If you are interested in trading in the stock market, getting started can be a daunting task. You may already be investing in mutual funds or index funds as part of your retirement plan but trading individual stocks requires a significantly different strategy.
Retirement investing usually involves choosing a few funds, setting up automatic contributions, then waiting a few decades, or simply handing over your money to a financial advisor. However, “trading” is a much shorter-term endeavour, requiring a lot more analysis and day-to-day activity to enter and exit the market on a regular basis.
If you are a beginner in stock trading, learning a few key strategies and how the market works as a whole can ensure you get your trading off to a good start.
The good news is that anyone with a brokerage account and some extra money can get started, but before diving in, first determine how much money you are willing to risk. This amount needs to be based not just on your financial situation, although that is important, but also on your own psychology and feelings about winning and losing. Don’t forget, when trading short-term, you’ll be much more focused on your profit and loss than you are with your long-term investments.
Psychologists have consistently concluded that (unfortunately for us humans) the emotional pain of losing money is significantly more than the joy of an equivalent gain. In other words, winning a thousand pounds may make you feel good, but losing a thousand pounds will make you feel a lot worse. It’s important to understand this first before it happens.
If you spend any time reading or listening to the financial press, you will hear them talk about the bulls and the bears. These are simply terms for stocks moving up or down. Bullish means that a stock is moving up and bearish means the stock is moving down. The terms come from how these animals attack.
Think of a bull charging a matador. He runs with his head down and then strikes by thrusting his horns upwards. A bear does the opposite, when it attacks, it rears up on its hind legs and then attacks downwards. When you hear these terms, just know they are euphemisms for stocks moving up and down.
It’s your choice as to how you make your trading decisions. These can be based off fundamental analysis (news, politics, company results, etc.) or technical analysis (charts and technical indicators) or a combination of the two.
Trading off fundamentals is generally used by longer-term buy-and-hold investors, but day traders can also have success with this type of trading.
Fundamental analysis involves looking at the news, financial statements and quarterly earnings reports to learn about the underlying health and profitability of the company. Whether you are investing for the long term, day trading, or anywhere in between, learning how to analyze the fundamentals of a company is important.
Now I know what you are thinking. How can one person with a laptop and a smartphone outsmart a professional hedge fund manager with a team of analysts and a slew of expensive proprietary software?
It’s actually quite feasible because you have one enormous advantage over them. You are dealing with much smaller amounts of money than they are, that makes you much more nimble when placing orders and executing trades.
Let’s say that a company CEO just reported a huge increase in profits during a quarterly earnings call after hours and you and a hedge fund manager both want to quickly buy the stock. You can place your order, and have it executed almost immediately, but the hedge fund manager has a big problem.
In order for it to be a worthwhile trade, they may have to buy many thousands of shares, or even more. Placing an order that large will result in a huge and instant price spike, and they will end up buying the stock at a much higher price which may make the trade not worthwhile.
Many individual stock traders can use their small size to their advantage and make outsized profits, on a percentage basis, by building a structured trade plan and being able to outmaneuver institutional investors.
Technical traders do not concern themselves with the underlying profitability of a company, but only look at the price action of stocks and try to predict the future by looking at the past. Certain price patterns repeat over and over again in the stock market, and by identifying them, day traders can make short-term profits.
Volumes of books have been written about technical analysis, but to start off one should learn a few of the basics. Simple support and resistance levels provide evidence of supply and demand areas within the market, and trends, channels, price patterns and other studies can be combined to build a robust trade plan to anticipate potential future price moves.
Similarly, many traders look at the daily charts of stocks overlaid with different moving averages. A moving average is a simple analysis tool that smooths out price data by creating a constantly updated average price. The average is taken over a specific period, like ten days, twenty minutes, thirty weeks, or any time period the trader chooses.
Points where the real time price chart crosses different moving averages can be seen as either bullish or bearish. For example, let’s say a stock has been lagging the market and its sector. When the price crosses above, say, the ten-day moving average, this can be seen as a bullish indication that the stock is getting ready to break out.
Instead of looking at all the stocks on the exchange trying to find one that fits your criteria, it is recommended that you pick a small number of stocks, maybe around five or so, and learn as much as you can about how they trade on a daily basis.
For example, if you follow a stock for a while, you may notice certain patterns of behaviour that emerge based on news events or earnings reports. A common time for these patterns to emerge is during earnings season, but they can happen at any time.
For example, you may notice that every time a certain company announces its earnings report after hours, the stock plummets, only to come right back up again when normal hours trading begins the next morning. By taking advantage of these patterns, a short-term stock trader can potentially make a nice sum of money in a relatively short time.
You may also notice patterns in the technical charts, for example how the price fluctuates but always bounces off the same price point near its bottom (support level). Basing trades on a few stocks you watch very closely will garner much more success than trying to trade them all.
Before you start trading stocks you should be aware of the pros and cons of trading and determine if this is the right decision for you. You, as an individual investor with no resources other than your computer and an Internet connection, are perfectly capable of making consistent profits in trading stocks. It can be a bumpy ride though, since not every trade or every day will be profitable.
Knowing yourself and how you react to losing money is crucial. You also have to be willing to put in the work, which can be time consuming. In order to make money trading stocks, you have to be willing to make time as well as steel yourself against potential losses.
You will most likely get started by buying and selling individual stocks. However, this involves paying out the full amount to buy the shares outright, so although this will limit the volatility of your profit and loss, it will also limit your potential gains.
A more rewarding (but potentially more risky) way to trade stocks is to trade them using a leveraged trading account, such as CFDs (Contracts For Difference) or spread-betting account. In these markets, you only need to pay a small deposit (or margin payment) to open a new position, and then a small percentage move in the stock can reward you with a much larger (leveraged) profit in your account. Of course, leverage (or margin trading) works both ways, so your potential losses would also be greater. However, this risk can be mitigated by protecting your positions with Stop Losses, which will automatically get you out of losing trades before your losses get too big.
There are pros and cons to margin trading. Profits generated when trading with a spread-betting account are tax free in UK, and the cost of trading can be very cheap. However, although this is not so relevant for day traders, margin trading does have its downside. If your trade goes against you but you believe the fundamentals of the underlying stock are still intact, you can simply ride out the temporary decline (if you have bought the actual shares), but if you are trading on margin, you may not be able to do this. If the price moves too far against you, the broker may issue a “margin call” which would automatically close out your position, often at a low level. That said, a well-managed short-term trading strategy should be able to avoid this in the vast majority of cases In summary, getting involved in stock trading can be very rewarding, both personally and financially. If you want to get started, make sure to commit to learning as much as you can, understand your own psychology and how you handle losses, and don’t ever commit more money than you are willing to lose..
After learning about stock trading, its pros and cons, start developing your profitable trading strategy through a combination of fundamental analysis and technical analysis by enrolling on one of our award winning, accredited trading courses.
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