The famous investing philosophy to be fearful when others are greedy, and greedy when others are fearful comes from the king of wise investors, Warren Buffet. This philosophy is timelessly profound, can be applied to any form of investing, be it real estate, the stock market, etc., and is simple to understand.

When others are greedy, it commonly means a recession is soon to follow, or at the very least that a bubble exists. You should be putting into consideration all of the potential risks when you do investments in a time of greed. However when others are fearful, it usually means we are in a deep recession or soon near it. This is the time to be greedy, when prices are dropping like flies because people lose perception of value in the midst of all the chaos. During times of fearfulness is when all the bargains can be found, and where the seeds are planted.

Our economy will recover and collapse time and time again, that is for certain. What isn’t for certain is whether you will keep a clear head through it all and stay the wise investor.

Sometimes investing can be incredibly simplified using common sense techniques. Applying common sense to your investing usually results with profitable returns too. The reason that using common sense works is that for some unexplainable reason there is a lack of it used in the stock market. As such, you can use common sense to somewhat predict/anticipate future stock market moves.

As I write this article, the stock market has taken an ugly tumble downward in the past few days. Fortunately for me I haven’t had so much as a penny invested in any stocks right now. The reason why I have my portfolio positioned 100% in cash is because I anticipated a poor start to the new year. How was I able to do it? I used common sense. Here’s how it’s done…

Look at the variables, and “become the market”…

Last year ended on a bad note with stock prices falling heavily. Meanwhile, oil prices were rising, concerns of recession and stagflation were becoming more prevalent, and the real estate crisis just kept getting worse. Despite the fact that many stocks were getting lower in price and looking attractive, I had to take a step back and ask myself some common sense questions. Questions like “Why would I want to be buying stocks right now?”, “What reasons do we have to look forward to a strong economy this year?”, and “Are we just delaying the inevitable recession?” ran through my mind.

Eventually the answer became clear that stocks were not the best choice at the moment. I also knew I wasn’t the only one who saw all of these red flags, so I anticipated that “the market” would feel the same way and wouldn’t want to be buying stocks right now. Going back to basic economics, more selling and less buying means lower prices.

That my friends, is common sense investing.

As an example: A financial news reporter states “We’re seeing prices head higer as the market believes the Federal Reserve will help ease lending issues. On the whole however the Stock Market has experienced some wild volatility as the market has struggled to find direction”.

In this example, the financial news reporter is saying that stock prices are rising because the majority opinion (“the market”) is that the Federal Reserve’s actions will help the Stock Market. In the second sentence, the reporter is stating that the stock market has experienced volatility because the majority opinion (“the market”) continued to switch it’s mind on whether to be positive or negative about the future of the Stock Market.

But why does the majority opinion matter?

The majority opinion matters because it is a collective reflection on whether we want to be buying or selling stocks. This goes back to basic economics; More buyers than sellers will cause prices to go higher, and more sellers than buyers will cause prices to go lower. So the majority opinion matters because it determines which direction stock prices will go.

What is Short Selling?

Short selling is the method by which investors and traders profit only if the price of a stock goes down. It is the opposite of buying long, which is the process of buying stocks and profiting only when they go higher in price. It is a risky strategy with limited upside, but it does enable you to make money if stock market prices are on the decline.

How does it Work?

The process of short selling stock works by first borrowing stock that you do not own. This can be considered the “buying” (or acquiring your shares) part of short selling. When you wish to no longer keep your borrowed shares, it is known as ‘buy to cover’ as you are buying the shares to cover the shares you borrowed. When you buy to cover, you purchase the shares at their new price versus the original price you short sold them at. If the new price is lower than the original short sell price, you’ve made a profit.

Here’s an example of short selling in action:

Suppose you short sell 100 shares of XYZ stock at $10 per share. You now are borrowing 100 shares of XYZ stock. Then XYZ drops in price to $95 per share, and you want to cash out and take your profits. So you ‘buy to cover’, which means you buy XYZ stock at $95 per share, and returned the shares to the lender of the XYZ stock who you orignally borrowed from. You then profitted $5 per share.

Downside of Short Selling

The biggest issue with short selling is the maximum return on your investment is 100 percent. This is because the most a stock price can go down is 100 percent. This is a problematic restriction to short selling by comparison to buying long. This is because when you buy long a stock you can theoritically make an unlimited percentage gain on your investment since stock prices have no rising limit. That’s just stock market mathematics for you.

Further, short selling only works as a short term strategy. History tells us that the stock market is always going higher in terms of prices, so short selling the stock market definitely wouldn’t be a smart idea if you are a long term investor. If you wish to be profitable with short selling, you need to be more focused on the short term, which means being more actively involved with your portfolio.

