What do you see when you look at RVBD?

With a little technical analysis you can see a bear flag with a potential 20 point target.

In a previous article, I strenuously warned against the temptation of holding overnight positions.  When I give my top ten rules of day trading “don’ts”, no overnights is Rule #1-5.  A close second (or I guess, sixth) is no dollar cost averaging.

As you probably know, dollar cost averaging is the process of buying additional stock after you’ve taken a prior loss.  The rationale for doing so is that, now that the price has been “discounted,” you can buy more of it and therefore, increase your chances of making a profit (or at least breaking even).

If you’ve ever dealt with a stockbroker, then you have very likely been introduced to this strategy.  That’s because dollar cost averaging is written on Page 1 of the Stockbroker’s Handbook under the chapter “They’ll Fall for It Every Time.”  It works like this:

Your broker calls and pitches XYZ stock.  According to your broker, this company has the greatest product, management and marketing strategy.  It is going to revolutionize its industry.  The broker is so excited about the stock that he has not only put all of his money into it, but he has put his dear old grandmother’s retirement fund into the stock.

You figure that he wouldn’t steer his grandmother wrong, so you buy 1,000 shares at $30 per share.  Over the course of the next few weeks, the stock price falls to $15 per share.  You’ve lost $15,000 or half of your original investment.  You think to yourself, “My broker’s poor granny.  Her retirement fund was wiped out!”  Well, perhaps that isn’t your first thought but you are distraught nonetheless.  You just sit in your office thinking, “How could I have been so stupid?”

Yet, you are awoken from your trance by the telephone.  It’s your broker on Line 2.  You can’t believe it!  After such terrible advice, you didn’t think you’d ever hear from him again.  You’re even more shocked when he calls to tell you the “good news” – that XYZ has lost half of its value.

“That’s good news?” you practically scream into the phone.

“No, it’s great news!” he responds, practically reading word for word from the handbook.  “If you thought XYZ was a good investment at $30 per share, it’s a ‘steal’ at $15 per share.  For the same $30,000, you can now buy 2,000 more shares of stock.  In that case, if it just goes back up to $20 you’ll break even.  If it goes back up to $30, you’ll be up by $30,000.  And if it goes up to $50 (and the broker is sure that it will), you will make … get this … $90,000!  You just have to buy more shares!  It’s a no-brainer!”

Now, here’s the weird part – you probably will buy more shares.  Why?  Because if you are like most people, you can’t stand the thought of cashing out a losing investment.  After all, the point of buying stock is to buy low and sell high.  Yet, up until now, you’ve done just the opposite.  However, by dollar cost averaging down the price of your investment, you increase the chances that you’ll eventually break even, if not make a profit.  So why not, right?

Wrong!   The poor house is full of people who dollar cost averaged away fortunes.  They kept buying stocks like Enron, Global Crossing and Worldcom all the way down to zero.  In many cases, they did so at the advice of a stockbroker, who, by the way, earned a commission on every trade.

Of course, as a day trader, you won’t have an outside stockbroker trying to talk you into dollar cost averaging.  Yet, you will have an “internal stockbroker” trying to talk you into doing so to avoid cashing out a losing position.  For example, let’s suppose you buy 1,000 shares of a stock at $19.00 and it falls to $18.10.  You’re down $900.  At this point, your internal stockbroker might try to talk you into buying another 1,000 shares with the thought that you can wipe out your loss if the stock just inches up another $0.45 to $18.55.

Hang up the phone!  Sure, the stock may very well inch back up, but it isn’t worth the risk.  Think about it.  You’re putting an additional $18,000 on the line to avoid a $900 loss.  In all, you could lose as much as $37,000 (remember, you invested $19,000 on the first trade) just because you’re unwilling to accept the loss of $900.  That just doesn’t make sense.

And, I know, you’re sure the stock is going to rise, right?  Or are you?  You didn’t have a good grasp on the direction of the stock when you bought it the first time.  Why do you think it will be any different this time?  Wouldn’t it be better to just consider it a lesson learned and be done with it?  In the overall scheme of things, $900 is a very inexpensive lesson.  Why make your loss almost 400 times greater to learn the same lesson?

