The Weekly Trader

As a followup to my previous column, It Might Be Time to Sell, I wrote an article for Marketwatch on trading in a bear market. Although this market could have a snapback rally, the technical damage to this market has been severe. Being on the short side of this market seems like the right place to be, at least for now. Here is the article:

MIAMI, Fla. (MarketWatch) — One of the most frustrating aspects of the stock market is that by the time you figure out what’s happened, it’s already too late.

To stay on top of the market, be open to when one trend ends and another begins. According to one professional trader, that time is now: the bull market has ended and a bear market has begun.

“The market temperature has changed. I’m seeing technical signals, which we haven’t seen since the 2007 top. This is a bear market, which could last for the next year,” said Dr. Alexander Elder, author of several bestselling books, including “Come Into My Trading Room,” and his latest, “To Trade or Not to Trade.”

Not surprisingly, Elder is short the U.S. market, which means he is selling individual stocks at a high price and planning to buy them back at a lower price in the future.

Another way to short the market is to buy an inverse exchange traded fund, or a bear market mutual fund. If you’re not comfortable being on the short side, you can always move to cash, at least temporarily. And if you don’t want to sell now, you can protect your stocks with stop loss orders.

“I am heavily short,” Elder said, “and I’m loving this market. I switched from a long position to a short position in mid-April. In a series of Marketwatch articles, Elder wrote that the top was when Apple hit its all time high on April 12th. Here is a link to one of his articles: “Three Major Signs the Bull Market has Ended.”

When will Elder be bullish again? Not anytime soon, he said. “It will be an unpleasant bear market but I don’t think it will be a disaster.”

1. Basic trading

A new trader might wonder how to make money in this difficult market environment. Elder has some advice: “Lots of smart people stumble into trading but don’t know the most basic rules. I think a terrible mistake that beginners make is wanting to make money from the get-go…you have to spend time educating yourself.”

Then, start with small positions, perhaps 100 or 200 shares, Elder said. “Money will come later if you play it right,” he added. “A beginner should open an account and trade a small size to learn how to do it.”

2. Diary of a trader

Elder is a proponent of maintaining a trading diary. “You have to keep track of your trades,” he said. “Keeping a diary makes you more thoughtful, and helps you learn from your successes and losses. You become your own teacher.”

He primarily uses technical indicators to make trading decisions, but does consider a few fundamentals. Said Elder: “When something comes across my screen that looks interesting, such as a new technology, it will put me on alert. Then I go to my charts and make the decision to buy or not to buy, to short or not to short.”

Elder doesn’t rely heavily on fundamentals “because they are always late,” he said. “By the time the fundamentals come out, prices have already started to change. That is why my primary attention is on technical analysis, but once in a while an exceptional piece of fundamental news appears.”

He relies on a short list of technical indicators and insists on using two time frames: a weekly and daily chart. “I use the weekly chart for strategic decisions and the daily chart to look for entries and exits.”

3. New High-New Low Index

Elder’s favorite leading indicator of the stock market is the New High-New Low Index.

This index tracks stocks that are making new highs or new lows for a specific time period. Elder uses this indicator to monitor the underlying breadth of the market (i.e. the number of stocks participating in the market’s move).

If stocks making new highs are expanding, this indicates the market breadth is positive, and the market is likely to rise. Conversely, if stocks making new lows are expanding, then market breadth is negative and the market is likely to fall. The most important signal is a divergence, when the market is rising but the number of stocks making new highs is falling.

“The New High-New Low is the single best leading indicator of the stock market,” Elder said. “I’m looking to see if it’s positive or negative, which tells me whether the bulls or bears are leading the market. Also, if the market goes to new highs but the New High-New Low indicator traces a bearish divergence, this is a tremendously dangerous sign.”

In the middle of May, Elder saw his signal: the number of stocks making new highs plummeted (although it’s recovered a bit since then). That brings us back to the beginning: Elder now believes the market breadth is negative, and a bear market has started.

“It’s not unusual to have a bear market,” he said. “The average duration of a bull market is three years, and this bull market started in March 2009. We could have a bear market for the next year.”

Day trading sounds so easy, doesn’t it? After all, isn’t it just sitting at your computer all day, buying and selling stocks — and piling up profits? Well, not exactly. Few people realize how much experience and skill is needed to make money as a day trader. It’s easy to get tripped up by mistakes, especially during your first year.

Here are 10 of the most common errors many day traders make.

1. Not having a Plan

“The most common mistake traders make is entering a trade without a good plan,” says Toni Turner, author of “A Beginner’s Guide to Day Trading Online.”

“Nearly every mistake can usually be traced to trading without a plan.” Too many rookie day traders enter the market without appreciating that they are wading into potentially dangerous waters. Protective planning against losses means determining your entry price for buying a particular stock, your exit price and an escape price — also known as a stop loss.

2. Misusing Margin

If there is anything that can destroy a day trader’s account, it’s margin. That’s when you borrow from a broker to buy securities. If used properly, margin is a valuable tool that can boost profits and give traders breathing room. When margin is used improperly, financing a trade with borrowed money can be dangerous to your wealth. In the past, many people misused margin, borrowing more from the brokerage than they could afford. It wiped out some traders’ accounts and helped to give day trading a bad name. It’s best to day trade with money you actually have, not money you borrowed.

