Stock trading can be a profitable activity. But successful investors must be very diligent, dedicating real time and resources to learn how to make money trading stocks to avoid losing their own capital.
According to an analysis of trading data of more than 80,000 traders by CuriousGNU, a data and visualisation website, a whopping 80% of stock day traders post a median loss of -36.30% over the course of a year.
While excitement about the success of other traders has likely brought you to this page, investing in stock markets might be intimidating to you. And so, this is a good reason to dive into this article and be better prepared.
Serious stock investors will need a wide range of economic knowledge, investment strategies, and emotional intelligence to make money in the stock trading world.
Bernard Baruch, a brilliant trader and investor, once said: “If you are ready to give up everything else and study the whole history and background of the market and all principal companies whose stocks are on the board as carefully as a medical student studies anatomy; if you can do all that and, in addition, you have the cool nerves of a gambler, the 6th sense of a clairvoyant and the courage of a lion, you have a ghost of a chance.”
Sarwa wants to prepare you: WIthout the basic prerequisite knowledge of how a stock market truly works and diligent self-education, most traders will quit.
According to a 2010 study from the University of California, Davis, 80% of day traders quit within the first two years, with only 1% of them making a profit net of fees.
Let’s face it: In the stock market, even just knowing the basics won’t always cut it.
In this article, we take you on a deep dive into certain strategies to implement in your stock trading journey. We’ll consider:
- What is stock trading?
- Types of stock trading
- How to make money trading stocks in 7 steps
- Where to start stock trading
At the end of this article, you will have some of the most important prerequisite knowledge for how to start stock trading and how to make money online trading.
[Want to learn how to invest in stocks? Schedule a free call with one of Sarwa’s wealth advisors, and we’ll guide you to find the best personal investment strategy to use our investment app Sarwa Trade.]
1. What is stock trading?
Simply stated, stock trading is the buying and selling of the stocks of companies. This buying and selling can take place on a stock exchange or on an OTC (over-the-counter) market.
A stock is a portion of ownership of a company that is made available to individual and institutional investors. When you purchase a stock, you have a stake in the company’s equity that corresponds to the number of shares you own.
To understand stock trading, it’s important to differentiate it from stock investing. While the stock investor is looking to profit from buying and holding a stock for a long period, a stock trader wants to profit more frequently from the short-term fluctuations of the stock.
Said differently, a stock investor waits for the company to grow its price through constant and consistent earnings (and profit from that) while the stock trader is more concerned about the short-term demand-and-supply driven fluctuations in price.
2. Types of stock trading
Though all stock trading, contra stock investing, involves taking small and frequent profits, we can also differentiate between different types of stock trading.
Day trading is a form of stock trading where traders open and close a position within a day.
Opening a position can mean either going long on a stock (buying a stock with the expectation of a rise in price) or going short (borrowing a stock from the broker and then selling it with the hope that the price will fall so you can buy it cheaper later and return it to the broker).
In short (no pun intended): closing a long position means selling the stock you bought and closing a short position means purchasing a stock so you can return it to the broker.
Swing traders stay in a position for more than a day. They enter into a position, then set a target price where they expect to take profit and another target price where they expect to cut short their losses if the trade goes against them (stop loss). It may take days or even weeks before the stock hits either the target price or the stop loss.
Position traders are trend traders. There are two types of trends in stock trading — upward and downward trends. An upward trend occurs when the price of a stock is rising (the charts are showing higher highs and higher lows) and a downward trend occurs when the price is falling (the charts are showing lower highs and lower lows).
A position trader enters a long position at the beginning of an upward trend and a short position at the beginning of a downward trend. He then waits until the trend is about to change before closing his position.
In the chart above, a position trender will take a long position on July 13, for example, and only close the position somewhere between November 23 and 30 when a candlestick pattern shows that a reversal is imminent. Similarly, a position trader will take a short position anywhere between November 23 and 30 and wait till February 15 when the candlestick pattern shows that a reversal is imminent.
Scalping involves quickly profiting from the bid-ask spreads that occur due to fluctuations in the supply and demand of a stock.