One of my friends learned his lesson in the hardest way imaginable.  He bought 2,000 shares of a stock, which went down $2.00 per share.  His total loss at that point was $4,000.  Yet, this guy wasn’t willing to take this loss so he bought more shares.  The stock fell again so … you guessed it … he bought more shares.  He kept dollar cost averaging until he turned 2,000 shares into 8,000 shares and a $4,000 loss into a $75,000 loss.

But there’s more to the story.  Eventually, the stock came back to within 25 cents of the break-even point.  Looking at the charts, I noticed that the stock was near its resistance and asked my friend if he was going to take his loss.  I’ll never forget his response.  “Are you kidding, Fausto?  If the stock just goes up a point, I’m up $8,000!”

Well, once again, you can guess what happened.  The stock knocked against its resistance level and went into a tailspin.  It fell so far and so fast that my friend ended up losing $150,000, which included his wedding money.  In the end, he did not get married to his fiancé.

Think about this for a moment.  My friend’s entire future was changed, in part, by his unwillingness to take a $2,000 loss.  Don’t make the same mistake.  When you are wrong about a stock (and you will be), don’t turn a small loss into a big one.  Simply cash out the position, take your loss and move on. 

» Click here to sign up for my free beginner stock course titled "Introductory Course for Traders and Investors" now

Perhaps you’ve heard about a proposal to levy a tax on stock transactions. This idea actually began circulating about a year ago as a way to curb “speculation” in the market, subdue the market’s volatility, and raise tax revenue, according to its proponents. But, the notion resurfaced recently due to a push by the AFL-CIO to make such a tax a reality. Specifically, the powerful union would like to see a one-tenth of a percent tax on every stock transaction. According to union officials, doing so could raise as much as $100 billion a year in tax revenue.

Now, if you’re not an active trader, you might be tempted to think such a tax wouldn’t affect you. But, you’d be wrong – very wrong. Basically, this tax would impact you as long as you had money in the stock market – even if you’ve never made a trade in your life.

But, first let’s look at how it would impact individuals who trade from their homes, either as a hobby or as a career.

This tax would be on every stock transaction – meaning that if you bought a stock and then sold it, you’d be paying this tax twice.

On top of that, some of these proposals have the tax being applied to the transaction amount. So, let’s say you bought 1000 shares of Microsoft (MSFT) at $25. Your transaction amount would be $25,000. With this tax, you’d be paying a $25 surcharge on this purchase alone.

Imagine how this would penalize daytraders and other types of traders who make anywhere from several trades to hundreds of trades per week. And, remember, traders already pay taxes on every trade they make. But, you’re not a trader. So, why should you care what happens to frequent traders? Because the impact of the tax wouldn’t stop there.

Such a move would likely force many active traders out of the market. This alone would lead to less liquidity in the market – which would actually exacerbate the volatility in the market. And, the illiquidity would lead to bigger spreads – that is, the difference between the bid and the ask price. Which means that when you tried to buy a stock for your retirement portfolio – or when your financial advisor or mutual fund manager did the same – there would be a higher price to pay for that stock.

Speaking of mutual funds, did you know that mutual fund companies, brokerage houses, and hedge funds make an enormous chunk of their annual profits through trading – not investing? It’s estimated, for instance, that Goldman Sachs makes 70% of its annual revenue through trading-related activities. And, as for those staid, supposedly conservative mutual fund companies? On average, mutual fund managers turn over their holdings at a 93% rate per year.

Now, consider that under this tax, every time a firm such as Goldman Sachs or Fidelity or Charles Schwab bought or sold a stock, they’d be hit with an extra fee. When you consider the billions of stock transactions these and other investment firms make, the financial consequences would be alarming. Just think of the hit their profit margins would take. So, who do you think would ultimately pay for these fees? That’s right – their customers. And that means your neighbor, your co-worker, your best friend – and, of course, you. Maybe even worse, some of these firms might try to avoid this tax by rerouting their trading overseas, which would take away from the billions of dollars that the financial services industry generates for our country.

So, when you hear discussions about this proposed tax, pay attention. It’s not just some random tax that will impact daytraders – it’s one that will affect anyone who has money in the stock market. Including you. Fausto Pugliese is the founder and president of Cyber Trading University, a world leader in online education and training for traders and investors in the markets.

