You might hear on television that the Dow Jones went up 100 points or fell 150 points on any given day. Then, you might ask yourself, what does this mean?
The Dow Jones is an index on which individuals and institutions trade public stocks. And if you aren’t a person who is trading stocks, rest assured that you’re not alone. Despite the longest bull market — i.e., a market favorable to buyers — in U.S. history, roughly 47% of Americans do not invest their money, according to a recent study by GOBankingRates.
Investors shouldn’t fear stock trading. It’s one of the best ways to build and preserve wealth over the long term. Between 1928 and 2018, the S&P 500 provided an average return with dividends of 11.67%, according to economist Robert Shiller and Yahoo Finance. That figure is way higher than the average return of a savings account in the United States.
New investors just getting started have plenty of ways to invest in the stock market. But make sure that you rely on trusted sources for advice. Even the most seasoned stock pickers have underperformed against their benchmarks over the long term, according to a 2016 report by S&P Dow Jones, which tracks performances of investment funds.
- What Is Stock Trading?
- How To Start Trading Stocks
- Smart Strategies for Stock Trading
- Best Ways To Learn Stock Trading as a Beginner
- Stock Market Terms and Definitions
What Is Stock Trading?
You can invest in public markets in a number of ways. One of the most popular methods is to trade stocks. Stocks are an investment that represents an ownership stake in a publicly traded company. When you buy a share of a company’s stock, you are purchasing a percentage of the company.
The stock market operates much like a public auction house. Investors buy and sell shares of a company’s stock by negotiating prices on an exchange. Buyers expect that prices will go higher, while sellers believe the stock is likely to head lower. To better understand how the stock market works, take a look at these types of trading and key trading strategies.
- Exchange Floor Trades: Turn on CNBC and you’ll see commentators reporting from the trading floor of the New York Stock Exchange. This trading floor is where traders engage in exchange floor trades. Say you have a broker named Bob. You tell Bob to buy 500 shares of a company. Bob’s firm will send an order to a floor clerk at the exchange. The floor clerk will tell one of the floor traders to fill your order. That floor trader can “make a market” — agree on a price with a seller and complete the trade. Your broker will receive a notification of your purchase and inform you of the final price. It will likely take a few days to confirm the trade.
- Electronic Trades: The rise of digital networks has made it easier for traders to buy and sell stocks in real time — without floor trades and at a fraction of their cost. Although the NYSE typically centers around floor trades, the NASDAQ is 100% electronic. Electronic trades rely on a massive network of digital trading platforms and networks to connect buyers and sellers. This network ensures instantaneous confirmation of trades.
- Active Trading: This is an investing strategy in which an individual buys and sells stocks in a more short-term way. Active traders might place 10 trades or more in a given month and attempt to time the market by buying and selling to earn profits.
- Passive Investing: This is a long-term strategy of buying and holding stocks for over a long period — typically months or years. It also refers to the purchase of index funds that track the performance of an index like the S&P 500 or the Dow Jones.
- Day Trading: This is the strategy of the active buying, selling and flipping of stocks over a very short period — even within the same trading session. Investors should understand that day trading is complicated. Just 13% of all day traders turn a profit in any given year, according to a 2011 study from the University of California-Berkeley. That figure declines to just 1% when talking about consistent year-over-year performance.
How To Trade Stocks: First Steps
Follow a few simple steps to get started trading stocks:
1. Decide What Type of Investor You Are
Deciding between active and passive investing will prepare you for the next steps in stock trading. Do you want to manage a portfolio on a day-to-day basis, or do you want to invest for the long term? Are you patient enough to withstand downturns in the stock markets? Or would you prefer to try to time the market by buying and selling stocks?
2. Determine Your Risk Tolerance
Stocks might or might not represent the best investment based on your risk tolerance. Perhaps you would prefer to buy and hold bonds, which are far more conservative and pay a fixed yearly return. Consider a variety of different trading strategies when building a portfolio.