In this system, a trader can take many positions in a day and exit them within a few minutes or hours. The focus is on profiting from small movements in stock prices. By taking many positions, the small movements in price can add up and become significant.
Deciding between these four types of stock trading will depend on your trading goals.
Do you need to make money daily, or do you prefer to wait for days and weeks? Similarly, do you want small profits that add up (like in scalping) or you prefer to wait for a trend to end and take a more significant profit at once (like in position trading)?
3. How to make money trading stocks in 7 steps
Whichever stock trading type you choose, you still need to learn strategies on how to trade stocks so you can make money from them.
It’s important to say here that every stock trader, even the most experienced ones, can lose money. What sets successful traders apart is that they make money more times than they lose it, and they can set up a win that brings in more money than a loss will take away.
A. Understand the stock market and go with what you know
Warren Buffet once said that “the most important investment you can make is in yourself.”
Consequently, the first step to take if you want to know how to make money trading is to better understand the stock market.
Aside from reading Sarwa’s blog and as many books as you can get your hands on about the stock market, you also need to gain knowledge and inspiration from the success stories of successful investors and traders.
Additionally, and especially for our purpose, Buffett has also said, “never invest in a business you cannot understand.” So, you should understand exactly what the business model and industry you are investing in, as well as how much you understand about how the overall stock market functions.
Another way to go about it is to start with what you know best. Literally. People buy certain stocks because they believe in the industry, or in the company, and that they have a better understanding of what they are trying to do. Ask yourself which industries you know most about.
B. Try: Build confidence with demo and fractional trading
To help stock traders perfect their strategies and reduce the risk of losing their money, some platforms allow you to trade with virtual money, a process called demo trading.
Before learning how to trade stocks with real money, you can start with a demo account. Use demo trading to perfect your strategy — identify the reasons you lose money and come up with a plan to stop them.
One way to reduce your risk while perfecting your strategy is to invest a little amount through fractional trading.
With fractional trading, you can buy a fraction of the share of a company. If the share of a stock is $100, this means you can buy 1/10th of a share for just $10. So, instead of working with a demo account, you can get your feet wet in the real market with just a small amount of money.
C. Fundamental analysis: A brief guide for what to look for when picking quality stocks
According to Warren Buffett, “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
Companies with good fundamentals will increase their earnings over time, and increased earnings will cause the market price to rise.
So, what should we be looking for?
First, ensure that the company has enough of a competitive advantage to maintain or increase its market share in the industry (or industries) where it operates.
If a company is losing market share, sales will reduce and drag earnings (income) down with it. On the other hand, if market share is increasing, sales and earnings are rising. Even if market share is the same and the entire industry is growing, sales and earnings will still rise.
One way to know if a company has a true competitive advantage is to look at its returns on earnings (net income/equity) and profit margin (net income/sales). You want these numbers to be increasing over time, as well as to be equal or better than the industry average.
Also, you want to ensure the company is not at a risk of short-term liquidity problems or medium-term/long-term bankruptcy. Therefore, you have to evaluate its current assets-over-liabilities ratio, as well as the debt-to-equity ratio. You’ll want the former to be increasing over time and the latter to be decreasing over time. However, in this case, a cross-sectional analysis — comparing these figures to industry averages — is better than a trend analysis — comparing them to historical figures since some industries use more leverage than others.
Overall, you want to choose companies that are increasing their sales and earnings and requiring less debt to do it over time. Those are companies with a clear competitive advantage, which means strong fundamentals.
D. Technical analysis: Learn how to read stock trading charts
Now, this section might be a bit long. Bear with us. It’s good to understand some of these stock trading concepts. You will then have a better understanding of what research shows works best when it comes to chart reading.
Learning how to trade stocks does not stop at picking the right ones. While fundamental analysis tells you which stocks to buy, technical analysis tells you when to buy them.
For long positions, stock traders buy when the price is low and wait for the price to rise to take profit. On the other hand, for short positions, stock traders sell when the price is high and wait for the price to fall to buy back.
