The Hustler's Digest StaffDo you want to start trading in stocks but don’t know how to start? Trading in stocks might be a tricky job to do but here is an ultimate guide for you to understand the process and know where to start.
guide for you to understand the process and know where to start.
A stock exchange is a process where traders and stockbrokers can buy and sell shares, bonds, and securities. Many large companies have their stocks listed on a stock exchange which makes them more liquid and hence more attractive to many investors. The stock may also be traded over the counter (OTC) which is through a dealer or broker.
A stock market is an important tool of a free-market economy. The platforms provide both traders and investors a chance to maximize their business profits. The companies are allowed to raise money by offering stock shares and corporate bonds, while common investors participate in the financial achievements of the companies, make profits through capital gains, and earn money through dividends.
The stock market works as a facilitating platform where savings and investments of individuals are efficiently channeled into productive investment opportunities. The activity, in the long run, helps in the capital formation and economic growth of a country.
While stock trading gives plenty of opportunities to individuals to make money, there are stumbling risks to the process as well, especially for beginners. It is crucial to understand the process and know the pros and cons of trading in stocks before diving into the phenomenon. Having a knowledge of how to trade in stocks and what are recurring risks involved in doing the business is really important.
What is a stock market?
The stock market broadly refers to the place characterized by a collection of exchanges where buying, selling, and issuance of shares of publicly held companies occur. Such financial activities take place under a defined set of institutionalized regulations, whether physical or electronic or via over-the-counter (OTC) marketplaces. The one who trades in the stock market buys or sells the shares on one or more of the stock exchanges which are part of the overall stock market.
Both the words ‘stock market’ and ‘stock exchange’ are used interchangeably but in a formal sense, the latter is a subset of the former. The leading stock exchanges in the United States include New York Stock Exchange (NYSE) and the Nasdaq. These leading stock exchanges and other venues make a larger stock market of the United States.
The stock market facilitates the buyers and sellers of securities to meet, interact, and transact at their convenience. The markets not only allow for price discovery for shares of the corporations, but it works as a barometer for the overall economy. Since the market is regulated by regulators such as the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA), these institutions assure a fair price and a high degree of liquidity as various market participants compete with one another for the best prices.
As a primary market, the stock market allows investors and companies to issue their sell shares to the common public through the process of initial public offering (IPO). Through this activity, companies get the necessary money from the investors. For example, a company can divide itself into a number of shares, say 20 million, and intends to sell part of those shares, say 5 million, each for $10.
To sell these shares, the company needs a reliable marketplace where it can find investors or buyers. The stock market is the place that will help it to sell these shares at the price of $10 and collect $50 million worth of funds. By this activity, investors will buy the shares and keep them for a preferred duration in anticipation of rising prices and any potential income from the dividend payments. The stock exchange, by facilitating this process will receive a fee for its services from the company and its financial partners.
What is stock trading?
Stock trading is an activity of buying and selling shares in companies in an effort to make money on daily changes in price. This is a short-term approach of stock traders as compared to traditional stock market investors who tend to be in it for the long haul.
While individuals can make easy money on stock trading if they time correctly, it involves a heavy risk of substantial losses. A single company can make a fortune more quickly than the market at large, but there are high chances of falling at the same speed. That is why financial advisors don’t recommend people to start trading in stock unless they have money to lose.
However, for interested investors, it is easy to learn about stock trading as online brokerages have made it possible to trade stocks online from your home computer or smartphone. You don’t have to work in Wall Street to learn about the stock trade, for that matter. But before formally making it to the stock market, you must know how the stock market works, the best apps for trading stocks, and how to manage your risk.
Types of stock trading
Active trading
Active trading is the act of buying and selling securities that are based on short-term movements to make a profit from the price movements on a short-term stock chart. Active traders believe that it is the short-term movements and capturing the market trend is where the profits are made.
Active trading is what an investor who places 10 or more orders in a month does. They strategize their profit on timing the market and trying to take advantage of short-term events (at the company level or based on market fluctuations) to turn a profit in the coming weeks and months.
Day trading
Day trading is a method of buying, selling, and closing the positions in a single trading day caring little about the inner workings of the underlying businesses. The goal of day trading is to make a few bucks in the next minutes, hours, or days based on daily price fluctuations. Traditionally, day trading is done by professional traders such as market makers or specialists, however, online trading has opened up possibilities for new traders too.
