Stock Trading for Beginners: 5 Mistakes That Can Leave You Broke
The stock market has had a tumultuous few years.
When the market tanked at the beginning of the pandemic in March 2020, many first-time investors saw an opportunity to get involved. Then the infamous GameStop short squeeze followed in 2021, with many amateurs leveraging resources like investment apps to take down hedge funds and short sellers.
During these unprecedented years of market volatility, online brokers like Charles Schwab, TD Ameritrade, Etrade and Robinhood have seen a tremendous increase in new accounts being opened. Many of those accounts belong to first-timer investors.
Today, with news of inflation, you may be rethinking keeping all your cash in a safe but low-yield savings account. But before you jump into the stock market game, it’s important to know what you’re doing — or you risk losing a lot of hard-earned money.
Are you a beginning investor who’s interested in the stock market? Let’s go over some basics before you fund a trading account.
What Are Stocks?
Also called equities, stocks are a type of security that allows everyday Americans to own a piece of a publicly traded company. A single unit of a stock is called a share, and investors in a business are called shareholders. Businesses sell these shares to fund their own growth, whether that is market expansion, a new product launch or even paying off debt.
In general, if the business makes money, so does the shareholder. The more shares you hold in a company, the more you stand to gain when the stock price goes up — or lose if the price goes down.
As a shareholder, you don’t actually make or lose money until you sell your share (unless the stock pays dividends). You could purchase a share of stock at $5, watch it rise to $10, see it drop to $2 and sell when it reaches $6 — for a $1 profit per share. While stock ownership can be a roller coaster, the only prices that ultimately matter are the price when you purchase it and the price when you sell. Ideally, you will sell a share when it is worth more than what you paid.
Historically, the rate of return for a stock has been higher than other investments, like certificates of deposit, bonds and savings accounts, but there is more risk involved.
The two leading stock exchanges in the U.S. market are Nasdaq and the New York Stock Exchange. Both are highly regulated by the federal government.
How to Start Investing in Stocks
Interested in the stock market? To start investing in stocks, you can open an online brokerage account to buy stocks (and stock funds). Most online brokers make the process quick and easy, but you will need a few things to get started:
- Your name
- Date of birth
- Social Security number
- Phone number, email address and physical address
- Driver’s license number (or passport)
- Employment status
Brokers may also ask about your net worth and investment goals to better advise you.
Where to Start Investing in Stocks
So where do you find a stock broker? Popular online brokers include Fidelity, TD Ameritrade, Charles Schwab and Etrade. But they’re not your only options.
In recent years, investment apps like Robinhood, Acorns and Webull have made it easier for the average person to get started investing in stocks. Check out our full list of the best investment apps to simplify your search.
You can also open a brokerage account with a financial professional who can manage your assets for you. For this service, they tend to take a small cut of your earnings.
If an online brokerage account or investment app feels too hands-on but you don’t necessarily want to work with a human advisor, you can also invest with a robo-advisor. Robo-advisors use complex algorithms to invest wisely on your behalf, keeping your investment goals and risk appetite in mind. These are the eight best robo-advisors for 2022.
8 Stock Trading Tips for Beginners
Think you’re ready to open a brokerage account and start investing? Follow these tips to assess whether you’ve got the proper funds and education in place and to successfully build your investments for the long haul:
1. Make Sure You Can Afford to Invest in Stocks
Before you play stock trader, let’s make sure you can afford it. Don’t even think about trading stocks if you aren’t investing for the long haul in a retirement account, like a 401(k) or Roth IRA.
You also need three to six months’ worth of living expenses in an emergency fund before you start investing. It’s essential that you don’t put this money in the stock market. You don’t want to be forced to sell your stocks for a loss because you need cash in a crisis.
And finally, let’s talk about debt: If you’re struggling with massive debt, especially high-interest credit card debt, you may want to prioritize paying that debt off first. In general, if the interest rate on your debt is higher than what you’d expect to make from stock market investing (about 10%), you’d be throwing away money by investing in stocks instead of paying down that debt.
2. Start with Index Funds
Index funds, such as those that track the overall stock market or a large part of it, like the S&P 500 index, are a great way to start investing in stocks. You invest in many stocks instead of handpicking your investments, which gives you an automatically diversified portfolio.
Over time, you might learn enough to confidently invest in individual stocks, but starting out with exchange-traded funds or mutual funds is a great idea.
Definitions
A mutual fund contains a healthy mix of assets, including stocks and bonds. Typically overseen by a professional money manager, a mutual fund serves as collaborative investment, with multiple shareholders pooling their resources to invest in the portfolio. If the mutual fund does well, all the shareholders benefit proportional to their investments. In general, mutual funds are a safer investment because they are inherently diversified.
