As some of you may know I dabble a bit in the stock market. Over the course of this dabbling I have become convinced that brokerage firms not only make money from the trade fees, but also by investing your money the way they see fit and by taking advantage of the efficiencies that you can not because of the rules that apply to you but not to them.
Take for example, regulation T. The way regulation T affects most investors is that unless you have a margin account with the broker to borrow funds to invest, then if you buy and sell the same security in the same day, you can not reinvest that money in a different stock for 2 more business days after settlement. Neither can you withdraw those funds from your brokerage account during that period. So basically the way this regulation is written gives brokerage firms the use of your money during those two days. They can earn returns on your investment during that time, but you can not. If you do happen to have a margin account, well the brokerage can force you to close out of your position for a loss, that's just not something I would want to risk. There are other reasons I don't want a margin account for that I'll go into detail about later.
Let's take another example... let's just take the stock quotes. Typically stock quotes are delayed by 20-30 minutes unless you pay additional for instant quotes, this puts the average investor at a disadvantage to the institutional investor (such as a brokerage firm), now this has been changing somewhat over the years. For example, I can get up to the second quotes as long as I have a position in that stock or a pending order for that stock or if I start to initiate an order for it. To take advantage of that, I often place multiple orders to buy stocks I want to get up to the second quotes on but order 1 share via a limit order at $0.001 - a price the stock shouldn't have any chance of hitting. The order never gets processed because the price never dips that low, and I can get access to up to the second quotes along with bid and ask quantities which matter even more to me (it will tell you whether the price is going to go up or down in the next few seconds by comparing those two numbers). But the bottom line is that they still try to put you at a disadvantage. Why? If they only made money off your trade fees, they wouldn't try to put you at a disadvantage like that.
Here's another example of the way the system is rigged to put individual investors at a disadvantage. Let's say you place a stock order after the market is closed, you want to buy the stock at or near it's opening price. But guess what? You can't do that because your order won't be processed until 30 minutes after the market opens. How much can the stock price move during those 30 mintues where only institutional investors are trading? I've seen some move by 200-300% during that period. Institutional investors can reap those profits, but you can not. So the bottom line is that they try to put you at a disadvantage. Why? If they only made money off your trade fees, they wouldn't try to put you at a disadvantage and discourage frequent trades like that.
All this brings me to the conclusion that brokerages are taking your money and investing it themselves when it's supposedly sitting on the sidelines waiting for settlement plus two business days. Otherwise the incentive for them would be for you to be as successful as possible and to trade often. Instead by the way they set up the rules (and yes, I do realize that many of these examples are SEC rules or the rules of the exchange, but they were all suggested by the brokers), it appears that the brokerages are incentivised more for you keeping your money on the sidelines... furthermore since they can take advantage of efficiencies that you can't, they're virtually assured of making a profit investing your money.
So we should all stay far, far away from any system that's rigged against us, right? WRONG! Sure it would be nice if the rules were different, if the playing field were level, but that doesn't mean there's no meat left on the bone for us individual investors. Indeed, there is still money to be made. I average between 1 and 3% realized gains per week, that might not sound like much, but it adds up and compounds over the course of the year to average between 60 and 200% for the year. When was the last time your 401K or mutual fund performed that well? Unless you have employer matching contributions, the answer is probably never, right? Neither have mine. Don't get me wrong, those investments have their place... but so does personal investment.
Here's the thing, I'm not an investment guru, I don't work on Wall St., and I don't have insider information. What I do have is a very basic strategy. It starts out with the premise that buying low and selling high is still the best way for individual investors to make money in the stock market. That sounds like a no-brainer, but there is another way called short-selling or shorting where you sell first then buy later and hopefully at a lower price, but a lot of investors run into trouble doing that when the stock skyrockets and the brokerage makes a margin call. You can lose many times more than you ever had to invest doing that. Not a smart move for the average investor.
It is followed by the premise that making less from a position than the cost of two trade fees isn't really making money at all, it's losing it. Hence my target from any position is to realize gains of at least $100 above the trade fees. On a position (stock) that I have $10,000 invested in, that means the stock needs to appreciate by 1.2%, on a position that I have $1,000 in it must appreciate by 12%, and for a position where I only have $100 invested, it has to appreciate by 120%.
I know what some of you are thinking... if you can find stocks that regularly appreciate or depreciate by 120% why don't you put a lot more than $100 in them. The answer is trade volume. Stocks that regularly swing by 100% are also stocks that in a whole day typically only see a couple thousand dollars worth of shares traded. If you sink $10,000 into a stock like that, first the price will skyrocket as you're buying it so only the first couple hundred bucks of that $10,000 will get stock at the low price, the next couple hundred will get the stock at your target sell price, and the rest will buy it above your target sell price... so you're virtually guaranteed to lose an arm and a leg right off the bat. But the flip side of that is that you won't be able to find enough buyers to buy at the high price when you do sell, and the price of the stock will plummet before you've sold more than a couple hundred bucks worth of the stock. Basically put, you're going to lose money doing that. You didn't even have a chance of making anything doing that. But that doesn't mean those stocks are bad positions entirely, it just means you have to dial back the amount you invest in them.
My rule of thumb is to look at a stock's daily average volume and multiply it by the price, if my investment in that position would be under 5% of that, then it's ok to continue considering that position. If it's more than 10%, it's too risky at best and flat out insane at worst. After that I look at how much the stock typically swings between high and low positions within a few days as well as wether it's seen an overall gain or loss over the past year. Do I dismiss the stocks with an overall losing streak over the past year? NO WAY! Those are some of my best performers. Instead I look at them as very short term positions, preferrably 1-2 days, 1-2 weeks at tops. As long as they get a little bump up in price, I can work with that. If they have a general trend of gains, then those I look at as potentially longer term investments.
Once I'm tracking several stocks and have my target buy and sell prices figured out to make that $100 - $500 target range I typically aim for, I set up trade triggers to buy that stock if it hits that buy price and then when it does I activate the trigger to sell it once it hits the other target price. Why do I set up trade triggers instead of simply placing limit orders? Simple, because if you place a limit order your money is tied up waiting for that trade to occur, with trade triggers your money can go into any of those orders and once you run out of money and another trade is triggered, the trade won't get processed as long as you don't have a margin account so you don't have to worry about coming up with the funds to cover those other buy triggers. In addition I've had placing limit orders bite me in the rear when the stock didn't stay at the limit buy price long enough to fill the total order that day and then I end up getting charged an additional trade fee to finish filling the order the following day or days later, so then I have to have it hit a higher target to keep that $100 mark which maybe means I don't get to realize those gains as quickly and overall it just costs me money, so I don't do that anymore, even though that was the rare event. Instead by placing market orders using trade triggers I still get to wait until the price hits my target but it's virtually guaranteed that the whole order will get processed.
So that's most of the basic rules I go by. A couple things any investor should keep in mind, never risk more than you can afford to lose, and don't think you can't lose everything you put into it. Another thing to remember, following any of my strategy is no guarantee you will see the kinds of returns that I have. You should also talk to an investment advisor before investing ( I am not an investment advisor and nothing in this article is meant to serve as advise, it is offered for entertainment and informational purposes only ).