Posted by strudy on Oct 19th, 2009

There are Four basic stages that a stock will go through at some time other in their trading history. It would be very prudent to recognise what these four stages entail as it could quite possibly save you from getting your fingers severely burnt and having a negative impact on your wallet.

Stage One.

This is the stage right after a stock has been experiencing a prolonged down trend. The stock which had previously been heading downwards begins to level off and now has begun starting to trade sideways forming a base a resistance line. What is now happening is that the sellers who once had the whip hand are now beginning to diminish because  buyers are beginning to get more numerous. Usually what happens now is that the stock just drifts happily sideways without indicating any clear trend either up or down.

Stage Two.

In this stage the stock breaks out through the resistance line and begins to uptrend. This is where the bulk of the profits are made in the stock market. But not every trader will notice this stock has begun to start trending upwards.  Everyone still assumes that the fundamentals are still not good.

But professional traders due to their experience know better. They are busy accumulating shares and are now  becoming ready to sell their stock off to those traders who will be buying in late. The major reasons for this is one due to inexperience and two the novice trader have only just heard the news or have only just noticed that this particular stock is gaining momentum and they become very frightened that they will miss out. This sets up stage 3.

Stage Three.

Now the stock begins to trade sideways again.Usually about the last highest price paid for the stock and now it starts to “churn”. At this point novice traders are just now buying in! This stage is very similar in pattern to stage 1. Buyers and sellers move into balance again and the stock just drifts along sideways. It is now almost ready to begin the next stage.

Stage Four.

This is stage when the  downtrend  begins.This is because the tide has changed and sellers now outnumber the buyers which automatically forces prices downwards. Nobody believes that the downtrend is happening! The fundamentals are still very good and everyone is still in love with this stock. But the novice trader thinks that the downtrend is just a “correction”.They hold and hold  hoping the stock price will reverse back up again. These are the traders who probably bought at the end of Stage 2 or during Stage 3. The more experienced traders have taken their profits and gone.

Here are a few strategies that might save you from getting your fingers burnt in future if by chance you are caught up in this type of scenario.

1. Do not be greedy. Have your set profit target in place and stick to it. Once you have made your profit,exit. For waiting too long on the hope that you might make a little more profit can see your profits melt away like mist in the morning sun.

2. Employ stop losses to lock in your hard won profits and to minimise losses.

3. And lastly do not be afraid to take a loss if you have made a mistake in judgment. Better a small loss now than a big one later.

4. Or if you have decided that you will now keep the stock for ” Long term” till it comes back to its original higher level. But bear in mind you are tying up your capital for a duration of time, possibly three months or even more, when you could have bought into other stocks, recuperated your losses and made a profit, all in the period of time you were waiting for the stock to recover to its former glory.

Chris Strudwick is a successful share trader on the Australian Stock Market Visit his weblogs at both http://www.asxnewbie.com AND http://www.aussie-retiree.com/ for more free articles and useful information about the stock market.

2 Comments to “How to Stop Getting Your Fingers Burnt While Trading Shares.”

1. on 07 Feb 2010 at 6:05 pm1Dave McLachlan

   Nice article Chris - sounds like another part of Dow Theory with the four stages of a market cycle but I like the way you break it down.

2. on 06 Mar 2010 at 10:18 am2Ian@stock-options-made-easy.com

   Especially like Stage 4 point #3. It is important not to make decisions based on fear, and sometimes it really is better to cut losses at an earlier stage.