What is Stock Trading?
Market and Stock Information for Traders and Investors 8
The Stock Market
Stock Trading – How To Get Stated
Making Money from Stock Trade
Stock Charts – How they Work
Trends,, Support and Resistance in Stock Charts – How to Analyze Them
Using Technical Analysis to Analyze Stock Charts
What Is Stock Trading?
If you have a weak stomach, then stock trading is not for you. This is because stock trading is a fast-paced, exciting, and but risky strategy for making money in the stock market. In the business called stock trading, you need to master some basic fundamental concepts before you place your first order. This calls for three comments at this stage. First, you need to:
- Become well-informed about the differences between stock investing and stock trading
- Be able to understand and evaluate all the various trading styles. By doing this, you will be able to decide which trading style is right for you.
- Familiarize yourself on how to use the popular trading strategies, particularly the basic technical analysis.
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Stock Trading and Stock Investing – The Key Facts
As I noted above, in order to decide whether stock trading is right for you, it is very important to understand the meanings of the concept and how it differs from stock investing. Before explaining these two concepts, I will first of all present the meaning of two important concepts that will serve to illustrate some of the more complex features involved in stock trading and stock investing: fundamental and technical analysis.
Fundamental versus Technical Analysis
To access a company’s financial health, which includes its debt and profitability, stock investors use a technique called fundamental analysis. By using fundamental analysis approach, stock investors can also predict as well as make profit from the long-term trend they observe in a company’s share price (Barnes &Noble, 2012; Miner, 2008; Gregorion, 2010; Ann, 2011). It is sufficient to note here that stock investors generally buy those stocks which they are convinced will increase in value over time, irrespective of the fact that the value increase may be gradual. One additional fact relating to stock investing may be worthy of comment at this point: most stock investors buys stock and hold them for at least one year. In some cases, they may hold on to the same stock for several decades. A good example of investors in this category is Warren Buffet, the Wall Street Billionaire who is often called the Sage of Omaha.
The strategy of buying stocks and then selling them within a brief time period is called stock trading. The brief time period generally ranges from a few minutes to a few months. This approach to stock business warrants the conclusion that the main aim of stock trading is to make profit from short-term trends in stock prices. In this regard, stock traders are not worried about a stock’s long-term prospects. All they want is to make quick profits from short-term changes in the prices of stocks. As a way of predicting the short-term trend in stock prices, stock traders generally use a method known as technical analysis, which involves conducting close examination of stock price charts so as to assess recent price movements (Barnes &Noble, 2012; Miner, 2008; Gregorion, 2010; Ann, 2011).
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Stock Price Charts
Also known as stock charts, the stock price charts are used to plot the prices of stocks over a given period of time. Among the components of the stock price charts is what is called the stock volume, which represents the number of shares or stocks traded over a certain timeframe (Ann, 2011; Barnes &Noble, 2012). Stock traders often use computer software to superimpose important indicators or statistics directly on stock charts. By doing this, they can then predict whether the stock will trend down (decrease in price) or trend up (decrease in price) by interpreting these indicators. Among these indicators, the simplest one is called the trend-line. Stock traders use trend-lines to ascertain the direction in which a stock will likely trade next. This is because trend-lines plot on a stock chart a line from the first price of the stock to the last (or most recent) price (see figure 1).
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It is important to note here that the method called technical analysis is often considered to be a useless and misguided approach to investing by the critics of stock trading. These critics based their argument against technical analysis on the provisions of the finance theory known as the efficient market hypothesis. According to this hypothesis, the prices of stocks constantly change because they reflect all the available information in the stock market – information that might affect a stock’s share price. The postulate of the efficient market hypothesis is clear: given that a stock’s recent price depends only on the relevant information about the stock that is available at the present moment, its recent price or volume trend does not really matter or is unreliable for making trading decisions (Ann, 2011; Barnes &Noble, 2012).
