How to Trade Stocks – A Beginner’s Guide
Learning how to trade stocks is daunting. It’s hard to know where to start and there’s lots of jargon to get your head around. Trading stocks without proper preparation also puts your money at risk. Luckily, our experts are here to help. With our beginner’s guide, you’ll learn:
- What stock trading is and how it differs from investing
- Which market forces drive stock prices
- Eight simple steps to kick start your trading career
What is Stock Trading?
Stock traders buy and sell stocks to profit from daily price changes. Stocks, also called shares, are tiny pieces of a company. Once you buy a share, you become a part owner in that company. If the company’s business is doing well, the value of the stock increases. If the company is having a tough time, the value of the stock drops. The goal, therefore, is to buy stocks when they’re low, sell them when they’re high, and make a profit.
It’s easy to get trading stocks confused with investing in stocks. People use these words interchangeably, but they don’t mean the same thing. The difference lies in how often you buy and sell.
Stock traders are interested in the short term. They focus on small price movements to profit in the next minute, hour, day, or month. Stock investors are interested in the long term. They ignore temporary fluctuations and hold on to their stocks for years or decades.
Although stock trading is fast-paced compared to investing, you can still choose your own speed. Usually, stock traders opt for one of these two main styles:
- Active Stock Trading – An active stock trader is simply someone who places several trades a month. Usually, they use a strategy that relies on reading the market and looking for opportunities that will turn a profit in the coming weeks. This could be company mergers, product releases, or employment statistics.
- Day Trading – Day trading is an incredibly popular sub-strategy of active trading. Day traders work on even short time frames. They may open and close trades within minutes or hours and rarely keep their stocks overnight. Instead of trading around the news, day traders use analytical tools and charts to identify micro trends in the market.
When learning how to trade stocks, you needn’t immediately choose a trading style, but consider how much time you want to invest in trading. Day trading is a full-time job, to spot such small price movements you must be glued to the computer screen. General active trading, however, is less demanding.
What Drives the Price of a Stock?
Stock prices change daily because of supply and demand. If more people want to buy a stock (demand), the price of the stock increases. Conversely, if more people want to sell a stock (supply), the price decreases. This is easy to understand, but how are stock prices created in the first place? We’re glad you asked.
At a basic level, the price of a stock depends on how much investors believe a company to be worth. A company can release stocks at one price but, if there’s no interest, they won’t sell. Market capitalization is the fancy term for the value of a company. You can work out a company’s market capitalization using the following formula:
Market Capitalization = Stock Price x Number of Shares Issued
For example, if Company A issues 50,000 shares and each share costs $50, its market capitalization will be $2.5 million. On the other hand, Company B could issue 5 million stocks priced at $20 each. The second company now has a value of $100 million.
It’s important to know how to calculate this figure when learning how to trade stocks, as it shows how individual share prices reflect little at all. Two companies with the same market capitalization could have different individual stock prices.
Market capitalization can also show you whether a stock is under or overvalued. Once a company releases stocks at one price, their value is now in the hands of the market. Here are a few things which can disrupt the initial price:
- Company News – Any news surrounding a company can cause changes in share price. For example, if the company releases an earnings report that reveals huge profits, the price of a stock will surge as more people will think it’s a good investment. Other news events that can affect stock prices include new product launches, missed targets, and a change of management. A stock may even change value based on what a key figure says, or how they act. For instance, in 2018, Tesla shares dropped because Elon Musk smoked weed on TV. In 2020, Tesla shares dropped yet again as Elon Musk tweeted that the company’s stock prices were too high.
- Economic Events – Economic factors such as interest rate charges, inflation, and financial outlook all affect stock prices. If interest rates and inflation increase, but the outlook for the period is bleak, demand will decrease and the share price will fall.
- Industry Trends – Industry trends drive stock prices, as similar companies have the same pressure. If an industry is booming, demand in that sector will increase, and stock prices will surge. For example, during the dotcom bubble, you could essentially launch any internet business and you’d see your share price rise. It’s also possible for the price of one company’s stocks to rise based on their competitor’s actions. In short, Apple’s pain is Samsung’s gain.
