Stock trading is one of the fastest and most efficient ways to build on your total net worth. Trading stocks allows individuals to generate profits by buying and selling stock securities. However, while stock trading is known to offer good returns in the long run, investing money in the stock market can be a very risky endeavour. Fortunately, with the right approach to manage these risks, investors can leverage trading opportunities in the stock market to secure their financial positions. But how are stocks traded, and what benefits do investors enjoy by trading stocks? In this guide, you will find every vital information that you should know about stock trading and tips on how to trade stocks.
What is a Stock?
A stock, also known as a share, is a financial security that represents an individual’s proportionate claim to the ownership of a corporation or company. This ownership extends to the company’s assets and earnings. The number of stocks held by an individual, therefore, reflects how much they are entitled to a company in relation to the corporation’s total outstanding shares.
Stock Trading Explained
Stock trading is the frequent buying and selling of equity securities in an attempt to capitalise on daily market events, such as price fluctuations for a profit. Most investors will build a diversified stock portfolio then hold these securities with an expectation to make gains at given market times.
Stock trading is classified into two major categories, including the following;
Day Trading – This is a short-term trading technique that involves the buying and selling stocks, and closing a financial position within the same trading day. This means that shares are bought and sold before the market is closed for the trading day. Day traders are known to be speculators, as they invest in stocks within an intention to generate profits within minutes or hours of trade.
Active Trading – This is a method of stock trading that involves buying and holding stocks for short term periods, intending to generate quick profits in the short run. Unlike day traders, an active trader will hold stocks for several days, weeks, or even months to take advantage of the short-term movements in the stock prices.
How to Trade Stocks
With the understanding of what stock trading is and the different categories of trading shares, it is easy to look into the process of stock trading. This step by step guide outlines the basic phases that constitute the logistics of trading shares.
Opening a Stock Dealing Account
A stock dealing or brokerage account is the platform where your identified broker initiates trading. Brokerage platforms are owned by licensed trading companies who execute a trade on your behalf. With your brokerage account, you can trade shares from companies that are listed in some of the major stock exchanges, including the Financial Times Stock Exchange or the London Stock Exchange. Note that you will be required to deposit a given amount to open this account. Minimum deposit requirements vary with different brokerage platforms.
Selecting a reputable stock dealing service provider
Plus500 is one of the world’s leading stock trading platforms, comprising of an online site and a mobile application. Plus500 is popular for its innovative features, proprietary trading, and other features that meet the ever-changing demands of the stock trading industry. The platform includes a free Demo Account that allows experienced traders and beginners to practise trading before getting into the real trading world.
eToro is popular not only for its plethora of features but also for their social trading capacity. This means that investors can observe and copy trading behaviours from experienced traders. eToro is probably the most preferred trading platform for beginners. The broker takes pride in their unique research tools that incorporated to complement the traders’ investment decisions.
This brokerage platform is known for 2-in-1 trading platforms that offer investors the freedom to choose the best platform to inject their money. The CMC Markets brokerage platforms include the MetaTrader 4 and Next Generation platforms that come with advanced technical indicators and trading tools. CMC Markets also features a mobile trading app that is compatible with both iOS and Android devices.
AvaTrade is another ideal stock dealing platform, that is best known for its reputable operations in Europe. AvaTrade hosts diverse platforms for multiple markets, making it a good choice for stock trading. The most exciting aspect of AvaTrade is its education and support tools that are built to empower traders for stock trading. These tools range from eBooks, videos, and day trading software for stock investment. You can also enjoy the broker’s AvaTradeGo mobile platform to trade stocks from your smartphone.
This is one of the oldest and leading stock trading platforms globally. Based in Europe, IG Markets has been a reliable trading tool for both beginners and experienced investors. IG Markets also features a mobile trading app and other educational tools to enhance the investor’s trading experience.
Setting Up Your Stock Trading Budget
This is where you allocate money to individual stocks for trading. You must be very careful with the proportion you allocate to each stock. This is because allocating significant amounts of your portfolio to given stocks exposes your savings to high levels of volatility. As the basic rule goes, consider investing the amount of money that you are willing to lose.
Place Your Stock Trades
Once you have opened a brokerage account and set your trading budget, you are now set to place your stock trades. How your trade will run is determined by several factors, including the following;
Limit Orders – This is where you set a price limit that is used to determine when a trade should be initiated. This means that you can only buy or sell stocks at or above your set limit. When buying stocks, an order will be initiated only when the stock prices fall to or below your set limits.
Market Orders – These are orders that initiate trade as soon as the stock prices become favourable for your investment.
Settlements – Your buying and selling orders will be executed online, initiating the trade instantly. However, the transfer of ownership of stocks might take place days after the trade. The process where the buyer credits money to the seller’s account is known as settlement. It is also during the settlement date when the transfer of ownership of stocks is completed.
