Stock Trading Basics
Over the last few years, the definition of stock market investing has changed due to advances in the online trading market.
In fact, it would be right to say that online stock trading which refers to the virtual trading activity of stocks just peaked in the last 3-5 years (from a global perspective). Regardless of this, there is still a long way to go because many markets are yet to join this new and interesting market.
Therefore, most of the traders are yet to grasp the basics of stock trading, because the game is quite different from what our parents would narrate. Back in the days, it was simply a matter of buying and holding company shares in anticipation of increased price in the future.
Some parents actually used stock investing as a vehicle for maximizing their retirement, and therefore, would not touch the shares until a specific date (NOT a specific price level).
Therefore, it has been a long walk since the days when stock traders used to receive certificates for owning a stake in a public company to a point where, traders buy and dump a stock within a matter of months, sometimes even within weeks/days.
So what are the stock trading basics?
To begin, it is important to understand the parties involved in stock trading.
Stock Exchange: This is the body responsible for executing trades and listing companies for the public to have an opportunity to buy stakes. The stock exchange carries different names across different countries and in some nations like the U.S, there are more than one.
In the United Kingdom, this forum is known as the London Stock Exchange and it gives people both local and foreign the opportunity to own a fraction of each of the listed companies, which include the likes of Barclays, Tesco, British Petroleum and Unilever, among others.
-The price of shares of Barclays at London Stock Exchange-LSE, since 2006-
Listed companies: When a company is in need of capital, it can either raise the money via debt, private placement, or from the public. In order for the company to raise money from the public, it has to be registered with a stock exchange from which the public can then buy and sell its shares.
When a company seeks capital from the public for the first time, this is called an initial public offering (IPO). It is one of the best ways investors use to invest in companies, but they can also buy and sell shares of already listed companies from the exchange.
The other terms of note include shares, which represent a stake in company ownership. Generally, a company’s worth is divided into a number of units (shares), which are then sold to investors on a per unit price. From there on, the forces of demand and supply, as well as various valuation metrics, determine the price of per share.
Investors can gain from owning the shares by either selling the shares when the price goes higher or holding them to receive periodic dividends.
Stock trading is one of the best ways of saving for retirement, especially when a trader identifies companies with strong financial base and a healthy dividend.
However, stock trading is also a common means of living these days, with some market players having become billionaires through stock trading. Warren Buffet is a perfect example.
Stock Trading Styles
In trading, strategies can range from the way a trader analyses a single trade to the overall approach on the market.
Some call it a tactic, while others prefer the simpler term, style. Whichever way, a trader needs to determine which style/tactic to use in the market, upon which he or she bases his entire activity in the market.
The main stock trading styles
First, there is need to distinguish between trading and traditional investing. In traditional investing, investors would categorize themselves either as value investors, growth investors, contrarian investors or a combination of them all among other cocktails.
However, when it comes to stock trading, with the focus term being trading, we have three major stock trading styles namely swing trading, day trading, and position trading. Some stock traders classify themselves differently, with very complicated trading strategies.
Furthermore, recent developments in technology have made it possible for traders to participate in automated trading (rule-based trading) whereby they generate a specific set of rules upon which if met, a trade executes accordingly.
So what is swing trading?
Swing trading is a technique used in stock trading to capitalize on stock and market reversal points. The technique revolves around the principle that stock prices will always fall after a continuous rally, or rise following an extended period of decline.
The work of a swing trader is to identify the period leading to a trend reversal and determine the next potential turning point. The trend in this scenario is usually a rising or a falling wedge. A wedge is a pattern created by a stock price movement characterized by higher highs and higher lows for a rising/bullish wedge, or lower lows and lower highs for a falling/bearish wedge. Here is a good illustration.
Now, as demonstrated on the chart, the shares of Apple appear to be well set for swing trading opportunities. Based on the current scenario, the shares appear ready for another reversal at $103, which would make a perfect point for a bullish swing trade.
The shares last closed at $105 after rebounding at $113. In this case, a trader placing a long position in the shares of Apple at $103 would be ideal to insert a stop loss at about $100, while taking profits at $110.
