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Stock Trading Basics
by Dave Guilford
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Overview
Buy low, sell high--that's the market's lullaby. It doesn't get more basic than that. But what does it mean? What if an investor buys low, and then the stock goes even lower? What are the mechanics involved in stock trading? How does margin work? What is a bid and ask price? This article answers these questions and more about the basics of stock trading.
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Function
The most basic stock trade is buying a stock (going long) and waiting for the stock price to go up. The price paid for the stock is determined by the bid and the ask (more accurately called the "offer") price on the stock. The offer (ask) price is the lowest price a market maker is willing to accept to sell the stock to an investor. The bid price is the highest price a market maker is willing to pay to buy the stock from an investor. In other words, you buy stock at the offer price and sell it at the bid price. The difference in the two prices is called the "spread" and represents the market maker's profit.
Once the stock has appreciated in value, the investor can then sell the stock for a profit to close the position. The most important thing to remember about stock trading is that for every buy there must be a sell, and for every sell the must be a buy. The market constantly seeks equilibrium between buyers and sellers, and that is what causes the fluctuations in stock price. When there are more buyers than sellers, the price goes up. Likewise, when there are more sellers than buyers, the price goes down.
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Types
Another type of stock trade is the short sale. The old adage, "Buy low, sell high" was mentioned earlier, but many investors don't realize a stock trade doesn't necessarily have to be done in that order. Sometimes an investor will sell a stock (go short) to open a position. Over the past decade, the rules governing short selling have been relaxed considerably. An investor sells a stock short when he expects the price of the stock to drop. After the stock drops, the short seller buys the stock back at the lower price to close the position and the difference is his profit.
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Time Frame
There is no set or standard time frame for holding an open stock position. When an young investor is investing for retirement, he may buy a stock and hold onto it for 40 or more years. Conversely, a day trader may be in and out of a trade in a matter of seconds. Certainly some types of trades, like short selling, require more vigilance on the part of the investor and are generally more short-term in nature.
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Considerations
Over time, stock trading has outperformed almost every other available investment. In order to achieve the growth of assets necessary to fund a comfortable retirement, some type of involvement in stock trading is almost a requirement, whether it comes in the form of a professional money manager running a mutual fund or an individual investor researching and picking his own stock trades.
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Expert Insight
Once an investor has some market experience, there are several tools available to increase leverage and accelerate growth in the investor's portfolio. One of the most common methods is margin trading. When an investor is approved to trade on margin, he is able to buy twice as much stock with the same amount of money, thus doubling any potential returns. While margin trading is not appropriate for beginning investors, seasoned investors should consider opening a margin account to take advantage of the increased leverage.
