Warren Buffett vs. the Profiteers of Doom

MIAMI, Fla. (MarketWatch) — Buffy the Vampire Slayer, meet Buffett the Doom Slayer.

The Oracle of Omaha, Warren Buffett, is firmly entrenched with optimists who believe the worst is over for both the U.S. economy and the stock market.

“It’s a terrible mistake to get pessimistic on America,” Buffett said on CNBC last month. “It has not worked since 1776 and it’s not going to work now.”

Tell that to Harry Dent, Gerald Celente and Robert Prechter — confirmed pessimists who predict a stock market crash, financial panic, and perhaps a run on the banks.

A market crash is coming in 2013 or 2014, Dent warned in an article in USA Today. “This will be a repeat of 2008-09, only bigger, when it finally hits,” said Dent, author of “The Great Crash Ahead.”

“Get out of the way,” Dent told USA Today. He suggests that you buy short-term U.S. Treasury bills and the U.S. dollar, and avoid stocks.

In that same article, trend forecaster Gerald Celente told Americans to brace for an “economic 9/11.” He predicted that the coming meltdown will lead to social unrest, anti-government sentiment, more people out of work, and a weaker U.S. dollar.

If there is a financial panic, Celente said it could trigger a run on the nation’s banks that might cause the government to invoke “economic martial law.” According to Celente, the threat is real. “When money stops flowing to the man on the street, blood starts flowing in the street.”

Celente suggests that you buy gold if the U.S. dollar plunges, plan a getaway to more stable countries, and arm yourself with weapons.

Meanwhile, author Robert Prechter was quoted in the USA Today story that “1930s-style deflation” could cause havoc with the nation’s finances. He warned that the major U.S. indexes could fall below their March 2009 lows. According to Prechter, just like in the 1930s, even a brief recovery will fail, and stocks could lose half their value. “The economic recovery has been weak, so the next downturn should generate bad news in a big way.”

Sunny side of the Street

Buffett is having none of that. “In terms of the economy,” he said on CNBC, “the luckiest person born in the history of the world is the baby being born in the United States. I mean, in terms of the outlook for their lives, they are going to live better than John D. Rockefeller lived or better than I lived.”

Buffett has said that you could sit down at the start of every year and list 20 reasons why things are terrible. “But the truth is, this economy works wonderfully. It’s working wonderfully now. I mean, it isn’t working for everybody at this moment, and it’s coming back from a terrible shock that it received in the fall of 2008.”

On CNBC, Buffett said that the U.S. financial crisis in 2008 was an “economic Pearl Harbor.” He said the country had never seen this kind of financial panic before. “The country almost stopped,” Buffett said. “And that financial panic bled over into the general economy very quickly and very severely. And we’ve been coming back now for three years from that, and we continue to come back. But I will predict that our businesses will have more people working for them at the end of this year than at the start of the year.”

Accordingly, Buffett is a big believer in stocks, though he noted that October 2008 was a better time to buy than now. Yet investors have to look ahead. Said Buffett: “This is a better time [to buy stocks] than 10 years from now will be.”

Buffett also believes it’s a great time to buy a home. “I’d finance it with a 30-year mortgage, and it’s a terrific deal,” he said.

Believe the optimists or the pessimists? The answer is to believe in yourself. Every day you’ll get conflicting views of the state of the world. No one really knows, so make your own informed, thoughtful decision.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).

10 Ways to Trade Penny Stocks

MIAMI, Fla. (MarketWatch) — The allure of penny stocks is simple: They don’t cost much money and promise big profits. But trading penny stocks is also a good way to lose money.

Sure, it’s possible to profit when you understand the game, but the odds are against you when you don’t. And worse: manipulators and scammers often run the penny-stock game.

For investors who can’t afford shares of Google or Apple, the potential gains from trades like this are too good to pass up. So penny-stock trading thrives. With a relatively small investment you can make a nice return if — and this is a big if — the trade works out. For example, say you buy 10,000 shares of a $.30 stock for $3,000. If the stock reaches $1, you’ve made $7,000, doubling your money. Read more: 5 strategies if you have less than $3,000 to invest. 

Dollars and sense

Penny stock promoters make sure to attach a disclaimer to their email, Twitter, or Facebook page, and take advantage of this language to embellish and deceive.

Penny stocks and their promoters also tend to stay one step ahead of securities regulators, though just last month the Securities and Exchange Commission charged a Florida-based firm, First Resource Group LLC, with penny-stock manipulation. Read more: Simple rule: Don’t buy a penny stock.

Even with these clear dangers, some people insist on trading the pennies. So, if you find yourself on the receiving end of a telephone call from a penny-stock promoter, or you spot an advertisement that promises dollars from your pennies — and you still decide that maybe penny stocks aren’t wooden nickels, just remember these 10 rules:

1. Ignore penny-stock success stories

Timothy Sykes, a penny-stock expert who trades both long and short, says you must not believe the penny-stock stories that are touted in emails and on social media websites.

“You have to say no,” Sykes said. “You can’t invest in penny stocks as if they were lotto tickets, but unfortunately that’s what most people do, and they lose again and again. Think of penny stocks as inmates in a prison that you can’t trust.”

Instead, Sykes says, focus on the profitable penny stocks with solid earnings growth and which are making 52-week highs.

2. Disregard tips and read the disclaimers

Penny stocks are sold more than bought — mostly via tips that come your way in emails and newsletters.

“The free penny-stock newsletters are not giving you tips out of the goodness of their heart,” Sykes said. “If you read the disclaimers at the bottom of the newsletters, they are getting paid to pitch a stock because their investors want exposure for the company. There is nothing wrong with wanting exposure, but almost all penny newsletters make false promises about their crappy companies.”

Sykes says there is a difference between stocks making a 52-week high based on an earnings breakout and stocks making a 52-week high because three newsletters picked it. Reading the disclaimers at the bottom of the email or newsletter, which the SEC requires them to do, will usually reveal a conflict of interest.

“Most newsletters don’t tell you the truth,” Sykes said. “They are being compensated to pump up the stock, and they rarely tell you when to sell. Often it’s far too late.”

3. Sell quickly

One allure of penny stocks is you can make 20% or 30% in a few days. If you make that kind of return with a penny stock, sell quickly.

Unfortunately, many traders get greedy, aiming for a 1,000% return. Considering that the penny stock you’re in might be getting pumped up, take any profits and move on.

4. Never listen to company management

In the murky penny-stock world, don’t believe what you hear from companies.

“You can’t trust anyone,” Sykes said. “The companies are trying to get their stock up so they can raise money and stay in business. There is no reliable business model or accurate data, so most penny stocks are scams that are created to enrich insiders.”

Sykes says large rings of the same people run promotions using different press releases and companies, including the reappearance of a notorious stock manipulator who was first convicted for an email pump-and-dump scheme when he was in high school.

