Stock Trading: How To Start and How To Do It Right
There are many ways to make money in the capital markets and there are two types of stock market participants: traders and investors. The difference is driven by the length of their stock holdings and their investment philosophy. Active stock trading prioritizes near-term profits over long-term gains. Given the stock market volatility, it can be risky to trade without understanding it.
The overdrawn picture of trading is depicted in many movies such as Wall Street and Big Short. A trader is generally shown as a stressed guy, looking intently at many charts open on his computer.
In contrast, real investors are in it for the long haul. They take investment positions based on the past performance of a company and its' stock or based on chart patterns. They keep themselves regularly updated on the news related to their targeted companies. News such as a change in the board of a company or earnings might be very informative. Investors buy and sell stocks at a much lower frequency compared to an active trader.
Today, it's possible to invest in the market from the comfort of your couch. But, before diving into that, you must first develop an understanding of the stock market.
What Is Stock Trading?
Stock traders make money by buying stocks at a low price and selling them later at a higher price. Stocks are generally held for "short-term," ranging from a few minutes to a few days. This trading style called day trading contrasts with stock trades in a blue-chip company and holding it for multiple years.
There are two main types of investing and stock trading strategies.
Active trading is when an investor places his bets trying to "time" the market. Active traders try to take advantage of events at the market or a company level. They bet on the fluctuation of stock prices due to the events, aiming to profit from it.
Day trading is a short-term strategy, where a trader buys and sell their positions on the same day. These traders, so-called "day-traders," hawkishly follow the price fluctuations in the market. They don't care about the business fundamentals of a given company. Their mantra is to make bucks while minimizing the risk of holding stocks for an extended period.
How To Trade Stocks
If you are new to the stock market, it might make sense not to take positions in specific companies. Instead, you might buy low-cost index funds or exchange traded funds. The index funds are specifically designed for small investors to don't have to invest time to do stock market research.
If you are interested in trading, here are the steps to follow:
1. Open a Brokerage Account
You need a brokerage account to become an active trader and investor in stock markets. These accounts hold the stocks you buy. In case you don't have an account, it's easy and hassle-free to open one with an online broker. Because you opened an account doesn't mean that you are required to trade. These days the account minimums are as low as $0. That means that you can enjoy the power of a high-end trading platform at no cost.
2. Allocate the Budget for Stock Trading
Allocating more than 10 percent of your capital to a given stock can expose you to that stock's volatility. Thus, it's best to avoid investing more than 10 percent of your capital in a given stock.
Here are a few things to remember to avoid issues.
- Stock market losses are common. Hence don't invest more than your loss acceptance.
- Never invest in an emergency or short-term need funds such as rent and tuition.
- Never invest with borrowed money.
- Don't forget to diversify your funds by investing in retirement accounts. Make it a point to invest at least 10 percent of your funds into a retirement savings account.
3. Practice With a Simulated Stock Trading Account
Before live trading, one must use a simulated trading environment for a learning experience. Virtual trading helps you to experience trading without risking their investment capital.
We reviewed several online brokers, and most of them offer a virtual environment. TD Ameritrade, TradeStation and Interactive Brokers are three of the most popular ones.
4. Understand the Difference Between Using Market Orders and Limit Orders
Now we are ready to trade. You can place various types of trade orders in the market. Here are the two most popular stock order types at a glance.
- Market order: The market order is an order type in which a trade is executed immediately at the best available price with high probabilities to get the order completed. It is essential to understand that market orders do not guarantee a price where the order gets executed.
- Limit order: A order is executed at the pre-decided price set by you. If no one is willing to pay that price to make a trade with you, the trade is not executed. For a buy order, the limit price is the most you are willing to pay. It is the least you are willing to receive for each unit of stock for a sell order.
5. Compare Your Results
When you "pick" stocks using your judgment and invest in them, it is called "stock picking." This is an alternative to investing in ready-made passive mutual funds, ETFs, or index funds. These funds pick stocks on your behalf and charge a commission for that service.
Trading and investing require time and effort. Hence, it would help if you looked at the returns compare to the benchmarks. When you decide to pick the stocks yourself, you should ensure that you can beat the returns of the benchmark. If the returns are inferior to those of passive funds such as ETF, they should invest in them instead of picking stocks.
