It's a good idea to practice stock trading before risking your hard earned money in the stock market. What's the most important thing to practice to increase your odds of being a successful trader? Learn how to spot a good catalyst.
Years ago, I use to teach the concept of a profit thesis. I've since replaced the term profit thesis with the word catalyst. A catalyst is what will cause a stock to move higher or lower. Think of the catalyst as the driver of the stock.
From a psychological point of view, a catalyst is the thing which causes less fear and more greed in market participants minds. A bearish catalyst would be just the opposite: the thing which causes more fear and less greed in traders minds.
The catalyst is the most important aspect of profitable stock trading. You could know absolutely nothing about chart patterns, volume, and the dozens of technical indicators every stock trading website talks about; however, if you are good at spotting catalysts quickly and positioning into the stock before the pop, you'll make your millions as a trader. Warren Buffett is a great example of an investor who knows little about how to read a stock chart, but man can he pick the catalyst right.
You can be the best technical analyst and chart reader in the world, but if you don't understand catalysts, you'll always lose your money to other traders that do.
Practice Stock Trading Google
In a previous lesson I talked about how to use Finviz “Top Gainers” to practice stock trading and determining the catalyst. Using Finviz is great for helping you define what a catalyst is so that you can get better at picking the good catalysts that can make a stock explode higher. The problem with using Finviz to find catalysts in the future is that the move is already over by the time the stock makes it on the “Top Gainers” list for that day. Here is a method you can use to spot catalysts before the big move takes place.
Go to Google Finance, scroll down to the “Trends” section and make sure the “Popular” tab is selected:
Look in the “Market Cap” column and pick the stocks with a market cap of under $2 billion. The reason we want small caps is because they are the stocks that have the potential to make explosive moves.
Think about what you are looking at here. Google is telling you what stocks most people are searching on. This is huge market intelligence that leverages Google's search engine to your advantage.
Start going through these companies and reading the press releases to determine what the catalyst is that is causing thousands of people to do searches on the company.
Practice Stock Trading Message Forums
Another great way to practice stock trading and finding catalysts before a stock pops is to use message forums to find out what people are talking about.
Message forums are not what they use to be. In fact, most message forums are a waste of time. They get you into time consuming vanity and flame wars and actually take away time you should be spending at doing your daily stock research. The other problem is that you have to join a dozen message forums and then monitor all of them every day. Who has time for that? Fortunately there is an awesome website that most people don't know about that lets you monitor all the top message forums in seconds. The website is called The Lion. The Lion indexes some 7,946,933,437 message, blog, Twitter and Facebook postings.
Go to The Lion, then scroll down to the section “Most Stock Searches”:
The section “Top Stock Discussions” looks good as well.
Start going through the press releases of each of these stocks and try and figure out why a lot of people are searching or talking about a particular stock. If it's because the stock chart looks hot, throw those stocks out. You are looking for a catalyst based on fundamental news. You are looking for “story stocks” where a story exists that can continue to pull in more and more traders on the long side. Chart patterns are not catalysts.
Using both Google Finance and The Lion to do your catalyst research can often position you into a trade before the big pop where it shows up as a “Top Gainer” for the day on Finviz.
Frequently Asked Questions about Practice Stock Trading
Where can I practice stock trading?
Take the stock trading lessons you learn on GuerillaStockTrading and practice stock trading for real on these websites; however, be aware that practicing trading on these websites and actually investing with your own real money are two different things.
When you invest your own real money, emotions come into play more so than practicing on the websites above. I have seen many new investors practice trading on these sites but when they actually started trading for real, they blew up their trading account because they were overcome by their emotions.
When you have real money at risk, you will find that you value things differently and your emotions will influence you much more. Fear may overcome you on an S&P 500 retracement causing you to sell too quickly. You might be down from a previously botched trade and so the emotion of greed kicks in and you hold the stock too long trying to make back your previous loss.
Practicing stock trading on one of the websites above is extremely valuable but just remember that it's a stepping stone towards trading for real and your performance on these virtual stock exchanges may not be indicative of your performance on a real exchange.
Investary posted the excellent two part video below talking about the Market Watch Virtual Stock Exchange Game.
Derek D'Angelo posted the excellent two part video series below on using the How the Market Works virtual stock exchange.
What does catalyst mean as it applies to the stock market?
A catalyst is the engine that drives a stock either higher or lower. A catalyst has nothing to do with a chart pattern. Catalysts are external news driven events that cause buyers (or sellers) to pile into a stock. The really good catalysts last for more than a day and cause extended trends to form.
I hear from dozens of traders every week and they all have a stock chart that they want me to look at. After they show me how awesome the chart is, I ask, “What is the catalyst?” I usually get a long winded response that talks about the chart setup or the volume, or the MACD, whatever. I seldom if ever get the right answer.
This means that most traders have no idea of what a catalyst is. Let me be frank. Screw charts and fundamental ratios. Tell me the catalyst! What is going to cause a lot of buyers to come into the stock and cause an uptrend that we can make money from? It's not the chart. That's in the past. It's not a technical indicator, that's also based on past market data. What's the future? What is going to make the short sellers cover their positions and race for the exit? If you can't answer that in one sentence or less, it's probably a stock you shouldn't buy.
Think about Warren Buffett or Peter Lynch. They didn't even use charts to build their fortunes, but they are masters at spotting the right catalysts.
Here are a few examples of common catalysts: mergers, acquisitions, avoiding a delisting after news of one pushed the stock price down, FDA approval, sympathy plays where an industry leader's stock pops and pulls up other stocks in the same industry with it, earnings surprise, new CEO, new Board of Directors appointment, new business, favorable government regulation, government contract, a new product release, positive forward guidance, analyst upgrade, favorable court ruling, a big investor coming into the stock like Warren Buffett or Carl Icahn, and so on.