How to Trade Stocks in 8 Simple Steps
Whilst learning how to trade stocks may seem complicated, it’s easy to get involved so long as you do your research first. Fortunately, with our step-by-step guide, you’ll be able to do just that.
Here are 8 simple steps to make your entry in stock trading straightforward:
1. Establish Your Trading Goals and Budget
To get off to a great start, you need to create a strict trading plan. The plan should include your total budget and how much profit you aim to make. This helps you to manage risk and to calculate how often, and how much, you can trade.
It’s important to remember that you must only invest money you can afford to lose. Never use money that you need for daily expenses or money saved for a specific goal. Don’t fund your account with your down payment savings or your pension fund.
A fully fledged trading plan stops you from chasing any old trade and making emotional decisions. Instead, you trade according to pre-set parameters. If you’ve hit your limits for the day, you simply start again tomorrow.
2. Choose an Online Stock Broker
The next step is to select a stock broker that suits your needs. Research exactly what account conditions you want, with your trading plan in mind. If you have a small budget, for example, you want to find a broker with low fees. If your plan includes trading whilst commuting, you need a broker with a mobile platform.
A reliable stock broker always offers strong regulation, fast execution speeds, a diverse range of stocks, and helpful educational materials.
3. Decide Which Stocks You Want to Trade
When choosing specific stocks, you need to determine the amount of risk you can take. As a beginner, it’s usually best to choose low-risk stocks from renowned companies like Amazon (AMZN), Apple (AAPL), and Netflix (NFLX). These companies have low volatility levels, yet individual shares can be expensive. On the other end of the scale, shares from new or small companies are cheap but unpredictable.
Another strategy for choosing stocks is to select from a sector you know well. If you have a background in medicine, choose pharmaceutical or healthcare stocks. Social media savvy? Trade shares in Snap Inc (SNAP) or Facebook (FB).
4. Consider Which Type of Trade is Best for You
Once you pick a stock to trade, you can move on to determining which type of trade you want to place. Here are some quick explanations of the most popular types of trades and their advantages:
- Market Orders – You can use market orders when you want to buy the stock at whatever price the broker offers at that moment. This type of trade is very straightforward and quick, allowing you to trade stocks immediately.
- Limit Orders – If you feel a stock is over or undervalued, placing a limit order is a good move. A limit order allows you to set the maximum price you wish to pay for the stock or the minimum price you want to sell it for. For instance, if a certain stock has a price of $65, but you don’t want to pay more than $60 for it, you can place a limit order at $60 or less. If the stock falls to that price, the broker will execute your trade. Limit orders are beneficial because they help you stick to your budget. However, if the stock never meets your limits, you may miss trading opportunities.
- Stop-Loss Orders – You can use a stop-loss order to buy or sell a stock once it reaches a certain price. For example, if you buy a stock for $30, you can set a stop-loss at $27 (10%). If the stock subsequently falls below this price, the broker will sell it for you automatically. Stop-loss orders help to limit your losses and manage your risk.
5. Calculate Your Trading Fees
Before you place a trade, always calculate what fees you need to pay. Most brokers charge commissions but watch out for the small print as there are a few ways your trades can end up costing more than you thought.
- Per Trade Commissions (set price) – With these fees, you pay a fixed amount each time you trade. This amount remains the same, regardless of if you trade 100 shares or 1,000. The benefit of per trade commissions is that there is a maximum limit on how much you will pay.
- Per Trade Commissions (each way) – These fees work in the same way as explained above, although the broker will charge you for both entering and exiting a trade. As you’ll never leave your positions open forever, this can be expensive. If a broker advertises a $10 commission per trade (each way), you end up paying $20. On a trade worth $100, this is then 20% of your investment.
- Per Trade Percentage Commissions – Some brokers charge a percentage amount on all trades. This can be per full trade or each way. If you’re learning how to trade with small amounts, percentage commissions can be great as the broker only usually takes up to 5%. However, if your trading larger amounts, this can add up fast. If you make a trade worth $1,000, you could end up paying $50 or even $100.