Another important aspect of swing trading is that aside from identifying the occurrence of swings, traders also pick the trading periods from which to plot their charts. These periods can range from the 4-hourly chart to the daily chart, as well as, the weekly chart and so on.
Day trading/quant trading
Day trading as discussed in an earlier article is sometimes used to refer to the overall online trading activity. However, day trading as a style refers to a very active trading activity that requires traders to participate in the market almost on a daily basis.
In some cases, traders make several trades per day resulting in what some analysts refer to as quant trading or quantitative trading.
Day traders prefer capitalizing on multiple fluctuations of stock price rather than wide margin shifts for profitability. This is also the reason why this type of trading is considered quantitative because it focuses on the number of trades, rather than the quality of profitability.
Position trading/momentum trading
Position traders tend to have a long-term view in their trading strategy. This involves identifying the direction of the main trend and assessing the strength of the trend as well.
Therefore, the use of indicators such as relative strength index RSI and MACD is usually very common. In contrast to swing trading, position traders use these indicators to determine whether it is worth riding a particular trend or not.
They are not concerned about the short-term rebounds and reversals, but rather what they view as the main direction of the stock price. As such, position traders tend to rely much on both fundamental and economic analysis than they do on technical analysis.
As I noted earlier, these are the main stock trading styles and they are quite different from what you would read on stock investing styles.
However, some traders have their own hybrid trading styles, and the most recent addition to automated trading, which more or less suits traders who do not wish to be highly involved in the day-to-day trading activity (passive trading).
Guide to Day Trading
By definition, day trading is the practice of buying and selling a particular security within the same day. History suggests that among the most day-traded securities are stocks, forex, and commodities. Day trading is quite different from the traditional forms of investment.
The difference between day trading and other forms of investment
First, in day trading the buyer of a particular security does not own the underlying asset for the period the trade remains open.
Secondly, in day trading, traders are allowed to take various positions short/long on different instruments regardless of their buying/selling potential. In traditional investing, investors are required to have a significant balance in their equity accounts to be allowed to short-sell a stock.
Furthermore, day trading allows traders to bet on more than they have in their accounts. For instance, a trader with $200 in his or her account could place a trade of $20,000. This is due to margin trading with some brokers offering as high as 400x in leverage.
Getting started with day trading
Day trading is one of the easiest methods of making money online, but just like any other business, traders should approach it with caution. After all, in any business, there is always the potential of making profits or losses.
This is why all brokers always caution traders and potential traders of the potential risks associated with day trading, especially when due to the use of margin in placing trades.
Nonetheless, seasoned traders have demonstrated that it is indeed very possible to make a lot of money in online trading especially when traders approach the market fully prepared.
By fully prepared means being aware of the potential risks and having learned some crucial basics of online trading.
Crucial tips for day traders
Limit the risk through diversification: The first rule of day trading is never to risk anything you are not prepared to lose. This is solely because of the impact of margin trading, which means that a trader could potentially lose everything in a single trade.
On the positive side though, margin trading gives traders the opportunity to make massive gains from a single trade. Nevertheless, it is highly advisable that traders do not risk more than 5% of their portfolio in a single trade.
Apply both technical and fundamental analysis where possible: Some traders go into the business of online trading without a clear strategy. However lucrative a trade looks, placing your bet without a clear strategy and thorough analysis will not make you reach.
It will most certainly work on some of the occasions but not always and it could prove catastrophic at some point. Therefore the application of fundamental and technical analysis (which will be discussed later), is vital to day trading.
Choose your online broker wisely: Currently, many companies are joining the business of online brokerage services. Traditional investment and commercial banks have joined, as well as, trading software developers. We also have market makers that primarily benefit by buying and selling securities for a profitable price.
It is important to differentiate the brokers and market makers when planning to get in the business of day trading because the risks and benefits associated with building a relationship with either of them are different.
Finally, day trading requires beginners to do a thorough review of the trading platform they choose to use, in terms of navigation, execution speed, customer support, and availability on various handheld devices among others.
