The 3 Step Guide to Trading Stocks
Learn stock trading with our 3-step guide – plus our tips for choosing the best money-making stocks.
Despite what you may have seen in the movies, stock trading is more complicated than simply putting on a nice suit picking up the phone and yelling, “Sell! Sell! Sell!”
For the vast majority of individuals, a much more realistic and reliable plan for achieving financial independence involves a lot of investment strategy which will help guarantee your financial future.
You might not know this, but long-term investing is the single most valuable activity anyone can do to get ready for retirement (or any other savings goal you might have).
The sooner you start investing for the long-term, the higher your chances of getting rich. You can find more about how to invest in stocks market here.
You might not know this, but over the years, we’ve been taught a lot of conflicting things about stocks. Some of those ideas are positive, such as, “You can make money by trading stocks,” but but some of those things are flat-out wrong. Like this one, “Stocks are too risky, and only professionals ever make any money.”
The purpose of this article is to start dispelling some of those false ideas. The simple fact of the matter is that investing in the stock market is one of the most secure ways to grow your wealth consistently over time…if you follow the 3 steps that we outline below.
What are stocks?
A stock is a little piece of a business. If you own a stock, you own a little bit of that business. Another word that’s often thrown around is the word “equity.” Equity means that you own a small part of the company. So, owning stock in a company and having equity in a company are the same thing.
The price of the stock will fluctuate daily, depending on how the company is performing relative to the broader economy. That means if Business A has a product that is selling well, the price of Business A’s stock will go up.
In contrast, if the product Business A sells does not sell well, the price of their stock is going to go down.
Pros: If the company is reliable and the stock price is reasonable, you can make a lot of money. Stocks are also considered “semi-liquid,” which means that you can sell them at any time.
Cons: If Business A is doing poorly, the stock price will go down. If you own their stock, you will lose money. Since, in our example, you only own the 1 stock, that means you have no way to get that money back unless the stock price of Business A goes back up again. You have no control in this situation, and you could end up losing all of your money.
This risk is why we advocate strongly for diversification of stocks.
Diversifying your investments is critical because it protects your money from the stock price of Business A going down. Diversification is simple enough; instead of putting all your money in one company, you should put a little bit of money into many companies. That way, if the stock price of one company goes down, you’ll only lose a small percentage of your total investment.
In addition, the stock price of the other companies you’ve invested in might simultaneously increase. In this situation, you could end up with a total profit even though one of your investments has lost money. That’s how diversification protects you.
Time In The Market
You may have heard the phrase “buy low and sell high.” While this mantra is technically correct, it’s little more than guessing, even for professional investors. In fact, less than 4% of all financial planners, hedge funds, fiduciary advisors, and investment brokers are able to consistently beat a low-cost ETF over a 10-year period (more on ETFs below). It’s not about timing the market. It’s about time you’ve spent in the market.
Warning: Do not start trading stocks until the rest of your finances are in order. The three things you should do before you start trading stocks are max out your 401(k), build an emergency fund and automate your personal finance system.
What Does It Mean To Trade in Stocks?
Many people get confused when we talk about “trading.” Different people have different definitions for this word, so it can be confusing depending on whom you’re reading. In general, “trading” refers to the buying and selling of a stock. So, if you purchase a stock, that’s considered a trade. Later on, if you sell your stock, that’s regarded as another trade.
To give a little bit more background and understanding about “stock trading,” we’re going to split it into two large categories – Exchange Floor Trading and Electronic Trading.
Exchange Floor Trading: Before the advent of the many digital tools we have today, the only way to have access to the stock market was to be physically present at the stock exchange. This what you usually see in the movies and on TV; hundreds of people surrounded by massive screens shouting prices at each other. The process of making a trade is relatively complex, but there are seven necessary steps that everyone has to take. Those steps are:
- Tell the broker to purchase stock
- The broker sends a clerk
- The broker finds a trader willing to sell shares
- They agree on a price
- And the purchase is complete.
- The money is exchanged for the stock
- And the purchase is complete
Electronic Trading: At its core, electronic trading follows the same steps as Exchange Floor Trading with the critical exception that those steps are handled electronically and automatically. You do not need to get on the trading floor of the New York Stock Exchange and scream “Sell!” louder than everyone else. You click or tap a few buttons, and your trade is complete.
This article will focus on electronic trading because that’s the most intuitive way for individual investors. It’s also the fastest. It’s how the vast majority of investors interact with the stock market, and you can get set up and involved in stock trading in just a few minutes from anywhere in the world.
