A Beginner's Guide to the Stock Market

by Matthew R. Kratter

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.

Until you become an advanced investor, don't ever buy a stock with a P/E of 10 or less.

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

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.

Take profits when you are so excited and happy about your trade that you are losing sleep. Take profits if a stock moves up 100% in 2 weeks or less. Take profits when you are up 300% from your entry price. Take profits when all of your friends and CNBC begin to talk a lot about the stock. At this point, the trade has become crowded, and hence much more dangerous. Take profits if a taxi driver or barber tell you to buy the stock. Exit (with a profit or loss) when the stock closes below its 50-day moving average. Use this method to capture shorter moves. Exit (with a profit or loss) when the stock closes below its 200-day moving average. Use this method to capture longer moves.

Exit (with a profit or loss) when the 50-day moving average crosses below the 200-day moving average. Use this method to capture longer moves. Use a 10-day or 20-day exponential moving average (EMA) as a trailing stop. Exit your position if the stock has a daily close below this EMA. You can also scale out of a profitable position. Sell 25% of your position every Monday for 4 weeks in a row, or something similar. That is a good way to lock in some profits, while still keeping some exposure to the stock in case it continues to move higher.

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.

Don’t buy stocks that are hitting 52-week lows. Don’t trade penny stocks. Don’t short stocks. Don’t trade on margin. Don’t trade other people’s ideas.

Never buy a stock after you have seen the first cockroach. When a stock goes down a lot, it can affect the company's fundamentals as well. Employee and management morale will deteriorate, the best employees may leave the company, and it may become more difficult for the company to raise money by selling shares or issuing debt.

Think of it this way: if a $100 stock moves $1, that is a 1% move. If a $5 stock moves $1, that is a 20% move. Many new traders underestimate the kind of emotional and financial damage that this kind of volatility can cause.

If you get a hot stock tip from your neighbor or at the gym, it’s best to ignore it. They probably have no idea what they are talking about.

Also, never place a trade based on something that you have just read in Barron's, Forbes, 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.

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.

If everyone is talking about something, it's almost always already priced into the market. That means that the stock has already moved to where it needs to be, based on all of the information that is currently available. As we mentioned before, to make money in trading or investing, you need to skate to where the puck is going to be, not to where it has already been.

A market that repeatedly fails to move higher will usually go down.

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.

If you are looking for a good long-term investment, buy a company that has the highest sales in its industry. So for home improvement, you want to own Home Depot; for fast food, McDonald's; for toothpaste, Colgate Palmolive; for payments, Visa; for smart phones, Apple; and for social media, Facebook. Once a business sells more than any other company in its industry, it becomes very difficult to compete with.

There's no substitute for being #1 in ...

"Don’t be a hero. Don’t have an ego. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead. My biggest hits have always come after I have had a great period and I started to think that I knew something."

Buy the strongest stocks that keep moving up. Add to your winners, get rid of your losers, and don't get too greedy.