5. Don’t sell short

Although shorting pumped-up penny stocks may seem attractive, don’t do it.

Penny stocks are too volatile, and if you’re on the wrong side of the trade, you could easily lose 50% or more on a short squeeze. Another problem is that it’s difficult to find shares of penny stock to short, especially those that made huge moves based on hype and newsletter tips. Leave shorting penny stocks to the pros.

6. Focus only on penny stocks with high volume

Stick with stocks that trade at least 100,000 shares a day. If you trade stocks with low volume, it could be difficult to get out of your position.

“You must be aware of the number of shares traded and the dollar volume,” Sykes said. He also suggests that you trade penny stocks that are priced at more than 50 cents a share. “Stocks that are trading less than 100,000 shares a day and are under 50 cents a share are not liquid enough to be in play,” he added.

7. Use mental stops

Because the bid-ask spreads on many penny stocks can be high, as much as 10%, hard stop-losses can actually cause you to lose money. p>

Although it takes more concentration, use mental stops. “I focus more on risk-reward than stops,” Sykes said. “If I want to make a dollar a share on a three-dollar stock, I will cut my losses at 20 cents so I have a 5:1 risk reward. I aim for 3:1 or 4:1, but not 1:1 or 2:1. If I think a dollar stock has only 50-cents upside (2:1), my mental stop loss will be at 10 cents because the risk-reward is better.”

8. Buy the best of the bunch

Sykes looks to buy penny stocks that have had an earnings breakout.

“I love buying penny stocks when they have good earnings, or when they are breaking out to 52-week highs on volume that is at least a quarter million shares a day,” he said. “They are easy to find if you look.”

The challenge is to find stocks that make 52-week highs that aren’t due to a pump-and-dump scheme. Examples of penny stocks that have fit Syke’s criteria in the past include Tangoe, Magal Security Systems, and Staar Surgical Co.

9. Don’t trade large positions

“You really need to be careful with position sizing,” Sykes said. “I learned the hard way not to trade big. My rule now is not to trade more than 10% of the stock’s daily volume.”

In addition, he said, limit your share size so you can get out of the stock faster.

10. Don’t fall in love with a stock

Every penny stock company wants you think it has an exciting story that will revolutionize the world. If you enter the penny stock arena, be cynical, do your own research, and diversify, even if a friends or family member is touting a stock.

Penny stocks have earned their bad reputation, so beware.

Michael Sincere is the author of Start Day Trading Now (Adams Media)

5 Trading Strategies if you have Less than $3,000

MIAMI (MarketWatch) — Recently I gave a talk at Colgate University, a liberal arts college in Hamilton, N.Y., about understanding stocks and studying the market.

It was homecoming weekend, and I was amazed that so many people attended the seminar. By the way, Colgate beat Cornell in overtime.

But in learning to be a successful investor, even a little bit of money can go a long way.

If you have less than $3,000 to invest or trade, it’s possible to participate in the financial markets. Learning about the market is a lifelong pursuit, so this initial investment is your “tuition.” Here are five strategies, ranked by risk level, to consider:

1. Think, plan, and study

What is the secret to the stock market? Above all, believe in yourself and what you can achieve.

Next, study the financial markets and talk to people to obtain investment ideas. Read up on the risks and rewards of stocks, bonds, and options. Join an investment club at your school or in your community to discuss ways to increase income. Finally, trade and invest online in practice trading accounts. Your goal is to not to just make money, but to find ways to make money work for you.

Risk: None.

2. Buy mutual funds

Buying and selling mutual funds is the easiest way to invest without a lot of money. Mutual funds are diversified, relatively inexpensive, and make sense for long-term investors.

Buying mutual funds can help you learn about stock sectors, indexes, diversification, and dividends. If you do invest in mutual funds, choose no-load funds, which are less costly than load funds. Although many mutual funds are professionally managed, you can still lose money if the stocks in the fund do poorly.

Risk: Medium. If you’re a novice, learn stock market basics with mutual funds.

3. Buy exchange traded funds

Many people prefer exchange-traded funds, which are similar to mutual funds but trade like stocks.

Stick to non-leveraged ETFs. The most popular ETFs are index funds such as the stocks that make up the Nasdaq 100, the S&P 500, and the Dow Jones Industrial Average. As with stocks, prices of ETFs change continuously during the day. The advantage of ETFs is they are relatively inexpensive, liquid, and provide instant diversification.

Risk: Medium to high. Like stocks, trading ETFs can lead to sudden and dramatic losses.

Trade or invest in one stock

For $1,000, you can open up a live trading account at a brokerage firm. When you use your own money, you experience the pain and joy (and greed and fear) of trading.

One strategy is to invest or trade in the stock of one company that you know. Learn all the nuances of the market through this one stock. If trading, learn when to enter, exit, and escape stock positions using support and resistance. If investing, study a company’s fundamentals such as earnings.

Although it’s tempting to buy penny stocks (stocks under $3), it’s also easy to lose all your money on that trade.

A sophisticated strategy is to sell short (you profit when the stock goes down) vulnerable stocks that rise on momentum, not fundamentals. This strategy is not recommended for beginners because you must use margin (i.e. borrow money from the brokerage) to finance your trades. You can also lose more money than you started with. Nevertheless, it’s important to know that you can profit when a stock goes down in price.

Risk: High. Owning one stock is risky because you are not diversified. Therefore, you’ll need to initiate a stop limit order to avoid major losses. Trading penny stocks and selling short are not recommended for novices.

5. Consider options

Once you’re knowledgeable about the stock market, consider investing in options. Although some people believe that options are too risky, many option strategies are less risky than buying or selling stocks. With options, you often know exactly how much you can make, or lose, before you make the trade.

One of the most understandable option strategies is to sell “covered calls” on a stock you own, and receive consistent income. You can also speculate by buying calls or puts, although most speculators lose money.

As you gain experience and knowledge, you can use option strategies to protect stock positions, or buy option spreads. Before trading options, it’s essential you learn about all the potential risks, especially if you are using more sophisticated strategies.

Risk: High. It’s possible to lose all of the money you initially invested when trading options. When buying options, you have to be right about the timing and direction of the underlying stock, and that’s difficult to achieve.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).

Money, Models, and the Market

Commentary: Wall Street may need a little help from angels

I am standing on the sidewalk in front of a SoHo clothing store in lower Manhattan. It’s Fashion’s Night Out, and thousands of people are having a one-night fashion celebration. On this night, models, celebrities, and designers are encouraging customers to shop for clothes at reduced prices. Judging by the festive crowds and ringing cash registers, the night is a huge success.