An exchange-traded fund, like a mutual fund, is a pooled investment. To a novice, the two funds operate the same. The key difference: You can buy and sell an exchange-traded fund on the stock exchange just as you would individual stocks. Mutual fund transactions, on the other hand, can only occur at the end of a trading day.
And finally, index funds are a type of mutual fund or ETF; index funds’ portfolios are designed to mimic an actual financial market index, like the S&P 500. Index funds are usually a key investment for retirement accounts, like IRAs and 401(k)s.
3. Practice with an Investment Simulator
Investing in the stock market with no previous experience is a lot like gambling. You’re leaving so much up to chance.
While stock investments always include risk, you’re much more likely to be successful once you learn from your mistakes and get a better handle on the market.
But you don’t have to make those mistakes with actual money. Instead, you can try out a stock market simulator. Such simulators use virtual dollars instead of real cash, so you can try out buying and selling stocks to see how much you would have gained or lost.
It’s possible that, as a beginner, you’ll lose a lot. But don’t sweat it: It’s only virtual money.
Once you get the hang of it, you can more confidently download an investment app to get started — for real.
Many brokers offer a free trading simulator to get started; two popular training options are Paper Trading by TD Ameritrade and Wall Street Survivor.
4. Do Your Research
An informed investor is a successful investor. If you’re going to participate in the stock market, you need to do your homework — regularly. That means researching potential companies’ financials, reading analyses of different companies and the market and even chatting with like-minded investors to get their feedback.
Investment resources like The Motley Fool, The Wall Street Journal and Morningstar are all great for education, but the content can sometimes get dry. Some investment apps, like Robinhood, include their own educational resources and stock market basics that can help you make decisions.
Don’t just rely on big news headlines to make your decisions. “One common costly mistake is to make buy-and-sell decisions based on price movements that have already happened,” said Brandon Renfro, CFP and assistant professor of finance at East Texas Baptist University. “Seeing a stock climb 10% overnight, for example, is exciting, but if you use that as the reason to buy today you are simply paying 10% more for the stock. A stock’s value to you is what it will earn in the future, not the past.”
Instead of reacting to headlines, a successful investor predicts them based on their research.
Stock investing tip: If you’re buying the same stock everyone else is, be prepared to hold onto it for the long haul. After a stock’s prices skyrocket, a dip — known in market parlance as a correction — often follows, so only invest if you see long-term value.
5. Focus on Investing, Not Trading
When you think about getting started in the stock market, you might envision yourself watching the numbers change minute by minute and making quick moves to secure a big win. But the reality is that, for most of us, the market should be a methodical, long-term investment vehicle.
“The best way to get started with stock trading apps is to gradually build a portfolio of great businesses, and then hang on to them for as long as they remain great businesses.” These wise words come from Matthew Frankel, certified financial planner at The Motley Fool’s The Ascent. “Sure, trading in and out of stock positions is certainly more exciting. But most people who have built serious wealth in the stock market didn’t do it by short-term trading. Good old-fashioned buy-and-hold investing remains the most surefire way to make money in stocks.”
So what’s the difference between stock trading and stock investing? Traders and investors both buy stocks in hopes of earning a profit. But the terms aren’t interchangeable. Stock investing is about buying good companies and holding them for the long term. Stock traders try to earn a quick profit on short-term movements in the stock market or other investments.
Frequent trading is often a losing bet in the long run. You risk making emotional decisions based on what the market is doing on a given day. That can lead you to buy high and sell low, which is the opposite of what any investor wants.
Unless you have a lot of money you’re OK with losing, stay away from day trading. On top of the high risk of losing money, you’ll also pay taxes at a higher rate on any money you earn. That’s because long-term capital gains (profits on investments you sell after more than a year) are taxed at a lower rate than short-term capital gains, which are treated as ordinary income.
To build wealth, it’s essential that you buy and hold an investment portfolio of stocks, bonds, mutual funds and ETFs for the long term. To be successful, you also need to invest money consistently over long stretches of time.
6. Diversify Your Portfolio
You probably know that it’s unwise to invest all your money in a single stock or two. But even if you own stock in dozens of companies, your investments may not have the diversified portfolio you think you do.
“Beginners often fail to properly diversify as well, often because they misunderstand what diversification really means,” Renfro said. “Diversification is more than just buying shares of different companies. Diversification requires buying shares in companies that respond differently to economic fluctuations and have different specific risks.”
The performance of a coffee chain and big-box retailer may not seem like they’re related. But both depend on people having disposable cash. They tend to be in the same malls and shopping centers (with some big retailers even having coffee shops inside their stores) so if one loses customers, it’s likely the other will as well.
To avoid major losses, it’s essential to pick stocks not just across different companies but across a broad mix of industries.