Day trading is a lucrative way of making money online, perhaps the easiest. However, just like any business, there is risk involved, but then again we all know that risk is what creates the potential for gains in an investment.
Stock Market Fundamental Analysis
In stock market investing, fundamental analysis is a technique of evaluating stocks that largely relies on the intrinsic value of the underlying asset. This technique is very common among value investors and seeks to determine the long-term potential of a particular stock.
So what exactly is fundamental analysis?
Well, fundamental analysis differs depending on the type of asset under evaluation. For instance, when it comes to bonds, a fundamental analyst would be looking at things like interest rates and the overall state of the economy of a particular country among other economic indicators.
On the other hand, for a commodity trader, say for instance wheat, things like rainfall seasons, the global demand for wheat and production volumes come into scrutiny while for stocks, the story is quite different.
Analysts focus more on company financial statements, with a specific focus on sales, earnings and market outlook, as well as, the company’s financial position.
Fundamental analysts use these items to determine the intrinsic value of the underlying security, in which case, they are able to say that the asset is either overvalued or undervalued thereby resulting in a sell or buy decision, respectively.
Some of the most useful fundamental analysis ratios include the price to earnings ratio (P/E), the price to sales ratio (P/S), sales/EBITDA, and various profitability margins and growth rates.
Application of fundamental analysis
When scrutinizing the financial statements of a particular company, the fundamental analyst is able to tell whether the recent performances have shown improvement compared to the past in what is referred to as trend analysis.
Additionally, the analyst is able to tell where the company stands in the industry and the prospects of doing better compared to industry competitors. For instance, Yahoo’s main rivals in the industry include Google, Facebook, and AOL, while Apple faces reasonable competition from the likes of Microsoft and Samsung.
This comparison is crucial in determining the company’s market share in terms of sales of various products, and hence the outlook.
Fundamental analyses are crucial to analyzing any security, but they are often overlooked when it comes to currency trading.
However, seasoned traders understand that things like economic growth forecasts and data, as well as geopolitical factors, are vital in when it comes to currency trading.
Interestingly, some call these economic analyses, but based on experience, the line that separates an economic analysis from a fundamental analysis is very thin, and sometimes misrepresented.
Stock Market Technical Analysis
In the world of financial markets, the stock market accounts for arguably the second largest market in the world, ideally behind forex trading.
Some investors are of the opinion that when it comes to trading stocks, technical analysis is least required, as they emphasize more on the fundamental aspects of a stock.
However, this is no entirely the case because some investors tend to look at things more short-term nowadays, thereby creating the need for use of technical analysis. Several online brokers have added assets from the stock market among their tradable instruments, which means day traders can also participate in the stock market.
Google, Apple, Microsoft, General Electric GE, and British Petroleum BP, are among the most traded stocks in the online trading market, and more are available for traders to add to their portfolios.
What is technical analysis?
This is a method commonly used by online traders to evaluate securities by analyzing statistics generated by market activity such as the price of a particular asset and the associated traded volume among others.
Supply and demand crucial in technical analysis
In technical analysis, the forces of supply and demand are very much obeyed and the question of whether the stock or commodity reflects the true valuation barely comes into play. This is what describes the short-term cyclical movement of stock prices as the forces of supply and demand dictate the market sentiment.
For instance, if the shares of Apple attract more buyers than sellers, then the price of the stock is likely to go up to reflect the imbalance in the market. Similarly, if the stock attracts more sellers than there are buyers, then the price is likely to fall.
Candlestick patterns and indicators the basis of technical analysis
Now in order to predict the likely direction of the stock price, analysts and traders use various tools and techniques to perform technical analysis. Some of the most common include the candlestick patterns and various indicators such as moving averages and strength indicators.
With candlestick patterns, traders employ the principle of two types of candles. The bear candle is normally red or white while a bullish candle is normally green/blue or black. Different platforms have their own color schemes, while others give the trader the opportunity to customize their colors.