Models and Money

In front of me are hundreds of awe-struck fans waiting in line to meet the angels: Victoria’s Secret Angels. Victoria’s Secret (NYSE:LTD), an American retailer of women’s clothes, is popular for its spectacular fashion shows and reasonably priced lingerie. The twelve Victoria’s Secret angels are some of the highest paid models in the industry, and a few go on to become supermodels. Victoria Secret’s Adriana Lima’s estimated annual income is eight million dollars; Alessandra Ambrosio’s estimated income is five million dollars.

Four angels suddenly enter the room, and the large crowd hushes. Adriana Lima, Alessandra Ambrosio, Lily Aldridge, and Erin Heatherton walk over to me for an interview. These million dollar models are charming, and very knowledgeable about Victoria’s Secret products. (See photos of my interview with the angels here: http://bit.ly/nBT6Ev.)

Models and the Market

What do fashion models have to do with the stock market? Actually, the stock market and fashion industry are more alike than many people realize. The similarity? Both are based on a fantasy: one promises to make you beautiful while the other may make you rich.

Yet, when customers enter a fashion store, they expect to be seduced by gorgeous models. When investors enter the market, theydon’t expect to hear fantastic promises that won’t come true. Instead of beautiful models, investors often feel as if they’re looking at the Emperor’s new clothes.

Even if Wall Street hired a flock of lovely angels, it’s not easy to inspire faith in its products. Who cares that the stock market rose more than 70 percent from its 2009 lows? Because many investors didn’t earn back their money, they feel that the market is rigged against them. Unlike the fashion industry, Wall Street has lost its sex appeal.

In the last few months, some people have revolted against Wall Street by protesting against an unfair financial system. There is some truth to the complaints, so unless Wall Street wants to lose investors for the next decade, they’ll need to change the way they do business.

How Wall Street can bring investors back

As the protests grow louder and last longer, Wall Street may want to consider taking the following steps:

  1. Create a fair stock market
    The stock market isn’t fair anymore. The market often goes up or down not based on fundamental or technical analysis but volume generated by high frequency traders (HFT) or flash traders. Although the increased volatility might help a handful of traders, it certainly doesn’t instill confidence in the system. In addition, some rules, such as the uptick rule, were eliminated or changed to favor insiders. If Wall Street wants to recover from the negative PR, they’ll need to create a fair stock market with logical regulations. Otherwise, it is buyer beware.
  2. Make a transparent stock market
    Right now, there are almost two stock markets, one for the insiders and the other for everyone else. “The average investor is not privy to how Wall Street really works,” explains former hedge fund manager Shah Gilani. “If you don’t know what is woven in that cloth, it’s hard to tell what kind of quality it’s going to be.” If Wall Street truly wants to level the playing field, then “they’ll have to start looking at what’s good for the economy and investors, and not just for them,” he cautions. (Click here for my full interview with Gilani: http://bit.ly/o8Okax.)
  3. Punish wrongdoers
    For years, the Securities and Exchange Commission (SEC) looked the other way while Bernard Madoff and others scammed individual investors. This gave the impression there were no consequences for illegal behavior. Lately, the SEC appears to have found courage, but some still want this agency defanged. When bad behavior is ignored or rewarded, it destroys people’s faith in the financial system. If individual investors or traders break the rules, they’ll get in big trouble. Who was penalized for helping cause the 2008 crash?
  4. Putting lipstick on a pig
    This season, the fashion trend is bright, bold, and colorful, anticipating good times ahead. On Wall Street, however, the market trend is indecisive and volatile. Unless Wall Street undergoes an extreme makeover, even angels with lipstick can’t make it pretty again.

Note: Here’s the Marketwatch link to the article: http://bit.ly/tpkb6p

4 Defensive Strategies for Anxious Investors

MIAMI, Fla. (MarketWatch) — If you’ve been following the market, you know that it’s resembled a wild roller coaster ride. Although selling in May was exactly the right move, when to get back in is less certain.

At the moment, the charts look dreadful: the major stock indexes are well below their moving averages, and other technical indicators signal dangerous conditions. For insights into this volatile market, I spoke with trader Toni Turner, author of The Beginner’s Guide to Day Trading Online (2nd Edition).

A few months ago, Turner noticed that the market was changing for the worse.

“Starting with the rebellion in Egypt, the stock market was rising but the weekly candlesticks were getting wider and wider, which reflects indecision,” she said. “I also looked at an indicator called Average True Range (ATR). When it started to rise, it suggested it was time to be defensive.”

Volatility knocks

Many people falsely believe that all this volatility is good for day traders. In fact, it’s difficult to make money when the market is making double- and triple intraday reverses. “Even one rumor can make the market turn on a dime,” Turner said. “We now have a headline-driven market, and it’s not based on the fundamentals of a sound economy.”

Because of the extreme volatility, it’s often difficult for traders to book profits. “For example, if there is a rumor that China is buying Italian bonds, the market shoots up,” Turner said. “The next day, traders discover the rumor is false and the market falls. Traders who are close to the information have already gotten out.”

When the market is this confused, Turner suggested a number of defensive strategies to use:

1. Determine who is the ‘boss du jour’

There’s always an underlying force that influences market direction. Identifying what is moving the market can help you be on the right side of the trade.

“My strategy is to establish what dynamic is leading the market,” Turner said, targeting what she calls the “boss du jour.” In the past, oil led the market, and often it’s the S&P 500 Index or Dow Jones Industrial Average futures.

“Right now the euro is the boss,” Turner said, “and it’s having a rough time. If the euro moves down, the market will often follow.” In the old days, U.S. traders didn’t pay much attention to the global markets, and few paid attention to the European Central Bank or unemployment in Germany. Now it’s a global market, and astute traders study world headlines for clues.

2. Use charts to identify congestion

One of the most basic skills in technical analysis is learning to identify confusion, or congestion.

“Congestion on a chart is a series of stops and starts on a chart,” Turner said. “Right now we see this congestion on stocks that are normally docile. I can’t relate this to any recent period in history. It’s a mess. If you look at the defensive ETF sectors such as XLU (Utilities SPDR), it’s usually a yawn, but when it’s acting like a tech stock, you have to wonder what is going on. Some of these stocks look like a kangaroo on speed.”

3. Avoid overpriced growth stocks

Although Turner is a trader, she studies stock fundamentals such as the P/E ratio, debt levels, and earnings.

“Don’t buy an overpriced growth stock with bad fundamentals,” she said. “These stocks were probably ‘bid up’ by traders. More than likely, there are hedge funds just waiting to short them on the next market downturn.”

Turner suggests taking a look at value stocks, especially if you are bottom picking. “Value stocks don’t usually get hammered as badly as growth stocks, when we experience a downturn.”

4. Pay attention to chart patterns

Not everyone believes that chart patterns are useful, but Turner disagrees.

“Patterns are human behavior on a screen,” she said. “Greed, fear, optimism, and anxiety are displayed. So when I see a bear flag pattern with wide candles being drawn on a chart with big gaps, it tells me the people trading this stock are confused and in disagreement. This is what I see on the SPY right now, and it’s been like this since August.”

