Stock Trading Guide

Different people tend to have different perception of the stock market and stock trading in general. Some believe they could make a fortune with a single trade overnight, while others feel rather reluctant to take the risk of trading a highly dynamic market segment such as stocks. In the first case, there are emotions such as greed involved, while in the second case – fear.

In fact, trading the stock market indeed is associated with a certain level of risk, but if one uses a disciplined approach, he/she could build his/her net worth gradually.

In the present guide we will take a deeper look at how the stock market works as well as at key terms and aspects of trading the stock exchanges worldwide.

Let us begin with some fundamental terms.

What do Shares/Stocks actually represent?

Shares/Stocks are financial instruments, which equal ownership in a particular company (corporation) and enable their owner to have a proportionate claim on that company’s assets and earnings. In other words, every shareholder (stock owner) owns a piece of the company that equals the number of shares he/she holds as a proportion of total outstanding shares. For example, if a person or an institutional investor owns 25,000 shares of a company that has 2,000,000 outstanding shares, then they own a 1.25% stake in it.

What types of Shares/Stocks are there?

Two types of shares exist in the corporate world – common shares and preferred shares. Common shares provide their owner with the right to vote at corporate meetings (for example, the annual general meeting of shareholders) on a variety of matters (for example, election of members to the corporate board of directors).

Most frequently, common shares provide their owners with equal voting rights (1 vote for each share owned). However, some companies may have multiple classes of shares with different voting rights. For example, XYZ Corporation may have a dual-class share structure – Class A shares that grant owners with 10 votes per share and Class B shares that can grant only 1 vote per share. The main reason why such dual or multiple-class share structures are designed is that they allow the founders of a particular company to maintain control over its assets, earnings as well as its strategic direction.

On the other hand, preferred shares do not provide their owner with voting rights. They are named this way because they give preference to their owner over common shareholders in the company when it comes to dividend payments and when it comes to receiving assets in the event of business liquidation.

Nowadays, when we use the term “Equities”, we usually refer to common shares, since their combined market value and trading volumes are much more formidable compared to those of preferred shares.

What does Initial Public Offering (IPO) mean?

To begin business operations, every startup company requires a considerable amount of capital. The latter can be raised in two possible ways – through a bank loan (funding through debt), or through share sale (funding through equity). As the business expands, the company may require access to even larger amounts of capital than what can be generated from daily operations or obtained through a bank loan. Therefore, the company may decide to go public – to sell shares to the public via an Initial Public Offering (IPO).

By doing so, the company will transform from a privately held entity (with only a few shareholders having control over it) to a publicly traded entity (where numerous members of the public will be holding its shares).

IPOs provide early investors in a particularly company with the opportunity to cash out a portion of their stake and, as a result, to generate decent gains.

As soon as the company’s shares are listed on a stock exchange and trading in those shares begins, their price will start fluctuating as market participants assess and revise their assessment of the shares’ intrinsic value.

What does intrinsic value of a stock mean?

Analysts within the financial industry tend to implement a variety of models in order to estimate the intrinsic value of a particular company’s stock. The intrinsic value can be described as fundamental, objective value associated with a financial instrument (stock), while the discrepancy between the stock’s current market price and the intrinsic value estimated by a financial analyst could translate into an investing opportunity.

Generally speaking, in case the stock’s current market price is below the estimated intrinsic value, then it may be a good time to buy that stock. And, in case the current market price is above the estimated intrinsic value, then it may be a good time to sell the stock.

To evaluate the intrinsic value of a stock, market analysts may employ models such as:

• Dividend Discount Models
• Residual Income Models
• Discounted Cash Flow Models

How can Stocks be classified?

Most frequently, stocks are classified by market capitalization and by sector. When we talk about market capitalization, we refer to the overall market value of the outstanding shares of a particular company. The market capitalization can be calculated when we multiply the total number of shares listed by the current market price of one share.

