The most common picture that comes to mind when people hear about stock trading is the one we see in movies where men in suits basically shout and wrestle each other in some huge New York building to bicker about money. Although to some extent, there is some truth to this image, trading in the stock market is actually a more complex concept that helps many people earn money and keep businesses alive.

The concept of trading fundamentally consists of the buying and selling of stocks among individuals or companies through brokers. Through buying a share of stock or a share of ownership in a particular company, an individual can then benefit and earn money from however the company they invested on may fair in the market.

There are two basic methods in which the stock market operates –on the exchange floor where buying and selling is done more traditionally and electronically where technology takes on the exchange game.

Trading On The Exchange Floor

The trading that occurs on the more traditional exchange floor of the New York Stock Exchange (NYSE) is basically what most of us have become accustomed to from seeing it in the movies and on television. Basically, the NYSE consists of many brokers who negotiate the deals for individuals to be able to trade stocks.

As chaotic as the stock exchange floor may seem, there is actually a common pattern that occurs among most simple trades. First, an order to buy a certain number of stocks would be negotiated through a broker. After this, the broker’s order department would forward this arrangement to their floor clerk on the exchange. The floor clerk would then inform the company’s floor traders in order to find other traders that are willing to sell the equal number of stocks from the company that is offered to be bought. After the two parties agree on a price and close the deal, the message would be forwarded back up the line, and the broker would then inform the interested buyer on the final price.

Negotiations may take a few minutes or even longer, depending on the performance of the stocks as well as the market. For more complex trades and larger orders of stocks however, there may be a more complicated process but the principles basically remain the same.

Trading Electronically

A growing trend these days however, is trading stocks electronically, which is done through advanced computerized systems. Unlike the NYSE that generally operates through the manpower of brokers, its counterpart, the National Association of Securities Dealers Automated Quotations (NASDAQ), trades stocks completely through electronic means.

These electronic markets forgo with human stockbrokers and instead make use of advanced computer networks to match buyers and sellers. And through this method, transactions are usually faster and more efficient.

Through electronic trading, investors get many benefits such as being able to get faster confirmations, as well as facilitating control by having online investing readily available through the Internet. However, brokers basically still handle the trades, as investors do not have direct access to the electronic markets.

The process that takes place in both methods however, is usually hidden from investors. Typically, if you are an investor, a call from your broker and regular reports on your stock investments would be provided for you, but you will not really get to see what is happening behind the scenes.

Through the investments that individuals make, many businesses are kept afloat and running. And in exchange for this, investors get a fair share of earnings. Stock trading may be a complex process, but at the end of the day, many people basically benefit from all of it. As a result, the whole concept becomes simple.

There are two major types of investments done in the stock-trading arena these days –short-term investments and long-term investments. If you find yourself overwhelmed and confused in choosing which type would be best, simply take note of the differences between these two varieties and consider the advantages and disadvantages of each to be guided in making the right decisions.

Basically, the major difference between the two investments is the fact that short-term plans are actually designed to show a substantial yield in a short time period. While long-term investments, on the other hand, are designed to last for quite a few years and present a slow yet progressive increase in its yield.

Let us discover more about the differences when it comes to the disadvantages and advantages of each type of investment.

Short-Term Investing and Traading

The major advantages of investing for a short-term plan are the potentials for growth at a very fast period of time, ranging from a few weeks to a few months. Although there may be fluctuating trends that could affect the market, short-term loans can still allow you more control over your money and you it is more likely that you can keep a more watchful eye on your investment.

However, this type of investment may be a bit riskier due to the fluctuations present in such a volatile stock market, as mentioned above. As compared to its long-term counterpart, this type of investment may much easily be affected by unpredictable circumstances because it is in a shorter period of time. And so, even if there is a very huge chance that you can make a lot of money in this type of investment, there are also great chances that you can lose a lot.

Long-Term Investments

For long-term investment plans on the other hand, there is a greater ability for this type of investment to gain small and distributed profits over a longer time frame. And because it has a slow-but-steady pace, it becomes more stable and involves fewer risks.

But of course, a disadvantage for the slow growth of your investments may indicate that you cannot expect to earn profit right away especially when you are badly in need of money. In addition, you may also have less control over your money because your investment would not mature right away.

Also take note that because investments may require a lot of fees to be paid as it progresses and due to occurring fluctuations in the market, most long-term investments may experience down time before they can actually climb up and become productive.

