How to Get Started With Trading
What Is Trading?
Trading, as opposed to investing, is speculating on the short-term movements of an asset price, either up or down, over a period of several days to several months. After setting up a brokerage account, you can generally trade a range of assets, from bonds, stocks (a.k.a equities/shares), currencies (a.k.a. FX/Forex), commodities and options. Brokers will usually let you buy (or short) the physical asset, or get "exposure" to the price movements with contracts such as spread-betting/CFD or otherwise.
Cash vs Margin Account
When setting up a trading account, the broker will generally let you open up a "cash" and/or "margin" account. Cash means you buy stocks with the cash you have, the biggest downside of which is losing your entire cash balance. Buying on margin means putting up, say, $10 to buy $100 worth of stock (10x leverage). The latter is much more risky of course, as you could easily wipe out your entire cash balance with small movements in the position if you're not careful!
What If I Only Have A Small Account?
Don't worry, you have the advantage of being more nimble, and have access to a wider range of assets. Many beginners in the stock market allocate several hundred dollars to blue chip companies, and then hope to become rich. This may work out if the US stock market trends upwards indefinitely. However, if you have a small account, you will be waiting for about 50-100 years!
If you want to grow your small account quicker, you generally need to successfully trade small, volatile stocks, or options. In other words, if you have a $1K account, you will trade MUCH differently than if you have a $1M account. The larger your account is, the less overall volatility you should take and the bigger the companies you should buy.
What Are Options?
Buying "call" stock options bet on a rising share price and "put" options bet on a falling share price.
One call (put) option contract gives you the right but not the obligation to buy (sell) 100 shares of stock at a specific point in the future. The benefit is that you only pay a small "premium", say several dollars to several hundred, to ride along with those 100 shares (leveraged), and your downside is limited entirely to the initial upfront cost. When buying an option, you will first have a look at the company's "option chain", which shows different contracts for different strike prices and time expirys.
Say AAPL is trading at $300 and you believe AAPL will be $350 within the next 12 months. You could buy the 12 month-out $350 call contract, which gives you the right to buy 100 shares of AAPL at $350 in 12 months time. Note you don't actually have to wait 12 months to expiry, you could sell the contract for a profit or loss any time after you buy. Having the ability to buy AAPL at $350 when its trading at $300 is useful if, say, AAPL rises to $400 in the next several months. Then your contract is far more valuable and you can hold it to expiry for profit or sell it in the market.
In summary, buying options allows you to bet on stock prices to rise or fall, for a limited downside upfront, with potentially much larger upside then just holding the stock.
One morbid example of options trading is leading up to the horrific 9/11 terror attack, it was discovered that a trading account in Germany had bought a lot of put options on several US airline companies. This was a bet on the share prices to drop precipitously, and buying put options was far more profitable than just shorting the stock.
What Strategies Should I Use?
Most brokers will suggest a lot of technical indicators (RSI, Fibonacci etc.) to try to figure out predictive patterns in stock prices. However most technical indicators (besides common-sense momentum) have zero predictive value and are pushed by brokers so that you trade often and generate commissions for them. No professional money manager looks at basically any of these indicators, besides from common sense moving average or momentum trends for guidance.
If you want to trade short-term trends, you should look at small market cap stocks traded on the NASDAQ exchange in the US. If there are any stocks left with predictable trend-like patterns of momentum, this is generally where you will find them. Be careful of the volatility however, and make sure the stocks have liquidity. Check paid Level 2 software and/or free daily volume charts to get a sense of how much liquidity a stock has before you trade it!
I Am Strong In Coding. Should I Use Machine Learning to Get An Edge?
NO! These types of coding projects are useful for experimenting with data or for showing your university/interviewer. However the likelihood that you will find some edge intraday trading Tesla stock with a basic machine learning classifier trained on daily close prices is next to 0.
Should I Invest Like Warren Buffett?
This style makes more sense the larger your account gets. However if you have a $1K account and try to buy and hold fundamentally sound companies, you MIGHT expand your account meaningfully in 50 years time. Also unless you have a strong technical background in corporate finance, you likely will have little understanding of what makes a successful company and what doesn't.
If you don't have these skills and you do have a larger account, it makes more sense to follow along with proven experts like Buffett when investing.
Do I Need To Consume Financial News To Trade?
Absolutely not. You SHOULD keep informed with news on assets you follow, and pay attention to reliable sources of useful information.
The vast majority of the time, mainstream news is comprised of bad analysts who didn't predict a move, trying to explain in hindsight why a move happened. A wise man once said "The Financial Times is the manuscript for trading failure", and I agree.
Companies will generally release news via press releases on their website with GlobeNewswire/PR Newswire, and all financial statements and regulatory disclosures will be on the SEC.gov EDGAR website for US. 10-Ks are a company's annual filing, 10-Qs are quarterly, 8-Ks are important financial disclosures (mergers etc.) and Form 4 is director/owner transactions in the stock.
In summary, use intelligent news sources to give useful information you (may) need to help make trading decisions. DON'T make your trading decisions based on what the Wall Street Journal or CNBC is saying!
I Found This Really Bad Publicly Traded Company. Easy Short, Right?
NO! Just because a company is fundamentally bad doesn't mean it's a good short. Some of the most fundamentally flawed companies have the largest price rises due to volatility caused by short squeezes.
Shorting is very risky because when you short a stock, you are borrowing the stock from someone else (for a daily borrow fee), selling it in the market and buying it back, ideally, at a lower price. However unlike buying a stock ("going long") where your greatest downside is a 100% loss, shorting has an infinite loss potential.
For example, many professional hedge funds were wiped out shorting TSLA on its meteoric rise from $180 in June 2019 to nearly $600 in Jan 2020. If you shorted at $180 and closed the position ("covered") at $600, you would be down $420 per share! Much worse than simply losing $180 per share if TSLA went to $0.
What Returns Are Good For A Year?
That depends on your account's volatility and consistency. A 400% return could be terrible if you gambled, got lucky and learned some bad lessons. This is why most hedge funds are judged on returns and volatility relative to their asset benchmark over a long period of time.
Returns are also a function of your account size. If you're managing a multi-billion dollar hedge fund, a return of 20% in a year is stellar. However a return of 100-500% in one option trade or high-volatility NASDAQ stock with a $1K account is pretty common (albeit not easy!).
Do I Need To Pay Tax With Trading?
If you buy an asset and sell it at a higher price, that is a capital gain. Every country is unique, for example in UK there is currently a threshold of £12,000 of tax-exempt capital gains you can make in a year. Also in the UK spread betting is tax-free.
Capital Losses can be deducted from gains.
Outside of stock, income from bonds and REITs is taxable.
All in all, make sure to consult with a professional in your area to find out your exact tax situation.
Trading is a short-term play, investing is a decades-long play. Ideally you should do both, however the skew is dictated by your account size and risk tolerance.
Cash trading is generally the most prudent, however you can still lose all of your money. If you want larger upside, either trade higher volatility assets intelligently or use options.
To further your education, watch some videos on finance, read some books, and dip you toes in the water by opening an account and starting off small!
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.