What is Trading?
In September 2022, companies trading on the London Stock Exchange (LSE) had an overall market value of about £3.58 trillion ($4.04 trillion).
Such an amount suggests a vast potential for first-time traders to make money by trading stocks on the LSE.
Additionally, there are other international exchanges where traders can transact, so there’s no lack of opportunity, as long as traders have the funds to buy and sell stocks and other financial instruments.
What is trading? How do you trade? What’s the purpose of trading, and what are its advantages? How does trading differ from investing? Is there a way to trade in the United Kingdom?
This article explains what trading is, how it works, its benefits, and how it’s different from investing. This article also explores stock trading, financial markets, and managing trading risks.
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What Does Trading Mean and How Do You Trade?
Trading involves buying and selling financial instruments so you can earn a profit. There are thousands of financial markets where you can trade, these include stocks, commodities, and currencies.
You can trade in indices like the S&P 500 and FTSE 250, foreign currencies, such as the U.S. dollar and Euro, or commodities like crude oil and natural gas.
A trader can be an individual investor or an international institution. Moreover, depending on the available trading instrument, you can trade directly, through a broker, on the phone, or through an online trading platform.
What You Need to Know About Trade
Simply put, trade is transferring goods or services from one entity to another, in exchange for money. These trades occur within a network called a market.
Barter was the first known form of trade, wherein traders exchanged items directly without using money. As economies developed over time,these individuals began using precious metals for exchange.
Today, most traders use money as a medium of exchange when negotiating trade. Money in the form of paper, credit, and non-physical funds helps make trade convenient.
When trade occurs between two dealers, like a buyer and seller, it’s called bilateral trade. On the other hand, trade between three or more individuals is a multilateral trade.
Virtual currency is a digital value accepted by natural or legal individuals for payment. This currency can be stored, transferred, or traded electronically.
Virtual money is an unregulated digital currency that is exchanged between members of a virtual community and controlled and issued by the currency’s developers.
This currency isn’t attached to a fiat currency (money not backed by a commodity) and isn’t issued by a central bank.
One essential thing you can do to boost your chances of succeeding as a trader in today’s markets, is to treat this activity like a business.
Therefore, just like any business, you need a strategic plan involving short- and long-term goals to succeed in the trading business.
To develop a successful trading plan, you must research and test your plan against historical data and in a live market, then review and reassess your strategy regularly.
You have two basic options to trade in today’s markets: on the physical exchange floor or electronically.
NASDAQ (National Association of Securities Dealers Automated Quotations) pioneered electronic stock trading, while the NYSE (New York Stock Exchange) uses floor traders to perform most trades.
Trading vs Investing
What makes trading different from investing? The distinction between these two activities is in how you make a profit and whether you own the asset or not.
Traders typically profit from buying assets for a low price and selling high, usually over the short or medium term.
On the other hand, investors buy shares of stock at a favourable price and take ownership of these shares.
The investor holds these stocks for a long period, then sells them at a higher premium, hoping that the share price increases over time and turns a profit.
Trading involves buying and selling stocks, currency pairs, commodities, or other financial instruments more frequently than investing.
The goal of trading is to generate profit that exceeds buy-and-hold investing returns.
How does floor trading work: let’s say you plan to buy 1,000 shares of Company A. First, you should instruct your broker to buy the shares at the market price. Your broker sends the buy order to a floor clerk on the exchange.
The clerk informs one of the firm’s floor traders, who looks for another trader who’s ready to sell 1,000 shares of Company A. The two traders agree on a price and close the deal.
Afterwards, a notification transmits up the line, and your broker informs you of the final price.
This stock trading process can take more than a few minutes, depending on the market and the stock. You can receive a confirmation notice in the mail after a few days.
Online trading has been an increasingly popular method in recent years. Traders can set up an online trading account and start trading shares quickly and easily.
Online trading platforms allow traders to place their buy and sell orders, stop-loss, and stop-limit orders.
These orders let you manage investments without watching the market 24/7.
