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Table of Contents

Overview................................................................................................................ 2

Opening a Brokerage Account ............................................................................... 3

Learning About Stocks ........................................................................................... 5

Trading Terminology .............................................................................................. 8

Trading for Profits ................................................................................................ 10

Summary.............................................................................................................. 13

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Overview

The stock market has made countless fortunes for people across the globe. It’s an investment vehicle that moves quickly and, for those who can understand it, wields considerable power. You don’t need a lot of money to get started. In fact, many of our traders started with only a few hundred dollars and then slowly built their accounts into significant numbers over time.

In the stock market game, he who has knowledge has power. The advent of the internet has changed the game and levelled the playing field for the individual investor. In the pre-internet era, if you wanted to trade stocks (god forbid, you even mentioned the word “options”), you would have had to set up a brokerage account at a large bricks-and-mortar type brokerage such as Merrill Lynch or Goldman Sachs. Then whenever you wanted to trade, you would look through the newspaper, which contained stale news, call your broker on the phone, ask him for a quote and then pay anywhere from $50 to over $250 just to execute a trade. It simply was not a viable way of doing business for the small investor.

The birth of retail electronic trading on the web in the late 1990s opened the door for the individual investor to compete with the big players. Companies like E-Trade, Ameritrade and Interactive Brokers began to offer cut-rate commissions that spawned the day-trading boom. That partially gave rise to the tech bubble of the late ‘90s and its subsequent crash. However, the important lesson that was learned was that small investors/traders no longer needed to have thousands of dollars in capital to get started with trading.

This guide provides you a step-by-step blueprint for how you can get started with trading and how you can profit from it. It will discuss how to open a brokerage account, what terminology you will need to know and will present examples of trades from start to close so that you can see exactly how easy it is to do this.

The content of this guide is predominantly geared towards the new trader but it does contain material that would be beneficial to the experienced trader as well. New traders will find this guide invaluable and will likely refer to it often, especially in their early trading days. The material here has been collected and refined over 15 years in order to give new traders a higher level of confidence in their new venture. We know you will enjoy it. Let’s get started.

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Opening a Brokerage Account

The first thing you will need before you can begin trading is a place to make your trades. Forget your traditional broker or bank. What you need is a supercharged online broker who specializes in two things – speed and economy. You will need speed so that you can simply log on to your account through your computer or smartphone app, place your trade and get on with your life. The economy part of the equation is important because as a trader, you will be opening and closing many more positions than your typical long-term investor. This economy means significant commission savings in the future.

Here are some brokerage firms and the reasons why you might consider them:

Interactive Brokers

generally the lowest commissions in the industry lightning-fast order execution allow you to trade many different products in many different markets paperwork to set up account can be cumbersome

TD Ameritrade

simple-to-use trading platform $9.99 internet trades $44.99 broker-assisted trades is highway robbery offers a narrower range of products and markets to trade

E-Trade

well known, easy-to-use interface good customer service no on-going maintenance fees commissions are near industry standard of $10/trade

Scottrade

low initial deposit requirement ($500) $7 trades online and in-person support and customer service

Remember, not all brokerages are created equal despite the fact that they all generally offer traders the same service. For example, if you are following along with our trades, you will have approximately 3 to 5 trades to put on every week. Any of the above-mentioned brokers will suffice. However, if you are executing more than 10 trades/week, you will want to consider

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someone like Interactive Brokers as their trading fees are pennies compared to the $7 - $10 that you would pay with some of the other brokers.

Another consideration is whether the brokerage offers options trading and its associated cost. Options are trading instruments whose values are determined by underlying stock. See Section 3, Learning About Stocks for details. Due to the fact that options are risky, most brokerages will ask you to complete additional forms to ensure that you understand the risk associated with options. While they are risky, options can also be used to protect your stock positions from unexpected geo-political events or market swings.

Any one of the brokerages listed above will be adequate for most new traders. What may help you decide which brokerage is right for you is how often you expect to trade (i.e commissions will start adding up), which markets you want to trade in and what products (stocks, options, futures) you want to trade. So, pick one and get ready to trade.

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Learning About Stocks

The stock market is a subject upon which many books have been written. Authors, since the beginning of the 20th century, have been trying to decipher the mechanics of the market and to predict its direction. In this section, we will discuss how the stock market works and how you can profit from it.

What is a stock? A stock or share of stock is a part of ownership in a company. For example, If you own one share of Microsoft (stock ticker: MSFT), you own one of hundreds of millions of shares in that company. Your share gives you not only ownership but also the right to vote on important decisions such as choosing the board of directors and management changes.

So, how does owning a share translate into profit for you? Without going into technical details about how shares are priced, the simple notion is that you can profit from two ways when you own shares. One is through dividends, which are payments to you from the profits of the company and the other is through the appreciation in the price of the shares. So, in general terms, if the company performs well, they will be able to pay dividends and their stock price will increase because their shares will be in demand.

An Example:

Say on June 1, you buy 100 shares of MSFT @ $30/share. You have now spent a total of $3000.00 (not including commissions which, as stated in the earlier chapter, are quite low). On June 30, MSFT pays a dividend of 30 cents per share. On July 15, MSFT reports better-than-expected earnings and the share price rises to $34.00.

