When you’re ready to start investing and/or trading the first thing you will need to do is open an account. The first step is to decide on a brokerage firm. There are three different levels of brokerage firms.
- Full-service brokers
- Discount brokers
- Online brokers
Full-service brokers charge higher commissions, but offer more services. They are the preferred broker for people who don’t have the time or the desire to do their own research and place their own trades.
Discount brokers charge lower commissions, but have fewer services to offer. They do not offer personalized investing advice. They are preferred by people that like to do their own research and place their own trades.
Online brokers are similar to discount brokers except they offer no brick and mortar locations (Web access only).
Next you will need to decide on what type of account you want to open. Here are a few types of accounts:
- Cash & Margin
- Cash, Margin & Option
Cash Account: This is the most common account. Securities (Stocks, ETFs, and Mutual Funds) must be paid in full at time of purchase.
Cash & Margin: To trade on margin you have to request margin approval. The broker will lend you a portion of the purchase price. The loan is collateralized by the securities and cash. If the value of the stock drops by a pre-determined amount, you will be asked to deposit more cash or sell a portion of the stock.
Cash, Margin & Option: To trade options you have to request options approval. Options strategies will also require margin. An option contract is a financial derivative bought by one party (option holder) and sold by another party (option writer). Completing an options agreement will require more information than for a cash account.
Here are the typical questions on most options agreements:
- Years of investment experience
- Years of options experience
- Funds available for options trading
- Average transaction size
- Number of transactions per year
- Types of transactions (Stocks, Options, etc.)
- What are your investment objectives? (Note: If you want to trade options, speculation should be one of the boxes you check.)
- What type of activity do you plan to conduct in your options account? (Note: Check all boxes, i.e. buy options, write covered options, create spreads, write uncovered options, etc.)
Most brokers will not allow options trading in an IRA (Individual Retirement Account), but there are some brokers that will allow it. Uncovered options strategies are not allowed in an IRA.
Attitude and Risk Tolerance
Successful investors/traders must have a positive attitude and a strong will to succeed. When learning to invest it is easy to get discouraged and quit. Most successful investors/traders have had multiple failures along the way. I don’t want that to happen to you! This article was created to give you an edge that most people didn’t have when they started investing.
To be successful, you must have:
- The right education
- The right tools
- The right attitude
If you have already been struggling in the stock market, go back and reexamine your prior trades and identify the problem area. One of the biggest mistakes new traders make is risking money they can’t afford to lose. They invest car payment money or rent money in the stock market, hoping they will double the money in a matter of hours to days…solving all financial problems. This crosses the line into gambling not investing.
The stock market has a proven track record of being a good place to invest money over the long term. The biggest enemy for most investors is emotion. When stocks are losing value and emotions kick in it’s hard to make good decisions. Being indecisive and doing nothing is the worst possible thing to do. Managing risk in a trade helps take the emotion out of investing.
Understanding that getting into a good stock doesn’t happen by accident. It takes research and patience to find good company’s to invest in.
To determine your risk tolerance, which in turn will determine your trading style ask yourself the following questions:
- How much am I willing to lose on any one trade without becoming emotional?
- Do I feel more comfortable buying and holding stocks for only short periods of time or do I like to buy and hold stocks for the long-term?
- Are the fundamentals of a stock or the chart of a stock more important to me?
- Do I like taking risk?
- Can I respond to news on my stocks if it impacts the chart or fundamentals?
Matching strategies with your personality and trading style is extremely important. You must identify your strengths and weaknesses in order to develop your trading style around them.
Mutual funds are the most commonly known investment vehicle. A mutual fund is made up of a pool of funds for the purpose of investing in securities (stocks, bonds, money market, etc.). Money managers operate the funds and invest the funds capital to produce capital gains and income for investors. The money managers must structure and maintain the portfolio to match the investment objectives outlined in the prospectus.
Mutual funds give small investors access to professionally managed and diversified portfolios. Each shareholder participates proportionally in the gain or loss of the fund.
Disadvantages of mutual funds:
- They do not trade like a stock
- Brokers charge higher commissions to buy and sell
- May have front or back load fees
Front-end load fees are paid to brokers, financial planners, and investment advisors as sales commissions upon initial purchase of a fund. These fees are not included in a funds operating expense.
Back-end load fees are paid to brokers, financial planners, and investment advisors as sales commissions upon selling a fund. The fee is a percentage of the value of the share being sold and the fee decreases yearly until the specified holding period ends, at which time it drops to zero. These fees are also not included in the funds operating expense.
No-load funds do not have front-end and back-end fees. Research shows that funds that charge loads do not necessarily outperform no-load funds.
Exchange-traded funds (ETFs) also known as index tracking stocks like mutual funds are a basket of stocks. There is an ETF for almost every sector of the market and for most countries.
Advantages of ETFs:
- Trade just like a stock
- Diversified like mutual funds
- Commissions are the same as on a stock trade
- Ability to buy on margin, sell short, and many have options available
You need to have goals and objectives. Treat investing like a business and set annual goals. Prior to the beginning of each year document your goals and objectives. Write down the percentage return you want to earn for that given year. Depending on the duration of the investment the percentage will vary. Be sure your goals are realistic and you take in consideration that the market average annual returns over the long-term are 10-12% annually.
- Never lose more than 50% on a option
- Never lose more than 10% on a stock
- 10% annual return this year in my IRA
- 20% annual return this year in my trading account
- Be more patient with my trades
- Spend 1 hour a week researching the stocks that I want to invest in
- Develop and apply money management rules
- Learn how to trade options
- Keep 20% of my account in cash for new investment and/or trade ideas