While stock trading is a relatively simple affair, earning profits by buying and selling stocks is really a tough job. Numerous intelligent and professional people have attempted to overcome the hazards associated with the stock market and make money, but failed in their efforts. In case, you have never put your money in the stock market, there is no need to hurry. The stock market will always remain there till you are well prepared to trade in stocks and make money too. Nevertheless, if you are interested in entering the stock market, you first step should be to open an account with a stock brokerage firm.
It is possible that you may be speculating as to the amount of money you should to have to commence business on the stock market. In fact, there are many people who will advise you to invest only the amount of money in the stock market that you can afford to lose happily in the transactions. However, the fact is that you are able to commence investing in the stock market if you have an additional $5000 or even less. It needs to be underlined here that a sum of $5000 is not enough to enable you to diversify your portfolio and thereby lessen the risks associated with trading stocks. You are able to create a properly diversified portfolio only if you have $5000 or more. This amount will help you to invest significantly in different securities and reduce your risks. The concept behind this is when you have a number of good securities in your portfolio; you are able to bank on some of them, while others may not be doing well in the market.
A full-service brokerage firm is a stock trading firm that not only buys and sells stocks on behalf of its clients (investors), but also offers them additional services such as research and advice. Hence, the services of a full-service brokerage firm are generally costlier compared to that of the discount brokers that only carry out stock trades.
Some of the biggest and most powerful stock brokerage firms on the Wall Street comprise the full-service brokerage businesses. These stock brokerage firms offer an assortment of financial as well as investment services and products. In fact, the services offered by them are all compassing - from investment counseling to research to banking services as well as the facility to purchase stocks and bonds, mutual funds and preset income products such as certificates of deposits (CDs). Despite the fact that the full-service brokerage firms are basically keen to draw affluent consumers, anyone is able to open an account with them. It may be noted here that unless you possess a very big portfolio it is better not to expect top personalized service from the full-service brokerage firms.
When any investor opens his or her account with a full-service brokerage firm, they are allocated a person from the organization to take care of their account. Investors who prefer 'do-it-yourself' type of service may avail the facility of the online brokerage system provided by a number of full-service brokerage firms. In the past, all such full-service brokerage firms were known as stock brokers, but now they prefer to be identified by creative names following the bad reputation thumped on the industry by a section of immoral brokers. Hence, now many full-service brokerage firms prefer to be known as financial consultants, financial advisers, money managers or account executives.
For the uninitiated, stock brokers charge the investors having accounts with them for advising the regarding the stocks they should buy and sell and also fill the order for each individual consumer. In return of their services, the stock brokers receive a cut on every stock trade and it is important to note that the commission they receive on one stock trade may often accumulate to a few thousand dollars. In other words, an investor actually pays a stock broker to manage his or her portfolio and also offer advice on investment related issues. Most of the full-service brokerage firms usually have the right to use investment-related research papers and these are considered to be more comprehensive and precise compared to the data provided to the common masses.
The commission-based payment system is disadvantageous for the investors, but suits the interests of the brokers better. This is because when you have a commission-based payment arrangement with a brokerage firm, they would want that you buy and sell stocks more frequently as this would enable them to earn cuts on each trade. In other words, the more frequently you trade your stocks, the more commission is earned by the stock brokers. In fact, there are a number of stock brokers who keep on persuading their clients to buy and sell their stocks more often so that they can earn more commission. Although this practice, known as churning in the stock market parlance, is unlawful, it is widespread too. Always remember that the broker will always try to guide you such financial and investment products that will yield them maximum commissions.
Hence, it is advisable that whenever you engage a stock broker to manage your portfolio, look for a sincere and proficient person who will really take care of your investment portfolio. You should actually try and avoid a fast-talking person who simply wants to make money for his or her firm by creating bigger commissions at your expense. The truth is that there are numerous retail stock brokers who neither have the time nor the comprehension to counsel you on top rate investment products. Then again, an expert stock broker is definitely capable of doing wonders for your investment portfolio.
A number of stock brokerage firms have modified their payment arrangement following the prevalent complaints from the investors regarding the commission-based system. However, so far, they have made this facility available only to the clients with large investment portfolios. As a result, these stock brokers have replaced the commission-based fee system with a one or two per cent annual charge on the entire stocks traded during a particular year. Finally, it is you who is the best person to judge if the full-service brokerage has been fulfilling all your stock asset requirements. It is advisable to mull over this issue with all seriousness as it is you own money that is to be won or lost.
