Although special trading strategies are often heavily touted by individuals and companies, they often fail to live up to the hype. Here is a list of a few popular trading strategies and market dangers that traders should be watching out for.
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Black Box Trading
Whenever you hear about black box trading, buyer beware! Black box trading involves using computerized algorithms that automatically trade an individual's account when certain conditions are met. A good example of this is a program that will buy shares of a company when the S&P 500 goes above a key technical level, or automatically sell a stock when an index drops below a key support level.
Black box trading may have been a novel concept years ago but today it is standard practice. As an article in the New York Times has noted how as "algorithms and traditional quantitative techniques have multiplied, their successes have slowed." It has been discovered that many times these black box programs do a better job of convincing individuals to invest than generating profits.
For every Goldman Sachs with a multi billion dollar black box trading strategy, there is a Bernie Madoff that is simply running a shell game.
Remember the March lows of 2009? If you were one of the investors that were frantically rushing to his computer, dumping shares of every stock that you owned, you probably wish that you had just waited out the market drop. Panic selling is one of the best ways to make sure that you lose money investing.
Panic selling is driven solely by fear. You stare at the computer screen nervously watching your company's shares take a nosedive. You convince yourself that the stock is heading straight to zero and that you will lose all of your money if you do not sell. So, you sell all your shares only to see the stock rebound over the next few weeks. That's a horrible feeling! Remember that there is nothing worse than getting overly emotional about an investment. (When everyone rushes to dump their stocks, you may find yourself with a great buying opportunity. Learn about it, in Profiting From Panic Selling.)
All across the airwaves, you hear that you can make money by shorting a stock. Short selling is when you sell shares of a company that you do not own. Short selling is a great way to make some quick cash if you are sure that a stock's price is going to decline. The only problem is that no can you be absolutely certain that a company's shares are going to drop. Selling a stock short is a bet that the shares will decline in a specified period of time.
The problem with short selling is that if the shares increase in value, you have to buy the shares back at that price. There is no cap on your losses in short selling. Short sellers may be right in their assertion but can find themselves squeezed out of their position before the stock's price increases. Brokerage firms can issue a margin call leaving the short seller hanging out to dry.
Momentum traders chase the big market movers. They buy and sell shares of the most actively traded stocks hoping to benefit from their upwards or downward momentum. Momentum traders are only concerned with two metrics: price and volume. You can catch huge price upswings if you are able to time your trades correctly. The problem with this strategy is that there is no fundamental or technical analysis for investments, which means that decisions are based purely on price action. If you predict incorrectly, you could find yourself trying to catch a falling knife. (Buy high and sell higher. Find out if you could surf these risky waters, in Riding The Momentum Investing Wave.)
The Bottom Line
These strategies may work for certain daytraders and financial experts but the average investor will find that the potential losses outweigh the possible gains any day.
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