When it comes to investing, knowing how and where to buy stocks can be just as important as what you buy.
From fundamental stock-pickers like Warren Buffett to caffeine-fueled day traders, investors typically have a process they follow.
If you are just starting out, that process should include basics like opening a brokerage account and knowing how to place an order. From there, you can move on to develop a method for picking what to buy and sell.
Owning stocks means very different things to different people. While specific holdings might change over time for all investors, there are some lasting differences in the types of portfolios people create for themselves - and, consequently, how they pick the stocks in those portfolios.
Naturally, different types of portfolios can also have implications on which brokerage an investor selects to support their particular investing goals.
That's why the two most fundamental steps to take when getting started buying stocks are:
- Deciding on your investor type
- Opening a brokerage account
Investor Type - How to Decide What Kind of Investor You Want to Be
Here are three ways you can approach buying and selling stocks:
1. Picking individual stocks
Are you attracted by understanding what makes companies tick and interested in trying to pick the next Apple or Microsoft?
It's not easy; but even if you don't have spectacular success, you can consistently make money over the long run if you focus on what makes companies the leaders in their fields.
All investors have winners and losers. Even if you are picking stocks individually, take care to own several different ones and don't let any one stock become too big a portion of your portfolio. Spreading your money over many different stocks is called diversification, and it can help you stay within your level of risk tolerance.
2. Technical analysis
Some investors aren't interested in the fundamental business models of the stocks they buy. They seek to capture a high volume of relatively small gains by looking at pricing discrepancies or short-term market trends.
Professionals who take this approach base it on sophisticated technical analysis. Because of the high volume of trading involved, this type of approach can be associated with day trading.
However, day traders are often looking to read market moves based on little more than hunches, whereas technical analysts use advanced data analysis to try to anticipate price movements.
A major risk of this approach is that past patterns of price movements in the markets often fail to repeat themselves in any predictable way.
3. Index/ETF diversification
Many people feel it's foolish to try to outguess the market by buying individual stocks. Instead, they seek to capture broad segments of the market with index funds or exchange traded funds (ETFs).
Index funds and ETFs take the same approach: They seek to mimic the moves of a designated segment of the market by capturing a representative cross-section of that market segment.
The only difference is that index funds are bought and sold as mutual funds while ETFs are funds that are traded on an exchange like individual stocks and bonds.
Buying an index fund or an ETF can be an easy and efficient way of getting a well-diversified portfolio. Just keep in mind that different funds set out to mimic different segments of the market, so the type of fund you choose can make a big difference to the risk and reward of your portfolio.
How to Find the Right Brokerage Account
Knowing what kind of investor you want to be can help put you in position to choose the right kind of brokerage account. The following are some of the major issues you could face:
Traditional vs. online brokerages
If you want a personal relationship with a traditional broker or financial advisor who can discuss your holdings with you and make recommendations, you might want to choose a well-qualified financial representative from a local brokerage office.
On the other hand, if you are comfortable making your own decisions, you might find that online brokerages offer more cost-effective ways to acquire and maintain a stock portfolio.
Trading habits affect pricing efficiency
Brokerage costs come in many forms, including monthly maintenance fees, trading commissions and margin interest. How you trade makes a big difference in what your costs would be.
If you expect to just make occasional trades of specific stocks, commission levels may be less important to you than the type of service and information you get from the broker.
However, if you are looking for a more high-volume trading approach, low commissions are essential. A high-volume approach may come from making frequent, short-term trades and/or from owning a large number of stocks.
Online Brokerage Commission Costs
|Online Broker Commissions|
|T. Rowe Price||$19.95|
>> Explore more online brokerage features here: Best Online Brokers for Stock Trading
How to Start Buying and Selling Stocks
Even if you don't prove to be the next Warren Buffett, you could find it a challenging and rewarding pursuit for years to come if you are serious about the process of buying and selling stock.
Buying and selling stock depends on a clear understanding of four fundamentals:
- Conducting research on the stocks you want to target
- Deciding how much you want to invest
- How to make clear trading orders
- Checking that your trades are processed correctly
1. How to Research Your Targets
No matter what type of investor you are, information is power. Get to know your targeted investments well before you buy.
Individual stock research
Picking individual stocks means knowing the ins and outs of the companies you are considering, and also recognizing the strengths and weaknesses of their competition.
You have to pay attention to demand for the company's products and services. Even the best company in a shrinking industry can be a poor investment.