(Originally Appeared in Equities Magazine)

Bernie Madoff went from being a relatively unknown name with the public to a highly recognized one in just a matter of months. And, of course, for all the wrong reasons.

But, what most people don’t understand about Madoff is that he made a great deal of his wealth not through his investments, but through his market maker firm. Avid traders knew his company as MADF on their Level II screens.

If you’re not familiar with market makers or their roles, these companies are registered to act as dealers in a stock. They buy, sell, and accumulate shares in a stock on behalf of their clients or for their own accounts. They fill both market and limit orders, and provide much-needed liquidity to maintain at least some level of stability in the stocks they feature.

So, how did Madoff’s firm – as well as other market makers – make so much money?

They do so in four basic ways. Market makers capture the spread between the bid and the ask price on orders, receive commissions from large institutional clients (such as mutual funds), get order flow from brokers, and trade for their own accounts. (Madoff was instrumental in developing the order flow aspect, in which market makers would pay brokers, such as E*Trade or Schwab, to funnel customer orders to them.)

All of this adds up – to a fortune – due to the sheer amount of trades processed each day. And, with the wild volatility and big movements we’ve seen over the past year or so, market makers are really making money.

It’s fascinating to watch market makers at work. You need a Level II screen to do this, and unless you know what to look for, most of the action will escape you. But, if you have a deep understanding of what’s going on, you’ll marvel at how adept market makers are at their craft, as well as how many tricks they employ on unsuspecting market participants to create even more profits for their firms.

While you may never be a market maker like Madoff or accumulate the amount of money he once had, you can see how a market maker operates by watching me in action it my classes. Trust me: It will be an eye-opener.

This post originally appeared on Equities Magazine's Blog Does this sound like you? You buy 1000 shares of a stock at $20. It promptly drops to $18. You’re now sitting on a paper loss of $2000. And, you’re not happy. But, you’re sitting on a lot of cash. You figure if you just buy another 1000 shares at $18, the stock only needs to rebound to $19 and you’ve erased your loss. That’s only a single point. Even better, if the stock merely goes back to $20 – your initial buying spot – you’ll be up $2000. And then if it climbs like you anticipated it would in the first place, you can have a healthy gain. Seems like a sound plan, right? Wrong. Completely wrong. If what I just described seems like something you would do, please follow what I’m about to tell you: Stop doing it. Why? It’s a dangerous game. Sure, sometimes this strategy works just fine. Too many other times, though, it doesn’t. And, that capital you worked so hard to build can quickly evaporate.

Follow up:

Now, I can’t blame you for falling into this mental trap. It’s human nature to delay or avoid pain for as long as possible. And, taking a loss – even a minor one like this – can be painful. But, honestly, if you’re not emotionally and mentally ready to accept losses on a regular basis, you’re not meant to be a trader. To make matters worse, some financial pundits and stockbrokers favor this exact sort of an approach. Hey, they say, if you liked the stock at $20, you gotta love it at $18, right? Wrong again. To begin, these groups are often selling this pitch to value investors who have long time horizons. But, you’re not an investor. You’re a trader with a short timeframe. You shouldn’t be listening to anything that has to do with investing. Beyond that, these sorts of moves are dangerous even for investors, as they face the same risk as traders in terms of endangering their capital. Let’s look at Citigroup. A year ago, the stock was around $50. Now, it’s less than a tenth of that. How many investors gladly bought all the way down, thinking they were getting a great buy? As a trader, how do you know that the stock mentioned in my hypothetical example won’t fall to $16? Or $14? Or $10? Will you keep averaging down all the way? If not, when will you get out? And, by then, how much of a hit will your portfolio have taken? As I teach in my classes, you must learn to be comfortable taking small losses. And, you must stick to your game plan, and not try to create plans on the fly. Actually, all of this relates to the most important characteristic of successful traders: discipline. As I’ve said time after time, you can have the best trading methodology, instincts, and equipment, but if you don’t follow your rules and maintain your discipline, you’ll get washed out of the market. It’s not a question of if, but when. So, the next time you’re in a situation like this and that inner voice tells you to stick with the stock and average down, just ignore it. Instead, take your loss, move on, and stay in the game.

