How to Trade Stocks

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How to Trade Stocks

Not everyone who buys and sells stocks is a stock trader, at least in the nuanced language of investing terms. Most investors fall into one of two camps. Depending on the frequency in which they transact and the strategy driving their actions, they’re either “traders” (think Gordon Gekko in the movie “Wall Street”) or “investors” (as in Warren Buffett).

What is stock trading?

The term stock trader typically refers to someone who frequently buys and sells stocks to capitalize on daily price fluctuations. These short-term traders are betting that they can make a few bucks in the next minute, hour, days or month, rather than buying stock in a blue-chip company to pass along to their grandkids someday.

Stock trading can be further refined based on certain criteria:

Active trading is what an investor who places 10 or more trades per month does. Typically, they use a strategy that relies heavily on timing the market, 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 or months.

Day trading is the strategy employed by investors who play hot potato with stocks — buying, selling and closing their positions of the same stock in a single trading day, caring little about the inner workings of the underlying businesses. (Position refers to the amount of a particular stock or fund you own.) The aim of the day trader is to make a few bucks in the next few minutes, hours or days based on daily price fluctuations.

How to trade stocks

If you’re trying your hand at stock trading for the first time, know that most investors are best served by keeping things simple and investing in a diversified mix of low-cost index funds to achieve — and this is key — long-term outperformance.

That said, the logistics of trading stocks comes down to six steps:

1. Open a brokerage account

Stock trading requires funding a brokerage account, a specific type of account designed to hold investments. If you don’t already have an account, you can open one with an online broker in a few minutes.

2. Set a stock trading budget

We have some advice: Even if you find a talent for trading stocks, allocating more than 10% of your portfolio to individual stocks can expose your savings to too much volatility. Other ground rules to manage risk: Invest only the amount of money you can afford to lose, don’t use money that’s earmarked for near-term, must-pay expenses (like a down payment on a house or car, or tuition money) and ratchet down that 10% if you don’t yet have a healthy emergency fund and at least 10% of your income funneled into a retirement savings account.

3. Learn to use market orders and limit orders

Once you have your brokerage account and budget in place, you can use your online broker’s website or trading platform to place your stock trades. You’ll be presented with several options for order types, which dictate how your trade goes through. We go through these in detail in our guide for how to buy stocks, but these are the two most common types:

  • Market order: Buys or sells the stock ASAP at the best available price.
  • Limit order: Buys or sells the stock only at or better than a specific price you set. For a buy order, the limit price will be the most you’re willing to pay and the order will go through only if the stock’s price falls to or below that amount.

4. Set up a practice stock-trading account 

There’s nothing better than hands-on, low-pressure experience, which investors can get via the virtual trading tools offered by many online stock brokers. Paper trading lets customers test their trading acumen and build up a track record before putting real dollars on the line.

5. Measure your returns against an appropriate benchmark

This is essential advice for all types of investors — not just active ones. The bottom-line goal for picking stocks is to be ahead of a benchmark index. That could be the Standard & Poor’s 500 index (often used as a proxy for “the market”), the Nasdaq composite index (for those investing primarily in technology stocks) or other smaller indexes that are composed of companies based on size, industry and geography.

Measuring results is key, and if a serious investor is unable to outperform the benchmark (something even pro investors struggle to do), then it makes financial sense to invest in a low-cost index mutual fund or ETF — essentially a basket of stocks whose performance closely aligns with that of one of the benchmark indexes.

6. Keep your perspective

Being a successful investor doesn’t require finding the next great breakout stock before everyone else. By the time you hear that XYZ stock is poised for a pop, so have thousands of professional traders and the potential likely has already been priced into the stock. It may be too late to make a quick turnaround profit, but that doesn’t mean you’re too late to the party. Truly great investments continue to deliver shareholder value for years, which is a good argument for treating active investing as a hobby and not a Hail Mary for quick riches.

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