What is stock trading?
The stock market is considered one of the most lucrative and enticing markets in the trading world. It refers to the collection of exchanges and markets where activities such as issuance, buying, and selling of publicly-held company shares occur. These financial activities usually conducted through over the counter marketplaces or institutionalized formal exchanges that operate under predefined directives.
The stock trader refers to an individual who frequently buys and sells stocks. These are usually short-term traders who capitalize on daily price fluctuations. Instead of purchasing stock in a blue-chip company and holding it for a long time, these traders aim to earn profits in minutes, hours, days, or months.
There are various stock speculation types conducted by different stock traders, namely, day trading and swing trading.
|Day Trading||Swing Trading|
Ultimately the success of stock trading depends greatly on the best trading platform and tools provided by stockbrokers. Traders should always consider working with the best stock broker available that caters to their requirements.
Before we move any forward to understand stock trading, we need to be aware of the stock order types, that we mention in brief below.
- Limit orders: A limit order refers to a buying or selling order for a stock at a specific price. There are two types of limit orders: buy limit order and sell limit order. Traders can execute a buy-limit order at the defined price or lower and execute a sell-limit order at the defined price or higher.
- Market Order: A market order refers to an immediate buy or sell order for a security. It guarantees that the order will execute without guaranteeing the specific price. Market orders are usually executed near or at the current bid price if it’s a sell order and near or at the ask price if it’s a buy order.
- Stop Order: A Stop order, also referred to as a stop-loss order, is a specific order to either buy or sell a stock once the stock reaches a pre-determined price known as the stop price. Investors usually enter a “buy stop order” at a stop price above the current market price. Use it to protect profit, limit a loss on any stock sold short, or enter a position on any stock to buy after it reaches a certain level.
How to become a successful trader?
There are many factors that a stock trader has to consider before he/she aims to become a successful trader. We unveil seven of the most essential tips to become a successful trader in brief below.
Keep Opinions Lightly and Stops Tightly: The key to being a successful trader in the stock market is a fast adaptation even if it’s a bear market. It gives traders a chance to learn about how the market responds to such events or any similar period of dull returns. Traders are also advised not to bet against the market, as it can have disastrous consequences if they aren’t careful.
Succeed with a trading plan: a trading plan is required for traders to help them make logical trading decisions after defining their ideal trade parameters. By implementing a comprehensive trading plan, stock traders can take more objective trading decisions, preserve better trading discipline and risk management, and allows a trader to learn from their past mistakes. All of the above can significantly increase your long-term profitability. When coming up with a trading plan, traders should consider the following.
- Traders should always prepare a trading plan beforehand and should not until after they have begun their trading session.
- As stock trading is influenced to a large degree by external factors such as national economic policies and news, a trader should always prepare a trading plan with provisions for both good and bad circumstances.
- All of the actions a trader takes even in dire economic situations should be prepared and added to the trading plan from the beginning.
- Traders should always remember to follow their trading plan, no matter how many external factors affect them. They should stick to their plan, cover the losses, and take profits accordingly.
Control risk/reward ratio: In trading, the risk/reward ratio represents the profit potential of a trade, relative to its potential loss. Both the risk and profit potential of a trade must be determined beforehand. That is how the trader attains the risk/reward ratio. A stop-loss order is used to determine the risk, where the risk is the difference in price between the entry point and the stop-loss order of the trade. Additionally, traders use a profit target to establish an exit point if the trades move favorably.
Traders consider a good risk-reward ratio to be anything higher than 1 to 3. This is because the chances of ending up profitable in the long run are significantly higher. To better explain this, let’s take an example of 10 consecutive trades with a risk-reward ratio of 1:3.
In ten trades, there are five losing trades worth $5000 ($1000 each) while there are five winning trades worth $15000 ($5000) each. Here, the trader still makes a profit of $15000-$5000 = $10000, even if he/she wins 50 % of the trades.
Take your time to buy: During stock trading, traders may face the situation where the stock market has taken a nosedive. Contrary to the common practice of selling off, traders are advised to remain steadfast in their investments. The dip in the stock market may be present an opportunity to buy at bargain prices. The practice of “buying the dip” follows the principle of buying low and selling high, with a more targeted approach. A stock trader can only buy the dip when there is a sharp decline in stock prices, with a strong indication that prices will rise again.
It is generally a bad idea to buy into a stock that is falling sharply. While massive gains can be generated if one picks the bottom of the stock, buying a stock at the wrong time can lead to significant losses. This is where the warning “don’t catch a falling knife” comes into play. However, there are times when the risk of further loss is minimal compared to the enormous profit potential. Traders can capitalize on such situations.
Diversify: In trading, diversification refers to a trader’s portfolio containing a mix of bonds, stocks, and other investments for building the path towards long-term investment success. Diversification helps to improve the potential returns for whatever risk the trader targets. It requires balancing risk and reward to choose a healthy mix of investments. Traders are required to monitor and periodically rebalance their asset allocation and investing habits to make a tremendous difference in the outcome.
Over concentration in a single investment is one of the risks associated with portfolio diversification. For example, no single stock or investment should make up more than 5% of the trader’s portfolio. This is why, according to fidelity, traders should diversify across stocks according to small, medium, and large market capitalization, as well as on other factors such as geography and different sectors.
Psychology matters: Thinking quickly, containing emotion, and exercising discipline are considered the main components of trading psychology. Fear and greed are the two most important emotions to be aware of and to keep under control.
- Understanding fear: It may so happen that a trader receives bad news about a particular stock and is overcome by fear. He/she may overreact and proceed to liquidate their entire holdings and not take any further risks. Instead of being affected by fear, traders should quantify the fear. Traders should thus be prepared on how to perceive these events instinctively and move past the emotional response of fear.
- Overcoming greed: Greed is another emotion that comes in between trading decisions and isn’t easy to overcome. Traders overcome by greed do so based on the instinct to do better, just to get the extra bit of profit. Traders should, thus, learn to recognize these emotions and instincts and create a trading plan based on rational behavior.
Don’t overtrade: The process of excessive buying and selling of stocks by an individual trader is known as overtrading. For an individual trader, over trading occurs when he/she crosses the limit on how many trades should be executed, based on the trading strategy they have created.
Several ways are overtrading can be prevented.
- Creating Rules: Traders should add rules to enter a trade that can prevent them from placing orders that deviate from their planned strategy.
- Committed to risk management: Being committed to risk management can help a trader exercise strict position size management, as well as diffuse the likelihood of a significant drawdown.
- Exercising self-awareness: Investors who are self-aware of overtrading can prevent it by frequently assessing their trading activity by looking at past trading patterns.
The Bottom Line
Success in stock trading depends both on the trader’s skills and management, as well on the type of broker one ultimately chooses. Traders should always look to pick a broker with the most suited tools and terms to their trading strategy and preferences.