Prior to 1987, an investor could only engage in stock trading by calling up his or her stock broker on the telephone. However, there were a privileged few who had lots and lots of money enabling them to purchase personal seats on any of the stock exchanges that granted them the facility to directly buy and sell stocks on the floor of the exchange. Incidentally, the basic flaw of this system was exposed in October 1987 when the stock markets in the United States virtually collapsed taking a plunge by over 20 per cent in a single day!
The crash was primarily owing to the fact that numerous panic stricken individual as well as institutional investors tried to sell the stocks owned by them simultaneously resulting in the jamming of the telephone lines. In many cases, even the stock brokers declined to answer the phone calls. At the same time, on several occasions, the stock brokers on the floor of the exchanges only filled the orders of the institutional investors, neglecting the cause of the individual investors preventing them from selling their stocks timely. As a result of the delayed sales of their stocks, hundreds and thousands of investors lost all their savings.
Following the stock market crash in October 1987, NASDAQ set up an exclusive computerized or automated arrangement called the SOES or Small Order Execution System that enabled the stock traders to put in their orders by electronic means and at a very viable price. In fact, the day traders were the first to take the benefit from SOES as they realized that this electronic system enabled them to sidestep the stock brokers and forward their orders straight to the stock exchange. While this marked the online stock trading development, the facility was only available to the day traders. It took another 10 years when the retail investors were also permitted to trade their stocks online through the SOES mode.
While online stock trading or buying and selling stocks on the Internet made it easier for investors to buy and sell their stocks, it also virtually deprived them of the facility to save money by going to the discount brokerage firms. In fact, the discount brokerages were meant for the retail traders who preferred the 'do-it-yourself' method of stock trading as well as paying small commissions. It may be mentioned here that as the commission percentage was quite low, the discount brokerages too offered minimum consultancy and research support.
Nevertheless, the Internet definitely changed the way the Wall Street has been operating for good. Soon, the discount traders started connecting their clients to the Internet. Now people could buy and sell stocks from the comfort of their homes and offices through the Internet in exchange for paltry commissions. They were no longer required to contact a stock broker before venturing out into stock trading. Despite the existence of the discount and deep discount brokerages even to this day, the majority of the individual investors consider them all as online brokerages.
Online stock trading or making investments online is very simple process and refers to buying and selling stocks from the comforts of an investor's home or office through their personal computers. Simply opening an account with an online investment firm does not entitle you to receive any investment counseling from the company. You only need to pay the online investment firm a commission, which is at times even lower than $10 for every stock you trade through the company. With the emergence of numerous online investment firms the competition among them has become cut throat. Hence, most of the online investment firms provide their clients with instant stock quotations, stock charts and interactive research for a very low fee. In fact, now any one can open an account on the Internet with an online stock trading brokerage for a fee that may just be a few hundred dollars.
However, opening an online account with a stock trading firm has its shortcomings too. As the commissions are too low, these online stock trading firms seldom offer any investment advice to their clients. And this makes it difficult for most people to trade online as they are constantly in need of counseling on their investments. Till recently, most people were of the view that online stock trading was a simple affair. However, this belief was crushed by the time the recent bull market ended. Hence, online stock trading or an online broker is not the right choice for an investor who is in need of regular investment advice or anyone having a huge investment portfolio.
When you contact an online brokerage firm or retail brokerage, it dispatches you an enrollment or registration form from the company. You need to fill out the form and send it back to the online stock brokerage along with a cheque or money order. On receiving the money from you, the online brokerage firm generally deposits the amount in a money market account that is somewhat like a savings account in any bank. Normally, it takes approximately 10 days for your online account to be activated.
It may be noted here that prior to buying the maiden stock, it is essential for an investor to know the type or order that he or she needs to place. It is also important that an investor picks up the terms used in the stock market parlance so that he or she may communicate better and easily with their stock broker.
The most widespread as well as the best and easiest kind of order that an investor may place is known as the market order. Supposing we search for the stock quotation on Bright Light (BRLT) and find that it is trading at $20 and $20.25. If you look back and refresh your remembrance, you would be required to pay the prevailing market price of $20.25 to purchase a Bright Light share at that particular moment. If you think the price is too high or doesn't suit you, there is no need to be anxious as the price would change the next minute.
