How to Trade Stocks: Share CFD Trading for Beginners

Before we dive in, it is important to recognise the distinction between traditional stock trading and trading share CFDs (Contracts for Difference) with Plus500. Trading share CFDs and trading shares on the cash market differ in several key aspects.

Firstly, when trading share CFDs, traders do not own the underlying asset but instead speculate on its price movements. In contrast, trading stocks on the cash market involves the actual ownership of shares, entitling investors to dividends and voting rights. Secondly, trading CFDs allows for leverage, enabling traders to control larger positions with a smaller amount of capital, whereas trading shares on the cash market requires the full purchase price upfront. However, leverage amplifies both profits and losses, making CFD trading inherently riskier.

Introduction to Stock Market Basics

The stock market encompasses various exchanges and over-the-counter (OTC) marketplaces where publicly held company shares are traded, all governed by specific regulations. Often used interchangeably with the term "stock exchange," traders engage in the sale and purchase of shares within the purview of these markets. Furthermore, they serve as collective platforms for price discovery and reflect the overall economic climate, offering participants fair pricing, liquidity, and transparency.

In the primary market, companies issue shares to the public via processes like initial public offerings (IPOs), enabling them to raise capital. Through this, companies divide their ownership into shares and sell them to investors, potentially issuing additional shares later through various offerings or repurchasing shares. Investors participate, expecting share value appreciation or dividends. The stock exchange facilitates this capital-raising process, earning fees from companies and their financial partners.

Additionally, investors may choose to utilise stock exchanges to trade securities they already own in the secondary market.

• The stock market encompasses various exchanges and over-the-counter (OTC) marketplaces where publicly held company shares are traded, offering fair pricing, liquidity, and transparency.
• Understanding stocks and shares involves recognizing that stocks represent ownership in a corporation, entitling shareholders to a portion of assets and profits commensurate with their stake.
• Stock markets work as collective platforms for investment activities, facilitating transactions between buyers and sellers dealing in shares of publicly traded companies, with market indexes providing insight into overall market performance.
• Stock trading strategies for beginners include day trading, swing trading, and position trading, each offering unique approaches to trading securities within varying time frames, with associated advantages and limitations.

What Are Stocks and Shares?

A stock, also known as equity, represents ownership in a corporation, with units referred to as "shares." Owning shares entitles individuals to a portion of the corporation's assets and profits commensurate with their stake. These securities are primarily traded on stock exchanges and form the cornerstone of many investors' portfolios, subject to government regulations aimed at safeguarding against fraudulent activities.

Corporations issue shares to generate capital for their operations, with shareholders holding a claim to the company's assets and earnings. The extent of ownership is determined by the number of shares owned relative to the total outstanding shares. For instance, if a company has 1,000 shares and an investor holds 100 shares, they possess a 10% claim on the company's assets and profits.

While shareholders are not owners of the corporation in a legal sense, corporations are treated as legal entities with distinct rights and responsibilities. They can file taxes, borrow funds, own property, and be subject to legal actions. This legal framework ensures that corporate assets are separate from those of shareholders, thereby limiting liability. In the event of bankruptcy, a shareholder's personal assets remain protected, though it is likely that the value of their shares will lose most, if not all, of their value. Similarly, major shareholders cannot liquidate company assets to settle personal debts.

How Stock Markets Work?

The stock market encompasses various marketplaces where securities such as shares and bonds are traded, offering accessible and transparent avenues for investment. It serves as the primary hub for investment activities, facilitating transactions between buyers and sellers dealing in shares of publicly traded companies.

Terms like "the stock market" and "Wall Street" encompass the entirety of securities trading, including stock exchanges where public company shares are listed and other markets for trading different securities. The New York Stock Exchange stands as the largest such market globally.

Market indexes such as the S&P 500 and the Dow Jones Industrial Average (USA 30) amalgamate stock prices, providing insight into the overall performance of the stock market on a daily basis.

Functionally, the stock market enables companies to raise capital by selling shares of stock, fostering wealth creation for individual investors. Companies use the stock market to secure funding for their operations by offering ownership stakes through shares of stock. Listing shares on stock exchanges grants them access to necessary capital without resorting to debt. In return for this opportunity, companies are obligated to disclose information and involve shareholders in business decisions.

Investors engage in the stock market by exchanging money for shares, benefiting as companies utilise capital to expand and increase their value over time, resulting in capital gains for investors. Additionally, companies distribute dividends to shareholders as profits grow.

Important Stock Trading Terms

Getting a handle on the common lingo used among stock traders is important for any market novice. Let’s take a look at some of the terms you’re most likely to bump into at the beginning of your trading journey:

Bear Market - In layman’s terms, the stock market can be understood as being in ‘bear territory’ when share values have come down from a recent high, usually by about 10-20%.

Bull Market - Conversely, a bull market is when share values are on a consistent uptrend from a recent point and the market mood is positive.

Ask - An Ask Price is the highest price the buyer of a security, such as a stock, is willing to pay for its ownership.

Bid - On the other hand, the Bid Price is the lowest price for which a seller of the given security is willing to let it go for.

