If you’re new to stock trading, this great post by Stephen at Wealth of Geeks is for you. It’s a real stock trading 101 article so I hope it gives you the foundation you need before putting any money at risk. Tim
Stock trading has become almost mandatory for anyone looking to build wealth today.
Several decades ago, stock trading was something done only by the rich on Wall Street. However, today with fast computers and online brokers, online trading has the lowest barriers to entry.
With the advent of online trading, anyone can register for an account with an online brokerage and buy and sell stocks within minutes.
What’s terrific about online trading is you can invest as much money you want into any publicly-traded company!
Think about it, any company you interacted with today, you can invest in. That daily breakfast hash you ordered from McDonald’s today? Just buy MCD. Did you watch Queen’s Gambit for the second time on Netflix? Just buy NFLX.
The list goes on…
While other investments like real estate require you to put forth a down payment and have an excellent credit score to obtain a mortgage, you don’t have to worry about any of this for stock trading. You’ll also have excellent liquidity without being tied down to any investments in the short-term and long term.
With the ease of stock trading on the market, issues remain as many people tend to lose money in the market due to:
- A lack of education,
- Treating stock markets as a gambling arena, or
- They are merely falling for common trading scams.
But, don’t let this intimidate you. By educating yourself, you can start trading online today!
Throughout this guide, we will be going over various strategies you can use to keep your money safe and make it work for you.
Let’s get into it.
What is Stock Trading?
Stock trading is the practice of buying and selling stocks to capitalize on short-term or long-term market events for a profit.
A company will issue shares of their company on the stock market, and these shares allow you to invest in their company – almost like crowdfunding.
There are various types of players in the stock market. There are day traders, swing traders, algorithmic traders, investors, and market-makers.
Each of these players has their strategies in the market, but all have the same goal at the end of the day – to make money.
Different Types of Stock Traders in the Market
Two traditional stock trading strategies are value investing and technical analysis trading.
Day traders typically like to perform technical analysis trading. They use charts and historical data to look at a stock’s price-volume action and trade based on market activity.
These trades typically are short-term and can be bought and sold within minutes! Swing traders are similar, but they usually hold on to stocks for a slightly longer time frame, usually days or weeks.
Meanwhile, investors are the complete opposite. Think people like your grandpa. They tend to buy a stock and hold it for a long time.
They usually rely on selling a stock when the company has been performing superbly over years and years, and it’s finally time to reap the profits.
The third type of trader is quantitative traders, an umbrella term for algorithmic traders and market-makers.
With the rise of computers and the internet, quantitative trading involves understanding complicated financial derivatives. The complicated code and advanced trading software usually price these derivatives.
Many banks, hedge funds, and asset management firms rely on these quantitative trading methods, as they are heavily based on research to outperform the market.
Hence, how smart money gains its edge over retail investors.
Common Money-Making Trading Strategies
1. Value Investing Strategies
There is one single question to be asked about value investing.
Is the company’s intrinsic value less than the price it’s selling for on the stock market? If so, you should invest if the company is undervalued.
Value investing originated from some well-known titans in the financial industry. If you’ve heard of Ben Graham, Warren Buffet, or Charlie Munger, they have heavily endorsed value investing.
So, how does value investing work?
Investment choices are based on the fundamental analysis of a company. It’s essential to make sure the company generates revenue, does not take on too much debt, has good management in place, etc.
It’s how investing should be done, in my opinion.
However, with governments today printing more money than ever, stock prices have been driven to the highest ever, creating many overvalued companies. So, finding a company at a discount price has become extremely difficult.
For more details about value investing, read up on The Intelligent Investor, as it covers everything you need to know about valuing a company’s intrinsic value. Keep in mind, it is a bit of a difficult read, but many of the principles are incredibly timeless and have worked for decades.
2. Technical Analysis Trading
Active trading based on technical analysis is a strategy most day traders employ. Essentially, they use short-term trading signals based on charts and technical indicators to interpret market volatility.
Charting relies on understanding the price-volume action of a stock. Insights driven from these charts determine if they should buy or sell a particular stock.
Have you seen pictures of people on Wall Street with dozens of computer monitors for their trading system? It’s because they have several screens open for many various trading indicators.
Technical analysis trading typically relies on you being glued to your monitors, as you need to be alert for any changes in the market. If negative market news comes out about a company you’re invested in, you need to be ready to sell.
There are many day-trading programs or courses out there, so you can invest in one and paper trade before day trading. However, understand it takes quite a bit of time and energy to become a professional day trader.
3. Financial Derivatives Trading (Options Trading)
Financial derivatives trading has always been a tool for companies to hedge their bets or generate profit. But in recent years, financial derivatives have become accessible for retail investors.
There are limitless financial derivatives out there, including options, futures, forward, swaps, etc.
The most common financial derivative traded is options. These financial derivatives generate a profit on top of your current stock trading strategies and reduce your risk, if necessary.
One strategy many retail investors employ is an option trade called covered calls.
