Previously, when it came to stock trading, you had to be a broker to buy and sell shares in a company. As regular people, we would have to go through one of those brokers who would charge large fees for the service. Then as the world entered the internet age brokerages moved online and consumers could start making trades through the brokerage websites. And as the competition increased the prices dropped to where companies like E*Trade and TD Ameritrade started to charge from $4 to $7 per trade. The investing app Robinhood released in 2014 has become popular among new investors wanting to get involved in buying and trading stocks because they don’t charge a commission for trading shares in a company.
And now, the other brokerages are following Robinhood’s lead. TD Ameritrade, E*Trade, and Charles Schwab have all announced they will now offer commission-free stock trades.
For the consumer that means no matter what service we use, we now have easier access to the stock market, but it also means that for those of us who have not studied investing, we might get in over our financial heads. Thankfully, most of these now free brokerages offer services that we can utilize to make smarter investments.
Getting Caught in Momentum Trades
Log into any investing app and you will see news stories about different businesses. This can be a good or a bad thing. For a new investor, we can see a story about how company X did something well or received a new contract, and so we might think it is a good investment. Then with our free investing app, we buy a bunch of shares of the company expecting it to go up only for it to go down. The mistake made was not looking at the fundamentals of the business — is the business being run well, are the profits vs losses looking good, and what does the future look like besides that one piece of news.
As an investor, it is easy to get caught up in the momentum of a trade. We see a company’s share price going up and up and want to get in on the action, so we buy. Maybe we get lucky and it keeps going up, but maybe we don’t. A good investor looks at the long-term economic trend of a company, not just the short-term price fluctuation.
When buying and selling a market trade there can be a delay from the point that the transaction is submitted to where it is processed. Online trades do not execute instantaneously. For example, you might enter a buy on company Y for $21.05 a share but by the time it goes through the price might have gone up, so your order executes at $21.06 instead. A good rule of thumb is to use limit trades. This allows you to set a price and a duration that it is good for.
The ease of trading stocks online can result in owing high taxes on investments at the end of the year. The reason for this is that selling a stock that results in a profit is considered capital gain. This means the tax rate paid on that income might be higher than expected. Also, since it isn’t automatically deducted like taxes from a paycheck, the capital gains tax will need to be paid at tax time, requiring you to have enough in the bank to cover the cost.
Try to hold shares in a company for longer than one year. If the shares are sold after one year of ownership, they would be taxed at your normal tax rate on gains from investments. By selling shares under 12 months of ownership, the tax rate could be as high as 35 percent.
You should see a tax advisor if you are unsure how your investments will be taxed.
Investing More Than You Can Afford
“This company will have a nice bump, so I’ll just take next month’s rent, buy a few shares, hit the bump, sell everything, get the rent back and have the extra for myself” — something gambling addicts think to themselves and unwise investors might think. Just as with gambling don’t invest more than you can afford to lose.
Charts and Financials
Some brokerages like TD Ameritrade overload users with access to different investing resources such as advanced charting, more market information, analysis ratings, etcetera, which can all be overwhelming to those unaccustomed to advanced charting and data analysis.
Robinhood, on the other hand, offers only a standard price movement line chart, candlestick chart, and limited information on the company. They offer a gold subscription service for only 5 dollars a month that has additional information about a company, but no useful additional charting or metric features. For the beginning investor who doesn’t know they need these things, they might rely on the little they have but are then limiting themselves in making informed decisions.
As an investor I recommend downloading a few other apps with more charting information, listening to podcasts, and reading up on what you need to know to help you decide between the information overload of some services to the missing information in others.
A day trader is someone who buys and sells stock within the same day. The rules around this are relevant because if you get classified as a day trader, the amount of taxes you pay on your trades goes up. It can be easy to unintentionally get classified as a day trader since the services are now free. You do a few day trades during the week and suddenly you are a day trader. So, be sure to monitor the number of trades you do in a single day during the week.
Currently the law is if you make over four-day trades during a five-day period you will get classified as a day trader.
Options trades are easy to trade when it comes to making short-term bets on companies but also an easy way to lose a lot of money for the novice. Select a company, select options, then follow the prompts to make a trade and bet if it will go up or down. This sounds easy enough but much more than just a simple up or down impacts if your options trade will close in the money.
Options as a whole are a tricky investment. I lost 500 dollars in my first options trade when I bet a company would go up and it didn’t because I didn’t know what I was doing at the time. Before doing any options trading, I highly recommend doing some studying in advance.
Don’t Get Greedy
A common mistake that new investors make is thinking, “the company is going up, so I shouldn’t sell now, I should wait for it to go up more.” We wait, only to find it goes down instead of up. Tesla is a good example of this, Elon Musk tweeted last fall about it hitting $420 a share, and people thought it actually would. But then a bit of bad news happened and the stock never hit that $420 (with the price dropping down to $250 at this point). I’ve made this mistake with Spotify. I bought the stock shortly after the IPO at $140 a share, it went up to $190 and I was thinking I should sell it, knowing that the company was not profitable at that time, but I got greedy and was waiting for it to hit $200, which it never did. At the time of this writing, it is around the $115 range. It might still go up! It might!
At The End of The Day
There are a lot of positives with no fee investing. It allows people without a lot of money to invest in companies previously reserved for those who could afford it. But it is important to remember to be cautious, especially for a new investor. Don’t get caught in momentum or the news of the day and use other resources to research a company before deciding if it is worth adding to your portfolio.
Disclaimer: I am not a professional stock advisor. So please take any advice provided with that in mind. I am speaking based on my personal experience having begun playing the stock market in the early 2000s, and my advice is based on my successes and failures.