A Beginner's Guide to the Stock Market

by Matthew R. Kratter

If you are going to trade before the market opens or in the after-hours market, always use a limit order.

Coke is a special kind of dividend stock. It is a Dividend Aristocrat, one of an elite group of companies that have raised their dividends every year for the past 25 years. Other Dividend Aristocrats include the Colgate-Palmolive Company, Johnson & Johnson, and McDonald's.

There's an easy way to own a piece of every Dividend Aristocrat: just buy some shares of NOBL. It is the ProShares S&P 500 Dividend Aristocrats ETF. It trades just like a stock, and you can purchase it using any brokerage account.

If you study Warren Buffett for many years as I have, you will begin to notice that his stock picks follow a certain pattern. They are usually strong, well-known brands like Coca-Cola and Apple. He also likes to own financial companies like Bank of America, American Express, and Wells Fargo-- probably because these companies are highly leveraged and so make a lot of money during the good times. They also get bailed out by the government during the bad times.

The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business.

Today people often confuse value investing with buying stocks with low P/E's. As we mentioned, that strategy worked well in the past when Warren Buffett was a young man, but it stopped working years ago. Until you become an advanced investor, don't ever buy a stock with a P/E of 10 or less. It's just a bad hole to fish in. It is full of companies with giant debt loads, falling revenues, or outdated products like faxes and typewriters. And probably a few frauds as well. So stay away.

Low P/E stocks are almost always pricing in future bad news. Don't ever expect to find good stocks in the bargain bin— unless perhaps you are at the end of a multi-year bear market. Even then, you are often better off buying a higher-quality company that has a higher P/E.

In 2009, Netflix had earnings of $116 million. In 2018, Netflix had earnings of $1.2 billion. On 28 December 2009, Netflix had a market cap of roughly $3 billion. That means that if you bought a share of Netflix stock at the end of 2009, you were literally buying it at a future P/E of 2.50 ($3 billion divided by $1.2 billion).

Wayne Gretzky: you must “skate” to where earnings are going to be, not to where they have been.

Here's the first rule for trading growth stocks: Ignore the high P/E.

At a new all-time high, everyone who owns the stock has a profit. All of the losers are gone: they have already exited at a loss, or at their break-even price. At new highs, there are only happy traders and investors left.

Never buy a growth stock if the stock is trading below its 200-day moving average, or if the 50-day moving average is trading below the 200-day moving average. If either of those two criteria are true, the stock is in a downtrend. There is nothing more dangerous than a growth stock in a downtrend.

If a growth stock is trading above its 50-day moving average, and the 50-day moving average is trading above the 200-day moving average, I am happy to be long. If the stock is trading at new 52-week highs or all-time highs, that’s even better. If a stock gaps up to new highs after a strong earnings report, that can be a great buy signal. Due to an anomaly called “Post-Earnings-Announcement Drift” (PEAD), a stock that has gapped up like this will have a tendency to continue moving in the same direction for many days or even weeks.

If the SPY and QQQ are trading above their 50-day moving averages, and if their 50-day moving averages are above their 200-day moving averages, it is a good sign that the general stock market is in an uptrend. That uptrend will put the wind at our backs when riding growth stocks higher.

Also, I like to look for growth stocks that have a market cap of $5 billion or less. It takes a lot less money to push a $5 billion stock higher than it does a $500 billion market cap stock.

I also like to look for growth stocks, where the float is less than 20% of the total number of shares outstanding. The “float” is simply the number of shares of a stock that are actually available for trading.

You can use this link to look up the float for any stock: https://finance.yahoo.com/quote/LYFT/key-statistics

Stocks with small floats like LYFT are very easy to push around. Because there are so few shares available to trade, it’s much easier for a small amount of buying or selling to move the stock up or down a lot.

I also like to look for growth stocks with a high short interest. “Short interest” is the quantity of shares that have been sold short by those who believe that the stock will go down. You can find a stock’s short interest here: https://finance.yahoo.com/quote/LYFT/key-statistics

Now short sellers (traders who are betting that a stock will go down) are usually pretty smart. When a stock keeps hitting new 52-week lows and it has a high short interest, you want to stay away. Valeant (VRX) was a perfect example of this.

High short interest is simply more fuel for a rocket stock’s ascent. That’s why if a growth stock is hitting new 52-week or all-time highs and it also has a “Short % of Float” that is greater than 10%, I get very interested. As the shorts get squeezed, a stock like this can sometimes move up 30% or more in a very short period of time.

Take profits when you are so excited and happy about your trade that you are losing sleep.

Take profits if a taxi driver or barber tell you to buy the stock.

Just be sure to never add to a losing position. Pick a stop loss level when you enter the trade and stick to it. Only losers average losers. Rocket stocks go up fast, but they can also go down fast.

I usually like to risk no more than 1% of my trading account on each stock trade. Let’s say that I am trading a $100,000 account. In that situation, I will risk only 1% of my account, or $1,000. If I enter the stock at 100 and the 50-day moving average is at 95, that means that my risk is 5 points on the stock (100-95). In that case, I should only buy 200 shares of stock. If I buy 200 shares of stock, and the stock falls 5 points, I will have lost $1,000 or just 1% of my total account size.

