Education is honestly one of the best ways to succeed with anything, and that’s true when it comes to investing in stocks. You need to learn investing basics like what to look for in a brokerage to what types of trades you should make.
This guide on how to start trading stocks will walk you through what you need to know to get started, plus tips that will help you reduce your risks as your portfolio grows.
How to Start Trading Stocks – 5-Step Guide for Beginners
1. Open a brokerage account
If you haven’t already opened a brokerage account, this is where you should start. Opening an account doesn't mean you have to start investing in stocks right away, but it gives you a chance to familiarize yourself with the platform before putting up any real cash.
There’s a growing list of highly reputable online stock brokers, but you want to take your time and find one that fits your needs. Here are 5 things to look for when choosing an online brokerage:
Investing in stocks has gotten significantly less expensive in the past few years, and it’s no longer difficult to find a reputable brokerage that charges $0 commissions for online stock trades. But also pay attention to annual fees, research fees, inactivity fees, and transfer fees. If you’re interested in more advanced trading strategies, like options trading, look for a brokerage that has low to $0 contract fees.
Research tools can help you grow your stock trading knowledge and make more informed trades. There are a lot of free tools out there and the best online brokerages give you access to premium research tools at no additional charge.
Strong customer support
Pay attention to how the brokerage handles customer support. Is it through a chat bot? Do they offer email or phone support? Customer support is important if you have questions or issues with your stock trading account.
Look for an investing platform that has positive user experience reviews. There will most likely be some learning curve, but spending too much time learning how the platform works will take your energy away from learning how to trade stocks.
In late 2020 through early 2021 stock trading surges slowed several online platforms. System outages are rare, but it can be incredibly frustrating if you can’t access your trading account.
2. Set a trading budget
A budget is a powerful tool that can help you reach your financial goals, and it’s something you want to consider as you start investing in stocks. The most important thing to think about is that you don’t want to invest more money than you can afford to lose.
The best way to protect yourself is to set a realistic stock trading budget. Most financial advisors will recommend not going much over 10% of your portfolio to individual stocks. You should make sure you have a health emergency savings fund and are already putting 10% to 15% of your income towards retirement savings.
Many financial advisors will recommend that you don’t start trading stocks until you’ve maxed out matching your 401(k) contributions form your employer and maxed out your annual contributions to your 401(k) and IRA. You can still trade stocks within your IRA, which can be beneficial because you can avoid or defer capital gains taxes because IRAs are tax-advantaged.
Trading stocks carries more risk than investing in mutual funds and index funds (what’s mostly used in retirement accounts). So it’s important to have your retirement savings tied down before you incur extra risk. Retirement investing can also give you a better feel for how the market moves and how to react when you are ready to trade individual stocks.
3. Understand what kind of trades to make
Brand new stock traders should stick with basic buy and sell trades in the beginning, and there are two common types you should be aware of when you first start:
- Market order: A buy or sell order to be executed immediately at the current market price. Market orders are executed as long as there are willing sellers and buyers.
- Limit order: An order to buy or sell a stock at a specific price or better. You set the price on limit orders, and they’re not guaranteed to execute. A buy order executes at the limit price or lower, and can only execute a sell order at the limit price or higher.
From there, some of the more advanced trading strategies include:
- Option trading: Buying options contracts gives you the right (not obligation) to buy or sell an underlying asset at a set price one or before a certain date. Investors use options for a number of reasons, the biggest being leverage.
- Trading on margin: This is borrowing money from your brokerage to trade stocks, which allows you to grow your portfolio. But it’s risky and only for more experienced traders.
- Shorting stocks: Trading on margin opens you up to shorting stocks, which is a strategy that bets the price of stock will drop in value. Shorting is basically borrowing a stock, selling it, and then buying it back to return to the lender.
I can’t stress this enough: stick to the basics as you learn how to start trading stocks. It’s better to experience the natural market volatility with the basic stuff before you dive into the deep end and stick your cash into riskier investments.
4. Practice stock trading
Paper trading accounts, sometimes called virtual accounts, are accounts that let you practice trades before you make them with real money. These accounts simulated trading, but you’re not spending money, and they can be a massive resource to brand new traders.