S&P 500 and the Nasdaq composite index are two of the most popular benchmark indexes to compare your performance.
6. Stay Focused
You don't need to find the next Apple or Microsoft before becoming a successful investor. Investing is a long-term game, and patience and good judgment are valuable assets. As Gordon Gekko says, "Greed is Good." Being greedy and losing their perspective has led to the downfall of many investors.
How To Succeed in Stock Trading
Irrespective of one's preference between investment and trading, you should follow these four tips.
1. Lower Risk by Building Positions Over Time and Not at Once
There is no need to take large positions at one shot. Take gradual positions after understanding how markets are performing. A slow and gradual position taking helps reduce exposure to price volatility, and you benefit from the so-called cost averaging effect.
2. Ignore the Gurus
There is some misinformation in the market, and you shouldn't react to that. A retail investor should spend time understanding and verifying the authenticity of the news. You should also be wary of an investment advisor who misdirects its clients to gain advisory fees. There is no alternative to due-diligence before investing money in a stock.
It is important to invest time in developing knowledge about capital markets. There are many trading books and online resources available. Warren Buffett's annual letters are an excellent resource to understand long-term investing.
3. Take Care of the Account Statements
It is important to maintain adequate records of trade losses and profit. Keeping records has been made convenient by brokerage houses. They provide their customers with tax statements.
A stock market participant should develop a basic understanding of capital gains taxes. You can partially offset your losses in the market by disclosing it in the tax filings.
4. Choose a broker that fits your investment style
There are multiple brokers available. Hence, choosing the right broker might seem a bit confusing. It is important to pick one broker that aligns well with your trading and investing style.
Those who trade actively would prefer low commission and a fast execution speed. Beginners should prefer brokers who provide educational resources, online tutorials, in-person seminars. They should also look for a user-friendly interface, on-the-go alerts, and customer service.
If you are looking for a long-haul in the equities market, it might be worthwhile to spend time understanding a company's business drivers. Understanding the fundamentals of a company helps to understand the performance of a stock. The more a retail investor learns about business fundamentals, the better it would be for them in the long run.
Stock Trading Conclusion
Stock trading is about making the right investment decisions by utilizing a powerful trading platform and trading technology. A buy and hold portfolio is a great investment strategy for people with low risk tolerance. Day traders use trading tools for buying and selling stocks aiming for short-term profits. Starting with investments like ETFs and trading stocks actively at a specific share price is the first step towards growing wealth. Stock trading of specific shares of a company should only be considered if the budget and available time allow it. An index fund is an excellent alternative if an average return of about 8 percent per year is an alternative.
Stock Trading FAQ
Which Stock Trading Site Is Best for Beginners?
We have reviewed stock trading sites and ranked them for beginners. We used many factors into consideration for the ranking. Some of the factors are costs, investment style, customer support levels.
What's a Suitable Stock Trading Method for Beginners?
Before trading live, it's important to practice trading on a virtual account. Also, it's important to start small in the live market. Making mistakes in the live market is common, and you should take the initial few months as a learning experience. After you built trading experience, then you might gradually increase investment capital.
Can You Trade Stocks With $100?
Different brokerage houses have different requirements. However, most of the online brokerages have no minimum capital requirement. Charles Schwab is one such low-cost brokerage, specifically designed for retail investors.
What Makes the Difference Between Stock Trading and Investing?
The main difference between stock trading and investing is the mentality. Even though the frequency of trades done in stock trading tends to be higher than in investing, this might not be the best way to classify the two. The main difference might stem from the fact that investors rely on business fundamentals while traders don't. Investors spend a reasonable amount of time and resources to understand the drivers of a company's profitability. Traders don't have such a mandate and generally ignore the inner-workings of a company.
What Are the Regular Trading Hours?
Regular trading hours on the Nasdaq and New York Stock Exchange are 9:30 a.m. to 4 p.m. Eastern time. The exchanges are open on non-holiday weekdays. There are also premarket and after-hours sessions. However, not all brokers allow retail investors to trade during these extended-market hours. The stock volatility is also higher during the non-regular hours. Hence, inexperienced traders should stay from trading in those hours.