DRAFT : How to Trade Stocks: A Guide for Aspiring Traders - MagnifyMoney
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DRAFT : How to Trade Stocks: A Guide for Aspiring Traders

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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 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

There is nothing inherently unsafe about a high-yield savings account. As long as you make sure you’re depositing your money into an FDIC-insured bank or NCUA-insured credit union, your money will be insured up to legal amounts in case your institution fails.

You may also want to double check an institution’s security measures before signing up for an account. Check whether their website and information is protected by encryption and firewalls. Reputable institutions will also include anti-virus and anti-fraud measures. Other protections include biometric logins (fingerprints or face match), two-factor verification and security questions.

There is often not much difference between high-interest savings accounts and money market accounts. A money market account is a type of savings account that also tends to have higher rates than traditional savings accounts.

Some money market accounts set themselves apart by offering a debit or ATM card and/or check-writing capabilities. These accounts offer further accessibility to your money. However, money market accounts still fall under the six-limit “convenient” transaction requirement, like regular savings accounts.

High-yield savings accounts are taxed like regular savings accounts. However, your earnings from a high-interest savings account are more likely to be taxed, as you are more likely to be earning more in that account than a traditional low-rate account.

Savings account earnings are taxed. Typically, if you made $10 or more in interest, your institution should send you and the Internal Revenue Service (IRS) a copy of Form 1099-INT, which details the interest you’ve earned in a year. Even if you don’t receive that form, the IRS will, and they will expect you to report your interest income on your tax return.

If you earn $1,500 or more in interest income in a year, you will also need to detail those sources of income on Schedule B of Form 1040.

Thanks to the Federal Reserve’s Regulation D, you can withdraw up to six times per statement cycle from a high-yield savings account, like any other savings account. This includes pre-authorized and automatic withdrawals and transfers, and transfers made by debit card, check or other similar ways. Due to the COVID-19 pandemic, those limits are currently waived, but banks still may choose to enforce them.

You can get around this limit by performing “less convenient” withdrawals, like those made in person at the bank or ATM. Exceptions to the rule also include withdrawals and transfers requested by mail and those initiated over the phone if you receive the withdrawal as a mailed check.

Online banks don’t incur the costs of maintaining brick-and-mortar branches. These costs include rent, building maintenance, staff salaries and the cost of keeping physical cash safe. Without these expenses weighing them down, online banks reap big savings — savings they then pass on to their customers in the form of high interest rates.