- Per Share Commissions – With this fee structure, the broker charges you based on the number of shares you buy or sell. If you buy 200 shares, you pay less than if you buy 5,000 shares. The broker may also place a minimum per share fee, which is usually equal to 100 shares. This means even if you only buy 20 fees, you pay for 100. Per share fees are, however, lower than per trade fees, which makes them a cheaper option for low-volume traders. If you learn how to trade stocks with a broker who charges per share fees, you can calculate your cost by multiplying the fee by the number of shares you want to trade.
6. Place Your First Trade (with a Demo Account)
Once you work out what you want to trade and how much you want to spend, open a demo account. We know you’re eager to trade now and you just want to get down to it, but a demo account allows you to practice without risking your hard-earned cash.
Most brokers offer demo accounts preloaded with virtual funds. To open one, you simply need to provide the broker with a few personal details such as your name, address, email, and social security number.
Once you set your demo account up, take some time to familiarize yourself with the trading platform. When you’re comfortable, open your first trade by deciding whether you want to buy or sell, and what order type you want to use.
You can then monitor your positions within the trading platform. Your running profits or losses will move in line with the underlying share prices. Once they reach a price where you’re happy to close the trade, you can do so by clicking ‘close’. Alternatively, you can close trades by taking the opposite position. So, if you bought a share, you close the trade by selling the same share.
7. Learn and Practice Stock Trading Strategies
To learn how to trade stocks successfully, you can’t let go of your demo account just yet. Instead, use your funds to test out stock trading strategies. There’s no universal strategy that works for everyone, but you should test out both fundamental and technical analysis techniques.
Fundamental analysis uses data and insights to determine a company’s value and potential for growth. Read company financial statements and pay attention to revenues, earnings, and profit margins. Fundamental analysis also includes researching the company’s managers, stakeholders, and competitors.
Technical analysis uses statistics to predict the price of a share. Technical analysts aren’t interested in the company’s value or trajectory, only the price movements of the market. To perform technical analysis, look at past prices, trends, and volume data using the charting tools and indicators within your trading platform.
8. Place Your First Trade (For Real This Time)
When you turn a profit regularly with your demo account, it’s finally the time to trade for real. To do this, you must first deposit funds. Most brokers accept multiple payment methods, including credit/debit cards, e-wallets, and bank transfers. When funding your account, think about how much you want to spend and how often you will deposit. This way, you won’t commit too much money to learning how to trade, but you needn’t waste time topping up your account either.
When placing your first real-money trade, simply follow the same process as with your demo account. That said, as your cash is now on the line, you must monitor your positions closely. If anything goes wrong now, your capital is at risk.
Top Stock Trading Tips from Our Experts
Our experts have years of experience in the markets. It’s what helped them to create this guide and, during their careers, they’ve picked up some tips too.
Save yourself from learning how to trade stocks the hard way. Consider our experts’ top three pieces of advice for new stock traders:
- Learn How to Do Your Taxes – By keeping your tax records as tidy as possible, you’ll save yourself both time and stress. Taxes on stock trades can become complicated, and you don’t want the IRS appearing on your doorstep. In the United States, you only pay tax when you sell a share for a profit. You can hold a stock for a year and you won’t pay anything. Once you sell it, however, you create income. If you generate your profits in the same year as the purchase, the IRS will tax you at your regular income rate. For profits from a share that you purchased over a year ago, the IRS will charge you either 0%, 15%, or 20%, depending on the size of the profit.
- Keep Your Cool – To be successful in the stock market, it’s not enough to have theoretical or practical knowledge. You also need to prepare yourself for different outcomes. The two main emotions you must keep in check are greed and fear. Both can lead to rash decisions, frustration over small profits or losses, and overtrading. To learn how to trade stocks effectively, you need to remain composed and stick to your trading plan.
- Don’t Listen to ‘Hot Tips’ – The internet is a place where you can find the answers to pretty much any question. For every correct response, however, there are dozens of uninformed and even dangerous answers. If you want to trade stocks safely, stay away from trading forums or tipster Twitter feeds. At best, these can be full of incorrect trading advice. At worst, they’re where shady characters go to drive up the price of a stock. As more people invest in a ‘hot tip’, the prices rise. Scammers then take their profits, sell their shares and the stock plummets in price. Again, stick to your trading plan and only consider stocks you know something about.