Stock trading for dummies
Stock trading for dummies
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So, you’re yet to take your first cautious steps into the world of trading. You’ve been saving your money and reading articles for a while but rather than clarify your initial course of action you’re more confused than ever. What do I do first? How much money do I need? Is now a good time to start? What are the risks? How much time will it take? These are all good questions. Let’s outline some of the main things you’ll need to have sorted to get you started on the right path.
1. Trading capital (money to invest)
Other costs such as guaranteed stop-loss orders are often also set fees regardless of trade size. Another problem with a small amount of capital is you are restricted as to how many positions (parcels of shares) you can hold. This, in turn, makes managing your risk more difficult. So to begin trading with, say, ,000 is actually more difficult than beginning with ,000 or 0,000. “But I’ve only got ,000 saved.” Well, wait until you’ve saved up some more. In the meantime you can educate yourself so you’ll be in-the-know when you’ve got a decent stake together.
3. Charting Software & Data
4. Record Keeping
Having good record keeping lets you know where you stand at any given moment and also helps your accountant at year end work out your situation with regards to tax.
5. Trading Plan
I was watching a bit of late night TV and there was this show called Dragons’ Den. The premise is that several entrepreneurs (or wannabes) pitch their business ideas to five wealthy investors to gain financial investment in exchange for a stake in their fledgling companies. As I watched, a distinct pattern emerged. Those who had a hobby or interest they thought they should be making money from fronted up asking for financial help but most often had flimsy, pie-in-the-sky figures, no research and a lightweight business plan.
6. An understanding of Charts and Indicators
7. Stop losses
It has been said by many successful traders that the rules of trading are:
- Let you profits run
- Cut short your losses
- Keep your position sizes small
- Stick to your Trading Plan
Many of Louise Bedford’s trading resources outline in detail how to choose the best stop loss method for you. Your stop loss acts to keep your loss small if a trade goes against you from the start. It also helps retain any profits you may have in an existing trade. As the share price rises, move your stop loss point up to position just under the latest share price action and when the trend reverses your stop will be hit and you can exit with the majority of your profits retained.
8. Capital Allocation
9. Trading System
Your trading system outlines the detailed steps you will take to engage the market. It describes how you will enter a trade, how you will exit and how you will size your positions.
We have already looked at stop losses which is your exit methodology. There are other types of signals you could rely on to exit a trade, but the key is, they need to be rule-based.
Many traders spend most of their time looking for the ‘perfect’ share to buy. Often they commit too much effort to this task and neglect the importance of having an exit strategy and sizing their positions sensibly. Looking for an entry signal can be as simple as identifying a share whose price has crossed above a long-term EMA (exponential moving average), that has been laid over the weekly share price. Moving to a daily chart you could then look for a technical signal or pattern that indicates a higher probability of the share price moving higher. Now you’re ready to place a buy order.
Position sizing – How many should I buy?
To get more ‘bang for your buck’ in the markets you can employ leverage. What this means is that for a set amount of money, you can take on more risk in exchange for the chance of greater gains. The simplest form of leverage is Margin Lending. Most people have heard of Margin Lending as it is (or used to be) aggressively promoted by most of the large broking firms.
The way it works is that a broking firm may have a selection of stocks over which they are comfortable to lend you money. You decide how much of one of these stocks you will buy and they will lend you typically 50% to 70% of the purchase price. The danger is, of course, leverage is a two-edged sword. Whilst your gains may be multiplied on the upside, you can also suffer magnified losses if the trade goes against you. Other forms of leverage can be used via CFDs, options and warrants. I encourage you to learn more about these through your own research. There are some great resources for this at the Trading Game online shop. To read more about other instruments that you can use to get more bang for your buck, read these links:
11. Other Strategies
12. CFDs, Options and Warrants
CFDs (contracts for difference), options and warrants can be employed via different strategies to make money from an up trending, down trending, or even sideways trending market. These tools are an important part of the sophisticated trader’s arsenal.
Trading is not just about how much money you make – it’s about how much you keep. When you become a trader, your business is to buy, hold and sell stock. There are many different market instruments you can trade such as shares, options, CFDs, forex and commodities. You’ll need to find an accountant who understands the tax implications of the activities you are undertaking.
Trust me, there are plenty of accountants who don’t understand how a trading business works. For example, there are specific tax implications associated with whether you define your trading activities as coming under the banner of being an investor or being a trader. Your accountant also needs to have a positive attitude to trading. Having an accountant who is cynical about what you’re doing can damage your mindset. Do your research and find someone who can help.
As traders become more experienced they generally move their focus from the details of what and when to buy to the subject of psychology. Trading will often make you come face-to-face with your inadequacies. Your flaws will be highlighted and your strengths will be minimised. It’s at these times you need to have some background in trading psychology so you can work your way through the inevitable challenges. The aim is to trade in an unemotional manner. Letting your emotions control your trading decisions will have you ignoring your trading rules as set down in your trading plan. Some people justify this sloppy approach and claim to be trading by ‘gut-feel’. This doesn’t work. Admit when you are wrong about a trade. The market is much bigger than you. Learn from your past mistakes, adjust your plan and continue.