Develop Strategies to Survive Stock Trading
Once you have traded stocks, you will need to come up with your strategies for surviving the events of the stock market. Mitigate risks by building your stock positions gradually and carefully. Do your research well before making the next move. You cannot survive stock trading if you invest with emotions. Get your facts right, undertake fundamental analysis, and do not forget to carry out technical analysis on the stocks.
Benefits of Trading Stocks
The primary aim of investing in stocks is to generate profits that can secure one’s financial position in the future. Trading stocks has, over the years, been a preferred avenue of investment for most investors due to the benefits that come with the stock market. Here are some of the benefits of trading stocks.
One of the primary reasons why investors trade stocks is their capacity to provide diversification. This is particularly an added advantage to individuals who have invested in other securities and investment commodities. The good thing with stock instruments is that their values change independently of other securities, such as bonds. This means that investing in stocks can be a way to weather losses experienced in other investment securities in economic downturns.
Most corporations and companies trade their stocks in the region’s major exchanges, such as the London Stock Exchange and Financial Times Stock Exchange. As a result, the average daily stock share volumes remain high, providing investors with high liquidity. This means that it is easy for traders to buy and sell shares without necessarily impacting stock prices.
Unlike most of the other securities markets, the stock market offers traders with a wide range of trading options in which they can invest their money. Such options include derivatives, shares, and mutual funds. The versatility in stock trading allows investors to mitigate risks that are linked to stocks by enhancing portfolio diversification.
The other advantage of trading stocks is that you are still entitled to earnings even when your traded stocks lose value. These earnings come in the form of dividend income that is generated at the end of every financial year of a given company. You can use your dividend income to build on your investment portfolio. You must, however, keep in mind that not all stocks generate dividend income. You only benefit from this form of annual payment only when you invest in the right stocks.
Acquisition of Ownership to a Company
As earlier stated, stocks reflect an individual’s ownership share in relation to a company’s total outstanding stocks. Buying shares, therefore, gives you an ownership stake into the selling company. This means that you can contribute to the strategic growth of the company, as well as vote on various corporate decisions. Additionally, you are entitled to annual reports of the company, which you can use to undertake fundamental analysis of the company.
The Pitfalls of Trading Stocks
Although trading stocks come with plenty of benefits to the investor, you should also be aware of the risks and pitfalls that are associated with the stock market. Here is a highlight of the key pitfalls of trading stocks.
High Volatility – Stock prices are subject to unpredictable movements and variations during different trading times. This means that the prices may grow upwards or drop when the market is affected. Factors that contribute to the volatility of stock markets include political crises, pandemics, and recessions. The upward volatility of stocks is an advantage to investors. Downward volatility, on the other hand, can result in significant financial losses.
Ownership Risks – While acquiring ownership into a company may be preferred for most investors, buying company shares also come with some disadvantages. For example, if a company is declared bankrupt, shareholders might end up without any proceeds from the dissolution of the company.
Liquidity Risk – The stock market is highly liquid, which makes it easy for investors to buy and sell stocks. However, this also exposes traders to the market liquidity risk. This refers to the inability to exit a financial position easily when trading stocks.
Types of Metrics Used When Considering Stock Investments
When deciding on the right stocks to choose to add to your investment portfolio, it is fundamental that you employ the right metrics. Stock investment metrics refer to data or criteria used to make an informed investment decision. In this segment, you will find some of the best metrics that you should when considering a stock investment.
Return on Investment (ROI)
This is the measure of money gained or lost by a company in an investment. For example, if you invested $1000 in a company then later sell the stocks at $2000, then your stocks will have generated a 100% ROI.
Price to Earnings (P/E) Ratio
This ratio compares the current share price of a company in relation to per-share earnings. This is one of the best metrics to establish the value of company stocks. To arrive at the P/E ratio, take the price per share value, and divide it by earnings per share value.
Earnings Per Share
This is a measure of the profitability of a given company. Earnings Per Share is calculated by dividing the difference in profit and dividends with the total outstanding shares. This metric is effective when used with other metrics, such as return on equity.
Return on Equity
This metric measures the company’s efficiency of generating profits. This means using fewer investments to generate more returns. You arrive at Return on Equity by dividing the company’s profits with the amount of equity. Equity, in this case, refers to the total amount of investments injected into a company.
Compound Annual Growth Rate
This metric establishes the annual rate of growth of an investment. Since stocks are volatile, some years may generate higher gains than the others. It is, therefore, essential to calculate the returns of an investment as an average over a given period of time.
Stock trading has been around for hundreds of years and is one of the oldest forms of investing. Stocks enable people to build their wealth through the accumulation of value in the stock price or in dividend income received by owning a piece of the company.