Getting Prepared for The Trading Day !!

With the Great Challenge of Facing the Stock Market each Day and the hope of pulling money out of it on a regular basis, a trader can do few things more important than prepare adequately. It should be no secret that many of the brightest minds in the world are at work to make their living in the stock market, and such competition cannot be taken lightly! Furthermore, while traders should not be in the prediction business, we must certainly have a game plan.

As time progresses, a trader will inevitably learn from his mistakes. This experience is the foundation for laying out a game plan in preparation for the Trading Day. Merely being a student of the market and of one’s own results will teach a trader to react certain ways to market conditions or events. It is this foundation which should be built upon in order for the trader to elevate his game to the next level (and it IS a game).

In order to develop a trading plan, a trader must begin with his personal style in mind. Swing trading involves a plan that may evolve over the course of a few days to a few weeks, while day trading can be faster-paced and more spontaneous. Personality, patience, and profit objectives will play a large role in which style of trading one may wish to employ, but the trader should choose his method as he plans for success.

Once the trading style is known, the trader must take into account current market conditions. Are recent days or weeks characterized by lasting trends, or by narrow ranges and choppy action? Knowing the answer to this question will put you miles ahead of many other traders who walk in each morning without taking current conditions into consideration. The market will catch you off guard as it changes its rhythm or volatility, but recent history serves as a guide until things change. This means choppy, low-volume, range-bound markets should likely be approached with smaller positions and the expectation of taking profit more quickly and in one piece. A trending market with larger range days and greater volume allow the trader to take bigger positions in hopes of scaling out in pieces as the market moves in the trader’s profitable direction.

Whether After the Market Closes or early in the day prior to the market’s open, some time should be spent determining an IF/THEN strategy for the upcoming session. Some traders may subscribe to a swing trading newsletter or converse with other successful traders, while others prefer to do their own research. One excellent way to find the following day’s trading list is to screen for stocks which meet custom criteria for price, volume, volatility, etc. An affordable stock charting software program will quickly narrow a large list of stocks down to a specifically filtered handful of trading candidates. The DoublingStocks Inc. 'MARL' is one such program, and it will scan thousands of stocks in just seconds or sort them by more than 100 included criteria or unlimited custom criteria. By screening for a handful of potential trades, the decision-making process is simplified and a plan is easier to carry out.

Consider finding a list of trade candidates for both the long and short side of the market, setting specific entry and exit prices, and then simply execute that plan. IF the long candidates rise to your entry prices, THEN purchase them. IF the short candidates break the levels of support you see, THEN short-sell them. IF none of your trade candidates trigger their entry prices, THEN do nothing! This kind of game plan will allow you to effectively respond to market conditions without having to predict direction or hope to be bailed out of losing positions. Approaching the market with the IF/THEN mentality also will help the trader to execute a plan, rather than fight the emotional urges to find excitement or force trades. Sometimes things will work exactly as planned and other times the market will whipsaw you right out of positions. Meeting the market with a game plan and sticking with it will undoubtedly allow the trader to work with less stress and emotion, which are two of the worst negative forces that traders face.

Feeling Well Physically is a very important trait which must be present for a trader to profit. Staying healthy and rested allows the trader to work with a clear mind and focus on the task at hand. Additionally, personal relationships can play a large role in a trader’s effectiveness. When life is rocky away from the trading screens, the successful trader must be willing to cut back on trading size or even back away from the market entirely. A prideful ego will not only cause rough waters on the home front with relationships, but it will also damage the trading account! A clear conscience allows quality rest and a fresh start each morning for returning to the market sharp and ready. Make the most of your weekends to catch up on personal to-do’s and relaxation. When Monday arrives, if you aren’t at your best, don’t expect your trading to be!

Finally, as the morning breaks and the market’s opening nears, follow a routine to get into the proper state of mind for following your plan. This may include reading up on current events, reviewing your charts one final time, grabbing your morning caffeine, or listening to your favorite song. Whatever it is, find what works for you when it comes to getting into the best mindset to extract profits from the market. Remember, the competition is serious and fierce, sharp-minded, and most of all, prepared. You should be too!

The Power of Margins

If you want an edge in investing, you have to be able to think beyond the usual.

Traditionally, margins represent the efficiency by which companies capture portions of sales dollars. As an analyst, I find myself looking at small changes in margins and wondering what is going on. But that focus is too narrow. Margins can provide much more information.

The traditional lens
Experienced investors can skip this part. But for the less-experienced folks, a few definitions are in order:

• Gross margin equals gross profit divided by sales. It indicates how well management is using labor and materials to support the business.
  
