The Basics of the Stock Market
2022-06-21 | Simpler Trading Team
Investing in the stock market is a critical path to gaining financial freedom. Whether you intend to save and invest money for retirement, you can also become a full or part-time trader and bring in added income by conducting technical analysis, studying charts, and using indicators.
The stock market is a viable exchange for many investors who have been using it to invest in their future. As great as the stock market is, it comes with risk. Ultimately risk is a good thing in the stock market, but you need to have a clear understanding of it, and the way to do that is by learning the basics of investing in stocks.
Learn How to Invest in Stocks
Society tends to have a complex viewpoint of investing. Many want to invest, but you’d be surprised how many people don’t know how, so they put off investing and saving for the future. No one needs to wait until they have all of their debts paid off, have landed a fantastic job, or happen to have the extra money in their pockets to begin investing in their future. You can start right now.
The Steps to Start investing:
- Open a brokerage account – a brokerage account is separate from a bank account and needed to invest in stocks and options. Here at Simpler Trading, we use tastyworks, TradeStation, and thinkorswim.
- Establish your investment strategy.
- Understand your risk gauge.
- Learn to paper trade with your new account – being comfortable operating your trading platform is key to executing your trades and conducting your technical and analytic research in a timely and proficient manner.
Anyone can start their brokerage account and start plotting their entry strategy to begin investing regardless of their life events. It’s incredible what can happen when you plan and make a budget that cuts out unnecessary expenses – and then you apply the money you saved to an investment strategy.
Create a Budget
You could be a candidate for cutting out expenses if your pet has more outfits than you do or orders takeout consistently rather than using your kitchen to prepare fresh meals. These are just two plausible examples of thousands of ways we choose to spend our disposable income.
Creating a budget to help meet your goals can propel your plans to invest. Did you know that studies show that writing down your goals can increase the likelihood of achieving them by up to 42%? When you write things down, you activate both parts of your brain – the imaginative and logic-based hemispheres.
Understanding Compound Interest
One of the first things everyone needs to learn as they dive into investing is the power of compounding interest. This is earning interest on interest – making more money and then growing your returns.
Compounding interest is one of the top reasons you should invest in the stock market.
Here’s an example: let’s say you invest $5,000 and add $100/month to your investment. On average, market returns are 8% annually. In five short years, your investment will grow to over $14,398!
To simplify this, the basic steps to learn how to invest are as follows:
- Eliminate unnecessary spending; live on less than you make.
- Don’t just think about it; write down your investment goals and budgeting plans.
- Understand the power of compounding interest, then continuously grow your trading/investing account using risk-management strategies.
Traders can get a handle on debts by prioritizing the order in which they pay them down. Not all debt is bad, and not all debt is created equal. Debt is necessary for most people to mortgage a home, buy a car, or attend higher education. While you have to repay these debts, they can provide tax credits that offset some payments.
Debt carries an interest rate, which can be compound Interest working against you. Credit cards usually carry a higher interest rate and can pay significantly more over time than you initially borrowed. This was money you could be investing! With these core first steps, you can be well on your way to using time-tested trading and investment strategies.
Are you Ready to Invest in the Stock Market?
If you are ready to start investing but don’t know where to start, why not start with Simpler Trading and sign up for the MEM Edge Report. The MEM Edge Report is a carefully researched report of the top stock picks, updated and delivered to you twice a week. The report is created by Mary Ellen McGonagle, who has 20 plus years of experience picking top stocks. She has also personally advised leading financial institutions and mutual fund managers on some of the most promising stocks they have ever traded. And now, Mary Ellen McGonagle focuses on individual investors and traders looking for the right stock trades at the right time. So sign up for the MEM Edge Report today and get the guidance you need.
Determine Your Investment Style
Investing for beginners may seem intimidating, but it doesn’t have to be. Traders learning the ropes should determine their long-term goals because this will determine their steps to reach them.
Many confuse the difference between the somewhat interchangeable terms of investing and trading. Investing in stocks involves taking a trading position of the stock, or other assets, for a longer-term that lasts from a few months to years. This investment style is heavily based on fundamental analysis.
Fundamental analysis uses earnings and company data to provide investors with longer-term investing guidance. They use this information for price movement forecasting. Essentially, studying the company’s economic and industrial factors and using specific parameters can predict a fall or rise in stock.
Investors compare one company’s financial strengths and capabilities to another company in the same industry or sector. This allows them to determine the fair value of the stock price of a particular company.
One of the most widely recognized investors is Warren Buffet. Warren’s criteria for a good investment is the valuation of the earnings per share (EPS), which is the company’s total earnings divided by all the company shares. A positive earnings-per-share can indicate good profitability.
On the other hand, trading stocks involves holding onto a stock or option for a much shorter time frame. These trading windows can be as short as mere minutes (scalping) to weeks or months. Traders are constantly looking for market opportunities – or shorter blips in the market that traders can take advantage of regardless of the longer-term or broader movement.
Trading stocks relies primarily on technical analysis. This analysis relies on charts and historical indicators that allow traders to determine whether a stock’s current price is sustainable or if the price may drop in the near future. Using this analysis, the focus is on the stock price itself and not necessarily on the financial strength of the company that issued the stock.
