Stock Trading

Wouldn't you love to own a business without ever having to report for work? Imagine if you could relax, watch your business grow, and collect the dividend checks as the money pours in! This situation might seem like a pipe dream, but it's nearer to reality than you might think. As you might have guessed, we're referring to owning stocks. This magnificent category of financial instruments is, undoubtedly, among the greatest tools ever invented for amassing wealth. Stocks are a part, if not the cornerstone, of almost any investment portfolio. When you begin on your road to financial freedom, you need to have a good understanding of stocks and how they trade on the stock market. Over the years, the average person's interest in the stock market has grown remarkably. What was once a toy of the rich has now emerged as the vehicle of choice for growing wealth. This demand coupled with developments in trading technology has opened up the markets so that nowadays nearly anybody can own stocks.

What Are Stocks?

The Definition of a Stock Plain and simple - a stock is a share in the ownership of a company. Stock corresponds to a claim on the company's assets and earnings. As you purchase more stock, your ownership stake in the company becomes greater. Shares, equity, or stock, all mean the same thing. Being an Owner Holding a company's stock means that you are among the many owners (shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that theoretically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are allowed to your share of the company's earnings as well as any voting rights attached to the stock.

How Stocks Trade

Most stocks are traded on exchanges, which are venues where buyers and sellers assemble and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You've probably noticed pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and gesturing to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. The principle of a stock market is to facilitate the exchange of securities between buyers and sellers, sinking the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is actually a super-sophisticated farmers' market linking buyers and sellers.

The New York Stock Exchange The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The "Big Board" was founded over 200 years ago in 1792 with the signing of the Buttonwood Agreement by 24 New York City stockbrokers and merchants. Currently the NYSE, with stocks like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and Wal-mart, is the preferred market for the largest companies in America.

The NYSE is the first type of exchange (as we referred to above), where much of the trading is done head to head on a trading floor. This is also known as a listed exchange. Orders come in through brokerage firms that are members of the exchange and flow down to floor brokers who go to a specific spot on the floor where the stock trades. At this location, known as the trading post, there is a specific person called the specialist whose job is to match buyers and sellers. Prices are determined using a bidding method: the current price is the highest amount any buyer is willing to pay and the lowest price at which someone is willing to sell. Once a trade has been made, the details are sent back to the brokerage firm, who then notifies the investor who placed the order. Although there is human contact in this process, computers play a significant role in the process.

The Nasdaq The second type of exchange is the virtual sort called an over-the-counter (OTC) market, of which the Nasdaq is the most popular. These markets consist of no central location or floor brokers whatsoever. Trading is done through a computer and telecommunications network of dealers. In the past, the largest companies were listed only on the NYSE while all other second tier stocks traded on the other exchanges. The tech boom of the late '90s changed all this; now the Nasdaq is home to several big technology companies such as Microsoft, Cisco, Intel, Dell and Oracle. This has resulted in the Nasdaq becoming a serious competitor to the NYSE.
On the Nasdaq, brokerages act as market makers for various stocks. A market maker offers continuous bid and ask prices within a prescribed percentage spread for shares for which they are designated to make a market. They may match up buyers and sellers directly but usually they will maintain an inventory of shares to meet the demands of investors.

Other Exchanges The third largest exchange in the U.S. is the American Stock Exchange (AMEX). The AMEX used to be an alternative to the NYSE, but that role has since been occupied by the Nasdaq. In fact, the National Association of Securities Dealers (NASD), which is the parent of Nasdaq, bought the AMEX in 1998. Almost all trading now on the AMEX is in small-cap stocks and derivatives. There are many stock exchanges located almost everywhere in the world. American markets are undoubtedly the largest, but they still constitute only a fraction of total investment around the globe. The two other main financial hubs are London, home of the London Stock Exchange, and Hong Kong, home of the Hong Kong Stock Exchange. The last place worth mentioning is the over-the-counter bulletin board (OTCBB). The Nasdaq is an over-the-counter market, but the term commonly refers to small public companies that don’t meet the listing requirements of any of the regulated markets, including the Nasdaq.

What are the Advantages and Disadvantages of Stock Trading?

Advantages of Stocks Trading:

Better returns. Actively trading stocks can yield better overall returns than simply buying and holding.

Huge Choice. There are thousands of stocks listed on markets in the US (such as the New York Stock Exchange and Nasdaq) and around the world. There is always a stock whose price is fluctuating - its just a matter of finding them.

Familiarity. The most traded stocks are in the largest companies that most of us have heard of and understand - Microsoft, IBM, Cisco etc.