Knowing how much you should invest in the stock market is incredibly important to figure out for your own financial sake. We’re all different in terms of our age, net worth, and risk-tolerance; A simple “invest 50% of your net assets in the stock market” recommendation is too vague for anyone to go by. So this article will show you what’s important when it comes to deciding how much money you should invest in the stock market.

Ultimately only you can decide what the right amount of money to invest in the stock market is. Nonetheless, these are the factors you need to consider when deciding how much of your money should go into stocks.

Take into Consideration:

Your Age

The younger you are the more aggressive you can be with your investments since you have more time to earn any money back that you may lose in the stock market. Retired and soon to be retired investors don’t have this luxury and have to look at investing much more cautiously than say a 25 year old. Since retired individuals usually rely on the dividends of their invested money to sustain their standard of living, they need to invest less to lower their risk.

How Aggressive You Wish To Be

In general, the more risk you take on the higher your potential gains and losses are. The more money you invest, the more risk you are essentially taking on (even if you invest in low risk stocks). So ask yourself what your goals are for the present and for the long term, and determine how aggressive you are on a 1-3 scale (1 being non-aggressive, 2 being neutral, 3 being aggressive).

How Good of An Investor You Currently Are

I’m a firm believer in the more experienced and skilled you are, the more you should invest (up to a certain point). In my case, I only invest 25% of my net assets. However as the years go on, I will consider myself worthy of taking on more risk given that I have more knowledge, skill, and experience under my belt.

Always remember:

Don’t invest money you can’t afford to Lose

The money you invest in the stock market should never, ever, ever, ever be money that you can’t afford to lose. Regardless of how much of it is invested, if you invest with money you need to sustain your standard of living you are putting too much risk and pressure on your portfolio and yourself.

Invest only as much as you are comfortable losing

While we all hope that we are successful in our investments, it is unrealistic to assume we couldn’t possibly lose every cent we put in. So when asking yourself “how much should I invest?”, remember that you need to be more comfortable with the fact that whatever amount of money you invest can possibly all be lost. Not only will this help you determine the level of risk you want to take on, but it will also keep you humble about your investments.

With all of this taken into consideration, you should have a rough estimate of how much of your money should be invested. However please speak to a non-commission based financial advisor/financial planner if you still feel unsure of how much you should invest.

Short Selling Stocks Is Anti-American

The Belief: Since you are short selling stocks you are hoping to make money when companies do poorly or go out of business, and thus are encouraging our economy to fail. This would be the opposite of “buying long” in hopes of the stock market going higher in prices and our economy strengthening.

The Truth: Short selling stocks is no different than buying stocks in the typical “long position”. The fact of the matter is that some companies are not bright spots in our economy, and are destined to fail regardless of whether you short sell the stock or not. In rare cases, short sellers can bring to attention scandals within companies and help bring the truth out, such as in the Enron scandal in 2001. Short selling is clearly not anti-American.

When Someone Makes Money, Someone Else Loses It

The Belief: This is the belief that the stock market is a zero-sum game. So when one investor losses money on a stock, someone else has gained that money. In essence, it is the belief that money never grows in the stock market, but is simply transferred from the ignorant to the savvy investor.

The Truth: This is a tricky stock market myth as it can be true in some situations, but in general the stock market is not a zero-sum game. What allows the stock market to go against this belief is that over the long term investors can all profit as long as the stock market is constantly going higher. So even if I lose some money on a few stocks this year and gain on some others, if I invest for the long term I will be profitable as will all other investors since prices are continously going higher over the long term. Only in the immediate short term can the stock market be considered a zero-sum game, where one investor’s loss is another investor’s gain.

Buy And Hold Is The Best Strategy

The Belief: The best way to grow your money is to find stocks you like and sit on them for as long as you can. You can’t beat the stock market, so you might as well just wait it out for many years.

The Truth: Unforunately while this used to be true many decades ago, the truth of the matter is that buy and hold is an extremely poor strategy in this day and age of the stock market. There are few companies these days that provide both genuine value and growth, and that is why buy and hold is an obsolete strategy.

You Can’t Beat The Stock Market

The Belief: Beating the stock market’s own performance is not possible, and those individuals that do actually accomplish this feat will not have their “luck” last for long. Don’t bother trying to outsmart the stock market, just accept that you aren’t going to outsmart the millions of other investors who believe the stock market isn’t beatable.

The Truth: The stock market is able to be beaten in terms of performance! Investors and traders do it every year, and some do it every year consistently. While it is not an easy to accomplish, it is at the very least possible. With that being said, most investors simply don’t have the time to actively manage their portfolios and thus do not have the ability to outperform the stock market over the long term, which is why this myth refuses to die.

