How to Trade Stocks: A Seven-Step Guide

If you have savings sitting in a bank account that is only earning a small amount of interest that may not even beat the rate of inflation, you may be interested in learning how to start investing in stocks. The S&P 500 index provides returns of about 10% annually on average, so the compounding effects of holding stocks can be significant over time.

Investing in stocks is actually quite easy when it comes to simply buying or selling a stock on a practical level. However, learning how to invest in stocks correctly and profitably takes time, effort, and skill.

Before getting into the details of how to invest in the stock market, it’s necessary to determine your goals. This boils down to the question of why you are investing in the first place. Some related questions that can help in figuring this out include:

• What do you value more: income or appreciation?
• Are you investing for retirement or more short-term goals?
• How much time do you have to manage your positions?
• Do you want to invest in specific sectors, broad market indices, or both?
• Does ethical investing play a role for you? For example, do you prefer not to invest in certain sectors, opting only for those that align with your personal values?

Income

If your goal is income, you may want to focus more on dividend stocks and related ETFs. These securities yield dividends, providing shareholders with regular quarterly or monthly payouts. However, they tend to benefit less from capital appreciation.

Retirement

Those building a retirement fund have additional considerations to make, such as the type of account to use. Tax-advantaged accounts like IRAs and Roth IRAs are common options. The risk appetite for such investors tends to vary according to age. Younger investors can afford to take more risk, while those closer to retirement age usually prefer to take a more risk-off approach since they won’t have time to recover from losses.

Short-term profits

Short-term traders take more risk and have to spend more time actively managing positions. This style requires a lot of education, research, and emotional awareness, and few traders outperform the market long-term. Even professional fund managers have a terrible track record, with 85% underperforming the S&P over a 10-year period.

ESG investing

Some investors want their investments to align with their personal values. For example, some people don’t want to invest in oil and gas companies. Asset managers have appealed to this desire by creating ETFs that exclude specific companies from the rest of the market or ETFs that focus on sectors like renewable energy or electric vehicles. These are commonly called “socially conscious ETFs,” “eco-conscious ETFs,” or similar terms. In general, these concerns fall under the umbrella term of ESG, or environmental-social governance.

Generally, a safe rule of thumb is the age-old adage, “Don’t invest more than you can afford to lose.” While you may be unlikely to lose 100% of your capital in a short time unless you’re exclusively picking high-risk stocks, this rule can still be beneficial.

A lot of investing is psychological. If you only invest what you can afford to lose, you’ll be better able to tolerate the amount of risk necessary for rewards (all investments involve risk) while not investing so much that it could lead to making irrational decisions like panic selling, going all-in on one thing, or overtrading. On the other hand, if you have too much of your net worth tied up in investments, even the slightest volatility can be emotionally intolerable.

Risk tolerance varies from individual to individual. This is almost entirely a matter of personal preference but should also be tempered with reason.

The easiest way to determine your risk tolerance is to ask yourself: how well can I tolerate a change in the value of my investments, and how much am I willing to lose? Note that the answers to these questions may only be discoverable through experience. Imagining a scenario and actually having money in the market that can gain or lose value are two different things.

When opening an account at a brokerage, you must select an account type. The most common options include standard brokerage accounts and tax-advantaged retirement accounts like IRAs. There are also various other types, like 529 education accounts and custodial brokerage accounts for children.

A standard brokerage account might be the best option for someone who wants to learn how to invest in the stock market but isn’t building a retirement fund.

Once you feel you know how to invest in stocks and are ready to get started, it’s time to pick a type of broker. There are an assortment of options and the best one for you will vary based on your strategy, financial needs, or experience level.

Full-service

A full-service stock broker offers personalized investment advice, financial planning, and a wide range of services, including portfolio management and research. Full-service brokers usually charge higher fees or commissions. However, in some cases brokers attempting to attract high net worth individuals may offer these services at a discount if you deposit a large amount of assets.

Roboadvisors

Roboadvisor accounts are artificial intelligence-powered virtual advisors that figure out how to start investing in the stock market on your behalf. All you have to do is answer some questions about your investment goals and risk tolerance and the roboadvisor will select a pre-made portfolio option for you. Any contributions you make will be split up into different assets at an allocation set by the AI.

Discount

A discount broker provides basic trading services at lower fees, allowing investors to buy and sell stocks with minimal guidance or advice. These services are often offered through online platforms with basic tools and resources.

Unless you hire a financial advisor to make all the decisions for you, the final step to learning how to invest in stocks involves picking individual securities (note: “securities” is an umbrella term used to describe financial assets like stocks, bonds, and ETFs).

Once you’ve taken care of the above steps, it’s now time to figure out which types of stocks you want to buy shares of. Here are some of the broad categories that different stocks fall under.

Types of stocks

Blue-chip stocks: Blue-chip stocks are shares of large, well-established companies with a history of financial stability and reliable performance.

ETFs: Exchange-traded funds (ETFs) are investment funds that hold a collection of stocks or other assets and can be traded on the stock market like a single stock.

Dividend stocks: Dividend stocks are shares of companies that regularly pay out a portion of their profits to shareholders in the form of dividends. Examples include real estate companies, such as REITs, that regularly pay out a portion of the rent collected from their tenants to investors in the form of dividends.

Small cap stocks: Small cap stocks represent shares of smaller companies with market values between $300 million and $2 billion. They often offer higher growth potential but with more risk.

Mid-cap stocks: Mid-cap stocks are shares of companies with market values between $2 billion and $10 billion, balancing the growth potential of small caps with the stability of larger companies.

Large-cap aka “mega-cap” stocks: These are the biggest companies in the world, with market caps of more than $10 billion.

The final aspect of investing in stocks involves managing your portfolio. The optimal way to do this will depend in large part on the various factors discussed earlier, like your risk tolerance, investment goals, and chosen account type. For this reason, there’s no right way to manage and review a portfolio. However, there are some general guidelines and examples to consider.

The long-term investor

Suppose you have a Roth IRA account that you plan to regularly contribute to for many years and you select index funds and low-risk ETFs as its main investments.

In this case, very little must be done to manage the account. In fact, less may be more because constantly checking on things could cause an investor to make emotional decisions, such as selling at inopportune times when market volatility strikes and a downturn occurs.

The better option tends to be to make continued purchases at regular intervals, aka dollar-cost averaging, so things continue to grow despite price action. On longer timeframes, markets tend to rise overall, so there’s not much to worry about if you’ve chosen the right assets and intend on holding for many years.

The short-term investor

Let’s look at an example at the other end of the spectrum: a swing or day trader looking to eke out profits on timeframes ranging from several weeks to several hours. In this case, positions require daily or even hourly monitoring and management.

Short-term traders often use high-risk strategies like options, futures, and leveraged ETFs. These investments can be so volatile that they must be monitored more frequently to avoid steep losses. A swing trader who holds positions for a few days to a few weeks might need to spend at least an hour every day monitoring their portfolio, while a day trader who holds positions for several hours or less may need four or more hours daily.