To find the right time to enter, you will need to do technical analysis. There are three basic elements of technical analysis:
Charts and candlesticks
Charts are visual representations of the price movements of a stock over a defined period.
You can set up a chart that represents price movements for the past day, week, month, quarter, etc. Day traders and scalpers focus on the daily chart, swing traders focus more on daily and weekly charts, and position traders will look at the weekly and monthly charts.
The two major types of charts are line charts and candlesticks. The former is a visual representation of the close price of the stock for a defined period. All the close prices for that period are visualised through a line that connects all the price points. A price point can represent the close price after a 1-min, 5-min, 15-min, 30-min, 1-hour, 5-hour, or 1-day interval. Day traders and scalpers focus more on shorter intervals (1-min, 5-min, 30-min, 1-hour) while swing traders and position traders tend to focus more on the longer intervals (5-hour, 1-day).
Sample Line Chart of Amazon Stock From January – October 2018
Source: Perkins e-learning
While the line charts are good at showing the trend of a stock price over a period, candlestick patterns contain more information which will help you identify current trends and predict future ones.
Basically, a candlestick chart represents the prices (opening price, closing price, highest price, and lowest price) of stocks as candlesticks. The body of the candlestick depicts the opening and closing price while the wick of the candle represents the highest and lowest price.
There are two types of candles: green candles and red candles.
For a green candle, the stock closed at a price higher than the opening price, which means the upper part of the body is the closing price and the lower part is the opening price. On the other hand, for a red candle, the stock closed at a price lower than the opening price, which means the upper part of the body is the opening price and the lower part is the closing price.
Source: Warrior Trading
What then is the use of candlesticks?
First, candlesticks, like line charts, can show how a stock is trending. If the candlesticks are showing higher highs (the highest price of the current candlestick is higher than the highest price of the previous) and higher lows (the lowest price of a current candlestick is higher than the lowest price of the previous), the stock is in an uptrend. If, on the other hand, there are lower highs and lower lows, the stock is in a downtrend.
Uptrend and downtrend on a candlestick chart
The trend of the stock will determine if you will go long (in an uptrend) or short (in a downtrend).
Second, candlesticks can help you predict future trends. Over time, traders have identified certain candlestick patterns that show when a trend will continue or when there will be a reversal (downtrend is about to become an uptrend, and vice versa).
There are many candlestick patterns available. Binance, a cryptocurrency trading platform, has an in-depth explanation of 12 of the most popular trend continuation and reversal candlestick patterns that you can consider.
A moving average shows the mean price of a stock over a defined period. Moving averages are plotted as a sort of line chart overlapping the candlesticks.
Source: IG Charts
In the above chart, the blue, red, and light-green lines across the candlesticks are moving averages.
There are two types of moving averages: simple and exponential.
A simple moving average takes the average of all stock prices within a specific period without regard for the most recent prices. On the contrary, an exponential moving average puts more weight on the most recent prices. The most popular simple moving averages are the 50-MA (50 days moving average), 150-MA (150 days moving average), and 200-MA (200 days moving average). For the extended moving averages, the common ones are the 9-EMA and 12-EMA.
But how do moving averages help you trade?
Basically, they can also help you to identify or clarify trends. When a higher moving average (e.g. the 150 MA or the 12 EMA) is above a lower moving average (e.g. the 50 MA or 9 EMA), there is a downtrend, and vice versa.
While indicators also show trends, they are primarily used to determine if a stock is being overbought or oversold. When a stock is being overbought, its capacity for a further price increase is minimal. And when it is being oversold, its capacity for a further price decrease is minimal.
The common indicators are:
- Relative Strength Indicator (RSI): The RSI ranges from 0 to 100. Figures above 70 are indicators of an overbought situation while figures below 30 are indicators of an oversold situation.
Source: IG Charts
- Stochastic Oscillator: The stochastic oscillator, like the RSI, also ranges from 0 to 100. Here, figures above 80 show that the market is overbought while figures below 20 shows that it’s oversold.
