Understand Something New about the Stock Market from a Beginner
The best advice I can give a beginner in the Stock Market is to watch Mad Money with Jim Cramer on CNBC an hour or two after the market closes. Cramer sounds like a mad man sometimes but we should all be so insane. I can’t say he is always right but I can say he teaches the strategies for minimizing your losses and making the most of your gains. One of his strategies is to be diversified. Another is to go with “best of breed” (the companies that are the best of their kind). The best idea is not to panic on a downturn because if a company is solid a pullback in its stock value may very well be a buying opportunity. Then when you have made a good profit, sell some and wait for another pullback to buy again. Then again, it is always necessary to keep watch on the market itself; check its pulse and be careful of an aneurism like the real estate bubble that knocked the legs out from under the banking system and put us into a deep recession and sent the unemployment rate to over ten percent.
From the viewpoint of a stock trader, the huge dip in the market was also a huge opportunity to make money. When the market dips and you believe it has reached its bottom, you BUY, BUY, BUY! When that happened, I thought the market was at the bottom as the DOW hit 8500 and seemed to be turning around. I sunk ,000 into some top companies like Caterpillar and US Steel and some oil related companies. At first the market stabilized but then the DOW sunk on down another 2000 points. I didn’t like that but did not panic even though I lost 00. I stuck with the companies I believed in and the market came back and a year later the ,000 had turned into ,000. Later, hearing advice from Cramer, I got out of US Steel just in time to save a loss.
An online broker is, in my opinion, the way to go. I do my trading with Thinkorswim.com but I do NOT recommend that you take advantage of buying stock on a “margin” account which means you buy more stock than the amount of money you have in your account. The margin is a loan and if you are not careful it can land you in a bit of trouble if the stocks take a dip. To open an account with a broker you have to deposit a certain amount of money (usually 00 or more) depending on the broker you choose.
I have recently turned my attention to OPTIONS because the amount of money risked is less. There are many strategies for buying or selling options but I am sticking mainly to buying CALL-options at the level which is known as “At the Money”. There are three main levels: At the Money, In the Money, and Out of the Money. First I need to discuss “strike price”. For example, if a stock is currently selling at .75 you may see strike prices at 40, 42.50, 45, 47.50, 50, 52.50, 55 and others, perhaps lower and higher. You may see strike prices at increments of , or or in increments of .50 as shown here. The strike price is the price that you are betting the stock will be above at the closing date which is the third Friday of the month. Therefore, since this particular stock is selling at close to , we say 50-strike is At the Money. If you buy a 45-strike you are In the Money so the price you pay will be the difference in the stock price and plus a premium above the stock price.
As the strike price approaches the stock price the premium price varies. The premium depends on the volatility of this particular stock and the lowest premium is usually about two or three steps In the Money from the stock price. We see in our example that the strike price closest to the actual stock price is 50-strike so let us suppose that the premium at that point is .50. In this case the call option would be .25 per share (50.75 minus 50 plus 2.50 equals 3.25) and the 50-strike is, of course, At the Money. Now since the premium at 50 is .50 the premium at 45 might be .00 so the 45-strike for this stock would be .75 per share (50.75 minus 45 plus 2 equals 7.75). The 47.50-strikes would have a premium between .00 and .50. When you are placing an order you do not see the premium amount, you just see the price per share on each strike price.
The strike prices that are set above the stock price are Out of the Money so you only pay a premium amount because you are betting the stock price will reach .50 or or will at least approach your strike price. If it does approach your strike price then the premium will increase and you can sell back your option for a profit. In this case the 52.50-strike might cost .50 per share and the 55-strike might cost .50 per share.
Let us suppose we have three weeks to closing and the stock price suddenly increases from .75 to .75 in one day. Now 52.50-strike is At the Money. The profit made on the options might be approximated as follows (Note that the stock went up but the options varied):
Strike………Buy………Sell……..Profit……..% profit
45………….7.75……..9.60………85……….24%
50………….3.25……..5.10………85……….57%
52.50………1.50……..3.25………75……….117%
55………….0.50……..1.50,,,,,,,,.00……….200%
However, as we get nearer to closing, the premium can decrease a bit and if we suppose that the stock price only goes up .00 over the three week period, then we will be lucky if we break even. Suppose the stock still goes up .00 but it takes three weeks to slowly get there, then the “sell” price of each of the above could be approximately .75 to .50 less than the sell price shown due to the decrease in the premium as closing gets near. Options are tricky sometimes and although Out of the Money can theoretically give you big gains, if a stock doesn’t move very much, that level can give you some losses that add up over time. For that reason I usually stick with At the Money or one step above or below (Out or In) and I watch for a solid stock that has tendencies of going up and down in short periods of time and I try to catch them on a dip with closing three, four, or five weeks away. When we get two weeks from closing, I generally start looking at the next month so closing will be six weeks away. I have to be pretty certain of a gain to buy a call with only two weeks to play.