3. Practice Stock Trading Early and Often
It’s important to practice trading. To do so, you might want to consider paper trading or virtual trading stocks. This means you start with a hypothetical amount of money and simulate the buying and selling of stocks. You can sign up at online brokerages like TD Ameritrade or Tradestation for a virtual trading app.
4. Open an Investing Account
When it’s time to start trading stocks, you’ll want to open a brokerage account. You can sign up with a broker who will purchase shares and make recommendations in exchange for pricey commissions. Or you can do online stock trading by applying for an account with a discount brokerage. These brokers receive a low, fixed commission for every trade you make.
The best online stock brokerages for beginner traders include Charles Schwab, TD Ameritrade, Merrill Edge, E-Trade and Fidelity.
First-time investors who are smartphone savvy can also choose from a variety of mobile apps that can save time and money when trading. For example, Robinhood is a digital application that allows users to buy stocks without commission costs. You can also save by investing in mutual funds with several different brokerages.
5. Decide Between Cash and Dividend Reinvestment
Many — but not all — companies pay a dividend. These cash payments are commonly paid by companies every quarter and during special events. Investors need to consider whether they want to receive the cash directly or reinvest these cash dividends back into the company. TD Ameritrade, for example, allows investors to reinvest their dividends without additional trading fees.
Find Out About: Best Brokers for Free Stock Trading
Smart Strategies for Stock Trading
Many strategies for trading stocks are available, but it’s important to start with a few basics.
Pay Off Your Debt First
Before you start investing in the stock market, consider paying off debt or establishing a portfolio that will provide you a return higher than your interest payments. Investing is as much about opportunity costs as it is profits.
Don’t Borrow To Buy
If you can’t afford to buy a stock outright, don’t buy it. And you should only trade stocks with money that you can afford to lose.
According to a recent GoBankingRates survey, 55% of Americans say they don’t have enough money to invest. But you can get started with the change in your pocket. Trading app Robinhood and several robo-advisors allow users to round up purchases on their debit cards and allocate that money directly into exchange-traded funds or stocks.
As you earn more money, you can purchase more shares and use different strategies to build your position. For example, you can use dollar-cost averaging, a process where you buy a fixed amount of the same stock every month or every quarter. This allows you to buy more shares when the price dips and fewer shares when the stock rises. Over time, the price averages out and reduces risk.
Keep Your Stock Trading Strategy Simple
A lot of market experts preach diversification to minimize risk. The theory goes that you don’t want to have all of your eggs in one basket when it comes to one stock or one sector. But Warren Buffett famously called diversification “protection against ignorance” and said owning 30 to 50 stocks is foolish.
A better way to invest is to follow an allocation model. The most popular is to hold a portfolio that consists of 60% stocks and 40% bonds. Also, you should keep your portfolio of stocks limited to between eight and 10 positions — a position being the stock representing a particular company — at any time.
Always Have Cash on Hand
Never invest all of your money into the stock market. It’s essential to have cash available for a variety of reasons. If the market pulls back, a price dip might present a terrific buying opportunity to buy a stock you want to own.
Avoid the Hype
One of the most important factors that investors need to know about stock markets is that markets aren’t truly about trading. Exchanges are designed for selling products, equities, companies and ideas. Keep in mind that someone is selling for a reason.
Also, investors should avoid penny stocks. Many speculators claim to have made life-changing wealth by investing in shares under $1. But the median penny stock investor receives an average return of -13.4% and holds each stock for an average of 16 days, according to the Securities and Exchange Commission. The Financial Industry Regulatory Authority has warned that many penny stocks are part of pump-and-dump and other nefarious schemes.
Use Fundamental and Technical Analysis
To understand the value of a company and a stock’s upside or downside, consider learning about two forms of stock analysis. These trading tools can give you an edge when you are investing in stocks.
- Fundamental analysis is the process of evaluating a company’s financial health, key financial ratios and the intrinsic value of a stock. By examining the underlying economic and financial factors impacting a firm, you can determine a perceived value of the stock and decide if it is undervalued.
