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Stock trading optionsSTOCK TRADING OPTIONS

5 Simple Trading Strategy Examples

I am a big fan of having a trading plan. Most top traders and investors will tell you that you need a plan. But, to have a plan, you need a place to start. So here are 5 really simple trading strategies to help build a portfolio.

Each of these strategies is presented to introduce you to each concept in a simple form. These simple explanations are not sufficient information to allow you to take action without the support of a professional financial advisor or more education. Please use these as a starting point to building your financial intelligence.

1) Dogs of the Dow. The Dow Jones industrial Average created by Charles Dow in 1896 is composed of the average price of 30 stocks using a formula that helps track the many changes to company stocks, stock splits, mergers and other changes over the years. The Dogs of the Dow works on the theory that companies go through normal cycles in growth, and contraction, but, over the long term, will continue to advance. By purchasing the 5 or 10 worst performers the investor is expecting to catch the next cycle up for the lagging performers and realize a higher dividend yield and growth in share price.

2) Cyclical Stocks. There are many well-documented cycles for different market sectors. Resource stocks such as mining companies typically have a very long cycle of 15 to 20 years that is not dependant on the economy of the day. Retailers run a shorter cycle and live and die by the current economic climate. This strategy requires the investor to look at a potential investment in relation to its long-term cycle, and hopefully buy at the low-point to get the best value. Cycles are usually driven by supply and demand. In the mining industry when prices are high, money is poured into developing new mines. As these mines come on-line the supply increases which drive prices down. With low prices no one is willing to invest in new mines. Once the new output is used up, and mines are exhausted the prices start to rise and the cycle starts again. For the mining industry it takes many years to ramp up supply again so this cycle can take years to repeat.

3) Penny Stock shot-gun. Personally this one has not worked for me. The idea is that penny stocks will either fail and go to $0, or shoot up 5, 10, 15 times or more. So the idea is to increase your chances by buying a dozen different stocks and statistically speaking you should catch a ride on one. If two hit you do very well, if three hit you are really hot. My experience is that I can defy statistics and pick 10 losers. This is really a diversification strategy centered on the Small Cap market sector. I think my failing was that just because I was buying in bulk there is no shortcut to pre-buy research. With Penny Stocks your research has to be stupendous to be successful. I would link this strategy with a Penny Stock trading publication with a good track record.

4) Call Option. An option needs more explanation that I can provide in this brief article. In this example I will reference high cost stocks that are priced over $75 with IBM as an example. The current price is $164 dollars a share. A very pricy stock. If you believe the price is going to go up, you could buy an options contract for $500 that says in 6 months you can buy the stock for $170. If after 6 months the stock is selling at $180, and you have the option to buy it for $170, then your $500 investment is now worth the difference between your strike price of $170, and the current price of $180, or $1000 for 100 shares. So you have made a 100% return in 6 months. The real magic of this is that you have only risked $500. If you are wrong, and the price is below $170 you loose the $500. It is gone. However, lets look at this from a different angle. If you purchased 100 shares for $16400, you would have had all that money tied up for 6 months. If the stock takes a 5% drop, your position would now be down to $15,865 or $820. Some would call a call option a high risk investment because with an option you can loose your entire investment, in this case, $500. However, it is also a limited risk investment because if you buy the actual stock you have $16400 at risk and if the market takes a dive your losses can escalate quickly.

5) Covered Call. Let’s take the above position again, but from the other side. Let’s say you hold 100 shares of IBM at $16400, and you think the stock is going to stay about the same, and you like the 1.6% dividend yield. You decide to sell a call option to the guy in strategy 4. Now you collect the $500 for the risk that you may have to sell your shares at $170, when the future price may be $180. So, you collect $500 then sell the position you bough for $16400 at $17000 for a total profit of $900. No too bad. If the stock stays at or below $170 then you keep the $500 and do it again. You can potentially do this 4 times a year and make an extra $2000 for holding IBM. You may think that the worst thing that can happen is you are forced to sell at a profit, but there is the possibility that IBM drops by 20% for example, and you take a $3200 loss. But, you accepted that risk when you bought the stock anyway, so selling a covered call is an effective way of drawing additional income from a stock that you have already decided to be a long term hold.

My guess is that there are thousands of strategies to select stocks, each with its own risk profile, profit potential, or loss potential. It is your responsibility to research, learn and invest in your own knowledge and skills to become effective.

And one final note, if you leave stock-picking to someone else you won’t know if they did a bad job. So, do it yourself. Then you’ll know.

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Sunday, February 6th, 2011 Stock Trading