Up to now we have achieved several steps to start investing:
- Your financial situation was determined
- The amount of money to invest was defined
- A brokerage account was opened
- The investment strategy and the assets to invest in were determined
The next step is to place an order and buy your first stock. But before that, you should be aware of some general terms, to not be confused in the first step.
What are stocks?
That’s a good question! A stock is a security that represents the ownership of a fraction of a company. So, by buying shares of a company you become a shareholder, that owns a small and tiny fraction of that company. Think about it, if you buy a share of Apple or Microsoft, you actually own a part of these companies.
In dependence on the type of stock you buy, you additionally have the right to take part in the annual shareholders meeting, and moreover to vote and influence the actions of the company.
What are dividends?
Dividends are a part of the company’s earnings, that are paid out to their shareholders. Usually they are paid once a year, every 6 months, quarterly, or even monthly. So besides profiting from the increase of the stock’s price, shareholders additionally get paid by the company regularly. Isn’t that great? By owning a share of a company, you actually own a part of that company, and a fraction of the company’s earnings, for which all employees are constantly working for, is paid out to you.
But not all companies are paying dividends. Some companies are more interested in expanding their business and thus invest all their earnings into their growth.
Other important stock market terms
There are so many different terms and order types out there, so that there is the potential, that you will be confused in the first place. In the following you will find a short overview of important terms to know and remember.
The bid price reflects the highest price that a buyer currently is willing to pay for the stock on the market.
The ask price, in contrast to the bid price, is the lowest price that the stock currently is sold on the market
The difference between the bid and ask price is the so-called spread, while the bid price generally is below the ask price.
If you are trading on a regular stock exchange, a trade only takes place if the bid and ask price are identical. This means the spread basically reduces to zero. Therefore, you need to pay a commission to your bank, to cover their expenses.
Besides that, commission free online or mobile brokers usually use the spread to create an income to cover their expenses. This means a trade also takes place if the bid and ask price are not identical. The difference or spread will be kept by the broker as a fee in this case.
If you are opening a long position on a stock, you basically buy the stock and bet on rising prices to benefit from. This is the most common method. If the price of the stock rises, you will make profit on your investment. If the price falls, you will lose money.
If you are opening a short position on a stock, you basically sell the stock and bet on falling prices to benefit from. If the price of the stock rises, you will lose money. If the price falls, you will make profit.
How does it work? By opening a short position, you will borrow the respective quantities of shares from your broker and sell them in the market. If then the prices of this stock fall as expected, you can buy back the shares from the market at a lower price. The shares will be given back to your broker and you can keep the profit, that you have just made by the difference in the buy and sell price. The major downside of short positions is, that your broker will charge fees for lending these shares to you, e.g. daily. Thus, a short position is not suitable for long-term investments in my point of view.
A market order is an order to buy or sell a stock at the currently best available price in the market. Usually the order is executed at the current bid or ask price. The advantage is, that if there is enough liquidity in the market, the order will be executed instantaneously. The disadvantage is, that you do not have control about the exact execution price. Monthly savings plans are always executed based on market orders. If you buy a stock based on a market order, you are considered to be a market taker.
A limit order is an order to buy or sell a stock at a predefined price. In terms of a buy order, the order will be executed at or below the predefined price. In terms of a sell order, the order will be executed at or above the predefined price. The advantage is, that you can control at which price you will buy or sell a stock in the market. The disadvantage is, that depending on the market price development and the price that you have defined, it could take longer to fill the order. Moreover, if your predefined price is not offered in the market, your order will not be executed. If you buy a stock based on a limit order, you are considered to be a market maker.
Many financial institutes offer the possibility to leverage your trades. I use this instrument only limited, just about 1% of my trades are leveraged. I do not consider myself an expert on leveraged trading, so I will not dive deeper into it. I just would like to mention to be careful with leveraged trades. Of course, they offer are great opportunity for faster gains, but the risks are higher and your losses can be tremendous.
These are only short and rough explanations to give you a quick overview about the most important terms. Especially in terms of order types, there are many other options, e.g. stop loss or stop limit orders. If you would like to dive a little bit deeper, I recommend following website.
Buy your first stock
Whether you would like to start investing in stocks or start investing in ETF´s, to place your first trade and invest your money, you just need to choose the stock or ETF you would like to buy and set an order in the market. But for that I do have two recommendations for you.
First, I recommend you to trade only between 9:00 am and 5:00 pm. The reason for that is, that these are the typical opening hours for most stock exchanges. Considering these market hours will help you to keep your costs low, as spread fees are lowest during the official market hours. Of course, you can trade e.g. in the pre-market, but commissions and spread fees are higher during that time.
Second, always use a limit order for every trade. As mentioned above, market orders do not provide any guarantee for the price you will pay. So, in case of short-term volatility, you could end up with a higher price you were willing to pay for a stock. Thus, by using a limit order you will be protected against such effects. If you want to buy a stock at the current market price, you can use a limit order and determine the price just a few cents below the current market price. By doing so, it is likely that it will be filled quickly, and you know the maximal price you will pay for the stock.
Congratulations you are now an official part of the stock market game!