How Stock Trading Works? Everything You Should Know

The majority of people own stocks mostly via mutual funds, but not many people know what stocks actually are. Buying stocks means you’re buying a piece of any company. If you are new to this stock trading thing, don’t worry. Today, we will provide you with an in-depth insight into the world of Stock Trading or How Stock Trading Works. So let’s begin…

What Are Stocks?

Stocks also known as equity, is a security that represents a fraction of the proportion of any company. Units of stocks are called shares. 

Stock exchanges are the primary platforms where stocks are bought and sold, forming a crucial part of many investors’ portfolios. Government regulations are in place to safeguard investors from fraudulent activities when trading stocks.

What is Stock Trading

Stock trading means buying and selling of shares of publicly traded companies on stock exchanges. When individuals purchase shares of a company, they become part-owners of that company, with a claim on its assets and earnings through dividends or capital appreciation. 

Traders engage in stock trading to profit from market fluctuations and company performance, with risks such as market volatility and specific news impacting stock prices.

Trading stocks can offer short-term profits to those who accurately predict market movements. However, it also poses the risk of significant losses. While a company’s fortunes can soar faster than the overall market, they can plummet just as swiftly.

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Types of Stock Trading 

Stock Trading can be of various types- 

Day Trading – it means buying and selling the same stocks within one single trading day. Day traders care little about the inner workings of the businesses. They focus on making small profits in minutes, and hours based on daily price swings.

Swing Trading – This involves holding stocks or shares for several days to a few months to profit from intermediate price trends. Traders rely heavily on technical analysis to identify when to enter and exit a position, set stop-loss and profit levels, and monitor positions based on market conditions

Position Trading – This refers to a long-term strategy where traders hold positions or stock for an extended period, usually several months or longer, to profit from major price trends in the market. This type of trading requires a lot more patience as compared to other trading.

How Does Stock Trading Work?

The key steps of trading stocks come down to six steps:

  1. Open a Brokerage Account

Trading of stocks requires a brokerage account. It is a type of account that is used to hold investments. If you are someone new to trading then you first need to open this account to start trading. Opening an account doesn’t mean you’re investing your money, it’s just a step you need to take to start trading. 

  1. Set a Trading Budget

Once you’ve opened a brokerage account, the second thing you need to do is set a trading budget. Even for a pro trader investing more than 10% of your portfolio on a single stock can be very risky. 

“If all of your money’s in one stock, you could potentially lose 50% of it overnight,” Moore says.

Invest only the amount that you can afford to lose. Invest only the amount that is in the buffer or that you can use for trading without any risk.

  1. Learn the Proper usage of Market Orders and Limit Orders

You can never start trading the second you create an account or set a budget. You need to have proper knowledge about the basics like –

Market orders – buying or selling stocks as soon as possible at the best available price.

Limit orders – Buys or sells the stock only at or better than a specific price you set. In a buy order, the limit price represents the maximum amount you are willing to pay. The order will only be executed if the stock’s price reaches or drops below this specified limit.

  1. Practice using a Paper Trading Account 

When you’re a first-time trader, you can practice using a paper trading account to get real-life experience of trading. This can help you understand a lot about trading. 

“Try investing in the market without putting money in the market yet to just see how it works,” says Moore.

Monitor the performance of a chosen stock over three to six months to observe its behavior. Alternatively, utilize the paper trading tools provided by various online stock brokers to practice trading virtually. This allows individuals to hone their trading abilities, assess their performance, and establish a trading history before committing real funds to the market.

  1. Measure Your Returns 

For all types of investors, not just active ones, the primary objective when selecting stocks is to surpass a benchmark index. This benchmark could be the S&P 500 index, commonly used to represent the overall market, the Nasdaq composite index for those focused on technology stocks, or other indexes based on company size, industry, or location. 

Analyzing the performance is crucial. If a dedicated investor cannot outperform the benchmark, a prudent approach would be to invest in a low-cost index mutual fund or ETF. These funds consist of a collection of stocks that closely mirror the returns of a specific benchmark index.

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Conclusion 

Stock trading is a field that offers opportunities for profit and growth but also carries undeniable risks. Understanding the basics of stocks, the types of trading strategies, and the essential steps involved in trading is crucial for success in the market. 

Whether engaging in day trading, swing trading, or position trading, investors must approach the market with caution, discipline, and a well-defined plan.