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Online Trading Rules For Risk Management

Aug. 30, 2012
5 mins
A man and woman work together at a desk

Making a decision has never been easy for me. Call me a classic Libra (or paranoid), but when I pick a side, it’s an art form - and I tend to fret endlessly about my choices. Perhaps it’s really no coincidence that I work for a rate comparison site!

Anyhow, long story short: choosing my first stock has been an agonizing experience.

Not to scare you, other newbie investors, off - but when it comes to choosing the best investment route for your hard-earned cash, there’s no easy way. Which is how I found myself standing in front of the world’s exchanges, $500 in initial capital clutched in my hand, and having a veritable panic attack.

Here’s what I’ve deduced so far from many hours pouring over candlestick charts, valuation analysis and trending 52-week highs and lows.

Set Your Trading Rules

Here’s my conundrum: while $500 is certainly not chump change for me, it isn’t a heck of a lot to throw around on the markets. To avoid running out of cash in a flash, I need to employ some shrewd strategy - and that means keeping a firm hold on my level of risk. Here are a few rules I’ve set for my trades:

Rule 1: I’m only going to spend $300 on my first trade. I feel comfortable with this number - while it may limit my trades to odd lots (traditional order sizes come in 100, 500 or 1,000 shares), I should be able to pick up a few shares of a nice, secure stock - and should I lose it all, it’s an amount I can financially absorb. It also leaves me with $200 to play around with later when I want to diversify with a second or third pick.

Rule 2: I’m staying away from penny stocks. These are shares priced so low, they’re almost too good to be true. While it’s initially tempting to get more bang for my buck on these (I can swing a full lot of 100, no sweat), the high level of uncertainty associated with these kinds of trades (and the conditions affecting their sectors) is outside my comfort zone for now.

Rule 3: No buying on margin. A few (slightly more) senior trading enthusiasts have inquired whether I’m interested in short selling, which is the practice of borrowing shares from the brokerage, and selling at the current price under the obligation of buying them back at a (hopefully) lower one. Should those prices go down, you’ve pocketed a nice profit - if they go up, though, you’re facing a loss. As the thought of potentially owing more than my initial $300 investment makes me green around the gills, I’m shelving this one for now.

Rule 4: I’m trading on the TSE: While I realize this commodity-focused exchange may limit my options somewhat, cutting out currency exchange appeals to me. Call me a patriot, or a chicken - I’m sticking with the Canadian dollar.

That leaves me with the kind of stance I’d like to take on my investment:

What’s Your Trade Stance?

Swing Trade: This means buying a stock for 1 to 4 days in the hopes of catching prices on an upward swing. An eagle eye on the market and a sharp sense of timing is a must for this one.

Trend Trade: This is a longer-term position taken in the hopes that a stock will trend higher in the weeks to come. Just some of the factors used to estimate this include cyclical price trends, year-over-year trends, risk factors facing the sector, financial standing of industry peers, etc.

Buy and Hold:  This is a conservative approach that requires meticulously selecting a stock and sitting on it for a length of time. By taking a long-term approach to the investment, you can avoid spazzing over short-term market fluctuations, and hunker down for the big picture.

Why I’m Not Going With My Practice Picks

If you’ve checked out the earlier entries to my Online Trading for Newbies series, you know that I’m an enthusiast of the premium yoga gear provider Lulu Lemon (LLL on the TSE), and had a blast using their stock to learn the ropes during my practice account days. Why you may ask, am I not going with them for keeps?

1: Their Price-to-Earnings Ratio is high: As of today, Lulu’s P/E is at 48.3  This has me thinking that while it’s a very popular stock, all this investor attention is pushing the price through the roof.

2: Their Fair Value Estimate is lower than their current share price: According to Questrade’s very handy Market Intelligence, the fair value estimate for Lulu is $55 a share - and as of today, it’s trading at $65. This means I can either jump on the overpriced bandwagon and hope the market squeezes profits higher - or wait until levels come back down at a later date and snap them up then. Seeing as I’m hoping to catch a stock with great potential at a discount, I think I’ll bide my time.

3: They rank “very high” on Morningstar’s Uncertainty scale: It’s the nature of the retail beast - new competitors on the scene can greatly jar a company’s current standing. As Gap and Nike both narrow in on the category of stylish women’s sportswear, and as Lulu continues to be a premium-priced product in a slowing economy, market bears are taking the “wait and see” approach - and so am I.

Side note... Those of you familiar with my training wheels trading days also know I had great fun buying Apple (APPL) stocks with my monopoly money. Let’s just say they’re a bit out of my price range these days...

Who Is The Chosen One?

Curious about what stock will be my first? Aren’t we all! Tune in next week to see which will be the official first pick of the series...  And if you’ve got any ticker tips for me to check out in the meantime, send them my way in a comment, or visit us on Twitter or Facebook.

Check out previous entries in the Online Trading for Newbies series:

Trading Stocks with Mobile Apps

What Is The Forex?

Picking Your Stocks? Do Your Homework

Choosing Your Best Online Brokerage

Learning to Trade Stocks Online: A Newbie’s Experience

Penelope Graham

A first-time homeowner and newbie investor, Penelope Graham is the quintessential millennial, navigating the world of personal finance and wealth management. A self-professed monetary policy nerd, she follows the often-controversial housing market closely and specializes in mortgage, credit card and personal finance news.

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