Practicing trades is a low-pressure way to test your stock trading strategies, and even advanced traders occasionally use paper trading accounts to test out new strategies without the worry of losing money. An added benefit of using a brokerage with a paper trading account is that you can test their platform before going live with your trades.
5. Research stocks before you trade
Picking which stocks to trade starts with good research, and the kind of research inventors do is something called fundamental analysis. It means looking at a range of factors to decide whether or not you want to add that stock to your portfolio.
Looking at a company’s financials is one of the biggest factors, and the SEC requires that all public companies release regular financial statements that disclose their performance. Look for Form 10-K and Form 10-Q, and then you can look at balance sheets, income statements, and cash flow statements.
You’ll want to check the company’s price-to-earnings (P/E) ratio to compare one company’s stock price to another. You should also look at other financial metrics like:
- Price-to-sales ratio (P/S)
- Earnings per share (EPS)
- Return on equity (ROE)
- Debt-to-equity ratio (D/E)
- Debt-to-asset ratio (D/A)
A good online stock broker will give you many the research tools you need to start, and you can also check financial news sites and online stock screeners for more information.
It’s also worth doing more qualitative research into the company itself. Look at the leadership team, how they make money, if they have a competitive advantage, etc.
Research can feel overwhelming at first, but buying stocks is like buying any other asset. You wouldn’t buy a new car without digging into the manufacturer's reputation or learning how much parts cost to replace. The same goes with a new house — you’d research the school district and property taxes before you bought.
Once you’ve done your research, it’s time to start investing in stocks. Considering all that you’ve done up to this point, investing is simple. Your brokerage will walk you through the trade, and you’re done!
More to know about investing in stocks
Investing in stocks is a way to increase your income and grow your wealth, but there’s still a lot of risk. The tips below will help you reduce your risk to build your portfolio safely.
Don’t fall for FOMO
Investor FOMO was at its peak in early 2021 as newbie stock traders attempted to capitalize on stocks like GameStop, Nokia, AMC, and others. The GameStop trend started on Reddit to squeeze hedge fund Melvin Capital or profit off shorting a stock depending on the investor.
As the GameStop stock news hit media outlets, inexperienced investors wanted in on the trade and drove up stock prices. GameStop stocks rose astronomically in under a month — at the beginning of January, the price was under $20 a share, and it hit $347.51 on January 31.
Some lucky investors did profit, but many didn’t, and that’s in part because they didn’t know what the heck they were doing. Instead of researching trades and executing orders that made sense, they were chasing whatever trend or hot tip they saw online.
This kind of hype will inevitably happen again, and while it’s easy to get caught in the hype, it’s a risky move.
Gradually build your positions
Learning to invest is exciting, and it can be tempting to dump in as much money as possible when you start. However, it’s better to build your positions over time with dollar-cost averaging because it reduces your exposure to price volatility.
Dollar-cost averaging is spreading out your stock purchases over time. The goal is to buy at roughly equal parts at regular intervals. Essentially it smooths out the purchase price by taking advantage of dips and not buying in completely at high points.
Pay attention to your taxes
Generally, if you profit from the sale of stock shares, you will owe taxes. This makes one of the most important investing basics is something called tax-loss harvesting. It’s a strategy of selling investments that are down and replacing them with similar investments, and then using your losses to offset your gains.
The goal of tax-loss harvesting is to reduce your taxable income, and it’s something you can do with good record-keeping and research.
Diversification is the best way to reduce your risk
Diversification is the practice of spreading your investments over a broad range of assets so you’re not over-exposed in one area. It means you’re not putting your whole stock budget in one stock — you should buy across multiple industries, sectors, company size (or market cap), and style. Diversifying your investments can help you weather market volatility and protect your investment long-term.
The final word on how to start trading stocks
Stock market investing can be a great way to build wealth and increase your income. Find a reputable online stockbroker, do your research, set a budget, and start investing.
But if the approach I’ve just outlined sounds too overwhelming, you can go for a more passive approach using a robo-advisor. They automate your investments, from which stocks to trade to tax-loss harvesting.
The point is, there are ways for nearly any type of investor to start trading stocks.