Parting words

For now, Turner suggests that rookie traders stand aside and take a breather. “It’s a difficult, headline-driven market. If you’re wise and try not to outthink the market, you can remain in cash for now. When the market starts to go our way again, you’ll have money to trade.” Read more of my interview with Toni Turner

When the market is this confused, staying on the sidelines makes sense. The war between the bulls and bears continues, and eventually one side will win. Until then, patient traders must wait for an opportunity to pounce. Unfortunately, that opportunity has not yet arrived.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).

7 Ways to Identify an Imminent Market Crash

MIAMI (MarketWatch) — For years, people have been warning of an impending stock-market crash. Those who listened buried their money in short-term bonds or cash and missed out on one of the greatest comebacks in market history.

The purpose of this article is to help traders and investors understand the clues and psychological characteristics that often precede a market crash. No one can predict the day or time, but if you pay attention, you can recognize the signals.

Clue no. 1: Leading stocks fall

This comes from “How To Make Money In Stocks” by Investor’s Business Daily founder and Chairman William J. O’Neil. If leading stocks such as Priceline.com Inc., Amazon.com Inc. and Apple Inc. start to break down and fall, this signals that the market is weakening and that the market’s dynamics are changing for the worse.

In addition, after the recent two-year bull market, expect choppy conditions moving forward, which increases the risk there could be a correction or crash. Bottom line: Pay attention to leading stocks.

Clue no. 2: September-October curse

Historically, most crashes occur in September and October. If you’re in the stock market, you must be acutely aware of these two months and be prepared for potential crashes. Because traders with trigger fingers know about the September-October curse, fear often increases during these two volatile months.

Clue no. 3: Speculation is rampant

Who can forget the crazy days of 1999 when Internet stocks like Qualcomm Inc. went up by 100 or more points in a day? My favorite example is the 17th-century tulip mania, when thousands of Dutch people paid more than $200,000 (using today’s exchange rate) for a single tulip bulb.

Although the current market environment is not that speculative, there are clues that some stocks are flying into the stratosphere. “You could make the case that the current valuations of Twitter, Facebook, LinkedIn, Pandora and Zillow are extreme,” says Timothy Sykes, professional trader and short-seller. “These companies have amazing business models and people think their businesses will never stop growing, but that is just bull. The odds are that Facebook’s valuation will see $60 billion valuation (currently $80 billion) before it sees $120 billion.”

Clue no. 4: Media doom and gloom

When the media begin to report that the market has been falling for a record number of days (i.e. “down for fifth straight session”), it makes people anxious. “It causes people to want to exit en masse,” says Sykes, “like a run on the bank. They are being influenced by fear.”

Although the media don’t create news, the cumulative effect of the negative news creates anxiety and fear. It might not take much for millions of investors to throw in the towel and sell. Read my interview with Timothy Sykes on the characteristics and clues that precede market crashes.

In addition to the above clues, it’s also important to study crash characteristics.

Characteristic No. 1: The catalyst

There is usually a big event that takes a weakened market lower. This can be the catalyst that causes the crash.

“Crashes don’t usually happen out of the blue,” according to Sykes. “Sometimes they do, but most crashes occur when the market is already downtrending.” He says that people are already selling into a downtrending market when they “suddenly puke it up one day. The momentum that causes a crash is built up over days, weeks or months.”

The most dangerous market is a long and gradual downtrend where there are no bounces. This can lead to a severe crash.

Note: The current market remains in a two-year uptrend, although it has been struggling lately.

Characteristic No. 2: The big bounce

As you probably know, the two big motivators in the stock market are fear and greed. Although greed can go on indefinitely, most people don’t remain in a perpetual state of fear for long. That is why after a big crash, there is often a big bounce. “Every crash throughout history has been followed by a bounce, no matter how fleeting,” says Sykes. “It might not be huge or long, but if you can sit in cash while everyone else is panicking, you have an opportunity.”

Flash crashes, although rare, can create the biggest bounce, he added.

Characteristic No. 3: Crashes rarely happen at tops

Most people think the market hits some magical number, like the Dow Jones Industrial Average at 13,000, and then crashes. This myth has caused people to miss out on many financial opportunities. “People love calling the top,” says Sykes, “because they think there will be a crash from the top. The market might fail to break out to new highs, but crashes usually don’t happen at the top.”

A more likely scenario, he remarked, is there’s a drop before the crash. “This scares the momentum buyers away, which can then lead to a crash.”

For example, it took 17 months for the blue-chip index to fall from 14,164 in October 2007 to 6,469 in March 2009. The most severe damage to the market lasted only five months beginning on Oct. 1, 2008, when the Dow already had fallen to 10,850.

Understanding the characteristics and clues of market crashes is essential for traders and investors. It’s also important to have a plan before the next crash occurs, which will be the subject of my next article.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).

How to Predict the Market’s Next Moves

MIAMI, Fla. (MarketWatch) — If you ask many traders which market indicator they’d use if they could only choose one, it would be moving averages.

Even if you don’t believe in technical analysis, take a look at moving averages, a powerful but simple indicator that gives important clues to market direction. The most popular are the 50-day, 100-day, and 200-day moving averages, although people use the 200-day measure as a guide to the long-term market trend.

But in a recent article, MarketWatch columnist Mark Hulbert found that a portfolio following the 200-day moving average hadn’t produced such impressive results over the past 20 years. “Even on a risk-adjusted basis over the last two decades, the 200-day moving average has lagged a simple buy-and-hold approach,” he wrote. Read more: 200-day moving average lags the market.

If you’re a buy-and-hold investor, you’re probably not interested in timing strategies, and as Hulbert concludes, the 200-day moving average may not be the ideal vehicle for timing the market. If you’re a trader, however, you can use moving averages for timing. More important, moving averages can help provide clues to market direction.

Short-term traders tend not to use the 200-day MA for timing, but prefer the 13-day, 20 or 21-day, or 50-day. For example, long-term trader Laszlo Birinyi, president of Birinyi Associates, makes his trades based in part on a stock’s 50-day moving average. Read more: Birinyi’s recent money moves.

Other traders use even shorter time frames such as the 8-day or 10-day moving average. They use it both for support and resistance, and also observe when one moving average crosses another. One popular crossover strategy: when the 8-day MA (the shorter moving average) crosses above the 13-day MA (the longer moving average), this is a signal to buy. Conversely, if the 8-day crosses below the 13-day MA, this could be a signal to sell.

Using moving averages for support and resistance

Traders, and investors, also use moving averages for support and resistance. For example, in June the S&P 500 sliced through the 50-day and 100-day moving averages. If the benchmark were to drop below its 200-day moving average, this would be a major sell signal.

