How to trade stocks: what should I know?
Investing is an important part of any successful long-term financial plan, and for some, part of that plan may include knowing how to trade stocks. If this applies to you and you’re new to investing, it’s probably confusing how to do it. We clear up all the confusion, including how to get started and the options for deciding which stocks to buy. Keep in mind that stock trading is not for everyone and you should always consider your goals, risk tolerance and time horizon before making an investment.
What are stocks?
Stocks are shares of the assets and profits of a public company. Buying them makes you a co-owner of the business and gives you a vested interest in its success or failure. When the company is doing well, the value of your shares, and therefore your overall investment portfolio, increases. Unfortunately, the reverse is also true: when the business does poorly, so do your returns.
But the numbers don’t tell the whole story. For example, a business may show net losses one year because it spent a lot of money on projects that promise to grow the business later, such as adding new buildings, equipment, or staff. So losing this year could actually mean big gains in the future and knowing that could help drive stock prices higher over time.
Also, stock performance isn’t strictly about the numbers anyway. This is because stock prices are ultimately determined by market forces, i.e. public demand or lack thereof. For example, even if a company is doing well in terms of earnings, bad news that might not be directly related to the company, such as a scandal involving the CEO or bad behavior by other employees, could cause some investors to sell and drive down stock prices. Thus, the public perception of the company may be just as important as its actual financial well-being.
All of this to say: Stock trading can be a tricky business as stocks can be difficult to value, especially for regular investors who haven’t dedicated their careers to doing so.
Why invest in stocks?
Most investors need at least a few stocks in their portfolio because they can be such rewarding investments. (Note that all investments come with risks that you need to consider.) Between 1926 and 2018, a 100% stock portfolio offered a healthy average annual return of 10.1%, according to data from the financial firm Vanguard. In comparison, a portfolio made up of 100% bonds (a generally less risky investment choice than stocks) would have gained only 5.3% per year, on average, over the same period.
Of course, the higher returns came after a much wilder ride: the all-stock portfolio suffered losses in 26 of those 93 years, dropping to 43.1% in 1931. Then, in 1933, it had its best year ever, earning 54.2%. percent. The bond portfolio had a smoother run, losing only 14 of 93 years and only 8.1% (in 1969). Its most profitable year was in 1982 with a return of 32.6%.
And just saving, while also very important, doesn’t produce much growth at all. In fact, the current annual percentage return on a savings account is less than 1%, according to Bankrate, and one-, three-, and five-year certificates of deposit (CDs) offer average rates of just 1.87 to 1.97%. Meanwhile, the current inflation rate as of November 2019 is 2.05%, according to InflationData.com. This means that savings money is actually losing purchasing power right now.
So to keep up with and fight inflation, you have to invest. Remember that while equities offer the greatest potential for growth, they also come with big risks. Maintaining a well-diversified portfolio, including stocks, should help balance risk and potential returns.
How to start trading stocks
Before investing in anything, you should first think about your financial goals, as well as your timeline for achieving them. Then you can build a well-diversified portfolio designed specifically to achieve those goals. And don’t forget that there are also different types of accounts for different purposes.
Consider different types of investment accounts
The type of account that’s right for you will greatly depend on your goals. For example, if you’re investing for your retirement, contributing to a 401(k) (or another employer-sponsored retirement plan, if you have one) is a good idea. In this case, your employer will generally have chosen the broker and the investment options for you. An Individual Retirement Account (IRA) is usually the best option for retirement. (Acorns offers a choice of three different types of IRAs, in addition to a regular brokerage account.)
Or if you’re investing for college, you might want to opt for a 529 plan, a tax-advantaged account that must be used to cover education costs. Choosing the right account can earn you big tax breaks.
For general medium-term goals, a regular brokerage account may be the right solution. These allow you to trade stocks or other investments like bonds and funds. They don’t have tax benefits like a retirement account, but you can access your money anytime without penalties. (Remember, the longer you leave your money there, the more likely you are to benefit from long-term market growth.)
Open an investment account
Once you have a strategy in mind, you can open an account and start trading stocks. There are many brokerages to choose from, so be sure to research all the details before making your choice. An important point to consider is the costs, including the commissions charged for each transaction (which can vary depending on the type of asset), other fees (such as annual and inactivity fees) and minimum balances. Reducing costs is an important and simple way to maintain returns. (With Acorns, users can open an investment account and invest in a portfolio of funds with exposure to thousands of stocks and bonds for $3 per month. Acorns charges no commission.)
Fund your account and start investing
Once you’ve sorted out all that logistics and funded your account, let the stock trading begin. It can be as simple as telling your broker to execute a trade for you or clicking a few buttons on your online broker’s website or app. (Keep in mind that some accounts offered by brokerage firms may also offer pre-selected portfolio combinations.)
All you have to do is specify the stock or stock fund, the number of shares you want to buy or the amount of money you need to invest in the stock, and the type of order you want to place. Your main choices are to use a market order (to buy the stock as soon as possible at the best available price) or a limit order (to set a maximum price you are willing to pay). A limit order only goes through if the stock falls below the specified price within the time frame you have selected.
Choosing stocks to buy
Determining which stocks to invest in depends on your goals, risk tolerance and time frame. But it’s a good idea to build a well-diversified portfolio.
Diversify your portfolio
Diversifying your portfolio between asset classes, like stocks and bonds, is smart. But it should also happen in the equity portion of your portfolio, with a good mix of foreign and domestic stocks, as well as companies of different sizes and in different industries. So getting your stock allocation well diversified means a lot more work than skimming a list of recently winning stocks to buy.
Invest in equity funds
A better option for most people is to invest in mutual funds or exchange-traded funds (ETFs) which handle all the stock selection for you. Going this route allows you to invest in hundreds or thousands of different stocks in one quick transaction. (Acorns portfolios include a mix of ETFs with allocations designed to match a variety of risk tolerances.)
Whatever investments you decide to trade, you can rest assured that by simply starting to invest, you are taking an important step towards achieving your financial goals.
Start investing with as little as $5 with Acorns.