Trading Stocks: A Beginner’s Guide

Trading Stocks: A Beginner’s Guide

In an everlasting effort to make my life even more awesome (and easier) and because I can never stop learning, I dabble in pretty much everything that trading has to offer. So, some months ago, I started to get into trading Stocks on a longer-term basis (Daily charts and higher). The more I got into it, the more I loved it (as is the case with pretty much everything). After creating a functioning trading routine that grants me funky profits without too much of an effort – compared to daytrading, anyway -, I thought it’s time to share the love. I know most people here are Forex of Futures traders, so let’s start with the basics.

Trading stocks is fun. Trading stocks is also expensive – and it can be quite overwhelming, especially for newbies to the market or people that come from Forex, for example. In Forex, we are used to around 50 instruments give or take. In stocks, well there are 50.000+ of them globally, all of them being traded in different stock exchanges all around the world (plus OTC). It can be quite a daunting task to find the right stock to trade, but more about that later.

 

  • What Are Stocks?

First things first – what is a stock? Stocks are shares issued by corporations. By buying a number of those shares, we can “own” a proxy-piece of that corporation. Important here is that we only own the shares, not the company. If we own 1% of all issued APPLE INC shares (AAPL), we do not own 1% of Apple. Apple has its own assets, and those are separated from the property of the shareholders. What our 1% share ownership grants us, however, is the right to vote for important company decisions (board of directors!) at shareholder meetings, get free drinks and food, and receive dividends (=profits) if the company decides to give them out. Also, you can sell your shares, of course, to turn a profit if they rose since the time you acquired them.

Stocks are given out by companies in order for them to raise money to grow the company, invest into new projects, and so on. The more shares you own, the more power your vote has. Hence the term “hostile acquisition” where a company buys up all shares of another company.

There are different kinds of stocks but the ones everyone is talking about and trading are the common stocks, so we will focus on those for now. As soon as a company does an IPO (Initial Public Offering), the shares issued by the company go out onto the stock market and into the hands of the new shareholders. Whenever we engage in trading activity on a stock market, we buy “second hand” stocks from already existing shareholders, not from the listed companies directly.

The prices of stocks are, as any other goods on open markets in the world, driven by supply and demand and as such are of course prone to fluctuation, speculation (and manipulation). Additionally to individual stocks, there are tons of indices like the S&P500, the Dow Jones, DAX, Nikkei and so on, which represent a basket of stocks. Indices move according to the stocks they contain (and their weighting schemes), give an overview of the “health” of the markets they represent and can be traded directly as Futures or ETFs, as well.

Now that we have a broad overview of what the stock market is, how the heck can we trade it?

 

  • How Do We Trade Stocks?

I just recently found out that my bank had this service where I could call them and tell them that I’d like to invest x amount of my bank account into a certain stock on the Frankfurt Stock Exchange. Funky. Horrendous fees, though. And I would have to call them whenever I wanted to get out. I think the guy on the other end of the line didn’t even know what “stoploss” meant.

So the usual option is, as in Forex, to use a broker. Unlike Forex, the stock market is highly regulated and there are really only a handful brokers worth looking at. Trading softwares usually come at a cost and are not free, like MT4. If they are free, as for example is the case with ThinkOrSwim by Ameritrade, the commissions of the brokerage are not very enticing. What I do is that I use ThinkOrSwim for charting and Interactive Brokers for entering my orders (their proprietary software is horrible, but platforms like Sierra Chart or TC2000 can connect to their API, if you don’t want to open an account with Ameritrade just to use TOS. However, TOS is for free once you have an account with Ameritrade and funded it with a few dollars, and most other charting platforms charge quite a few dollars per month).

For IB, you will need a minimum deposit of 10.000$ unless you are aged below 25, in which case you would need 3.000$. Also, if you are from the US, the pattern daytrader rule applies so you will need a bit more than those 10k, I think 25k was the number but better Google it. There are quite huge differences in trading costs, minimum deposits, and software costs, depending on what combination you use so I suggest you do your due diligence before you decide on a broker/trading software combination.

As far as order types go, they are similar to Forex – stops, limits, market orders, and then there are some advanced order types depending on the exchange you are trading on and whether your broker/software supports them, but they are not of interest to us right now. Just a quick note: If you want to trade End Of Day trading strategies like me, look at buy-stop-limit orders (or sell-stop-limit orders) as they are highly important simply because of the fact that AHT (after hours trading) makes stocks gap a lot more than Forex pairs, for example. You don’t want to get filled at an unfavorable price but you still want to get filled when the prices gap (but not too much), that’s what stop-limit orders are for. Regular trading hours on the stock market are not 24/7, exchanges typically open for around 8 hours each day. Also, AHT is a very interesting thing to play with, but generally, it is better for retailers to enter their trades in the first hour of the active session because of increased volatility and spreads during after hours, OR using stop-limit orders, however, you will not get a fill all the time and that can be frustrating, just be aware of that. I will cover this in another article. If you want to see what happens during the extended trading hours, Trading View offers this in their Pro package, for example.

Calculating position sizing is quite easy as well – suppose you want to buy a stock which is priced at 6$, and you want to get out at 5$ with a loss and at 8$ with a profit. If you buy one stock, this will cost you 6$+commission and you will get out at 5$ with a 1$ loss and at 8$ with a 2$ win, so 2:1 RRR. Now if you want to up the stakes, simple! Buy 2 Stocks. Now you have a potential 2$ loss and a 4$ win, but you will need 12$ instead of 6$ in your brokerage account to get into the trade (plus margin for drawdown).

