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- Stock trading involves buying and selling stocks for profits within a short time period.
- Trading is a risky venture, and to do it successfully requires time and understanding the market.
- Trade smarter by setting your budget, risk tolerance, and trading strategy ahead of time.
We all want to be the next person to win big with a lucky stock trade. Unfortunately, this isn't in the cards for most traders. In reality, it takes a lot of knowledge, research, discipline, and patience to become a profitable stock trader.
"Investing is not about getting rich quick. Investing is about getting rich slowly," says Randy Frederick, vice president of trading and derivatives at Charles Schwab. These are wise words to live by if you're new to the stock market and wondering if trading is right for you.
But if you're curious about the thrill of short-term buying and selling and the potential profits that can come along with it, here are the basics of stock trading and the steps that will help get you started.
What is stock trading?
Stock trading entails buying and holding stocks for a short period of time in order to turn a quick and significant profit. Traders aim to take advantage of short-term pricing fluctuations in the market.
Trading can be contrasted with investing, the approach to the stock market that aims to gradually build wealth by holding assets over a long period of time. Whereas investors buy stocks and hold them for many years, traders hold them for only an hour, a day, a week, or a few months.
There are two main types of stock trading: active and passive trading.
Active trading is a highly technical approach with the goal of capitalizing on short-term price fluctuations. Active traders are generally divided into two camps, based on the time period in which they hold their securities:
- Day traders: Day trading refers to any strategy that involves buying and selling stock over a single day, such as seconds, minutes, or hours.
- Swing traders: Swing trading involves buying securities and holding them for days or weeks.
Passive trading focuses more on stocks' long-term trends, rather than short-term fluctuations or market news. Position trading is a type of passive trading.
Passive traders buy based on overall market trends, and sell when they believe the security hits its peak, which can take months. They generally trade less than active traders. In this way, passive traders are more akin to long-term investors who follow a buy-and-hold strategy.
How to learn stock trading
Stock trading is a tricky business. Yes, trading individual stocks can be exciting and profitable, but it's not easy. Here are a few things to keep in mind:
Successful trading takes time and commitment. If you're just starting out in trading stocks, it's best to avoid day trading and consider longer-term strategies. "Day trading is actually the worst option for beginner investors," says Frederick. In reality, for every person who makes millions off of a lucky trade, there's thousands of others who lost money trying the same tactic.
Whether you plan to trade full-time or part-time, the bottom line is trading requires a lot of time to follow the markets and spot opportunities. And when it comes to trading within short-to-medium timeframes, timing can often be everything.
Trading has tax implications. Don't let the thrill of making a quick buck distract from your obligation to the IRS. It's important to understand how taxes on trades could affect your tax bill.
When you sell your stocks for a profit, you are subject to capital gains tax. While profits on stocks held for more than a year get a special tax rate —meaning you'll most likely pay lower taxes — profits on stocks held for less than a year are taxed at the same rate as your regular income.
Knowledge is power for trading safely. Instead of blindly pursuing "hot" stock tips from a neighbor or recommendations from Wall Street analysts, it pays to develop your own trading ideas. When you study historical stock movements and research an investment yourself, you'll be able to ride market volatility or formulate an exit strategy with confidence.
Moreover, experts agree that one of the worst things you can do is let your emotions or bias influence your investing decisions. Excessive emotional trading is one of the most common ways investors damage their returns.
How to start trading stocks
Now that you're armed with the stock-trading basics, it's time to get into the real deal. Just make sure you take your time to learn the ropes. "Dip your toe in," Frederick says. "Don't dive in."
1. Open a trading account
You will need a broker to make trades, so you'll want to find one that you like and trust. There are several brokers to choose from, each with their own specialties.
As you decide on a broker, choose one with the tools, features, and interface that best complement your trading style and know-how. Other things to consider are fee structures, on-the-go accessibility, stock analysis tools, and educational resources. In the end, beginner traders will want a firm that has a wide offering and that will be there when times get tough.
If you're not sure where to begin, see our recommendations for the best stock trading apps.
2. Set your budget
Set a trading budget for yourself and stick to it. Frederick suggests that if you're drawn toward shiny new investments or companies, allocate up to 1% or 2% of your investment budget toward those assets. You can start trading with just about any amount, but don't touch money you might need in the short-term, like for mortgage payments or emergencies.