When I'm buying IPOs, I like to focus on more obscure companies, which I often find on this calendar of new IPOs:

When I want to trade a recent IPO, I usually just watch it for a couple of weeks, to get a better feel for how it is trading. If I feel that the S&P 500 is about to go down, I will often short a recent IPO that has a small float (assuming that I am able to borrow the shares to short). If the S&P 500 goes down 10%, a new IPO might go down 50-75%. Likewise, if the S&P 500 has been going down for a few months and my indicators tell me that it is near a bottom, I will often buy a recent IPO with a small float. If the S&P 500 rallies 10% off its lows, a new IPO could go up more than 100%.

For these kind of trades, I usually use a 15-day exponential moving average (EMA) line as my trailing stop. If the stock closes below that line, I will immediately exit the trade. It's very important to trade IPOs with a stop loss and strict discipline. I've known too many people who bought an IPO for a trade, ignored their stop loss, and decided to hold onto the IPO as an investment. Many of those stocks ended up going to zero.

You'll notice that in this example, we sold something (a call option) that we didn't already own. Don't worry about this for now. If you decide to do a trade like this, just make sure that you use a "sell to open" order when selling the call option. If you decide to exit this position, you'll need to use a "buy to close" order to get rid of the call option. After this order is executed, you are free to sell your stock as you normally would. Just never sell your stock before you have exited the call position, or you'll risk getting yourself in trouble.

Covered calls are much easier than they sound. This is another one of those cases where you can learn more by actually doing it, than you can by just reading about it. As we mentioned before, covered calls work best when a stock is trapped in a trading range (i.e. trading sideways).

Here's a day trading strategy that works to capture moves like this: Find a stock that is gapping up on good news (like a better than expected earnings report). Wait 15 minutes after the market's open, and note the stock's price at that time. Put in a limit order to buy the stock at that price. If your order is not executed in the next 15 minutes, cancel your order and walk away. If your order is filled, hold on to the stock for the rest of the trading day, and then take profits a couple of minutes before the market closes that day. Exit the stock early if it trades below the lowest price of that first 15 minutes of morning trading. It's that simple. This strategy takes advantage of a stock's tendency to keep moving in the same direction of its morning gap, as large institutional players like mutual funds and hedge funds adjust their positions

so many new traders lose a lot of money trying to catch the proverbial “falling knife.” In spite of what everyone will tell you, you are almost always much better off buying a stock that is hitting 52-week highs than one hitting 52-week lows.

The Wall Street Journal, or have just seen on CNBC. Never buy a stock based on an analyst upgrade, or sell a stock based on an analyst downgrade. I’ve seen analysts finally downgrade a stock only once it has fallen 50%. Analysts are lagging indicators. They tend to upgrade stocks that have already moved up, and downgrade stocks that have already moved down. There is also a strong selection bias among analysts. The best analysts get hired by hedge funds, and you never hear from them again. The worst analysts stay at the banks or brokerage houses, and continue to dispense their mediocre advice. Huge amounts of money have been lost by following their advice.

It's almost always a bearish sign when a stock sells off after a good earnings report. If a stock that has had a big run-up falls on a good earnings report, it may be a sign that the uptrend is over. The opposite is also true. When a stock still rallies after a “bad” earnings report, it is a bullish sign. It’s also a bullish sign if the stock market rallies after a negative economic report. Many people get stubborn and try to tell the stock market what to do. Smart traders listen to the market instead.

Just because you need to make money today does not mean that the opportunity will be automatically available. You must learn to be content with what the market is currently able to offer you.

Don’t force a trade. Be patient, and wait for the fat pitch. If you can learn patience and discipline, the market will eventually r...

There is a seasonality to the stock market that we should not ignore. Although the 2 most famous stock market crashes both occurred in October (1929 and 1987), September has historically been the weakest month for the stock market. Average historical returns for June and August are also negative. This has led to the famous expression "Sell in May and go away." Stock market returns from November through April have historically been much higher than stock market returns from May through October. This doesn’t necessarily mean that you should sell all of your stocks and go to cash every May. But it does mean that you should be more cautious when trading during the summer months. Many traders and investors are at the beach, so liquidity is lower and volatility is higher.

George Soros: "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

John Maynard Keynes: "Markets can remain irrational longer than you can remain solvent."

Dennis Gartman: "The markets will return to rationality the moment that you have ...

William Eckhardt: "Either a trade is good enough to take, in which case it should be implemented at full size, or it's...

Ed Seykota: "Fundamentals that you read about are typically useless as the market has already discounted the price, and I call them 'funny-mentals.' I am primarily a trend trader with touches of hunches based on about twenty years of experience. In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading. Way d...

Jim Rogers: "I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime. Even people who lose money in the market say, 'I just lost my money, now I have to do something to make it ...

Bruce Kovner: "Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I'm getting out before I get in. The position size on a trade is determined by the ...