Getting started in stock trading can be difficult. Below is a low-down on what stock trading is, how it is done, and why people engage in trading stocks.
When people talk about the Australian stock market or shares, they usually refer to the Australian Securities Exchange (ASX). The ASX is where shares in Australian companies are traded between investors. It is similar to America’s Nasdaq or the New York Stock Exchange.
Most people trade through a broker, who they pay to buy and sell shares. Shares can be bought and sold either online or over the phone.
Two types of trading on the ASX
- On-market: this is done through a stockbroker, and all orders are placed through the ASX. Most people trade shares on-market.
- Off-market: this is direct between two investors, and no stockbroker or intermediary is involved. This type of transaction is usually only used by sophisticated investors or large institutional investors.
When you buy shares, you become a shareholder in that company. As a shareholder, you have certain rights, including the right to vote at shareholders’ meetings and receive dividends (a share of the company’s profits). Most people who invest in shares do so for one of two reasons: to make a profit by selling their shares later at a higher price or receiving regular income through dividends.
Two main ways to make money from shares
Capital gains happen when you sell your shares for more than you paid for them. To make a capital gain, you first need to buy shares (we call this going long). When you sell the shares, this is called closing your position.
If the share price has gone up since you bought them, you’ve made a capital gain. For example, let’s say you buy 100 shares in Company XYZ at $5 each. The total cost of your investment is $500 ($5 x 100). Company XYZ does well, and the share price goes up to $7. You sell your shares and receive $700 ($7 x 100). Your capital gain is $200.
Dividends are paid out of a company’s profits to shareholders. They provide you with regular income, even if the share price doesn’t rise.
Company XYZ pays a fully franked dividend of 10 cents per share. If you own 1,000 shares, you’ll receive a dividend of $100 (1,000 x 10 cents). A fully franked dividend means that the company has already paid tax on the profit that it’s distributing to shareholders.
If you have shares in an Australian company, you may be entitled to other benefits such as rights to new shares (rights issues) or the ability to convert your shares into other securities.
It’s important to remember that shares can go down and up in value, so you could lose money if you sell them for less than you paid. Before investing in shares, make sure you understand the risks involved.
Two primary types of risk when it comes to investing in shares
- Market risk: this is the risk that share prices will go down, either in general or for a particular company or sector.
- Company-specific risk: this is the risk that a particular company will underperform or even go bankrupt. You can minimise this risk by diversifying your portfolio across several companies and sectors.
Why trade stocks?
There are many reasons people trade stocks. Some people trade to make money from the short-term price movements, while others trade to build a long-term investment portfolio.
People also trade stocks for different reasons. Some people trade to make money from the short-term price movements, while others trade to build a long-term investment portfolio.
Some common reasons people trade stocks include:
- To make money from the short-term price movements. This is known as speculative trading.
- To hedge against downside risk. This is when you buy shares in a company that you think will do well even if the overall market falls.
- To diversify your portfolio. This is when you spread your investments across several different companies and sectors to reduce your overall risk.
- To get regular income. This is when you invest in shares that pay regular dividends.
- To invest for the long term. This is when you buy shares in a company that you think will do well over the next few years or even decades.
- To trade on margin. This is when you use borrowed money to buy shares. It can be a high-risk strategy as you could lose more money than you invest if the share price falls.
See here how stock trading works and the type of stocks you can trade in Australia.