Online trading platforms have several handy features, like the facility to check an order’s status, access real-time stock quotes, and get updated on company news.
Additionally, novice investors can practice with a demo account or online stock simulator to get the feel of online trading.
Equity trading involves buying and selling company stocks through a major stock exchange like the NYSE or the London Stock Exchange (LSE).
If you own the shares, you can place an equity trade through an agent or a brokerage account.
One benefit of equity trading firms is that they offer trading expertise, comprehensive market research, and unique trading systems.
Currency or forex trading is a 24-hour market that covers three sessions: the United States, European, and Asian trading sessions.
Some of these sessions overlap due to time zones, but the main currencies trade during those market hours.
For instance, dollar-based pairs will find the highest trading volume during the U.S. trading session.
Currency is traded in varying sizes, starting with a micro lot representing 1,000 units of a currency.
So if you funded your trading account in U.S. dollars, a micro lot equals $1,000 of the base currency.
Other sizes include a mini lot worth 10,000 units and a standard lot worth 100,000 units.
All currency trading happens in pairs. In forex, you can buy one currency by selling another. Meanwhile, you can purchase or sell a single stock in the stock market.
To invest is to gradually build your wealth over an extended period by buying and holding a portfolio of stocks, bonds, mutual funds, and other investment instruments.
The Principles of Trading
If you apply the trading concept in the financial markets, the principle is to buy something in exchange for money.
Therefore, when you’re trading shares, you’re actually buying or selling a company’s stock. If your shares’ value increases, you can profit by selling those shares at a higher price.
However, if you buy something at a specific price and sell it at a lower amount, you’ll experience a loss.
Why does the value of the shares go up or down? It’s because the value changes according to supply and demand. For example, if there’s a higher demand for a product, people will be willing to pay more.
What Is the Purpose of Trading?
People engage in trading to buy and sell stocks, currency pairs, commodities, and other instruments to earn money.
Traders generate profits by buying these instruments at a lower price and selling them for a higher cost within a short period of time.
What Are the Advantages of Trading?
Traders can work for financial institutions, in which case they trade through the funds and credits of a company, and they get paid a combination of bonus and salary.
As another option, traders can also work for themselves and trade using their own money and credit. With this alternative, they can keep most of the profit to themselves.
Highlights of Trading
Trade happens within a country or among trading nations. In the case of international trade, the comparative advantage theory assumes that trade benefits all parties.
However, there are some who are against trading, saying such activity will likely lead to stratification (deepens the division between classes) within countries.
Economists recommend free trade among nations, but protectionism through tariffs or customs duties can arise due to political motivations.
What Assets and Markets Can You Trade?
- Forex: Deal with more than 50 foreign currency pairs, including major, minor, and exotic currencies
- Commodities: Trade Brent crude oil and WTI oil at low margins
- Metals: Exchange gold, silver, palladium and platinum
- Indices: Trade in some of the world’s popular indices like the S&P 500, NASDAQ 100, and FTSE 100
- Cryptocurrencies: Trade popular crypto CFDs (contracts for differences) like Bitcoin, Dogecoin, and Litecoin
When choosing whether to trade or invest, consider the following:
- Investing is an approach applicable to long-term purposes like retirement accounts.
- Trading involves short-term strategies to maximise returns daily, monthly, or quarterly.
- Investors are more likely to ride out short-term losses, while traders will attempt to make transactions that can help them profit quickly from fluctuating markets.
What You Need to Know About Traders
Traders can work for a financial institution where they trade using their company’s money to earn their salaries and bonuses.
However, traders can also do business by themselves using their own funds for trading, allowing them to keep all the profits.
There are several kinds of traders using various trading strategies, such as:
- Fundamental trading: Traders performing this type of trading conduct fundamental analysis and focus on corporate events like earnings reports, reorganisations, and mergers and acquisitions that can affect a stock’s price.
- Technical trading: Technical traders focus on charts and graphs and use various technical indicators to analyse these diagrams to find the buy and sell signals.