Fundamentals Don’t Lie

The fundamentals of the Dot-com bubble were horrible, most new public companies weren’t profitable and some had no intention of ever making a profit. IPOs were going sky high while the business model itself showed no realistic way to turn a profit. These big warnings are known as red flags, and they were everywhere during the dot-com bubble. The educated investors and professionals in the stock market saw these red flags and knew that a crash was coming, and that’s why they were successful during the Dot-com bubble. The rest were left to fight to sell their rapidly devaluing stocks.

Lesson learned: If you are investing in the stock market for the long term, don’t invest when prices are overvalued and fundamentals are poor. The combination of these two problems are practically begging for an eventual stock market crash if things don’t turn around. You want to invest when you see nothing but green flags, not red.

Trading stock market momentum is fine, but always remember it’s just momentum!

The stock market rallied during the dot-com bubble for good reason: everyone and their grandma was excited about Internet based companies. The overall investor’s belief was optimistic and this fueled a multi-year rally that had seemingly endless momentum. But as we just learned, the fundamentals were garbage and when the momentum died, the party was over and the stock market crashed.

Lesson learned: If trading/short-term investing is your thing, then get your profit and get out. Don’t get caught up in how much higher your stocks can go, just sell them when you believe it’s time to get out. When the reality of overbought stocks comes into realization, you want to be the guy with all of your stock sold, not the guy caught off guard while panicking about what you should do.

Life-Altering Changes Don’t Happen Overnight

The optimism for the Dot-com bubble was supported by the belief that internet business was somehow going to instantly take off and going to retail stores would be a thing of the past. Huge issues such as customers having to pay heavy shipping fees were regarded as not important, and the stock market rallied while believing that we’d all be buying our groceries online and ordering our pizza from a .com site. The problem was that none of this was actually occurring, and it was really just wishful thinking since most companies had no realistic business model to get these society changing ideas off the ground.

Lesson learned: The internet was invented in the 1950’s; It didn’t become popular until the 1990’s. When a company or many companies are promising life-altering changes in how we live our lives, be very skeptical. Even if these ideas for change are realistic, they don’t happen overnight, in most cases they don’t happen for decades!

Let’s use the example of a recently volatile stock known as E-Trade Financial (ETFC). The stock price experienced a large sell off and dropped to $8.59 per share, a 58.7% drop. The next day a rally occurred in the stock market and E-Trade’s stock soared up 40.9%. This left the stock at $5.00 at the end of the day. This is a key example of how the percentage mathematics used in stock prices can easily be misleading to casual investors.

Now let’s break down this problem in simpler terms. Suppose you bought XYZ stock at $10 per share. It remains around $10 per share and suddenly it falls 80% one day due to a sell off and ends the day at a meager $2 per share. The next day, the aggregate stock market sentiment is the stock was oversold, so a rally occurs and the stock soars up 50%. If you were a long term investor during all this madness, you’d still be down significantly. A 50% rally in a $2 per share stock will only result in a $3 stock price. Which means despite the face value of 80%-50%=30%, you are actually down 70% on your investment of XYZ stock because the price per share ultimately went from $10 to $3.

Investing in the stock market is confusing enough already to the amateur investor in today’s conditions; So always keep this in mind when you research and analyze stocks as this is an easy mathetmatic occurrence to forget about or overlook.

Watch CNBC
In particular “The Closing Bell” (4pm Eastern Time Zone) on CNBC recaps the most significant daily events in the stock market, the economy, and any important variables that affect the two. However if you have the time to watch a few hours of CNBC on any given weekday, I highly recommend you sit down and immerse yourself in the stock market news and discussions displayed on CNBC. You’ll not only catch breaking news, but you’re bound to listen to exclusive interviews with mutual fund managers, hedge fund managers, stock market analysts, and other individuals who have strong influence over the stock market.

Subscribe to a Financial Media Newsletter
Find a reputable source for financial news and get yourself a subscription. Some financial media sites even offer their articles for free. I use the Wall Street Journal Online, but there are plenty of great sources for financial news such as Investor’s Business Daily, MarketWatch.com, and TheStreet.com.

If you have the option between an online subscription and an actual newspaper subscription, choose the online edition. You’ll be able to get much more up to date information as opposed to the newspaper edition. Plus if there is any after-market activity or breaking news that occurs after the final version of the newspaper goes out, you’ll basically be missing out on that late breaking news.