While you can certainly invest and trade, it’s essential to understand which elements to study, for instance, the trade setup or the investment position. If you are trading, you should be investing long-term, as well. Or, you can choose to invest and not trade.
Both strategies have different outlooks. Investors are looking for longer-term plays, passive income, and consistent companies with strong fundamentals to continue growing over the next 5, 10, and 15 years. If you aren’t interested in the daily or weekly maintenance of your investments, investing provides a slower pace – and often less risky – return over time. The ability to wait out a dip in the stock price to return to a previous high is an advantage a shorter-term trader would not have.
This is why the study of fundamental analysis is important to investors. Should a company stock or underlying asset not have the capability to survive a serious drop in the stock price, no amount of time may help it return to the previous high.
If you’re ready to take a more active approach in the markets – with quick entries and exits – trading might be for you. There are many conservative stock trading strategies that beginning traders can use to start.
Which Stocks to Trade First
Investment and trading decisions are based on trading style and risk management. This causes traders and investors just getting started to ask, “What stocks to buy today?”
There are different types of stocks for investors to consider.
Common stock represents partial ownership in a company. This stock class entitles investors to generate profits, usually paid in annual or quarterly dividends. Common stockholders elect that company’s board of directors and have rights to a company’s assets in a liquidation event – but only after preferred stock shareholders and other debt holders have been paid. These different classifications belong to the same stock.
Otherwise, company stocks – common or preferred – are also classified based on their fundamental analysis and projections. They can be classified according to, among other things, their presumed potential for growth. Growth stocks are typically companies that are growing and reinvesting their profits. Value stocks are those that trade at a discount when compared to the company’s performance.
Generally, growth stocks tend to outperform during economic expansion and when interest rates are low. An example of a growth stock would be those in the technology sector. With access to affordable financing, technology stocks benefit from a robust economy and generally outperform the broader market.
Conversely, value stocks typically have more attractive valuations than the broader market. Value stocks are generally found in the financial, healthcare, and energy sectors. Value stocks usually generate reliable income streams.
While investors and traders generally research individual companies and stocks, many traders and investors use mutual funds and exchange-traded funds to mirror the markets in their investment accounts.
These indexed investment vehicles suit many investor strategies with the easily tradable exchange-traded fund (ETF) – a favorite of many Simpler traders. ETFs can be compared to a basket of stocks that can precisely track an industry sector or the markets as a whole. While there is an inherent risk with any investment in the stock market, ETFs can help mitigate some risk by spreading out investments over multiple stocks. Should one stock go down, all of your eggs aren’t in one basket.
ETFs differ from mutual funds in a couple of ways:
- Mutual funds have direct fund management daily, while ETFs are passively invested in mimicking the indices.
- Mutual funds generally have higher fees than ETFs.
- Mutual funds are not easily tradable as they can take a day (or longer) to settle and reinvest.
- ETFs tend to be more cost-effective (and more liquid) as they trade on exchanges just as shares of stock do.
A few of the favorite ETFs that track the overall market are worth looking at their holdings and which index they track are as follows:
When investing in ETFs, traders and investors should look for a passive return of income (ROI) of 8 -10% per year. This is never a guarantee, but the most important thing is for investors (holding longer-term) to not focus on the daily moves up and down.
Make Diversified Money Moves
Young investors will have slightly higher risk tolerance. They can allocate their portfolio holdings to include more aggressive growth funds.
A bonus of trading or investing in ETFs is they exercise diversification in their makeup. Even while an ETF is diversified by holding more than one stock, investors will still want to invest in ETFs from different sectors and industries due to sector rotation.
The adage “don’t put all your eggs in one basket” might be “old,” but it still rings true. It creates a visual of one basket of eggs in the hen house crashing down, yet three others remain unharmed.
Trading and investment accounts should be structured in such a way as to mitigate risks in the markets. These diversification strategies vary depending on the long-term goal of the investor, as well as the amount of time before the invested funds will be cashed out.
Investors in their early 30s, with no children and higher risk tolerance, might have portfolios allocated with the following 1) ~10% Income Funds; 2) ~35% to Growth Funds; 3) ~55% to Aggressive Growth Funds. At this risk level, you can further simplify and allocate 80-90% to stocks and 10-20% to bonds. There are several ways to reallocate your portfolio. Your trading platform may even have an asset allocation tool in its dashboard. Investing is a long-term play; the earlier you begin, the longer the amount of time the account has to grow. Remember compounding interest?
Trading Platforms as Workspaces
Online trading platforms such as tastyworks, TradingView, TD Ameritrade, and many others serve as the bridge between the strategy you want to employ and the market itself. While investors can use brokers to place their trades, the movement to place trades online has gained popularity with traders and investors.
Software systems are used for trading securities in the market and allow traders to manage their market positions. Online trading platforms are usually free or offered at a discount to maintain a funded account and make a specified number of trades per month.
Trading platforms can offer sophisticated tools such as real-time streaming quotes, advanced charting tools, live news feeds, educational resources, and access to proprietary research. The platforms generally have an academic area to practice trading stocks.
