Stock Trading (2024)

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• Stock trading involves buying and selling stocks for profits within a short time period.
• Trading is a risky venture, and doing it successfully requires time and understanding the market.
• Trade smarter by setting your budget, risk tolerance, and trading strategy ahead of time.

We all want to be the next person to win big with a lucky stock trade. Unfortunately, this isn't in the cards for most traders. In reality, it takes a lot of knowledge, research, discipline, and patience to become a profitable stock trader.

"Investing is not about getting rich quick. Investing is about getting rich slowly," says Randy Frederick, a financial expert who previously served as vice president of trading and derivatives at Charles Schwab. These are wise words to live by if you're new to the stock market and wondering if trading is right for you.

Stock trading is a tricky business. Yes, trading individual stocks can be exciting and profitable, but it's not easy. Here are a few things to keep in mind:

Successful trading takes time and commitment. If you're just starting out in trading stocks, it's best to avoid day trading and consider longer-term stock trading strategies. "Day trading is actually the worst option for beginner investors," says Frederick. In reality, for every person who makes millions off of a lucky trade, there's thousands of others who lost money trying the same tactic.

But if you're curious about the thrill of short-term buying and selling and the potential profits that can come along with it, here are the basics of stock trading and the steps that will help get you started.

Understanding stock trading

What is stock trading?

Stock trading entails buying and holding stocks for a short period of time in order to turn a quick and significant profit. Traders aim to take advantage of short-term pricing fluctuations in the market.

Trading can be contrasted with investing in stocks, the approach to the stock market that aims to gradually build wealth by holding assets over a long period of time. Whereas investors buy stocks and hold them for many years, traders hold them for only an hour, a day, a week, or a few months.

How the stock market works

Stock prices are based on expectations of future profitability, with the value of any individual stock being a function of supply and demand. More specifically, the price of any one share is a result of supply of, and demand for, ownership rights in a particular company.

The stock market as a whole functions largely on sentiment. The market is created by a large number of retail and institutional investors, who respond to different factors (like the latest news developments) and then buy and sell stocks in response.

It is important to remember that the stock market can be very fickle, shifting quickly and experiencing sharp price fluctuations.

Types of stock trading

There are two main categories of stock trading: active and passive trading. Active trading is a highly technical approach with the goal of capitalizing on short-term price fluctuations.

Traders are generally divided into one of two camps, based on the time period in which they hold their securities. These two camps are day traders and swing traders.

Day trading

Day trading refers to any strategy that involves buying and selling stock over a single day, such as seconds, minutes, or hours. This strategy can be highly profitable, but it can also result in substantial losses.

This strategy is not for the faint of heart or for newcomers. Anyone who is considering this approach and has not used it previously should be sure to conduct thorough due diligence on day trading.

Swing trading

Swing trading involves buying securities and holding them for days or weeks. The idea behind this is profiting from an upward movement or "swing" in the market.

Swing traders frequently use technical analysis, which involves analyzing trends in terms of both price movements and volume. Traders who use technical analysis believe that by examining a security's price and volume history, they can get a better sense of what it will do in the future.

Position trading

Position trading is a more long-term strategy focused more on stocks' broader trends than short-term fluctuations or market news. It could be described as the opposite of day trading, since it involves purchasing shares and retaining them for a time, which could be a matter of weeks or years.

Position trading is a type of passive trading. Passive traders buy based on overall market trends, and sell when they believe the security hits its peak, which can take months. They generally trade less than active traders. In this way, passive traders are more akin to long-term investors who follow a buy-and-hold strategy.

When using position trading, investors may harness both technical analysis and fundamental analysis, which involves reviewing a company's "fundamentals" such as revenue and earnings and determining its true worth. By doing this, you can get a better sense of whether a particular security is undervalued or overvalued.

Scalping

Scalping is a very short-term strategy that involves making a large number of trades per day in order to generate many small profits. An investor using this approach might make hundreds of trades in a single day.

The idea behind this approach is that it might be easier to profit from many small price movements than a single large one. By using this strategy, a trader can generate many small wins in the course of a day.

Traders who use this strategy must be ready to exit a stock they purchased even if it is on its way up. If a trader sells a stock, they can always buy back in again later.

Essential stock trading strategies

Technical analysis

Technical analysis involves studying a security's price and volume history in an effort to get a better sense of what it will do next and identify the best times to enter and exit a position. By studying a security's price history, you can identify trends in its movements.

Fundamental analysis

Fundamental analysis involves evaluating a company's fundamentals, for example its revenue and earnings, to get a better sense of whether it is undervalued, overvalued, or fairly priced. While a technical analyst may look at statistical trends and patterns with charts, a fundamental analyst will start with a company's financial statements.

While the two styles of analysis are oftentimes considered as opposing approaches, it makes financial sense to combine the two methods to give you a broad understanding of the markets to help you better gauge where your investment is heading.

More specifically, you can use fundamental analysis to find stocks that are undervalued relative to their sector or the broader market and then harness technical analysis to pinpoint the best time to buy shares of that stock.

Momentum trading

Momentum traders look to benefit from trends in the price of a stock or other security. If a share of stock is trending higher, it will often continue to move that way. Once the momentum dies down, it's time to sell.