In choosing between these two major types of investments, the most important thing you have to consider in order to gauge which plan would become more beneficial to you is to contemplate on your reasons for investing.

If you invested in stocks with the ultimate goal to earn money fast then surely a short-term plan would suit you. But on the other hand, if you want to invest for future and insurance purposes like in cases wherein you want to have money when you grow old, then a long-term plan for investing is best.

Whatever your decision may be, always remember that there are advantages and disadvantage in all kinds of investments. And ultimately, to become successful in your endeavor, you must be willing to take on minimal risks and make smart decisions in order to manage your trades.

There are three important differences between investing and trading. Overlooking them can lead to confusion. A beginning trader, for example, may use the terms interchangeably and misapply their rules with mixed and unrepeatable results. Investing and trading become more effective when their differences are clearly recognized. An investor’s goal is to take long term ownership of an instrument with a high level of confidence that it will continually increase in value. A trader buys and sells to capitalize on short term relative changes in value with a somewhat lower level of confidence. Goals, time frame and levels of confidence can be used to outline two completely different sets of rules. This will not be an exhaustive discussion of those rules but is intended to highlight some important practical implications of their differences. Long term investing is discussed first followed by short term trading.

My mentor, Dr. Stephen Cooper, defines long term investing as buying and holding an instrument for 5 years or more. The reason for this seemingly narrow definition is that when one invests long term, the idea is to “buy and hold” or “buy and forget”. In order to do this, it is necessary to take the emotions of greed and fear out of the equation. Mutual funds are favored because of they are professionally managed and they naturally diversify your investment over dozens or even hundreds of stocks. This does not mean just any mutual fund and it does not mean that one has to stay with the same mutual fund for the entire time. But it does imply that one stays within the investment class.

First, the fund in question should have at least a 5 or 10 year track record of proven annual gains. You should feel confident that the investment is reasonably safe. You are not continually watching the markets to take advantage of or to avoid short term ups and downs. You have a plan.

Second, performance of the instrument in question should be measured in terms of a well defined benchmark. One such benchmark is the S&P 500 Index that is an average of the performance of 500 of the largest and best performing stocks in the US markets. Looking back as far as the 1930′s, over any 5 year period the S&P 500 Index has gained in price about 96% of the time. This is quite remarkable. If one widens the window to 10 years, he finds that over any 10 year period the Index has gained in price 100% of the time. The S&P500 Index has gained an average of 10.9% a year for the past 10 years. So the S&P500 Index is the benchmark.

If one just invests in the S&P500 index, he can expect to earn, on average, about 10.9% a year. There are many ways to enter this kind of investment. One way is to buy the trading symbol SPY, which is an Exchange Traded Fund that tracks the S&P500 and trades just like a stock. Or, one can buy a mutual fund that tracks the S&P500, such as the Vanguard S&P 500 Index Fund with a trading symbol VFINX. There are others, as well. Yahoo.com has a mutual fund screener that lists scores of mutual funds having annualized returns in excess of 20% over the past 5 years. However, one should try to find a screener that gives performance for the past 10 years or more, if possible. To put this into perspective, 90% of the 10,000 or so mutual funds that exist do not perform as well as the S&P500 each year.

The fact that 10.9% is average market performance for the past 10 years is all the more remarkable when one considers that the average bank deposit yield is less than 2%, 10 year Treasury yields are about 4.2% and 30 year Treasury yields are only 4.8%. Corporate bond yields approximate those of the S&P500. There is a reason for this disparity, though. Treasuries are considered the safest of all paper investments, being backed by the United States Government. FDIC regulated savings accounts are probably the next safest while stocks and corporate bonds are considered a bit more risky. Savings accounts are possibly the most liquid, followed by stocks and bonds.