- Micro-trading and scalping: Scalpers perform numerous trades, ranging from dozens to hundreds daily. The goal of scalpers is to make a small but frequent profit from their trades.
- Momentum trading: Momentum traders buy and sell stocks that have a significant movement toward one direction and trade in high volume. Once the trader catches the momentum, they can profit from it.
- Swing trading: Swing traders are those who hold their positions for more than a day to try and capture a trend. They use technical analysis to find stocks with short-term price momentum.
Nowadays, trading is more accessible to the general public and is no longer limited to professionals with financial education.
This broader accessibility allows individuals to use trading as an extra income source and an intellectual challenge.
Where Have You Heard About Traders?
If you’ve seen finance- and trading-related news, you’ll likely see pictures of traders staring at computer screens or making hand gestures on the trading floor.
For some individuals, this scenario is probably one of the earliest they’ve heard about traders.
So think of traders as the most visible symbols of the financial markets, especially those working on face-to-face trading floors.
Who Trades and Who Invests?
One significant difference between traders and investors is the length of time they hold their assets.
Traders usually prefer to profit from price fluctuations and shorter trends, while investors hold their investments for a longer time.
Ways to Trade in the U.K. and How to Get Started
The most popular trading methods in the U.K. are CFD trading and spread betting, which are forms of derivative trading. On the other hand, most investors prefer share dealing.
How Do You Begin Trading?
To start your trading journey, follow these tips:
Learning to Trade
Like businesses, trading can be profitable for people who find success in it, but there are also individuals who don’t succeed.
Therefore, you should take your time to learn the basics of trading. This activity isn’t a get-rich-quick scheme, so avoid thinking of trading as such, and you’ll lower your chances of failing.
Before you start your first trade, ensure that you have the technical skills to trade and the proper mindset and emotional state to handle profits and losses.
Choosing Your Trading Account
- Standard: This option is for new and intermediate traders who want a complete trading experience.
- Pro: This account type is for professional traders who prefer low commission rates and spreads.
- VIP: This account is for professionals who prefer high-volume trading and access to raw forex interbank market spreads.
Picking Your Asset and Market
Trading CFDs and foreign currency can be highly speculative and may not be suitable for many investors. The leverage produced by trading on margin can work for or against you, and losses can go over your whole investment.
Invest only with money you can afford to lose, and ensure that you fully understand the risks involved.
Deciding Whether to Trade the Spot Price, Options, or Futures
Spot trading refers to the buying and selling of assets at the current market price, called the spot or cash price.
If you’re into short-term trading, you can use this method since spot trading has a relatively low spread despite its overnight fees.
If you’re a medium- or long-term trader, consider trading futures if you’re into buying or selling assets at a predetermined price by a specific date and before the contract’s expiry. Futures don’t have overnight fees but have higher spreads.
Another alternative over futures are options, which are contracts that grant the owner and holder the right, without obligation, to buy or sell an instrument at a specific amount, price, and date.
With CFD trading, you have two ways to trade: going long (buy first, then sell when you earn a profit) or short (sell first, then buy when the price goes down). CFD trading also allows you to trade in spot, futures, or options markets.
If you choose share dealing, you can only perform long trading. Moreover, you can only trade in the spot market.
Four Trading Examples
To give you an idea of how trading goes, please refer to the following examples:
Trading Shares via Spread Bets
Suppose you decide to trade Company A’s stocks at the current underlying price of 90.75.
If the stock has a one-point spread, the buy price should be 91.25 (+0.50), and the sell price should be 90.25 (-0.50).
Meanwhile, if you believe the share price will increase, you can buy Company A’s shares at $10 per point of movement.
So if the margin requirement is 20%, you must deposit $182.50 ($10 x 91.25 x 20%) to open the position.
To make a profit, you must sell your position when the stock’s price is above 91.25. Therefore, if the share price rises to 120, the buy price becomes 120.50 (+50), and the sell price becomes 119.50 (-50).
If you sell the stock at 120.25, you can make a profit of $290 ((120.25 – 91.25) x $10 per point).