Whenever I’m with a group of new day traders, it isn’t long before the conversation turns to trading vehicles – the mixture of computer hardware and software used to trade.  And just like tastes in motor vehicles, there is a wide variety of tastes in trading vehicles.

Some traders opt for the “luxury model” trading system.  They must have all of the latest and greatest gizmos and gadgets.  They outfit their systems with several monitors and all of the software bells and whistles you can imagine.  In fact, if you didn’t know better, you’d think these people were single-handedly landing the Space Shuttle. To the other extreme, you find the trader who insists on buying the “economy class” system.  They equip themselves with the bare minimum – a low-end computer, an acceptable internet connection and the least expensively priced trading tools.  They figure that it doesn’t matter how you look when you roll onto Easy Street, just so long as you get there.

Of course, in day trading, as in life, the best course of action is somewhere in the middle.  However, if you must veer towards any extreme, I urge you to steer clear of trying to enter into financial race in an economy vehicle.  After all, would you attempt to win the Indianapolis 500 driving a 1973 Ford Pinto?  Of course not.  Well, the same principle applies in the market.  The few dollars you save will pale in comparison to the fortune you squander by settling for inferior functionality.  At a minimum, your trading vehicle must have the following features:

A Top of the Line Computer By “top of the line”, I mean that your computer should have an excess of CPU speed and RAM.  If your computer is just powerful enough to run your trading software, then it’s performance is going to be sluggish.  And trust me, there is nothing more frustrating (or expensive) as being locked out of money-making opportunities because your computer has frozen up.

High Speed Internet Access This really should go without saying.  If you try to travel the information superhighway via dial up, you’re going to find yourself being run into a ditch.  This is particularly true in the market where millions of shares trade hands every second.  You must invest in the fastest (and most reliable) Internet connection available to you.

Level II Access Just as your access to the Internet must be timely, your access to current market information must be timely as well.  And while stock market information abounds on the Internet, it isn’t always timely.  For example, stock quotes posted on a web portal may be delayed by as much as 20 minutes.  Trying to day trade by relying on outdated information is like trying to drive a car by looking solely through the rear view mirror, it’s a recipe for disaster.

Of course, even having current information isn’t enough if the information isn’t also complete.  And by complete, I mean that the information must go beyond just the Level I information, such as the last bid and ask.  You want to be able to see how the market makers are positioning themselves with respect to the stock.  You need Level II information.

And don’t fall into the trap of trying to save a few bucks by getting “Level 1 ¾” access.  Some providers have begun selling access that lets you see the ECNs, but not the market makers.  Remember, you want to be able to play follow the leader and not follow the follower.  You need to know what the real experts are doing in the market, not the Ordinary Joes like you and me.

Bells and Whistles Ideally, your Level II execution system should be linked to your charting tools.  You don’t want to spend valuable time searching for current stock charts.  You want to be able to type in the symbol and have your charts pop up.  Also, you should be able to customize which charts are displayed.  I like to be able to see the 1-minute chart, intraday chart and 1-year chart at a glance.  You also want to have immediate access to the top gainers and losers of the day to alert you to lucrative trading opportunities.  When looking at these lists, I like to set my system to sort them by percentages and not just overall dollar amounts.

Of course, you should be careful to avoid cluttering your screen with too much information.  You don’t want to miss a good trading opportunity because the pertinent information was hidden behind a useless chart or graph on the screen.

Double Vision One solution to the problem of hidden information is to invest in a computer capable of displaying on two monitors at once.  That way, you can see twice as much information as you could view on one screen.  Of course, you don’t want to take this idea to the extreme.  Ten monitors won’t allow you to view ten times as much information.  From my experience, I’ve found that two screens are probably all you can watch at one time anyway.  If you try to watch any more than two, you usually end up not watch any.

That being said, you don’t want to scrimp on your trading vehicle.  That’s simply being penny wise and fortune foolish.  In fact, if the price of a solid trading system is a problem for you, then you’re probably like the person in the Mercedes dealership asking about the car’s gas mileage.  If you can’t afford the gas, then you certainly can’t afford the car.  Likewise, if you can’t afford an adequate trading platform, then you’re probably trying to perform on the wrong stage.

