Contents
Stock Trading vs. Stock Investing
Should You Trade Stocks?
A Trader’s Guide to Stock Markets
How to Get Started Trading Stocks
How to Make Stock Trades
How Stock Charts Work
How to Analyze Trends, Support, and Resistance in Stock Charts
How to Use Technical Analysis Indicators to Analyze Stock Charts
 |
- Understand the difference between stock investing and stock trading
- Evaluate various trading styles and decide which (if any) is right for you
- Utilize popular trading strategies, including basic technical analysis
|
 |
|
 |
 |
|
Stock Trading vs. Stock Investing
Before you can decide whether stock trading is right for you, it’s important to understand the differences between stock trading and stock investing.
Fundamental Analysis vs. Technical Analysis
Stock investors use a technique called fundamental analysis to assess a company’s financial health, including its profitability and debt, to try to predict and profit from the long-term trend in the company’s share price. Investors buy stocks that they believe will increase in value gradually over time: most investors own stocks for at least a year, and some hold on to the same stocks for several decades.
Stock trading is the process of trading—buying and then selling—a stock within a brief time period, which ranges from a few seconds to a few months at the most. The main aim of stock trading is to profit from short-term trends in share prices, regardless of a stock’s long-term prospects. To predict short-term trends in stock prices, traders use a technique called technical analysis in which they assess the recent price movement through close examination of stock price charts.
Stock Price Charts
Stock price charts (called stock charts or charts for short) plot the share price of a stock over a certain timeframe. Stock charts also typically include the share volume, or the number of shares traded. Traders use software that superimposes indicators, or statistics, directly onto price charts. They can then interpret these indicators to help predict whether the stock will trend up (increase in price) or trend down (decrease in price). One of the simplest indicators, the trendline, plots a line from the first price to the last (most recent) price on a stock’s chart and is thought to indicate the direction in which the stock will likely trade next.
Does Technical Analysis Really Work?
Critics of stock trading often dismiss technical analysis as a misguided and useless approach to investing. Their main argument against technical analysis is based on the efficient market hypothesis, which states that stock prices constantly change to reflect all the available information that might affect a stock’s share price. According to the efficient market hypothesis, a stock’s recent price or volume trends don’t matter, because a stock’s price depends only on the relevant information about the stock that’s available at the present moment.
Proponents of technical analysis refute the efficient market hypothesis, claiming that the market is not perfectly efficient. For instance, they point out that people often buy and sell stocks based on hype or emotions, rather than on the “information” that should determine the stock’s share price. Because traders think that the market is not perfectly efficient, they believe that they can identify and profit from trends in share price and volume alone. Whether or not they’re right remains up for debate—no one has proven that technical analysis really works.
Why Traders and Investors Buy Stocks
Stock traders and stock investors share the same goal—to make money. Even so, the reasons why traders and investors decide which stocks to buy—and when to buy and sell them—differ considerably.
Why Do Investors Buy Stocks?
Most stock investors buy either individual stocks or baskets of stocks contained in stock mutual funds or ETFs (exchange-traded funds). Investors who buy an individual stocks believe that, over the long term, the stock will rise in value as the company’s fundamentals improve, which in turn should increase demand for the stock. Investors who buy stock mutual funds or ETFs believe that the stocks contained in the fund or ETF will rise for the same reason—fundamentals will increase, which in turn will boost the price of the stocks in the fund or ETF.
Why Do Traders Buy Stocks?
Most stock traders ignore a company’s current fundamentals and long-term prospects. Instead, they focus only on recent movement in a stock’s share price and volume.
- When the indicators signal an imminent uptrend, they buy the stock.
- When the indicators signal an imminent downtrend, they sell the stock.
How Traders and Investors Buy Stocks
Traders and investors don’t buy and sell stocks directly on stock exchanges. Instead, they use brokers.
Full-Service and Discount Brokers
Stock investors tend to buy and sell stocks through either full-service brokers or discount brokers.
