Beginners Should Heed 4 Steps to Trading Success

While I'm thankfully not planning a schmaltzy self-help title of my own, I do believe there are some basic steps for beginners to take — in proper order — to become better-than-average investors. They might not all be sufficient to guarantee profitable results, but they are, in my opinion, absolutely necessary nonetheless.

It also means starting as a saver. I can't tell you how much easier it is to deal with the emotional demands of speculation when you know you've got at least nine months' worth of living expenses — generous living expenses — tucked in a liquid and high-yielding account. As I pointed out last week, trading demands that we all, at times, deal with loss. That is only possible to do, while still keeping a rational mind, when you've got a cushion of cash to mentally shoulder the blow.

Following prices for most people comes down to reading the day's headlines and seeing what the immediate market reaction is in those particular names. For example, many traders watched California Pizza Kitchen (CPKI) rise 7.4% on Friday after the restaurant chain posted a 15% rise in first-quarter revenue. And if you were long the stock, maybe you'd decide to sell it. If you thought their good fortune was set to continue, maybe you'd buy it or wait for a pullback and get in. That's not following prices, however, but following the news.

Those who had been following price action would've known, even before the headline, that CPKI as well as other restaurant operators like Darden Restaurants (DRI), McDonald's (MCD) and IHOP (IHP) have been objectively strong stocks for some time. It wouldn't have taken a few good earnings reports to have drawn your attention to the stock; the price action itself would've taken care of that long ago.

Aspiring investors should be irresistibly interested in prices, from stocks to soybeans. They should be familiar with the latest trends in interest rates, equities and commodities, even those that aren't receiving above-the-fold coverage in the morning business section. They should also have a sense of the current correlations between various markets. For example when stocks rally, what does gold tend to do? What about big-cap tech or home builders? Or when equities fall, which names are leading the way lower? Do bonds tend to rally or also break lower with stocks? This is integral to know, regardless if the day's news headlines don't fully explain the price action. What matters is how prices move, not why.

To that end, whether your portfolio has a few thousand dollars or many times that, I encourage aspiring investors to start with a reasonable allocation that's total risk capital. Of course, you shouldn't treat it as "play money," but as a legitimate investment on which you expect to achieve outsize returns. Quickly, every new investor realizes that it just ain't that easy.

There are innumerable ways you can lose money in the markets, and even the pros make mistakes every day. But because there are a few basic lessons one can only learn when trading real money, I think managing a small account, either stock or futures, is a good place to start before putting your entire nest egg to work.

After funding their account, most folks immediately begin trading up a storm. They waste precious resources floundering around with low-priced or penny stocks. Then they buy a highflier just as it begins to break and Martingale the position on the way down. Pretty soon, they've hung themselves and blown out. Sound familiar? It's happened to all of us. The idea is to initially make the mistakes with small dollars and use the experience to prevent blow-ups from happening in the future.

Experienced traders know that consistent profitability is difficult, and with every windfall usually comes a period of low or negative return. As Lou Mannheim, the wise old trader played by Hal Holbrook advised Charlie Sheen in the movie "Wall Street," "You're on a roll, kid. Enjoy it while it lasts, 'cause it never does."

So despite the media stereotype of freewheeling financiers regularly dropping $1,000 on bottles of Cristal, the reality is that most successful money minds are generally more frugal than flamboyant. They don't live outside of their means, leverage themselves to the hilt or invest money in things that don't hold their value. In almost all cases, they'd rather have the money than the things money can buy. To that end, investors tend to spend money only on those purchases they truly value. Most folks who work for a living, even speculators, tend to respect the value of a dollar enough not to throw it away.

So this Tuesday at the Money Show in Las Vegas, you won't see me dropping cash at the tables or sports book. Instead I'll be sipping drinks by the pool, getting a fancy massage and feasting on an outstanding dinner. For my money, those are much more valuable experiences than the fleeting rush created over the roll of the dice.

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.