However, the most important fact to note is that a bear candle is created when the closing price is lower than the opening price, while a bullish candle occurs when the stock price closes higher than the opening price.
In trading, technical analysis is equally important as fundamental analysis especially for traders looking at short-term investing.
With time, traders are able to spot various pattern son candlestick charts without drawing any lines, which comes in handy for high-speed traders.
10 ways to Analyse a stock
By definition, a stock is a name given to represent equity investment in a company. We have two types, namely common stock and preferred stock. Preferred stock carries an element of debt in it because this represents a class of shareholders who get paid first, before the common stockholders.
In this discussion, we are going to focus on common stock. This type of equity investment opens the door for the public to invest in a publicly listed company at the stock exchange.
Now, in order to buy stocks, it is important to do an analysis of the company to determine the likely returns based on the prevailing market price. Here are ten ways to analyze a stock.
1. Price/Book Value Ratio
Price/Book value (P/B)= market price per share divided by book value per share of the stock. The book value per share is available in company financial statements while the price per share is available on leading financial websites like Google Finance or Yahoo Finance among others, as well as, the exchange on which the stock is listed.
This ratio is used to analyze how expensive a stock is compared to its book valuation. In most cases, high P/B multiples suggest positive investor sentiment, while low multiples suggest cautionary views from investors. Otherwise, the higher the P/B multiple, the expensive the stock is, and vice-versa.
2. Price/Earnings Ratio
This is the most commonly used metric when it comes to stock valuations. Earnings are crucial to determining a company’s future performance and analysts use this ratio to establish whether the company’s current valuation is attractive based on outlook and industry rivals.
The price/earnings ratio (P/E)= market price per share divided by earnings per share. Low P/E may suggest that either the stock is undervalued or the company’s outlook looks is unattractive to investors and vice-versa.
3. Profitability margins
Every investor invests in making a profit. In stocks, investors rely a lot on the ability of the business to remain profitable. One of the best ways of assessing a company’s profitability is looking at its profitability margins.
The gross margin, which is the percentage gross profit along with the operating margin and net profit margin are crucial to determining a company’s ability to remain profitable in the near future. High rates in these metrics suggest a healthy business profit wise, which also indicates flexibility and ability to invest in new products.
4. Rate of return
Another important way to analyze a stock involves the use of the company’s assets and equity. The return on assets and return on equity are used to determine the company’s efficiency in utilizing shareholder funds (return on equity ROE or ROI-Return on Investment) and assets (return on assets ROA).
Generally, high rates of ROI or ROE and ROA mean that the company is doing well and hence investors should be happy. However, it is always good to compare with industry average to determine how the company is really doing because sometimes this could mean the company is under-investing and could, therefore, lose a foothold in the market in the near future.
5. Analysis on Dividends
Dividend analysis is one of the basic principles of analyzing a stock. In fact, most investors take a keen look at the company’s dividend yield and history before deciding on whether to invest in the stock or not.
The payout ratio is also a key item in dividend analysis with analysts recommending a ceiling threshold of 60% of earnings. Companies with dividend yields of 5% and above are considered attractive, while a healthy dividend growth rate also suggests the company’s ability to continue paying a good dividend.
If a company’s revenue projection indicates a declining sales value, then the ability of the company to grow comes into question. Growth investors look at the company’s ability to grow revenue by analyzing the competitiveness of its products in the market.
Revenue growth rate is used to determine the potential future valuation of the company from which investors can draw conclusions on their investing decisions.
7. Insider Trading
This is the ideal way of knowing the sentiments of the company’s key shareholders. Insider transactions shade the light on how company directors and hedge funds are trading the stock.
Heavy selling could signify a near-term decline in the price of the stock while heavy buying indicates an opportunity to buy the stock. However, this is not always the case for thinly traded stocks, as they are subject to manipulation in a bid to tinkering with the stock price.
8. Analyst Recommendations
In some cases, investors may capitalize on analyst recommendations on the value of a particular stock. Historically, when a leading analyst issues a Buy recommendation on a stock, the stock price responds by rising significantly on the day.
