the table.
At a Las Vegas casino, if someone wins at craps, they might "let it all ride." They keep betting everything they have - what they came with and what they've won. They win big - until they lose it all.
Using trading strategies like a Las Vegas gambler is a recipe for disaster.
People think "big trades make big money." They want to do the biggest trades they can. So they pile all their winnings into their next trade.
* That works until they lose. Then they lose big because they "let it all ride."
But smart trading strategies are safe trading strategies.
* An investor's job is to lower his risk. The lower his risk, the closer he gets to safe money.
The best trading strategies grow portfolios slowly.
* Re-invest part of trading profits. 50% is a good amount.
* Set aside the rest. It will offer safety in hard times.
* Take 50% of profits even if the trade stays open.
* With a $10,000 profit, take $5,000 immediately, and leave the rest invested.
* The $5,000 saved is a cushion against a later fall in the stock.
Don't buy more when the price is falling.
What are some trading strategies when the price falls?
* Panic and sell at once - always bad.
* Hold on and hope - always bad.
* Stick with the Exit Strategy you decided in advance, and sell if and when the price falls that far - smart.
* Buy more - often bad.
Buying more when the price is falling feels smart -
* Lower average cost.
* Get more of a good stock.
But remember that smart trading strategies are safe trading strategies. Buy when the price is falling and increase risk.
* Increasing the size of the position raises risk - automatically.
* The falling price gives negative feedback about the stock even while buying more raises risk.
* "Markets can stay irrational longer than you can remain solvent." ~ John Maynard Keynes.
* Don't assume the stock will bounce back soon. It may not.
Most people buy more of a falling stock because they don't want to be wrong. Don't let ego ruin good trading strategies.