Source: IG Charts
- Bollinger Bands: They show the volatility of a stock over a defined period. When the bollinger bands are too far from each other, it represents high volatility. When prices are above the upper line of the bollinger band, traders interpret it as an overbought condition and when prices are below the lower line, traders construe it as an oversold condition.
The two red lines in the chart below are bollinger bands.
Source: IG Charts
- Moving Average Convergence Divergence (MACD): MACD shows the changes in the momentum of a stock by comparing two moving averages (simple or exponential). Convergence shows that two moving averages are coming together, hence a decreasing momentum, while divergence shows they are growing apart, hence an increasing momentum.
Source: IG Charts
E. Create and stick to your strategy: The wait game
A big part of learning how to make money online trading depends on creating a solid strategy.
Your stock trading strategy will determine how you decide to enter into a trade. For example, which candlestick patterns will you use to predict future trends, which moving averages will you use to identify trends, what relationship must the moving average have with the candlesticks to indicate a good entry point, which indicators will show if the stock is overbought or oversold, how do you determine support and resistance, and how do they impact your decision?
A good trading strategy will have specific and comprehensive criteria for entering a trade.
Moreover, a good trader will always stick to their strategy. “Never, ever argue with your trading system,” said Michael Covel, author of The Little Book of Trading.
If all your criteria don’t fall into place, then don’t take the trade. Taking a trade due to the pressure of other people commending the trade is risky. As Warren Buffet said, “The most important quality for an investor is temperament, not intellect.” So learning to keep your emotions in check and to go with the strategy you have chosen can be among the most important assets you have.
“There is a time to go long, a time to go short, and a time to go fishing,” said Jesse Livermore, the pioneer of day trading. In other words, you don’t have to place a stock trade when your strategy tells you not to.
“If most traders would learn to sit on their hands 50 percent of the time, they would make a lot more money,” according to Bill Lipschutz, director of portfolio management at Hathersage Capital.
Of course, you can change a strategy if it’s no longer working for you. However, changing a strategy is different from ignoring a strategy to take a risky trade. If you need to change a strategy then you should stop trading, rework the strategy, and then resume trading with the new strategy. When the new strategy is in place, you must also ensure you don’t take any trade unless your strategy gives you a go-ahead.
F. Diversify your capital: Buy many quality stocks
Even the best strategies are not flawless. However, as said above, the important thing is to win more times than you lose and for a win to bring in more money than a loss will take away.
A good way to do this is to reduce your risk through diversification. Diversification, in essence, is a strategy that dictates that you should not put all your eggs in one basket. Instead of buying a single stock or two stocks, you should trade many quality stocks (with good fundamentals) so as to reduce your overall risk.
For investors, this means buying stocks that are negatively correlated; however, for traders, it means implementing a good risk management system.
Ray Dalio, goes by three general rules:
- “Diversifying well is the most important thing you need to do in order to invest well.”
- “Don’t make the mistake of thinking those things that have gone up are better, rather than more expensive.” (A nice reminder that past performance is no guarantee of future results.)
- “Do the opposite of what your instincts are.” (Or put in another way: Buy when others are fearful, sell when everyone is greedy.)
Risk management helps to reduce the amount you can lose when you take a losing trade by ensuring you only invest a small portion of your capital in any particular stock.
For example, if your trading capital is AED 10,000, you can’t put a significant part of that in just one trade. Instead, maybe only 1% to 5% of your capital will go into any single stock; indeed, a common guideline from investment professionals is to not invest more than 5% into any one stock.
So, for Stock A, no matter how confident you are in the trade, you are only putting between AED 100 and AED 500. This helps you to diversify your risk into various stocks such that one loss will not significantly burn your capital.
“I have two basic rules about winning in trading as well as in life,” said Larry Hite, founder of Hite Capital Management, a hedge fund. “One. If you don’t bet, you can’t win. 2. If you lose all your chips, you can’t bet.” Never lose all your chips. Or as Marty Schwartz, author of Pit Bull: Lessons from Wall Street’s Champion Day Trader, puts it, “The most important thing in making money is not letting your losses get out of hand.” Diversify, diversify, and diversify.