Other than these main types of trading, there are other strategies of trading:
Swing trading
At the end of the trend, there is typically a price fluctuation as the new trend starts establishing itself. At this point, swing traders come into the scene by buying and selling as that price volatility sets in. Swing traders are typically held for more than a day for a shorter time than trend traders.
They often create a set of rules based on technical or fundamental analysis. These rules and algorithms are designed to dictate when to buy and sell a security. It does not however figure out the exact and predict the peak or valley of a price move, but it needs a market that moves in one direction or another.
Position trading
Position trading is also known as ‘buy and hold strategy ‘and not active trading because it may last for several days, to several weeks, and sometimes even longer, depending on the trend. Position traders use long-term charts in a combination with other methods to determine the trend of the current market direction.
Scalping
It is one of the quickest strategies employed by traders in active trading. Essentially, it involves identifying and exploiting bid-ask spreads which are a little wider or narrower than normal due to a temporary imbalance in demand and supply.
The Scalpers don’t make big moves or transact high volumes, rather, they capitalize on small moves that occur frequently, with measured transactions. As the profit on small trade is lower, the scalpers look for relatively liquid markets to increase the frequency of their trades. Contrary to swing traders, scalpers prefer quiet markets that are not prone to sudden price movements.
Stock market participants
Along with short-term traders and long-term investors, there are many participants who are associated with the market to facilitate the working. Each one of them has a unique role to play but it becomes intertwined and dependent on each other to make sure that the market runs effectively. Following are the participants associated with the market:
Stockbrokers
They are also known as registered representatives in the United States who are licensed professionals and buy and sell securities on behalf of the investors. Their role is that of an intermediary providing services between stock exchange and investors by buying and selling stocks on behalf of the investors. He needs an account with a retail broker to gain access to the market.
Investment bankers
The investment bankers offer services to private companies by representing them to the public via an IPO or companies which are involved in pending mergers and acquisitions. They take care of the listing process by following the regulatory requirements of the stock market.
Portfolio managers
Portfolio managers are professionals who invest portfolios or collections of securities for their clients. They make decisions based on analysts and make buying and selling according to their knowledge. Hedge funds, mutual funds companies, and pension plans need portfolio managers’ services to make decisions and set the investment strategies for the money that they hold.
Custodians
The depot service providers and custodians are the institutions that hold on to clients’ securities for safekeeping in order to minimize the risk of loss or theft. These institutions also work in sync with the stock exchange to transfer shares to/from the respective accounts of transacting parties based on trading on the stock market.
Speculators
Speculators engage in directional bets in the market with individual stocks or broader indexes. They usually take short positions by short selling and long positions by buying shares. Based on the fundamentals of analytical techniques, speculators hold on to their position for a relatively long term. Other speculators trade quickly and often, as in the case of day traders.
Market makers
They are the broker-dealers who facilitate the trade of shares by posting bids and asking prices and maintaining an inventory of shares. Their job is to ensure the liquidity in the market for a particular set of shares, earn profit from the difference between the bid and ask for a price that they quote.
Arbitrageurs
These are the traders who identify mispricing in the market for relatively low-risk profits. The market ensures its efficiency by this activity. Algorithmic and high-frequency trading (HFT) programs are dealt with in this type of arbitrage.
For-profit institutes
The stock exchanges work as for-profit institutes which facilitate trading between buyers and sellers and charge a fee for their services. Their primary source of revenue is the transaction fees that are charged for each trade carried out on these platforms. Besides, exchanges earn revenue from the listing fees charged to companies during the IPO and other follow-on offerings.
The platform also earns from selling market data it generates in its places such as real-time data, summary data, reference data, history data, which is vital for equity research and other uses. Many exchanges also sell technology products such as trading terminals and dedicated network connections to the exchange, to the interested parties to the interested parties for a suitable fee.
How to buy stocks?
Here is a step-to-step guide on how to buy stocks
1. Open an account to buy stock
A brokerage account is a good start for buying stocks but it’s not the only option to start your work. If you see yourself as a hands-on investor who aspires to research different companies and learn about markets, an online brokerage account is a great place to get started buying stocks. These online brokerage accounts offer tax-advantaged and taxable accounts.
If you want to buy stocks to fund your retirement, consider getting an Individual Retirement Account (IRA) which will offer you some tax advantages such as tax-deferred growth of your investment and potential tax credits on your tax return. In case you are investing a day sooner than retirement, or you’ve already maxed out your retirement accounts, get to your taxable brokerage account. However, you don’t get tax advantages of IRAs on these accounts, they also don’t have any limitations on how much money you can deposit or when you can withdraw funds.
