There might be a product you use so much that your friends and relatives say you should buy stock in the company. If you’re like most people, though, you probably won’t.
It’s rare for investors to hold individual stock. Federal Reserve data show that less than 14% of families invest this way. In most cases, people are investing in stocks indirectly, through mutual funds or index funds.
But if you’re itching to get hands-on with some active stock trading, this guide will help get you started.
1. Decide if this is the right strategy for you
The majority of 401(k) plans don’t allow participants to purchase individual stocks — instead, investors choose from a selection of mutual and index funds. Both give investors a mix of stocks or other securities, which is less risky than individual stock trading. After choosing which funds to invest in, the account holder is largely hands-off.
Trading individual stock not only carries more risk, it requires more effort than investing in mutual or index funds. You need to actively watch your positions and understand whether and how to react to market moves. This is not the kind of risk most retirement investors want to take on.
But if you’ve maxed out 401(k) matching dollars from your employer and you’ve also started investing in an IRA, you can typically buy and trade stocks within that account. Trading within an IRA can be beneficial: Because these accounts are tax-advantaged, taxes on capital gains will be deferred or avoided completely.
If you’ve contributed the annual maximums to a 401(k) and an IRA, you are likely on track to meet retirement goals and willing and able to take more risk by stock trading, so you might want to open a taxable brokerage account with an online broker and trade within that account.
2. Get an education
Before you trade anything, learn everything you can about investing and the markets.Mistakes can be costly.
Also, most brokers offer their own educational centers and a staff of former traders or investment advisors who can guide you. Some brokers, such as TD Ameritrade andOptionsHouse, offer their clients paper trading, a simulation of trading that is a great way to practice without money or risk involved.
3. Select an online broker
Once you have a better handle on what you’re doing, you’ll also have some idea of what you need in an online broker. Consider what sort of stock trading software is the best fit.New traders will want a platform that is streamlined, easy to navigate, and incorporates how-to advice and a trader community of peers to help answer questions.
Other considerations in choosing an online broker include how often you plan to trade — which will affect expenses — and what level of research and tools you expect.
In general, beginner traders should prioritize customer support, educational resources, and account and trade minimums over things like commissions — which run between $4 and $12 per trade — particularly because you probably won’t be trading frequently. If you do start trading more often, you can always move to a lower-cost broker.
4. Start researching stocks
Your account is open, and you’re ready to start investing. What’s next? Picking stocks, of course, and that’s the hairy part.
Most traders start by doing a thorough analysis of a company, looking at public information including earnings reports, financial filings and SEC reports, as well as outside research reports from professional analysts. Much of this should be provided by your broker, along with recent company news and risk ratings.
Start slowly, picking one or two stocks and investing a set amount of money that you are prepared to lose. You can plow gains back into the stock — or into other companies — but don’t add more money to the pot until you know what you’re doing and can put research into other companies.
5. Make a plan and stick to it
Investing can be emotional, particularly for those new to the game. Losing money doesn’t feel good, and it’s easy to panic and pull out at the wrong time. It’s also easy to get swept up in the excitement of what feels like a winning stock.
That’s why it’s important to plan how much you want to invest at what price, and determine how far you’re willing to let a stock fall before you get out. Using the right type of trade order can help you stay on plan and avoid emotional responses. For example, stop-loss orders trigger a sale if a stock drops to a certain price, which can minimize risk and losses.
The bottom line
You don’t need to engage in stock trading to accumulate a nest egg. The best way to build wealth is by saving early and often, then investing that money in a diversified portfolio that takes an appropriate amount of risk for your age. But if you’re keen to trade, go into it slowly with a base of knowledge and awareness of potential risks.