Disadvantages of Stocks Trading:

Leverage. With a margined account the maximum amount of leverage available for stock trading is usually 4:1. Meaning a $25,000 could trade up to $100,000 of stock. This is insignificant compared to other markets trading.

Pattern Day Trader Rules. Requires at least $25,000 to be held in a trading account if the trader completes more than 4 trades in a 5 day period.

Uptick Rule on Short Selling. A trader must halt until a stock price ticks up before they can short sell it.

Need to Borrow Stock to Short. Stocks are physical commodities and if a trader wishes to go short then the broker must have arrangements in place to borrow that stock from a shareholder until the trader closes their position. This limits the opportunities available for short selling. Contrast this to futures trading where selling is as easy as buying.

Making Your First Trade

When an individual is prepared to make his initial trade, either in simulation or live, he can use the following steps:

Open the online software related to trading. Login to the trading account by using your username and password. When the screen displays the main trading window make sure that the stock that you want to buy is displayed, and that your market data connection is lively and healthy.

Open your Chart to display the main charting window.

Watch the market, and hold on for your trading system's entry necessities to be met.

After you have entered your trade, ensure that your target and discontinue loss orders have been positioned, either manually, or automatically by the trading software that you are using. In a majority of trading systems, the target order should also be a limit order, and the stop loss order should be a stop order. These order types will allow your target order to be packed as soon as possible, while ensuring that the stop loss order will be filled if it is necessary.

Observe the stock market while your trade is active, and hang on for either your target or stop loss orders to be filled. If your trading system comprises any target or stop loss changes, then you can alter your target and stop loss orders accordingly by using your order entry software. Depending on the type of your trading system, you may have to wait from a few minutes to a couple of hours for your trade to exit. Do not be lured to adjust the trade if this is not detailed by your trading system.

If the trading system comprises a specific exit indication (like the zero line cross trade), then you can walk out of your trade via your order entry software. If your trading system does not give any exit signs, then you should have to wait until any of your target or stop loss orders are filled, which will exit your trade appropriately.

Once one of the trade's exit orders has been filled, one should ensure that any imminent orders have been cancelled in your order entry software. If need be, you can also review your trade and your accomplished profit or loss is displayed via the trading software.

If the trading system has a regular profit target, and you have arrived at your target, then you should stop trading for that day and close your trading software.

If you have not yet reached your regular profit target, and the market is still vigorous, you can carry on trading from step no. 3 (Wait for a Trade).

Stock Trading Terminology

A Few Simple Terms

Capital Gain: The sum in which an asset’s selling price surpasses its initial purchase price. This is the gain that is the outcome from the sale of an asset and generally receives more positive tax treatment than normal gains. An asset that hasn’t been sold yet but would produce profit if sold is an unrealized gain.
Equity: Ownership interest in a company in the form of ordinary stock or preferred stock. It is also called shareholders equity, book value or net worth.
Ticker Symbol: A scheme of letters used to recognize stocks or mutual funds. They are up to three letters and are utilized for stocks that are listed and are traded in the stock exchange. Symbols that have four letters are used for the NASAQ stocks and symbols that have five letters ending with an x are used for mutual funds.
Volatility: The condition at which the price of a security fluctuates and is found by finding out the annualized standard divergence of daily change in price. High volatility is the condition when stock moves up and down very rapidly within short periods of time. If the stock price hardly ever changes then it has low volatility.

Methods

Technical Analysis: Technical analysis is the procedure of assessing securities by analyzing market information through the use of open interest, stock charts of price, volume in order to forecast future market trends. This technique presumes that market psychology manipulates trading in a fashion that allow prediction of when a stock may rise or fall. The inherent value of the security is not considered, but in its place the overall state of the market is analyzed.
Fundamental Analysis: This method is used to analyze the value of a security in which the investor carefully analyzes the company’s earnings , growth potential , financials, operation, assets, management, debt, products and competition. This type of study takes into account the variables that exactly connect to the company itself.

Strategies

Buy and Hold: This strategy takes place when stocks are purchased and held for a long duration of time, despite the market’s fluctuations. It is established on the assumption that share prices will go up over the next decade or two, and the market as a whole will go up, despite short-term rise and fall either because of rising inflation or business sequences.
Growth Strategy: This strategy is based on investing in those companies that are emerging faster than others in the same industry. The aim is to make capital gains rather than dividends.
Short Selling: Short Selling is borrowing of a security or a commodity futures contract from a broker and thereafter selling it with the consideration that it must at a later stage be bought back and shall be returned to the broker. This strategy tries to profit from the falling prices of stock and the investor’s broker will borrow the stocks with the assurance that the investor will return them at a later stage. The gain is the difference at which the stock was initially sold and the price to buy it back, minus any costs and commissions.

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