On the surface, trading stocks seems easy. Buy a stock, stare at the price until it goes up and then hit the sell button to cash in your gains. While that’s true on paper, stock trading is much more nuanced.
When you trade stocks, you’re not investing — which is a long-term strategy typically focused on buying and holding investments. Instead, you’re trying to capitalize on short-term price movements, often within the same day. Trading is also a process riddled with hidden pitfalls if you don’t understand the potential impacts on your portfolio and finances.
What is stock trading?
In simplest terms, stock trading is buying and selling stocks to turn a short-term profit. Traders study market trends and price movements to predict when a stock’s price will go up and down and make transactions using that data.
Trading can produce immediate gains if a company’s stock price rises after you’ve purchased shares. However, trading also carries significant risks. Retail traders are impacted more by short-term market volatility than long-term investors. When a stock price plummets after you purchase it, you may suffer a substantial loss if the price doesn’t recover by the time you sell your position.
Trading vs. investing: What’s the difference?
Time is the critical difference between trading and investing.
Traders and investors both look to make a profit by buying and selling assets, but they do so with different timeframes or time horizons. Traders turn over their positions quickly and attempt to time the market to make money with their trades over the short term. On the other hand, investors buy and hold their positions for the long term.
- Traders are the house flippers of the stock market. They look to turn a quick profit and often identify when they’ll sell a position ahead of time. Some traders will offload a stock within minutes or hours of buying it. Others may hold their shares for several days or even weeks before selling.
- Investors focus on time in the market instead of timing the market. Investing involves buying stocks and other assets with the expectation that they’ll increase in value in the months, years and decades to come. Investors typically have long-term investment objectives, like saving for retirement or buying a home.
Stock trading strategies
While time horizon sets traders apart from investors, it also differentiates various trading strategies from each other.
- Day trading involves buying and selling stocks on the same day. Day traders primarily rely on the daily fluctuations of stock prices and pay less attention to the underlying fundamentals of a company, which may determine the performance of a stock over the long run.
- Swing trading uses a slightly longer time horizon than day trading. Swing traders buy and sell stocks over several days or weeks. They typically use technical analysis to time these transactions and capitalize on price fluctuations.
- Scalp trading relies on a high volume of low-profit trades to generate income. Traders who use a scalping strategy may conduct hundreds of transactions in a given day and hold stocks for only minutes at a time.
Before you start trading
If you’re learning to swim, you won’t immediately jump into a pool’s deep end from the tallest diving board. Instead, you’ll develop your skills in the shallow end and build your confidence.
Taking a similar, measured approach before diving headfirst into the world of trading can help you minimize mistakes and build your trading skills faster.
Before you risk your money on live trades, be sure to:
- Study the stock market. Trading is complicated and risky, so having a solid foundation of knowledge will bolster your eventual ability to trade. You may also benefit from reading books about investing and trading and watching online tutorials.
- Learn technical analysis. Traders typically evaluate stocks and predict their movement using technical analysis, the study of past price changes and historical trends. Familiarize yourself with this method of analysis and use it to identify potential assets to trade.
- Practice trading with a simulator. Many online brokers now offer trading simulators so you can practice trading before risking real money. While this is a critical step, understand that virtual trading won’t replicate the emotional component of live trading.
How to trade stocks
Now that you’ve done your research and practiced using a simulator, you’re ready to start trading stocks for real.
- Open a brokerage account. You can easily open a brokerage account using an online stock broker or even place trades using a trading app. Just be mindful of a broker’s transaction fees or select a broker that doesn’t charge commissions on trades.
- Set a trading budget. Never trade stocks with money you’ll need for near-term expenses like rent or mortgage payments. Instead, allocate only a portion of your investment portfolio or monthly discretionary budget for trading.
- Trade using market and limit orders. When it comes time to place trades, use market and limit orders. The former allows you to purchase stocks immediately, but the price you pay isn’t guaranteed. The latter enables you to automatically buy and sell stocks when they hit a specific price.
- Understand what you’re buying and selling. Take time to research a trading opportunity before placing trades. The Securities and Exchange Commission (SEC) offers this recommendation: “If you don’t understand the investment, don’t buy into it.”
- Evaluate your performance against a benchmark. Monitor your performance and compare it to a benchmark like the S&P 500 or a more specific stock index. You may rethink your trading strategy if you’re consistently underperforming a comparable benchmark.
- Be mindful of your tax liability. Trading can result in a hefty tax bill. The profits realized from trades are considered short-term capital gains and get taxed as ordinary income (up to 37%). When you sell an asset that you’ve held for over a year, you face the more favorable long-term capital gains rates, which top out at 20% for the highest earners.
Now that you know how to trade stocks, you’re ready to set a plan and start building your stock portfolio. Remember the risks, do your research and take things slow to start. Easing into stock trading helps prevent mistakes. It can also help make mistakes — and you will make mistakes — less costly.
Frequently asked questions
Beginning investors can buy stocks through an online brokerage or a financial advisor. An online brokerage is generally the most cost-effective, as many offer low account minimums and commission-free trades – ideal for the budget-minded beginning investor.
To trade penny stocks (low-priced stocks usually with a net asset value (NAV) of $5.00 or less per share), you’ll need to open an account at a brokerage that supports penny stock trading like Fidelity, TD Ameritrade or Charles Schwab.
While you can place orders to buy or sell stock over the weekend (on Saturday or Sunday), your trade won’t be executed until the market opens on Monday morning. Regular stock market trading hours on the New York Stock Exchange (NYSE) and Nasdaq are 9:30 a.m. to 4:00 p.m., ET Monday through Friday.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.