Fausto Pugliese. President and Founder of Cyber Trading University.

In a very familiar old joke, one gentleman asks another, “How do you get to Carnegie Hall?”  The second gentleman responds, “Practice.”  I believe the same advice applies to the person who asks how to become a successful day trader. The simple truth of the matter is that most day trading systems (at least the good ones) are not terribly complex.  For instance, my system is built on the simple premise of follow the (market) leader.  It isn’t rocket science.  After all, if it was, I wouldn’t be able to follow it.  Yet, all too often, my day trading students let the simplicity of the system lull them into a false sense of security.

The truth of the matter is that most things in life are simple.  It’s simple to swim, drive a car or hit the perfect golf shot.  It’s only a matter of taking very simple actions and putting them together in a specific order so that you produce the desired result.  Yet, very often, the ability to put these steps together requires practice and plenty of it.

Think about it.  If you had the good fortune of taking a private golf lesson from Tiger Woods, would you then immediately quit your job and try out for the PGA tour?  Of course not.  But why not?  After all, if Tiger told you everything that it took to be a PGA champion, then why can’t you just follow his advice and start raking in the big bucks yourself?  It works for him.  It should work for you, right?  Wrong!  The reason it works for Tiger Woods is because he has spent more than 20 years practicing his craft.

The same is true when you read a book or article on day trading or attend a live training.  Trying to translate that knowledge into day trading profits without practice would be like trying to learn to swim by merely reading a book.  It won’t work.  You can get an understanding of the basic techniques from a book but in order to really learn to swim, you must get in the water and splash around a bit.  Well, the same thing is true for day trading.  You must get into the water (in this case, the market) and splash around some.  In other words, you must practice what you learn.

Needless to say, when you first start out, you’re not going to be a master day trader.  You’re going to swallow some water.  For that reason, I always recommend that my students refrain from doing any live trading for at least the first 30 days after taking my course.  During this time, I ask them to set their trading software to training mode and simply practice what they’ve learned.  Only after they are consistently making a profit should they even consider “going live.”  If you’re new to day trading, I recommend the same thing for you.  Practice what you’ve learned until you can carry out the actions that will make you consistent profits.

In my experience, this is where many of my students stumble.  They can’t resist the temptation of getting in the game.  After all, it isn’t much fun to brag to your friends that you are making a killing in the market on paper.  And you certainly can’t use your paper profits to put a down payment on a new car or take your family on vacation.  Yet, paper profits are much better than the alternative – real losses.  After all, if you think your family will look at you funny when you tell them that you just made $7,500 in paper profits, then just imagine the looks you will receive when you have to admit that you are $7,500 behind in real money because you jumped headlong into the deep end of the market without first learning to stay afloat.

As I see it, if you’re going to make mistakes (and you will), it’s best to make those mistakes for free.  Over the years, I’ve met many day traders who didn’t heed this advice.  They were so anxious to try out their newfound skills that they ended up exposing themselves to significant financial losses.  As a result, they spent their first few years of day trading trying to recoup the losses they incurred in the first few months.

To demonstrate how devastating these early losses can be, let’s suppose you belly flop into day trading by losing half of your initial investment in the first few months.  With half the capital to work with, you will need to be twice as good as the average trader just to make the same amount.  Of course, you won’t be twice as good as the average trader because you’re just starting out.  Yet, the need for spectacular returns will force you into making spectacular blunders and before long, you will be dead broke or very close to it.

Trust me on this one.  I’ve seen it more times than I care to remember.  Yet, each time, it is equally frustrating because it is 100% preventable by just taking the time to practice the system you’ve been taught.

And how long should you stay in training mode?  Until you can consistently make money on paper.  A .333 batting average is great for a baseball player but it is disastrous for a day trader.  Therefore, you shouldn’t even think about lacing up your cleats and getting into the day trading game until you are able to make paper profits at least four out of five days.

I realize that this may seem like a lot of time spent on the sidelines.  Yet, if you ask me, “How do I get to Easy Street?”  My answer will be “Practice!”

Fausto Pugliese. President and Founder of Cyber Trading University.