  
• Operating margin equals operating income divided by sales. This is one way to show how well management is running the business.
  
  
• Net margin equals net income divided by sales. This is the bottom line or the amount of money left after all expenses are paid.

Margins look at how much a company gets from each sales dollar after accounting for certain expenses. But let's go deeper.

The fuel lens
One way to think about gross margins is fuel. Gross margins power the operating decisions that a company makes. Typically, higher gross margins give companies flexibility in their operating decisions. And that's a good thing to use when comparing competitors. Below are 3M's (NYSE: MMM) historical margins.

	2000	2001	2002	2003	2004	LTM 2005
Gross Margin %	47.4%	45.5%	48.7%	49.1%	50.2%	50.3%
Operating Margin %	18.3%	14.2%	18.7%	20.4%	22.9%	23.3%
Net Margin %	10.7%	8.9%	12.1%	13.2%	14.9%	15.0%

Philip Durell understands what these margins mean to 3M. When recommending 3M for The Motley Fool's Inside Value newsletter service, Philip broke down operating income growth and operating margins by business unit to show just how strong a company 3M is.

And more importantly, Philip understands that those gross margins fuel 3M's world-renowned innovation engine. Without them, 3M would not enjoy its competitive advantages, nor create as much value as it does.

The power lens
Taking a page from evolutionary biology, the powerful survive and control the environment, while the efficient are relegated to their niches. Sure, efficiency is important along the way, but power is required to survive and get stronger in the face of intense competition.

Stealing from legendary value investor Bill Miller, I think Amazon.com (Nasdaq: AMZN) offers a perfect example of this way of thinking. During Amazon's development, CEO Jeff Bezos kept gross margin percentages fairly flat and focused on growing gross margin dollars instead.

Fortunately, David Gardner noticed the same thing when recommending Overstock.com (Nasdaq: OSTK) to the Motley Fool Rule Breakers readers. Below is Overstock's margin analysis.

	2001	2002	2003	2004	LTM 2005
Gross Margin %	13.4%	20.0%	10.7%	13.3%	14.7%
Gross Margin (millions)	$5.4	$18.3	$25.5	$65.8	$94.4
Operating Margin %	(32.3%)	(1.3%)	(4.9%)	(1.0%)	(1.6%)
Net Margin %	(34.5%)	(5.0%)	(5.0%)	(1.0%)	(1.1%)

Like Amazon.com, gross margins percentages are relatively flat and not very large. In fact, CEO Patrick Byrne wants to keep gross margins near 15% in order to keep customers loyal because it's cheaper to keep customers than to acquire them (see "The psychology lens" below). And operating and net margins are essentially break-even. But notice how gross margin dollars are growing rapidly. That's pure power that's enabled Overstock.com to build its brand, build customer loyalty, and try new ideas, like auctions.

Again, power (dollars), not efficiency (percentages), makes Overstock.com a force to be reckoned with over time.

But there is risk in this model, however -- management risk. As an investor, you need to have confidence that management can execute the plan to sacrifice near-term profitability for long-term value creation.

The psychology lens
Although this may seem like a stretch, margins can actually create powerful incentives for people.

Costco (Nasdaq: COST) caps its gross margins at 14% for most items and 15% for private-label products for two reasons: to attract and keep customers shopping in its stores and to align the behaviors of all of its employees to serving customers and controlling costs.

Fortunately, Tom Gardner recognized this when he recommended Costco for Stock Advisor. As a Costco customer, Tom knows he's getting a great price. And Costco employees know that to create value, they have to serve customers as well and as cheaply as possible.

From the numbers below, gross margins are low, which brings in lots of new customers and keeps membership renewal rates over 85%. And excellent cost control generates more and more free cash flow over time.

	2000	2001	2002	2003	2004	LTM 2005
Gross Margin %	11.9%	12.1%	12.3%	12.5%	12.5%	12.6%
Cash from Operations (millions)	$1,070.4	$1,032.6	$1,018.2	$1,507.2	$2,098.8	$1,738.0
Capital Expenditure (millions)	$1,228.4	$1,447.5	$1,038.6	$810.7	$705.6	$888.5
Free Cash Flow* (millions)	($158.0)	($414.9)	($20.4)	$696.5	$1,393.2	$849.5

*Free cash flow equals cash from operations minus capital spending

As I see it, Costco's gross margin strategy is the glue that binds the employees to the customers and creates lots of value.

The Foolish bottom line
Margins are important. But how you use margin information is more important to your investing success. So don't stay on the surface when analyzing margins. Your portfolio will thank you for it later.