Let’s see what has happened:

June 1 Buy 100 shares @ $30/share ($3,000.00)

June 30 Receive 30 cents per share dividend $30.00

July Sell 100 shares of MSFT @ $34/share $3,400.00

Total $430.00__

The net result is that you have a gain of $430 in approximately 45 days. This is phenomenal by any definition but let’s see exactly how much you have made on a percentage basis.

To calculate your net return, simply do the following:

$430/$3,000 = 14.33%

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To calculate your annualized return (what you would have earned in a year at your current rate of return), simply do the following:

365/45 x 0.1433 = 116.23%

Compare that to your annualized returns on bonds, mutual funds and other investments in your portfolio and you will see why stocks can provide so much better returns.

Short Selling

NOTE: This is an advanced concept and should be attempted only after having experience with the traditional buy-low, sell-high strategy noted above.

We’ve discussed the situation above where you expect the price of the stock to increase. In this case, everyone wins. That is, the company experiences profits, the share price increases and, therefore, all investors in the company gain. But, what if your research showed that a particular stock is expected to go down? What do you do in that case? Thankfully, you can employ a strategy called Short Selling, which, in its simplest form, is the idea of selling a stock that you do not own and then buying it back when the price is lower. Confusing? It should not be.

Imagine that your broker has only two clients, you and John and that John currently owns 500 shares of Facebook (FB). Your outlook on FB is negative and you expect the price to go down and you would like to sell 100 shares. Your broker will lend you 100 shares of FB from John, sell them for you and give you the proceeds. You will, of course, be charged interest for the shares that you have borrowed and will also have to cover your short position if the stock starts to go up.

An example:

September 1 Sell Short 100 shares of FB @ $40/share $4000.00 September 10 FB declares a 10 cents/share dividend ($10.00) October 9 Interest charged by brokerage @ 1% ($40.00) October 10 FB issues a negative earnings report and the stock drops to $35 and you close your position ($3500.00) Total $450.00__

The explanation: When you sell short the shares on September 1, your account is credited with $4,000. When a dividend is paid, you have to pay that to the owner of the shares and, therefore, your account is debited. Your account is also debited for the interest charge. When you finally buy back the shares, your account is finally debited for the price of shares and your position is closed.

To calculate your gain on a percentage basis, simply do the following:

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$450/$4050 = 11.1%; Annualized: 365/40 x .111 = 101.28%

As you can see, short sales can be powerful tools in a trader’s arsenal but should be monitored carefully as a price move in the wrong direction could require immediate correction or closing of the position.

These are basic concepts of buying and selling stock and are the building blocks of more advanced concepts such as options and stock futures.

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Trading Terminology

As you have already seen throughout the earlier chapters of this book, the trading world has its own terminology and you will need to learn that terminology in order to become a successful trader.

Here are some important terms that you should know:

Annualized Return: Translating the figures for a given period into an annual rate.

Back-Testing: The concept of testing a strategy on historical data and then employing that strategy to new data to see if the results are consistent.

Bear Market: A stock market with a prevalence of declining prices.

Bid and Ask: Highest price and lowest price that traders will pay for a particular security.

Bonds: A long-term or short-term debt security with a stated interest rate and fixed due dates, issued by a corporation or government.

Broker-dealer: A firm that handles transactions for its clients and also trades for its own account.

Bull Market: A securities market characterized by rising prices.

Buy and Hold: The concept of buying a security for the long term rather than a quick profit.

Capital Gains : Gains resulting from the sale of securities. Generally taxed at a more favorable rate than earned income.

Capital Losses: Losses resulting from selling a security at a loss.

Charting: The concept of studying charts, with pricing, volume and other indicators, to predict future stock price movements.

Cover: Concept used in short selling, which relates to the purchasing back of a security that was sold earlier.

Dividend: Stockholder receipt of a share of a company's profits.

Earnings Estimate: Estimated earnings projected for a company for a particular period.

Fill: A completed order whether it’s to buy or sell.

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Fundamental Analysis: method of securities analysis that focuses on sales, earnings and the value of a given company’s assets.

Limit Order: An order to buy or sell where a specific price and time to execute the order are specified.

Long: position where a trader has purchased a stock with the objective of selling it after it increases in price.

Margin: In stock trading, refers to an account where the purchase of stock may be financed with borrowed money

Market Order: order where the instructions are to execute it immediately at the best available price.

Market Value: Company value determined by investors, obtained by multiplying the current price of company stock by the common shares outstanding.

Option: A contract that provides the right but not the obligation to buy or sell a specified security within a specified time period.

Price/Earnings Ratio: Stock price divided by annual earnings per share.

Selling Short: Selling a security and then borrowing that security for delivery with the intent of replacing the security at a lower price.

Stop Loss: Risk minimization technique whereby a trade is liquidated to stop any further decline in value.

Technical Analysis: A type of market analysis that studies demand and supply for securities based on trading volume and price action.

Volume: Number of shares that are traded for a given market or tradable within a specified time period.