- Full-service brokers: Major investment banks and brokerage houses, such as Merrill Lynch and Morgan Stanley. Since they are generally the slowest way to execute (fill) stock orders and charge the highest commissions ($50–150 per trade), full-service brokers are generally not suited for stock trading.
- Discount brokers: Smaller brokerage houses that offer fewer services, but charge much lower commissions ($7–50 per trade), than full-service brokers. Beginner traders often use discount brokers to trade, which can work fine as long as you’re making only a few trades per month. If you begin to trade more often, you’ll probably pay less in commissions by working with a direct-access broker (see below). You’ll also most likely benefit from the more robust trading-related services that direct-access brokers provide.
Direct-Access Brokers
Rather than use full-service or discount brokers to buy and sell stocks, most traders use direct-access brokers. These brokers enable traders to trade stocks completely on their own—without dealing with an intermediary—by using an electronic trading platform called a direct-access trading system (DAT). Direct-access brokers typically offer traders a fee structure that makes frequent trading more economical than with a full-service or discount broker. They also typically provide a suite of features designed for traders, including real-time quotes and real-time market data.
On-Location Brokers
On-location brokers serve professional traders. They offer trading rooms with complete trading terminals that you can “rent” by the day, week, or month. In addition to the service fees charged for renting a terminal, these brokers typically charge commissions as well. On-location brokers are intended for full-time traders, not for beginners.
Information that Traders and Investors Use
To research stocks before buying them, investors and traders need access to stock-related information, such as pricing data and stock price charts. The most popular sources of free stock data are websites such as Google Finance (finance.google.com) and Yahoo! Finance (finance.yahoo.com). The free stock data that these sites provide are typically delayed by at least 15 minutes.
Though free stock data can suffice for investors, delayed data is useless to most traders, since traders buy and sell stocks within very brief timeframes. Instead of the freely available data that investors use, traders use real-time market data—up-to-the-minute information that traders can stream onto their computers instantly as it’s published. The two types of data that traders use most often are:
- Real-time charts
- Real-time stock quotes
Real-Time Charts
Real-time charts, also known as streaming charts, are constantly updated charts that traders can “stream” onto their computer monitors. With real-time charts, traders can plot indicators on a stock’s price chart to track and analyze the stock’s price movement as it happens. Most direct-access brokers provide real-time charts as a standard feature, though you can also buy stand-alone real-time charting software or use real-time charting services, such as PCQuote (www.pcquote.com), MarketScreen (www.marketscreen.com), or StockCharts.com (www.stockcharts.com), that charge monthly fees of about $25–50.
Real-Time Stock Quotes
A stock quote is a snapshot of the supply and demand for a stock, including the stock’s most recent bid prices and ask prices, at any given moment.
- Bid price: The price at which buyers are willing to buy the stock. Also called “the bid” for short.
- Ask price: The price at which sellers are willing to sell a stock. Also called “the ask” for short.
- Bid-ask spread: The difference between the current bid and ask. Also called “the spread” for short. For instance, a stock with a $10 bid price and an $11 ask price has a spread of $1.
Level I and Level II Quotes
Stock quotes come in two types:
- Level I quotes: These display the highest bid and the lowest ask price for each stock on a particular market.
- Level II quotes: These show a full picture of the market for a stock, including the stock’s most recent transactions. Level II quotes include order prices and sizes at or near the current bid and ask, as well as information about the source of each order (whether it was placed by an institution or an individual). On NASDAQ Level II, for instance, traders can see all relevant data about each of the NASDAQ’s market makers, including their MMID (market maker ID), the current bid and ask prices and order sizes for stocks they trade, and a record of their most recent transactions.
Direct-access brokers typically offer Level I quotes as part of their standard quotes package and charge an additional monthly fee for Level II data.
| Acknowledgments & Disclaimer |
Download & Print this Quamut to Go
Complete 6-page Quamut to Go PDF only $2.95