If your standard position size is 100$, then you simply divide 100$ by your stoploss size (1$) and now you know that you have to buy 100 pieces of that particular share, so you will need 600$+margin (stop loss x2 is a safe bet to use as a cushion, so 800$ in your brokerage account to open this trade, but of course, you should not risk 100$ if your account is 800$ – this is just an example for position sizing, not for risk management).

Now some brokers offer a 1:4 leverage for daytrades and a 1:2 for overnight trades, for example, but that is about as high as it gets. No batshit insane 1:100 or whatever you are using right now on your Forex account, and that is good. The highest I have ever seen in the stock game was 1:5 but I am very happy using a 1:2 leverage. This is why I say trading stocks is expensive. You will need much more money to play with to risk the same amount of $ in your account as opposed to Forex. Believe me, this is a good thing.

Also, typically, stocks are only bought, but most brokers these days also offer short-selling (basically, a margin-trick where you borrow money to sell stocks at a future price).

 

  • What Stocks Do We Trade?

In Forex, this is quite easy to do. Either trade the majors with small spreads as a daytrader or as a swingtrader, go for the minors exotics as well, and you would have around 60 instruments at max. In stocks, well there are 50.000 and more all around the globe, and IB, for example, allows you to trade a lot of them. Even trading on the monthly charts, there is no way we could ever scan that many stocks manually. Even if we focused “only” on the 6.000+ or so US stocks/equities, we would have a lot on our hands. So what is there to do? The magic word is “screener”.

Screeners filter stocks according to various criteria you can define. Softwares like TOS have a screener already built in, but you can also use Finviz, for example, a mighty tool. Everyone has their own criteria for filtering, and once again, this is a topic for another article. I encourage you to play around a bit with the filters and getting to know the metrics as they are important not only for investors but also for traders (especially if you want to find stocks that move for great swing trades, for example, or to find stocks that are viable for day trading).

Here are the most basic metrics about a stock that will get you started.

  • Stock Price

Well, captain obvious, but still important. It tells you how much you have to pay for opening a position of x shares. Also, if a stock is priced below 5$ on a main exchange, it is regarded as a penny stock, which most traders stay away from due to illiquidity and volatility, but some traders only trade these. I stay away from them (for now).

  • Market Capitalisation (market cap / mcap)

Tells how you how big a company is and is calculated by multiplying the stock price with the outstanding shares. As a quick reference, the Apple (AAPL) market cap is $795.32 billion, Snapchat (SNAP) market cap is $22.89 billion. Differences are made between large cap companies ($10bln to $200bln), small cap companies ($300mln to $2bln), etc.

  • Volume

Simply indicates how many shares were traded during the time unit you are looking at. Higher volume = easier to get in and out of stocks, more stable, less erratic moves, and so on. I tend to avoid stocks with an average volume of below $500k per day, but again, this is really up to the individual. I am still testing screener configurations and have not yet made a final conclusion as to what are my favorite settings.

  • Earnings Per Share (EPS)

Divide the profit of a company by its total number of shares and you get the EPS. It serves as an indicator of a company’s profitability and is more interesting to long-term investors than short-term traders.

  • Price-To-Earnings Ratio (P/E)

P/E is one of the most important valuation tools of a stock. You get it by dividing the stock price by TTM earnings (TTM earnings = Trailing Twelve Months earnings). A low PE (<15) generally means that the stock is cheap (underpriced/undervalued) and should reverse to the mean to the upside in the future. A high PE means the opposite. Of course, we cannot trade solely by this number and need more (technical) indicators if we want to go long or short.

  • Price-To-Earnings-Growth Ratio (PEG)

This is calculated by dividing the current P/E  by its earnings growth rate of a certain period. Below 1 is regarded as a low PEG, around 1 is fairly priced, above 2 is high (overpriced). One of my favorite indicators and if I spot a technical setup to go long, ideally the PEG is below 1 for a higher probability trade.

  • Dividend Yield

The profits that a company shares with their shareholders (if and when they decide to do so). More interesting for long term investors, but a company that pays dividends usually is quite profitable.

Now there are tons more of indicators and metrics about stocks and I really encourage you to have some fun with Finviz and see how filtering for different metrics validates (or invalidates) your technical setups. You could first scan for technical setups and then see whether the fundamentals support your analysis, or first scan for the best movers and then see whether you can find technical entries with favorable RRR setups (that is what I do).

Finviz can, additionally to descriptive and fundamental indicators, also scan for chart patterns, candlesticks, and so on. After applying my filters, out of all the stocks, I get around 20-30 each day on the Daily Charts, of which I then enter maybe 2-3. Maximum market selection, love it. I have not taken a trade below triple-A EVER in the stock market and my winrate and RRR reflect that.

Scanning the markets, individually selecting setups, and then entering and managing orders takes me around 2 hours per day and is a lot of fun.

Additionally, what I find to be a huge advantage really, is that the markets are not open 24/5. That way, I feel much more relaxed, and have much more time for my analysis, even on the Daily Charts. In future articles, I will talk more about order types, finding setups, setting up your scanner, and so on.

Let me know if there is interest from your side, and I will delve much deeper into this topic and share with you everything I find along the way. Exciting! I really do love learning new things.

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