Here’s a quick and dirty guide for the complete novice who wants to learn how to invest in the stock market.
Here’s our quick and dirty guide for learning how to invest in the stock market for the complete novice:
1) Determine the type of trading account you want to open. Opening an account is simple. There are literally hundreds of online brokers to choose from. If you’re just getting started, I’d recommend Zecco.com or Scottrade.com. Both are cheap and fairly straightforward, and they do a good job of walking you through the sign-up process.
All you need to get started is some cash, time to fill out the required forms and an understanding of the type of account you’d like to open. If you want to invest in the stock market, but you’re not necessarily doing it for retirement, you should open an “Individual Account” rather than an IRA. Your gains in an individual account are subject to taxes and you’re also allowed to write-off losses. Best of all, you can transfer money out of your individual account without being subject to the penalties you’d have to pay if you were trading via an IRA.
If you’re planning to invest for retirement, you should open an IRA trading account. There are two types: Traditional IRAs and Roth IRAs.
Traditional IRAs allow you to deduct your contributions from your tax return every year (effectively meaning you pay less in taxes while you’re working). When you reach retirement age and withdraw cash from your Traditional IRA account, you will be subject to taxes. Roth IRAs are not tax-deductible, but when you withdraw your cash after retirement, you don’t have to pay taxes on those withdraws. In general, less sophisticated investors should opt for a Traditional IRA.
2) Determine whether or not you want to trade on margin. While filling out the required forms to set up your account, you’ll be asked a barrage of questions. One key question is whether or not you’d like to apply for a margin trading account. Margin accounts function like a line of credit that your broker extends to you so that you can invest more money than you put into your account. This also means you can lose more money than you put into your account. I wouldn’t recommend jumping into investing and immediately opting for a margin account. In the words of billionaire investor Warren Buffett: “Leverage is the only way a smart guy can go broke.” Important note: Margin is only available in individual accounts, not IRA accounts. You’ll also be charged interest on the cash you borrow from your broker.
3) Wait for your funds to clear. After you’ve set up your trading account, you’ll be asked to fund your account. Typically, brokerages will require an “initial deposit” of $500 or more (in some cases as much $2,500) to activate your account. These funds can be deposited electronically, by check or via wire. Of course, you’ll have to wait to wait for the funds to clear. Once they do, you’ll generally be notified via email that your account is credited and available for trading.
3) Place your first buy order. To place your first buy order on the stock market, you’re going to need to know the stock ticker for the company you’d like to invest in. An easy way to figure this out is by going to Google Finance and typing the name of a company into the search bar at the top of the page. For example, if you searched for Apple, you’d be taken to Apple’s quote page where you’d see the company’s ticker is AAPL.
Now that you have a ticker, return to your broker’s site (at Zecco, Scottrade or wherever else you chose to open a trading account), log in and hit the “trade” link. You should now see a series of boxes where you can place your order. Place the ticker (“AAPL”) in the ticker box, and indicate the number (or “quantity”) of shares you’d like to buy. Today, Apple shares are trading at $345.43. Therefore, if you enter a buy order for 10 shares of AAPL, your total cost would be $3,454.30. That’s an extreme example, of course. Most shares cost far less than $345.
While entering your buy order, you’ll see options for the type of buy order you’d like to place. Those options include a limit order or a market order. In most cases, a market order will suffice. That means you want to buy a specific number of shares at “market” price. But what’s market price? In essence, a market buy order means you’ll pay the cheapest available price to acquire shares in a particular company. For high-volume stocks (stocks with a trading volume of 500,000 shares or more per day), your order should get filled at or near the current quote price.
For shares that don’t change hands very often, you’ll want to avoid placing a market order since there may be a significant gap between the “market” price and the “ask” price. Let’s say for example you want to buy shares in Company XYZ, and the current quote for the shares is $2. Unfortunately, Company XYZ doesn’t get much action on the NYSE. Let’s say the company’s got a trading volume of 5,000 shares. That means just 5,000 shares change hands every day. Since the market is open from 9:30 a.m. to 4 p.m. EST, that’s not much trading. There may be stretches of several hours throughout the day when no one buys or sells shares in Company XYZ.
There are, however, a few people who want to sell shares in Company XYZ, and they have a standing order on the market to sell shares only if the price hits $3 (what’s known as a sell limit order). If you blindly submit a market order for shares in Company XYZ, and the only current seller is some guy who’s asking $3 per share, your buy order will be matched with his sell order, and you’ll be the proud owner of shares in Company XYZ at a cost of $3 per share – even though the quoted price was only $2 per share! Since no one was willing to actually sell shares at $2 per share, you got paired up with someone who was willing to part ways with his shares for $3 per share, and you just paid a 50 percent premium on the cost of the shares! That’s not a great way to make money trading stocks.
So, how can you avoid that? Place a limit order instead of a market order. If you want to buy shares in Company XYZ, but you’re only willing to pay $2.01, you can select “limit order” and enter a limit order price of $2.01. Your buy order will then be triggered ONLY if there’s someone out there willing to sell their shares for $2.01 or less.
You can get even more fancy with your buy orders by taking advantage of “buy stop orders”, “buy stop limit orders” and “buy trailing stop orders”, but those fall outside the purview of this column. For the vast majority of beginning traders, market orders and limit orders will suffice.
4) Place your first sell order. It’s a been a few weeks since you bought shares in a particular company, and hopefully, share prices have risen. Now, you want to sell your shares and pocket the gains.
Selling shares is as easy as buying shares. Just click on the number of shares you have in your account and place a sell market order or a sell limit order. A sell market order means you’re willing to sell shares at any available price. A sell limit order means you’re willing to sell your shares, but only if there’s a buyer out there willing to pay the price you’ve set. Congrats. You’ve just bought and sold your first few shares! I’ll be posting common pitfalls to avoid in the coming weeks. Good luck!