Trading Shares via CFDs
Suppose Company B trades its shares at 25.525 with a buy price of 25.550 and a sell price of 25.500.
If you predict that the stock value will increase in a few days, you can choose to buy 100 share CFDs at 25.550.
Suppose the share price climbs to 27.525, so the buy price becomes 27.550, and the sell price becomes 27.500. You can then close your position by selling 100 share CFDs at 27.500.
To calculate your profit, multiply the difference between the closing and opening price by the share size. So your gross profit in this situation will be $195 ((27.500 – 25.550) x 100).
Trading Indices via Spread Bets
This trade type is similar to spread bet trading, except you’re trading indices.
Let’s say you decide to trade on the NASDAQ 100 with a market value of 11,360, a buy price of 11,360.5, and a sell price of 11,359.5.
If you buy at $10 per point at 11,360.5 at a 1% margin factor, you should deposit $1,136.05 ($10 x 11,360.5 x 1%).
Trading Indices via CFDs
If you believe the NASDAQ 100 index’s value will go above its current price of 11,360 with a buy price of 11,361.5 and a sell price of 11,258.5.
Then you can buy 100 NASDAQ 100 CFDs at the buy price of 11,361.5.
Let’s say one NASDAQ 100 CFD is worth $10, and the index’s price increases to 11,370 (buy at 11,371.5 and sell at 11,368.5).
If you sell your CFDs at 11,368.5, you can make a profit of $7,000 ((11,368.5 – 11,361.5) x $10 x 100 CFDs).
Types of Stock Trading
There are two primary types of stock trading:
- Active trading: Active traders usually place ten or more trades per month. The trader often uses a strategy that relies on market timing to try and take advantage of short-term market fluctuations based on company-level events to turn a profit.
- Day trading: A day trader aims to make some cash in the next few minutes, hours, or days according to daily price fluctuations.
Investors who like a bit of activity, such as buying, selling, and holding their stock positions in a single trading day will likely employ this strategy.
How to Trade Stocks
If you’re trying out stock trading for the first time, start by keeping things simple. Consider investing in a diversified portfolio of low-cost index funds to achieve long-term performance.
With this consideration, you can start trading stocks by following these five steps:
Open a Brokerage Account
To begin stock trading, you must fund a brokerage account that’s designed to hold investments. If you don’t have an account, open one with an online broker, which should take a few minutes only.
Opening an account doesn’t mean investing money immediately. However, having an account gives you the option to invest when you’re ready.
Set a Stock Trading Budget
Consider allocating no more than 10% of your portfolio to a single stock. Budgeting more than that amount can start exposing your savings to higher volatility.
Another suggestion is to begin saving $200 a month. When you reach $1,000, you can invest $500 of that into different stocks. Keep the uninvested $500 as a buffer for emergencies.
Moreover, you should invest only the money you can afford to lose. In other words, don’t use the money you’ve budgeted for essential expenses like household bills or tuition.
Learn to Use Market and Limit Orders
After opening a brokerage account and funding it, you can use your broker’s trading platform to place stock trades.
When you buy stocks, you have two ordering options:
- Market order: Buy or sell stocks immediately at the best available price.
- Limit order: Buy or sell stock at a specific price you set. The limit price is the most you’re willing to pay. The order pushes through only if the stock’s price hits that amount.
Measure Returns Against an Appropriate Benchmark
When measuring results, consider using an appropriate benchmark, like indices, to determine your stock’s performance.
If an investor can’t outperform the benchmark, investing in ETFs (exchange-traded funds) or a low-cost index mutual fund should make more financial sense since these funds’ performance closely aligns with those benchmark indices.
Maintain Your Perspective
Being a successful trader or investor doesn’t mean finding the next breakout stock before others do.
Even if you think it’s too late to make a quick profit, you can still benefit from great investments because they deliver shareholder value for years.
If you’re into active investing, you should treat it as a hobby rather than a get-rich-quick scheme.
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How to Manage Stock Trading Risks
Regardless of where you are on the investor-trader spectrum, consider these four tips on how to trade stocks safely:
Lower Risk by Building Positions Gradually
Take your time to buy assets through low-risk methods like dollar cost averaging to reduce your exposure to price volatility.
