A Refresher Course in Active Trading

The third quarter featured the best gains in the Dow Jones industrial average since 1998, but the first few days of October haven't been as promising. U.S. News spoke with Randy Frederick of Charles Schwab, who offers a quick refresher course for investors on how to navigate this uncertain market. Is it time for a pullback, or does the market still present attractive opportunities? Frederick says it's too soon to tell but that there are certain investing basics that every active investor should keep in mind. Excerpts:

Don't try to time the market. "Scale in and out of positions slowly," he says. Too many investors try to time the market—either selling off everything before the market peaks or jumping back all-in before it bottoms out. Both result in missed opportunities to make money. If last week's returns are any indicator, the market may be heading toward a sell-off. For the time being, what should investors do?

Says Frederick: "You can do quite well as an investor if you get into the uptrend a little bit after it's already started and then get out of the market a little bit after it has already started to decline. Right now, even though we may have gone down by about 5 percent (last week), we still have a 15 percent move (in the third quarter), and you would still have a nice profit if you were to start scaling back a little bit right now as opposed to bailing out entirely, because if we go back up, then you're missing out."

Give exchange-traded funds a shot. For all but the best investors, it's virtually impossible to have consistent success picking and choosing individual companies, says Frederick. Instead, he backs using less volatile ETFs.

"All ETFs, with the exception of leveraged ETFs, have really an inability to ever go to zero," he says. "I don't think most people buy stocks with the thought that it's going to go to zero, but as we saw last fall, many big blue-chip stocks that many would have never imagined would have ever gone to or even gotten close to that did."

If you're fond of a particular sector or region, ETFs also can be a safer bet. Frederick says that more and more of his clients are using ETFs as their primary option for investing in foreign markets.

[See Bond ETFs: the Ins and Outs.]

Don't get attached, and always do your own research. We know you've heard it before, but if everyone listened, we wouldn't keep bringing it up. Frederick says inexperienced investors still get "married" to a stock that they become emotionally attached to. Even if the stock plummets for whatever reason, investors can't part with the investment. To which Frederick says, "That's just not a wise way to invest, but it's amazing how many people will get into that sort of mentality."

Frederick's last word of advice: "One of the things I tell people regularly is that you should never trade a product or a market that you don't understand." There are a lot of investment vehicles out there that can be profitable for certain investors, but Frederick warns that he has seen far too many investors get involved with risky or complicated bets, such as leveraged ETFs or volatility options that they don't fully understand. If you feel unsure about how something is traded or what its risks are, Frederick has five words for you. "You are bound to lose."