- Technical analysis is the evaluation of a stock’s price trends and patterns on a historical chart. Technical analysts believe that past trading activity and movement in prices can determine future moves in a stock price.
Research the Source of Your Advice
When you search the internet for insight on the market, it’s important to research the so-called expert recommending a stock. Take time to explore their track record, biography and expertise.
Best Ways To Learn Stock Trading as a Beginner
Investing is a constant learning process, which means you should continue to seek new sources of education. Some good places to start include:
- YouTube videos on stock trading
- Books such as Benjamin Graham’s “The Intelligent Investor.” The book is the basis for value investing and lays out a few key lessons central to the strategy of investors such as Warren Buffett.
- Local and online stock-trading courses
Stock Market Terms and Definitions
Also, it’s essential to learn the terminology of the stock market. Here are a few key terms and their definitions:
|Stock Market Terms and Definitions|
|Stock Market Term||Definition|
|Annual Report||A company report drafted each year to attract additional investor capital. The report contains the firm’s yearly balance sheet, its cash flow and an update on past performance and future strategy.|
|Bear Market||A market that is in a downward trend, typically measured by a 20% reduction over two months. So, if the Dow Jones falls from 25,000 to 20,000, it would be down 20% and thus in a bear market.|
|Beta||This measures the relationship between a stock’s price and the direction of the broader market. If a stock has a beta of 2, it means that for every 1 point that the broader market moves, the stock moves by 2 points, and vice versa.|
|Blue Chip Stocks||The stocks of large, sector-leading firms. These companies typically offer strong dividends, strong fundamentals, strong leadership and the potential for appreciation.|
|Bid-Ask||The bid is the price that buyers are willing to pay for a stock. The ask is the price at which sellers are willing to sell the stock.|
|Dividend||A payment from the company’s profits that is returned to investors, typically every quarter. The annual dividend is a percentage of the company’s share price, commonly referred to as the stock’s yield.|
|Initial Public Offering||The first sale of a company’s stock when it trades publicly on an exchange. Typically, companies are privately owned prior to the IPO.|
|Margin||A margin account allows traders to borrow money from brokers to buy a stock or take a position on a company. The margin represents the difference between a stock’s price and the amount of the loan. Margin trading is risky and is best avoided by inexperienced investors|
|Moving Average||The average price of a stock over a period of time. The most common timeframes cited are the 50-day and 200-day moving averages.|
|Quote||A data point that tells you the latest stock price. Yahoo! Finance and Google Finance will show you a stock’s price, but it is typically delayed by 15 minutes.|
|Short Selling||To short a stock is to bet against the price of a stock — meaning you expect the price to go down. To short-sell a stock, you borrow shares from a brokerage or other stockholder with the agreement to return it to them later. You then sell the stock for a profit. If the stock falls, you can buy it back and return the stock for a profit. If the stock rises, you take the loss when you buy it back and return it to its original owner.|
|Spread||The difference between the bid price and the ask price. If a buyer is willing to bid $15.90 for a stock, and the seller sets an ask price of $16.00, the spread would be 10 cents.|
|Stock Ticker||You’ve probably seen the letters GOOGL next to Alphabet Inc. This is an alphabetical symbol that represents a publicly traded stock.|
|Volume||The numbers of a company’s shares that trade over a particular period.|
Educate yourself on companies and determine which ones interest you. And remember, there’s little evidence that anyone other than the most elite stock pickers has ever been able to beat the market trading stocks. Investing in funds and engaging in passive investing has been a more successful strategy over the long term.
More Resources for New Investors:
- How To Find the Best Trading Platform for Beginners
- How After-Hours Trading Works
- The Complete Guide to ETFs
Garrett Baldwin was the editor of the stock trading magazine Modern Trader. He is a regular commentator on investments for Money Morning, Finalternatives and several other investment publications for active traders. He holds an MBA in Finance from Indiana University.