|
 So you think you want to start trading stocks, but you'd really like to understand what is going on before you start investing your hard-earned money. This article is going to be a very simple introduction to stock trading basics. We'll explain what takes place when you trade a stock and what to look out for when calculating the return on your investment.
Buying and Selling Stocks
Stock trading is really kind of a misleading term to that is used to describe what actually takes places when you are buying or selling stocks. Like most financial markets, the stock market is very efficient and pretty much obeys the laws of supply and demand.
If you want to sell a share of stock, there is always someone ready to buy that share from you - at the right price. The stock exchanges throughout the world bring order to all of the trades that take place each day, making sure that buyers and sellers can quickly find each other.
Stock Exchange Floor
The New York Stock Exchange is the picture that most people have in their minds when they think of trading stocks. That's because they still use an exchange floor where the "market makers" still use hand terminals or pads, overhead monitors and hand gestures to complete their stock transactions.
The NYSE depends on these specialists or market makers to match up the buyers and sellers and make sure that a robust "market" always exists for the stock or stocks that they are responsible for. The NYSE trading floor and all of the people that make trading a reality is quite a sight to behold - and that is why you see pictures of the stock exchange floor in the newspaper all the time.
Electronic Exchanges
Unlike the NYSE, the NASDAQ is a completely electronic exchange - and pictures of computers are pretty boring. The NASDAQ uses a sophisticated network of computers to match buyers and sellers of stock. This makes electronic exchanges very fast, with almost instantaneous confirmation of stock trades.
Electronic exchanges give many investors an added feeling of control over their trades, but either method - exchange floors or electronic exchanges - still requires the use of a stock broker.
Stock Trades and Stock Brokers
As an individual, you do not have direct access to the stock market. Stock brokers are used to make sure the exchange rules are enforced and that all stock traders have the funds necessary to complete their transactions.
So whether you are online day-trading or calling a stock broker over the telephone, the stock broker provides the market and the investor with essential services. And the more personal this service is, the higher the commission you will be charged. For example, stock brokers that answer the telephone and make trades on your behalf might charge you $30.00 to complete a transaction. This is a generalization, and the actual fee structures may vary with the dollar amount or number of shares traded.
Electronic Stock Brokers
Some of the more notable "electronic" brokers allow you to make online trades through an account you've established with them. These companies also use sophisticated computer networks to send your buy and sell orders to the correct stock exchange. This means that electronic brokers compete for your business based on price or low commissions, not personalized service.
Purchasing and Selling a Stock
Let's take a quick look at the steps involved when you buy and sell a stock.
- Decide on a Broker - The first step is to decide on the level of personalized service you want or need in a stock broker. Once you've figured that out, you need to establish an account with that broker and deposit money into that account. In this example, let's assume you've deposited $2,000.00 with a broker into a personal account.
- Conduct Stock Research - You've finished up your stock research and let's say you've decided to purchase 20 shares of 3M Company at $77.25. Because you are new to stock trading, you've decided that you need more personalized service and call your broker over the phone to place the order.
- Stock Order Issued - The broker places the order and the trade completes at $77.25. The broker takes 20 x $77.25 or $1,545.00 from your account to pay for the stock and also takes out $30.00 for her commission. Your account now has a cash balance of $425.00 plus 20 shares of 3M stock. The shares in your account are held in "street name." That means there is no physical stock certificate you can touch and hold.
Making Money Trading Stocks
Let's assume that 3M releases some good news and the stock market has reacted rationally by increasing their value for 3M to $80.00. At that price point, you decide to take your profits and sell your 3M shares. You call your broker and they complete the transaction by selling 20 shares at $80.00 and put the $1,600.00 in cash back into your account. They also charge you their standard fee of $30.00 for the trade. So at the end of the day, you now have $425.00 + $1,600.00 - $30.00 or $1,995.00.
But wait a minute, you purchased 3M at $77.25 and sold it at $80.00. You started with $2,000.00 in your account and now you have $1,995.00 - you thought you were making money trading stocks, not losing it! But you also paid $60.00 in trading / broker commissions and look what these fees did to your total return on this investment - a net loss of $5.00!
Impact of Commissions on ROI
The above example serves as an important lesson in stock trading basics that we hope will stick with you. Make sure you understand the impact commissions will have on your investments. Your initial investment of $1,545.00 carried with it $60.00 in commissions or 3.88% of your investment goes towards fees.
To lower the impact of commissions on the return on your investment, you either need to place larger trades or seek brokers with lower commissions. Alternatively, you can get started in the market with no-load mutual funds.
Mutual funds are a great choice for investors that don't have a lot of money right now or those that want to start out slowly in the market without putting a lot of money at risk. Mutual funds allow investors to instantly create a diverse portfolio of stocks in a very efficient manner. We've got lots of articles on that topic, so research your options and make an informed decision.
About the Author - Stock Trading Basics
Copyright © 2005 - 2007 Money-Zine.com
Stock Market Resources on the Web |
Home 
