When uncertain use cash and/or options

At times it is better to hold cash instead of taking a position; especially if there is going to be a major announcement with uncertain outcome. You may not make any money by holding cash, but you will also not lose any. You can then take advantage of whatever situation arises after the announcement.

If you still want to take a position before the announcement then take a small position, or use options to control the amount of risk you want to take. You can buy put options if you believe the announcement will be negative (long puts increase in value as the underlying price goes down); or you can buy call options if you think the announcement will be positive (long call options increase in value as the underlying price goes up). The benefit of using these option strategies is that you limit your risk to the premium paid for the options.

Announcements for which you should hold cash or use options include;

1. Major economic data release (Check Bloomberg Economic calendar for the events with red asterisks)
2. Geopolitical events
3. Company earnings release or other major corporate announcements
4. FDA announcements

"All that glisters is not gold"

We all become investors for the same reason: to grow our capital. For the sake of growth we are always looking to buy low and sell high. When you go bargain hunting, you should always ask yourself why a particular company is trading low while its competitors are trading high. You may think you have found Gold but it might turn out to be Pyrite: it may glitter but it might not have any value. These companies are known as “value traps.” These companies are traps because when you think you have found value, the price depreciation does not cease.

In every business, the goal of management is to provide value for shareholders. A company's stock price is one indication of how much value management is creating for shareholders. When a stock's price appreciates shareholders benefit from the increase price; so how should you view a company whose stock price does not increase, but continuous decreases? From my perspective, stock price depreciation means that the company is not a great investment. Although it is not an investment, it might make a good trade – assuming you know how to take advantage of the price movement.

(NOTE: please don't become a trader until you have had enough practice).

You might wonder how a company can create value for shareholders. One way is to provide products and services that consumers want. If consumers want it then it would create demand > Increased demand would lead to higher revenues > High revenues minus expenses  = profits. These profits are where shareholder value comes from. Once investors/traders/speculators see that a company's financial statement has value, the demand for the company's stock will go higher (this is indicated by high volume); which leads to appreciation in the stock price.

As a result, when you see that a company's stock price is trading cheaply you should not come to the conclusion that you have found a bargain. It is possible that there is something fundamentally wrong with the company, and that the company stock price might continue going down. The fundamental problem can be management, demand for the company's products and services, etc. 

As a beginner don't become a contrarian and "rush where angels fear to tread."

"A fool and his money are easily parted"

One reason why I recommended using the DOW as your initial watchlist was to protect you from some volatility. When it comes to the stock market, volatility is synonymous with high risk. While high risk does increase you chances of profits, it also increase your chances of losing your capital. Once you start taking on high risk you cease being an investor and become a speculator. You can become a speculator after gaining some experience.

Speculation provides both excitement and pains. The DOW components are not going to provide you much excitement. You are not going to get adrenaline rush by watching their price movements, but you will not get a heart attach either. As a beginner you just want something boring -- at this point too much excitement is not good for your heart. Do you remember the rumor on how Nelson Rockefeller died? Do you want your portfolio to also die from that much excitement?

You are becoming a speculator if you are doing any of the following

1. You are buying stocks priced at < $5 (most great investments cost more than $5/share)
2. Percent changes in your portfolio are higher than movements in market indexes (i.e. your portfolio contains high beta names and/or names with high implied volatility. High beta and high implied volatility = high risk)
3. You can have astronomical gains or loses depending on an announcement (example: you own Biotech company that is waiting for FDA approval)
4. You own companies without any products on the market
5. You spend more time watching what is going on with the Nasdaq
6. You bought shares in a company, but you don't know what the company does
7. Most of your positions trade on the OTC or have small market cap
8. You buy foreign names but don't pay attention to foreign news
9. You own a company whose PE ratio can buy a share of ABT. High PE might be an indication of overvalued company. If the company does not meet expectations, the price will sink like the Titan but at a faster rate.

It is possible to find a diamond in the rough, but you are more likely to go through a rough patch before you find that diamond. Don't get me wrong, speculative names have their place in your portfolio – mainly as trades (i.e. you don't hold them longer than 3 months). But you should only trade speculative names after you have become better educated.

As a beginner if you become speculative you are more likely to lose your capital. So don't be a fool, because a fool and his money are easily parted.

Making off like a bandit

It is very difficult to accurately forecast stock market direction; so when you get a chance to take some profit, please take it. You never know what tomorrow will bring. Furthermore, because of unexpected market volatility your profits can become loses in a heartbeat. Watching profits turn into loses only leads to regret.

As you learn more you will become aware that the stock market is a leading indicator – i.e. it forecasts how the economy will be in the near future. If the stock market is a leading indicator, what can you use to forecast where the stock market is heading – i.e. what is a leading indicator for a leading indicator (Double integration of stock market???? Second derivative of stock market??)? The current stock market price consists of what happened yesterday and what is going to happen in the near future. The only events that are not priced into the stock market are those events that are unforeseen. .

Since many of us cannot tell what tomorrow will bring, we are unable to forecast what the market will do tomorrow. The inability to predict tomorrow does not stop market analysts from formulating a forecast. You can use economic data (they are made available by federal agencies and other institutions) and technical analysis to forecast market direction. But you have to understand that if any unforeseen event happens your forecast will be invalid.

As a result, because it is so difficult to forecast the stock market you should take some profit when you are given the chance. You are the only one who can decide how much profit is enough profit.

Become a bandit when you get the opportunity to make off like a bandit. Carpe Diem!! SEIZE THE PROFITS!

The DOW as your intial watchlist

A large watchlist makes it difficult to learn more about the individual companies on the list. Knowing the companies you invest in is the first step to becoming a successful investor.

The DOW is composed of 30 blue chip companies. This makes it is easier to follow the individual companies -- i.e. following their news events, economic events, announcements, etc. Furthermore these companies are stable; so you will not have to worry too much about violent price movements.

Also, most of these companies pay dividends. This would allow you to gain some income while educating yourself to become a better investor. If you are luck you might even get some price appreciation along with the dividends.

The DOW components are also from different sectors. So if you prefer a company from a particular sector you will have a company that fits your need.