7 Basic Concepts of Stock Trading You Must Know Before Getting Started
Trading stocks for the first time can be a bit overwhelming if you don’t know exactly what you are doing.
Nowadays, brokerage firms have made available to individual investors the kind of tools that were only accessible to professionals in the past, and even though this is positive to some extent, it can also make beginners feel as if this activity is just too much for them.
In this article, we will explain some basic concepts about trading to improve our reader’s understanding of what they might be seeing in the reports, news, and trading platforms they now have access to.
Some of these concepts might be familiar to you already while others you may not have ever heard about them like what a pattern day trader is.
Technical analysis is one of the cornerstones of trading. This practice involves assessing the price action and volumes of the different stocks available in the market to identify potential opportunities.
Some of the techniques used to analyze stocks include charting, which involves the identification of price and volume patterns. Other more advanced methodologies involve the use of popular indicators such as the Relative Strength Index (RSI) and simple or exponential moving averages.
Finally, the most sophisticated traders may take things to the next level by creating proprietary indicators that trigger buy and sell signals that they can use to operate.
Long & Short Position
A long position is opened when a certain asset is bought. Traders who take a long position believe that the price of the asset will increase in the future. Meanwhile, a short position involves short-selling an asset.
In this process, the trader borrows a certain stock from his/her broker and sells it with the expectation of buying it back at a lower price in the future. Hence, the working thesis for a short position is that the price of the asset will decline in the future.
A stop-loss order is a type of trade order that is executed once the asset reaches the stop price. The goal of this order is to limit the losses that a trader can take on an individual position.
Setting a stop-loss order for every trade opened is considered a fundamental risk management strategy for traders.
The take-profit level is a target price at which a sell order (for long positions) is executed. Most traders have a pre-defined entry and exit price for every trade. This allows them to stay objective and reach their desired win rate and reward-to-risk ratio.
Bullish & Bearish
The word bullish means that all data at hand is pointing to an upcoming increase in the price of the financial asset being analyzed. Meanwhile, the term bearish indicates that the same assessment is pointing to an upcoming decline in the price.
Analysts and media outlets tend to use these words to refer to the overall attitude of market participants toward an individual asset, market, industry, or asset class.
Pattern Day Trader
A pattern day trader (PDT) is a designation given to traders that execute four or more transactions within 5 business days by using the same brokerage account. This designation was created by the Financial Industry Regulatory Authority (FINRA) of the United States and seeks to increase oversight of high-frequency traders (HFTs).
If a trader is classified as a PDT, there will be a mandatory minimum account balance of $25,000. If the equity value of the account drops below this threshold at any point, the account holder will not be able to make transactions until a deposit is made or the value of the assets held within the account rise to that level.
A spread is the difference between the bid and ask price of a certain financial asset. The most liquid stocks tend to trade at narrow bid/ask spreads.
Some brokerage firms earn money via spreads. This means that they charge the trader a premium above the bid price when buying and reduce the asking price by a certain percentage when selling.
Trading financial assets have been made easier by the introduction of user-friendly interfaces. However, understanding the terminology used by brokerage firms to engage in this activity is not necessarily as easy as it seems.
The concepts outlined in this article are the most frequently employed when describing the operations of a trader and, by knowing them, you will feel more comfortable when enjoying the services of your preferred brokerage firm.