A sell recommendation results in a reverse reaction while neutral recommendation results to little or no change in price.
9. Earnings announcements and surprises
In investing, under-promising to over-deliver does not always work out well for the company. Most companies often outperform their revenue and earnings guidance, perhaps signaling an unexpected improvement in results.
Therefore, this can be an opportunity to buy a stock or a value trap for unsuspecting investors. Nonetheless, the general view is that positive earnings surprise should signal a promising outlook for the company.
This is the most important when it comes to analyzing the value of a stock. Any company can fall under bad management, and any company can grow under good management.
Therefore, it is important to check out who is in charge and in what department, from product development and research all the way to sales and marketing.
The bottom line is that good management sets up the pace for building a good company, and then the rest follow.
However, as mentioned earlier, analyzing a stock takes more than just one of these methods and therefore, investors should be keen to evaluate a company based on more of these steps.
Going Long, Going Short Explained
In shares trading you will at some point realize that two major jargons resonate among traders namely, being long on a certain stock or short on another.
Going Long Explained
Going long is nothing more than buying shares of a particular stock. The term long comes into play mainly because of the aspect of holding on to the shares with the objective of selling them in the future when the price goes up to your desired level. The rule here is to buy low and sell high.
Going long is sometimes used to describe a positive market sentiment in which case, investors would be bullish on the market or a particular stock. However, they are never long on the said stock unless they actually buy it.
In the example above, if you bought 1,000 shares of Alibaba at $85 per share and sold them at $120 per share, then you would have made $35,000 in profits within a month. That is, ($120×1,000)-($85×1,000)= $120,000-$85,000=$35,000.
The concept of going short is a little complicated compared to going long. Here you actually sell the shares before owning them.
Investors choose to sell short shares of a particular company if they perceive the stock to be overvalued. However, in order to do this, they are required to have margin accounts. Margins accounts allow traders to short stocks with intention of buying back the stock at their desired lower prices.
However, if the price of a particular stock rises, then the investor holding a short position is required to top up his or her margin account to cover for the increased price. In other words, the investor should have enough money in his or her margin account to buy back the number of shares short sold.
Going long and going short are two, of the most used terms in trading and represent the main trading positions in the world of financial markets.
Nonetheless, it is important to keep in mind that shorting the market is not for everyone as brokers charge additional interest on short trades, aside from commissions and the trading price.
How to read Stock Prices and Quotes
In shares trading, the real cost of buying a stock is broken into several units. The first and most important is the price of buying s single share of a particular stock; say, for instance, Tesco (U.K) or Apple (U.S).
In addition to this cost, traders pay a commission for every transaction, which varies depending on the broker. Some charge certain amount per share, while others charge a fixed figure per transaction.
Now, when it comes to trading in a stock, a trader is presented with three key prices. We have the Bid price, the Ask price, and the last price. The bid and ask prices are accompanied by another figure (the volume), which shows the number of shares requested or being sold against a particular bid/ask quotation.
How to read the stock price
Now, take an example based on the data above obtained from Yahoo Finance. To begin, the price of one share of Apple Inc. is $109.92, which in this case is the last price. The bid price is $109.88 while ask price is 109.89.
An investor looking to buy 100 shares of Apple will pay $10,989, while an investor looking to sell will receive $10,988. This is because the seller is only willing to sell at a price of $109.89, while the buyer is looking to buy at a price of $109.88, a $0.01 differential.
On the other hand, the shares of Tesco are priced in U.K pence. The last price of Tesco shares at LSE (London Stock Exchange) is 229 pence, while the bid and ask prices are at 228.95 pence and 229.05 pence respectively.
Therefore, an investor looking to buy 100 shares of Tesco will pay 22905 pence for the lot, while an investor looking to sell 100 shares of Tesco will receive 22895 pence for the lot. In this case, the bid and ask price per share indicates a differential of 10 pence.
The price differential between the bid and ask is what helps in creating price movements of stock subject to the forces of demand and supply.
