What is trading?
A beginner's guide to trading stocks
- Fidelity Smart Money
- – 08/26/2022
- All trading involves buying and selling investments, but the way your trading is classified depends in large part on your timeline—if you're active on a monthly, weekly, daily, or even hourly basis.
- You might think trading is something only pros on Wall Street do, but with the rise of commission-free stock trading and investment apps, now anyone can trade.
- Self-directed trading can be time-consuming and risky. Due to risk of loss, consider how trading fits into your personal situation.
You likely hear about the stock market and the trading that powers it all the time. But what does "trading" actually mean—and how can you get started if you want to?
What is trading?
Trading is buying and selling investments, such as stocks, bonds, commodities, and other types of assets, with the goal of making a profit. With an active investing strategy, you're buying and selling on a monthly, weekly, daily, or even hourly basis. Investing passively, on the other hand, is when you buy and hold onto your investments for the long term.
You might think of trading as something only Wall Street pros do, but with the rise of commission-free stock trading and easy-to-use investing apps, now anyone can trade, often right from their smartphone.
But just because anyone can trade doesn't mean they should. Trading often involves purchasing individual stocks, which can be risky. Instead of spreading out your money across tens—or hundreds—of investments, as you might with a mutual fund or exchange-traded fund (ETF), you may be concentrating it into just a few companies.
While a single company may experience rapid growth and reward investors, it can also unexpectedly drop in value, leaving shareholders with stocks worth a fraction of their previous price. These kinds of swings may be blips on a long-term investor's radar, but be more significant for those with shorter timelines who must accept losses that might have recovered in months or years to come.
If you want to trade actively, you need to understand the risks and be comfortable with them. If you are investing for the long term, you might choose to keep the majority of your portfolio invested with a passive trading strategy in mind. And remember: You don't have to engage in active trading at all to be a successful long-term investor. In fact, many successful long-term investors do not trade constantly.
Types of trading
All trading involves buying and selling investments, but the way your trading is classified depends in large part on your timeline.
When you day trade, you buy and sell stocks, ETFs, and other assets multiple times a day. Before the end of the trading day, you usually sell everything off, with any profits (or losses) hitting your trading account.
Because of the time required to research potential investments, follow changes and trends in the market, and implement all the trades you want, day trading can be as all-consuming as a full-time job.
A slightly less hands-on sibling of day trading, swing trading is when you hold investments for days or weeks to capitalize on upticks—or swings—in the market. Like day trading, swing trading requires a lot of research and awareness of market and investment trends. You don't, after all, want to miss the window to catch the swing and make a potentially profitable sale.
But unlike day trading, you aren't limiting yourself to an instant turnaround, and you're less likely to be impacted by a single bad day—or even a handful of bad days. By letting you wait days or weeks, swing trading gives you (and your investments) more time to realize a potential profit.
At its most basic, "taking a position" simply means buying an investment. Building on that, position traders are those who take that investment position and stick with it for the longer term. Based on their research and knowledge of investment trends, they hope that prices will rise through the short-term downward blips that may frustrate traders with shorter timelines.
Position traders may hold their position for many months or years. And because they take a long-term view, position traders aren't likely to let the news of the day influence their investment strategies, unless that news changes their understanding of an investment's future long-term growth.
Of the 3 types of trading discussed here, position trading comes the closest to what many refer to as just "investing," a strategy that relies on long-term growth, often over years or decades, to help grow wealth.
Advantages of trading
- You have complete control over the investments you pick. This lets you follow your own hunches and invest in companies you believe in—and possibly profit if their stocks gain value.
- You can learn first-hand about the stock market. Because it requires more hands-on involvement than buy-and-hold investing, trading can help you better understand trends in the market.
Risks of trading
- You may lose some, or all, of the money you use to trade stocks. This, of course, is true of investing in general. But it's particularly worth keeping in mind with trading. Though they may have lucky days, research has shown that the vast majority of active traders lose money over the long term.*
- Active trading can be time-consuming, as it requires a lot of research and near-constant monitoring to ensure you make informed trades. As an everyday consumer, you also may not have access to the types of company and industry reports professional traders have. And even if you do, you may not have the time or expertise to fully understand and act on them, putting you at a comparative disadvantage.
- Trading can be stressful, especially when you're watching your account balance fall.
- You face even greater risks if you borrow money using margin to fund your trades. Some traders like margin–essentially a loan from your brokerage firm, where it holds what you own in your account as collateral—to use their available funds more efficiently. However, trading with margin opens traders up to losses greater than the funds they may have to invest and should only be used by advanced traders with enough money to cover losses (and then some).
How to trade stocks
Once you've decided you want to start trading, it's easy to open a brokerage account and become an active participant in the stock market.
1. Pick a brokerage account
You'll need a brokerage account to trade. If you don't have one already, you will want to consider selecting a broker that charges low fees, has low or no account minimum, offers your preferred trading capabilities (such as a wide range of order types and margin accounts, among others), seeks to execute your trades at the best prices, and offers a trading platform that you are comfortable using.
2. Research investment options
Smart trading begins with research. You don't want to blindly buy a stock on the off chance that it increases in value. Instead, you'll want to dive into industry research and reports about the health of companies and their financial futures. Fidelity provides a range of stock research tools to help you make the most of your trading, including a 5-step guide to making your first successful trades.
3. Create a trading plan and exit strategy
Once you've picked the companies or funds you'd like to trade, figure out how you will buy shares, plus your plan for selling them.
You can place many different types of purchase requests, or orders, when you trade. By default, you'll likely be offered a market order, which means that you agree to buy or sell an investment at its current price. If you're concerned about a stock changing value quickly, you may consider a limit order, which allows you to input the most you want to pay. Your brokerage won't execute your order unless the stock is available for that price or lower.
You'll also want to think through which situations would make you want to sell your investments. It's important to decide the minimum amount of profit you want to see from a trade, as well as what an acceptable amount to lose is. Aim to stick to this plan, especially when stock prices fall, as it can be hard in the moment to determine if you should hold on and wait for a rebound or sell and cut your losses.
Another option is to consider placing a stop-loss order, which automatically sells a stock at a predetermined price and can help safeguard you from losing any more than you agree to.
Keep in mind any additional trading requirements
Depending on how you trade, you may need to consider a few additional things:
- If you engage in day trading, you may need to have a minimum amount in your accounts—usually $25,000. Check with your brokerage to confirm.
- If you use a margin account to help power-up your purchasing power with borrowed funds, you may be subject to a "margin call" if the value of your account dips below a certain amount. This means the value of your collateral is no longer great enough to back the loan and your brokerage demands you put more cash or owned equities into your account. If you cannot, this may result in your holdings being sold at a loss.
- Your brokerage will report gains and losses to the Internal Revenue Service (IRS). Gains from sales will be taxed, and the taxes you pay on investments held for less than a year may be higher than those you would pay on longer-held investments, which benefit from long-term capital gains tax rates. You may be able to deduct a portion of your losses from your current year's, as well as future years', taxes through tax-loss harvesting.
The bottom line about trading
If you have the time, money, and interest in market research, you may consider actively trading a small portion of your total holdings. Be sure to create a trading plan to guide you along the way and help prepare you for the market's inevitable ups and downs.
Next steps to consider
How to open an account
Start saving and investing for your future.
Learn what you need to know before trading the market.
Choosing investments wisely
How to employ a methodical approach to asset allocation.