When it comes to potentially making your money work for you, stock trading is a fabulous prospect. While in the past, it used to only be relegated to professionals and hedge fund managers, nowadays, anyone can technically participate in stock trading. This is especially because technology has evolved rapidly, meaning trading can be done entirely online, rather than at in-person exchanges. In this article, we take an overview of stock trading – what it is, the types of stock trading available, and how to trade stocks. Keep reading below to learn more about this topic.
What is stock trading?
Stock trading involves the buying and selling of shares in publicly traded companies. This usually occurs on stock exchanges such as the NASDAQ or New York Stock Exchange (NYSE).
When someone buys shares of a company, they effectively become a small part-owner of that company. This means they have some claims on their assets and earnings, usually in the form of dividends or capital appreciation. The value of the shares depends on a variety of factors, including the company’s outlook, financial performance, overall market conditions, and investor sentiments.
Unlike investing, stock trading is often a short-term approach, with trades completed in a matter of hours, days, or weeks. In contrast, investing is a longer-term approach that can take years to see fruit.
Types of stock trading
For the most part, stock trading is categorised based on a trader’s desired holding period, or time horizon. Long-term trading involves buying shares of a company and holding them for an extensive period, usually for months. The goal of this is to take advantage of the growth of the company over time and to earn dividends on the shares.
Short-term trading involves buying and selling shares over a briefer period of time – usually a few days, weeks, sometimes even minutes. The goal of short-term traders is to make quick trades by taking advantage of market fluctuations. For example, day traders have an intraday time horizon, making several trades over the course of a single day – and sometimes a few days. Swing traders on the other hand have a more medium-term outlook, looking to capture trends and momentum over several weeks or months.
Ultra-short-term traders may use algorithms to help them place trades in milliseconds to scalp or make a series of small but quick profits. They are also known as high-frequency traders (HFTs) and often used computer programs to execute their trades based on preset criteria. While high-frequency trading is often in the realm of professional traders and hedge funds, algorithmic trading platforms are becoming increasingly popular and available to most retail traders.
What to trade
There are thousands upon thousands of stocks listed on the stock exchange, and many more that can be traded over-the-counter (OTC). As a stock trader, this is incredibly overwhelming. As such, you will need to narrow this down. Fortunately, most brokerage platforms have filters and screens that allow you to do just that.
In general, most stocks are categorised based on market capitalisation, industry, and whether they present growth or value investing opportunities.
The market cap of a company represents the value of its hares multiplied by the number of shares it has outstanding. In general, stocks with bigger market caps represent larger, more mature, and stable companies with less growth opportunity but also less volatility. On the other hand, small-cap are usually riskier but can provide traders with more long-term growth.
Mostly, a stock market’s market cap can be split up as:
- Mega cap: This has a market cap of over $200 billion
- Big/large cap: This has a market cap between $10 billion to $200 billion
- Midcap: This has a market cap between $2 billion to $10 billion
- Small cap: This has a market cap between $250 million to $2 billion
- Microcap: This has a market cap between $50 million to less than $250 million
- Nanocap: This has a market cap of less than $50 million
What a company mainly does and the industry they typically work in will be reflected in the performance of their stocks. For instance, a consumer staples stock will tend to fare well during a recession because people will always need their products. On the other hand, a consumer discretionary stock may wind up suffering as consumers cut back on optional purchases when the economy is not doing so well.
A company’s industry classification, known as its Global Industry Classification Standard (GICS) is a critical tool for investors who want to create a diversified portfolio. It can also help to identify competitors of a company in the same industry.
Some stock market sectors include communication services, energy, healthcare, industrial, real estate, utilities, information technology, and more.
Growth vs Value
Growth stocks are specifically shares of companies that are expected to grow faster than the overall market due to their potential for innovation, expansion, or disruptive technology. These are often newer companies, startups, or smaller-cap stocks.
Conversely, value stocks are shares of companies that are perceived to be undervalued by the market and have strong fundamentals. Value traders look for stocks with solid fundamentals, such as low price-to-earnings and price-to-book ratios as indicators of their financial strength relative to their market price. Value stocks may also pay higher dividends to stockholders.
Exchange-traded funds (ETFs) trade similar to shares of stock, but each ETF share represents holdings in various different stocks. ETFs offer traders a way to gain access to an entire industry or market, broad market index, or asset class just by using a single instrument.
How to trade stocks
Open a brokerage account
In order to begin stock trading, one must first open a brokerage account. That is a specific account type designed to hold investments. Opening a brokerage account is pretty straightforward – here are plenty of online brokers around. Opening an account doesn’t technically mean you are investing straight away – it just gives you the option to do so once you are ready.
Set a stock trading budget
According to a few experts, putting more than 10% of your portfolio in an individual stock can be risky. As such, there are a few simple rules experienced traders follow to make sure they do not incur heavy losses. These include:
- Invest only the amount of money you can afford to lose
- Do not use money that is going towards near-term, must-pay expense such as tuition payments, utilities or down payments
- Lower the 10% if you do not have a healthy emergency fund and make sure 10-15% of your income is put into a retirement account
Learn to use market and limit orders
One you have your brokerage account and an appropriate budget in place, you can use your broker’s website or app to place your stock trades. You will be shown several options for order types. These dictate how your trade goes through. The two most common type include:
Market order: This is used to buy or sell the stock ASAP at the best available price.
Limit order: This is used to buy or sell the stock only at or better than a specific price you set. For a buy order, the limit price will be the most you are willing to pay. The order will go through only if the stock’s price falls to or below the amount.