Companies that have a market capitalization of between $300 million and $2 billion are usually considered as small-cap companies. Additionally, companies with a market capitalization of between $2 billion and $10 billion are regarded as mid-cap companies, while those with a market capitalization of more than $10 billion are considered as large-cap companies.

When it comes to stock classification by sector, we usually refer to the Global Industry Classification Standard (GICS), introduced by MSCI and S&P Dow Jones Indices in 1999. It represents an industry classification system, comprised of 11 sectors and 24 industry groups, and reflects the breadth, depth and evolution of different industries. GICS includes the following sectors:

• Industrials
• Materials
• Energy
• Health Care
• Financials
• Consumer Staples
• Consumer Discretionary
• Communication Services
• Information Technology
• Real Estate
• Utilities

More conservative investors will usually give preference in their portfolios to sectors whose comprising stocks offer attractive dividends and have better price stability – for example, sectors such as consumer staples, utilities or health care. Meanwhile, investors with higher risk tolerance will prefer sectors with higher price volatility such as energy, financials or information technology.

What is a Stock Market Index?

Along with individual shares/stocks, market participants pay particular attention to Stock Indices. A Stock Index represents aggregated prices of different stocks that are included in it. The movement of Stock Indices reflects the net effect of the movements of every individual stock included. When we speak about the stock market, we usually refer to some major Stock Indices such as the S&P 500, the Dow Jones 30 Industrial Average, the FTSE 100 and so on.

We can say that Stock Indices represent a valuable measure of the performance of a particular stock market. The majority of indices are market capitalization-weighted, or the weight of every index component (stock) is proportional to its market capitalization. There are price-weighted indices as well, such as the Dow Jones 30 Industrial Average, which includes the shares of 30 major, blue-chip US companies.

Some of the major Stock Indices, which investors tend to watch closely every day, include:

• US S&P 500
• Dow Jones 30 Industrial Average
• NASDAQ 100
• S&P/TSX Composite Index in Canada
• FTSE 100 in the UK
• CAC 40 in France
• DAX 40 in Germany
• IBEX 35 in Spain
• BOVESPA in Brazil
• Hang Seng in Hong Kong
• Nikkei 225 in Japan
• TOPIX in Japan
• CSI 300 in China
• Shanghai Composite in China
• S&P ASX 200 in Australia
• SENSEX in India
• KOSPI in South Korea

What is a Stock Exchange?

A stock exchange represents a secondary market, where existing owners of shares can make deals with potential buyers. We should note that publicly traded companies on the stock market do not purchase and sell their own shares. This means when an investor purchases shares of a company’s stock on the market, he/she will not buy them from the company itself, but rather from other existing shareholder. Also, when an investor sells his/her shares on the market, he/she will not sell them back to the company, but rather to another investor.

You may ask how stock buyers and stock sellers are matched, since they may not find each other at any given moment. On many exchanges, there are professional traders, known as market makers or specialists, who maintain continuous bids and offers. On one side of the market are the bids and on the other – the offers, while the price difference between them is known as a spread. The tighter the bid-ask spread and the bigger the size of the bids and the offers (or the amount of shares on every side of the market), the higher the liquidity of a particular stock. Additionally, in case there are a number of buyers and sellers at sequentially higher and lower prices, the market is considered as having a good depth. A high-quality stock market will usually have narrow bid-ask spreads, high liquidity and good depth.

Initially, stock buyers and sellers were matched manually on an exchange via a system known as “open outcry”. Or, traders used to use verbal and hand signal communications in order to purchase and sell “blocks of stocks” on the floor of the stock exchange. Years later, that system was replaced by electronic trading systems at the majority of stock exchanges. This way stock buyers and sellers can be matched faster and much more efficiently, while trading costs were reduced and trade execution was greatly accelerated.

In many developed countries, stock exchanges are self-regulatory organizations and non-governmental organizations, which are empowered to issue and enforce industry regulations and standards. Stock exchanges’ major objective is to ensure investor protection through rules promoting ethics and equality. Notable self-regulatory organizations in the United States include the National Association of Securities Dealers (NASD) and the Financial Industry Regulatory Authority (FINRA).

