What Is Stock Trading?

Stock Trading: An Overview

Stock trading involves buying and selling shares in publicly traded companies. In the United States, this typically occurs on stock exchanges like the New York Stock Exchange (NYSE) or the Nasdaq stock market.

When someone buys shares of a company, they effectively become a small part-owner of that company and have some claim on its assets and earnings, in the form of dividends and/or capital appreciation. The value of the shares depends on a variety of factors, including the company’s financial performance, outlook, overall market conditions, and investor sentiment.

This is a comprehensive guide to stock trading basics and the different types of stock trading, as well as tips for getting started.

Types of Stock Trading

Stock trading and the people who do it come in many varieties and feature myriad strategies and approaches. Often, stock trading is categorized based on one’s desired holding period, or time horizon.

Long-term trading involves buying shares of a company and holding onto them for an extended period, usually several years or even decades. The goal of long-term trading is to benefit from the growth of the company over time and to earn dividends on the shares. Long-term buy-and-hold traders are often categorized more as investors but may also be called position traders.

Short-term trading, on the other hand, involves buying and selling shares over a briefer period of time—usually a few days, weeks, or months. The goal of short-term traders is to make quick profits by taking advantage of market fluctuations. Day traders have an intraday time horizon, making several trades over the course of a single day or a few days. Swing traders have a more medium-term outlook, looking to capture trends and momentum over several weeks or months.

Ultra-short-term traders may employ algorithms to help them place trades in milliseconds to “scalp,” or make a series of small but quick profits. Also known as high-frequency traders (HFTs), they use computer programs to execute trades based on preset criteria. While high-frequency trading is usually the realm of professional Wall Street traders and hedge funds, algorithmic platforms are becoming increasingly available to ordinary traders.

What to Trade

There are more than 5,700 stocks listed on the NYSE and Nasdaq alone, and many thousands more listed over the counter (OTC). As a stock trader, you will want to narrow this universe down. Most brokerage platforms have filters and screeners that allow you to do that.

In general, stocks are categorized based on market capitalization, industry, and whether they present growth or value investing opportunities.

Market Cap

The market cap of a company represents the value of its shares multiplied by the number of shares it has outstanding. In general, stocks with bigger market caps represent larger, more mature, and stable companies with less growth opportunity but also less volatility. On the other hand, small-cap stocks tend to be riskier but can provide more long-term growth.

Usually, a stock’s market cap can be segmented as:

• Mega cap: Market cap of $200 billion and greater
• Big (large) cap: $10 billion and greater, up to $200 billion
• Midcap: $2 billion to $10 billion
• Small cap: $250 million to $2 billion
  
• Microcap: $50 million to less than $250 million
• Nano cap: Less than $50 million

Industry Sector

What companies do and the industry they work in typically will be reflected in the performance of their stocks. For instance, a consumer staples stock (meaning shares in a company that makes goods essential to consumers) will tend to fare well in a recession because people will always need their products. A consumer discretionary stock (for example, luxury items), on the other hand, may suffer as consumers cut back on optional purchases when the economy falters.

A company’s industry classification, known as its Global Industry Classification Standard, or GICS code, is a critical tool for an investor whose aim is to create a diversified portfolio, or for identifying competitors of a company in the same industry. GICS codes define 11 economic sectors.

These are further divided into 25 industry groups, then into 74 industries, and finally into 163 subindustries. Each stock has a code to identify it at all four of these levels in terms of the company’s principal business. The 11 stock market sectors are:

• Communication services
• Consumer discretionary
• Consumer staples
• Energy
• Financials
• Healthcare
• Industrials
• Information technology
• Materials
• Real estate
• Utilities

Growth vs. Value

Growth stocks are shares of companies that are expected to grow faster than the overall market due to their potential for innovation, expansion, or disruptive technology. These are often smaller-cap and newer companies.

Value stocks are shares of companies that are perceived to be undervalued by the market and have strong fundamentals. Value traders look for stocks with solid fundamentals, such as low price-to-earnings (P/E) and price-to-book (P/B) ratios as indicators of their financial strength relative to their market price. Value stocks also may pay higher dividends.

