Rule 1
Never trade with borrowed money.
It's called "leverage" or "margin." Your trading strategies use money you borrow from your broker. Some people even max out their credit cards, or take out home loans. Don't do it!
It sounds so tempting -
*Put up only a little money. Your broker puts up the rest.
* You make bigger profits. Get returns on the borrowed money as well as your own.
Until the roof falls in -
* Losses are multiplied as much as profits. If you lose, your loss is much bigger.
* If prices go down, the stock you bought with borrowed money is no longer worth enough to be collateral for the loan.
* Your broker can demand more money as collateral. That's a "margin call."
* If you don't have it, he can sell your stock.
* You lose almost everything.
* "Margin calls" can wipe you out.
* Meanwhile, you have to pay interest on the loan.
Buy shares with your own money, and you can ride out a price dip. Buy shares with borrowed money, and a price dip gets you a margin call. The added profit potential is more than canceled by the added risk.
Smart trading strategies are safe trading strategies. Don't use "leverage."
Rule 2
Always take part of your winnings off the table.
At a Las Vegas casino, if someone wins at craps, they might "let it all ride." They keep betting everything they have - what they came with and what they've won. You know the end of the story. They win big - until they lose it all.
Using trading strategies like a Las Vegas gambler is a recipe for disaster.
People think "big trades make big money." They want to do the biggest trades they can. So they pile all their winnings into their next trade.
* That works until they lose. Then they lose big because they "let it all ride."
But smart trading strategies are safe trading strategies.
* An investor's job is to lower his risk. The lower his risk, the closer he gets to safe money.
The best trading strategies grow your portfolio slowly.
* Re-invest part of your share trading profits. 50% is a good amount.
* Set aside the rest. It will keep you safe in hard times.
* Take 50% of your profits even if you don't want to close a trade.
* With a $10,000 profit, take $5,000 immediately, and leave the rest invested.
* The $5,000 you saved cushions you against a later fall in the stock.
Rule 3
Don't buy more when the price is falling.
What are your trading strategies when the price falls?
* Panic and sell at once - always bad.
* Hold on and hope - always bad.
* Stick with the Exit Strategy you decided in advance, and sell if and when the price falls enough - smart.
* Buy more - often bad.
Buying more when the price is falling feels smart -
* Lower your average cost.
* Get more of a good stock.
But remember that smart trading strategies are safe trading strategies. Buy when the price is falling and you raise your risk.
* Increasing the size of your position raises your risk - automatically.
* The falling price gives you negative feedback about the stock even as you raise your risk.
* "Markets can stay irrational longer than you can remain solvent." ~ John Maynard Keynes.
* You assume the stock will bounce back soon. It may not.
Most people buy more of a falling stock because they don't want to be wrong. Don't let ego ruin your trading strategies.
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Dr. Bob Rubin, Editor