Traders in shares, indices, forex or commodities should always have a backdrop of basic rules, which revolve around going with the trend, limiting losses and good money management. In other papers, we have covered these items extensively, together with how to avoid mistakes and other important factors to watch when trading CFDs. There are, however, some commonsense rules that do not have to be applied to rigorously, but add another level of comfort within what can be a very stressful process.
A simple first rule – watch the cost
Market makers and other brokers are not stupid, and the setting of prices and spreads (or slippage) depends on several factors including time of the day, volatility and before and after news items. If you have a system that is not tailored to quick, intra-day moves, and your chosen timeframe is to look for results within anything up to a month, then minute by minute timing is less important than getting the overall picture correct.
On that basis you need to reduce your slippage costs as much as possible, so the time to place trades should be when the spreads are narrowest. After a while you should be used to the normal minimum spreads on most shares, and unless there is a pressing need to immediately deal (maybe on a profits warning or takeover news), then it pays to always ensure the spread is at the minimum before dealing.
This means not trading in the first few minutes of the trading day as buyers and sellers position themselves for the session. Sometimes the whole market may not only be marked down, for instance on a heavy fall in Far Eastern stocks overnight, but spreads might be wider because of the frenetic nature of early dealing. After a while though the spreads should usually return to normal, and you can deal more comfortably.
Example: You have a system that uses 3% targets and 2% stops, and say you normally buy and sell Royal Bank of Scotland shares with a minimum 1p spread, which represents a 0.05% or 5 basis point spread. From time to time the spread widens and can be as much as 5p after an outside event or early in the morning. This means that if applied to both sides of the trade, dealing on this wider spread would cost an additional 0.4% or 40 more basis points and effectively negates almost half of the edge of your system, which is fairly serious.
Moving on from this, it pays to stick to the biggest and most liquid stocks for the majority of your trading and this is a quick list of the leaders in the UK and which have the narrowest spreads:
Banks: Barclays, HBOS, HSBC, Lloyds, Royal Bank of Scotland, Standard Chartered
Beverages: Diageo, SAB Miller
Food producers: Unilever
Food retailing: Tesco
Household Goods: Reckitt Benckiser
Insurance: Aviva, Prudential
Mining: Anglo American, BHP Billiton, Rio Tinto, Xstrata
Oils: BP, Royal Dutch Shell, BG Group
Pharmaceuticals: Astra Zeneca, Glaxo Smithkline
Telecoms: BT, Vodafone
Tobacco: BAT Industries
Utilities: National Grid
Rule 2: Get to know a few stocks very closely and increase your knowledge
Many market professionals focus on one area of the market, and some simply trade a handful or even just one issue, be it a particular commodity, Treasury bond or stockmarket index. You will probably find that you become accustomed to the ebbs and flows of certain shares, and if you feel you are on the boil with these companies, then you have an edge.
If you decide to focus on say ten UK shares, you should get to know their trading ranges, average daily volume, sentiment to their particular sector, previous support and resistance levels, the tone of previous management comments and when news is due.
Furthermore, it goes without saying that when trading commodity stocks including miners and oil companies, you need to be aware of movements in the price and direction of principal metals and crude oil. Because there are other factors in play when institutions buy or sell in the market, such as dividend payments, overall market action or takeover hopes, share price movements can sometimes lag a rise or fall in the underlying commodity, but this is very important to each company’s overall profitability. Likewise, overall retail sales figures are important to the retail sector, which is obvious, and the health of the housing market and interest rates affect financial stocks.
A couple of extra rules
The ‘trend is your friend’ is a valid theme throughout swing trading, but it pays to only go long when the price offers further upside potential, or there is another volume and/or candlestick signal, otherwise you risk buying at the top. The aim is to ride an established trend, so while it is OK to miss the first part of a move, you should not buy when a trend may be about to reverse.
Broker upgrades and newspaper tips are a waste of time, because they are usually already factored into the market by the time it is your turn to place a trade. Whilst some analysis can be excellent and thought provoking, the persons giving the advice may sometimes have a different agenda. Price and volume action is the key when trading, but of course for longer term decision making the fundamentals must be examined as well.
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