When it comes to trading or investing, the ultimate goal is to make money. However, success in the markets is not just about finding good ideas; it also requires discipline, emotional control, and proper risk management. Following basic trading rules can help smooth the process and improve the odds of success.
1. Is the Trade Speculative or Non-Speculative?
- Non-speculative trades are typically in high-quality companies, which tend to have more stable price movements and lower risk. These stocks are less volatile and easier to manage.
- Speculative trades involve riskier companies, often smaller or less established, with higher volatility and potential for larger price swings. Examples include nano-cap stocks or companies in emerging industries like NFTs or biotech.
Example:
- Non-speculative trade: Microsoft (MSFT) â large, stable, with lower volatility.
- Speculative trade: KLX Energy Services (KLXE) â a small, volatile company.
Key Differences:
- Non-speculative: Lower risk, lower volatility.
- Speculative: Higher risk, higher volatility.
2. Know the Stock’s Key Metrics
Before entering a trade, understand the stock’s:
- Market Capitalization (Market Cap): Categorizes stocks by size (mega-cap, large-cap, small-cap, etc.). This helps you gauge the level of risk and volatility.
- Mega-cap: $200 billion or more.
- Nano-cap: Below $50 million.
- Average Trading Volume: Shows how liquid a stock is. A stock with thin volume can be hard to trade and may experience wild price swings.
- Aim for a minimum of 100,000 to 200,000 shares traded daily.
- Average True Range (ATR): Measures the stock’s average daily price movement. Higher ATR means more volatility.
- Beta: Compares a stock’s volatility to the overall market (S&P 500). A beta above 1 means the stock is more volatile than the market; below 1 means less volatile.
Example:
- Microsoft (MSFT): Market cap of $2.3 trillion, beta of 0.8 (less volatile than the market), ATR of $4.50 (about 1.5% daily move).
- Takung Art (TKAT): Market cap of $64 million, beta of 3.1 (more volatile), ATR of $0.98 (18% daily move).
By knowing these metrics, you can better understand the risks and potential price movements of the stock you’re trading.
3. Use a Scale-In Approach
Instead of buying all at once, enter trades gradually, especially in more volatile stocks. Scaling in allows you to average down your entry price if the stock dips.
Example:
- You want to buy Palantir Tech (PLTR) at $25.00/share. Instead of buying all at once, buy in stages. Start at $25.00/share, and plan to add more shares at $23.75 and $22.50, for an average entry price of around $23.75/share.
This approach can reduce risk and improve your overall entry point.
Additional Basic Rules
- Avoid holding trades through earnings unless you have a specific strategy for trading earnings reports. Earnings can cause large, unpredictable price swings.
- Manage position sizing based on risk. Higher-quality trades (non-speculative, high volume, low beta, and ATR) should take up a larger portion of your account, while speculative, higher-risk trades should be kept small. Example:
- For a $100,000 account, you might risk $1,000-$3,000 in a speculative stock with a small market cap but be comfortable risking $10,000-$20,000 in a large-cap stock with high liquidity and low volatility.
- Stocks can always fall lower than you expect. In market sell-offs, a stock might continue to drop, even when it seems overextended.
Summary
Before entering a trade, ensure you:
- Understand whether it is speculative or non-speculative.
- Know the stock’s market cap, trading volume, ATR, and beta.
- Use a scale-in approach for buying stocks.
- Avoid holding trades through earnings unless you’re prepared for volatility.
- Maintain appropriate position sizes based on the trade’s quality and risk.
These rules help manage risk and position sizing, which are critical for long-term trading success. While not applicable to every situation, these guidelines are essential for developing discipline in the markets.