Keep a News Ticker Running on Your Computer
There are many ways to have a stock market news ticker running on your computer. The easiest way is to use whatever tools your online broker has in the form of a news ticker and just leave it running in the background. Periodically check up on the ticker for any major news that can affect the stock market and/or economy. There are also plenty of programs available for purchase out there that will also report stock market news, but I would highly recommend using your broker’s own tools for a simple task such as retrieving up the to the minute stock marke news. It will keep things simple and most likely will be cheaper than purchasing some independent software.

My opinion on the matter is that as an amateur in the stock market, you should consider trying all forms of wealth growth until you find what works for you. I’ve been in the stock market since 2005, and here’s what I consider to be the pros and cons of investing and trading.

Investing

Pros:

• Statistically you are more likely to succeed than traders are in the long term
• More likely to have consistent percentage returns per year than traders are
• Less time consuming and psychologically less stressful
• Less commission fees than trading

Cons:

• Lower percentage returns in the short term
• Easy to lose interest due to lack of involvement required. Usually leading to poor portfolio performance.

Trading

Pros:

• If successful, a trader’s percentage gains are typically higher than investor’s
• There is always money to be made somewhere in the short term
• Builds even more discipline than investing does (assuming you are successful)

Cons:

• High broker fees due to commission being taken on buy/sell orders
• More time consuming and considerably more psychologically stressful than investing

Overall, I would ultimatley recommend investing over trading simply due to the fact that most individuals just aren’t capable of being successful as a trader. It takes vast amounts of market knowledge, discipline, understanding of psychological issues, and a little bit of luck to make it as a trader. Whereas an investor can simply choose a few mutual funds coupled with some fundamentally strong long terms stocks and end up more successful than most would-be traders after 10 years.

Site Layout – 4 out of 5
E-Trade’s site layout is effective, intuitive, professional, and easy on the eyes. Compared to some of the other online stock brokers I’ve used in the past, E-Trade easily ranks the highest in this category. Finding my portfolio’s allocation is just as easy as finding quotes for a stock.

Tools – 3 out of 5
E-Trade has powerful and easy use tools for just about everything you’d need as an investor. It has fully customizable market and trading platforms, along with other useful tools such as asset allocation, account performance, income estimator, risk estimator, and more. The only complaint I have is that some of their more effective and desired tools are not free to users unless you pay a fee or have a minimum numbers of trades per quarter.

Security – 5 out of 5
E-Trade really sets itself apart from its competitors because they offer a free SecurID product to ensure that your account stays in your protected and in your possession at all times. I love the SecurID product, it’s extremely easy to use, creates an incredibly strong second layer of protection on my account, and of course it was free thanks to E-Trade. This feature alone is enough for me to stay with E-Trade, because I like sleeping at night knowing that I have added protection on my account.

Customer Service – 5 out of 5
E-Trade’s customer service is extremely good, especially in a time where most customer service departments are full of outsourced employees who are reading off a page of specified things to say. Customer service employees are friendly, knowledgeable, and extremely helpful. I’ve made countless numbers of calls to their customer service phone number and had my questions and issues resolved instantly. In fact, E-Trade was recognized for outstanding customer service in 2007 by Smart Money (a financial magazine).

Commission Fees - 2 out of 5
This is really the only downside to E-Trade. With E-Trade your commission fees are higher than most online discount brokerages unless you make a minimum number of trades per quarter. I tend to overlook this part of E-Trade as it is obvious that the higher commission fee is definitely worth what I get in return compared to other brokerages.

Overall – 4 out of 5
E-Trade is a great online discount brokerage, and I truly believe E-Trade leads the industry with their superior tools, outstanding customer service, and ease of use for investors. Their commission fees are definitely higher than their competition, but if you want the best, you should expect to pay a little more than usual.

Paper trading is usually recommended as a training prerequisite before investing/trading in the stock market. It works by pretending you own X amount of shares of Y stock that you selected and tracking your results in a set period of time to simulate being in the stock market. Paper trading is simply a waste of time though and I wouldn’t recommend anyone bother with it.

Yes, paper trading has its benefits for the extreme beginner, but it’s ability to teach you how to invest or trade is incredibly limited. Paper trading will give you a basic idea of how the stock market functions, but beyond that it just doesn’t make much sense to bother doing it. Simply put, there are much better ways to prepare you for the stock market than paper trading. Here’s why:

Builds false confidence
Let us suppose you had a rather lucrative paper trading experience. You feel good about yourself and think you’re ready to invest or trade the stock market. You open your brokerage account, and find out after a few bad trades (which are inevitable) that the only thing you know is that you know nothing. This is because paper trading is so one dimensional compared to the real thing that you don’t get much of an education.

