Buying stocks is an investment that represents part ownership in a corporation, entitling the stockholder to part of that company’s earnings and assets.
While investing in individual stocks isn’t for everyone, determining your strategy ahead of time can make it less vexing, says Michael Antonelli, managing director and equity sales trader at Baird, a Milwaukee-based investment bank.
“It’s important to know the risks before tackling a task that can be both exciting and frustrating at the same time,” he says. “Not only are you up against other humans, but you are also up against algorithms and computers that can make buy and sell trades in a fraction of a second.”
For novice investors who are learning stock trading basics, here are answers to a few common questions:
- How much money do you need to start stock trading?
- What are different stock trading strategies?
- When do you buy stocks?
- When do you sell stocks?
How Much Money Do You Need to Start Stock Trading?
While many discount brokerage firms allow you to open an account with a low minimum amount, a good rule of thumb to follow is to start with a $1,000 investment that you can lose, experts say.
“The stock market isn’t a magic ATM and investors should never put in money that they need or will miss,” says Jason Spatafora, a Miami-based trader and founder of Paper Street Capital.
What Are Different Stock Trading Strategies?
There are dozens of various stock trading strategies, but the two primary styles of investing are active and passive management.
Passive investors invest in mutual funds and exchange-traded funds, which mirror broad stock market indices, such as the Dow Jones Industrial Average or the S&P 500 Index, says Robert Johnson, a finance professor at the Heider College of Business at Creighton University in Omaha, Nebraska.
Broad stock market indices tend to be much less volatile than buying individual shares because of its diversification. Another advantage of passive management is that the fees are much lower compared with active management.
“Reduced costs are a definitive advantage for passive management and have been one of the driving reasons for the growth of passive management,” he says. “An investor can’t control the returns they earn on their investments, but they can control the costs.”
Having a mix of both passive and active management in your portfolio is another strategy. Investors should concentrate on the fees and select mutual funds and ETFs with low-fee ratios, experts say.
In active management, specific stocks are picked to outperform the market. The catch is that the returns are uncertain and volatility is a constant risk. Choosing stocks can be a fool’s errand and remains extremely challenging.
“Stock trading is not for everyone and even the savviest market veterans have been sidelined during the recent market volatility,” says Ron McCoy, CEO of Freedom Capital Advisors in Winter Garden, Florida.
When Do You Buy Stocks?
Distinguishing between a trade and an investment before buying a stock is important, McCoy says. A trade of a stock is short term, lasting anywhere from a couple of hours to a few days. In contrast, stocks held longer are considered an investment.
Investors must know whether their risk is going into a trade and have an idea of an exit point ahead of time, he says. Use stop losses and a profit targets for your entry and exit points.
“I would not recommend new investors try and trade given the level of experience required to be successful,” he says. “The majority of today’s volume involves computers, so realize who you are playing with. The saying ‘the trend is your friend’ is true. Heed the advice.”
Adopting either technical or fundamental analysis are strategies which both have risks, Antonelli says. Some investors prefer to utilize fundamental analysis to dissect company earnings and macro trends to decide when to buy and sell a stock. Others chose to follow technical analysis because they believe “price and charts don’t lie when it comes to investor supply and demand,” he says.
“Investors need to know that individual stocks can be risky, and even when they think they understand a company, something can come along to disrupt them and their investment,” he says. “Even great companies struggle. Just look at GE (NYSE: GE), a name that was once considered the gold standard for American companies that now languishes below $10 a share.”
One strategy is to buy a stock when the intrinsic value that is based upon fundamental factors is lower than the current stock price, Johnson says. One metric that investors utilize is comparing the price-earnings ratio to the growth rate, commonly referred to as PEG.
Computing a PEG ratio is one method. For instance, if a stock is selling at a PE ratio of 16 times earnings and has an expected growth rate of 8 percent, it has a PEG ratio of 2, he says. The lower the PEG ratio, the greater margin of safety.
“Investors don’t even need to compute the ratio as many websites do that for them,” Johnson says.
When Do You Sell Stocks?
A stock should be sold when the reasons you bought it deteriorate or because it is overvalued.
“Perhaps the only thing investors dislike more than risk is suffering losses,” Johnson says. “Investors convince themselves that until they sell the stock and realize the loss, they haven’t really suffered it. Investors are so reluctant to suffer losses that they will hold losers even though the tax code encourages realizing losses.”
If a stock moves against you, think critically about whether your reason to buy the stock was wrong, he says. Determine if the market is truly undervaluing the stock and its price will likely rebound.
“Do your best not to succumb to getting even, the affliction of needing to win back your losses before liquidating an investment,” Johnson says.
Look for companies that are innovative and insulated from technology that could make their niche or sector obsolete, Spatafora says. Knowing when to buy or sell a stock is a matter of choice and requires a large amount of discipline, he adds.
“I always encourage people to take profit, but I also believe investors need to set limits on losses,” he says. “Never assume something will go back up just because it went down 10 percent or more.”
If you generate a nice profit, there’s no rule that states you have to sell it all at once, McCoy says. “You could choose to sell half and keep an eye out for further gains and place a stop order underneath.”
New traders should try several strategies until they find one that is a good fit, says Peter Roselle, a Treasure Coast, Florida-based trader. Using chart patterns, such as ascending of descending wedges or head-and-shoulders patterns along with technical indicators like the relative strength index, known as RSI, or 50-day or 200-day moving averages are a good method.
“The goal is being able to ride the momentum up or down, following the path of least resistance,” he says.
Avoid allowing a trade to become too big or a large percentage of your portfolio.
“It could also push you into buying or selling at the wrong time,” Roselle says. “As traders, we want the decision making process to be as unemotional as possible. The price action should tell you what to do. When I buy or sell, it is because the indicators I use are all pointing to a similar outcome.”
Trade within the bounds you set before buying the stock, whether it is a dollar amount or percentage increase or decline. Maintain some of your assets in cash assets, such as certificates of deposit, known as CDs, or short-term government debt that is liquid – this allows you to buy a stock when it’s warranted, experts say.
Roselle’s advice: “The market does not know or care how big or small your positions are and ‘fighting the tape’ is a losing battle. Know your risk tolerance and remember, cash is a valid position as well.”