If you are thinking about trading stocks, you might need to consider some important points. We have put together this guide to help novice traders understand how stocks work. It may provide some ideas on how to analyse stocks and choose the ones that fit your trading approach.
Basic Facts About Stocks
When someone buys a stock (also called a share), they become owners of a small fraction of a business. Stock prices are generally determined by supply and demand: someone is always looking to buy stocks, while others are selling. To learn more general information about stocks,
Stock Market Sectors
When picking stocks for trading, you may start by deciding on the market sector. Sectors have various factors influencing their businesses. Some tend to be more affected by external factors, such as economic and political conditions. Others develop according to certain business cycles (intervals of growth followed by a decrease in economic activity).
Business Cycles
Business cycles are commonly divided into 4 stages: recession, recovery, expansion and slowdown. Each has its own characteristics and affects companies from various sectors differently.
For instance, during a recession (when economic activity is decreasing), companies from Real estate and Technology sectors show weaker results. This is because their businesses are tied to highly discretionary spending from consumers and businesses. To put it simply, people tend to save on these expenses when money is tight.
However, Consumer Staples, Utilities and Health Care usually perform better in such conditions. These sectors are called non-cyclical, as they are less affected by changes in the economy. Because people have to spend money on food and healthcare anyway, these businesses tend to do well even if the economy in general is struggling.
On the other hand, during a recovery, consumers expect economic growth and increase their discretionary spending. Businesses expand their commercial activities as well, which leads to growth in sectors like the Real Estate. But sectors that performed better during the recession — Consumer Staples, Utilities and Health Care — tend to go down as investors turn to more cyclical sectors to catch new market trends and get higher returns.
How to Use Business Cycles for Stock Trading?
It is important to understand business cycles to pick market sectors that may be performing better at the moment. And then choose stocks for trading that represent these sectors to achieve positive results.
When selecting individual stocks within a sector, it may prove useful to look at where and how each company fits in. What is its market share? Does it have some advantage over the competition? Answers to these questions may help choose stocks for trading that might provide interesting opportunities.
If you prefer trading stocks from a particular sector, it might also be useful to follow its main players and learn more about the competition. For example, have a look at this video showing price fluctuations of top video game stocks over a 5-year period. It offers an overview of how stock prices of different companies in this sector changed over the years. It may provide ideas on how this sector might be developing in the future.
Each sector develops in its own unique way. So it may be wise to analyse them separately and consider factors that influence them to choose stocks for trading.
Types of Stocks
There are different types of stocks that you may choose for trading. Here is a brief overview of the main ones.
- Based on market capitalization (the total worth of all their shares):
- Type Market Capitalization
- Large-cap companies $10 billion to $200 billion
- Mid-cap companies $2 billion to $10 billion
- Small-cap companies $300 million to $2 billion
- Based on growth potential:
- TypeCharacteristics
- Value stock Successful companies, usually leaders in their sector. They do not grow as fast (if at all), but maintain more stable stock prices. These stocks might be a good choice for long-term investment.
- Growth stock Companies with fast rising profits that are developing quickly. They might provide higher returns, but also carry more risks. Constant growth is their main strength, so if it slows down, stock prices may drop. As these stocks are more volatile and tend to fluctuate, they may offer more interesting opportunities for traders.
- Based on the perceived stock quality:
- Type Characteristics
- Blue-chip stocks Large companies – leaders in their sectors. They can generally provide a sense of stability and lower risks for investors. May be less interesting for short-term traders.
- Penny stocks Smaller companies with considerably inexpensive stocks, often less than $1 per share. They tend to be affected by many external factors, so prices might often fluctuate. This may be attractive for traders, but also carries potential risks.
Diversification – having a portfolio that consists of assets from different sectors and various stock types – might be an idea to consider. This approach may help to manage risks in a changing market, when some sectors perform better than others. In any case, make sure you carefully weigh all the risks before making trading decisions.
How to Choose Stocks?
Learn Asset Analysis
Fundamental Analysis of Stocks
Technical Analysis of Stocks
Choose your broker
Make a Trading Plan
- Your budget: how much money are you willing to put in?
- Trading schedule: when do you trade? How often do you check your deals?
- Your risk tolerance: when do you close your deals? How long do you keep losing trades open?
- Your trading method: do you open and close all deals within one day? Or do you keep them open until the trend changes? How many trades do you open per day?
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