You may also get the choice to open a margin account on your brokerage account. With a margin account, you can borrow money to buy stocks. This way the experienced investors buy more shares of stocks with less of their own money in exchange for some additional costs and much more risk.
● Direct Stock Purchase Plan
If you have already planned stocks that you’ve decided to buy, you can consider a direct stock purchase plan. Not all of the companies make the trade through this method, but many of the renowned, largest companies, and most popular names do and you don’t need a brokerage account to buy stocks in this way. You’ll most likely be paying some amount of fee, however.
Direct stock purchase plans are usually administered by third parties, rather than the companies themselves. The two most common direct purchase plan administrators are American Stock Transfer % Trust Company (AST) and Computershare and both of the firms charge additional fees for direct purchase plans. Contrary to that, most online brokers charge no fee or commissions to buy and sell shares of stock.
For example, you can buy the one-time amount of $500 of Coca-Cola stock on Computershare for a $5 fee or set up 10 recurring $50 purchases for a $2.50 fee. Either way, you’ll pay a $0.05 processing fee for every share you bought. Reinvesting any dividend incurs a charge of 5% amount that you invest up to 5%. Computershare will round up your investment with fractional shares if there is a necessity.
● Full-service brokerage
Full-service brokerages provide a variety of financial services to clients from retirement planning and tax preparation to estate planning. They also provide help to buy stocks. The trouble with the full-service brokerages is that they charge more fees compared to online brokers.
Wealthy individuals may find full-service more convenient as they don’t have to waste extra time to stay on top of their complicated financial lives because full-service offers them special treatment as well as a high level of trust. But if all you want is to buy stocks, an online brokerage or direct purchase plan would be a better option for you.
Robo-advisors
Robo-advisors are automated investing platforms that track your financial goals, risk tolerance, and investing timelines. As you sign up on Robo-advisors’ platforms, you are asked a series of questions to evaluate these factors and then invest your money in a managed portfolio of exchange-traded funds (ETF) that is tailored to your needs.
Note that with Robo-investors, you are not buying stocks directly but you’re buying a portfolio of ETFs. Some of these funds will surely be stock ETFs such as the SPDR S&P 500 ETF Trust (SPY), which tries to match the performance of the S&P 500 stock index. But others could be broad bond funds such as Vanguard Total Bond Market ETF (BND) which invests in fixed income securities.
Given these factors, it does not mean that Robo-advisor is a bad choice to consider especially if you are more of a hands-off investor. Just keep in mind that it may not be your first choice if you want to buy stocks.
2. Research which stocks do you want to buy
There are thousands of publicly traded companies out there that offer shares of stock on the market. It makes it hard to choose which stocks to buy. One way to think about researching the stock is to adopt a well-thought-out strategy such as buying growth stocks or buying a portfolio of dividend stocks.
● Growth stocks
These are the shares of companies that see rapid and robust gains in profits and revenues. Usually, companies that fall into this category are relatively young companies with plenty of room to grow or the companies that are offering their services to the markets with lots of room for growth. Whether the shares of growth stocks seem expensive or not, investing in growth stocks assure that continued rapid growth will deliver strong price gains over time.
● Value stocks
These are the shares of stock that are priced at a specific discount and stand to see price gains as the market comes to realize its true value. With value investing, you’ll look for shares on sale with low price-to-earnings and price-to-book ratios. The goal is to buy stocks that are underpriced and hold on to them over a long period of time.
● Dividend stocks
Stockholders get a dividend amount in earnings from the dividend stocks. When you buy dividend stocks, you earn a steady amount of income from the investments whether the prices of the stocks keep on fluctuating. Some sectors such as telecommunication and utilities are more likely to pay dividends.
Use a stock screener to find stocks to buy
No matter whatever strategy you employ for buying stocks, finding the stocks will still be a challenging job. The stock screener will help you to narrow down your research and provides filters to screen out all the companies that do not meet your demands. You can find stock screeners on nearly all the online brokerage accounts, and also there are more free versions available online that you can use to initiate your search.
The stock screener will help you filter for small-cap stocks or large-cap stocks and view a list of companies with declining share prices and stocks that are at all-time highs. You can generally search stocks by industry or market sector. Filtering by P/E ratio is a great way to find shares that are underpriced or overpriced.
3. Execute trade in your account
So far you have opened a brokerage account and found your intended stocks you’d like to buy, now is the time to execute the trade on your account. Before you put an order to buy the stock, you need to know the details of the process. As purchasing is not as simple as pressing a button and ordering stock, you generally have to pick an order type, which will instruct you about the options on how you want to buy a stock.