Why? Because the 200-day moving average, and other moving averages, act as support (which is like a floor), or resistance (which is like a ceiling). It takes a lot of buying or selling pressure to move the market above or below a moving average.

Yet moving averages are not perfect. First, they are considered lagging indicators, which means they follow prices. In other words, they are often slow to react to market conditions. By the time the index drops below the moving average, you may already be out of luck. In addition, moving averages are not ideal during choppy trading environments. Like any indicator, you never want to make trades based solely on its results without confirming with other indicators.

Moving averages for rookie traders

If you are a rookie trader and want to know more about moving averages, here’s a brief tutorial.

Moving averages show the value of a security’s price over a period of time, such as the last 10, 20, 50, 100, or 200 days. Most people overlay the stock price over its moving average on a chart to get a good feel where the stock or market is headed.

Calculating a moving average is not difficult. For example, the 20-day simple moving average is found by taking an average of the last 20 days of the market’s closing price and dividing by 20. So as the 21st day is added, the first day is dropped off. It’s constantly moving, which is why it’s called a moving average. In addition to the simple moving average, many people use the exponential moving average, which gives more weight to the most recent time periods.

Many traders have designed strategies based on moving averages. With the help of a professional technician, last year I back-tested dozens of trading strategies. What did I find? The moving average crossover strategy (buy when the 50-day crosses over the 200-day, and sell when the 50-day crosses below the 200-day) consistently ranks high, especially when the market is trending.

The advantage of using moving averages is that it helps keep your emotions out of the trade.

Bottom line: If you are an investor or trader, you can gain valuable information by watching how stocks or indexes react when they rise above, or below, their moving averages.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).

10 Rules for Rookie Day Traders

MIAMI, Fla. (MarketWatch) — If you are going to day trade, it’s essential to have a set of rules to manage any possible scenario. Even more important, you must also have the discipline to follow these rules.

Sometimes, in the heat of battle, traders will throw out their own rules and play it by ear — usually with disastrous results.

Although there are many rules, the following are the 10 most important:

1. The three E’s: enter, exit, escape

Rule No. 1 is having an enter price, an exit price, and an escape price in case of a worst-case scenario. This is rule number one for a reason. Before you press the “Enter” key, you must know when to get in, when to get out, and what to do if the trade doesn’t work out as expected.

Escaping a trade, also known as using a stop price, is essential if you want to minimize losses. Knowing when to get in or out will help you to lock in profits, as well as save you from potential disasters. Read more: 4 big risks to your investment portfolio now.

2. Avoid trading during the first 15 minutes of the market open

Those first 15 minutes of market action are often panic trades or market orders placed the night before. Novice day traders should avoid this time period while also looking for reversals. If you’re looking to make quick profits, it’s best to wait a while until you’re able to spot rewarding opportunities. Even many pros avoid the market open.

3. Use limit orders, not market orders

A market order simply tells your broker to buy or sell at the best available price. Unfortunately, best doesn’t necessarily mean profitable. The drawback to market orders was revealed during the May 2010 “flash crash.” When market orders were triggered on that day, many sell orders were filled at 10-, 15-, or 20 points lower than anticipated. A limit order, however, lets you control the maximum price you’ll pay or the minimum price you’ll sell. You set the parameters, which is why limit orders are recommended.

4. Rookie traders should avoid using margin

When you use margin, you are borrowing money from your brokerage to finance all or part of a trade. Full-time day traders (i.e. pattern day traders) are usually allowed 4:1 intraday margin. For example, with a $30,000 trading account, you’ll be given enough buying power to purchase $120,000 worth of securities. Overnight, however, the margin requirement is still 2:1.

When used properly, margin can leverage, or increase, potential returns. The problem is that if a trade goes against you, margin will increase losses. One of the reasons that day trading got a bad name a decade ago was because of margin, when people cashed in their 401k(s) and borrowed bundles of money to finance their trades. When the bull market ended in 2000, so did many traders’ accounts. Bottom line: if you are a novice trader, first learn how to day trade stocks without using margin.

5. Have a selling plan

Many rookies spend most of their time thinking about stocks they want to buy without considering when to sell. Before you enter the market, you need to know in advance when to exit, hopefully with a profit. “Playing it by ear” is not a selling strategy, nor is hope. As a day trader, you’ll set a price target as well as a time target.

6. Keep a journal of all your trades

Many pros swear by their journal, where they keep records of all their winning and losing trades. Writing down what you did right, or wrong, will help you improve as a trader, which is your primary goal. Not surprisingly, you’ll probably learn more from your losers than your winners.

7. Practice day trading in a paper-trading account

Although not everyone agrees that practice trading is important, it can be beneficial to some traders. If you do open a practice account, be sure to trade with a realistic amount of money. It’s not helpful to practice trade with a million dollars if the most you have in your account is $30,000. Also, if you do practice trade, think of it as an educational exercise, not a game.

8. Never act on tips from uninformed sources

Most pros know that buying stocks based on tips from uninformed acquaintances will almost always lead to bad trades. Knowing what stocks to buy is not enough. You also have to know when to sell, and by then the tipster is long gone. Legendary trader Jesse Livermore said it best when he wrote this about tips: “I know from experience that nobody can give me a tip or a series of tips that will make more money for me than my own judgment.”

If you can’t trust your own judgment, you may want to avoid day trading altogether.

9. Cut your losses

Managing losing trades is the key to surviving as a day trader. Although you also want to let your winners run, you can’t afford to let them run for too long. It’s more art than science to get it right, but learning how to control losses is essential if you are going to day trade. Once again, never forget the three E’s: (enter, exit, and escape).

10. Be willing to lose before you can win

Although many traders can handle winners, controlling losing stocks can be difficult. Many rookies panic at the first hint of losses, and end up making a series of impulsive trades that cost them money. If you’re day trading, you must be willing to accept some losses. The key: know in advance what you’ll do if you’re confronted with losses.

Although anyone can learn to day trade, few have the discipline to make consistent profits. What trips up many people are their emotions, which is why it’s so important to create a set of flexible rules. Your goal: follow the rules to help keep you on the right side of any trade.

Michael Sincere is the author of Start Day Trading Now (Adams Media)

Daytrading 101: What You Need to Know

Michael Sincere has helped thousands of beginning traders by way of his many books. In this interview, I ask him about getting started in daytrading today and what it takes to be successful and minimize risk to a new trading account.

We discuss the best indicators for beginners and how sentiment can be used to gauge whether the market is near a top or bottom. We also discuss the amount of money a new trader should start with and how to use stops to limit the downside risk in any one trade. I also ask Michael about the realities of trading for a living and whether it is possible to start daytrading while still holding down a full-time job.

