In today's electronic world, it's estimated that over 200 securities firms now offer clients the ability to invest online. Times are changing, and investing over the Internet represents a dramatic transformation in the relationship between the broker and their clients.
As with all forms of investing, an educated individual has a better chance to make the correct choice and avoid a costly mistake. The objective of this article is to help beginners to understand what to look out before opening an online account with a broker.
What's Different with Online Investing?
There are three factors beginners need to understand when it comes to online investing: trade execution, researching stocks, and a quick primer on the most fascinating form of online trading: day trading.
Online Stock Trades
Whether an individual has worked with a traditional brokerage house in the past, or is a beginner that's ready to start investing, perhaps the single most important factor they need to understand is how to trade stocks. There are four basic ways to buy or sell stocks: market orders, limit orders, stop orders, and stop limits.
Market Orders
A market order is the fastest way to buy or sell a stock online. Placing a market order tells the broker to sell or buy a stock at the prevailing market price.
With a market order, the broker is guaranteeing the execution of an order. The order does not guarantee anything other than the trade occurring at the prevailing market price. With state-of-the-art computers supporting the online investment community, a market order is executed nearly instantaneously.
Limit Orders
A limit order is a request to buy or sell a stock at the price specified. There is no guarantee that the buy or sell order will ever be executed. If the order is executed, the trade will occur at the price specified, or better.
Investors place limit orders when they can afford to wait for a stock's price to rise or fall, or when an investor believes a stock's price will increase or decrease to their financial advantage.
Sell orders will execute at a price that is at or above the order limit, while buy orders will occur when the price is at or below the order limit.
Stop Orders
A stop order is a request to buy or sell a stock at the prevailing market price, but only after a stock trades past the stop price. Once a stock's price moves past this point, the stop order becomes a market order.
Investors will place a stop order to protect a profit, or limit a loss, on a stock that they already own.
Stop Limit Orders
A stop limit order is a combination of a limit order and a stop order. A stop limit order is used to protect an investor's profit or limit their loss. Once a stock moves past the stop price, a limit order is placed. At this point, the rules of a limit order are in effect, meaning the investor is guaranteed the limit price, but not the execution of the stock trade.
Anyone that's invested through a traditional broker in the past will probably recognize all of the terms just discussed. A beginner that thinks there is more to trading stocks online than was just discussed is going to be disappointed or pleasantly surprised.
Day Trading
The practice of day trading takes online investing to the extreme. The speed of information and computers today allow day traders to rapidly change investments, and conduct a large number of transactions in a given day.
Day traders typically adopt the strategy of buying and selling stocks throughout the day with the hope that price momentum will result in profits. They stare at computer screens all day long searching for a stock that is moving quickly in one direction. Their investment in a stock may only last minutes as they attempt to close out a position before a stock's price reverses itself.
Anyone thinking about investing, and eventually becoming a day trader, needs to be prepared to suffer financial losses. In fact, most day traders never graduate to profit-making status because the learning process can be such a painful financial experience.
Traditional investors that carefully research stocks believe day traders are more like gamblers. The "rush" of day trading can be addicting. Never take out a second mortgage, or risk losing retirement funds, just for the thrill of a stock trade. If making money was that easy, everyone would be doing it.
Researching Stocks Online
Perhaps one of the most useful tools available to investors is the ability to thoroughly research stocks before buying or selling shares. Yahoo! Finance, Google Finance and nearly all online brokers provide investors with information that can be used to assess the financial health of the stocks they're evaluating. Our current favorite is Microsoft's Money Central.
In fact, we have an entire series dedicated to the topic of researching stocks that mimics the approach taken by Microsoft. Reviewing this information can be extremely valuable before making an investment of any kind:
While investing online makes it convenient to purchase and sell a stock, that's not a good reason to skip research. In fact, conducting additional stock research is a good use of the time saved because of the availability of information online.
Investing Tips
Finally, here is a short list of tips that can help make the investing experience more satisfying:
Obtain information from the broker substantiating all marketing claims of trading speed. Make sure the real trading speed is aligned with the advertised speed.
Determine if the data seen are delayed or near real time stock quotes.
Understand the process for entering or canceling an online stock order (limit or stop loss).
Review the process that occurs if the broker's website experiences an interruption, and it's no longer possible to place an order online. Even if the broker claims to have redundancy for their website, an ISP could also break the connection to the Internet. Understand the backup process.
Keep all customer service telephone numbers handy in case assistance is needed during the learning process.
Investing online was meant to streamline the trading process and empower the investor. However, the technology has also spawned innovative ways of investing such as day trading, which is not always a positive experience. As speeds increase and technology continues to improve, the future holds even more promising services for those that wish to leverage technology to help them with their investments.
Additional Resources
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