3. Learn the basic types of stock analysis
Generally, trading relies on "technical analysis," or making decisions based on stock price and historical market data, rather than "fundamental analysis," which involves evaluating a company and determining its true worth.
The goal of technical analysis is to analyze price movements of a security in an attempt to forecast future price movements. While a technical analyst may look at statistical trends and patterns with charts, a fundamental analyst will start with a company's financial statements.
While the two styles of analysis are oftentimes considered as opposing approaches, it makes financial sense to combine the two methods to give you a broad understanding of the markets to help you better gauge where your investment is heading.
In short: Any time well spent learning the fundamentals of stock trading is time well spent.
4. Practice with a stock market simulator
As you begin improving your analytical skills, you can easily put them to practice. Give stock trading a try without putting real money on the line with virtual trading, or paper trading. Virtual trading allows you to test your trading skills in a low-stakes environment.
Reputable online programs include TD Ameritrade's paperMoney, MarketWatch's Virtual Stock Exchange, and Power E*TRADE.
5. Plan your first trade
Once you fund your brokerage account and you're ready to place your first trade, it's time to drum up a plan, which will help you maintain discipline and consistency as a trader.
A good trading plan typically outlines entry (buy) and exit (sell) points, informed by your skill level, risk level, and your overall goals. Keep in mind that every position you hold will most likely come with its own technical parameters —so keep in mind the time and effort you'll need to give each stock the attention it deserves.
FAQs on stock trading
What are fractional shares?
A fractional share allows an investor to own a small portion, or fraction, of one whole share of a stock. Exchange-traded fundscan also be bought as fractional shares. Previously, retail investors would need to have thousands of dollars to invest in an expensivestocklike Amazon, for example. Now, they can own a slice of Amazon with as little as $5, so they can build a diversified portfolio no matter their investing budget.
What is a broker?
A stockbroker is a type of broker that allows you to buy and sell stocks, bonds, and other securities. When you choose a broker, you open abrokerage account, which is a fundamental step to becoming an investor.Securities are bought and sold on stock exchanges, like theNew York Stock ExchangeandNasdaq. Because these exchanges require special access or membership to trade, investors need brokers to facilitate transactions.Broker firms and individuals become members of specific exchanges by meeting certain regulatory standards set by the Financial Industry Regulatory Authority (FINRA).
What is a cyclical stock?
A cyclical stock rises and falls in tandem with the economy. When the economy is strong, unemployment is low, and production and consumer spending are high, cyclical stocks tend to gain value. But when a weakening economy hits — causing businesses to contract and lay workers off, and people to shut their wallets — the value of these stocks goes down.
Cyclical stocks can rapidly drive gains in a portfolio when the economy expands, with supply and demand in specific sectors growing. But they can also quickly reduce the value of a portfolio when spending slows and the economy starts to shrink, further dampening demand. So timing is key to investing wisely with cyclical stocks.
What is a defensive stock?
A defensive stock can be relied on to provide consistent returns even during an economic or market downturn. These companies typically offer goods or services people buy even when the economy isn't doing well. There are no hard and fast rules to define a defensive stock, but there are some general guidelines you should look for:
- History of success:The company is established and very large. It has a couple of decades in business, at the very least, and a total market value in the billions is a reasonable threshold.
- Consistent dividends:The stock has consistently paiddividendsover a long period of time — 10 years or longer.
- Low volatility:Thebeta coefficient,which measures a stock share's movements compared to the overallstock market's, is low — ideally below 1. This indicates that the stock isn't greatly affected by market swings. The beta coefficient is a complex economist's tool, but you can often find it in analysts' reports on a company, or it may be included in its online stock listing.
What is momentum investing?
Momentum investing is a different approach to the stock market than other investing strategies, focusing on the pure market instead of fundamentals that drive the market. In physics, an object in motion will stay in motion until it's acted upon by an external force. Momentum investors apply the same rule to stock prices, expecting a growth trend to continue over the course of a few months. Momentum investing works on the belief that if a stock's price is increasing, it will continue to increase in the intermediate term. Once that momentum dries up — either the price has plateaued or starts declining — it's time to sell.
Lauren Perez is a New York City-based freelance writer who has been on the personal finance beat for five years. Her work has appeared in Forbes, MagnifyMoney, LendingTree, and SmartAsset. In addition to deposits and investing, Lauren can be found writing personal essays and covering culture.
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