Also, you need to ensure that when you take a trade, what you will gain from winning is higher than what you will lose if you fail. For example, if you trade with AED 100, you must ensure that what you will gain is at least 1.1X what you will lose if the trade fails.
Similarly, ensure that you never lose all your money in a losing trade by setting a stop loss. A stop loss is a target price which signifies that you should exit a trade to avoid further losses. Your trading strategy must include how you determine your stop losses. Therefore, the maximum amount you can lose is the difference between the price you entered and your stop loss target price. So, the amount of profit you expect to make must be at least 1.1X that possible loss.
G. Measure your performance
“What gets measured gets managed,” said Peter Drucker, the father of modern management. Learning how to make money trading stocks thus requires you to keep a tab on every trade you take and how it turns out.
Remember that the way you make money stock trading is to ensure that your wins outweigh your losses. To know that, you must keep updated records of your performance.
Once you can measure, then you can manage. A way to manage is to perfect your trading strategy. Why are you making losses? How can you avoid or minimise those losses? What needs to change in your strategy for better results?
A good thing to do is to learn from other more successful stock traders. Nevertheless, avoid being a clone. Learn from their strategy and use the good points you find to perfect yours instead of swallowing it hook, line, and sinker.
4. Where to start stock trading
Once you have a strategy in place, you can now move on to how to begin trading stocks by choosing the right trading platform.
There are many trading platforms available, some local and some international; therefore, you need to ensure you are choosing one with the best offerings for you.
Below are some of the most important factors to consider when choosing a trading platform:
Low minimum capital requirements
Some trading platforms will require that you have a minimum amount in your account before you can trade.
However, if you are learning how to start trading stock as a beginner, then you might not have the confidence yet to start with a large amount. Also, even if you have the confidence, your capital might not be up to the required minimum. Hence, it’s better to go for platforms that don’t have any minimum capital requirements.
Another factor especially important if you are learning how to start trading stocks as a beginner is that the platform allows you to do fractional trading. Fractional trading allows you to buy a fraction of a share of a company. So if you are interested in Apple (AAPL) but you don’t have $144 to buy a full share of the company, you can buy 1/10 of the stock for $14.
Fractional trading is also important for risk management or diversification purposes. By purchasing fractions of many stocks instead of a single share of one expensive stock, you can diversify and reduce your risk.
A good trading platform will provide you with a well-designed platform or dashboard where you can monitor all of your trades and evaluate your portfolio in one place.
More important in cyberspace is the presence of good bank-level SSL security to protect your data and capital. If the platform is not forthright about the protection they provide, call or email them to ask. Don’t trade on any platform where you are not sure of your safety.
Access to good customer support is also essential. A good trading platform will provide multiple options including phone calls, emails, social media, live chats, etc. Also, ensure the customer support staff are respectable and friendly.
When you open and close a position, trading platforms will charge you a commission or trading fees. The fees you pay will eat into your profit or increase your losses, so it’s essential you look for the lowest-fee trading platform available (without ignoring the other factors, of course).
Sarwa Trade is a trading platform in the UAE that is commission-free with no minimum capital requirements. We have dependable customer support, a well-designed platform/dashboard, bank-level SSL security, and we allow you to buy fractions of a share on our new trading platform.
If you are ready to implement the trading strategy you have created above, register on Sarwa Trade and you can begin to enjoy amazing features designed to help you achieve your trading goals.
Sarwa is a UAE-based investing platform and offers local accounts with an international reach. This means that we allow local residents to access global markets, without added international transfer fees.
- Stock traders focus on earning frequent short-term profits while investors focus on long-term profits.
- One can be a day trader, scalper, position trader, or swing trader, depending on financial goals.
- To properly learn how to make make money trading stocks, you must understand the stock market, choose the right stocks, diversify, stick to your strategy, and measure your performance.
- Your success also depends on the trading platform you use. Use a broker with cheap or no commission fee, bank-level SSL security, no minimum capital requirements, good customer support, well-designed dashboards, and a provision for fractional trading.