Nowadays, many stock exchanges across the globe are linked together electronically, which ensures greater efficiency and higher liquidity of the stock market.

Which are the largest stock exchanges worldwide?

The signing of the Buttonwood Agreement in 1792 by 24 New York City stockbrokers and merchants laid the foundation of the New York Stock Exchange (NYSE). Before the incorporation, brokers and traders used to hold unofficial meetings under a buttonwood tree on Wall Street in order to purchase and sell shares. In 1817, New York stockbrokers, who operated under the agreement, introduced significant changes and reorganized as the New York Stock and Exchange Board. Trading at the NYSE is conducted on Monday through Friday from 9:30 am – 4:00 pm ET, with the exception of official holidays (New Year’s Day, Martin Luther King, Jr. Day, Washington’s Birthday, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas). The exchange closes early on the day that precedes Independence Day and on the day that follows Thanksgiving and Christmas Eve. There are 253 trading days per year, on average, at the NYSE.

The NYSE and NASDAQ are the two biggest stock exchanges worldwide in terms of total market capitalization of all the companies listed. Currently, there are 20 stock exchanges in the United States alone, registered with the Securities and Exchange Commission (SEC), with the majority of them being owned by the NYSE, NASDAQ or CBOE.

As of May 2021, the 20 largest stock exchanges worldwide by total market capitalization of listed companies include:

* Included are Copenhagen Stock Exchange, Stockholm Stock Exchange, Helsinki Stock Exchange, Tallinn Stock Exchange, Riga Stock Exchange, Vilnius Stock Exchange and Iceland Stock Exchange.

When it comes to the number of companies listed on some of the largest exchanges worldwide, that information is presented in the table below.

Now, let us take a look at the 50 companies having the largest market capitalization worldwide, according to October 20th 2021 data. Note that the table contains publicly traded companies only.

What is a “block”?

In stock trading, when we talk about “blocks”, we refer to large orders containing shares of one and the same stock, or orders that have a considerable notional value. Most frequently, one block contains at least 10,000 shares of a company stock, or it has a total market value of at least $200,000-$250,000.

According to market data, block trading accounts for nearly 20% of the trading volume on the NASDAQ.

Asset managers at large mutual funds, hedge funds, banks as well as insurance companies usually employ block trading, as they take a long-term view of financial markets in their investment decision making and take huge positions in stocks.

Large stock buybacks by large corporations can also be conducted via block trading.

We should note that, sometimes, block trades are conducted outside of the open market, so that the impact on the stock’s price is reduced.

How is the Stock of a company priced?

On a stock market, a company’s shares can be priced in several ways, but most commonly, this is done via an auction, where bids and offers are placed to buy and sell. A bid represents the price level, at which a market participant is willing to buy the particular shares, while an offer/ask represents the price, at which another participant is willing to sell. In case the bid and the ask levels coincide, we say that a trade is secured.

The stock market is comprised of millions of traders and investors, who usually have different ideas about the valuation of a given stock and, therefore, they have different price levels, at which they wish to buy or to sell. As those traders and investors convert their intentions to actions, thousands of transactions (buy and sell) occur at the market, which cause minute-by-minute gyrations in that given stock during the trading session.

The difference between the bid price and the ask price for a stock is known as a bid-ask spread. It reflects the difference between the highest price a buyer wishes to pay for the given stock (the highest bid) and the lowest price at which a seller wishes to sell the stock (the lowest ask). A trade/transaction occurs, when the buyer accepts the ask price, or when the seller accepts the bid price.

