First Steps: Step Five - Short-term Trading for Profit

There are many different investment methods available to the individual investor. The next three parts of this series will look at a specific approach to investing on the New Zealand and Australian Stock Markets.

The first investment method to be discussed is short-term trading for profit.

The most important characteristic of short-term trading is that you are buying a share with the exclusive intention to profit almost immediately. Although this may often be a reason for any person to invest in shares, it is especially important to the short-term trader.

Successful short-term trading requires exceptional discipline. When you decide to trade, you are deciding to submit yourself to a serious emotional challenge. You must be capable of controlling your emotions and you must develop a sound and comprehensive trading plan.

There are many investors in New Zealand and Australia who have recently become involved in the sharemarket with the intention to be short-term traders. Many have failed to completely understand the complex plan that must be in place to successfully trade the local markets profitably.

Short-term trading can take several forms.

For example, buying a share because you read about it in the paper and then selling it a week later for a higher price can be considered a short-term trade. However the same purchase becomes a long-term investment if the price does not increase in value and the share is not sold. Unsurprisingly, many investors who buy a share with the intention of making a short-term trade end up being long-term investors.

Another increasingly popular tool used by short-term traders is "technical analysis". Technical traders use the historical and current price of a share to make buy and sell decisions.

Technical analysis is a widely respected and used method of stock analysis in the United States. A large number of US investors will consider the technical viewpoint before buying a stock, regardless of the desired investment timeframe. This is strongly reflected in the content of many international investment web sites that offer extensive charting facilities.

Traders who use technical analysis will typically use some form of charting software to display the performance of each share. Traders typically choose to analyse the market once a day, after the market is closed. This "end of day" approach allows the trader to track how their shares and the market overall has performed, and to make trading decisions for the following day.

A more intensive approach to trading is to use live market information to place buying and selling decisions during the time that the markets are open. This is commonly known as "day trading" and often conjures images of stressed traders furiously talking to brokers on multiple telephones. Day-trading the local markets is difficult due to the low levels of volatility and liquidity present in many New Zealand and Australian shares.

Technical analysis provides a trader with a number of different ways to choose which share to trade. Most charting software enables the user to filter the entire market to identify particular price characteristics. You might decide to search for shares that are performing strongly, or filter only those shares that are currently reaching new lows for any time period. The trend and volatility of the share can be measured and buy decisions can be made.

An intricate part of a short-term trading plan is "capital management". Short-term traders must always be aware of their current market position, and understand how this relates to their current level of risk. Basic capital management strategies include separating your capital into several portions. This is a valuable addition for any investment plan, but is essential for a trader because successful traders understand that not all trades will be profitable.

Non-profitable trades are part of a successful short-term investor's plan. It is important to remember that you simply cannot get it right every time. If you accept and expect that some of the shares that you purchase will not perform than you are in a better position to control your losses. Having a clear plan for selling non-performing shares quickly will result in you cutting your losses before they become crippling "long-term investments"

On the other hand, allowing profits to accumulate is almost as important as controlling your losses. Many traders have missed out on significant profit opportunities because they were too eager to sell after making ten or twenty percent in a few days or weeks. Allowing a share to fluctuate in price as it moves upwards will often make the difference between a ten-percent trade and a thirty-percent trade.

As mentioned in a previous article, there are three clear and distinct parts to investing and they apply equally for short-term trading. You must first decide what to buy, you must closely track that trade with a strategy capable of giving you a signal to sell at an appropriate time, and you must sell according to your plan. If you are interested in becoming a short-term trader, make sure you have an effective plan and that you are aware of the risk inherent to all stock market investing.

The next installment in this series will outline longer-term investing, and discuss the investment plan of a long-term, fundamental investor.

This article was written by Nick McCaw from Intelligent Investing.