The Basics of Stock Trading

So you want to trade stocks online but are not sure of how to start or what trading strategy to use.

Making money on the stockmarket seems like it can’t be too hard, after all there are plenty of traders making a good living and they aren’t any smarter than you. This site will provide you with free information on how to trade stocks, we have nothing that you need to buy to get to the “secrets”.

How do you trade stocks online then?

First you need to sign up with an online stockbroker. There are plenty of them around – you need one that offers real-time prices, real-time charts, real-time information and news and that is cheap – a few dollars a trade is all you need to pay. Most of them are pretty much the same, but personally I do NOT recommend TDWaterhouse, having had major problems with them in the past.

Secondly when trading stocks, take care ! It is easy to lose money, particularly if you are a beginner, so start off with small trades, or with dummy (pretend) trades just to see what woud have happened if ….. etc…

Your aim is clearly to make money and you can indeed make money fast, but you must also limit your risks. So don’t go nuts! Not every trade you make will be a winning trade, so you must make sure that you make more money from your winning trades than you lose with your losing trades.

Also, bear in mind that on this site we talk about “trading” not “investing”. Investors are in it for the long haul (years or even decades). Traders are short-term i.e. minutes, hours, days, weeks or sometimes months. We do not recommend “day trading” (buying and selling stocks on the the same day) for beginners, “swing trading” (days, weeks or months) is a more realistic approach for beginners.

If you think you are an investor not a trader then check out Warren Buffett, the most successful long-term investor of all time, who considers that the stock market is a “means for transferring money from the impatient to the patient”.

Long-term investing, requires researching company fundamentals i.e. their accounts, financial statements, what they produce etc… and it requires time and a belief that the company is telling you the truth, which not everybody has or does.

Short-term stock trading as understood on this site, requires no understanding of what a company does. Short-term trades are based on stock charts, in the belief that the charts give signals as to where a share price is headed next.

When trading, your aim is to make a quick profit of around 10% (or less) after which you sell your shares and move on to your next trade. For this to happen you need to get to grips with stock charts and have a basic understanding of why stock prices move up or down in the short-term.

Some ill-informed people claim that stock charts are no more reliable than tea leaves or a pin. But this is based on a misunderstanding of what drives a stock price up or down. You have no control over tea leaves, their distribution is random. Charts, however, are not the result of random events, they are the result of human behavior.

If enough people buy a stock, its price will go up (usually), due to the simple law of supply and demand. If enough people sell a stock, its price will go down. Stock charts, however, can also be used to see into the future and predict when traders will start to buy or sell stocks in a company. It is often claimed that “the news comes out in the charts first” by which is meant that if a stock chart starts moving down for no apparent reason, then often, some time later, news will be announced explaining why the stock price had been moving. The reason is that there are always people who know what is going to happen before it happens and they either start selling or buying ahead of the event, or rumors are started and people in the loop take early positions.

Apart from rumors, there are other signals that can predict future stock price movements. These chart signals are used by professional traders as they tell them it is time to buy or sell.

One such signal is the “200 day moving average”. The 200 day m.a. is the average of a stock price over the last 200 days. Any charting service will plot it alongside the stock price. A stock falling beneath its 200 day moving average is considered to be a bad sign and professional traders will tend to sell when this happens (or just before it happens). As a result when the stock price does indeed fall below the 200 day m.a. the momentum of selling will drive the price even lower. This “proves” that the decision to sell was the right decision. It is, in fact, a self-fulfilling prophecy. When people expect something to happen, they take decisions on the basis of what they expect to happen. This ensures that what they expected to happen actually happen, thus “proving” that their decision was the right one.

This is how professional traders use charting (alos known as technical analysis). As a private investor you absolutely must understand what the professional traders are looking for and what their reactions are likely to be.

This, in short, is why stock charts are not like tea leaves, they are the direct result, in graphic form, of human behavior.