How Do You Trade Stocks Profitably?
Now that you know the basic process of buying and selling a stock, the next questions that usually show up are:
- How do I know what stock to buy?
- How to buy stocks?
- At what price should I buy my stock?
These are excellent questions, but you’re skipping some necessary steps, and that makes it impossible to answer them properly. So we need to take a step back and walk through our 3 step process for trading stocks profitably.
There is a process that you can follow before you invest in any stock to help you know whether or not buying that ock is the right good decision (for your specific situation). Keep reading for our 3-step guide to trading stocks profitably.
Step 1 – Set Financial Goals
An essential step for profitable investing is knowing why you’re investing and having a clear, specific goal for all of your investments. For example,
- Are you trying to save money for retirement?
- Are you trying to earn money for purchasing home?
- Do you love the company, and you want to support them?
The way you answer those 3 questions will dramatically affect the way that you invest, the amounts that you invest, and the price points you’ll be willing to invest at.
The first step is always to identify your “why.” After that, you need to hone that “why” into a specific and clear goal. There is a goal-setting framework called SMART goals that helps with this. SMART stands for Specific, Measurable, Attainable, Relevant, and Time-Restricted. To help walk yourself through the process of setting a SMART goal, ask yourself these questions:
- Specific – What is the real, tangible result for my investments? What does success look like?
- Measurable – What do I have to achieve for me to consider my goal complete? What’s the best way to measure my progress?
- Attainable – Is it even possible? What resources do I need to make it possible?
- Relevant – How does this goal connect with my other goals and more significant life purpose? How will this goal affect my day-to-day life?
- Time-restricted – When does it have to be done? When does it have to be reevaluated? When does it need to be updated?
For most people, stock trading is a means for simply generating more income. With that income, we can do more things such as buying a car, having a down payment for a home, or even taking a vacation. A SMART goal can be very complex or a single sentence.
One example of a SMART goal could be:
“I want to earn a minimum of 10% per year in my portfolio for the next 30 years so that I can retire and be financially free.”
Another example could be:
“I want my investment portfolio to reach $50,000 so that I can purchase a new home in three years.”
Your investment goals might be bigger or smaller than these, but without knowing what your investment goals are, you can never know:
- The right companies to buy stock in;
- The right prices for your situation;
- When you should purchase stock;
- When you should sell your stock.
Step 2: Open An Investment Account
You cannot trade stocks without an investment account or so called trading account. It just can’t be done. Luckily, there are many different brokerages, online trading platforms, and investment accounts that you can choose from.
If you’re a beginning investor, it’s best to choose a brokerage that has an online platform that is intuitive for you. E*TRADE and TD Ameritrade both have excellent platforms, but there are many others that you can choose from as well.
When you’re ready, follow the steps below to open your brokerage account:
- Step 1 – Gather all of your personal information such as your social security number, your bank information (routing and account numbers), your employer’s address, your address, and often a secondary form of identification such as a driver’s license. Having all of these in one place before you begin filling out any forms can cut your application time down from 1 hour (or more) to less than 15 minutes.
- Step 2 – Choose the brokerage that you want to work with.
- Step 3 – Go to their website and click on the “Open Account” button.
- Step 4 – Begin filling out the application for an “Individual Brokerage Account” or “An Individual Investment Account.”
- Step 5 – Fill out the application with all of your personal information– address, name, employer info, Social Security number, birth date.
- Step 6 – Fill out your bank information so that the brokerage can access your initial deposit. The majority of brokers require a minimum deposit before you can open your investment account.
- Step 7 – Complete the application and do something else. Most brokerages use an ACH transfer, which takes anywhere from 3 to 7 days to complete. While you are waiting for the transfer to complete, you cannot trade any stocks. However, this is a great time to read financial news and be aware of current trends and factors influencing what stocks you intend to purchase.
After you receive approval for your initial deposit, you can log in to your investment account and start trading stocks and building your portfolio.
Step 3: What Stocks Should You Buy First?
Millions of stocks can be purchased at any moment. And one of the biggest challenges that new investors have is determining which stock to buy first. One of the easiest ways to narrow it down is to think about companies that you like and use regularly.
In 10 minutes or less, most people are able to come up with at least 15 different companies that they use on a daily or weekly basis. It can often help if you focus on a few different areas of the economy (these areas are called “sectors” inside of the stock market).