If you agree to pay the current market price of a stock, your order will be filled quickly. Have you ever wondered why this happens? This is primarily owing to the fact that many people are selling their Bright Light shares to you believing that that is the best price they can get for the shares of the company they own at that moment. Many will compare this to purchasing a car and paying the listed price. Here the trick is that if you want to acquire a stock fast and easily, you just need to pay its market price. It may be mentioned here that while paying the market price of a stock you are actually paying a wee bit extra for getting it quickly.
In addition to the marker order, an investor may also place a limit order. Compared to the market order, the limit order is slightly more complex, but it enables the investor to bargain a better price for the stock. Contrary to the market order, where you buy a stock according to its prevailing market price, in the case of the limit order, the investor is able to decide for him or herself the precise price that they want to pay to acquire the stock or get when they sell it. However, the downside of a limit share is that it consumes more time to fill the order. In effect, the order may actually never be filled, particularly if the price chosen by the investor is too high or too low.
Let's take the case of Bright Light stocks to understand the manner in which the limit order functions. Suppose an investor wants to buy Bright Light stock which is trading at $20 per share. However, the investor believes that he or she is able to get a better or lower price for it and, hence, as an alternative to purchasing the stock at the current market price or $20 per share, they decide to place an order to purchase the stock at a limit price of $19. Now, the investor's order will only be initiated and filled only when the price of a Bright Light share drops to $19. In that case, the investor will be buying the share at the then current market price of the Bright Light share. However, in case the Bright Light stock never falls to $19, the investor's order will never be filled.
When an investor enters a limit order, he or she has a couple of options. For instance, let's suppose that an investor puts in a limit order to acquire 100 shares of Bright Light at $19 per share, despite the fact that the current market price of the share is $20 for each share. In such a situation, it is important for the investor to spell out if his or her order is applicable only for that particular day (known as day order) or till they cancel their order (called good-till-canceled order or GTC). In case the investor opts for the GTC order, he or she may get on with their business and not be anxious till the order is filled some day later on. In case, the investor opts for a day order and the brokerage fails to fill his or her order on the same day, it will be cancelled by design at the close of that day.
There are times, irrespective of the reasons and where an investor places his or her limit order, they may find it never being filled at competitive costs. All said and done, the limit order offers an investor with plenty of suppleness. In the event of an investor actually wanting to shop for stocks, he or she is able to place limit orders for nearly any price they desire. For instance, in the case of a limit offer, an investor can deliberately under estimate the cost of a stock even at around 10 points lower that its current price. It is important to mention here that in case the limit order placed by the investor gets filled there is no reason why the value of the particular stock would not fall even more.
Like its name denotes, a stop-loss order is designed to actually protect the profits of an investor if the stock owned by him or her is a success or lessen the investor's losses at a time when value of the stock owned by him or her is going down. In effect, a stop-loss order directs the stock brokerage to sell a stock or security when its price falls to a certain level specified by the investor. In order to comprehend how a stop-loss order works, let's take the instance of Bright Light stocks once again. Let us assume that an investor acquires a Bright Light stock at $20 each share. At the time of purchasing the stock the investor places a stop-loss order say at $18 per share. In other words, this means that in the even of the price of a Bright Light share dropping to $18, the brokerage will be automatically selling the shares, restricting the investor's loss to 10 per cent. While it is assured that the investors directives would be implemented by the brokerage, there is no guarantee that the shares will be sold at the precise price wanted by the investor.
There are a number of people who do not accept that stop-loss orders are beneficial. In fact, these people are of the view that when the price of a stock goes down, it is an excellent occasion to acquire it and not sell the stock.
Nevertheless, it is a fact that the stop-loss order is not absolutely faultless. For instance, when the market is extremely unstable, it is possible that the stop-loss order of an investor will be filled involuntarily. Here is an example of what may occur in such a situation. Using the above mentioned instance of a Bright Light stock, an investor places a stop-loss order at $18 per share. A few hours after this, the price of a Bright Light share actually drops to $18 and the stop loss is set off. Initially, the investor will be happy to note that he or she has been able to sell off their stock before the prices plunged further. However, when the investor finds that the price of a Bright Light jumps to $22 after a temporary low of 10 per cent at $18, the investor will repent that he or she has sold the stock at a loss in a hurry.
