Stock trading refers to the buying and selling of stocks in the stock market. Contrary to what the name might suggest, stock trading is done in exchange for cash, and not in exchange for other stocks. A stock (or shares) is a basically a unit of ownership of a company’s profits, losses or assets. Companies issue shares to the public to raise funds so as to grow or undertake ambitious new projects. This is what is referred to as an IPO (Initial Public Offering), which is the first time a company floats its shares to the public.
Understanding Stock Trading
A stock market is a collection of buyers and sellers of stocks. It is where investors perform stock trading. An example of a stock exchange is the NYSE (New York Stock Exchange). Investors participate in the stock market in the following ways:
A stockbroker executes buy or sell orders in the stock exchange on behalf of individual or institutional investors. By matching stock buyers and sellers, stockbrokers create liquidity in the market, and for their efforts, they charge a fee or commission. Additionally, stockbrokers offer other services, such as advising or recommending to their clients which stocks to buy, hold or sell. To deal with a traditional stockbroker, an investor can visit their brick and mortar offices, or call the broker to buy or sell their preferred shares.
Online stockbrokers offer the same services as traditional stockbrokers, but electronically. They have reduced the previous hustle of stock trading to just a click on the computer. In addition to making stock trading more convenient, online stockbrokers have also made it faster, cheaper, and allow for short selling and leveraged trading. Short selling is the act of speculating that the price of a particular stock will fall and making money out of it; while leveraged trading allows investors to trade on margin, exposing them to bigger profits with minimal capital commitment.
Direct Exchange Access
Direct exchange access is a technology that allows investors to trade directly with market makers. The technology allows direct linkages to stock exchanges, such as the NYSE, which allows for super-fast execution of trade transactions. Direct access brokers also have near zero slippages. The major disadvantage with these brokers is that they have a high-volume requirement, which means that small retail traders can sometimes incur an inactivity fee if they do not place sufficient trades during any one month. As well, these brokers are not beginner friendly; they are more suited to experienced investors.
Successful Stock Trading
Like in any market, stock trading profits are realised when one buys low and sells high, pocketing the difference. This means that the most important thing in the stock market is picking the right stock. Basically, the right stock is one that is undervalued by the market. When picking up such a stock, it is expected that market forces will, over time, achieve the true value of the stock, thus allowing you to realise the gains.
Stocks are a representation of the health of an underlying company. This means that one of the major factors that will influence stock prices is company related news, which may come out frequently, or occasionally, such as earnings reports. It is important to track such news releases so as to determine the market sentiment to any particular stock. The objective for analysing company news is to determine the true valuation of a company in relation to its stock price. A company with positive fundamentals and an undervalued stock price is the sweet spot for any investor. To pick out such a stock, an investor should assess the metrics below:
The price to earnings ratio is a common and easy to use stock evaluation metric. In calculation, the P/E ratio is simply derived by dividing the stock price by the annualised earnings per share. This value is then compared to other P/Es, such as an index or industry, where the underlying company operates. For instance, if company A has a P/E ratio of 10, while the industry average is 25, company A will be considered undervalued, and thus very attractive to an investor.
It is important to analyse the dividend policy of a company. Dividends are a distribution of a portion of a company’s profits to shareholders. Some companies pay dividends, while others do not. Usually, non-dividend paying stocks realise huge stock price gains, while dividend paying stocks can grow in value at a slower pace. Investors who desire huge capital growth can hunt for quality non-dividend paying stocks, whereas investors who desire the cushion of frequent payouts, can search for high dividend paying stocks.
Price to Sales Ratio
This ratio compares a company’s revenues to its stock price. It can be calculated by dividing the stock price by the company’s annualised sales per share. Generally, a low ratio implies a possible undervaluation, while a high ratio suggests the company may be overvalued.
Stock trading can be a very lucrative endeavour. To achieve success, investors must learn how to interpret various companies’ financial news and reports, so they can are able to determine their proper valuations.