- Clothing: JCPenney, under armor, Levi Strauss
- Manufacturing: Ford, GMC, CSX Corporation
- Services: Uber, UPS
- Food: Walmart, Kroger, Trader Joe’s
- Technology: Google, Apple, Facebook
- Entertainment: Netflix, Disney, NBC Universal
Instead of 1 million stock options to choose from, you know have less than 20. This makes it much easier to choose and also for your research. Doing appropriate investment research is fundamental to success when trading stocks.
Be aware that just because you are familiar with the brand does not translate to that company being a good stock investment for your particular situation. It’s generally unwise to purchase stock in a company just because you use it every day. For example, most Americans have some appliance in their home that was made by General Electric. However, for the past 15 years, the stock price at General Electric has been consistently going down. So even though it’s a brand that almost everyone in the country can recognize instantly, it has been a consistently losing stock for thousands of investors and is generally not recommended.
There are four different areas that you need to carefully look at in order to evaluate and analyze each of those 15 stocks that you have chosen. Those four areas are:
- Growth/Revenues/Profit: This information is the core of any stock price. It can get complicated and is often intimidating for new investors, but the basics are relatively simple. Growth is measured in percent and refers to the increase in stock price for a period of time, usually the current calendar year. Revenue refers to the total amount of money the company generated for a specific period of time. Profit refers to the total amount of revenue the company generated minus the expenses the company paid during that same period of time.
- Products: Is the company going to launch new products in the future? What news have you heard about future releases? Are there any significant updates coming?
- Management: Are the people who manage the company good at what they do? Have they received negative attention because of dishonest or manipulative practices? What is the company philosophy? How often are they hiring new people?
- Trends: Has total revenue increased over the past year? Over the past two years? Five years?
The key to all of this is that you do research and lots of it but only on those 15 to 20 companies. Do NOT try to research the entire stock market. In general, you should avoid a stock if you see anything that makes you doubt them in these five areas that makes you question their future potential. In the end, investing is about future potential, so if you’d invest in companies that have low potential, it’s more challenging to get your money back.
When you first start, there will be lots of charts, earnings reports, balance sheets, and financial entertainment that will be difficult to navigate. The key to this is to continue reading the reports, watching the news, and reviewing the information that you have. The more involved you become in this research, the better you will understand the reports. The more you understand the reports and information, the better your investment decisions will be. As with anything, you have to take that first step and then keep practicing in order to get good.
Should You Invest Now Or Later?
Remember what I said above about putting your finances in order? Trading stocks is one of the best tools for generating greater wealth for you and your family. However, it only works well if you:
- Are out of debt;
- Have an emergency fund;
- Have maxed out your 401(k) contributions;
- Have automated your finances.
After you’ve done all of these things, it’s very wise to dedicate 5% – 25% of your income to invest. However, less than 5% of that should be put into individual stocks.
Why is that?
The best way to build long-term wealth is through low-cost, diversified index funds, also known as ETFs.
ETF stands for Exchange-traded Fund, which is a special type of “stock” that you can own. But when you buy a share in an ETF, you buy shares in multiple companies simultaneously. For example, one share in the S&P 500 ETF from Vanguard contains all 500 companies of the S&P500. So when you purchase a share in the S&P500 ETF, you own a small percentage of ALL of those companies at the same time. This is how ETFs can help you automatically diversify your investments.
There are many different types of ETFs and the way they are diversified changes for each type of ETF. Some ETFs are diversified across an entire market like the S&P 500 ETF. Other ETFs are diversified across separate market sectors like a Technology ETF.
So how will this work out in real life?
Let’s do some math. If you are 25 years old and you decide to invest $500 per month in one low cost diversified index fund like the S&P 500 ETF from Vanguard. How much would your investment be worth when you’re 60 years old?
According to past data projected into the future – $1,116,612.89.
That means you could make more than $1 million by only investing a few thousand dollars per year.
As you can see, investing for the long-term is much more about consistently putting in small amounts of money than it is about buying the hottest stock or the wishful thinking of “buy low, sell high.”
If you’re just starting out, great! The most crucial step is to start investing, and the sooner you start, the more money you can make in the future. That’s why we here at Business 24-7 have created our Ultimate Personal Finance Guide.
It’s a comprehensive guide that will walk you through the basic investing concepts that you need to master in order to achieve the financial freedom you’re looking for. Tons of topics from automating your expenses to mastering your 401(k) are explained in detail in our guide. You’ll see, step-by-step, exactly what you need to start doing now so that you can reach your big financial goals faster than you ever thought possible.
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