One recent example was an Out of the Money 85-strike call on CLF, a company called Cliffs Natural Resources. I paid .50 per share for two contracts (200 shares) without a stop-loss because I was confident the stock would go up within the five weeks. The risk was 0. In the first three days I lost about and the market was pretty much level. The next day the market remained level but CLF went up in value over .50 a share. It wiped out my loss and gave me a profit of 0 on the 0 risked. I cashed in on 100% profit in less than a week. This was the second time CLF had made me a 0 gain. Of course, since I am still learning about options, next week I might take a loss but now I am gambling with HOUSE MONEY. If. instead of options, I had purchased 100 shares (one contract) of CLF stock at a share, it would have cost 00, then when it went up to .50, I would have made 0 on that one contract. I prefer risking less for a larger percentage gain.
After I buy a call, if I see a 50% profit the first week, I cash it in. If I do not see that profit the first week I wait for 100% gain even if I have to wait until near the closing date. Sometimes I have a brief gain,then it turns around and hits the stop-loss value and I take a loss. The trick is to control the losses and make the most of the gains. I generally close my positions well before the deadline, sometimes in that last week even if my goal of 100% has not been reached. If I have a feeling in the last week that the market has been too high and is due for a dip, I’m too conservative (or too chicken) to wait for the deadline.
Most explanations of options revolve around the assumption that you are optioning to buy or sell a stock when in today’s market you are buying an option for the purpose of selling that option at a profit. You may have no intention of actually buying the stock. If you want to buy the stock, you simply sell your call option and go to that trade category and buy the stock. With regard to the options, you have until that special Friday to close out the deal or you lose your money. The date of closing is Saturday but the market is closed on Saturday so deals must be finished on Friday. It is suggested that you close out by about one hour before the market closes on that Friday. If you wait until later you take a chance of missing the deadline of 4pm (EST, or EDT) at close of the market. If your internet service happens to be down you can rush to the library and close your options. If for any reason (no matter how good the excuse) you miss the deadline, you lose the money. It is a good idea to go to the library and check out the WiFi in advance if at any time you plan to wait until the last minute to close a position. With Thinkorswim.com I have to open my account a different way in WiFi than when I am at home. Check that with your broker.
There are CALLS and PUTS, buying and selling of each and it can get complicated. Buying a put and selling a call is like betting that a stock price will go down. Buying a call and selling a put is like betting a stock price will go up. I would recommend that a beginner just keep it simple. When you buy a call or put make it a CUSTOM BUY with a stop tied to it so that if the stock goes in the wrong direction your loss will only be whatever you set. Your buy and stop orders should not be day orders because if your buy order is filled your stop order will be cancelled at the close of the day if it is a day order. Your buy order SHOULD BE A “LIMIT” order but your stop order should be a “market” order not a “limit” order. Since the market sometimes moves very quickly a stop order that has a limit can be missed in a period of a few seconds and might not be triggered because the market has passed the limit. A “market” stop order will be triggered even if it is a few cents off of what you had planned.
One more detail that I should mention is the fact that stock shares can be purchased in any amount but when you open up a buy or sell order the online broker generally has 100 as the number of shares to order. You can change that to any amount. They consider 100 to be what they call a contract amount but when we talk about stock securities, you can buy any number that you choose. The contract amount really comes into play when you order options. Options must be ordered in number of contracts, not number of shares of stock. When you order options check the number of contracts that you are ordering. My broker automatically puts 10 contracts in the online order form so that represents 1000 shares of stock. You can decrease that down to one or two contracts as you please. As a beginner you may want to stick with one contract at a time until you are confident with options. Remember too that if you buy more than one contract, the amount that you set in your triggered stop order will be multiplied by the number of contracts.
DISCLAIMER: I’m still learning about the market and there is much to learn. I submit this article here because some friends have asked about my progress in the market. So a year from now I may write more. However, you must remember that large amounts of money can be lost in stock securities and in options so proceed with caution and at your own risk. This article is presented for information purposes only and you should consult your own financial professional for advice and do your own research.
I am interested in motivating individuals to learn about the stock market and other subjects. I can suggest reliable information to those who want to learn something new.
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