If you’re a beginning trader and looking for some veteran guidance, this interview is for you. Markets discussed: Stocks, Options

Tim Bourquin: Hello everybody. This is Tim Bourquin. Thanks very much for joining me for another interview this week. Today, we’re going to be speaking with Michael Sincere. He is an author and a trader himself. He has written a bunch of books, Understanding StocksAll About Market IndicatorsAfter-Hours Trader that he co-authored and his latest book is Start Day Trading Now. So, I wanted to get Michael on the phone and talk to him about the state of trading and maybe talk about some of the books that he’s written in terms of indicators as well because I know those are always popular. So, Michael, thanks very much for joining me on the phone today.

Michael Sincere: Thank you very much, Tim.

Tim Bourquin: All right. Let’s talk about…I’m going to start right off with it. We’ll talk about your latest book, Start Day Trading Now, which as a title, I was a little surprised at because is now a good time to be a daytrader? I mean we all heard about daytrading before the dot com and it seemed like everybody was into it and then we lost a lot of people. Is it coming back? Is daytrading in vogue again?

Michael Sincere: I don’t know if it really ever completely left. There’s always a group of people who are always going to daytrade. I would say, the mass of people maybe have kind of moved away from it. But is it a good time to daytrade? I think there’s always an opportunity for daytrading, I mean for any kind of trading. In the book, I tend to talk about it as a strategy. So if you think of it as a strategy, yes, you can daytrade almost any time. So you can either use it as a part-time or a full-time strategy.

Tim Bourquin: All right. When you talk about daytrading as a strategy, obviously it means getting in and out the same day, but what kind of is the basis of a daytrader strategy that you’re looking at?

Michael Sincere: Well, first of all, it wouldn’t be scalping. That was where I think many people…or it got kind of a bad name. And scalping would be like you’re going in and out hundreds of times a day, for pennies. But the kind of strategy I’m thinking of is where you would focus on one or two stocks and definitely get in and out within the day for a point or two if you can, get what you can but before the end of the day. But most important is not to use the scalping strategies that gave it a bad name.

Tim Bourquin: So how are you recommending people go out and find these opportunities? What am I looking for in terms of price or indicators that you like to use?

Michael Sincere: Well, you’re looking for volatile stocks, I mean obviously, that are moving up and down. You try to avoid the penny stocks. I mean it really means monitoring, the stock market, looking for those opportunities and there’s many of them. I mean many stocks are very volatile. If you look at the top active stock, the ten top active stocks, they give you many ideas for what you can choose for daytrading.

Tim Bourquin: So that sounds like mostly stocks that have been in the news or announcing some sort of news that day.

Michael Sincere: Well, the news strategy is a little tricky. Yeah, that’s a tough one to implement. Some traders have done that very well, but often they do it the opposite. Once, the news is the released, they’ll go against the stock. But, everyone has their own idea of which stocks to pick. I mean some people have scanning software, which they set up a certain criteria and it will come up with a specific stock that they want to find. One thing, I tend to write for beginners. If I was a beginner, for a beginner, they would focus on let’s say one or two stocks and just master those stocks, become…learn the personality of that stock. And if you can get a somewhat volatile stock that fits that isn’t too expensive, and you can just follow it for a month or so, you’ll know. I mean you’ll get a much better feel when you can buy or sell it.

Tim Bourquin: So kind of just watching the ebb and flow it sounds like and when it’s headed down in pattern that you’re familiar with, that you’ve seen before, get ready to buy.

Michael Sincere: Exactly. Exactly.

Tim Bourquin: Okay.

Michael Sincere: I mean for a beginner, for a beginner. I mean obviously for experienced traders, they’re going to have their own list of stocks to watch or stalk as some say.

Tim Bourquin: One of the books, the “All About Market Indicators,” indicators of course are huge and especially newer traders are always looking for that Holy Grail indicator that will be 90% right and that they can just follow day in and day out. Then you’ve got this other crowd that says indicators are all rubbish. You should be following price only and looking at support and resistance and that’s all you need. What are your thoughts there?

Michael Sincere: Well first, there’s no Holy Grail. [Laughs] That’s what I’ve learned. They’re still looking for it, that Holy Grail indicator because if someone found it, you would never hear about it. They would keep it to themselves. So that’s the first thing I learned is that you’ll often read about people saying, “I found the indicator, the Holy Grail,” but again, they keep it to themselves. As for me, everyone has their favorites. From talking to many of the experts and the ones who actually created these indicators, my thoughts are first, on a technical side, you can’t go wrong or the one that seems to be most reliable in general, not 100%, is the moving averages. It’s simple, it’s easy to use and it gives you a very good guideline of which side of the market to be on. Another indicator for let’s say a larger picture, not for daytrading but for, say, investing or longer term trading would be the sentiment indicators. I found those really the most fascinating of all. And that basically is, you’ll look and see what the crowd is doing and if the crowd is really bullish, overly bullish, you do the opposite. So basically, you’re looking at how the sentiment is, if it’s bullish or bearish and then you really do the reverse of the crowd.

Tim Bourquin: Give us an example of a sentiment indicator.

Michael Sincere: Well, the two are the AAII I would call it. The American Association of Individual Investors, which is published, I think every week. And that one they’ll give the public. In my book, I actually give the web address and how to look those up and what rating. So basically, when it gets to a 60% rating of a bullishness that’s when you might want to do the opposite. Now it doesn’t mean on that day or that week. It’s just it’s kind of a trend that you’re looking at and as it gets higher and higher and if it gets to above the 60 level, it’s getting a little bit too much. I’ll give you an example. In March 2009, on the bearish side, it hit as high as 70% and as you may know that was the low of the market.

Tim Bourquin: Typically, the crowd is wrong. [Laughs]

Michael Sincere: Right, exactly.

Tim Bourquin: Now, do you follow then the Commitment of Traders Report? Is that the same kind of thing?

Michael Sincere: It’s the same kind of thing. I haven’t followed that as much. I know that a lot of people do follow that. I had mentioned it in the book, but I think it’s a similar thing for traders.

Tim Bourquin: Now, the moving averages, let’s just jump back to that for a minute. Do you have a favorite or one that you’ve found was the most accurate maybe for short term or let’s just talk about day trading since that’s our topic. Is it a 5-period, 20-period, what do you like to use?

Michael Sincere: Yeah. The 5 and the 10 are really good. First, I tend to look at an overall picture, which will be the 50, the 100, and the 200. And obviously the 200 even though it’s not technically for day trading, if the 200 is giving you a good reading, then as day trader, you can be on that side. I mean I would be bullish in a bullish market so but basically the 5 and the 10. The old moving crossover strategy is great. It tends to work and again not 100%.

Tim Bourquin: So kind of waiting for a short term to cross above the longer term average as a buy signal?

Michael Sincere: Exactly. And then below on that sell signal.

Tim Bourquin: Do you also use moving averages to place stops? Is that a method?