Fails to Simulate the Stock Market
The problem here is that you just can’t simulate the stock market, or what it feels like to be in the stock market. The variables that influence the stock market are practically limitless that I find myself unable to truly explain the depth of this issue. Economic forecasts, hedge fund influences, media headlines, market confidence, etc.; Paper trading just can’t capture all of those little things that compose the stock market, and without that you aren’t getting a real simulation.

Lacks Market Psychology Lessons
This is a huge issue as well. Regardless of whether you are a trader or an investor, being successful in the stock market is largely dependant on how well you can control your emotions. If you remember only one thing from this article let it be that paper trading will completely mislead you in terms of how it feels to have your money on the line. There is no substitute for learning how to discipline your emotions than to battle it out in the real stock market.

Wastes time that could be used for real learning
If you want to prepare yourself so you can get into the stock market, buy some credible investing books and read them front to back, check out my beginner articles, and subscribe to a credible financial media newsletter/paper.  It will definitely be more time consuming than paper trading will be, but what you will learn will be so much more in depth than what paper trading has to offer.

Every investor needs a self created list of rules to invest by so that they stay disciplined and successful. Many investors learn the hard way what the do’s and don’t’s of the stock market are, but fail to write them down so that they don’t repeat these mistakes over the course of their investing career. You need to make a list of rules to invest by yourself, and this article will show you how to do that.

But before we get into the process of creating a list of rules, you may be asking yourself “why do I need to make the list on my own?”. No, it’s not because I’m too lazy to give you a specific rule list, it’s because each investor has their own strategies, goals, and styles that make them different. So a list of rules that might work for one investor might be terrible for another. With a list of rules to invest by created by yourself, you can use your own experience to identify what works and doesn’t work for you. If you have no experience in the stock market, scroll down to the section titled “My own rules” to see my personal set of rules for investing to give yourself an idea of where to start when creating your rules.

Creating Your List of Investing Rules

Creating the Do’s…

Think of all the investments you made this year that were both rational and successful. What similarities did these investments have in common? Try to isolate these similarities and find ways that they can be made into rules. For example, if you made several investments in stocks with good fundamentals and they were all successful, a good rule to create would be “only invest in stocks with good fundamentals”. Your list of “Do’s” should consist of rules that will always be a good foundation for choosing stocks to invest in.

Creating the Don’t’s…

Now think of all the investments you made this year that were unsuccessful and/or irrational. Think about what made these stocks poor investment choices and what was ultimately wrong with them. As an example, suppose you invested in a stock just because you heard about it from some market analyst on television and invested solely by that analyst’s advice. So your rule would be to “never invest by analyst opinion alone”. Opposite to the list of “Do’s”, your “Don’t’s” list should consist of rules that contain all of the wrong reasons to invest in stock.

Remember: You don’t need a list of investing rules that is longer than most fictional novels. Keep it simple and stick to the universal rules that will make you a successful and rational investor.

My Own Rules

Do…

1. Invest in stocks with strong fundamentals
2. Stay up to date with the stock market on a daily basis
3. Do research on a stock before buying/shorting it
4. Diversify your portfolio
5. Sell some shares on a high performing stock that may have peaked
6. Stay unemotional under all circumstances

Don’t…

1. Go by your gut feeling
2. Let momentum be the only reason for investing
3. Attempt to trade market volatility
4. Rely on analysts’ opinion alone
5. Let the fear of failure become an obstacle

Oh, and the golden rule for investing: Buy low, sell high.

Every investor has their own strategies, methods, and techniques to achieving success. Though despite these differences, all successful investors share the same distinct traits which truly separate them from the herd. The five traits of a successful investor are:

1. Highly disciplined and committed

Discipline is the backbone of a successful investor. Being highly disciplined means you are committed to your efforts so that you are always prepared. If you want to be successful in the stock market, you need to commit to it. There is no such thing as a free lunch. Successful investors don’t let the hurdles such as previous investing failures get in their way, and neither should you. If you know how to invest properly, discipline and commitment will ultimately be your gateway to success.

2. Invests without emotion

Emotions are the handicap of the novice investor. Successful investors know that rational investing is fundamental, so they disregard their emotions while analyzing their investments positions, decisions, and ideas. If emotions are thrown into consideration while investing, the thought process of a rational investor becomes clouded and often leads to failure.

3. Always up to date with the market

A funny thing about the stock market is that everybody has the same information, but everybody interprets it differently. Successful investors are always up to date about the current market by using unbiased financial media sources to get their information. The stock market is full of variables that can drastically influence market prices, so staying on top of those variables is crucial.

4. Possesses a realistic outlook on investing

Having a realistic outlook on investing and success coincides with being highly disciplined and committed. Successful investors understand that they probably will not become the next Warren Buffet, by which I mean they won’t make astronomical returns on their investments. However, humble expectations often lead to high returns, as an investor without excessive greed will have a clear state of mind and will invest properly.