The provisions of the efficient market hypothesis is, however, refuted by the proponents of technical analysis. The logic of their argument for discrediting the efficient market hypothesis runs as follows: the market is not perfectly efficient. According to them, most people usually buy and sell stocks based on emotions or hype. In their view, only a very small amount of people buy and sell stocks on the basis of the information that would determine the price of the stock. Hence stock traders believe that they can identify and profit from trends in stock price and volume alone because they are convinced that the market is not perfectly efficient (Ann, 2011; Barnes &Noble, 2012). The bottom line here is this: because no one has proven that technical analysis really works(or do not work), whether or not the proponents of that method are right remains up for debate. It is sufficient to state here that many stock traders, including large brokerage firms, has made(and have continued to make) millions of dollars by using technical analysis approach. In addition, many stock traders and brokerage firms have also went bankrupt after using this trading approach.
Why Buy and Sell Stocks?
One unavoidable conclusion from what I have covered so far is that stock investors and stock traders shares one common goal, which is, to make money. However, the reasons why they decide when to buy and sell stocks – and which stocks to buy – differ considerably.
Why Investors Buy Stocks
It is in the DNA of most stock investors to buy either baskets of stocks contained in stock mutual funds (or exchange-traded funds[ETF]), or individual stocks. Stock investors often buy individual stocks if they are convinced that, as the company’s fundamentals improve, the stock will rise in value. When this happens, the demand for the stock will increase, leading to more increment in its value. Investors who buy buy ETFs or stock mutual funds do so for the same reason: the prices of the stocks contained in the ETF or mutual funds will be boosted when the companies’ fundamentals increase (Ann, 2011; Barnes &Noble, 2012).
Why Traders Buy Stocks
Most stock traders are not really interested in a company’s long-term prospects or current fundamentals. Their main concern and interest is on the recent movements in the volume and the prices of stocks (Ann, 2011; Barnes &Noble, 2012).
- They buy a stock whenever the indicators signals an imminent uptrend
- They sell the stock whenever the indicators signal an imminent downtrend
Note that investors and traders do not actually buy their stocks directly on the the listed stock
exchanges. To buy or sell their stocks, they use the services of professionals called stock brokers.
New Concepts: Full-Service and Discount Brokers
As I noted above, to buy and sell stocks, the stock investors and stock traders use brokers, particularly the full-service and discount brokers.
The full-service brokers include the large brokerage houses and major investment banks such as Morgan Stanley and Merrill Lynch. The full-service brokers are generally not suited for stock trading because they are the slowest way to execute(fill) stock orders. Besides, they often charge the highest commissions(from about $40-$160 per trade).
The smaller brokerage houses who charge much lower commissions(about $7-$50 per trade) and offer fewer services than the full-service brokers are called the discount brokers (see table 1). Those beginner traders who are making only a few trades per month often use discount brokers to trade. However, they generally pay less in commissions by working with direct access broker if they begin to trade more often. By using direct access brokers, they also benefit from the more robust trading-related services which they(the direct access brokers) provide.
Most traders use direct access brokers rather than use full-service or discount brokers to buy and sell stocks. This is because these brokers enable traders to use an electronic platform called a direct access trading system(DAT) to trade stocks completely on their own, without dealing with an intermediary. In addition, the direct access brokers offer traders a lower fee structure which make frequent trading more economical – an advantage they will
Table 1 – Top Online and Discount Brokerages
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Source: Black Enterprise, 2012
not enjoy if they use the services of a full-service or discount broker. Also, in addition to providing information on real-time quotes and real-time market data to brokers, direct-access brokers typically provide a suite of features designed to help stock traders in their work. Examples of direct access brokers include Scottrade, E-Trade and Ameritrade(see table 1).
On-location brokers is the name given to those brokers who serve professional traders. Generally speaking, the on-location brokers offer trading rooms – which are rooms fitted with complete trading terminals which professional traders can “rent” by the month, week or day. These brokers typically charge commissions as well as services fees for renting the terminals (Ann, 2011; Barnes &Noble, 2012).
Market and Stock Information for Stock Traders and Investors
Traders and investors need access to stock-related information in order to research stock before buying them. They can get these information free of charge from such websites as Google(finance.google.com) and Yahoo!(finance.yahoo.com). Note that the free stock data that these sites provide are generally delayed, sometimes by as much as 16 minutes. Also, since traders buy and sell stocks within very brief timeframes, delayed stock data is useless for them. Hence, while the free stock data from Google and Yahoo! Can suffice for investors, they are useless to most traders. This further means that while investors are very comfortable using the freely available data, traders use real-time market data. This kind of data contain up-to-the-minute information stock traders can easily stream unto their computers instantly as soon as they are published (Ann, 2011; Barnes &Noble, 2012). There are two types of real-time market data which traders use
- Real-Time stock quotes
- Real-time charts
Real-Time Stock Quotes
A snapshot of the demand and supply for a stock is called a stock quote. At any given moment, a stock quote also shows the the stock’s most recent ask prices and bid prices.
