Stock trading involves buying and selling shares in companies in an effort to make money on daily changes in price. Traders watch the short-term price fluctuations of these stocks closely and then try to buy low and sell high.
This short-term approach is what sets stock traders apart from traditional stock market investors who tend to be in it for the long haul. While trading individual stocks can bring quick gains for those who time the market correctly, it also carries the danger of substantial losses. A single company’s fortunes can rise more quickly than the market at large, but they can just as easily fall. “Trading isn’t for the faint of heart,” says Nathaniel Moore, a certified financial planner and a certified kingdom advisor at AGAPE Planning Partners in Fresno, California. “Don’t take the risk and invest money if you need it.” If you do have the money and want to learn trading, online brokerages have made it possible to trade stocks quickly from your computer or smartphone. But before you dive in, you should make sure you know how the stock market works, the best apps for trading stocks, and how to manage your risk.
Types of stock trading
There are two main types of stock trading
is what an investor who places 10 or more trades per month does. Typically, they use a strategy that relies heavily on timing the market, trying to take advantage of short-term events (at the company level or based on market fluctuations) to turn a profit in the coming weeks or months.
is the strategy employed by investors who play hot potato with stocks — buying, selling and closing their positions of the same stock in a single trading day, caring little about the inner workings of the underlying businesses. (Position refers to the amount of a particular stock or fund you own.) The aim of the day trader is to make a few bucks in the next few minutes, hours or days based on daily price fluctuations.
How to trade stocks
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.
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. It just gives you the option to do so once you’re ready.
Even if you find a talent for trading stocks, allocating more than 10% of your portfolio to an individual stock can expose your savings to too much volatility.
“If all of your money’s in one stock, you could potentially lose 50% of it overnight,” Moore says.
If you want to invest, he says, you could start by saving $200 a month. When you get to $1,000, you could invest $500 of that. Consider the $500 you’re not investing like a parachute. You might not need it, but it’s there if you do. 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 such as 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.
Once you have your brokerage account and budget in place, you can use your online broker’s website or trading platform to place your stock trades. You’ll be presented with several options for order types, which dictate how your trade goes through. We go through these in detail in our guide for how to buy stocks, but these are the two most common types:
Market order: Buys or sells the stock ASAP at the best available price.
Limit order: Buys or sells the stock only at or better than a specific price you set. For a buy order, the limit price will be the most you’re willing to pay and the order will go through only if the stock’s price falls to or below that amount.
Try investing in the market without putting money in the market yet to just see how it works,” says Moore.
You can do that by investing your time, he says, pick a stock and monitor it for three to six months to see how it performs. You can also learn the market via the paper trading tools offered by many online stock brokers. Virtual trading with stock market simulators lets customers test their trading acumen and build up a track record before putting real dollars on the line.
This is essential advice for all types of investors — not just active ones. The bottom-line goal for picking stocks is to be ahead of a benchmark index. That could be the Standard & Poor’s 500 index (often used as a proxy for “the market”), the Nasdaq composite index (for those investing primarily in technology stocks) or other smaller indexes that are composed of companies based on size, industry and geography.
Measuring results is key, and if a serious investor is unable to outperform the benchmark (something even pro investors struggle to do), then it makes financial sense to invest in a low-cost index mutual fund or ETF — essentially a basket of stocks whose performance closely aligns with that of one of the benchmark indexes.
Being a successful investor doesn’t require finding the next great breakout stock before everyone else. By the time you hear that a certain stock is poised for a pop, so have thousands of professional traders, and the potential likely has already been priced into the stock. It may be too late to make a quick turnaround profit, but that doesn’t mean you’re too late to the party. Truly great investments continue to deliver shareholder value for years, which is a good argument for treating active investing as a hobby and not a get-rich-quick scheme.