5. Always has a plan

Not having a plan while you invest is like a coach telling his players “Just go out there and win”. Sure, if you’re lucky and/or naturally talented enough, you might make a few successful investments, but this plan (or lack of) hardly is effective in the long term. Successful investors understand the importance of having a plan. They know where they want to get in, where they want to get out, what they will do if something changes or goes wrong, and what their goals ultimately are. Having a plan keeps an investor focused so that they will stay rational while they invest.

What is the point of the stock market? Why do companies sell shares?
The point of the stock market is fundamentally simple, but can often be complicated in today’s conditions. In it’s simplest form, the point of the stock market is for companies to sell a portion of their company in the form of shares to raise money, and investors purchase shares to receive a portion of the company’s profits relative to the portion of shares they purchased. Of course, this description of the stock market hasn’t been accurate for decades…

While most companies’ reason for going public and selling shares of their company is still to raise money that will be reinvested into the company, some companies now go public for the sake of extracting the worth of their company. This usually occurs in an overbought stock market where IPOs are a hot commodity. In other words, sometimes companies go public just to ride good momentum in the stock market and never plan to reinvest the raised money into their own company.

Fortunately most informed investors are aware of this technique used by underachieving companies, so this has never been much of a issue. The investor’s goal in the market is to grow his wealth, but that goal is now fulfilled by more than just dividends. The old adage of buy and hold is no longer relevant in today’s market. In fact, many major public companies don’t even provide dividends to their shareholders. These companies prefer to reinvest their extra cash in the company for growth purposes, than to pay their shareholders their portion of the profits. So in the current market, the investor’s purpose is to grow his wealth through any way possible (as long as it’s legal). Methods of growing wealth include buying long, selling short, speculation investing, dividends, etc.

Who or What steers the Stock Market?
The list of variables that streer the stock market are practically limitless, but the most influential and significant factor in determining the direction of the stock market is the economy. In general, the stock market and the economy move in a positive relationship (when the economy is up, the stock market is up and vice versa), but this is not always the case.

Often times the confusion and/or irrational exuberance of investors leads to an unusual relationship between the stock market and the economy. By unusual, I mean that it is possible for the economy to have completely different characteristics in terms of growth than the stock market. For example: the economy can be stagnant with no signs of growth, meanwhile the stock market is rallying upward. Another example: the economy can have moderate growth, but the stock market can be declining downward. The reasons these unusual relationships form are best left for the more advanced articles you can find on this website.

That does it for Part I of the mini-series “Introduction to the Stock Market”. Stay tuned for the next edition coming soon.

If your original purpose was to purchase shares in a company to achieve a good percentage return on your investment, but this goal was reached in a short period of time and you sold your shares, all this makes you is a quick investor. Not a trader. A trader by my definition is someone who looks to solely play the momentum of a stock in their favor and use tools such as technical analysis to find reasonable entry and exit points in a stock.

However, my definition of an investor is someone who looks at the fundamentals of a company, considers outside market variables, and sees potential for good returns on his investment. The time it takes to achieve the returns is irrelevant. What is important in distinguishing an investor from a trader is that an investor is looking for his profit regardless of how long it takes to achieve it, as long as it is the best placement for his money to grow.

Please note that I have nothing against traders. Trading just isn’t my style. I prefer to invest instead of trade because it helps me sleep better at night. Just kidding. Although there’s some truth in that statement.

Spotting signs of a potential stock market correction or crash is a relatively easy task if you understand basic economics and if you are keeping up with the market on a daily basis. However, if neither applies to you, look for a combination of most, if not all of these signs as indicators of a potential stock market disaster (these signs by themselves aren’t enough reason to expect market declines):

Fundamental Problems Exist in the Economy
The Dotcom bubble in the late 90’s came to a hard crash after it became apparent that the hype of the online business models were not successful. The Dotcom bubble is a perfect example of a significant fundamental problem that once existed in the economy but was ignored by the stock market as it rallied higher. During the Dotcom bubble, the stock market rallied significantly as investors couldn’t get enough of the internet companies. The problem was that most of these companies weren’t profitable, some never intended to be either, choosing to ride the momentum of the stock market to make the most amount of cash they could off their stock. So while the stock market soared, our economy told a different story. If you observe fundamental problems in the economy while the stock market itself is rallying, be wary of a potential correction or even possibly a crash (although a crash seems unlikely).