You should look into high-dividend stocks that pay a portion of earnings to investors or invest in ETFs to allow you to spread your risk across multiple companies.
Ignore Hot Tips
Individuals posting on online stock-picking forums and paying for sponsored ads promoting sure-fire stocks are likely part of pump-and-dump schemes. These individuals may buy many shares in a thinly traded, little-known company and hype it up online.
Then, as unsuspecting investors buy shares and drive prices up, these suspicious individuals dump their shares, cash in their profits, and send the stock’s value to crash.
Keep Good Tax Records for the IRS
If you don’t have an account with a tax-favoured status like a 401(k), your taxes on investment gains and losses can become complicated.
The IRS (Internal Revenue Service) implements different tax rates, rules, and tax forms for different trader types.
So if you sell stocks and make money from the activity, set aside extra cash for your tax bills.
Where to Trade Stocks
First, you need a broker before you can trade stocks. You should choose one with the terms and tools that align with your experience and investing style.
Investors new to trading should also choose a broker who can teach the trade tools through educational articles, in-person seminars, and online tutorials.
Other features to consider are the availability and quality of analysis tools, easy order entry, and customer service.
The Financial Markets: What Are They?
Financial markets are where buyers and sellers come together in a fixed place called an exchange and at the specific opening and closing times.
Prices are determined purely by the interaction of the buyers and the sellers.
The financial markets trade in those instruments such as equities (shares), indices of equities (derivatives), bonds, commodities like crude oil and gold, and currency pairs.
An Increase in Demand Is an Increase in the Price
To illustrate how this concept works, let’s take buying food as an example.
For example: 50 people enter the market and want to buy apples, but the stall owner only has 40. The buyers offer to pay more for the goods to ensure that they will get the apples before the stock runs out.
So the stall owner can raise the price because they know there’s more demand for the apples than his supply.
An Increase in Supply Is a Decrease in the Price
Using the same example, suppose another stall owner enters the market and has more apples to sell. The apple supply has now increased significantly.
The newly arrived stall owner can consider selling apples cheaper than the first stall owner to entice customers, who will probably want to buy at a lower price.
In this case, the first stall owner will likely decrease their price.
Application to the Financial Markets
The supply and demand concept is the same in the financial world. So if a company posts positive results and pays attractive dividends, more people will want to buy the company’s shares. This increased demand can lead to a share price increase.
The following are the latest trends regarding international trading:
- Forced dynamism, wherein international trade gives way to trends shaping the global political, economic, and cultural environment
- Cooperation among countries
- Growth in emerging markets
- Sharing of technology
- Liberalisation of cross-border movements
- What is trading in simple terms?
Trading is exchanging one item for another. In other words, trading is buying and selling something or exchanging goods for money.
- Can you trade stocks with $100?
You can trade stocks for as low as $100 depending on your investment strategy and whether your broker allows trading that amount.
- Do day traders make money?
Day traders can make money depending on their trading preferences and risk management strategies.
- What time can I start day trading?
International markets have varying schedules and trading hours. The NASDAQ 100 CFD is open from 1:00 AM to 11:59 PM.
- How do you make money with options trading?
Options are contracts that give you a right, without obligation, to buy or sell financial instruments at a specific amount, price, and date.
So if you buy low and sell high with these conditions, you can make money with options.
- What stock trading strategy is good for beginners?
Take your time to buy assets through low-risk methods like dollar cost averaging to reduce your exposure to price volatility.
Try looking into high-dividend stocks that pay a portion of earnings to investors or invest in ETFs to allow you to spread your risk across multiple companies.
Sign up for an account today and start your trading and investing journey with Zenfinex. We provide in-depth market analysis and video tutorials to help you learn more about trading and receive insights from our team of expert analysts.
- Market capitalization of all companies trading on the London Stock Exchange (LSE) from January 2015 to September 2022
- Investing vs. Trading: What’s the Difference?