- The price at which the stock buyers are willing to buy the stock is called the bid price. It is also called the “bid” for short
- The price at which the stock sellers are willing to sell a stock is called the ask price (or the “ask” for short)
- The difference between the current bid price and ask price is called the bid-ask spread(or the “spread” for short). For example, the spread is $2 for a stock with a $10 bid price and a $12 ask price.
Those constantly updated charts which stock traders can “stream” onto their computer monitors are called real-time charts(or straming charts). Generally speaking, stock traders can plot indicators on a stock’s price to track and analyze the stock price’s movement as it happens by using real-time charts. Fortunately for stock traders, most of the direct access brokers (such as Scottrade, E-Trade and Ameritrade) provide real time charts as a standard feature. In addition, traders can use real-time charting services, such as stockcharts(www.stockcharts.com), MarketScreen(www.marketscreen.com), and PCQuote(www.pcquote.com); or buy stand-alone real-time charting software such as Metastock, Tradestation and eSignal.
Level I and Level II Quotes
There are two main types of stock quotes – the level I and level II quotes.
- Level I Quotes: Generally speaking, level I quotes displays the lowest ask price as well as the highest bid for each stock on a particular stock market(Ann, 2011;Barnes &Noble, 2012);
- Level II Quotes: In addition to showing a stock’s most recent transactions, level II quotes show a full picture of the market for a stock. Hence level II quotes quotes includes order prices, the sizes at or near the current bid and ask, and information that shows the source of each order(such as whether the order was placed by an individual or an institution). For instance, the NASDAQ level II show traders all the relevant data they need about each of NASDAQ’s market makers, such as the market maker ID(MMID), the current ask and bid prices, a record of their most recent transactions, and the order sizes for stocks they trade(see table 2).
It is important to note here that while direct-access brokers charge monthly fees for level II data, they generally offer level I quotes free of charge as part of their standard quote package.
Table 2 – Sample Level II Price Quote For A Company
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Stock Trading – Grim Facts
Stock trading has some inherent risks. As a result, you have to meet the following requirements before you consider trading stocks:
Your Personal Finance Goal
You should not get involved with stock trading if you have not achieved your basic personal finance goals, which include saving up an emergency fund of up to at least 6 month’s worth of expenses. Also, before you begin to contemplate stock trading, you need to achieve all other major savings goals, such as saving up for the purchase of a car or a house (Ann, 2011; Barnes &Noble, 2012).
Having Diversified or Balanced Investment Portfolio
You need to understand that if your goal is to build and maintain a balanced investment portfolio, then stock trading is not a viable alternative. The basic insight from this assertion is thus clear:you should establish a diversified portfolio of investments designed to meet your long-term financial goals before you begin trading on stocks (Ann, 2011; Barnes &Noble, 2012).
Your Degree of Risk Tolerance
The amount of risk that you can comfortably accept in your investments is known as your risk tolerance. Hence, to trade on stock, it’s best to use only the money which you have a very high risk tolerance. In other words, trading on stocks with the money you might need to use at a specific point in the near future is not a good practice (Barnes &Noble, 2012; Miner, 2008; Gregorion, 2010; Ann, 2011).
Stock Trading Is A Risky Business
The uncertainty about an investment’s return over a given timeframe is known as risk. The degree to which the value of a stock and other similar investment tends to fluctuate over time is known as volatility. There is a very strong degree of correlation between risk and volatility, on the one hand, and an investment’s return, on the other. Hence when the an investment’s risk is high, its volatility and potential return will be high and vice versa. Generally speaking, the risk and volatility of a stock(or an investment), to a very large extent, depends primarily on your holding period (Barnes &Noble, 2012; Miner, 2008; Gregorion, 2010; Ann, 2011):