Michael Sincere: Yeah. And again, I interviewed some of the best traders so I would have to go with… I mean their expertise is tremendous and a lot of them do use it as stops. Do you know what I mean? Me, personally, I tended to have my own method for stops, but it’s not moving averages. I mean what you really have to do, as I give anyone advice, is really to experiment to find out what works for you. I mean everyone has their own method. that’s probably the best advice I can give is just to experiment and find your own method.

Tim Bourquin: In your new book, you also talk about managing risk and how important that is for a day trader. How does a day trader manage their risk?

Michael Sincere: Man, first, I can tell you that I have a PhD in all the mistakes that you can make. So that’s one thing I can tell you right there. So I know a lot about managing risks. Managing risks, first it does come back to the stops. I mean before you enter any position, you always want to know what’s the worst that can happen. You want to really know an enter price and exit price. So before you get in to manage risks, know where you’re going to get out. So many people just don’t put stops and it’s unbelievable to me. So as a day trader, you’re going to keep tighter stops because, things are moving much more rapidly. So that’s probably the first step of managing risks is using stops, either trailing or regular hard stops.

Tim Bourquin: How about the position size itself, does that figure into the equation?

Michael Sincere: Yes, it does. It does. one of the mistakes a lot of people do is they will just always do a thousand shares all the time without…It doesn’t matter the risk. It doesn’t matter the size. But you really want to vary that. I mean it’s part of an equation. Some of the risk-reward equations that I talk about in the book they can get really complicated and really the idea is to keep it as pretty simple as you possibly can, the calculations. But as far — as a beginner, I’d basically advice starting with a smaller amount of shares and then as you get more experience, you can increase those shares. But the main thing is don’t just say 1000 shares all the time.

Tim Bourquin: The question that always comes up in terms of and its related to share size I guess is how much money do I need to start to day trade? Should I take $20,000 out of my retirement account to do this? Do I need $10,000? Can I start with $250 on some on these Forex firms that offer that? What’s your advice there?

Michael Sincere: Well, first if you’re a beginner, if you’re a novice trader…I mean first, there are rules on what it is to be a day trader. And first thing before I forget is do not take your money out of your retirement. That should be separate, okay. Daytrading is a…what I often say is that you should have one account for let’s say long term investing, which could be your 41k and then another account for let’s say trading. Now as far as the rules of trading, you need a minimum of $25,000 if you are going to be a pattern day trader, which means you’re making four trades within a five-day period. So if you are going to make four day trades within a five-day period, you will have to have that minimum $25,000. Also, you could be a part-time trader and you won’t need to do that minimum. But being a part-time trader, it’s always tricky to limit yourself to less than those four trades. so as far as…Again, when I’m talking to novice traders, I say start small with small share size and a few thousand dollars. I hate to even put a number on it. But just I would I say a smaller share size. But no, don’t put $20,000 into the market at one time if you’re a beginner because I can almost guarantee you’re going to lose it.

Tim Bourquin: And it’s about being comfortable I guess with that risk. If you’re constantly, biting your fingernails about losing this money, you’re going to make probably bad trading decisions.

Michael Sincere: Yeah. I mean the real trick to the whole thing is an education. I mean that’s why you go to shows, you go read books. You really need to educate yourself. The mistake people have made in the past is they read one book or something or they talk to a group of people and they think, okay, I can day trade. This is easy. Well, learning how to day trade is easy. the mechanics of it is not that difficult. The hard part is the psychological part, not fully understanding the risk of what’s involved. And that’s why so many people got killed. I mean they thought, oh, it’s so easy to make a point in a day. Yes, it is, but it’s just as easy to lose that point and people weren’t ready psychologically for that. And that’s why like any educational thing, like any endeavor that you do, it’s really important that you take the time to learn it. We’re not talking about a couple of days or weeks but months to learn and to practice.

Tim Bourquin: Now for a lot of people back in the late ’90 or early 2000s, it was all about quitting the job to trade full time. That seems to have gone away quite a bit for most people. If somebody is going to start day trading, how do they do that though if they’ve got a full-time job? They’re going to be at work during most of market hours. Any advice there?

Michael Sincere: Yeah. I mean you can set up stops. I mean obviously first you start educating yourself. Some people I’ve known actually will put in their order before they got to work but put in a stop. like a buy stop so if it reaches a certain point, you will actually buy and you can actually set it up that after a certain point, it will sell. So you could set up automatic buys and sells. some would argue that that’s really not recommended, I mean, because you’re really leaving a lot to the computer. A true dedicated day trader will not leave their computer. They will be sitting there and watching it. But if you are doing it on a part-time, occasional basis, and you’re not risking a lot of money, and you’re at work, you could try this out and see if it works. If it doesn’t work for you, don’t do it. To add to that, I would say it’s not recommended, but there are ways to get around them I mean.

Tim Bourquin: And I suppose you could check your portfolio at work occasionally and not get in too much trouble.

Michael Sincere: Exactly. Exactly. Basically, with the phones and everything, I mean you can really do monitor outside of work. But the main point of that is to set up stops. So if you are going to set up a trade early then be sure you have a stop on both sides of it.

Tim Bourquin: There’s so many things to trade these days. Every day, the exchanges come out or companies come out with new products to trade, new ETFs, new futures, contracts, where does somebody start? We’ve talked about stocks here, but could I start with futures? Should I start with options?

Michael Sincere: Well, I can give you my own opinion from just talking to other people. They say that with futures, it’s very, very difficult to do well in the futures market. I mean it’s that — and I even have some stories from friends who’ve tried it. So I would say it takes a very, very special kind of dedicated person to master the futures market. For a novice person, they’re going to get killed, in my opinion, in this if they started fooling around with futures. That may change in the future, no pun intended. They may come up with other products. But right now, as it stands… Now options, as you may know I wrote a book on options. So there are option strategies that are actually less risky than stocks and one of them are like selling covered calls. there are some risks, but as long as you’re aware of them, they can be managed. So I would say stocks are within the realm, options are within the realm. But again, I’m not an expert on futures so someone might disagree on that. But for a novice, I would say avoid the futures market.

Tim Bourquin: So for someone just getting started, start with some stocks that are volatile, low share size, put some moving averages up there and are there other indicators? We hear a lot about Fibonacci, things like that that I should be looking at?

Michael Sincere: I talked about Fibonacci. Fibonacci is out there. Some really love it. They think it’s the greatest thing in the world. Others are like this is beyond — this is a magical mystical thing. There are enough people who believe in Fibonacci so there is something to it. But I wouldn’t start with that. That would be probably one of the last indicators. the ones that are the top five would be the moving averages, the MACD, the Bollinger bands, stochastics are really good or RSI, they tell the same thing. So those five are a great place to start as far as indicators and you can get most of the information you need from those five. But Fibonacci is pretty much out there. I mean, it would take a lot of study to really master that one.

