If you think of investments that could beat inflation and give you good returns, one option might be to start investing in the stock market. But, on the other hand, if you have decided to do the same and go for it all by yourself, it’s not a bad idea.
The stock market can help you make a lot of money, but you can lose all your money if you are tempted to invest randomly without knowing the nitty-gritty of the market. So here’s what you need to know about the market.
Get to Know the Stock Market
Before you get started trading stocks, it’s important to know how the market works. Here are some key terms to know.
- Stocks: These are the format of ownership stakes in companies.
- Shares: These are units of stock.
- Stock price: The price reflects the value of a company and its outlook, as determined by those trading the stock (traders and investors). Stocks don’t have set prices. Instead, they continually fluctuate as they’re bought and sold.
- Exchange: Stocks trade on exchanges, which have set hours. Most buying and selling of stocks occur during these hours, although some trading does occur outside these hours. Trading outside of hours is called “pre-market” or “after-hours trading.”
- NYSE: The New York stock exchange is the largest in the world. Seventy of the biggest corporations in the world are traded on the NYSE, along with thousands of other stocks. Its hours are 9:30 a.m. to 4:00 p.m. Eastern time, Monday through Friday.
- Nasdaq: The Nasdaq is another stock exchange. All of its trades are made electronically, and its hours are also 9:30 a.m. to 4:00 p.m. Eastern Time, Monday through Friday.
- Ticker symbol: These are one- to five-letter codes used to trade stocks. For example, the ticker symbol for Amazon is AMZN.
- Bid-ask spread: The price to buy a security is the “ask price.” The price to sell a security is the “bid price.” The difference between these two is the bid-ask spread. It’s a measure of supply and demand for a given stock as well as a measure of liquidity. A tight bid-ask spread indicates that a stock has good liquidity.
- Market liquidity: Liquidity means that the stock can be bought or sold quickly at a stable price.
- Short selling: While many investors buy a stock and sell it later for a profit, it’s also possible to sell first and then buy the stock at a lower price. That’s called “short selling.” Investors can sell first by borrowing the stock.
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Decide What Kind of Trader You want to be
As you consider how to get started in the stock market, you also need to decide what kind of trader you want to be. Do you see yourself trading every day? Do you want to trade a couple of times per week? Or do you want to buy stocks and hold them for the long term?
While there’s no right or wrong way to trade, there are risks and rewards to different approaches. Common approaches include:
- Day trading: Day traders buy and sell stocks throughout the day. The Securities and Exchange Commission (SEC) defines pattern day traders as those who execute four or more day trades within five business days. Day traders often use borrowed money, leading to debt if the day trading isn’t profitable. However, it has the potential for quick returns.
- Swing trading: This is a longer-term approach than day trading. This type of trader takes trades that last from a day to several weeks. This practice offers relatively quick rewards and less potential for loss than day trading, but it’s still a labor-intensive approach.
- Investing: This is the buying and holding of stocks for the long term, which could be months or even years.
Things you need before you trade in the stock market
If you’re trying your hand at stock trading for the first time, know that most investors are best served by keeping things simple and investing in a diversified mix of low-cost index funds to achieve, and this is key long-term outperformance.
That said, the logistics of trading stocks comes down to these steps:
1. Open a brokerage account
Stock trading requires funding a brokerage account, a specific type of account designed to hold investments. If you don’t already have an account, you can open one with an online broker in a few minutes. But don’t worry, opening an account doesn’t mean you’re investing your money quite yet. Instead, it just gives you the option to do so once you’re ready.
Set a stock trading budget
Even if you find talent for trading stocks, allocating more than 10% of your portfolio to individual stocks can expose your savings to too much volatility. But this isn’t the only rule to manage risk. Other do’s and don’ts include:
- Invest only the amount of money you can afford to lose.
- Don’t use money that’s earmarked for near-term, must-pay expenses like a down payment or tuition.
- Ratchet down that 10% if you don’t yet have a healthy emergency fund and 10% to 15% of your income funneled into a retirement savings account
3. Get an education
Before you trade anything, learn everything you can about investing and the markets. Mistakes can be costly. There are a lot of free educational resources that teach how to trade through an online broker. For example, consider Morningstar’s Investing Classroom or one of the investing courses on Udemy.com.
Read more: Is investing in the stock market good or bad
Also, most stockbrokers offer their own educational centers. In addition, some brokers, such as TD Ameritrade, offer their clients paper trading, a simulation of trading that is a great way to practice without money or risk involved.
4. Practice with a virtual trading account
There’s nothing better than a hands-on, low-pressure experience, which you can get via the virtual trading tools offered by many online stock brokers. Paper trading or a virtual trading account lets you test your trading acumen and build up a track record before putting real dollars on the line.
While making a profit on a virtual platform doesn’t necessarily mean that real money profits will come just as easily, it’s a valuable tool for learning how trading works and what style fits you the best.
Read more: How to succeed trading Cryptocurrency
The Bottom Line
Trading stocks is exciting because it involves risk and reward. Starting to trade is the easy part, though. Be prepared for losses, and don’t trade more than you can afford to lose. Over time, you’ll learn what works for you, your goals, and your financial situation.