There are people who work out the problem utilizing a 'mental' stop loss, while there are many who jot it down on paper. Nevertheless, the fact remains that the majority of the investors do not have the required control to sell a stock when its price reaches the objective price. While some investors are vividly shaken up when they find the value of their preferred stocks going down, say by a dozen points, there are others who try to make themselves believe that the fall in the stock price is only a provisional affair. Again, there is another section of investors who would never want to divest themselves of the falling stocks on the pretext that 'they are just too low-priced to be sold'.
Hence, the main thing in stock trading is that prior to buying a stock, it is important that an investor does some advance thinking regarding when he or she would sell the stock in case they have taken a wrong decision by buying the stock. In fact, to a certain extent, the stop-loss order may be compared to an insurance policy that one uses when something unforeseen occurs. Like an insurance policy, the stop-loss order may help prevent an investor lose his or her entire savings. It may be mentioned here that with some brokerages one may also place a trailing stop order that goes up as the price of the stock increases.
An investor also has the option of placing a stop limit order. A stop limit order is very much akin to the stop-loss order, barring the fact that once the stock touches the price specified by the investor, the order transforms into a limit order and not a market order. When an investor places a stop limit order, he or she needs to specify two prices - one, the stop price and, the other, limit price.
Let us assume that an investor has already filled out the requisite forms and opened an account with an online brokerage. Suppose the investor's initial balance is $2500, which the brokerage has put in a money market account. Next, the investor is at his or her personal computer and desires to acquire 100 shares of Bright Light at the current market price. Happily enough, the online brokers have now made buying and selling stocks through the Internet a very simple affair. In the event the investor has a stock broker, he or she is able to call the stock broker on the telephone and place their order. In addition, majority of the online brokers also permit their clients to place their order on their respective websites.
Any investor having an online broker should open the website of his or her stock broker and go through the instructions available on the computer screen. Next, the investor needs to type the symbol for Bright Light, i.e. BRLT, type 100 shares in the required box and chose market or del. It is essential for the investor to be cautious while typing the details so that no mistake is made. Having filled the necessary information, the investor should press the 'Enter' key and the computer will take care of the remaining task. However, it is pertinent to mention that some of the things that take place after the investor has entered the requisite details, depends on the stock he or she has opted for.
Till a while back, the Bright Light stock was trading at $20.25 each share, but now it has gone up to $21.00 per share. Since the investor has placed a market order to buy Bright Light stock, his or her order is filled instantaneously. And as the investor has placed an order for 100 shares, the brokerage firm will mechanically remove $2100 from his or her money market account to purchase these shares at $21.00 each. In addition, the brokerage firm will also subtract its commission of $9.99 as payment for its services to the investor in trading the stock. With all this over, now the investor has eventually become a shareholder of Bright Light.
Now, if the Bright Light moves up by a point, the investor will have, what is known as a paper gain of $100 in stock market parlance. Making a profit of $100 on an investment of $2100 within hours or days is not a bad idea at all and may even be called good enough way to make a living. Once the investment is over and it is earning money, the investor is free to do anything - visit the beach for pleasure or work and observe his or her money yield more money. It is really an interesting aspect as instead of the investor working for his or her money, their money is actually working for them!
In the event an investor desires to purchase a stock listed on the New York Stock Exchange (NYSE), the order will be directed to a professional on the stock exchange who will fill the investor's order by electronic means. Alternately, if the investor wants to acquire a stock listed with the NASDAQ, a market marker will take care of the order and also fill it electronically. Irrespective of the stock chosen by an investor, it is very likely that his or her order will be routed to an ECN or electronic communication network where the order will be coordinated by electronic means.
Every investor (remember, not a day trader) is basically concerned with the fact that his or her order is implemented fast and for a rational price. It may be mentioned here that there are a number of online brokerage firms catering the day traders provide 'price improvement' - meaning that the broker's computer software will help the day traders to locate the most viable price. The online brokerage firms also offer the investors special trading software that enables an investor to mention as to who they would like to take care of their orders. This particular software is known as Level II and enables an investor to spot the names of all the professionals, market makers and ECNs and they are free to opt for anyone to handle their orders. In the next step, the investors can chose the most viable price available on the market.