Here we come to a point where we need to note that the stock market is an excellent representation of the laws of supply and demand at work. In case the number of buyers for a particular stock exceeds the number of sellers of it, the stock’s price will increase. In case the number of sellers of the stock exceeds the number of buyers, the stock’s price will decrease. If there are more buyers for a stock than there are sellers, buyers may wish to raise their bids to obtain that stock. Sellers will, as a result, ask higher prices for the stock, driving the stock’s price higher. If there are more sellers of a stock than there are buyers, sellers may wish to accept lower offer prices for that stock. Buyers will, as a result, reduce their bid prices for the stock, while pushing the stock’s price lower.

Stock exchanges actually ensure a platform where trading can be executed with ease by matching stock buyers and stock sellers. In order for the average investor to gain access to a stock exchange, he/she requires the service of a stockbroker, which will act as an intermediary between the buyer and the seller.

What does a Stockbroker do?

Stockbrokers are professionals, who carry out market trading orders on behalf of their clients. They are also known as registered representatives or investment advisors. Stockbrokers usually work for a particular brokerage company and manage transactions of its individual and institutional clients. In exchange for their effort, stockbrokers receive payment in the form of commission, though there are also other compensation methods depending on the brokerage firm.

It has already become practice brokerages and other broker-dealer firms themselves to be referred to as stockbrokers. Those firms can be either discount brokers or full-service brokers. Discount brokers usually engage only in buying or selling activities on behalf of their clientele. Meanwhile, full-service brokers usually offer a wider range of financial services, including research, investment advice or portfolio management. Nowadays, the majority of online brokers are actually discount brokers and they execute client trades either free-of-charge, or for a small fixed-price commission. We should also note that there are online brokers offering premium services for a higher commission.

As we said earlier, stockbrokers act as middle-men between the stock market (exchanges) and the members of the investing public. Once brokers receive a trade order from their clients, they attempt to have it filled at the best possible price. For that service brokers are paid a fee (a commission). Since the introduction of online trading platforms and mobile trading apps, which ensure convenience for clients to handle their own trade orders, many stockbrokers have become mostly financial advisors or financial planners.

The relentless competition within the online trading field has forced online brokerages to reduce commissions (in some cases even to zero). Against that backdrop, discount brokers have begun offering additional services such as research and education, along with their pure execution service.

To buy and sell shares on major stock exchanges such as the NYSE, one is required to either be a member of the exchange itself, or work for a member firm. Those member firms and individuals working for them are authorized as brokers or broker-dealers by the Financial Industry Regulatory Authority (FINRA).

When it comes to broker licensing regimes concerning stock exchanges across the globe, we should note that:

1. In the United States, registered stockbrokers are required to have the FINRA Series 7 and Series 63 or 66 licenses, while they have to be sponsored by a registered investment firm;
2. In the United Kingdom, stockbrokers are required to achieve specific qualifications from the Financial Conduct Authority (FCA);
3. In Canada, stockbrokers are required to successfully complete the Canadian Securities Course, Conduct and Practices Handbook as well as the 90-day Investment Advisor Training Program;
4. In Singapore, to become a stockbroker, one needs to pass several exams – Modules 1A, 5, 6 and 6A, which are administered by the Institute of Banking and Finance. Licenses are provided by the Monetary Authority of Singapore (MAS) and the Singapore Exchange;
5. In Hong Kong, to become a stockbroker, one needs to be employed by a licensed brokerage firm and to pass three exams administered by the Hong Kong Securities Institute. Once the exams are passed, candidates must still be approved by Hong Kong’s financial regulatory authority to obtain a broker license.

Today brokers who work for discount brokerage firms may either be in the role of over-the-phone agents, or of branch officers in a physical office. Another group of stockbrokers may be employed by investment banks or specialized brokerage firms, which offer services mostly to institutional investors and high-net-worth individuals. Another recent innovation in the brokerage services field includes the so called roboadvisers – algorithmic investment management conducted via web or mobile app interface.

Until recently, it was extremely expensive for the average investor to access the stock market. On the other hand, high-net-worth individuals and large institutional investors could access the exchange by using the services of full-service brokerages, as they could afford to pay a massive amount of money for filling a trade order.