ETFs

Exchange-traded funds, commonly known as ETFs, trade like shares of stock, but each ETF share represents holdings in several different stocks. ETFs offer traders a way to gain access to an entire industry sector, broad market index, or asset class using a single instrument.

Where to Trade Stocks

Stocks are listed on one or more exchanges, or they can be traded on over-the-counter (OTC) markets. Exchanges such as the New York Stock Exchange (NYSE) and the Nasdaq stock market in the U.S. provide a centralized marketplace for buying and selling stocks, and they set the rules and regulations for trading activities.

OTC trading takes place away from stock exchanges and can occur via electronic communication networks (ECNs) or through dealers who specialize in a particular type of security or market segment, like the OTC Markets Group Inc. OTC trading is typically reserved for smaller or less well-known companies (often in the form of so-called penny stocks), shares of some non-U.S. companies, or securities that don’t meet the listing requirements of major exchanges.

OTC trading carries some particular risks, such as reduced transparency and liquidity, as well as the potential for fraudulent activity. Therefore, traders need to exercise caution and conduct thorough research before trading OTC stocks or other securities.

Most brokerage firms today give their users access to exchange-traded and OTC stocks.

How to Trade Stocks

To start trading stocks, individuals need to open a brokerage account with a reputable broker. A brokerage account is a type of investment account that allows investors to buy and sell stocks, bonds, and other securities.

Once the account is set up, traders should start researching companies and analyzing their financials to make informed investment decisions. It’s also wise to set a budget for trading and to invest only the amount of money that you can afford to lose. When ready, traders can then place orders to buy or sell shares of a company through their broker.

There are several order types and specifications that a trader can use:

• A market order is the most basic type of stock order and instructs the broker to complete the order at the best available price. Market orders are generally always executed, unless there is no trading liquidity.
• A limit order seeks to buy or sell a stock at a specific price or better. Limit orders give the trader more control over the price they will pay to buy or sell a security. Limit orders can remain in effect until they are executed, expire, or are canceled.
• A stop order instructs the broker to buy or sell an asset once it reaches a specified price above or below the current price. A stop order can be a market order, meaning that it takes any price when triggered, or a stop-limit order that can only execute within a certain price range (limit) after being triggered. Stop orders are often used to minimize losses (stop-loss).
• A day order must be executed during the same trading day when the order is placed.
• Good-’til-canceled (GTC) orders remain in effect until they are filled or canceled.
• Immediate or cancel (IOC) means that the order only remains active for a very short period of time, such as several seconds.
• An all-or-none (AON) order specifies that the entire size of the order be filled, and partial fills won’t be accepted.
• A fill-or-kill (FOK) order must be completed immediately and completely or not at all, and it combines an AON order with an IOC order.

Stock Trading Risks

It is important to note that stock trading involves risks, and investors should be prepared to lose money. Stock prices are subject to fluctuations caused by various market factors, including macroeconomic conditions, geopolitics, and global events. This is known as market risk or systematic risk because it affects the entire stock market.

Individual stocks also can lose money due to sector- or company-specific news and events, such as an earnings miss vs. analysts’ forecasts or impending bankruptcy. As such, this is called specific risk (or unsystematic risk). This can result in significant losses if the market moves against a trader’s position.

To manage these risks, investors should conduct thorough research and analysis, develop a well-defined trading plan, set risk management measures such as stop-loss orders, and stay disciplined in executing their strategy. Additionally, when you trade stocks, you should avoid investing more money than you can afford to lose and consider diversifying your portfolio to reduce overall risk.

The Bottom Line

Stock trading involves buying and selling shares of a public company. Trading can be an exciting and lucrative opportunity, but it also involves risks that investors should be aware of, including the possibility of losing significant amounts of money. Therefore, it’s important to conduct thorough research and analysis before making any investment decisions.

By following these tips and understanding the basics of stock trading, you can make informed decisions and work toward achieving your investment goals.