5 Ways to Win with a Small Account

12/09/2011 6:00 am EST

Focus: STRATEGIES

Michael Sincere

Author, Understanding Stocks

Even traders with small accounts can participate and make money in the markets. Michael Sincere gives three ideas on how to do it.

I recently gave a talk at Colgate University, a liberal arts college in Hamilton, NY, about understanding stocks and studying the market. It was homecoming weekend, and most students didn’t seem in the mood for any type of studying. Plus, college students typically don’t have spare change to plunk down on stocks.

But in learning to be a successful trader or investor, even a little bit of money can go a long way.

If you have less than $3,000 to invest or trade, it’s possible to participate in the financial markets. Learning about the market is a lifelong pursuit, so this initial investment is your “tuition.” Here are five strategies, ranked by risk level, to consider:

Think, Plan, and Study

What is the secret to the stock market? Above all, believe in yourself and what you can achieve.

Next, study the financial markets and talk to people to obtain investment ideas. Read up on the risks and rewards of stocks, bonds, and options. Join an investment club at your school or in your community to discuss ways to increase income. Finally, trade and invest online in practice trading accounts. Your goal is to not to just make money, but to find ways to make money work for you.

Risk: None

Buy Mutual Funds

Buying and selling mutual funds is the easiest way to invest without a lot of money. Mutual funds are diversified, relatively inexpensive, and make sense for long-term investors.

Buying mutual funds can help you learn about stock sectors, indexes, diversification, and dividends. If you do invest in mutual funds, choose no-load funds, which are less costly than load funds. Although many mutual funds are professionally managed, you can still lose money if the stocks in the fund do poorly.

Risk: Medium. If you’re a novice, learn stock market basics with mutual funds.

Buy Exchange Traded Funds (ETFs)

Many people prefer exchange traded funds, which are similar to mutual funds but trade like stocks.

Stick to non-leveraged ETFs. The most popular ETFs are index funds such as the stocks that make up the Nasdaq 100 (QQQ), the S&P 500 (SPY), and the Dow Jones Industrial Average (DIA).

As with stocks, prices of ETFs change continuously during the day. The advantage of ETFs is they are relatively inexpensive, liquid, and provide instant diversification.

Risk: Medium to high. Like stocks, trading ETFs can lead to sudden and dramatic losses.

NEXT: Trade or Invest in Just One Stock

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Trade or Invest in Just One Stock

For $1,000, you can open up a live trading account at a brokerage firm. When you use your own money, you experience the pain and joy (and greed and fear) of trading.

One strategy is to invest in or trade the stock of one company that you know. Learn all the nuances of the market through this one stock. If trading, learn when to enter, exit, and escape stock positions using support and resistance. If investing, study a company’s fundamentals, such as earnings.

Although it’s tempting to buy penny stocks (stocks under $3), it’s also easy to lose all your money on those trades.

A sophisticated strategy is to sell short (you profit when the stock goes down) vulnerable stocks that rise on momentum, not fundamentals. This strategy is not recommended for beginners because you must use margin (i.e. borrow money from the brokerage) to finance your trades. You can also lose more money than you started with. Nevertheless, it’s important to know that you can profit when a stock goes down in price.

Risk: High. Owning one stock is risky because you are not diversified. Therefore, you’ll need to initiate a stop limit order to avoid major losses. Trading penny stocks and selling short are not recommended for novices.

Consider Options

Once you’re knowledgeable about the stock market, consider investing in options. Although some people believe that options are too risky, many option strategies are less risky than buying or selling stocks. With options, you often know exactly how much you can make or lose before you make the trade.

One of the most understandable option strategies is to sell “covered calls” on a stock you own, and receive consistent income. You can also speculate by buying calls or puts, although most speculators lose money.

As you gain experience and knowledge, you can use option strategies to protect stock positions, or buy option spreads. Before trading options, it’s essential you learn about all the potential risks, especially if you are using more sophisticated strategies.

Risk: High. It’s possible to lose all of the money you initially invested when trading options. When buying options, you have to be right about the timing and direction of the underlying stock, and that’s difficult to achieve.

By Michael Sincere, author, Understanding Options, Understanding Stocks, and Start Day Trading Now

Visit the author’s Web site here.

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