Traders and investors need to consider fees and features when comparing trading platforms, as both can affect the overall returns.
These are some of the basic orders you might place on a trading platform:
A market order is the most basic type of trade. It is an order to buy or sell immediately at the current price. If you buy a stock, you will pay the price at or near the posted ask. The ask is the price a seller is willing to accept for a security.
You will receive a price at or near the posted bid price when selling a stock. The bid price is the price a buyer is willing to pay for a security. The last traded price is not necessarily the price at which the market order will be executed. In fast-moving and volatile markets, the price that executes can deviate from the last traded price.
Market orders do not guarantee a price but ensure the order’s immediate execution. Market orders are executed as soon as possible, although the investor doesn’t know the exact price at which the stock will be bought or sold.
A limit order is a pending order that allows investors to buy and sell stock at a set price in the future. This order will only execute if the price reaches that pre-defined level. The order will not be filled if the stock price does not meet that level. For example, if you wanted to buy a stock at $100, you could enter a limit order for this amount. However, you could still buy it for less.
There are four types of limit orders:
- Buy Limit: This is an order to purchase a security at or below the specified price. Limit orders must be placed on the correct side of the market to ensure they will execute at a beneficial price. This means placing the order at or below the current market bid for a buy limit order.
- Sell Limit: This is an order to sell a security at or above a specified price. To ensure an improved price, the order must be placed at or above the current market ask.
- Buy Stop: This is an order to buy a security at a price above the current market bid. A stop order to buy becomes active only after a specified price level has been reached. This is known as the stop level. Buy stops are orders placed above the market and sell stop orders are placed below the market.
- Sell Stop: This is an order to sell a security below the current market ask price. As with the buy stop, a stop order to sell becomes active only after a specified price level has been reached.
Charting tools and indicators are necessary because the trades you make will depend on market direction. A simple long stock position is bullish and anticipates growth, while a short stock position is bearish.
When traders make a long trade, they purchase an asset to sell when the price increases. The terms “buy” and “long” are used interchangeably.
When traders and investors are in a short trade, they borrow an asset, sell it, and hope to buy it back when the price goes down. Traders and investors use long and short positions to achieve different results.
As traders gain experience, they may place options trades. These trades involve contracts to buy or sell a stock – not the stock itself. A long call option position is poised to capture bullish (or upward) movement in the stock price as the trader expects the stock price to rise and buys calls with a lower strike price.
The short call option position offers a similar strategy to short selling without the need to borrow the stock. Often, the short investor borrows the shares from a brokerage firm in a margin account to make the delivery, hoping the stock price will fall. The trader buys the shares at a lower price to pay back the dealer who loaned them. If the price doesn’t fall and keeps going up, the short seller may be subject to a margin call from their broker.
Pre-Work Makes Stocks Move
Regardless of when you decide to start investing – it’s never too late to make your first stock purchase.
With an account opened, funded, and ready to go, traders can use their charts and indicators to determine whether they want to buy, hold, or buy the dip. Depending on the time frame of your trades, buying or selling depends on a different type of research and affects your historical charts.
A single stock can be the beneficiary of very different strategies depending on the trader’s goals. Traders should focus on the investments that are researched and not participate in fear of missing out (FOMO) when others are chasing stocks. By the time most of us hear the news of a stock movement, it’s almost always too late to get in on that move anyway.
By maintaining risk management strategies that limit exposure to trades that can take out a trading account, traders and investors alike can make solid market moves. If you find still find yourself needing guidance on the right stocks to pick in the stock market, then we would urge you to sign up for the MEM Edge Report. Where Mary Ellen McGonagle, the Senior managing Director of Equities at Simpler Trading will research the market for you and give you market updates twice a week.
FAQs on the Stock Market
Q: Why should I invest in a market is headed for lower lows?
A: Traders and investors prefer an entry when oversold stock prices are hovering at low prices. There are different reasons a trade may or may not be a good idea. But as a general rule, buying the dip is an attempt to capture a stock that you want to own at a temporarily lower price, with the idea the stock will go up over time based on its past performance. Bottom Fishing is based on the same idea, except you are looking for stocks that are so low that they theoretically have nowhere to go but up. Bottom fishing is a riskier venture as some stocks may have dropped to lower lows for a reason.
Q: What is the difference between a long and short trade?
A: Traders place trades based on market or stock directions in hopes of capturing a profit regardless of direction. Long trades are considered a buy-in in hopes the stock price will rise, and the trader can make a profit. Short trades are considered a sell and are designed to profit from dropping stock prices.
Q: Why should I use indicators to place trades? Doesn’t the market news tell me everything I need to know?
A: Traders and investors must include trading and investing education into their trading strategies. It’s essential to understand why a trading strategy or investment may or may not be good. Early investors and traders have already affected its potential by the time a stock price or market movement has made its way to a news desk.
Q: How do you build discipline in trading?
A: Key components of building a trading discipline: have a trading plan, know how often you want to trade and what asset classes, choose a strategy and stick to it.
Q: How do you take a long position on a stock?
A: To go long on a stock you have to obtain an account from a brokerage firm where you will have the ability to buy stocks.