However, as the Internet and related technologies progressed, it became possible for discount brokers to offer their clientele less expensive, fast and automated online access to the stock market. Nowadays, there are also brokerages (such as Robinhood, for instance) that allow the purchase of fractional shares, while suiting the needs of micro-investors. Today the majority of trading accounts in the stock market are managed by the respective account owners and held by a particular discount brokerage.

What are the advantages and disadvantages of Stock Exchange listing?

A company listed on a reputable stock exchange will certainly benefit from:

1. Access to liquidity for shares that its shareholders own;
2. Opportunity to set up stock options plans more easily. Such initiatives are crucial for luring highly coveted professionals to work in the company;
3. Opportunity to raise more funds with the issue of additional shares;
4. A publicly traded company can use listed shares to make acquisitions, where part or the entire amount is paid in stock;
5. A publicly traded company becomes “more visible” in the marketplace. The price of its shares can rise as a result of analyst coverage or higher demand from institutional investors.

There are, of course, certain disadvantages associated with stock exchange listing:

1. First of all, to be listed on a reputable exchange incurs considerable costs for the company such as listing fees as well as higher compliance and reporting expenses;
2. Second, exchange regulations may be too complicated and may affect the company’s ability to run its business operations;
3. And third, the majority of investors tend to be focused more on short-term outcomes. As a result, many companies steer their resources toward objectives such as exceeding analyst estimates for quarterly earnings and revenue, for example, instead of focusing on their long-term corporate strategy.

Next, let us discuss some practical considerations, which you may take into account before you begin trading stocks. Note that to be successful in stock trading, you need to have a proper approach to the market itself, suitable education and research, as well as discipline.

Day Trading and Swing Trading

There are two popular ways to approach the stock market – either by trading it on a daily basis, or by taking advantage of a more medium-term development in stock prices. We should categorically distinguish active stock trading from stock investing! To invest in stocks is a process that unfolds in a long-term (months and even years). On the other hand, to trade stocks actively is associated with taking a short-to-medium term approach. In this line of thought, day trading and swing trading are two popular ways to actively trade the stock market.

Day trading involves executing intraday trades in a particular stock. A day trader will open and close his/her position in the market within the same trading day (trading session). Or, the trades’ duration can be between several seconds and several hours, depending on daily volatility in prices. Day traders employ mostly technical analysis, when implementing their trading strategies. They will be looking to identify price trends with the help of technical indicators such as moving averages, the RSI, the MACD or Bollinger Bands, as well as by closely examining segments of the price chart for possible “chart setups” or formations (that could indicate either a trend continuation or a trend reversal).

Swing trading is a more medium-term approach. Swing traders will hold their positions in the market open for a time period ranging from several days to several weeks (sometimes up to a few months). To execute their trading strategies, swing traders will usually employ technical analysis in combination with fundamental analysis. The latter includes closely following macroeconomic and political developments as well as corporate news and financial results reported by companies.

In order to choose between those two approaches, you may need to determine:

• your total investment objectives
• the time horizon in which to achieve those objectives
• your risk tolerance
• the type of strategy that best suits your current lifestyle
• the time you need to spend educating yourself.

Creating a trading account with a stockbroker

As a retail investor, you will need to open a brokerage account in order to gain access to tradable asset classes such as Stocks, Bonds, Mutual Funds and etc. As with a traditional bank account, the brokerage account allows you to transfer funds in and out at your convenience, but it also gives you access to the stock market.

At present, opening a brokerage account online has become a quite fast and hassle-free procedure. New traders and retail investors are very welcome at leading discount brokers such as TD Ameritrade, Interactive Brokers or E-Trade, as they have a reasonable minimum deposit requirement to open an online trading account and also offer stock trading with zero commissions.

Now let us discuss the specific steps of opening an account with an online brokerage.