The converse is also true, meaning that if a share of stock has been falling in value, it will frequently keep moving that way, experiencing a downward trend.

Trend following

One good strategy involving stocks is following trends. If you can pinpoint a share of stock that is in an obvious uptrend, you can potentially purchase those shares and benefit from the upward price movement.

If a stock is consistently reaching higher lows, it is in a clear uptrend. Once you have singled out this trend, it may be a great time to buy.

Another consideration is that trends don't last forever. If a stock experiences a downward trend, that trend may run out, and that could result in the stock entering an upward trend, which may be a good time to buy.

Tools and platforms for stock trading

Choosing a brokerage

When choosing the best brokerage for you, you need to take a minute to assess your needs. If you are just getting started, educational materials and training could be quite useful. However, if you are more seasoned, a brokerage offering advanced charting capabilities might be far more interesting.

Trading software and apps

Real-time market data and news

Real-time market data can make the difference between making well-informed trades and not. Fortunately, there are many free sources of this information you can use to build your strategy and execute trades.

You can get free, real-time market data from Nasdaq and The New York Stock Exchange, for example. Finance-focused websites can also be a good source of this information.

Risk management in stock trading

There are many different techniques you can do to manage the risks associated with trading. One of the most basic (and useful) strategies is diversification. Don't put all your eggs into one basket, the saying goes.

In this case, this means don't put all your money behind one big trade. Some traders use what is referred to as the 1% trade, which means that you shouldn't put more than 1% of the capital you have set aside for this purpose into any one particular trade.

Another approach you can use is harnessing put options, derivatives contracts that give you the ability to sell an underlying asset for a predetermined price within a specific time frame. If you buy shares of a stock, as well as some put options on that stock, you can sell the put options should the stock fall in value, which will allow you to recoup some of the money you lost when the stock's price declined.

It's also important to formulate a plan before you enter a trade. You should get a sense of when you will exit your position before you enter it.

Setting stop-loss orders

Another way to manage risk is using stop-loss orders, which automatically execute trades (to buy or sell on asset) when that asset drops to a certain price. If you place one of these on a share of stock, for example, you can use it to manage downside risk, the risk of the principal you invested in a trade falling in value.

Managing leverage

Leverage involves borrowing money, and when it comes to stocks, it means trading on margin. Trading on margin involves getting a loan from a broker, which will use your capital as collateral.

Leverage is something that you can use to enhance your gains, because you can get more with less. On the other hand, using leverage can also intensify your losses.

Steps to start trading stocks

There is a lot of information out there, but if you want to know how to start trading stocks, there are some simple, concrete actions you can take.

Opening a trading account

You will need a broker to make trades, so you'll want to find one that you like and trust. Fortunately, there are many different options available.

As you decide on a broker, choose one with the tools, features, and interface that best complement your trading style and know-how. Other things to consider are fee structures, on-the-go accessibility, stock analysis tools, and educational resources. In the end, beginner traders will want a firm that has a wide offering and that will be there when times get tough.

If you're not sure where to begin, see our recommendations for the best stock trading apps.

Developing a trading plan

It is important to plan your work and work your plan. When it comes to creating a formalized plan for trading stocks, one good place to start is considering your objectives. What is your goal in engaging in this activity?

Are you looking to generate some extra income? Another major consideration is how much time you want to put into stock trading. Do you want to trade full-time and use it to pay your bills or approach it more like a part-time job?

Another major consideration is how much risk you are willing to incur. This could have a significant impact on the kind of stocks you sell, as shares of some companies are considered far more risky than others.

Next, you should determine what personal trading strategies and risk-management techniques you want to use.

Practicing with paper trading

Once you have developed your trading plan, you can test it out by doing some paper trading, an approach you can use before you put your capital at risk. Through paper trading, you can try out your trading strategies to see what returns (and losses) they would produce.

You could harness paper trading for a few months, for example, before switching to executing trades with actual money.

Common mistakes to avoid in stock trading

Overtrading

Overtrading refers to excessive trading, which is an activity that a new investor can fall into if they let their emotions get the better of them. Some investors participate in so-called revenge trading, which involves making many (or large) trades in order to make up for losses.

This sort of approach can quickly spiral out of control, causing a trader to suffer sharp losses and potentially rack up a significant amount of trading fees.

One good way to manage the risk of overtrading is to simply be self-aware. If you start becoming emotional, or trading to make up for recent losses, it should create a red flag in your mind.

Another good way to combat this possibility is to create and follow a strict risk management plan, specifically one that places limits on the size of positions you take while trading.

Letting emotions drive decisions

Experts agree that one of the worst things you can do is let your emotions or bias influence your investing decisions. Excessive emotional trading is one of the most common ways investors damage their returns.

It is crucial to develop a trading plan and stick to it instead of letting your emotions get the best of you. If you let emotion take over, you could easily become susceptible to problems like irrational exuberance (having overly high expectations of a particular asset class) or alternatively, get caught up in mass hysteria.

Both individual stocks, and also the broader stock market, can be oversold or undersold for long periods of time.

Stock trading FAQs