Covered calls are a great way to pick up additional monthly profits as you are essentially selling insurance while holding onto your current stock investments.
To give you an example of how this works:
- Say you purchased a stock with a share price of $20.
- Additionally, you decide to sell a call option contract for $2 with a strike price of $25 and an expiry date at the end of this month.
The call option owner can essentially exercise their right to buy the stock from you at $25 at the end of the month.
Now, suppose at the end of the month, the stock value goes up to $27. Two scenarios can happen, the owner of the call option can
- Exercise the option, or they can
- Let the option expire worthlessly.
In most cases, the owner of the call option will exercise the option.
At that point, you will make $5 of profit off because you’re selling your stock to the call option owner at $25. However, you will miss out on $2 of profit since you sold the stock at $25 instead of $27. But, you will also receive $2 from selling the call option.
In the end, you will still make a profit of $7. Not bad, eh?
Trading options is an excellent way of generating additional income, as you are picking up a premium for holding the stock, and you can simply buy back the stock after the call option has been exercised.
There are many more financial derivatives strategies out there you can employ, but be sure to do your due diligence as sometimes these derivatives can get a bit tricky!
Note: Work with a trusted firm such as ThinkMarkets.
4. Algorithmic Trading
This trading strategy is extremely challenging to incorporate, as it requires a significant amount of individual research and time!
You have to build up the infrastructure to automate your trades, research mathematically proven strategies, backtest your trades for profitability, etc.
Most people who employ this type of trading have extreme amounts of education and usually have a Master’s or a Ph.D. degree.
Algorithmic trading utilizes statistical and mathematical methods to reduce risk and guarantee profitable trades based on mispricings or arbitrage opportunities in the market.
What’s unique about this type of proprietary trading method is that instead of speculating if your trade will make money, you’re using historical data to increase your future trades’ success.
Currently, big banks, hedge funds, and asset management firms focus on algorithmic trading. So it’s challenging for retail investors to get into this type of trading.
Additionally, some over-the-counter (OTC) traded financial derivates are not readily available to retail investors.
However, many retail investors are self-motivated to learn this on their own. Books I recommend are:
- Options, Futures, and Other Derivatives by John C. Hull
- Quantitative Trading: How to Build Your Own Algorithmic Trading Business by Ernest P. Chan
Interestingly enough, Mindful Trader, run by a Stanford Graduate, has released their stock trading alert program. Their program incorporates mathematical and statistical trading strategies. They claim a 146% median annual return, which has been backtested over 20 years.
So, this is an excellent way for you to get exposure to these types of strategies.
Rise of Passive Investing
In recent years, passive investing has become extremely popular for retail investors. With low investment fees and growing animosity towards banks and mutual funds, it’s no question the active investing industry was ripe for disruption.
Passive investing is a long-term investing strategy where you’re investing in diversified indexes or, at the very least, exchange-traded funds (ETFs) that track indexes.
These indexes consist of many stocks based on various criteria. For example, SPY is the most popular ETF that tracks the top 500 large and mid-size companies listed on the Standard and Poors 500 index.
If you can’t beat the market, you might as well invest in the market.
Furthermore, it has become increasingly popular to invest in ETFs that target a specific trend or industry. For instance, some of my favorite ETFs include:
- TAN: TAN is an ETF focusing on targeted exposure to solar power energy, making it potentially useful for betting on long-term adoption of this energy source or capitalizing on perceived short-term mispricings.
- BOTZ: BOTZ is an ETF focusing on investing in companies that potentially stand to benefit from increased adoption and utilization of robotics and artificial intelligence, including those involved with industrial robotics and automation, non-industrial robots, and autonomous vehicles.
Many of these ETFs have a prospectus that includes vital information such as:
- Investment strategy
- Investment objectives
- Risk factors
- Tax and legal information
Investing in these passive funds is a great way to put your money on auto-pilot and let it work for you without the need for learning about active trading.
Ultimately, there are many ways to trade stocks online. So, be sure to find a strategy that works for you and guarantees you profits during this period of wealth creation. However, I do recommend doing proper research before you invest in anything.
On a side note, there are many online brokers out there with many different trading platforms. Before you open a self-directed trading account, be sure to look for low-fee brokers. Some popular brokers are TD Ameritrade or Charles Schwab.
As an affiliate, I’ve partnered with TradingView to bring you their unique stock screener that helps filter the best and most profitable trading opportunities. Get a free trial and access their charting platform with market-leading features.
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Disclosure: The author is not a licensed or registered investment adviser or broker/dealer. They are not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
Learn how to diversify and hedge your long-only stock portfolio. Sign up for a free insight into the Swing Trading 101 program developed over thousands of hours of trading over hundreds of thousands of dollars across stock, commodities, options, and cryptocurrencies. It’s designed to empower you to take a unique but strategic approach to the markets. Learn more about swing trading.
Tim Thomas has investments in real estate.
Tim Thomas has no positions in the stocks, ETFs or commodities mentioned.
Featured image credit: Shutterstock.