The Basics of Trading

TC

I agree with your comments re: "THIS IS SUPPOSE TO BE A BEGGINERS FIRST STEPS".

I rate myself as not even a beginner, so am looking to threads like these to learn a few things. After not even half way through I am met with phrases like Risk/Reward, protective stop, cup and handle, BillG's nice but SCARY Sharescope chart, and many other terms.

As a beginner looking for an introduction to these concepts I was expecting something more basic. FTSE Beater please continue with your approach, its very helpful. The other folks wanting to contribute perhaps a small suggestion for others like me who are keeping quite and trying to read through this lot. Why not define any new concepts/terms before using them. This way more of us will benefit and follow your discussion. Perhaps other threads can be used for the more advanced trader if you feel you must discuss in a more technical vein.

Cheers
NastyItch

"therefore, you are 'covering your short'.

Covering just means closing"

Ok, so by the same logic would 'covering your long' mean closing a long position, or does the jargon only apply to shorts

The word 'covering' tends to apply to shorts only.

You 'close' a long, but 'cover' a short - in both these cases you are closing your position to make you flat. If you are flat it means you do not have a position (trade) open.

In the chat rooms people tend to say "cover at 837.5 for +1". So that tells you that they were short, and have closed their short at 837.5 for +1 point. And "close at 837.5 for +1", so you know they were long and are closing their trade at 837.5 for a gain of one point.

For the sake of completeness, perhaps I can add my own two penn'orth on short covering. As previously explained, a short position involves selling shares you don't own with a view to making a profit on a fall in price. Eventually you have to give them back to the original owner, which means buying them in the market at the price then prevailing. Obviously the hope is that you buy them back for less than the price at which you originally sold.

When you buy a share, the maximum at risk is the price you paid. If the share goes to zero, then you have lost your initial stake, but no more. With a short position, risks are unlimited. So you may sell at a 100 in the expectation that the price will fall to 80, giving you a profit of 20. If the price starts to rise, there is no limit as to how far it can go. Share prices can double quickly (particularly after a prolonged fall). A takeover bid may come in which raises the price. So you may sell for 100, which drops 100 into your account - some of which will be needed to buy back ("cover") later, but if the price rises to 1000, then you have a loss of 900 - hence the derivation of the expression "don't get caught short" - nothing to do with toilets!

After a prolonged fall, those holding shorts may feel that it is time to take their profit, so they "cover their shorts" by buying in the shares they have shorted so that they can be returned to their original owner. This buying can push up prices, and those who remain short see their profits decline, so they also decide to cover, increasing the buying volume, and accelerating the price rise. A rise in prices may be read by those not already in the market that a recovery is in place and these investors/traders may also start to buy, adding to the wave of buying from the covering shorts. This goes some way to explaing why initial recoveries can be so dramatic. One minute you have investors selling shares they hold, and there are also traders short selling, and no one buying. Then traders start to cover their shorts, genuine buyers also come in, and everyone who wants to sell has already sold. Short covering + genuine buyers + no sellers = a price spike up.

A sudden rally in prices due to short covering can be frantic, and is known as a "short squeeze". Market Makers may mark up prices if they know that there are a large number of short holders of the stock to shake them out. The big question when these rallies take place is whether it is just due to short covering - in which case once the shorts have closed their position the buying will dry up and the liklihood is that the share will revert to the original trend - or has the rally been caused by new buyers, in which case the buying may continue leading to a sustained rise in price.

Hi NastyItch.

Thank you very much for your post, it gives me an idea of who is reading and what issues need tackling.

I'm sorry for not explaining the terms better, and from now on I will make sure I do so. In the mean time, these are the terms you were asking about.

Risk/Reward - The risk is the amount your prepared to lose. The Reward is the reward you expect to get if the trade goes your way. If you then divide the Reward by the Risk you end up with a RR or Reward/Risk ratio - It's mainly used to get your mind to see if the trade your entering into carries to much risk for the reward, in which case the trade shouldn't be traded. After all you wouldn't buy a car that had mechanical problems as the risk of it breaking down is too high.

Protective stop - This is linked to a stop-loss. The stop-loss is there to say if the price goes against me this much then "I'll get out - It's already cost me too much" - The protective stop is normally set a long way from the price and is used as an Emergency stop loss to protect against big disasters. For one reason or another, it's really not worth having a protective stop - but a Stop-loss is vital!!!

cup and handle - This is a charting pattern. The best explanation I found is http://www.investopedia.com/terms/c/cupandhandle.asp
This is what the pattern looks like
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It really is an advanced pattern and something I might cover later on.

Hope this Helps

Thanks FB

It all helps, and starts to tie in with stuff I'm reading in Murphy.

Ta also to RogerM and Skimbleshanks for their explanations. I always wondered what longs and shorts meant (other than the one covers the other on my legs) I SEE SOME LIGHT, FAINT BUT APPROACHING!!!

NastyItch

Beware the light at the end of the tunnel.............. It could be someone bringing bad news...

Thanks again to every one that replied to my question Re "COVER".
At first I thought it was a stupid question and sat on it for some time.Hope it helped others to understand the meaning of COVER.

RogerM.

I thought your explanation was exelent.I never really understood how covering shorts produced a bear squeeze etc .

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