These two types of orders are most common that you may be given the option to choose from:
● Limit order
In this type of order, you mention a price, and the buyer only gets executed if the stocks fall into the named price or lower in the given period of time. If the ordered stocks never reach the mentioned price in a limited amount of time, your order expires and the trade gets canceled.
● Market order
This type of order instructs the broker to buy the stock immediately at the lowest price available in the market. The current prices won’t be the static price when you enter a market order, prices keep on fluctuating and get changed in milliseconds. You are only telling the broker to make an order at the lowest available price, and that is the price over which your order will be executed.
If your account balance is low but the stock share that you are looking to buy is very high, consider fractional shares. A fractional share is a portion of an equity stock that is less than one full share. Take Google parent, Alphabet, Inc.: As of early October 2020, Alphabet is priced at $1,500 a share. Considering this option, you can invest as little as a few dollars in the stock. A growing number of brokers including Fidelity and Robinhood, Charles Schwab, to name a few, sell fractional shares.
4. Use dollar-cost averaging to buy a stock over time
The trouble with the stock market is that the prices keep on fluctuating. You don’t know if it is reasonable today, it can get lower or higher the other day. Dollar-cost averaging provides a solution to this problem: buy stocks with a set amount of money at regular intervals, and you may pay a lesser amount of money per share on average over time.
With a dollar-cost average strategy, you can get started buying stocks right away with a little amount of time rather than waiting for building a large balance in your account. This mitigates the risk of buying either extremely high or low since you are spreading out your purchases over a long period of time.
Buying ‘low’ and selling ‘high’ is a mantra of successful stock purchasing you might have heard multiple times. But practicing it for a longer period of time can be hard psychologically as it can be very hard even for experts to agree on what is a low and high price for the given stock. Automated, recurring stock purchases that use dollar-cost average help you avoid the challenge and make investing routine.
5. Think carefully about when to sell your stock
The ideal time for selling your stock is when you need money. Long-term investors keep a strategy centered on financial goals and a timeline to achieve them. It means that it should include a comprehensive plan to start tapping your investment and use the cash which you have collected at the right time.
It also means that deciding on when you should sell the stocks has little to do with what the stock markets are doing at any given moment. Unless you are day-trading and looking to turn a quick profit, you don’t have to even worry about keeping an eye on day-to-day price movements.
Stock sales and capital gains taxes
In order to give your broker a ruling to make a sale, make sure to understand the tax consequences first. If the stock price is higher since the time you have bought the stocks, you may have to pay capital gains taxes. Gains on the shares you keep for a year are more subject to the higher ordinary income tax rate, up to 37%, depending on your income.
Shares that are being sold after more than a year get taxed at the lower long-term capital gains rate of 0% to 20% in 2020. In case of price down, you can use the loss to offset gains you may have earned somewhere else in your portfolio.
For instance, if you keep a share whose price has lowered by $10, and you own another stock that gained $15 per share, you can sell both stocks and owe taxes on the $5 a share difference. But keep in mind the wash-sale rule that says once you take advantage of this tax benefit, you cannot buy the stocks you sold at a loss or any similar stock for 30 days.
How to manage stock market risks?
Stock trading can be an easy tool to make money if the traders have an in-depth knowledge of the stock market and accumulate enough money to lose at some time. But lacking that knowledge and sophisticated intelligence regarding the working of the market can be proved lethal for the investors. So in order to have a knowledge of how to entrench the position in the market, traders should know how to avoid or minimize risks. Following tips can be of some help in the case when a trader falls on the investor-trader spectrum:
1. Lower risk by building positions gradually
Keep this in mind that there is no need to cannonball deep into any given position. Take your good time to make a decision of buying (via dollar-cost averaging or buying in threads). It will help reduce investor exposure to price volatility.
2. Ignore ‘hot tips’
People posting in online stock-picking forums and paying for sponsored ads jeering sure-thing stocks are not your friends. In many cases, they are part of a pump-and-dump racket where shady investors purchase buckets of shares in a little-known, thinly-traded company and hit the internet to get the hype.
As unwitting investors load up on shares and drive the prices up, the crooks make their profit, dump their shares, and send the stock careening back to earth. Remember that it doesn’t help them line their pockets.