The basis for reading stock prices rests on those three sets of prices. The last price in a trading session, which the normally the current price, the bid price, and ask price. Therefore, it is important to know what price to look out for depending on what you intend to do.
If you are looking to sell your shares, then you would be looking at the bid price while those looking to buy shares should keep a close eye on the asking price.
Bull and Bear Markets
In the financial markets, the overall movement of prices of various stocks and market indices occurs in three major forms. We have the bull market, the bear market, and a flat market. The latter is not very popular among traders because, in any way, it does not present many opportunities in terms of profit potential.
However, the bull and bear market are perfect for traders because they are able to capitalize on the short-term reversals and rebounds by taking various positions on the individual stocks or market indices.
In general, the bull and bear markets are seen to represent the overall direction of a particular market or class of securities. For instance, the gold market, the FTSE 100 or the S&P 500, but even individual securities like the shares of Barclays or Tesco, could also be analyzed from a bullish/bearish perspective.
So how do you distinguish bull and bear markets?
The movement of the price of stocks and commodities occurs in three forms, upwards, downwards and sideways. When the price of a stock/commodity moves in one direction over an extended period, this is called a trend. Thus, a trend can either be bullish (for a bull market), bearish (for a bear market) or flat (for a market that maintains a sideways movement).
Now, a bull market occurs when the price of a particular commodity or index is in a continuous upward movement. Here is a good illustration of bull and bear markets, using the FTSE 100 Special Index.
The index experienced a bull market from 2003 to 2008 and 2009 to present. However, it is quite clear that the market remained bearish from 2008 to 2009, during which the world experienced the global financial crises.
In some cases the trend is characterized by significant fluctuations in prices, like has been the case over the last five years, but looking at the market from a wider perspective, it is possible to determine the overall direction.
The bottom line is that when analyzing the overall trend of the market, analysts are likely to arrive at the same conclusion. However, some traders like to look at the market short-term, which means their opinions might differ.
For instance, the illustration demonstrated using the FTSE 100 suggests that over the last two years, the index movement remained sideways, thereby resulting in a flat trend. Therefore, it is always good to look at the time in perspective when talking about bull and bear markets.
Stock Charts Explained
Stock charts are technical analyst’ best friends when it comes to stock trading. With stock charts, analysts are able to perform different sets of analysis in a bid to identifying key market opportunities based on statistical data.
When analyzing a stock based on a stock chart data, traders must first identify the period. Ideally, stock charts are displayed based on daily trading information by default. However, it is possible to change this into an hourly, weekly or monthly period, or even sometimes, into a 15 or 30 minute period etc.
The horizontal axis represents the periods while the vertical axis represents the price of the underlying security.
Types of stock charts
Generally, there are two major types that analysts tend to use more frequently; the OHLC (Open, High, Low and Close) charts and the candlestick charts.
In this example, I have used the Google price chart to describe OHLC Bars stock chart. Now, notice the red bars indicate a bearish bar. A bearish bar in OHLC Bar chart form when the day’s closing price is lower than the opening price.
The extensions on either side of the branches represent the highest and lowest prices reached during the day, respectively. Also, notice that the opening price branch forms on the left of the bar, while the closing price branch forms on the right side of the bar.
Again, notice the periods on the horizontal axis and the price on the vertical axis. Finally, do not forget that in this case, every bar represents a day of trading activity.
Just like in the case of the OHLC bars, a bearish candle is represented by a red body and forms when the price of the underlying security closes low compared to the opening price. On the other hand, if the price closes higher than it opened, then a bullish candle (green in color) forms.
The extensions below and above the main body of the candlestick are called shadows and they represent the highest and lowest prices reached during the day.
In the case above, one candlestick denotes a whole day of trading activity, while the horizontal axis and the vertical axis represent the periods and price respectively.
Stock charts are very important in analyzing the stock market, especially when applied to individual stocks, indices or ETFs. They are also very useful in currency trading and analysts now use them to come up with different trading theories.
The bottom line is that to an excellent trader, you will need to learn a thing or two about stock charts because they form the backbone of technical analysis.