Learn About Stocks
What are stocks?
Stocks represent ownership in a company. When you purchase a stock, you acquire a small piece of that company, known as a share. Companies issue shares to raise capital for various purposes, such as expanding operations, developing new products, or paying off debt. As a shareholder, you participate in the company’s success; if the company performs well and its value increases, the value of your shares can also rise, potentially allowing you to sell them at a profit. Moreover, some companies distribute dividends, which are portions of their profits paid out to shareholders. Stocks are traded on various exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq, where their prices are influenced by a vast number of factors including the company’s performance, economic indicators, and market sentiment.
How to trade stocks
Trading stocks involves the buying and selling of shares through a brokerage account, which acts as an intermediary between you and the stock market. To start trading, you need to open an account with a brokerage firm, which can be traditional or online-based. Online brokerages like Robinhood, E*TRADE, Charles Schwab, and Fidelity are user-friendly platforms where you can place orders, monitor your investments, and access research tools. Once your account is funded, you can begin buying and selling stocks. When you're ready to make a trade, you place an order through your brokerage platform. After purchasing a stock, you can choose to hold onto it as a long-term investment or sell it when its price reaches a desirable level, aiming to make a profit. Day trading involves buying and selling stocks within the same trading day to profit from short-term price movements. In the U.S., the Financial Industry Regulatory Authority (FINRA) requires day traders to maintain a minimum balance of $25,000 in their brokerage account if they execute four or more day trades within five business days. This rule, known as the Pattern Day Trader (PDT) rule, is designed to ensure traders have sufficient capital to cover potential losses.
Types of stock orders
Market Order: This type of order is executed immediately at the current market price. It’s the fastest way to buy or sell shares but doesn’t guarantee the execution price.
Limit Order: A limit order allows you to specify the price at which you want to buy or sell a stock. The trade will only be executed if the stock reaches the specified price, giving you control over the transaction price.
Stop Order: Also known as a stop-loss order, this becomes a market order once the stock reaches a predetermined price. It’s used to limit losses by selling a stock before its price drops further.
Stop-Limit Order: This combines features of stop and limit orders. Once the stop price is reached, the order becomes a limit order rather than a market order. This ensures you don’t sell below a specified price.
Trailing Stop Order: A trailing stop order allows you to set a stop price that moves with the stock’s price. If the stock price increases, the stop price adjusts upwards, protecting profits while limiting potential losses.
Good 'Til Canceled (GTC) Order: This order remains active until you cancel it. Unlike day orders, which expire at the end of the trading day, GTC orders can remain in effect for several months.
Options vs Stocks
Stocks and options are both investment tools, but they work in different ways. Stocks represent ownership in a company. When you buy a stock, you own a piece of that company, and you can make money if the company's value goes up. It's a straightforward concept: buy low, sell high, and sometimes earn dividends if the company pays out profits to shareholders. Options, however, are more like contracts. They give you the right, but not the obligation, to buy or sell a stock at a specific price before a certain date. There are two main types: call options and put options. A call option lets you buy a stock at a set price, which is useful if you think the stock's price will go up. A put option lets you sell a stock at a set price, which can be handy if you think the stock's price will go down. Options can be used to hedge against potential losses or to speculate on stock price movements, offering more flexibility, but are incredibly hard to trade and need a good understanding of the market.
Buying vs Shorting Stocks
Buying stocks, also known as taking a long position, involves purchasing shares with the expectation that their price will increase over time. This is the traditional and most common approach to stock investment. By buying shares, you own a portion of the company, and if the company grows and performs well, the value of your shares can increase, allowing you to sell them at a profit. Additionally, you may receive dividends if the company distributes a portion of its profits to shareholders.
Shorting stocks, or short selling, is a strategy used when you believe a stock's price will decline. It involves borrowing shares from a broker and selling them at the current market price. Later, you aim to buy back the same number of shares at a lower price and return them to the broker, profiting from the difference. Short selling is lucrative; in a declining market you can make a lot of money, but it comes with higher risks compared to buying stocks, as potential losses can be unlimited if the stock price rises instead of falling.