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Trading for Profits

Now that you have a good, fundamental understanding of how the stock market works, let’s see just how you can use that knowledge to make profits.

Technical Analysis

As noted earlier, technical analysis involves the use of charts, volume and price action to make trading decisions. Let’s take a look to see how we would have made some trading decision by reviewing a live chart:

As you can see, FB was languishing in the $25 - $27 price range from June 10 to July 24. Then, on July 24 had a big breakout to $34 because of better-than-expected earnings. The price action shows positive sentiment towards FB at that time. Since it’s difficult to predict earnings or other unknown events, we do not even try to do so in our analysis.

In this case, let’s see what would have happened if you had decided to go long on FB on July 25 and decided to sell when trading volume dropped significantly during the week of August 12-16:

July 25 Buy 100 shares of FB @ $34 $(3,400.00)

August 15 Sell 100 shares of FB @ $36.56 $3,656.00____

Total $256.00

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Your net return on percentage basis is:

256/3400 = 7.53%; Annualized: 365/21 x .0753 = 130.88 %

Remember, there was no consideration here of what FB’s earnings actually were or how strong their financial statements are. This was simply reading the price action and volume over a number of weeks and making decisions based on it. We’ve certainly oversimplified what goes into reading these charts and it is important to know that as a simple assessment of price and volume may not be enough in all cases. Our pro traders, with their many years of experience, regularly use more than 15 different indicators on these charts to make their trading decisions.

Fundamental Analyis

Fundamental Analysis is the study of financial statements in order to make trading decisions. Warren Buffett uses a form of trading that is similar to this, where he tries to assess companies and determine which of them have stock prices that are lower than the value that is suggested by the company’s financial statements.

This is a complex field and volumes can and have been written on it. The objective here is to introduce you to two major aspects of a company’s financial statements, namely the balance sheet and income statement.

The following are examples of a condensed balance sheet of Amazon.com (AMZN):

Period Ending Dec 31, 2012 Dec 31, 2011 Dec 31, 2010

Assets

Total Current Assets 21,296,000 17,490,000 13,747,000

Long Term Investments - - -

Property Plant and Equipment 7,060,000 4,417,000 2,414,000

Goodwill 2,552,000 1,955,000 1,349,000

Intangible Assets - - -

Accumulated Amortization - - -

Other Assets 1,524,000 1,388,000 1,265,000

Deferred Long Term Asset Charges 123,000 28,000 22,000

Total Assets 32,555,000 25,278,000 18,797,000

Liabilities

Total Current Liabilities 19,002,000 14,896,000 10,372,000

Long Term Debt 3,084,000 255,000 -

Other Liabilities 2,277,000 2,370,000 1,561,000

Deferred Long Term Liability Charges - - -

Minority Interest - - -

Negative Goodwill - - -

Total Liabilities 24,363,000 17,521,000 11,933,000

Stockholders' Equity

Total Stockholder Equity 8,192,000 7,757,000 6,864,000

Net Tangible Assets 5,640,000 5,802,000 5,515,000

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Here is the income statement for AMZN:

Period Ending Dec 31, 2012 Dec 31, 2011 Dec 31, 2010

Total Revenue 61,093,000 48,077,000 34,204,000

Cost of Revenue 45,971,000 37,288,000 26,561,000

Gross Profit 15,122,000 10,789,000 7,643,000

Operating Expenses

Research Development - - -

Selling General and Administrative 14,446,000 9,927,000 6,237,000

Non Recurring - - -

Others - - -

Total Operating Expenses - - -

Operating Income or Loss 676,000 862,000 1,406,000

Income from Continuing Operations

Total Other Income/Expenses Net (40,000) 137,000 130,000

Earnings Before Interest And Taxes 636,000 999,000 1,536,000

Interest Expense 92,000 65,000 39,000

Income Before Tax 544,000 934,000 1,497,000

Income Tax Expense 428,000 291,000 352,000

Minority Interest - - -

Net Income From Continuing Ops (39,000) 631,000 1,152,000

Net Income (39,000) 631,000 1,152,000

What can we assess from these statements? We see that the company’s current assets have been improving each year since 2010. That is a sign of a healthy company. However, on closer examination, we note that their current liabilities have also been increasing and by a greater percentage on a year-over-year basis.

When we look at the income statement, we note something that looks alarming on the surface. We see that the company had a loss during 2012, after having significant profits in the prior years. Once again, when we examine a bit closer by reading through their 10-k, which details the company’s operations, we note that the company is spending money on initiatives that will pay off in the long-run but which had to be paid for during the year.

The balance sheet presents the health of the company at a particular point in time, whereas the income statement shows the results of operations during the year. Reviewing these two statements and, more importantly, the meaning behind the numbers will help you assess the health of a company and its future prospects.

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Summary

The trading world is a vast ocean of possibilities. For people that are motivated to learn and have time for that learning, there are many opportunities for profit. For the beginner trader, the important thing is to get started. Open a brokerage account, learn the trading terminology, don’t be afraid to study financial statements and, most importantly, make the decision to become a successful trader.