Finally, even if you pick the right company, you also have to analyze the relationship between the stock's price and the earnings outlook for the company. Overpaying for a good company can really hurt your returns.
Researching mutual funds and ETFs
If you are taking a broad-brush approach by buying mutual funds and ETFs, there is still some research you should do before you make an investment. This research should include knowing what the fund's objectives and expenses are.
Some funds are actively managed, while others seek simply to own enough stocks to behave like a certain market or segment or the market. The latter are called indexed or passively managed funds.
- Actively managed funds
If you want an actively managed fund, you should check out how well the fund has performed in the past. Be sure to look at performance in both up and down markets. Also, check whether the management team that earned that track record is still in place.
- Passively managed funds
For passively managed funds, a key consideration is tracking error. This measures how similarly the fund has performed compared to the index it is trying to mimic.
When it comes to expenses, both ETFs and mutual funds have ongoing expenses and transaction-related expenses.
The ongoing expenses are included in what's called an expense ratio: the amount those expenses represent annually as a percentage of the fund's assets. Generally speaking, ETFs have lower expense ratios than mutual funds, but you should check so as not to make any assumptions.
When you buy mutual funds, they often charge commissions known as "loads." These represent a certain percentage of the value of the trade. Since ETFs are traded on exchanges, they are often subject to brokerage commissions instead of sales loads. Keep in mind that you may encounter those commissions both when buying and selling the stock.
2. Set Your Limits - How to Decide How Much to Invest
Before you buy a stock, figure out how much you are willing to pay for it and how much you want to own.
Setting a price matters for both individual stocks and indexed funds. Whether it is an individual company or the market as a whole, your decision may depend on how expensive stock prices are at the time you buy.
Position sizes also matter.
Owning too much of one thing can be risky. Even if you buy an indexed fund, you have to decide how much of your overall portfolio you want that segment of the market to represent.
Calculate your stock purchase amounts - whether via funds or individual securities - based on what percentage of your total holding you want them to represent.
Typically, you need to convert the dollar amount you want to buy to the number of shares it would represent in order to place an order for the right amount. Divide the dollar amount by the share price in order to get the number of shares you want to buy.
3. How to Make Clear Trading Orders
Stocks are traded using specific symbols. These help distinguish each security from others that might have similar names.
Often the symbols are pretty obvious - for example, General Motors is "GM" and Amazon is "AMZN." That seems fairly natural, but you have to be careful to look up the precise symbol for the stock you want to buy.
For example, if you buy stock symbol AAPL you will be buying Apple, the global consumer technology giant. However, if you buy APLE you will be buying Apple Hospitality, a real estate company.
Define price limits
Besides specifying what you want to buy and how many shares, you have to decide whether to set a price limit for your order.
- Limit orders
If you only want to buy the stock at or below a certain price, you should place a limit order. This specifies the price you are willing to pay, and the trade won't be made unless the stock can be obtained at or below that price.
- Market orders
In contrast, a market order authorizes the broker to purchase the stock at whatever the best available price happens to be.
Along with giving your broker a market order or a limit order, you have to choose between a day order and a good-till-cancelled (GTC) order.
- Day orders
A day order only remains active for the day you placed it. If the broker isn't able to fulfill your order that day, either because your price isn't met or the stock trades too thinly, the order will be cancelled at the end of the day unless you renew it the following day.
- GTC orders
A GTC order means that the broker will continue to try to buy the stock for as long as it takes until the order is filled.
Give Specific Instructions
Your trading instructions should include:
- Whether you want to buy or sell
- The stock symbol
- The number of shares you want to buy
- Whether it is a market or a limit order
- The price, if you are placing a limit order
- Whether it is a day order or a GTC order
4. How to Check for Trade Execution
When you place a trade order, you should keep a record of your instructions. Once the trade has been completed (or "executed" as it's typically called by investment professionals) that record will allow you to check to see whether everything was done according to your instructions.
Once the trade has been executed, you will receive what is called a confirmation from the broker. The trade confirmation contains all the details about the trade.
As soon as you receive a confirmation, go item by item through the list of trading instructions shown in the prior section and compare your instructions against the trade confirmation to make sure everything matches up. If there is a problem, it is vital that you notify the broker immediately.
The trade confirmation should also show the commission charged on the trade. Check this as well to make sure the amount of money matches your understanding of what trading through that broker is supposed to cost.
The above tips on how to buy stocks can help get you started. From there, be prepared to continue learning to improve your process.