Knowing how to trade stocks also means getting educated on the various factors that impact stock prices, including economic and market indicators, company financials and stock market trends.
It also means understating the risks involved in learning how to trade stocks, and recognizing what stock market categories work best for your unique needs.
Learn How to Invest in Stocks
Learning how to invest stocks before trading is worth the effort. Study after study shows that stocks are among the fastest ways to accumulate wealth.
Since 1926, common stocks, on average, have returned 10% a year to investors. Over the same time period, government bonds have returned between 5%-and-6%, according to Morningstar.
Consequently, the value of stocks grows faster and more robust than bonds or bank money market accounts.
According to data from New York University, $100 invested in stocks, bonds, and money market funds in 1928, and left untouched, would have yielded the following portfolio cash amounts by the end of 2017:
- Stocks: $399,885.98
- Treasury Bills: $2,015.63
- Treasury Bonds: $7,309.87
Key Steps in Learning to Trade Stocks
There's no shortage of options when learning how to trade stocks. For new stock traders, those options can be overwhelming, so it's a good idea to clear the deck and make sure you're financially ready to trade stocks, with no distractions.
That means clearing any debt, checking your credit score and improving it, if necessary, and having a good amount of money in your savings account to trade successfully. Learning how to trade stocks also means knowing the amounts of your current investment and/or retirement portfolio.
Once those tasks are in order, focus on these moves to get started trading stocks:
- Establish your goals. Your first step in learning how to trade stocks is to know where you're headed. That depends on several qualifying factors, including your age, your income level, your short-term financial needs (for example, saving for a wedding, a new baby, or a new home) and your long-term financial needs (saving for retirement, paying off a home, starting a business, or saving for college, are all good examples.) Once you've established and prioritized your goals and establish a timeframe for reaching them, you can start the process of choosing the stock investments that best meet your unique goals and needs.
- Establish your risk tolerance. Every stock trader has a risk-based comfort level when investing in the stock market. Focus on stocks that best combat the risk you are concerned about, be it inflation, taxation, liquidity, or all of the above. Mix your portfolio assets across different stock categories, and try to cover the various types of risk associated with investing. By and large, if you lose 10% or so in your stock portfolio, and that causes you to lose sleep at night, then stay cautious with your stock market trades.
- Establish a stable stock portfolio goal. For new stock market traders, keeping things simple is a good strategy. Normally, a stock portfolio of between 10-and-20 well-researched stocks constitutes a good starter portfolio. Having a short, more limited stock portfolio gives you the time needed to thoroughly understand each stock, investigate the underlying company financials, and assess any relevant risk factors. That also gives you the time necessary to investigate the different types of stock categories, like large-cap, mid-cap, small-cap and international stocks, and get to know the various industry-specific stock sector categories, like manufacturing, technology, financials and consumer goods stocks.
- Establish a knowledge baseline for stock market trading success. Hold off on making your first stock market trade until you get a grip on some stock market trading basics. Make these items on your stock market educational checklist a top priority:
- Know your metrics. Recognizing the terms that professional stock market traders use when they evaluate stocks is a "must do" for stock traders. Stock trading terms like price-to-earnings ratio (P/E ratio), compound annual growth rate (CAGR), return on equity (ROE) can reveal the inner workings of a stock, and point you toward a "buy" or "sell" decision. Check out this list of key stock market definition terms and keep it handy when you're trading in stocks.
- Know your stock market orders. Trade executions are dependent on the type of stock market trades you make. Market orders are the most common form of stock trades, but investors need to familiarize themselves with other stock market trade classifications, like stop limit orders and trailing stop loss orders, which are treated differently trade-execution-wise. The U.S. Securities and Exchange Commission has a helpful tutorial on the types of stock market orders.
- Know your investment account type. Stock market investors usually opt for a traditional cash account when trading stocks. But other options are available, including margin accounts (which allow you to borrow money to buy stocks, at heightened risk.)
- Know where to buy stocks. You can buy shares of stocks in various ways, including buying them through a broker or buying them online. In general, you'll pay more in trade execution fees by buying shares through a traditional stockbroker. With the vast improvements in digital stock trading, you can easily purchase stocks through online trading platforms like Scottrade for $7 per trade, or via Charles Schwab at about $5 per trade.
Strategies for Smart Stock Trading
Perhaps the best way to strategize your stock market trading experience is to view it physically, as a steel vessel made up of sensible, proven and comprehensive stocks that you'll use as armor for investing wisely in the stock market.
In doing so, look for companies with solid financial performance that are managed by seasoned and savvy executives. Also, favor companies with histories of above-average earnings growth, like Proctor & Gamble, American Express and Coca-Cola.
Also, keep these factors in mind when learning how to trade stocks:
- Keep your stock trading simple. When starting out, stay away from younger technology-driven stocks, since they're much too young, risky and difficult to evaluate. Instead, take a measured 10-year evaluation outlook when choosing stocks, examining their past 10-year performance and their potential 10-year performance down the road.
- Guarantee a return on equity. Companies that can't look out 10 years to be accurately gauged shouldn't make it into your starter portfolio. Neither should companies that require a lot of capital. To the contrary, focus on companies with low capital needs that tend to generate significantly higher returns.
- Have cash on the barrel. Look for companies that have deep pockets and ample cash flow. Usually, these companies have plenty of financial resources to pay their bills and keep growing, and keep making money for shareholders like you.
- Maintain low debt. Low debt leaves a company significant room for growth and allows earnings to grow based on shareholders' equity versus having to borrow money.
- Emphasize value. Target investments in undervalued companies with good long-term growth potential. Identifying such companies isn't easy but, he's has mastered the methodology by favoring stocks that are unjustifiably low based on their intrinsic worth -- according to an analysis of a company's fundamentals. He looks for good revenue producers that, despite being underpriced, are capably managed.
- Have long-term potential. Aim to select stocks solely on the basis of their overall potential as a company. Once you add such a stock to your portfolio, hang on to it for years, or even decades, as long as the share price keeps growing, and the underlying company fundamentals stay strong. Additionally, don't worry whether other investors recognize the stocks' value, but whether the stock earns money in the long term.
Stick to Your Plan
When you're learning how to trade stocks, stay sensible and don't chase investment returns, especially those deemed "hot" by street prognosticators. Consult your financial advisor, craft a plan that works for you, and stick to it - no matter what.
Also remember that stocks are volatile, and that stuff happens. Don't react to market crises emotionally - always keep a cool head and stick to your long-term plan.
Yes, it's tough to stay calm in a volatile market, but patience really is a virtue on Wall Street. Exhale and remember that stocks historically reward long-term investors - and that's exactly the kind of stock trader you want to become.