Blue-chip Stock - Blue-chip stocks are shares of firms that generally draw positive market sentiment. Typically, these companies boast extensive operational histories, consistent earnings, and a tradition of distributing dividends to shareholders. With market capitalizations sometimes in the billions of dollars, blue chip entities typically dominate their respective industries. Because of their stability and potential for solid returns, shares of companies like IBM (IBM), Coca-Cola (KO), and Microsoft (MSFT), among others, are often considered blue chips.

Dividend - Stock dividends are payments in the form of stock or cash issued by companies to their shareholders.

Stock Market Orders

An ‘order’ is the instructions an investor gives to their broker or brokerage firm to sell or purchase a security. Accordingly, understanding the differences between the different order types is crucial when stock trading, as they can yield widely disparate results. Three primary order types—market orders, limit orders, and stop orders—serve distinct purposes, and knowing when to utilise each is key.

Market

Firstly, a market order is employed to buy or sell a stock at the current best available price in the market. This type of order guarantees execution but not a specific price. Market orders are ideal when immediate execution is paramount, such as when a stock is deemed appropriately priced, or when a swift fill is desired. When considering the timing of these orders, market orders should generally be placed when the market is open to ensure execution at current prices. However, it's important to note that stock prices can fluctuate rapidly, especially between market sessions, due to various factors such as earnings releases or unexpected events impacting the market.

Limit

Conversely, a limit order imposes restrictions on the maximum price to be paid (for a buy limit) or the minimum price to be received (for a sell limit). It ensures execution only at the specified limit price or better, offering control over the trade's price. This type of order is suitable when anticipating buying at a lower price or selling at a higher one compared to the current quote.

Stop

Stop orders come into play when a stock reaches or surpasses a predetermined price, triggering a market order. This type of order is used to protect unrealized gains, limit losses, or capitalise on potential price movements. A sell stop order, often referred to as a "stop-loss" order, is placed below the current market price to guard against losses, while a buy stop order is set above the market price to capture potential upward momentum.

It's essential to understand that stop orders may not guarantee execution at the specified price, especially if market conditions change rapidly. They offer a means to automate trades based on predefined conditions but do not eliminate all risks associated with market fluctuations.

Researching and Choosing Stocks

Embarking on your investment journey can indeed feel overwhelming, but having some of the right strategies in place, can help you navigate the intricacies of the stock market with more confidence. It all begins with grasping fundamental principles like the P/E (price earnings) ratio that measures how expensive a company’s shares are and the health of a company's balance sheet. These are some of the building blocks that you should consider when making your investment decisions.

Moreover, take the time to reflect on your investment goals. Are you aiming for a steady stream of income, safeguarding your wealth, or chasing after capital appreciation? Each objective calls for a tailored approach to selecting stocks and constructing a portfolio that aligns with your aspirations. Remember, diversification is your ally, spreading risk across various sectors and asset classes can help safeguard against market volatility.

Stay attuned to market trends and economic indicators by actively engaging with financial news and industry developments. This not only keeps you informed but also empowers you to make better-informed decisions. As you delve into the world of stock picking, consider crafting narratives or "stories" behind your chosen investments. Grounded in qualitative research and thorough analysis, these narratives provide a deeper understanding of the potential behind your investment choices.

Practical strategies can greatly aid your stock selection process. Explore options such as utilising other asset types such as Exchange Traded Funds (ETFs), employing screening tools, and seeking insights from reputable sources. Corporate presentations offer valuable insights into a company's financial health and growth prospects, so be sure to scrutinise them closely.

Above all, never underestimate the importance of due diligence. Conducting thorough research is your best defence against potential pitfalls in the stock market. And remember, it's perfectly acceptable to refrain from making investments if the associated risks outweigh the potential returns.

By embracing these strategies and incorporating them into your investment approach, you'll find yourself better equipped to navigate the complexities of stock selection. With each decision informed by your financial objectives and backed by diligent research, you'll likely pave the way towards building a more robust investment portfolio tailored to your aspirations and goals.

Diversification

Diversification stands as a fundamental risk management strategy in the realm of investment, aiming to mitigate risk by spreading investments across a variety of assets within a portfolio. This strategy involves diversifying across distinct asset types and investment vehicles to limit exposure to any single asset type and assists in effective risk management. The underlying rationale is that a portfolio that contains a range of different asset classes offers both higher returns in the long run as well as lower risks.

To achieve diversification, investors often invest in different asset classes such as stocks, bonds, real estate, or cryptocurrency among other asset classes. Additionally, diversification can be achieved through various means, including investing in different countries, industries, sizes of companies, or term lengths for income-generating investments. The quality of diversification is typically assessed by analysing the correlation coefficient of pairs of assets, with the goal of ensuring that investments within the portfolio respond differently to market influences.

Understanding the concept of diversification involves recognizing that maintaining a well-diversified portfolio typically involves holding around 25 to 30 stocks; this number is believed by researchers to aid in risk reduction. The goal of diversifying your portfolio is to balance the negative performance of some investments with the positive performance of others.