To help you calibrate the safety and liquidity question, the long bond holders are comparing bond yields they now receive with next year’s anticipated stock yields. Consider that next year’s anticipated S&P500 yield is around 4.7% based on the reciprocal of its average price to earnings ratio (P/E) of 21.2. Yet the 10 year annualized return of the index has been 10.9%. Bond holders are prepared to accept half the historical yield of stocks for added safety and stability. In any given year, stocks may go either up or down. Bond yields are not expected to fluctuate widely from one year to the next, although they have been know to do so. It is as if bond holders want to be free to invest short term, as well as, long term. Many bond holders are thereby traders and not investors and accept a lower yield for this flexibility. But if one has decided once and for all that an investment is for the long term, high yield stock mutual funds or the S&P500 Index, itself, seem the best way to go. Using the simple compound interest formula, $10,000 invested in the S&P500 index at 10.9% a year becomes $132,827.70 after 25 years. At 21%, the amount after 25 years is more than $1 million. If in addition to averaging 21%, one adds just $100 a month, the total amount after 25 years exceeds $1.8 million. Dr. C. rightly believes that 90% of one’s capital should be allocated over a several such investments.

Now that you’ve allocated 90% of your funds to long term investing, that leaves you about 10% for trading. Short to intermediate term trading is an area that most of us are more familiar with, probably due to its popularity. Yet it is significantly more complex and only about 12% of traders are successful. The time frame for trading is less than 5 years and is more typically from a couple of minutes to a couple of years. The typical probability of being right on the direction of a trade approaches an average high of about 70% when an appropriate trading system is used to less than about 30% without a trading system.

Even at the low end of the spectrum, you can avoid getting wiped out by managing the size of your trades to less than about 4% of your trading portfolio and limiting each loss to no more than 25% of any given trade while letting your winners run until they decrease by no more than 25% from their peak. These percentages can be increased after there is evidence that the probability of choosing the correct direction of a trade has improved.

Intermediate term trading is based more on fundamental analysis which attempts to assign a value to a company’s stock based on its history of earnings, assets, cash flow, sales and any number of objective measures in relation to its current stock price. It may also include projections of future earnings based on news of business agreements and changing market conditions. Some refer to this as value investing. In any case, the objective is to buy a company’s stock at bargain prices and wait for the market to realize its value and bid up the price before selling. When the stock is fairly priced, the instrument is sold unless one sees continuing growth in the value of the stock, in which case he moves it over into the investment category.

Since trading depends on the changing perceived value of a stock, your trading time frame should be chosen based on how well you are able detach yourself from the emotions of greed and fear. The better one can remove emotions from trading, the shorter the time frame he can successfully trade. On the other hand, when you feel surges of emotion before, during or immediately after a trade, it’s time to step back and consider choosing your trades more carefully and trading less frequently. One’s ability to remove emotions from trading takes a great deal of practice.

This is not just a moral statement. An entire universe of what’s called technical analysis is based on the aggregate emotional behavior of traders and forms the basis of short term trading. Technical analysis is a study of price and volume patterns of a stock over time. Pure technicians, as they are called, claim that all pertinent news and valuations are imbedded into a stock’s technical behavior. A long list of technical indicators has evolved to describe the emotional behavior of the stock market. Most technical indicators are based on moving averages over a predefined time period. Indicator time periods should be adjusted to fit the trading time frame. The subject is far too large to do it justice in less than several volumes of print. The lower level of confidence involved in trading is the reason for the large number of indicators used.

While long term investors may use only a single long term moving average with confidence to track steadily increasing value, traders use multiple indicators to deal with shorter time frames of oscillating value and higher risk. To improve your results and make them more repeatable, consider your expectations of changing value, your time frame and your level of confidence in predicting the outcome. Then you will know which set of rules to apply.

James Andrews publishes the Wiser Trader Stocks and Options Newsletter. Information on selected stock market trading systems, including those of Dr Stephen Cooper, can be found at http://www.wisertrader.com/tradingsystems/stockandoptiontrading.html. © 2004 Permission is granted to reproduce this article, as long as, this paragraph is included intact.

Article reprinted with permission from netterweb.com

1. Never put up trading money you can’t afford to lose.

Never trade with your house payment, rent, car payment, etc. Never mortgage your property for trading capital. You are playing with fire if you violate the first rule of trading. The fact will always remain that you can or may lose a good portion or even all of your trading capital. This is why rule #1 is so important.

2. Keep your trading costs down.
There are many great brokers that offer low cost commissions, with great service and excellent trade executions. If you are a high volume trader or a frequent trader, you can save a good sum of many just by trading with a different broker. Sometimes the difference between being profitable and trading with a loss can be the cost of commissions. Explore your options, check out several brokers.

