Online Stock Trading 101: A Beginner's Guide

Learn the Ropes If You're a Newbie to Online Trading

Image shows a man sitting at a desk with trading features on his computer screen. He's reading a book that says "how to start trading". Text reads: "Tips to start trading stocks: open an account with a respected broker (online or in person); avoid the wash-sale rule of accidentally selling and then re-buying the same stock shares; try to avoid expenses and fees; understand the taxes that you may have to pay on your investments"

Image by Hilary Allison © The Balance 2020

It's important to educate yourself before you consider any type of investment or investment strategy. This beginner's guide to online stock trading will give you a starting point and walk you through the basics so you can feel confident in assessing your options, picking a brokerage, and placing a trade.

Choose an Online Broker

If you haven't already opened a brokerage account with a respected online stock brokerage, do it now. Take your time researching so you can feel confident you are choosing the best online stock broker for your situation. As you research, consider factors like whether there are trading commission fees (many brokerages offer free trading), how intuitive the app or website is, and any research or educational tools available for customers.

Choosing the best brokerage ultimately comes down to personal preference, and traders have a lot of options. Established giants like Fidelity and Charles Schwab have channeled their decades of expertise into both online and app-based trading tools. There are also newcomers that specialize in perfecting the user experience of their apps, such as Robinhood, WeBull, and SoFi.

Research Stocks to Trade

Once you have a brokerage, you can buy stocks, but what stocks should you buy? If you're brand new to trading, the best place to start may not be with stocks, but with exchange-traded funds (ETFs). ETFs allow investors to buy a bundle of stocks at once—which can help if you don't feel confident choosing one company over another. ETFs built to replicate major indices like the Dow, Nasdaq, and S&P 500 are good places to start to give your portfolio broad exposure to the U.S. stock market. Many traders also diversify their holdings with assets other than stocks, such as bonds, as a way of hedging their risk during stock market downturns.

If you decide to invest in individual stocks, make sure to use some financial analysis ratios to compare a company's performance to its competitors. Successfully choosing individual stocks is difficult, but extensive comparative analysis can help ensure you're adding the best stocks to your portfolio.

Decide What Kind of Trade Is Right for You

When you want to buy (or sell) a stock, ETF, or any other traded asset, you have options for the type of trade order you want to place. The two most basic types are market orders and limit orders. Market orders execute immediately for the best price available at that moment. Limit orders won't necessarily execute right away, but they give you greater control over the price you pay (or receive, when selling). Once you own a stock, you might consider placing a trailing stop loss sell order, which allows you to continue riding positive momentum and automatically sell when the trade starts to turn on you.

No order type is necessarily better than another. They all have their place, and by learning as many of them as possible, you ensure you're using the right tool for your scenario.

Know What It'll Cost You to Trade Stocks

One of the biggest enemies of successful stock trading is expenses. They represent money you pay just to own or trade securities. One type of expense is a commission fee, which you should consider while shopping around for brokerages.

If you're buying individual stocks through a brokerage that doesn't charge commission fees, you might not incur any expenses. However, when you start trading ETFs, mutual funds, and other types of investments, then you need to understand expense ratios. These funds are managed by a person who is paid a percentage of the fund's assets every year. So, if an ETF has an expense ratio of 0.1%, that means that you will pay $0.10 per year in expenses for every $100 you invest in the ETF.

Aside from expenses, you also need to consider your risk tolerance. A common risk assessment method involves considering a hypothetical scenario in which your investments suddenly lose 50% of their value. Would you buy more after the crash, do nothing, or sell? If you would buy more, you have an aggressive risk tolerance, and you can afford to take more risks. If you would sell, you have a conservative risk tolerance, and you should seek out relatively safe investments.

Understanding how you would emotionally react to losses is one thing, and understanding how much you can lose without sacrificing financial stability is another. You may have an aggressive risk tolerance, but if you don't have an emergency fund to fall back on in case of sudden job loss, then you shouldn't use your limited funds to invest in risky stocks.

Understand How Trading Stocks Affects Your Tax Bill

Along with expenses, it's important to understand the tax rules for each of your positions, especially if you're going to actively trade stocks. The taxes you pay on stock profits are known as capital gains taxes. In general, you pay more capital gains taxes when you hold a stock for less than a year, and you pay less when you hold a stock for more than a year. This tax structure is designed to encourage long-term investing.

While selling stocks for a profit will increase your tax bill, selling stocks for a loss will decrease your tax bill. To prevent people from taking advantage of these tax benefits, there's something known as the "wash sale rule." Essentially, this rule delays the tax implications of any profits or losses if you re-enter the same position within 30 days. In other words, if you sell a stock for a loss, and then buy the same stock a week later, your loss will no longer give you tax benefits—it's carried over into your new position. The loss will be accounted for once you sell the stock again.

If minimizing your tax bill is a primary concern, consider investing in a retirement account like a Roth IRA or 401(k) plan instead of using a standard brokerage account.

Trade Your First Stock

When you're ready to place your first trade, fund your brokerage account by transferring money to it from a bank account. Once your funds have settled (some brokerages give you the money immediately while the transfer is processing), then you simply need to select the stock you want to trade, pick an order type, and place the order.

After placing the order, watch it to make sure it actually executes. If you're using market orders, it should execute immediately. However, if you're using limit orders, your order might not execute right away. If you become impatient, you can try moving your limit price closer to the ask price (if you're buying) or the bid price (if you're selling).

Learn About Advanced Stock Trading Strategies

Beginners should stick with simple buy and sell trades until they learn the ropes. However, once someone masters those basic concepts, there are many advanced strategies that can be added to a trader's toolbelt. For example, options expose traders to greater volatility, allowing them to experience quicker gains (as well as quicker losses).

Another advanced strategy is borrowing money from your brokerage firm to trade stocks. This is known as trading on margin. This approach to trading stocks is very, very risky, so steer clear until you feel confident in your trading abilities. Margin allows a trader to exponentially grow their portfolio, but it can also quickly land them in debt.

Margin traders also have the ability to short stocks. A trader who shorts stock sells the stock first and then buys it later. When the shorted stock falls, the short seller makes money, because they can buy the stock back at a cheaper price than they previously sold it for. If the stock price increases, the short seller is in trouble, because they still have to buy the stock to close their position.

Alternatives to Trading Stocks

Trading stocks is just one way to engage in the market. Even when you add in ETF trading, you're still barely scratching the surface of investing methods. Mutual funds, for example, don't trade like stocks or ETFs, but they allow people to invest in many different sections of the market.

Robo advisers are app-based investment services that use algorithms and the answers to basic questions automate investment decisions. These are popular with beginners because they're easy to understand and they come with relatively low fees, compared to hiring a traditional financial adviser to pick and choose investments for you.

Article Sources

  1. Office of Investor Education and Advocacy. "Wash Sales." Accessed Sept. 22, 2020.