Investors employ various diversification strategies, including diversifying across asset classes, industries or sectors, corporate lifecycle stages (growth vs. value), market capitalizations (large vs. small), risk profiles, maturity lengths, and physical locations (foreign vs. domestic). Each strategy offers unique benefits and considerations, contributing to the overall risk management of the portfolio.

While diversification offers numerous advantages, such as likely reducing portfolio risk and potentially increasing long-term returns, it also has drawbacks. Managing a diversified portfolio can be time-consuming and incur additional transaction fees and commissions. Furthermore, diversification may limit short-term gains and could overwhelm inexperienced investors.

Ultimately, the goal of diversification is to minimise unsystematic risk specific to individual investments, thereby enhancing the overall risk-adjusted performance of the portfolio. By understanding the principles and strategies of diversification, investors are more likely to navigate market fluctuations and build more resilient investment portfolios aligned with their financial objectives.

Trading Strategies for Beginners

For beginning stock traders, understanding different trading strategies is crucial to navigating the market effectively. Here we introduce three common strategies: day trading, swing trading, and position trading, each offering unique approaches to trading securities within varying time frames.

Day trading is a trading strategy where securities are bought and sold within the same trading day, aiming to profit from price movements in a security and closing all positions by the market close. While commonly associated with individual investors working from home, day traders also operate within large financial institutions like banks and hedge funds.

Day trading offers the potential for high profits per trade, with the flexibility to work from anywhere with an internet connection. However, it comes with high risk, as traders can lose significant amounts without a solid understanding of market trends and risk management. Emotional trading decisions and trading costs can also detract from potential gains.

Swing trading involves buying and holding securities for a short period, usually from days to months, to capitalise on short-term price movements. While offering reduced transaction costs and more time for analysis, swing traders must manage sudden market moves and maintain discipline to avoid emotional decisions.

Position trading, however, is used to refer to the strategy by which traders hold positions for a longer range of time, ranging from months to even years. While potentially offering higher gains and fewer transaction costs, position traders face exposure to sudden market events and limited liquidity.

Active trading strategies like day trading, swing trading, and position trading offer advantages such as high return potential, flexibility, and control over investment decisions. However, they come with limitations including high risk, time and effort required, transaction costs, emotional stress, and tax implications from short-term capital gains. It's crucial for traders to weigh these factors carefully and have a solid understanding of risk management concepts before engaging in active trading.

Traditional Stock Market vs. Share CFD Trading

Before delving into the world of share CFD trading with Plus500, it's crucial to understand the distinctions between traditional stock trading and trading share CFDs (Contracts for Difference). These two approaches vary significantly in several key aspects.

First and foremost, in share CFD trading, traders do not possess the underlying asset but rather speculate on its price movements. Conversely, engaging in stock trading on the cash market involves actual ownership of shares, granting investors dividends and voting rights. This fundamental difference in ownership structure sets the foundation for contrasting trading methodologies.

Secondly, share CFD trading offers the advantage of leverage, allowing traders to control larger positions with a smaller capital outlay. In contrast, trading shares on the cash market necessitates the full purchase price upfront. However, it's essential to recognize that while leverage can amplify profits, it also magnifies potential losses, thereby inherently increasing the risk associated with CFD trading.

Share CFD trading with Plus500 provides an avenue for speculating on the prices of publicly-listed companies traded on prominent exchanges like the New York Stock Exchange, London Stock Exchange, NASDAQ, and Tokyo Stock Exchange, without the obligation of owning the underlying stocks.

One notable feature of stock CFD trading is the utilisation of leverage, which allows traders to increase their market exposure using margin. This implies that only a fraction of the total trade value is required, offering potential opportunities for enhanced returns, albeit accompanied by increased risk.

In Conclusion

In conclusion, understanding the fundamentals of the stock market lays some of the groundwork for better-informed investment decisions. From grasping the intricacies of primary and secondary markets to delving into stock trading strategies suitable for beginners, individuals can embark on their investment journey with more confidence. Moreover, concepts like diversification can serve as indispensable tools in helping manage risk and maximising potential returns within investment portfolios. By embracing these principles and employing common trading strategies, beginners can better navigate the complexities of the stock market landscape, potentially positioning themselves for long-term financial success.

FAQs

What are shares, and how do they differ from stocks?

The term 'stocks' can encompass ownership in one or multiple companies, investor holdings, or a portfolio, while 'shares' specifically denotes ownership in a single company or a financial instrument.

How do I open an account to trade Share CFDs?

You can begin trading share CFDs by visiting our website or platform and completing the registration and account verification process. More information about the process of opening a Plus500 CFD trading account can be found here.

What are some common mistakes that beginners should avoid?

Some common mistakes that novice share traders should avoid include having unclear investment goals, not performing adequate research before investing, and not taking steps to diversify their investment portfolios.

What is the difference between fundamental and technical analysis?

Technical analysis takes longer-term trends in the trading volume and price of a given security, while fundamental analysis focuses on gauging the innate value of securities to gauge their intrinsic value.