First, you have to decide how much assistance you will require from your stockbroker. There are a number of types of brokerage accounts on offer and each of them has its advantages and drawbacks. You will need to do a good research of the brokerage, its account types, trading platforms and trading conditions to determine if it could suit your financial objectives. More specifically, you may pay attention to the broker’s fees associated with opening and using the brokerage account, whether its online trading platform offers user-friendly interface and features, whether it has a minimum deposit requirement and, if it does, whether that minimum amount is convenient for you. Also, you may need to look into the stockbroker’s educational and market research materials. Nowadays, most of the leading brokerages tend to offer highly competitive and interactive educational content on their web page or dedicated blog.

Stockbrokers will usually offer both self-managed and managed trading accounts. A self-managed brokerage account is actually a trading account that you can manage entirely by yourself. If you consider your knowledge of the stock market and skill level as sufficient to begin day trading stocks with real money, then this may be the right choice of an account for you. A managed brokerage account is a trading account managed by a professional (usually a registered investment advisor working for the brokerage). If you consider yourself not entirely confident to start trading on your own, then this account type may be a good option for you.

Second, after you have selected a brokerage company to work with, you will have to apply for a brokerage account. Today many discount brokers will allow its clients to do so directly online, while the procedure itself usually takes between 10 and 15 minutes. To apply for a stock brokerage account, you will be required to provide specific information:

1. personal information such as full name, mailing address, phone number, social security number, current financial situation and assets;
2. information about your tax status – in the application form, the brokerage may require of you to answer questions such as whether you are opening the account as an individual or as a business entity, whether you are filing individually or jointly with your spouse and so on;
3. information concerning your personal risk tolerance – the application form may include questions about your investment experience, investment strategy and investment objectives as well as knowledge of risk management;
4. some other information may also be required.

Third, you need to fund your brokerage account. If the broker has a minimum initial amount requirement, you will have to satisfy it and what you put down as a deposit on top of it is entirely up to you. Since no gains are guaranteed when trading stocks, you need to carefully assess what amount you will be comfortable to invest so that your monthly budget is not disrupted. Also, bear in mind that you should not invest an amount that you cannot afford to lose!

Detecting “the best” Stocks to buy in the market now

You should always be looking for Stocks that have the highest possibility to make a significant move. This is where a reliable “stock screener” tool may prove quite useful. Today the majority of leading stockbrokers offer either built-in or fully customizable screener tools, allowing you to view a selection of Stocks based on particular parameters (market cap, analyst rating, price movement in percentage, region, industry and so on). TD Ameritrade’s Think or Swim trading software is one of the good options, for instance. Still, a good stock screener is just the first step of the whole process called trading.

High Volume as indicator in Stock trading

Experienced stock traders will probably tell you that volume is the first key indicator they pay attention to when selecting the best Stocks to invest in. Volume means a higher potential for price volatility and volatility provides numerous trading opportunities for active traders. High volume enables traders to enter and exit their positions in the stock market at optimal price levels.

In case a Stock is showing well above-average, “unusual” volume, there probably is a catalyst (“unusual” event) that has caused it. That catalyst may not necessarily be a specific corporate event or financial report, but rather some news of industrywide importance, which led to a surge in volume. For example, in 2020 there was an enormous bullish speculation surrounding the electric vehicle industry and during the price rally the majority of electric vehicle Stocks gained in value, no matter that a particular company in the sector did not have a driver (catalyst).

Identifying unusually high volume in a Stock or in a Sector opens the door for potential trading opportunities, which may not be detected by inexperienced traders. There are some stock screeners that will visualize the top “unusual volume” Stocks.

Stock market news

Stock news (whether events or reports that concern a particular company or news concerning the entire industry) can also be a strong catalyst behind share price movement. Mergers and acquisitions or FDA approvals are very likely to trigger a move up in a particular company’s stock. In other cases, if a stock is showing considerable movement with no real catalyst, then it probably is due to some speculation in the market.

The VWAP technical indicator

Both day traders and swing traders use the volume-weighted average price (VWAP) as a technical analysis indicator. It reflects the average price level at which a particular stock has traded throughout the trading session, while the indicator takes into account both price and volume. This indicator helps traders detect stocks that are trading in proximity to their VWAP. If you use the VWAP indicator in combination with a volume indicator, you will be able to focus only on trending stocks which are testing VWAP levels.

