- 2000: Volume 9, No. 3 The Four-Step Process to Successful Online Investing

In the last part of the twentieth century, the Internet was transformed from a government communications tool designed for use by researchers, into a worldwide communications and information network for use by everyone. Today, more than 40 million households are connected to the Internet, and that rate is expected to continue growing until Internet access becomes as ubiquitous as televisions, telephones and VCR's throughout America.

Of the thousands of potential applications for the Internet, one of the most exciting is the ability for individuals to be able to invest online. Everything from mountains of free investment information on companies, brokers and strategies, to newsletters and experts offering their opinions about where the markets and individual stocks are going, can be easily located with just a few keystrokes.

The first step in becoming an online investor is to open a brokerage account. One of the best sites for comparison shopping for a broker is www.sonic.net/donaldj. Figure 1 provides an example of the type of listing and review you'll find on the various brokers-and it's all free.

Figure 1

This site lists and ranks discount brokers by features, cost, ability to do certain types of trading, and many other factors. The information comes from users of these brokers, who provide the feedback to Donald Johnson, the site's proprietor.

Next, you'll want to locate some sites to provide you with fundamental and technical information about the overall market and the companies you're interested in owning. Some of the easiest and most informative sites listing this kind of financial information include http://finance.yahoo.com, www.moneycentral.com, www.cnbc.com, and www.cnnfn.com for fundamental information, and www.stockcharts.com, www.completetrader.com, and www.investtech.com for technical analysis.

For fundamental analysis, one of the most well-known and easiest sites to use is http://finance.yahoo.com (see Figure 2).

Figure 2

Many sites also offer free intra-day and end-of-day analyses of the market's activity. An example of the end-of-day free Daily Dow Industrials Analysis from www.completetrader.com can be seen in Figure 3.

Figure 3

Now that your online account is set up and you have several resources for technical and fundamental information about the overall market and the individual stocks that interest you, the next step is to research the trade and begin "The 4-Step Process to Successful Online Investing:"

Step One—Monitor Chart Patterns

The first step in researching the trade is to monitor chart patterns for signs of a coming run. A proven methodology for finding stocks ready to make a run is to look at stocks that have recently hit a new 52-week high and have pulled back a bit. Typically, due to a wave of selling, the stock will take a breather as those sellers looking to exit turn their shares over to those buyers looking to own the stock as it (hopefully) powers upward to new, higher highs. The result, then, is a pullback that could last for a few days, several weeks, or longer. Be sure that the pullbacks don't penetrate the 50-day or 200-day moving average, the reason being that these are key support levels that are watched by many investors and institutional traders as entry or exit points. If a stock bounces off a key support moving average, there is often a rush of new money into the stock, and its run to new highs often continues. However, if the key support levels are broken, the incoming money will look for other opportunities, current holders of the stock will exit in droves, and the stock typically falls hard from here. The best way to research this charting pattern is to use a Website such as www.bigcharts.com and set the chart to show the 50- and 200-day moving averages as seenn in Figure 4.

Figure 4

This is the chart of storage giant EMC. The red line is the 50-day moving average, and the blue line is the 200-day moving average. Over the last six months, each time EMC has made a new 52-week high, it has pulled back to its 50-day moving average. The only time it broke through the average was during the major downturn in mid-April. Still, it was one of the first stocks out of the cellar when the market turned upward. An example of a stock that peaked a new high and failed to bounce off support on the subsequent pullback is Research in Motion (RIMM) as illustrated in Figure 5.

Figure 5

Step Two—Review the News

The next step in looking for great trades online is to review the news of the companies that you've identified as having strong chart patterns. What is the fundamental picture for the company? Do they have an earnings report coming up or a split? These are events that typically bring new buyers into the stock (although they may be buying on the rumor, then selling once the news is out, so be careful if you're time frame is short-term). To keep up with the fundamental picture of the company, use one of the sites I've listed above, read company reports, and watch the financial news programs such as CNBC, CNNFN, and Bloomberg, as well as the Nightly Business Report on public television. You'll want to get a good "feel" for the company, its direction over the coming quarters and years ahead, their product pipeline, and potential business relationships that can give the company a stronger competitive edge in the markets they serve.

Step Three—Pick a Strategy

Once you've identified the stock, verified its technical strength with charts and its fundamental strength with a check on the internals, it's time to pick a strategy to capitalize on the potential move.

If you are trading only stock, there's really just one strategy, buying the stock, but several variations that can make it more profitable for you. For instance, if you are looking to create regular cash flow and are adept at using the technical charts, you may want to look for stocks that channel between certain support and resistance levels. For example, suppose the stock channels between 30 and 40. Maybe it channels three times per year. You may wish to buy the stock when it gets into the low 30s (so as to be in the stock in the event it turns around above 30) and exit the position in the high 30s (in the event it turns south before reaching 40). If you made six points every time it moved through this up move and it repeated itself three times per year, you'd make 18 points on your investment of 32 or so. If you bought the stock at 32 and held it, at the top of the channel at the end of the year you'd have made about six to eight points on your 32.

When using options to trade online, there are more than 20 different types of plays that can be placed on the underlying stock. Some of these will make money if the stock goes up, some will profit if the stock goes down, and some will make their most profit if the stock stays within a narrow range. What's more, with options it's possible to create a trade where the maximum profit of the trade comes at a price that's actually lower than the current price of the stock, giving yourself some cushion while still achieving a nice return on your investment.

If you are an options trader, an indispensable site for information on options pricing, volatility, and other measures critical to your success is www.optionetics.com. (See Figure 6.)

Figure 6

The site provides intra-day market analyses as well as an end of day wrap, and new educational articles each day on investing and trading for those interested in stocks, options or both. There's also live market data and listings of the day's winners, losers, new highs and new lows.

Step Four—Track Your Open Positions

The last step in the four-step process of successful online investing is to track your open positions on a day-to-day basis, rather than minute-to-minute. Many Web sites and online brokerages will allow you to enter your stock or option portfolio and track your results. Some will even email you nightly with a summary of your positions. What I have found to be rare is a free portfolio tracker that will allow you to track both stock and option positions in the same portfolio. This is especially useful if you have multiple accounts in cyberland and wish to see a one-stop consolidation of everything. The www.optionetics.com site offers just such a portfolio tracker.

While the four-step process for successful online investing has been used profitably by thousands of traders since the advent of online investing, please remember that it only works if you do all of your homework on the stock and the strategy you intend to use.

I recommend that you always paper trade a handful of stocks to continually hone your skills and build your confidence so that when the time comes to put your own money into the market, you'll do so intelligently and confidently.

Investing online can be one of the most rewarding endeavors, both psychologically and financially. However, it's a learning experience that will give you the test before teaching you the lesson, if you allow it to do so. Following the four-step process to successful online investing will help you put the lessons in front of the test.

Happy Trading!

Ed Hecht is an Options Analyst and Staff Writer for www.optionetics.com, an educational firm dedicated to empowering investors through knowledge. Questions or comments should be sent to edhecht@yahoo.com.