Online stock trading gives you the chance to invest in the stock market, without the need for a personal broker or a large amount of money. In online trading you place your orders to buy and sell stocks electronically. You decide which stocks you want to buy or sell, how many and at what price, and you place the order yourself through the broker's Web site.
The broker's site is connected to the major stock exchanges and the over-the-counter market. The brokerage site maintains your account, executes your online trading transactions, charges and credits your account and keeps an up-to-date record of your transaction history.
Choosing an online broker
When you're ready to start trading online, the first thing to do is select an online broker. Different brokers have different requirements in terms of how much money you need to open an account, the commissions charged for each transaction and other fees. Services also vary, with some sites offering investment tools, advice and research.
Some broker sites let you get started in online trading for as little as $100. The commissions charged for each order can vary from $3 up to $19.95 or more. You should find out what other fees the broker may charge, such as inactivity fees or maintenance fees. Web sites such as Business Week, Consumer Search, The Motley Fool and Smart Money provide comparisons of online brokers.
Security is another critical factor to consider. In online trading, you need to be sure you are dealing with a reputable broker. The US Securities and Exchange Commission (SEC) allows you to check out brokers and provides a lot of other information useful to investors on its Web site at www.sec.gov.
The Financial Industry Regulatory Authority, Inc. (FINRA) (www.finra.org) is the largest non-governmental regulator of all securities firms in the United States. The Investing Online Resource Center at www.investingonline.org is another great place to get advice on online trading and to know who you are dealing with.
Setting up an online trading account
Once you decide on a broker for your online trading, you set up an account. You will need to provide your personal information, including your annual income and net worth. You will also be asked questions about your investment and financial history to determine your suitability for the type of account you are requesting. Online trading in options is an example of an activity that may be restricted, due to the potential for significant losses.
You can trade online with a cash account or margin account. A cash account works like a checking account-you buy stocks with the money in your account. With a margin account you can buy on credit. You can borrow money from the broker based on the equity of the stock you own, using it as collateral. A margin account gives you more power and flexibility but also involves a higher risk.
Doing research
For online trading, you need to do research to know what stocks to buy and sell and at what price. You should go to the Web site of the company whose stock you want to buy and download the prospectus, which has detailed information on the company.
The SEC's EDGAR database (www.sec.gov/edgar) can also provide you with a wealth of information for your online trading. Here you can find all the annual and quarterly reports that companies must file with the SEC.
You can listen to companies' conference calls, in which management discusses how the company is doing and what it expects for the future. You can find schedules of these conference calls on financial Web sites and you can often download them.
Keeping up on the news is an important part of your research for online trading. Trade journals specific to the industry of the companies you are interested in can be especially enlightening.
Types of orders
It is important to understand the different types of orders you can place and how to make them work for you. A market order is an instruction to buy or sell a certain number of shares at the current market price. The advantage is that you are almost always guaranteed that your order will be executed. The disadvantage is that you may not get the price you want.
With a limit order, you specify the price; a buy order will be executed only at your limit price or lower and a sell order only at the limit price or higher. The advantage is that you avoid unexpected market fluctuations. The disadvantage is that your order may not be executed right away, depending on whether there are willing buyers and sellers at that price.
A stop-loss order sets a sell price for the broker. When a stock drops below that price, it is automatically sold. This type of order protects you from sudden drops in the market price when you want to sell.
Forex trading
Online trading in foreign currency is called Forex trading. This is a huge market with a volume exceeding $2 trillion a day. With Forex trading, you are simultaneously buying one currency and selling another. Currencies are traded in pairs, such as the euro and the US dollar, or the British pound and the Japanese yen.
You make money in online trading in foreign currencies by predicting how the exchange rates of different currencies will fluctuate as a reflection of the relative current and future strength of the underlying economy. You trade based on your expectation that the value of the currency you bought will increase in value compared with the currency you sold.
You can get started in online trading in foreign currencies by opening a micro account with around $200. Many Forex trading sites provide free demo accounts that allow you to practice before you actually put your money on the line.
Trade carefully
Online trading allows you to take control of your investments directly, and it can be less expensive than investing in mutual funds or hiring a personal financial advisor to manage your assets. The tradeoff is that you'll need to do extensive research on the securities you buy and sell.
The easy access to your investments poses dangers as well as advantages. Online trading can be very addictive to some and it can lead you to make decisions based on emotion rather than evidence. Understand your tolerance for risk before you begin and don't get caught in the cycle of chasing gains with short-term trades.
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