Understanding the Stock Market - Just Enough to Keep it Simple

by Jeffrey Lin

Recommended skill level: 1/4 (Rookie)

Lets go back to the sports vs. stock market example. Think of the stock market as the football game or basketball game. How the game goes, like how the market goes, depends on what the players (and coaches) on both team does. In the stock market, the star players, the ones that matters, are the "Big Money" like mutual funds, the country of China (or Germany or Russia, etc), and financial firms. These folks with billions and trillions to throw around are the ones who turn the tides. The rest of us, including many millionaires, can only tag along. You just want to be on the winning team when they're on a hot streak, then change jerseys to whichever team gets the hot hand.

For example, when countries like China decide to buy something like gold or oil, the price of gold or oil will keep going up for months. So when you see a trend like that, just go with it! It's next to impossible to know who really is causing that big trend and how much they really want to buy. But does it matter? If you just went with it and made money as gold or oil went up for months, do you really care who or why? To be honest, as a investor and trader myself, and interviewing a lot of financial professionals, few people know inside information like that. The rest of us make our money by just going with it, and reading it in the news like everyone else. Sometimes you find out several big "Superstar" players moved the stock market in one direction, then the teams changed and different players moved the market in a different direction or continued to carry the ball in the same direction. Other times you never find out enough to know why something happened. If you waited to try to find out, you'll never make any money.

The basics of successful investing really is that simple. If you're just starting out, forget the millions of possible patterns and trends that can make you money. Just start with the only 3 things stocks can do: go up, go down, or stay around the same price. You can make money on stocks when it goes up (by buying) or when it goes down (by shorting, like shortsales on homes). Find something that's trending up or down, bet that way, and stick with it. When that trend seems over, find another trend and do the same. Staying on the right side of the trend has probably made the biggest difference in my successes, and lost me the most money when I tried to bet against the trend.

Biggest dangers people may encounter is trying to see a trend that isn't there, or thinking a trend is over and start betting the other way. The rest of investing is just improving on finding trends, different ways of finding better trends, and ways to manage each bet for the best risk/reward. That's the hard part that people spend their lives perfecting.  A good way is to track statistics to find a pattern, either with a stock scanning software like FINVIZ or Worden's TeleChart/FreeStockChart.  For example, this week (March 1, 2011), options legend Larry McMillan mentioned this statistic that shows a very strong pattern:

"94% of the 2010 S&P 500 gains were achieved on the first day of the month; 69% of the S&P 500 gains over the last 20 years were registered on the first trading day of the month."

We'll talk about that next time. In the mean time, you can take a look at our listings of investing resources and stock trading coaches.