Tim Bourquin: All right. Let’s finish up just talking about the current market conditions as they stand here. Gold hitting all-time high, silver hitting all-time highs, oil seems to be rising a little bit here. The stock market continues to go up even though people are talking about inflation and quantitative easing that sort of thing. Any general thoughts here about the overall market and where we’re headed?

Michael Sincere: Well, I can say one thing is that people still don’t believe in the stock market and that from a sentiment’s side, that’s really positive for the stock market. There are people who just can’t stand the market and they are just waiting for it drop and meanwhile the market, as it often does, fools everybody and keeps going up. if you look at the indicators there, I mean there have been a couple of setbacks. But in general, the market has been above the 100, it’s been above the 200. It was — I haven’t looked at it in just the last day or two, but it got right on the edge of it I think on the 50 actually and then now it’s above it. So my feeling is that it’s positive. I mean everything is looking positive. Obviously, there could be unexpected events that could take it down, but at this point, you have to go with the trend. One thing I’ve learned about indicators and about the market is that no one can really with any degree of tremendous accuracy predict what the market is going to do. But what you can do is gather all these clues together and that includes indicators and make a diagnosis. Now, if I was going to diagnose it now, I would say it’s very positive and obviously that could change very quickly. So that’s my thought right now. Now as far as gold, it’s been ten-year bull market and I guess we’re going on 11 years. So what I do is I’ll look for clues that there could be a reversal and even though there’s a lot of negative news out there, I mean someone could easily make the negative side of this. You want to see how is it going to affect the stock market and until I see those clues that are going to negatively affect the stock market, I would still be long.

Tim Bourquin: What does that look like, those negative clues? What would you be looking for?

Michael Sincere: Well, obviously, inflation going higher. I mean we have what’s happening in Japan. We have the Middle East. All of these things could affect it negatively. I mean there might be a government shutdown they say in a few days. That would be unbelievable for the stock market. I mean that’s something you really have to watch for. I mean as a trader, you’re always looking for those kinds of signs. But if the government shuts down, that would not be good.

Tim Bourquin: A lot of fundamental things to be aware of right now.

Michael Sincere: Yeah. It’s one thing about trading is that you tend to — you need to look at some of the fundamental factors as well as the technical factors, at least that’s what I find a lot of traders will do. Some only are technical, but I find that a lot of traders will do both. And same with investors, investors will often, not just look at fundamentals but look at things like moving averages and the MACD and the MACD by the way is a favorite for a lot of investors all that —

Tim Bourquin: Yeah. I know a lot of them put it up on their chart for sure.

Michael Sincere: Yes.

Tim Bourquin: Well, Michael, what’s the best way to take a look at your books? Go to Amazon? Do you have a website? Where should we send some folks?

Michael Sincere: Yeah. My website is www.michaelsincere.com.

Tim Bourquin: Easy enough.

Michael Sincere: All my books are on there.

Tim Bourquin: All right, great. We’ll link to that.

Michael Sincere: Or go to Amazon, Barnes & Noble and almost every bookstore in the world I guess.

Tim Bourquin: All right, great. We will link to that and send folks over there to take a look at some of the books you have and your latest one of course. So, Michael, thanks very much for your time on the phone today.

Michael Sincere: Great. Thanks.

 Click here for a .pdf version of the full transcript for this interview

What Daytraders Can Teach Investors

MIAMI, Fla. (MarketWatch) — With the huge advances in the stock market over the past year and heightened volatility, daytraders are back. Or maybe they never left.

In the 1990’s, daytrading was all the rage, especially using risky strategies like scalping, where you’re in and out of hundreds of stocks in seconds or minutes, aiming to make small but quick profits.

More recently, scalping is the strategy of choice of high-frequency traders (HFTs), the ultimate daytraders, who use high-speed computers to scalp for pennies in nanoseconds. Those pennies can add up to billions of dollars in trading profits every year.

Although retail traders can’t compete with these advanced computers, many lone daytraders have returned to the stock market using a variety of sophisticated trading strategies.

Margin and the “Pattern Daytrader”

One reason that daytraders previously got into financial trouble was because of margin. Margin, the borrowing of funds from your brokerage, is a useful tool if used properly, but dangerous when misused.

At most brokerages, you can borrow up to 50% of a stock’s value. For example, if you have $10,000 in stock, the brokerage may lend you an additional $10,000 to buy more shares (that’s 2:1 buying power). The Federal Reserve, not your broker, sets the maximum you are allowed to borrow.

You get much more buying power if you are deemed a “pattern daytrader,” which is anyone who makes more than four daytrades within a five-day period. The downside: Once designated as a pattern daytrader, you must keep a minimum of $25,000 in your account at all times.

If you are a pattern daytrader, you will probably be allowed 4:1 intraday buying power, or leverage.

For example, if you have $30,000 in your account, you will be given enough buying power to buy a total of $120,000 in securities. This is total for the day because overnight, the margin rate returns to 2:1.

To get around these restrictions, some daytraders only trade part time, although it’s then not easy to stay within the rule of making four daytrades within five days.

While most people don’t have the discipline, time, and guts to daytrade full time, trading part time can make sense for many people. If used in this way, daytrading is just another strategy applied during certain market conditions.

Strict Rules

Although many people tease daytraders for having short-term outlooks, they can teach you a thing or two.

To survive, they follow a strict set of rules. For example, rule one is never carry a losing stock overnight (although some daytraders will hold a winning stock for a second day).

Selling a loser is hard for many people, who often hope their stock will come back to even. One way to cut losses or to lock in gains is to use stop losses, especially trailing stops. Trailing stops, which can be entered as a percentage or a dollar amount, adjust or trail behind a rising stock price.

Example: You buy a stock at $25 and enter a trailing stop order of $1. Every penny that the stock moves higher, the trailing stop increases by one penny. If the stock moves to $27, for example, the trailing stop order tags along, adjusting higher. In this case, if the share price then falls to $26 (-$1), an order is triggered, and becomes a market (or limit) order to sell. You can also set a percentage of 1% or 2%, for example.

Unfortunately, while trailing stops are effective when a stock makes a substantial run, trailing stops may not trigger under extremely volatile conditions. Therefore, if you’re aiming for smaller profits, you may want to use hard or mental stops. In addition to a trailing stop order, you should also experiment with trailing-stop limit orders.

No matter what you think of daytrading, it’s clear that many people have learned from the past, when unknowledgeable traders quit their jobs and cleared out their 401(k)s to daytrade. Many modern daytraders trade less frequently and are choosier about the buys and sells they make.

Michael Sincere is the author of Start Day Trading Now (Adams Media, 2011), Understanding Options (McGraw-Hill, 2006), All About Market Indicators (McGraw-Hill, 2010), and Understanding Stocks (McGraw-Hill, 2003).