High float and Low float Stocks

Stock float is another key day trading term that concerns every publicly traded company. It reflects the number of outstanding shares of stock available to trade minus the shares held by company employees or insiders. The stock float is actually all the shares of a company that investors are able to trade in the open market.

Stock traders usually look to stock float in order to determine supply and demand of a particular stock. In case a stock has a high stock float, there are more shares available to trade in the market and it would require higher buying and selling activity for the stock to move. On the other hand, if a stock has a low stock float and if a surge in volume occurs, this would lead to a more considerable price movement because of supply and demand.

Next, let us discuss some chart patterns (technical analysis studies), which you may be able to use when employing day trading or swing trading strategies to buy stocks. These patterns may help you earn a profit when stock prices are trending up. In order to buy stocks at low price levels and sell them at high price levels, you will have to learn to identify bullish (uptrend) chart patterns.

The Golden Cross Pattern

It is perhaps one of the most popular chart setups among active traders. For this pattern we need to deploy two technical indicators on the price chart – a short-term moving average (MA) and a long-term moving average. Most frequently, those would be the 50-day MA and the 200-day MA. The so called “Golden Cross” occurs when the short-term MA (50-day) of the stock crosses above the long-term MA (200-day). If you examine larger time periods (chart timeframes) such as daily or weekly charts, the Golden Cross pattern will indicate stronger bullish breakouts that last for longer stretches of time.

The Double Bottom Pattern

Also known as a “W-shaped” pattern, the Double Bottom setup is considered as one that indicates a trend reversal in a stock’s price movement. The setup occurs on the price chart when the stock’s price hits roughly the same trough (notable low level) two times and then bounces up. In case the price reaches roughly one and the same low level twice and then rebounds immediately off them, this indicates there is a strong support for the stock at those levels. Traders will usually enter the market as soon as the stock rallies after hitting the second low level. This setup may occur on various chart timeframes, but it tends to be more reliable if detected on larger charts.

Risks associated with stock trading

The stock market can bring handsome rewards, but it is also regarded as being extremely risky (unlike other market segments such as government bonds which usually have a low-risk profile). More precisely, there are several types of risks that every investor in stocks may encounter.

First of all, there is a market (or systematic) risk. The stock market can experience periods of exceptionally high volatility and can be quite unpredictable, as it may be affected by various market and economic factors (no matter if those are local or global). A specific market can be heavily influenced by macroeconomic, geographical, political, social, health situation-related and other factors.

Second, there is a global risk. Since most of the stock exchanges worldwide are open, they can be affected by disruptions in all major markets. Therefore, investors are exposed to economic and other events that occur around the world and this should always be factored into their risk assessment.

Third, there is an interest rate risk. Changes to central banks’ interest rate policies may influence different stocks to different extents. Let us take the Hong Kong Stock Exchange, for example. Due to the USD/HKD exchange rate peg, interest rate changes in Hong Kong may be directly affected by interest rate changes in the United States. As a result, Hong Kong shares may track the performance of US shares.

Fourth, there is a business risk. A publicly traded company, in which you decide to invest, could have a considerable drop in revenue and earnings or could even go out of business. The reasons for such outcomes could vary, but usually they are related with poor management, intense competition or a slowdown in the particular industry.

Fifth, there is a risk of inadequate corporate governance. An exchange-listed company, in which you decide to invest, may be managed improperly or may be involved in transactions that could affect the interests of its shareholders (for instance, the acquisition of an over-valued asset). The regulatory authorities will usually not be concerned with the commercial decisions of a listed company as long as they do not violate regulations.

Sixth, there is a liquidity risk. Low-cap stocks are usually less liquid than high-cap stocks. You should be aware of the additional risk of getting tied up in stocks that may be too difficult or too costly to dispose of.