3. Keep good records for the IRS
If you are not using an account that enjoys tax-favored status such as a Roth or traditional IRA, or 401 (k) or other such workplace accounts, taxes on investment gains and losses can get complicated. The IRS applies different rules and tax rates and requires different types of filing of forms for different types of traders. Another benefit that you can gain by keeping a record is that loser investments can be used to cancel out the taxes paid on income through a neat strategy known as tax-loss harvesting.
Trading in penny stocks
Penny stocks are those that trade at a very low price, have very low market capitalization, are mostly illiquid, and are usually listed on the smaller exchanges. Although penny stocks are highly risky, involving a small amount of investment, they have the potential to turn a small investment into a fortune.
Many institutions consider a penny stock to be anything that trades for less than $5 per share. While penny stocks can reach a good value, there is an option to stock in less than a penny. The case with penny stock trading is like cryptocurrency; you can make a good profit, but you must invest carefully.
Most of these companies are new which haven’t entrenched their position, have small market capitalization, and haven’t established a track record as successful businesses which makes them speculative investments for investors and traders.
Despite their lower price investment, there is a higher risk attached to this type of trading than regular stocks. The reason for this fact is simple; the companies that hold penny stocks typically have minimal operations and don’t make huge profits. They usually trade on pink sheets or on FINRA’s Over The Counter Bulletin Board (OTCBB). They are not required to file with the Securities and Exchange Commission (SEC).
These stocks possess low liquidity due to a lack of sellers and buyers, so orders may not be filled right away or even at all. Besides, volatility seems to be high among OTC stocks, and bid-ask spreads are frequently large. People tend to be attracted to invest in penny stocks due to the cheap cost and simple math of this type of stock.
Putting it in the example, if you buy shares for $0.20, and if the stock goes up by $0.10, then you earn a profit of 50%. In a similar case, however, it is also likely that your $0.20 share will go down by $0.10 and you lose 50%. Hence, a $1,000 investment could lose value pretty quickly. Even if you buy penny stocks carefully, you have to deal with several more risk factors than you do with other types of investments.
FAQs about stock trading
● What is a good stock trading strategy for beginners?
Before formally getting into stock trading, having a comprehensive strategy is crucial. Firstly, practice with a virtual trading account, then start by doing low investments to avoid unnecessary risks. Having acquired some stability, you can gradually increase the amount of investment, but remember not to invest anything that you cannot afford to lose, especially in risky strategies. That is why most of the investment advisors recommend that the bulk of the investment portfolio be invested in mutual funds, exchange-traded funds, and index funds.
● Which stock trading site is best for beginners?
‘Online stock brokers’ are proven to be the best option for beginners based on the stock broker’s investment selection, account fees, customer support, account minimum, trading costs, and more.
● Can you trade stocks for $100?
Yes, as long as the share price is below $100 and your brokerage account does not have any fees or required minimums that can push the transaction higher than $100. The best online brokers for beginners won’t have minimums or fees so any stocks lesser than $100 can be bought from any company. Some brokers also allow you to buy fractional shares which means you can purchase a portion of a share if you can’t afford the full shared price.
● What time can I start day-trading?
Normal timings on Nasdaq and New York Stock Exchange start from 9:30-4:00 pm Eastern time on non-holiday weekdays. However, there are also pre-market and after-sessions at the market, not all brokers allow you to trade in these hours but many do, you need to check if your broker allows you to trade.
● What is the difference between stock trading and investing?
The primary difference between the two is how often you buy and sell stocks. Traders buy and sell more frequently while investors buy and hold for a longer period of time.
● How much do I need to start trading penny stocks?
FINRA sets a requirement of $25,000 in your brokerage account to initiate your trade but there are other brokers who allow you to trade with a lower minimum. Check your penny stocks app or broker to learn more.
Conclusion
A stock is an aggregation of buying and selling of stocks, also called shares, which represents ownership claims on the business. These may include securities displayed on a public stock exchange as well as stock that is traded privately including shares of the private companies that are sold to investors through equity crowdfunding platforms.
Stocks can be categorized by the country where the company is domiciled. For example, Novartis and Nestle are domiciled in Switzerland and traded on the SIX Swiss exchange, so they are considered a part of the Swiss stock market, however, the stocks may be traded on an exchange in other countries for instance American depositary receipts (ADR) is traded on U.S stock market.
As businesses have been transformed in the digital era, stock trading has also developed easier ways for investors and traders to initiate their trade and make their position strong there. The beginners should study the whole process before getting into the business because stock trading can offer many financial opportunities for people to make easy money but if there is no proper strategy to employ while trading, there are higher chances to fail very badly. That’s why experts recommend not to invest money that you can’t afford to lose.
