Stock trading, in theory, sounds very simple – buy low, sell high. However, this frequently repeated slogan tends to do a disservice to beginning traders by oversimplifying it. Most people who start trading fail to consider the risk involved when trading and immediately stumble upon its pitfalls, such as overtrading, over-leveraging, and getting margin called. In fact, various reports show that as much as 90% of traders lose money from stock trading. Here are five things to know as a beginner to help improve your chances of profiting in the stock market over time.
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Bears vs Bulls
The stock market moves in accordance with market sentiment. Bullish traders predict the price of a stock is going up, so they buy more of the company’s stock. Bearish traders, on the other hand, think the price of a stock is going down, so they short or sell the company’s stock. This back-and-forth sentiment is what moves markets. Of course, average traders with a few thousand dollars in their account do little to impact market movements. Most of the price changes that happen are caused by the buying and selling of institutional traders with larger accounts.
Fundamental vs Technical Analysis
Most trading strategies can be categorized as either fundamental or technical analysis. The fundamental analysis revolves around macroeconomic events, such as supply and demand, sector health, earnings reports, and sales of the company. Technical analysis, on the other hand, uses indicators, such as the Relative Strength Index and Moving Averages, to predict future price direction. Most technical indicators are free to use, such as the free NinjaTrader indicators. Many technical traders argue that these indicators can help you gain a competitive edge in stock trading.
A margin call is issued only on trading accounts that use leverage. Traders have the option to use leverage in order to amplify potential profits, but with the risk of also amplifying potential losses. If the current loss in a position becomes too high, your broker issues a margin call to warn you that they may close the position themselves if you do not add more money to your account in order to meet the minimum margin requirements. The margin requirement pertains to the dollar amount you must shell out for a leveraged position. You can avoid getting margin calls by limiting your position size for any given trade and setting a stop loss for each trade. A stop loss automatically closes a losing position when the company’s stock hits a specific price.
Risk vs Reward Ratio
If there is one fundamental thing you should take from this article, it’s that success in stock trading revolves around sound risk management. And one parameter that gauges whether or not you have good risk management in your trading is the risk versus reward ratio. If you can maintain a high risk versus reward ratio, you’ll come out profitable over time. At the very least, you should maintain a 1:2 RR ratio, meaning that for every $1 you risk on a stock trade, you stand to gain $2. The higher your RR ratio is, the less impacted your trading account will be every time it sustains a losing trade.
Psychological Side of Trading
While trading is often distinguished between technical and fundamental analysis, there is also a psychological aspect to it that plays a major role in your bottom line. As much as you put an effort towards listening in to company earnings calls and reading financial reports, you should also train your mindset when it comes to trading, particularly how to deal with losses. When faced with a losing position, can you control yourself from doubling down on your position? Can you close a losing trade at your predetermined price point?
These are five things every beginner should know before they even risk their first real dollar on the stock market or any financial market for that matter. Create a plan that takes into consideration the items aforementioned in this article to maximize your chances of profit. Other things to consider include having enough money to start trading, determining which brokerage platform to use, identifying companies and sectors to focus on, and finding out what your appetite for risk is.