Stock investing tip: A better way to diversify your portfolio is to buy exchange-traded funds instead of individual stocks.
7. Don’t Dabble Too Much at First
Online brokers might tempt you with flashy concepts like fractional shares, cryptocurrency and margin trading. But when you’re just getting your footing, don’t try too much too fast.
Fractional shares are a unique opportunity for you to buy a portion of a stock — particularly one that’s too expensive for you otherwise. If you have a company that you’re really interested in but the stock price is too high, like Apple or Google, fractional shares are a cool tool for you to try out. But everything in moderation.
If cryptocurrency is still a head-scratcher for you, start your investment journey with more traditional options. As you learn more, you may find that trading cryptocurrency makes sense for your portfolio. But it’s definitely not a day 1, week 1, month 1 or even year 1 investment if you’re entirely new to the stock market.
And finally, margin trading. Our advice? Just don’t. When you set up a margin account, you can borrow up to 50% of a stock’s value. The 50% you own is your collateral, while the remainder is essentially a line of credit you can use to buy stocks. And of course you pay interest on that loan.
It sounds great because it lets you buy more stocks with less money up front. But when it goes badly, it intensifies your losses.
“Margin is an easy way for inexperienced investors to get wiped out,” Frankel said. “Think of it this way: If you invest $1,000 in a stock and it loses 50% of its value, you can take your $500 and walk away. On the other hand, if you had used $1,000 of your own money and $1,000 in margin, you’d be left with nothing.”
Stock investing tip: Stay away from using margin if you’re new to trading.
8. Leave It to the Professionals
If you don’t want to do the extensive research that the stock market requires, it might be better to leave your investments in the hands of an expert — even if that’s a robot. While robo-advisors and human brokers do typically charge a small fee for their services, it’s far less risky than making uninformed decisions on your own.
If you do want to manage your own individual stocks, choose a brokerage account that gives you access to real-life human advisors who can offer investment advice when you need it.
Other Investment Options
Stocks, ETFs and mutual funds aren’t your only options as a beginner to investing. Interest rates for high-yield savings accounts and money market accounts have been on the rise since taking a dip at the start of the pandemic, and even with small investment funds, you have the opportunity to get into real estate.
Here are a few ways you can start investing today:
- High-yield savings account: Leaving your money in a low-interest savings account isn’t doing you much good, other than keeping the money relatively safe. If you can, find a high-yield savings account that pays at least 1.00% APY. It can’t match the returns of the stock market, but it’s an easy and low-risk way to make your money grow while keeping it liquid. These are the five best high-yield savings accounts currently offered.
- Bonds: Bonds may not have the high-stakes risk-and-reward appeal of the stock market, but they are another way to grow your money over time. A diversified investment portfolio should include low-risk bonds to balance out riskier stock investments. Wondering how to get started? Here’s how to invest in bonds as a beginner.
- Certificates of deposit: Checking accounts and savings accounts are pretty straightforward, and if you’re thinking about investing in the stock market, you’ve likely got a handle on how these work. But have you considered opening a certificate of deposit at your bank or credit union? Your funds are less liquid when stored in such accounts, but they can have a higher rate of return than other deposit accounts.
- Real estate: Buying a house or land is expensive and has become increasingly difficult in recent years. You may not have the cash to make an attractive offer on a new home, but you can put some money into a real estate investment trust (REIT). This allows you to enjoy the benefits of renting out property without having to pay for it all yourself (or take on the traditional role of a landlord). Not sure where to begin? Here’s how to invest in REITs to diversify your portfolio.
Frequently Asked Questions (FAQs) About Beginner Stock Investing
If you’re just getting into the stock game, you likely have lots of questions. We’ve rounded up answers to the most commonly asked questions.
Investing in stocks comes with inherent risk. In general, you can expect a 10% rate of return when investing in stocks through a diversified portfolio, but you have the potential to lose large amounts of money if you invest in the wrong companies. If you are unsure how to invest in stocks, it’s a good idea to focus on ETFs and mutual funds instead of individual stocks.
If you don’t have a lot of money to work with, you can focus your investment on penny stocks, which are common stocks that are valued at less than a dollar. These stocks are highly speculative and may not pay off in the long run. Alternatively, you can use an online broker that allows you to buy fractional shares of a stock for a lower cost than a single share.
If you are investing in individual stocks rather than mutual funds, you should conduct extensive research before selecting your investments. Resources like Morningstar and The Wall Street Journal are great for making decisions and evaluating potential companies to invest in. Your investment app may provide other educational resources to help you make good investment decisions.
Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to AskPenny@thepennyhoader.com. Contributor Timothy Moore covers banks, investing and insurance topics, among others, for The Penny Hoarder.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.
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