Stock trading is a popular way for investors to make money. Before getting in the game, you need a stockbroker and a brokerage account. You can open one with most large investment firms, such as Charles Schwab, Fidelity Investments, TD Ameritrade or E*TRADE.
A brokerage account gives you access to buying stocks and other investments. Every firm has different requirements for opening an account. They may offer promotions that require you to deposit a certain amount of money into your new account before being able to trade. You can learn this here.
Once you have deposited enough money, it’s time to buy your first shares of stock! If this seems too complicated or risky for you, don’t worry. There are many investment alternatives besides individual stock picking—like investing in mutual funds.
There are many advantages to trading stocks, including making money in both up and down markets. Stock prices tend to move in the general direction over time to get positive returns on their investments over a long period.
Stock selection
Stock selection is important because some companies fail while others flourish, resulting in unpredictable investment outcomes for individual stocks. For example, during the dot-com bubble of 1999–2000, one popular tech stock was CMGI.
During that time, it rose from $1/share to nearly $100! Within two years, it had fallen back below $1 per share. Since CMGI wasn’t producing any revenue or earnings at that point, investors lost faith, and there was no future price appreciation.
Stock trading also involves more risk than the other major investment types. A stock price can drop to zero or cut in half within a year. A few bad days of trading can wipe out your entire account balance—and then some! It’s also impossible to predict when market-wide declines will occur, which is why investing for retirement accounts requires diversification across multiple asset classes and long time horizons.
If you plan on using your investments within five years, it’s best not to use stocks at all because of their inherently high volatility.
There are three main types of stock trades:
Day trading
Day traders make many small trades each day, trying to profit from short-term price fluctuations. Sometimes traders only look for quick one-day moves, but others hold positions for weeks or months. In either case, investors must have the money in their account to make these trades, and they can lose more than they’ve invested if prices move against them.
Buy-and-hold
In a buy-and-hold strategy, investors purchase a stock and don’t sell it for a long time. This is good news because there are no tax consequences from selling a stock held for at least one year.
However, you will want to take your gains into your income when you decide to sell so that you can pay federal taxes at up to 20% on gains above an annual threshold ($36,900 in 2018).
It’s also important to note that capital gains taxes are based on your cost basis—the original price paid for the stock, not the current price. At purchase, you should have a good idea of your basis and keep track of it.
If you’re taking advantage of tax-loss harvesting, periodically selling investments that are trading at less than their cost basis can offset any capital gains taxes that would otherwise be owed on your investment gains for the year.
This way, you can minimize or eliminate your tax bills just by making sure all your investments are sold at a loss—but only if prices fall so low that they trigger capital losses in your brokerage account.
This is great for people who buy and hold because it essentially means taking free money from the government each year when they file their taxes.
Short selling
The third type of trade is called short selling. When a stock is shorted, the seller borrows shares from their broker and then sells them at market price, hoping that it will go down to be purchased back at a lower price to make a profit.
There’s an unlimited risk when selling short because you could potentially lose more than you invested if prices rise instead of falling as expected.
On top of that, you must pay interest on the money borrowed to sell those shares, which lowers your net profits even further. Keep in mind that investors cannot quickly and cheaply take advantage of this strategy without first gaining access to capital separate from the investment account where their cash has been stored.
Not all brokers allow short selling, especially for new investors, should also be noted.
What does this mean for you?
Since stock prices can drop so steeply, it’s not the best investment choice if you’re investing during retirement or saving up for something big in the next five years.
It may be okay to own some stocks. Just don’t go all in—and that goes double if your timeframe is less than a year! If you want to start trading but still stay diversified, buying an exchange-traded fund (ETF) is one way to get exposure to the stock market without having actual shares of individual companies.
They are popular because they will track an index like the Dow Jones or Nasdaq 100 and help decrease overall investment volatility while also providing tax benefits. There are plenty of ETFs available with different strategies to choose from, so make sure you do your research before pulling the trigger.
In conclusion
The payoff can be high when investing in stocks, but it’s not suited for everyone. If you are interested in learning more about trading or want to dabble with a small amount of money until you know what you’re doing, stick with mutual funds. They may charge higher fees than index funds, but they are relatively easy to understand and rarely require short-term commitments.