Investing in the stock market can be very lucrative, but it can also be very costly if you are not prepared. Before you start trading stocks, be sure to understand the basic terms associated with trading.
The ask is the price the stock is offered to buy, and the bid is the price offered to sell (an easy way to remember is BASK - buy at the ask, and sell at the bid). To trade a stock you have two order types: market order or limit order. A market order means that your order will be filled at the current market price of the stock and execution is instantaneous. A limit order means there is a condition on the order that must be met before the trade is executed. For instance, if you place a limit order to buy GOOG at $450 and GOOG is currently trading at $455, the asking price of GOOG must drop down to $450 or better before your order is filled. If GOOG opens up at say $440 the next day, you will get that lower price of $440 (you are not stuck with paying your limit price of $450). Just think of the limit price as the best price you are willing to trade the stock.
A buy stop is for more advanced traders and this is means that you set a stop price above the current market price (usually above a resistance level) and the order is executed when the stock rises up to your stop price, which triggers your order to be filled at the next available ask. This is a mometum trade, and by the stock rising above its resistance level, it is expected to rise even higher. For more about this refer to technical analysis.
A stop loss (or a sell stop) is very common and very useful. With a stop loss, you are placing an open order to sell your stock if the price drops down to a certain level. For instance, if you buy GOOG at $450 and you want to protect your downside, you would place a sell stop at let's say $400. This means if GOOG drops down to $400 your shares are automatically sold at the next available bid. This is a good way to get out of a falling stock so you do not ride it all the way down. This is a very hard concept for new investors to grasp. They say, why would I want to sell GOOG at $400 when I bought it for $450? I like to answer this with another question: Would you buy GOOG right now if you had the available cash? Most investors would say no. Why would you want to buy a stock that is in a down trend and poised to go even lower? It is better to take your cash out and put it in something better. You can always buy GOOG back when the trend turns around.
An even better protection is a trailing stop. A trailing stop is just like a stop loss, however it automatically follows your stock up to protect your profits. For instance, if you buy GOOG at $450 and you set your trailing stop at $50 points back, the trailing stop will follow your stock up. If GOOG is trading at $550 your trailing stop will now be at $500, instead of at $400 if you placed a static stop loss. With a static stop loss, you would have to manually increase your stops.
Now that you have a little background on the basics of stock trading, you are ready to start learning the three basic principals of stock trading: pick valuable companies; take advantage of market fluctuations; and have an exit strategy. Continue on to fundamental analysis.