Extended Amounts of Violent Volatility
If you are noticing high levels of volatility in the stock market for an extended period of time, this is a clear indication that something is wrong in the stock market. High volatility is nothing unusual by itself, and can arguably be considered healthy for the stock market. However if the stock market is experiencing see-saw like volatility (for example: one day the market rallies and the next day it plummets) for long periods of time, such as over a month’s time frame, then this is a sign there is too much confusion and confliction about which direction the stock market is heading.

Financial Media Reports Only Noise
If it seems like all you read or hear lately from the financial media is how our economy is in trouble, how there are serious underlying issues that need to be addressed, etc., then you are listening to what is known as noise. When you notice that the financial media has nothing but noise-like information to report for extended periods of time, then fear and instability get planted into the stock market. This relates with the psychology of investing, and it is important because a market that has seeds of doubt planted into it make it a fragile market, easily capable of correcting or crashing.

Unjustified Stock Market Prices
Identifying this sign does require knowledge of market prices, but you can simplify this and look at how high the three most popular indexes are (Dow Jones Industrial Average, NASDAQ, S&P 500). Read statements from the Federal Reserve and respected market analysts, and consider what our economic forecast for the year is. Ask yourself, how much has our economy grown so far in comparison to our stock market. Is there an inverse relationship? Should the market be at these high prices? If the answer is no, you know that the stock market can drop much lower than it can rally higher. Thus your risk is much higher than your reward. More about the risk versus reward will be discussed further in the article (yeah, it’s a long one).

Now that you’ve learned the technique to identify a fragile and correction/crash prone stock market, you now need to learn how to decide what your best plan of action is to be. If you read my other article “The Fundamentals of Successful Investing“, you know that having a plan is crucial. Even more so than usual, as a plummeting stock market catches most investors by surprise, so they have no plan to escape the chaos and ultimately fall victim to their emotions. This is arguably one of the reasons why panic selling occurs during a stock market correction and leads to a crash.   You have three basic decisions after you’ve reached your conclusion on the market, you can either:

1. Short sell the market
2. Buy long or stay long positioned the market
3. Sell your positions, stay 100% in cash and wait for a good re-entry point

So the question becomes, which move is the right one? To rationally consider the best choice of action, attempt to envision all of the problematic variables in the stock market. What could go wrong, what could go right, and what is realistically going to happen. If the potential risks of your plan of action outweigh the potential rewards of your plan of action, then you should reconsider. Remember, the key to successful investing is using a rational approach to form opinions of the market. If you know you’re putting yourself more at risk than you are at reward, you aren’t being rational.

If you find that the potential risks and rewards are about the same, then you should stay out of the stock market. When you can’t make a good decision because the stock market’s future looks too open to speculation, then there is no reward, just risk. Staying in a market that realistically could go either way (up or down) is not investing, it’s gambling. How can you have a plan of action when you aren’t even sure which way the market will go? The answer is to stay out of the market, and wait for a clear sign that the confusion has ended, and it is time to re-enter the market.

Walk the Walk, not just talk the talk. The techniques posted in this article are strategies I developed over time. Using these techniques I was able to avoid two stock market corrections in 2007. Here is a picture I took off my E-Trade account showing my performance versus the S&P 500. Note the stock market corrections that occurred and the performance of my portfolio not being affected. Click the image to enlarge it.

Penny stocks exist on a different market exchange that is mostly unregulated by the Securities and Exchange Commission (Known as the OTCBB and Pink Sheets). The chances of finding a legitimate penny stock are very low. Most penny stocks are simply shell companies, that go through cycles of momentum and stock price because of the individuals who trade them. One day a penny stock can be up 300%, then the next day it can be down 90%, yet literally nothing at all has occurred in the company. Here are the reasons to stay away from the Penny Stocks:

Low Liquidity, High Risk
Unlike the stocks listed in major exchanges such as the S&P 500, penny stocks have very low daily volume. What this means is that you can buy shares of a penny stock, and in some cases have no one to sell it to! On average, penny stocks have volume equivalent to a few thousand dollars being exchanged every day. You want and sometimes need good liquidity in a stock so you can make a quick entry and exit, especially in penny stocks where the stock price can tank on a whim.

Pump and Dumpers
If you ever receive an email or possibly an advertisement that claims you need to immediately “invest” in a penny stock, you’ve been a target of pumping and dumping. The idea behind this is to create unfounded hype for a penny stock the pumper already owns, then as his victims buy into his hype and drive up the price of the stock significantly, the pumper sells his shares for a large profit. Meanwhile, those that bought into the hype will quickly lose their money as the upward stock momentum drops and the stock price heads south.

Inability to do Homework
Penny stocks differ from the stocks on major exchanges in that they have little to no following at all. You almost never find a penny stock being talked about by the financial media. There is usually no analyst opinions on penny stocks, which should put up an immediate red flag. If this company were actually worth something, wouldn’t analysts be interested in it?