3. Be a student of the markets. Learn and use both Technical Analysis and Fundamental Analysis.
The top pros in every profession are constantly trying to improve their game. Trading is no different. It is one of the most competitive industries in the world with some of the brighest people involved in it. You should constantly be a “student” of the market(s) you are involved in. Constantly learning and improving your edge. Don’t rely only on Technical Analysis or just Fundamental Analysis. Although you may focus on one, understand how both pictures can influence the market.

4. Do your own homework.
Never trade solely on someone else’s suggestion or tips. Study methods are markets that you are unfamiliar with completely for YOURSELF before you put trust in it. Understand the idiosyncracies of the signals of each before you trade with it. Be responsible for your own decisions.

5. Pick your spots to enter the market. Do not enter the market blindly just because it’s moving.

Find your entry points based on careful evaluation and analysis. Don’t rush into a market just because it is moving up or down right now. Markets have a tendency to move back to retracement levels. Find an entry point based on careful analysis and stick with it. Then make small adjustments if you do not get the fill you want… but, NEVER chase a market just to get in…just find another entry point. Chasing markets usually end up being very costly.

6. Have your gameplan in advance. Don’t make it up along the way.
This goes along with rule #5. Have an overall trading game plan, and a plan for each particular trade, and stick with it. Realize trading plans involve time of entry, price of entry, contingency plans, price and time of profit and total time anticipated for the trade, along with stop loss plans. And those are just the basics. Without at least, these basics involved in each trade, you are trading haphazardly, and possibly blind.

7. Always use protective stops.
A successful Chicago floor trader once said…”Always keep your powder dry…You need your ammo for the next battle.” In other words, if you blow all of your capital or most of it on one trade, you won’t be around to trade another day. Trading opportunities come and go, but they will always appear again in the future. Always use protective stops so that you will have capital for that next trade.

8. Always use price profit targets to close part or all of your position.
A good rule of thumb is to take half of your position off the table if you are fortunate enough to be on a trade that doubles in value. This way you get your initial capital back, and still have money on the table for the trade to mature even more. A better rule of thumb is to take all of your money if you realize a double in a very quick amount of time, and then reconsider and re-evaluate the market and your options.

9. Never let a winning postion turn into a money losing trade.
If you use stops and move them along with profitable winning positions you can protect your profits. For example, if you are long only move your stops UP, if you are short, only move your stops DOWN. Move your stops only in the direction of the PROFIT. Not the other way around. Also…

10. Never let a “pre-stopped loss” turn into a bigger loss.

The brother of rule #9…Never let a small loss turn into a bigger loss. Never let a pre-determined stop loss turn into a larger losing trade. Get out when your stop is hit. Never widen your stops on a losing trade, just to stay in the trade. By changing your stop you are potentially opening the door for a much larger loss and you are deviating from your trading plan. Don’t do it. Never let a potentially small loss turn into a potentially big loss.

11. Never over-leverage yourself.
Never trade more stocks, options, or futures contract than you can afford to lose. Sure if you win it’s great, but if you lose it’s that much more dangerous.

12. Always take trading breaks. Get rest.
Trading is exciting and exhausting. Although not much physical energy is involved (unless you are a floor trader), the mental energy used is tremendous. Take breaks away from the markets just to refresh yourself, and get a different perspective on the markets and life. There is more to life than trading. Remember this.

13. Diversification is important…and safe.
The old saying goes, don’t put all of your eggs in one basket. Diversify your capital into different stocks, futures, or whatever you are trading. Keep in mind to diversify into different sectors too.

14. Don’t try to make it all in one trade, or one day, week, month, or year.
Let your methodology work for you. Making money in trading consistently is the key….and becoming a consistent trader takes time, patience and skill. There is no such thing as instant or overnight success in trading and investing. Look at trading or investing as a career or profession (even if you are only involved part time). Treat it seriously. Do not take it lightly… and remember rule #12.

15. Learn from your mistakes.
This is why rule #4 is so important. When you study your trades and understand WHY you are trading the market….When you lose money with an un-profitable trade, consider it an error in judgement, and learn from it, so that you avoid making the same mistake(s) in the future. Pros rarely make the same mistake more than once, amateurs keep on doing the same stupid things over and over. You can not afford to be an amateur in the trading business. Consider your losses an education at the “UT” – “University of Trading”, and then remember them.

Keeping these 15 rules in mind when trading should help you minimize losses and maximize your return on investment.