How to Trade Stocks - Profitable Trading Situations

Accumulation/Distribution

Look at it from the standpoint of smart money. If the smart money is buying, it is accumulating; if it is selling, it is distributing. Smart money buys for one reason only - to make money - so the stock usually rises as a result. It sells when it feels the stock has reached its expected price target, so the stock usually falls.

Buyout

If a publicly traded company acquires another publicly traded company, the stock of the buyer usually falls, whereas the stock of the company being acquired usually jumps as the buyer must offer a premium over the current price to induce the current stockholders to sell.

Falling Knife

Every once in a while something really bad happens and a stock drops like a rock. That's where many amateurs feel compelled to buy on the theory that the stock is now cheap, or that the market is wrong. As you can never predict where a stock will hit bottom, buying a falling stock is akin to trying to catch a falling knife.

Gaps

When some important news comes out after AH (see below), the stock may gap up or down the following morning. Nobody gets to trade at the prices inside the gap: the stock closes at, say, $20.00, opens at $23.00. Some traders believe that most gaps close eventually (the price drifts inside the gap) and trade against them, fading the gap.

Insider Buying/Selling

Insiders are officers, directors and major shareholders of a company. Many traders feel that when insiders are selling, so should you: nobody knows the company better than its management and major stakeholders. By the same token, if insiders are buying, so should you as the buying may indicate that insiders feel strongly about the company's prospects.

Options Expiration

Options expire on certain days. Since options have different terms, there are days throughout the year when 3 or 4 types of options expire simultaneously, called triple or quadruple witching expiration. Market volume and volatility typically increase on those days.

Most option buyers are small retail investors; most option sellers are large institutions. If an option expires worthless, the option seller gets to keep the premium he collects from the buyer. One way to keep the premium is to move the stock away from the strike price to make the option expire worthless. That is exactly what institutions do on option expiration days.

Short Interest

Some traders interpret a high short position in a stock as a bullish sign on the premise that, unlike the longs who can hold their shares indefinitely, shorts must cover (close out) their positions -buy back the stock - at some point.

Short Squeeze

When some unexpected good news about a company with a high short interest comes out, shorts rush to cover. Specialists, MMs, and institutions often withdraw their offers to sell at that point, creating an artificial shortage of shares available for purchase. The shorts' rush to buy causes the stock price to spike.

Trading Hours

The hours NYSE is open for trading (9.00 am - 4.00 pm) are called trading or regular hours. Stocks can also trade before the market opens (pre-market) and after it closes (AH - After Hours). Most active trader platforms provide access to pre-market or AH trading (limit orders only). When a company releases news AH that affect the stock price, you may try to profit by trading ahead of the crowd in AH or pre-market.

Many part-time investors make their decisions in the evening and enter market orders for the following day overnight. That creates an order backlog for the opening that specialists and MMs work in the morning. That's why the first hour of trading is often not indicative of a stock's true move as it is believed to be amateurs' trading. Many professional traders trade against amateurs: if amateurs are buying, the professionals are selling, and vice versa.

How a stock closes is more important than how it opens. Some traders take their positions for the following day based on the close. Knowing this, other traders paint the tape: effect trades for the sole purpose of influencing other traders' decision that distort the true picture.

Window Dressing

Month-, quarter-, and year-end institutional buying of winners and dumping of losers (burying the evidence). The goal is to make customer statements look good by having all the right stocks (even though they may not have made any money in them) and none of the losers. Window dressing exacerbates stocks' moves, creating profitable trading opportunities.