If you are still unsure about what is going on, consult a more experienced trader. There are plenty of books available on trading psychology. Consistency is the key to long-term success in the markets. Often people have a trading plan that is fundamentally sound but they second guess themselves and deviate away from their rules. Having a good grasp of your mindset can also help you establish a productive work/life balance, and let’s face it, isn’t that what we’re all trying to achieve?
Individuals new to the concept of investing often want to start trading stocks, but don't understand where to begin. This article is structured to be a simple introduction to stock trading basics. We'll explain what takes place when trading a stock, and what to look out for when calculating the return on investment.
Buying and Selling Stocks
Stock trading is a misleading term, since stocks are not really traded. The term describes the activity associated with buying or selling stocks. Like most financial markets, the stock market is very efficient, and follows the laws of supply and demand in a fairly consistent manner.
Stock Exchange Floor
The floor of the New York Stock Exchange is the picture that most people have in their minds when they think of trading stocks. That's because the NYSE still uses a physical exchange floor, where the "market makers" use handheld terminals, overhead monitors, and hand gestures to complete their transactions.
The NYSE depends on these specialists, or market makers, to match buyers with sellers. They also ensure that a robust "market" exists for the stock, or stocks, they are responsible for managing. The NYSE trading floor, and all the people that make trading a reality, is quite a sight to behold. That is why pictures of the stock exchange floor often appear in the newspaper.
Unlike the NYSE, the NASDAQ is a completely electronic exchange. The NASDAQ uses a sophisticated network of computers to match buyers with sellers of stock. This makes electronic exchanges very fast, with almost instantaneous confirmation of stock trades.
Electronic exchanges give many investors an added feeling of control over their trades. But either method, exchange floors or electronic exchanges, still requires the use of a stockbroker.
Role of the Stockbroker
Individuals do not have direct access to the stock market. Stockbrokers are used to make sure the exchange rules are enforced, and that all stock traders have the funds necessary to complete their transactions.
So, whether an investor is day-trading or calling a broker over the telephone, the stockbroker provides the market, and the investor, with essential services. The more personalize this service is for an investor, the higher the commission charged. For example, stockbrokers that answer the telephone and make trades on an investor's behalf might charge .00 or more to complete a single transaction. This is a generalization, and the actual fee structures will vary with the dollar amount or number of shares traded.
Some of the more notable "electronic" brokers allow investors to make online trades through an account established with their companies. These businesses use sophisticated computer networks to send buy and sell orders to the correct stock exchange. Electronic brokers typically compete for clients based on price, or low commissions, not personalized service.
Buying and Selling a Stock
Let's take a quick look at the steps involved when buying and selling a stock.
- Choosing a Broker: The first step is to decide on the level of personalized service needed. Once this has been determined, an account is established with the broker, and money is deposited into the account. In this example, let's assume an investor has deposited ,000.00 into a personal account.
- Conduct Stock Research: It's now time to complete any stock research. In this example, the investor has decided to purchase 20 shares of 3M Company at .25. Because the investor is new to stock trading, they've decided they need more personalized service, and call a broker over the phone to place the order.
- Stock Order Issued: The broker places the order, and the trade completes at .25. The broker takes 20 x .25, or ,545.00, from the investor's account to pay for the stock, and also charges a .00 fee as a commission. The account now has a cash balance of 5.00 plus 20 shares of 3M stock. The shares in the account are held in "street name." This means there is no physical stock certificate to touch or hold.
Making Money Trading Stocks
Let's assume that 3M releases some good news, and the stock market has reacted rationally by increasing their value for 3M to .00. At that price point, the investor decides to take their profits and sell their shares of 3M stock. They call their broker and complete the transaction by selling 20 shares of 3M at .00. The ,600.00 in cash from the sale is placed back into the investor's account. Once again, the broker charges their standard fee of .00 for the trade. At the end of the day, the investor now has 5.00 + ,600.00 - .00 or ,995.00 in their account.
But wait a minute, the investor purchased 3M at .25 and sold it at .00. They started with ,000.00 in their account and now have ,995.00. The investor thought they were making money trading stocks, not losing it!
Unfortunately, the investor paid .00 in trading / broker commissions. In this example, those fees had a significant impact on the total return on this investment.
Impact of Commissions on ROI
The above example serves as an important lesson in stock trading basics that needs to be carefully considered before investing in the market or choosing a broker. Make sure the impact commissions will have on investments is completely understood. In the above example, the initial investment of ,545.00 carried with it .00 in commissions. A total of 3.88% of the investment was paid to the broker.
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