3. Chasing Trades

One of the most common day-trading errors is chasing a fast-moving stock on the way up or down. More than likely, this could lead to an unprofitable trade. “When we see a stock go higher and higher, we all want to join in the celebration,” Turner says. “The problem is that experienced traders are going out the back door while new traders are coming in.” If you miss a stock on the way up or down, let it go. There will be other trading opportunities.

4. Not Understanding Market and Limit Orders

Not everyone agrees on which is best — market orders or limit orders. A market order is an order to buy or sell a stock at the current market price. With a limit order, you can establish your maximum or minimum price for trading a security. Market orders get filled fast, but you let the market control your order. Conversely, limit orders allow you to control the parameters.

“Now that spreads are a penny or two on many stocks, limit orders make no sense,” says Deron Wagner, founder and head trader of Morpheus Trading Group. “You could miss a fast-moving stock just to save a few cents.” With high-quality liquid stocks, you can use either a market or limit order.

5. Listening to Tips

At least once, nearly every trader gets fooled into buying stocks based on tips from persuasive sources. Even when the tipsters are right, they aren’t there to tell you when to sell. It takes a lot of self-control to keep your ears closed, but successful day traders rely on their own judgment — not on what others are saying.

6. Refusing to Cut Losses

It’s human nature to hope that a losing stock turns around. But if you’re a day trader, refusing to cut losses can damage your account. “Instead of hoping for a stock to go back up, take that money and transfer it into a stock that is really going up,” says day trader John Kurisko, host of Day Trading Radio. When a stock is headed south, be disciplined enough to prevent a small loss from turning into a much bigger one.

7. Trading Too Early or Too Late in the Day

The first and last 15 to 20 minutes of the trading day are usually chaotic, as market orders are filled from anxious investors rushing to make moves near the opening or closing bell. You also are competing with institutional and high-frequency traders. “The first and last 15 minutes are too volatile for new traders,” Kurisko says. “It’s like the Wild West, and sometimes there is no rhyme or reason to it. Also, the indicators don’t have enough data, so they get choppy.”

8. Letting Your Emotions Rule

What does it take to become a better trader? Discipline. “You need to develop a set of strict rules that takes the emotion out of a trade,” Kurisko says. “Most day traders use technical analysis.”

For example, Kurisko uses stochastics, an indicator used by many traders to determine if a stock is overbought or oversold. If the stock is oversold, then he starts to buy. “You must listen to the charts, not the news,” he adds.

9. Having Unrealistic Expectations

Some rookie day traders keep looking for something magical that will bring them easy profits. A few have already calculated how much money they plan to make in the market. Unfortunately, the market has other ideas. “Don’t seek a silver bullet,” Wagner says, “because there isn’t one. Some people will jump around looking for different instruments and strategies without taking an honest assessment of themselves. There is no easy way to play the market.” He says traders need a strategy, rules and discipline to become profitable.

10. Going Into day Trading Uneducated

Uninformed day traders think that anyone can make money day trading. But to be successful at it, you’ll need training. “If you were laying on the operating table, waiting for your surgeon to take out your appendix, you wouldn’t want that surgeon to walk in reading a pamphlet, ‘How to Remove an Appendix in 10 Easy Lessons,'” Turner says. She says to be a consistently winning trader, you should start with paper trades, and then study hard so you understand how the market works. “Learning to day trade successfully can take as long as going through college and obtaining a degree,” she says.

My latest article for Marketwatch.com on the one Muppet that trades well, and the eight Muppets that lose money 🙂

Many investors were taken aback last month when an ex-Goldman Sachs executive revealed that clients were sometimes referred to as “muppets” in interoffice emails. If you know anything about Muppets, you’d know that being called a Muppet isn’t necessarily an insult.  http://bit.ly/HIMU0j

This is my latest article for Marketwatch, about Warren Buffett, and his optimistic outlook on the U.S. stock market and economy, versus three doomsayers: http://bit.ly/xAWTKX

Note: This paragraph was not included in the final version of the article (via the CNBC interview):

Buffett also believes that it’s a great time to buy a home right now, as long as you live in it. “I’d finance it with a 30-year mortgage, and it’s a terrific deal.” If he was the handy type, and Buffett isn’t, he’d buy a couple of houses at distressed prices and find renters. “It’s a leveraged way of owning a very cheap asset now, and I think that’s probably as attractive an investment as you can make now. But I think equities are very attractive compared to everything else.”

I wrote an article about the pros and cons of penny stocks for Marketwatch, which you can find here: http://bit.ly/wl7S1r

My article is one of the most popular today. In my article, I didn’t include the following information: The penny stock that is being touted by newsletters and on email is NSRS (North Springs Resource Company). Although this dollar stock is on a roll right now, the good times will eventually end. After being up as much as 25% a day on some days, if you made any profits on this penny stock, take the money and run.