Here it is pertinent to mention that unless an investor is an expert in stock trading or the online stock broker offers the software free of cost, there is hardly any reason why one should install the Level II software. In majority of instances, the online broker will direct or route an investor's order to an ECN where the order will be taken case of with utmost proficiency. In fact, a fast moving market is the best occasion to find out how fast an investor's brokerage firm is handling his or her order. However, it needs to be underlined that the best brokers are those who perform equally proficiently in various market situations.
In case an investor does not have the money to buy the stock he or she wants to, they may borrow money from their brokerage firm for the purpose. Thus, when a brokerage lends money to an investor to acquire stocks, it is called 'going on margin' in the stock market parlance. Here margin basically denotes that the investor is borrowing money from his or her brokerage firm to enable them to acquire extra shares of the same stock.
Normally, a brokerage firm offers an investor a two-to-one rate of margin. For instance, if an investor pays a sum of $2000 to his or her brokerage firm to purchase Bright Light shares, the firm will lend the investor an added $2000 enabling him or her to spend a total sum of $4000 to acquire shares of Bright Light. The brokerage firm will charge an interest on the additional $2000 it lends the investor at the interest rates prevailing in the market.
The margin offers a great benefit to the investors as it enables them to make use of someone else's money, known as 'leveraging', to earn profits. This is a wonderful facility for the investors if the prices of their stocks are going up. However, it is a bane when the prices of the stocks begin to fall. In case, the price of the stocks falls, the investor not only loses all or a major share of his or her original investment, but also has to repay the loan taken from the brokerage firm. As the stock markets are volatile more often than not and prices of stocks normally go down faster than they rise, margins can actually be enormously dangerous.
Way back during the 1920s, the margin requisites were very low compared to the current rate. In those days, the margin requirements were merely 10-to-1. In effect, this meant that if only a small sum of $1000 was available with an investor for investing in stocks, the brokerage would lend them an added $9,000. It is significant to note that the margin was one of the major reasons behind the stock market crash of 1929. This is because when the stock market collapsed, people who had purchased stocks on margin did not have the cash to repay their loans. At this stage, the banks and brokerages who had lent money to the investors intervened to take control of such people's bank savings accounts, homes and whatever they could lay their hands on to recover their money.
In 1934, the then President of the United States Franklin Delano Roosevelt established the Securities and Exchange Commission (SEC), a government bureau entrusted with the job of ensuring that the stock market operated in a just manner and for safeguarding the interests of the investors. Among the various rules executed by the SEC, the most significant one was related to an augmentation in the margin prerequisites.
If the stocks on an investor drop considerably while he or she is on margin, they may receive the terrifying margin call. In this case, the brokerage that had borrowed money to the investor to enable him or her to purchase more shares of the same stock will call them up and demand that the investor pays them more money. In the event of the investor failing to initiate immediate action in this regard, the brokerage enjoys the privilege to sell the stock till the proportion of the margin restores appropriate levels, which is more often than not 30 per cent or even higher. It is anticipated that several thousand people were compelled to sell their stock to pay off their debts during the latest bear market. These unfortunate investors were not in a position to obtain adequate money to sustain their margin accounts.
The electronic communication networks, better known as ECNs, are basically specialized computer systems that operate out of people's view to coordinate buy and sell orders by an electronic means. The ECNs function in union with different stock exchanges to process an investor's order more quickly as well as proficiently and also very economically. This is possible as there is no role of the humans in the functioning of the ECNs. In launch of the ECNs not only transformed the manner in which the stocks were traded earlier, but also helped the investors to trade in stocks without having to pay huge commissions.
In fact, the ECNs function as electronic agents in return for nominal fees that may be worth only a few pennies for each share. If an investor or trader directly goes to the stock exchange through an ECN they are able to keep away from numerous financial tricks played by the market makers and professionals. Sometimes it is absorbing to learn what happens to an investor's order behind the scene. It is surprising to note that despite the crucial role played by the ECNs in filling orders, many people are still unaware of their existence. The fact is that as long as their orders are filled quickly and at reasonable fees, majority of the investors do not bother to know how their order is actually being filled.