Understanding How To Buy And Sell Stock

The Basic Functions

The old standard was to pay a broker to make transactions and do trading for you. But with the emergence of the Internet people can do their trading electronically for as low as $6.95 a trade. People think this is a great deal so they eagerly jump into the stock market without having any prior knowledge whatsoever of what they are doing. And what once looked like a great deal has turned over a huge profit to trading firms due to excessive trading and low maintenance.

It's very simple how it works. You can sign for a brokerage account at a variety of places; the most popular being Scottrade, Ameritrade, and ETrade, but there are many out there that offer better savings. Once signed up, you can begin purchasing and selling stock almost instantaneously.

The Stock Symbol

Each company before being listed on the New York Stock Exchange or other exchange will have a dedicated symbol (usually up to 4 characters on the NYSE). For example, Walmart is known as WMT, Target is known as TGT, and Ford is known as just F. You can lookup symbols through Google or yahoo or even using your online brokerage account, but you will need the symbol before you can make a purchase. Please be careful that you do not transpose or mistype a character because you may accidentally end up with the wrong stock.

Buying and Selling - Limits, Stops, and Stop Limit Orders

When you go to buy or sell a stock you have several options that you can put in place to protect yourself against immediate losses and if used improperly can reduce your capital gains.

Market Price

Generally speaking if you don't use any of the options than you would buy or sell the stock ar market price. This means that whatever the going rate or quote is for that stock at the time of transaction is what you will receive.

Stop Order (Stop Loss)

A Stop Order is where you will set a certain amount. In buying for example, let's say you wanted to pay 30 dollars for Walmart (WMT) stock but no more. Let's also say that Walmart is currently trading at 28 dollars at the session open but is rising in value due to a good earnings report but you don't want to purchase the stock until it hits 30 dollars to make sure that is' really going to rise. By placing a Buy Stop Order of 30 dollars your online brokerage account will wait for the stock price to hit 30 dollars and then turn into a market order where it will try to purchase the stock at market value. Now let's say that you own Walmart and you paid 30 dollars for it but you don't want to lose a lot of money so you place a Sell Stop Order of 29 dollars. Your transaction will not become active until Walmart reaches 29 dollars at some point during the day. Once it reaches 29 dollars your order becomes a regular market order and it will make it's best attempt to fill your order at market price.

Limit Order

With a Limit Order you will set maximum and minimum prices you are willing to buy and sell at. When placing a Buy Limit Order on a company what you are saying is that I want to buy this stock as long as it as less than this amount. For example, if I put in a Buy Limit Order on Vonage (VG) for 10 dollars and the stock is currently trading at 7 dollars then it will continuously try to buy Vonage stock until it surpasses the 10 dollar mark. When placing a Sell Limit Order you are saying that I want to sell my stock but I am not willing to sell it for any price under my limit. For example, if you currently own Vonage and it's trading at 7 dollars and you decide that you want to sell it but for no less than 6 dollars than you would place a Sell Limit Order with a target price of 6 dollars. The brokerage services would continually try to fill your order up until the point when Vonage drops below 6 dollars.

Stop Limit Order

This is a combination of both a Stop Order and a Limit Order. When buying you will be able to set two prices, which have to be set above the current trading price. For example, let's say that Advanced Micro Devices (AMD) is currently trading at 20 dollars a share. You would like to buy them but not until they reach a price of $20.50 and you aren't willing to pay more than $21.00. You would then set your Stop price to $20.50 and your Limit Price to $21.00. The brokerage service would then try to fill your order once the $20.50 mark has been reached up until the point when it hits $21.00. If the price goes over $21.00 then your order will not be filled until it drops back below $21.00 for whatever time frame you specified your order to be active for (usually 1-30 days). Remember that a Stop-Limit Order is just a combination of the two. When the stop price is reached it then converts into a Limit Order. So if AMD were to hit the stop price of $20.50 it would still fill the order even if it dropped below $20.50 before filling. In fact, your order would be converted to a Limit Order so it would continuously try to buy AMD until it exceeds $21.00 regardless of how low the stock price dropped. A Sell Stop Limit works in the opposite fashion. If you owned AMD and it was currently trading at $20 and you wanted to sell it if it were to hit $19 but you don't want to sell it if it goes below $18 before it's filled then you would set your Stop Price to $19 and your Limit Price to $18.

Put and Call Options

There is a way to participate in the stock market without ever actually purchasing stock in a company. It's very similar to making predictions on which way you think the stock price of a company is going to go and then betting money on it. These are called options and it is a technique used by mainly professional investors to make money in the stock market regardless of whether it is going up or down. For every bet that is made there is a bet against it and using these two opposing bets a contract is formed between the buyer and the seller. A contract is usually considered 100 shares.

Put Options

A Put Option allows the purchaser of this contract to sell a commodity at a pre-set price agreed upon in the contract. The contract usually expires within 30 days and it doesn't have to be exercised. For example, if Bob thinks Google (GOOG) is going to plummet after their next earnings report from $400 to $300 then Bob may wish to use a Put Option and find a contract that allows him to sell Google(GOOG) at $400 anytime within the next 30 days or whatever time frame is necessary for this prediction. Bob buys 5 contracts (500 shares) paying a $20 premium per share for the contract ($10,000 total) and Google does indeed drop but only to $350. Bob could now exercise his option and sell his 5 contracts which will give him (500 shares * $400) minus (500 shares * $350) minus the $10,000 he spent on the contract. This would give him a ($200,000 - $175,000 - $10,000) $15,000 capital gain from this transaction. Let's say Google (GOOG) went up instead to $450. Bob is not required to exercise his transaction because it would result in a loss and the $10,000 he spent on the contract is non-refundable.

Call Options

Call Options work the opposite way of Put Options. Taking the same scenario above let's say that Bob thinks google will go up to $500 after the earnings report is released from $400. Bob uses a Call Option and buys 5 contracts (500 shares) of Google paying a premium of $20 per share ($10,000). The earnings report is released and Google increases to $550. Bob has the right to purchase 500 shares of Google at $400 from the writer of the contract and can now resell them at $550 if he exercises his option. So Bob gets ($550 * 500) - ($400 * 500) - ($10,000 premium) $65,000 from exercising his option. If Google were to drop instead of increase then Bob has the right not to exercise his option and he would then forfeit his $10,000 on the expiration date of the contract.

Trading on Margin

Trading on margin is an excellent way to amplify your gains when you make the right picks but it is also an excellent way to amplify the losses as well. Most brokerage firms allow you to buy on margin of up to 50%. That means you could purchase $20,000 of a stock only using $10,000 of your own money and borrowing the other $10,000. It's a really good way to capitalize on short term investments but has never been recommended for long-term holdings because the $10,000 you borrowed usually comes with an APR of around 10% that you pay each month from your account. Also, incase of a sudden market crash, most brokerage services require you to keep at least 30% and sometimes even 50% Current Market Value in your account.

Therefore, if you purchase stock for $20,000 using $10,000 of your own and $10,000 borrowed than you must maintain 30% of the $20,000 at all times which is $6,000 of your own money in the account. Keep in mind that the money you borrow will never change so if that $20,000 in stock lost 20% of it's value then you would have ($20,000 * .8) $16,000 in stock left; $6,000 which is of your own money and $10,000 which is still the lenders money. If the stock fell anymore than that they are allowed to sell your shares unless you add more cash to the account.

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