Seventh, there is a risk of a particular stock being suspended from trading. This is a measure that aims to prevent any uneven information dissemination as well as insider trading opportunities and to ensure trading in the stock is conducted on a fully informed basis. Buying and selling the stock will not be accessible during the period of suspension, but there is a chance that its price changes due to shifts in market and business risk.

And finally, there is a policy risk. Any notable shifts in government policies and regulations may deeply affect the stocks of companies in the relevant industries.

We should note that the risks in stock trading cannot be avoided completely, but can certainly be managed. You should always be mindful of your risk exposure in accordance with your investment goals and risk tolerance – determine what amount you are willing to allocate to the stock market and what amount you feel comfortable to lose. After that, restrict your exposure to an acceptable extent. Also, it is crucial to consider if a particular listed company has the ability to deliver sustainable earnings and, therefore, underpin its stock price rally in a longer term. And finally, be very cautious when you are trading a Stock, driven by rumors or speculation – in case the latter turn out to be incorrect, there is a high possibility that the stock’s price reverses direction.

Some additional considerations – researching Stocks, trade orders, trade costs, taxes

If you are completely new to the stock market, selecting individual Stocks to add to your portfolio may not be the most appropriate way to start. A good choice of individual Stocks is based on a profound analysis of financial ratios in order to determine how a particular company is faring compared to its competitors. Therefore, you may try trading Exchange-traded Funds (ETFs), which enable you to operate with a bundle of Stocks at once. There are several types of ETFs, but the most suitable for beginners are probably ETFs that replicate major Stock market indices (S&P 500, for example), as they will give you broad exposure to the stock market.

Buying and selling Stocks or ETFs is associated with placing different types of trade orders. Most commonly, those are market orders and limit orders. Market orders equal immediate trade execution at the best price level available at the moment. Limit orders, on the other hand, do not necessarily ensure immediate execution, but they will give you a better control over the price you pay (if buying) or the price you receive (if selling). Limit orders allow you to set a specific price level at which you are willing to buy or to sell a particular Stock or ETF. This way you will be able to get the most out of your trade. Once you have purchased a Stock or ETF, you may place a Trailing Stop sell order, which will allow you to keep the asset as long as the market is trending up and automatically sell when the market reverses direction and the price moves down beyond a certain point.

Another key moment to consider, if you want to be successful in stock trading, includes trade costs (money you pay to open or close a trade position in the market). Most frequently, those costs are the commission fees charged by the stock brokerage. In this line of thought, you may take your time researching different brokers and select one charging low fees. It is also possible that the brokerage firm will not charge any commissions for trading Stocks and, in this case, you will not incur any trade costs. Yet, when trading ETFs, you will need to be aware of expense ratios. These funds are usually managed by a professional who receives annual compensation in the form of a percentage of the fund’s assets. If the expense ratio for a particular ETF is 0.2%, then you will have to pay $0.20 per year in expenses for every $100 you have invested.

Finally, when you trade Stocks actively, the profits you earn will be taxed – you will have to pay “capital gains tax”. Generally, you will pay more taxes if you hold a Stock for a period of less than 1 year and you will pay less if the holding period is longer than 1 year. Such a tax structure is purposed to encourage investing in a long term.

Conclusion

The stock market is associated with a high level of risk, but if approached in a disciplined manner, it can help you build value gradually over time (we should note this market segment can be much more rewarding if compared to a traditional bank deposit, for example, given that interest rates are currently near rock bottom levels and cannot even cover the annual rate of inflation).

In this guide we discussed some key aspects related to stock trading and the market itself, but note that if you want to be a successful stock trader you will have to invest as much time as possible in a quality education (either provided by a particular brokerage or obtained from other sources) and you should strive to develop any new skill acquired.

A good way to practice what you have learned is to use paper trading money on a stock simulator before you start investing real money. With paper trading you will be able to build your confidence in the stock market, after which the transition to real money trading will be a lot easier.

R. Perry