Enjoy the Ride
Penny stocks are known for their wild and violent swings in momentum. You could walk away from your trading station/computer for an hour and come back and realize your penny stock went up 25%, then plummeted into the red. With penny stocks, you need to spend many hours every day watching your positions, otherwise you risk missing the golden opportunity of profit.

Unfortunately, I know this article probably won’t sway any new investors to avoid penny stocks. The lure of rapid, high percentage gains is too strong for naive investors. But hey, if you end up losing half your portfolio from a penny stock, don’t say I didn’t warn you.

Looking for advice? Consult yourself!
By no means do I suggest isolating yourself from the market analysts, infact I recommend you read and research everything the analysts say about the market and/or your stock(s). However, you should never invest only by what others are saying. This applies to every situation, from something you heard on an online message board, to any TV analysts opinions’ (I love Jim Cramer’s show and the Fast Money show though). If you are new to the market and feel that you can’t make decisions for yourself yet, then stay on the sidelines until you’ve gotten comfortable and confident enough to invest by your own decision making. Always remember that you never know what someone else’s agenda is when they offer you advice.

Get a feel for the market by keeping up with it
I need to state right away that investing by your gut feeling is the most foolish thing you could do, even more foolish than investing solely by what other people tell you. I highly recommend purchasing a subscription to the Wall Street Journal (I use the online edition), or any financial newsletter that will allow you to keep up with the current economic events. The reason it is important to stay up to date with market happenings is because there are always key events (ex: Federal Reserve meeting, Company earnings for a quarter, etc) that can significantly affect the market. If you’re new to the market, keeping up with the market by reading financial newsletters is also a great way to ease your way into stock market investing.

Have a plan
After doing your homework, and definitely before you buy/short the stock you’re interested in, you need to have a plan. Are you planning to hold for the long term? Looking for a short term momentum play? Know something the market doesn’t know (just kidding, that’s illegal)? You need to have a plan where you state clearly to yourself, this is where I want to get in, and this is where I want to get out. It is important to do this so that you can keep a clear state of mind, and stick to your goals. Otherwise, you can fall victim to your emotions. Which brings me to my next point…

Throw your emotions out the window
When it comes to investing, it is hard to not become emotional when you’re losing or gaining money. But to be successful in investing, you need to mentally train yourself to leave your emotions out of your thought process when you invest. It is imperative to realize that sometimes you will simply lose money, sometimes large amounts. As well, you sometimes will gain large amounts of money. Neither should matter in your thought process of what you plan on doing with your stock. If you ever become emotional while investing with stocks, you’re setting yourself up for failure. Which now brings me up to my next point..

Don’t be afraid of failure
If all you do is fear that your next move will put your portfolio in the red, you’ll miss out on the potential winning moves. Most investors are wrong more than half of the time they invest, so don’t feel discouraged if you’re taking on losses. If you let fear rule your thoughts, you’re once again falling victim for to your emotions. Condition yourself to realize that learning how to invest successfully is truly a right of passage. Always remember that if you invest rationally, with your emotions set aside, do your homework, and keep up with the market, you should ultimately be successful.

Trust Yourself If You Know You’re Right
To give you a personal example: I was on the sidelines with 100% of my money in cash thinking that the market was headed for a correction. It took over a month, and 500 points upwards in the Dow Jones Industrial Average, before I saw that same index drop over 1000 points downward. It is very trying on your goals and your opinion of the stock market when everything is happening to the complete opposite of your beliefs. In cases like this when you find yourself doubting yourself, it is important to sit down, and rationally consider the situation. Ask yourself questions such as: Has anything changed? Could it be that I was wrong? Is the market just being irrational? Re-evaluate your plan if necessary. In my case, I doubted myself every day, but I reassured myself that the upward rally in the market wasn’t justified, my initial beliefs of the problems in the market were still there, and in the end I came out correct. If you know you’re right, stick to your guns, but don’t be afraid to re-consider your position/beliefs.

Never invest in penny stocks
It has been said that trying to find a legitimate penny stock company is like trying to find a prostitute without any STDs. Just about every single penny stock is scam. Penny stocks operate on a different trading board, in which the SEC does not regulate, and that does not require for the companies to submit their annual earnings and other important documents. Most of these stocks are pump and dump stocks, offering no real value. Many first time investors are tempted to trade penny stocks (and I do emphasize the word “trade”, because you cannot invest in a penny stock) because of their perceived low cost and higher volatility that presents a potential for big gains. If you’d like more information on penny stocks, read my article “The Risks of Penny Stocks“.