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Stock Trading Basics – Trading Factors

Introduction

Virtually everyone, at least in the developed world, knows at least that the stock market exists, and many make investments therein, with the hopes of making a profit. To be able to do so, however, requires extensive knowledge of how the market works. In this article, we will describe the three kinds of market trading strategies, stock trading basics — what they are and which one works for which market goals.

A brief history

It is hard to believe, but the stock exchange as we know it today is a result of Columbus’s rediscovery of the New World. European businessmen saw that there were vast profits to be made in these new lands, but the amount of money needed to start up was more than any one person could make, so people pooled their funds. The first stock exchange was founded in Antwerp in 1531.

The three basic types of trading strategies

Stock trading strategies fall into several types — market making, trend following, trading the news, arbitrage, trend following and so on — but they can all be grouped into three basic types. These are:

  1. trend following
  2. trend fading
  3. scalping

Each has its own basis and its own advantages in different areas, as the following subsections will indicate.

Trend following

The trend follower bases his investment decisions by analyzing, not the fundamental strength of the businesses, but rather the market prices and use the information thus gathered to take advantage of those moves, either long-, medium- or short-term, that seem to pay out the best rewards. This involves, specifically, a technical analysis — that is, you analyze the market by charting how it performs over time and focus on trends. A large part of such analysis requires the use of computer models to determine the general direction in which the market is moving.

Because they aim to invest in markets that have been performing best, trend followers naturally do not enter the market until after the trend has established itself “properly.” They leave the market if the trend reverses itself. Stock trader Van Tharp talked about trend following in his book Trade Your Way to Financial Freedom.

Trend fading

Trend fading, on the other hand, involves trading against current trends. This is naturally more risk, and so you should not use this strategy unless you have high risk tolerance. The short-term gains are potentially very great and no complex analysis is required.

Scalping

The word scalping, when used in business, has at least three meanings, one of which implies fraud. Legitimate scalping means attempting to earn many profits on small changes in prices. Such traders choose this strategy because it is easier to track small changes than large ones.

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Online Stock Trading Basics

Online stock trading is a big business. The advent of the internet and high-speed connectivity have facilitated the expansion of this industry and as a result there are more online brokerages than ever before. Before jumping in, it is worth noting that since this is real money we are working with here (retirement money in many cases), it is important for new investors to thoroughly educate themselves. Luckily, most brokerage firms offer excellent education services.

Types of Online Stock Trading

There are many options for investors to trade and the kind you find attractive depends on many factors. How much capital will you be working with? How much risk are you willing to take? How much time can you afford to dedicate to market research? Consider the following options.

  • Day trading was in its heyday when the internet took off in earnest. Traders buy and sell positions in as close to real time as possible, often capturing gains (or suffering losses) several times a day. Day traders must be willing to invest a lot of time to following the ups and downs of the market and accept a high level of risk.
  • DRIP funds (Dividend Reinvestment Plans) are a good choice for traders that are of a buy-and-hold mindset and for those with limited funds. Not all stocks and bonds participate in this kind of investment plan but many do. The main benefit is that you can invest by a dollar amount rather than a specific number of shares. And when one of your positions pays a dividend, that money is automatically invested back into that position, usually as a portion of a share.
  • Conventional online brokerage firms are very popular with investors with mid to long-term goals but that don’t want to do research every day. You deposit funds into your account and buy and sell shares. Generally, each trade is charged a reasonable commission. These firms typically offer very high quality education and research tools.
  • Binary options trading is what the name suggests—two outcomes are possible. Traders predict the movement of an asset and predict the outcome within a certain period of time and the payout (or loss) is known in advance. With this type of trading it doesn’t matter whether the market is in a bull or bear phase, only the movement matters. Since this kind of trading bears such a similarity to gambling many binary options firms are not allowed to do business in the US.

Types of Investments

There are many types of investments available for trading. Online stock trading is the most common but many economists recommend owning a mixed bag of positions, mainly stocks and bonds. Conventional wisdom has it that stocks do better in a bull market while bonds do better in a bear market so this type of diversification is safer. Keep in mind that some municipal bonds are tax free.

Mutual funds are considered a safer investment strategy as well because these funds hold positions in a mixture of stocks and bonds in a market niche or location. The downside is that you are relying on a fund manager to make the picks for you and you must have confidence in his abilities. Next, index funds hold positions in various indexes and mirror their benchmarks.

Online stock trading can be a lucrative venture but it demands an education in the way the markets operate and investors must be willing to take some degree of risk. It is important to keep this in mind when deciding which types of trading strategies you would like to adopt.