Three online stock trading pitfalls to avoid

Online stock trading can be lucrative or lead to disaster. If you're thinking about dabbling make sure to be smart and avoid these three online stock trading pitfalls. 

Richard Drew/AP/File
Trader Richard Scardino, left, works on the floor of the New York Stock Exchange, Friday, Oct. 2, 2015.

If you think online stock trading is a ticket to early retirement, you should know that it’s hard for even professional investors to beat the market: Over the 10-year period ending in 2014, 82% of large-cap fund managers underperformed the S&P 500, according to the year-end S&P Dow Jones scorecard.

Even so, about half of U.S. retail investors trade at least once per month, according to State Street. Frequent trading can leave investors susceptible to costly landmines. To safely allocate a small portion of a diversified portfolio to stock trading, you’ll want to avoid the most common pitfalls.

1. High commissions

Commissions can add up if you trade frequently.

If you’re just dabbling in the market, consider using Robinhood, which offers commission-free trading for a large selection of U.S. stocks and ETFs. One drawback: The company currently supports only taxable brokerage accounts. Retirement investors should fully fund a 401(k) and an IRA before contributing to a taxable account.

If you’re trading more seriously, consider your needs, then select the lowest-cost brokerage that meets them. In general, you’ll pay more for an online broker that offers a premium trading platform and top-tier research and tools, such as TD Ameritrade, which charges $9.99 per stock or ETF trade. If you don’t need or want those features, a discount broker such as OptionsHouse or TradeKing, both of which charge only $4.95 per trade, might suit your needs.

2. Emotional reactions

Many experts advise separating emotions from investment decisions, one reason whydollar-cost averaging is a good strategy for many long-term investors. But research shows that even seasoned traders make emotional decisions.

The best way to keep your emotions in check is to make a plan and stick to it: Decide how much you want to invest, how much you’re willing to lose, and at what price you’ll get in and out.

Setting such a strategy can help you avoid chasing hot stocks. A rapid rise can mean other investors are moving out, and you risk buying at a premium before the stock falls.

3. Incorrect order entry

When it comes to trading, you can’t play the game unless you understand the lingo — and there’s a lot of lingo. If you don’t understand, you might place the wrong kind of trade.

The default option is a market order, which places a trade — to buy or sell — for the best price available. In most cases, though, it would be better to cap risk by using stop-loss orders and stop-limit orders, which set the prices at which you want to buy or sell a stock, then trigger orders when the stock hits that price.

Before you dive in, take advantage of free investor education resources. If you’re confused during the order process, reach out to a customer service representative at your online broker; many are registered investment advisors or former traders. (If you have the order placed for you, beware of broker-assisted trade fees).

The bottom line

Most investors do best with a diversified portfolio of low-cost index funds and little to no trading of individual stocks. But dabbling in the stock market with a small percentage of your investable assets can be fun and — in some cases — lucrative, provided you understand the risks involved, minimize commissions and plan to invest for the long term.

This article appeared first at NerdWallet.

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